<PAGE>
REGISTRATION NO. 333-40551
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 4
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
DISCOVERY ZONE, INC.
(Exact name of Registrant as specified in its charter)
--------------------------
<TABLE>
<S> <C> <C>
DELAWARE 7990 36-3877601
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification No.)
</TABLE>
------------------------
565 TAXTER ROAD
FIFTH FLOOR
ELMSFORD, NEW YORK 10523
(914) 345-4500
ATTENTION: ANDREW M. SMITH, ESQ.
(Registrant's Address)
--------------------------
SUBSIDIARY GUARANTOR REGISTRANTS
<TABLE>
<CAPTION>
EXACT NAME OF ADDRESS PRIMARY STANDARD I.R.S.
SUBSIDIARY GUARANTOR AND STATE OR INDUSTRIAL EMPLOYER
REGISTRANT AS TELEPHONE JURISDICTION OF CLASSIFICATION IDENTIFICATION
SPECIFIED IN ITS CHARTER NUMBER INCORPORATION CODE NUMBER NUMBER
- ------------------------------------------ -------------------------- ------------------ --------------------- -----------------
<S> <C> <C> <C> <C>
Discovery Zone (Canada) Limited........... c/o Discovery Zone, Inc. Canada 7990 NONE
565 Taxter Road, Fifth APPLICABLE
Floor
Elmsford, New York 10523
(914) 345-4500
Discovery Zone (Puerto Rico), Inc......... c/o Discovery Zone, Inc. Puerto Rico 7990 36-3892589
565 Taxter Road, Fifth
Floor
Elmsford, New York 10523
(914) 345-4500
Discovery Zone (Nevada) Licensing, Inc.... c/o Discovery Zone, Inc. Nevada 7990 NONE
565 Taxter Road, Fifth APPLICABLE
Floor
Elmsford, New York 10523
(914) 345-4500
</TABLE>
COPIES TO:
STEPHEN T. GIOVE, ESQ.
SHEARMAN & STERLING
599 LEXINGTON AVENUE
NEW YORK, NEW YORK 10022
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
CROSS-REFERENCE SHEET
LOCATION IN PROSPECTUS OF INFORMATION
REQUIRED BY PART I OF FORM S-4
<TABLE>
<CAPTION>
ITEM NO. CAPTION LOCATION IN PROSPECTUS
- --------- -------------------------------------------------- --------------------------------------------------
<S> <C> <C>
Item 1 Forepart of Registration Statement and Outside
Front Cover Page of Prospectus.................... Facing Page of Registration Statement;
Cross-Reference Sheet; Outside Front Cover Page
Item 2 Inside Front and Outside Back Cover Pages of
Prospectus........................................ Inside Front Cover Page; "Available Information";
Outside Back Cover Page
Item 3 Risk Factors, Ratio of Earnings to Fixed Charges
and Other Information............................. "Summary"; "Risk Factors"; "Selected Historical
Financial Data"; "Financial Statements"
Item 4 Terms of the Transaction.......................... "Summary"; "The Exchange Offer"; "Description of
Exchange Notes"; "Certain U.S. Federal Income Tax
Considerations"
Item 5 Financial Information............................. "Selected Historical Financial Data"
Item 6 Material Contracts with the Company Being
Acquired.......................................... Not applicable
Item 7 Additional Information Required for Reoffering by
Persons and Parties Deemed to Be Underwriters..... Not applicable
Item 8 Interests of Named Experts and Counsel............ "Legal Matters"
Item 9 Disclosure of Commission Position on
Indemnification for Securities Act Liabilities.... Not applicable
Item 10 Information with Respect to S-3 Companies......... Not applicable
Item 11 Incorporation of Certain Information by
Reference......................................... Not applicable
Item 12 Information with Respect to S-2 or S-3
Registrants....................................... Not applicable
Item 13 Incorporation of Certain Information by
Reference......................................... Not applicable
Item 14 Information with Respect to Registrants Other Than
S-2 or S-3 Registrants............................ "Summary"; "Selected Historical Financial Data";
"Management's Discussion and Analysis of Financial
Condition and Results of Operations"; "Business";
"Certain U.S. Federal Income Tax Considerations";
"Financial Statements"
Item 15 Information with Respect to S-3 Companies......... Not applicable
Item 16 Information with Respect to S-2 or S-3
Companies......................................... Not applicable
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ITEM NO. CAPTION LOCATION IN PROSPECTUS
- --------- -------------------------------------------------- --------------------------------------------------
<S> <C> <C>
Item 17 Information with Respect to Companies Other Than
S-2 or S-3 Companies.............................. "Summary"; "Selected Historical Financial Data";
"Management's Discussion and Analysis of Financial
Condition and Results of Operations"; "Business";
"Certain U.S. Federal Income Tax Considerations";
"Financial Statements"
Item 18 Information if Proxies, Consents or Authorizations
Are to Be Solicited............................... Not applicable
Item 19 Information if Proxies, Consents or Authorizations
Are Not to Be Solicited in an Exchange Offer...... "Exchange Offer"; "Management"; "Principal
Stockholders"
</TABLE>
<PAGE>
OFFER TO EXCHANGE
13 1/2% SENIOR SECURED NOTES DUE 2002
FOR ALL OUTSTANDING
13 1/2% SENIOR SECURED NOTES DUE 2002
($85,000,000 PRINCIPAL AMOUNT OUTSTANDING)
OF
DISCOVERY ZONE, INC.
(INCORPORATED IN THE STATE OF DELAWARE)
------------------------
THE EXCHANGE OFFER
WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME,
ON FEBRUARY 27, 1998, UNLESS EXTENDED
------------------------
Discovery Zone, Inc., a Delaware corporation ("DZ" or the "Company"), hereby
offers, upon the terms and subject to the conditions set forth in this
Prospectus and the accompanying Letter of Transmittal, to exchange $85,000,000
aggregate principal amount of its 13 1/2% Senior Secured Notes due 2002 (the
"Exchange Notes"), which have been registered under the Securities Act of 1933,
as amended (the "Securities Act"), pursuant to a Registration Statement (as
defined herein) of which this Prospectus constitutes a part, for $85,000,000
aggregate principal amount of the outstanding 13 1/2% Senior Secured Notes due
2002 (the "Private Notes") of the Company (the "Exchange Offer"). The Exchange
Notes and the Private Notes are collectively referred to herein as the "Notes."
The Company will accept for exchange any and all Private Notes that are
validly tendered on or prior to 5:00 p.m., New York City time, on the date the
Exchange Offer expires, which will be February 27, 1998 unless the Exchange
Offer is extended (the "Expiration Date"). In the event that the Exchange Offer
is extended, it will remain in effect for a maximum of 90 business days,
including all extensions. Tenders of Private Notes may be withdrawn at any time
prior to 5:00 p.m., New York City time, on the Expiration Date. The Exchange
Offer is not conditioned upon any minimum principal amount of Private Notes
being tendered for exchange. However, the Exchange Offer is subject to certain
conditions which may be waived by the Company and to the terms and provisions of
the Registration Rights Agreement (as defined herein). See "The Exchange Offer."
The Company has agreed to pay the expenses of the Exchange Offer.
<PAGE>
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION") OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
THE DATE OF THIS PROSPECTUS IS JANUARY 30, 1998.
<PAGE>
The Exchange Notes will be obligations of the Company entitled to the
benefits of the Indenture (as defined herein). The form and terms of the
Exchange Notes are identical in all material respects to the form and terms of
the Private Notes, except that the Exchange Notes, having been registered under
the Securities Act, will not contain terms with respect to transfer
restrictions. In addition, following the completion of the Exchange Offer, none
of the Notes will be entitled to the benefits of the Registration Rights
Agreement relating to contingent increases in the interest rates provided for
pursuant thereto. See "The Exchange Offer."
SEE "RISK FACTORS" COMMENCING ON PAGE 19 FOR A DISCUSSION OF CERTAIN
INFORMATION THAT SHOULD BE CONSIDERED PRIOR TO AN INVESTMENT IN THE EXCHANGE
NOTES.
The Exchange Notes will mature on August 1, 2002. Interest on the Exchange
Notes is payable in cash quarterly in arrears on each February 1, May 1, August
1 and November 1, commencing February 1, 1998, and shall accrue at a rate of
13 1/2% per annum from the last Interest Payment Date (as defined herein) on
which interest was paid on the Private Notes so surrendered. Interest on the
Private Notes has accrued from July 22, 1997 also at a rate of 13 1/2% per
annum. Interest on each Private Note accepted for exchange will cease to accrue
upon issuance of a corresponding Exchange Note. A portion of the net proceeds of
the offering of the Private Notes was used to fund the Escrowed Interest Account
(as defined herein) from which the Company shall pay the scheduled interest
payments on the Exchange Notes through August 1, 1999.
The Exchange Notes will be redeemable, at the option of the Company, in
whole or in part, at any time on or after August 1, 1999, at the redemption
prices set forth herein, plus accrued and unpaid interest, if any, to the date
of redemption. In addition, prior to August 1, 1999, the Company may redeem up
to 35% of the original principal amount of the Exchange Notes with the proceeds
of one or more offerings (each, a "Primary Offering") of Capital Stock (other
than Disqualified Stock) (each as defined herein) at 115% of the principal
amount thereof, plus accrued and unpaid interest, if any, to the date of
repurchase; PROVIDED, HOWEVER, that any such Primary Offering results in net
proceeds to the Company of at least $20.0 million. Upon a Change of Control (as
defined herein), the Company is required to offer to repurchase all of the then
outstanding Exchange Notes at 101% of the principal amount thereof, plus accrued
and unpaid interest, if any, to the date of repurchase.
The Exchange Notes will be senior secured indebtedness of the Company and
will rank senior in right of payment to all subordinated indebtedness of the
Company and pari passu in right of payment with all unsubordinated indebtedness
of the Company. The Exchange Notes will be guaranteed on a full, unconditional,
and joint and several senior secured basis by each of the Company's current and
future Subsidiaries (as defined herein) other than Block Party and the Limited
Investment Subsidiaries (each as defined herein). The Company has no Limited
Investment Subsidiaries and the operations of Block Party are inconsequential to
the results of operations of the Company taken as a whole. Because all of the
Subsidiary Guarantors will guarantee the Company's obligations under the
Exchange Notes on a full, unconditional, and joint and several basis, the
Company has not included separate financial statements with respect to the
Subsidiary Guarantors in this Prospectus. The Exchange Notes will be initially
secured by a first priority security interest in certain assets of the Company
(including cash, accounts receivable, inventory, equipment, general intangibles,
intellectual property rights and certain other fixed assets (except real estate
leasehold interests existing prior to the offering of the Private Notes and
certain real property, fixtures and leasehold improvements)) and by a pledge of
the capital stock of all current and future Subsidiaries. The Exchange Notes
will also be secured by a first priority mortgage lien on certain leasehold
interests acquired by the Company in new store properties after the offering of
the Private Notes (subject to certain conditions) and by a subordinate lien on
certain of the Company's real property and improvements thereon. The Company
will be permitted under certain circumstances to enter into a new credit
facility (in a principal amount not to exceed $10.0 million), in which case the
first priority security interest in certain collateral securing the Exchange
Notes will be subordinated to a lien securing such credit facility.
2
<PAGE>
The exchange of the Private Notes for the Exchange Notes will be made
pursuant to the Exchange Offer and in accordance with the Indenture.
The Private Notes were initially represented by one or more global Private
Notes (the "Old Global Note") in registered form, registered in the name of Cede
& Co., as nominee for The Depositary Trust Company (the "DTC"), as depositary.
The Private Notes sold to Institutional Accredited Investors who are not
Qualified Institutional Buyers (as defined in Rule 144A of the Securities Act)
were issued in certificated, fully registered form without interest coupons and
were registered in the name of such Institutional Accredited Investors or their
nominees. The Exchange Notes exchanged for Private Notes will be represented,
respectively, by one or more global Exchange Notes (the "New Global Note") in
registered form, registered in the name of a nominee of DTC. Except in limited
circumstances, Exchange Notes in certificated form will not be issued in
exchange for beneficial interests in a New Global Note. See "Description of
Exchange Notes -- New Certificated Notes."
Based on no-action letters issued by the staff of the Commission to third
parties, the Company believes the Exchange Notes issued pursuant to the Exchange
Offer in exchange for Private Notes may be offered for resale, resold and
otherwise transferred by a holder thereof (other than (i) a broker-dealer that
purchased such Private Notes directly from the Company to resell pursuant to
Rule 144A or any other available exemption under the Securities Act or (ii) a
person that is an "affiliate" of the Company within the meaning of Rule 405 of
the Securities Act) without compliance with the registration and prospectus
delivery provisions of the Securities Act; PROVIDED that the holder acquires
such Exchange Notes in the ordinary course of its business and is not
participating, and has no arrangement or understanding with any person to
participate, in the distribution of the Exchange Notes. Holders of Private Notes
wishing to accept the Exchange Offer must represent to the Company that such
conditions have been met. In the event that the Company's belief is inaccurate,
holders of Exchange Notes who transfer Exchange Notes in violation of the
prospectus delivery provisions of the Securities Act and without exemption from
registration thereunder may incur liability under the Securities Act. The
Company does not assume or indemnify holders against such liability.
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. The Letter of Transmittal
states that, by so acknowledging and by delivering a prospectus, a broker-dealer
will not be deemed to admit that it is an "underwriter" within the meaning of
the Securities Act. This Prospectus, as it may be amended or supplemented from
time to time, may be used by a broker-dealer in connection with resales of
Exchange Notes received in exchange for Private Notes where such Private Notes
were acquired by such broker-dealer as a result of market-making activities or
other trading activities. For a period of 180 days after the Expiration Date, or
such shorter period which will terminate when such broker-dealers have completed
all resales subject to applicable prospectus delivery requirements, the Company
has agreed that it will make this Prospectus available to any broker-dealer for
use in connection with any such resale. See "Plan of Distribution."
The Company believes that none of the registered holders of the Private
Notes is an affiliate (as such term is defined in Rule 405 under the Securities
Act) of the Company.
The Private Notes have been designated eligible for trading in the Private
Initial Offerings, Resales and Trading through Automated Linkages ("PORTAL")
Market of the National Association of Securities Dealers (the "NASD"). The
Company does not intend to apply for listing of the Exchange Notes on any
securities exchange or to seek approval through any automated quotation system.
There can be no assurance regarding the future development of a market for the
Exchange Notes, or the ability of holders of the Exchange Notes to sell their
Exchange Notes or the price at which such holders may be able to sell their
Exchange Notes. If such a market were to develop, the Exchange Notes could trade
at prices that may be higher or lower than the initial public offering price
depending on many factors, including prevailing
3
<PAGE>
interest rates, the Company's operating results and the market for similar
securities. See "Risk Factors -- Absence of Public Market."
Holders of Private Notes whose Private Notes are not tendered and accepted
in the Exchange Offer will continue to hold such Private Notes and will be
entitled to all the rights and preferences and will be subject to the
limitations applicable thereto under the Indenture. Following consummation of
the Exchange Offer, the holders of Private Notes will continue to be subject to
existing restrictions upon transfer thereof and the Company will have no further
obligation to such holders to provide for the registration under the Securities
Act of the Private Notes held by them.
The Company will not receive any proceeds from, and has agreed to bear all
registration expenses of, the Exchange Offer. No dealer-manager is being used in
connection with the Exchange Offer. See "The Exchange Offer -- Resale of the
Exchange Notes."
THE COMPANY IS NOT ASKING FOR A PROXY AND THE HOLDERS OF THE PRIVATE NOTES
ARE REQUESTED NOT TO SEND THE COMPANY A PROXY.
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF PRIVATE NOTES IN ANY JURISDICTION IN
WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION. NEITHER THE DELIVERY
OF THIS PROSPECTUS NOR ANY EXCHANGE MADE PURSUANT HERETO SHALL UNDER ANY
CIRCUMSTANCES IMPLY THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
OR THAT THE INFORMATION SET FORTH HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO
THE DATE HEREOF.
NOTICE TO NEW HAMPSHIRE RESIDENTS: NEITHER THE FACT THAT A REGISTRATION
STATEMENT OR AN APPLICATION FOR A LICENSE HAS BEEN FILED UNDER CHAPTER 421-B
WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT THAT A SECURITY IS EFFECTIVELY
REGISTERED OR A PERSON IS LICENSED IN THE STATE OF NEW HAMPSHIRE CONSTITUTES A
FINDING BY THE SECRETARY OF STATE THAT ANY DOCUMENT FILED UNDER RSA 421-B IS
TRUE, COMPLETE AND NOT MISLEADING. NEITHER ANY SUCH FACT NOR THE FACT THAT AN
EXEMPTION OR EXCEPTION IS AVAILABLE FOR A SECURITY OR A TRANSACTION MEANS THAT
THE SECRETARY OF STATE HAS PASSED IN ANY WAY UPON THE MERITS OR QUALIFICATIONS
OF, OR RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON, SECURITY OR TRANSACTION. IT
IS UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER
OR CLIENT ANY REPRESENTATION INCONSISTENT WITH THE PROVISIONS OF THIS PARAGRAPH.
4
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (including all amendments thereto, the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
Exchange Notes offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto, certain portions of which have been omitted pursuant to the
rules and regulations of the Commission. Statements made in this Prospectus as
to the contents of any contract, agreement or other document are not necessarily
complete. With respect to each such contract, agreement or other document filed
as an exhibit to the Registration Statement, reference is made to such exhibit
for a more complete description of the matter involved, and each such statement
is qualified in its entirety by such reference.
The Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith is required to file reports and other
information with the Commission. The Registration Statement (with exhibits), as
well as such reports and other information, when so filed, can be inspected and
copied at the public reference facilities maintained by the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549; and at the regional offices of the
Commission at 7 World Trade Center, 13th Floor, New York, New York 10048; and at
500 West Madison Street, Chicago, Illinois 60661. Copies of such material may be
obtained from the Public Reference Section of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, at prescribed rates. The Commission maintains a
website on the Internet at http://www.sec.gov that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission.
------------------------
REFERENCES MADE IN THIS PROSPECTUS TO "DISCOVERY ZONE, INC.," "DZ" AND THE
COMPANY'S LOGO, REFER TO REGISTERED TRADEMARKS AND SERVICE MARKS OWNED BY THE
COMPANY. REFERENCES MADE IN THIS PROSPECTUS TO "PEPSI-COLA COMPANY" AND "PEPSI"
REFER TO REGISTERED TRADEMARKS OF THE PEPSI-COLA COMPANY. REFERENCES MADE IN
THIS PROSPECTUS TO "PIZZA HUT, INC." AND "PIZZA HUT" REFER TO REGISTERED
TRADEMARKS AND SERVICE MARKS OF TRICON GLOBAL RESTAURANTS, INC. REFERENCES MADE
TO "PLAYORENA" AND "GYMBOREE" REFER TO THE REGISTERED TRADEMARKS AND SERVICE
MARKS OF EDUPLAY CORPORATION AND THE GYMBOREE CORPORATION, RESPECTIVELY.
5
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS,
INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. AS USED IN
THIS PROSPECTUS, UNLESS THE CONTEXT OTHERWISE REQUIRES, REFERENCES TO THE
"COMPANY" OR "DZ" MEAN, COLLECTIVELY, DISCOVERY ZONE, INC. AND ITS CONSOLIDATED
SUBSIDIARIES. REFERENCES TO ANY HISTORICAL FISCAL YEAR REFER TO THE TWELVE
MONTHS ENDING ON DECEMBER 31 OF SUCH YEAR. THIS PROSPECTUS CONTAINS FORWARD
LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED IN THOSE FORWARD
LOOKING STATEMENTS AS A RESULT OF NUMEROUS FACTORS, INCLUDING THOSE SET FORTH
UNDER RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS.
THE COMPANY
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 206 FunCenters in 39 states, Canada and Puerto Rico targeted at children ages
two to 12. The Company also operates two Block Party entertainment centers,
which target adult customers (the "Block Party Stores"). The Company emerged
from protection under Chapter 11 of the U.S. Bankruptcy Code ("Chapter 11") on
July 29, 1997 (the "Effective Date") and, in connection therewith, was acquired
by an affiliate of Wellspring Associates L.L.C. (together with its affiliates,
"Wellspring").
The Company's FunCenters are designed to offer children a unique
entertainment experience while meeting their parents' needs for value and
convenience. FunCenters are generally located in strip shopping centers and, to
a lesser extent, in shopping malls, and currently include the following
features: (i) "soft play" zones consisting of a series of tubes, slides, ball
bins, climbing mountains, air and water 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 believes it is well positioned to capitalize on a variety of
favorable demographics in its customer base, including projected growth over the
next fifteen years in the population of children under the age of 13, which
management expects will lead to increased spending on children's leisure
activities. Management estimates that in 1996 DZ hosted approximately 21 million
visits by children and adults in the 206 FunCenters.
NEW OWNERSHIP AND MANAGEMENT
Wellspring is a private investment firm focused on identifying, acquiring
and turning around underperforming companies. Wellspring has recruited a new
senior management team at DZ led by Scott W. Bernstein, who joined Wellspring in
June 1996 as an industry consultant and became President and Chief Executive
Officer of the Company in December 1996. Mr. Bernstein has extensive experience
in the family entertainment business, having 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. In addition to Mr. Bernstein, the
Company has hired several other senior managers with backgrounds in the
entertainment industry and consumer marketing.
Wellspring and the new management team believe that the Company has not
historically fulfilled its potential. The Company was established in 1989 and,
in order to capitalize on significant market demand for its FunCenter concept,
expanded from 28 locations in 1991 to 336 locations by the end of 1995. As a
result of the Company's leading market position, widespread consumer acceptance
of the FunCenter concept and strong industry growth dynamics, the Company
achieved a peak equity market capitalization of approximately $1.3 billion in
September 1993. However, in its rush to accelerate revenue growth, the Company
incurred substantial indebtedness, entered into many above-market leases, opened
and acquired
6
<PAGE>
stores that diverted sales from existing sites, acquired stores without
demonstrated market penetration and failed to update its product. The Company's
rapid expansion resulted in a loss of control over costs and quality at the
store and corporate levels, which diminished the level of customer service,
reduced store operating margins and caused selling, general and administrative
expenses to increase dramatically.
Wellspring and the new management team developed a new business strategy
which is reflected in the turnaround plan described below (the "Turnaround
Plan"). The Turnaround Plan seeks to: (i) restore the Company's core business
through continued expense reductions; (ii) revitalize and reposition the DZ
brand name through new in-store programs and additional entertainment
activities, combined with a refocused marketing strategy; and (iii) manage the
Company's growth through controlled development of new FunCenters.
BUSINESS STRATEGY AND TURNAROUND PLAN
The Company has begun to implement the Turnaround Plan, which is designed to
reduce costs, enhance core product offerings and reposition the Company from an
operator of indoor playgrounds to the leading national provider of high quality
children's indoor entertainment. Management believes that these initiatives will
increase attendance, in-store spending and operating cash flow although there
can be no assurance that this will happen. See "Risk Factors". The Company's
business strategy is being implemented in the following three phases:
PHASE 1--RESTORE CORE BUSINESS. The Company has implemented a broad cost
reduction program that includes four key components: (i) the closing of
unprofitable FunCenters during the reorganization under Chapter 11; (ii) the
elimination of excessive selling, general and administrative expenses; (iii)
the implementation of a variety of financial and quality controls designed
to significantly improve operating margins at the FunCenter level; and (iv)
the establishment of a broad-based incentive compensation plan at the store
and regional management levels tied to EBITDA (as defined herein) at the
store level and service quality measures.
PHASE 2--IMPROVE PRODUCT AND REPOSITION/RELAUNCH DZ BRAND. To increase
attendance and in-store spending, management is currently implementing
programs designed to upgrade and expand the range of core entertainment
products offered at FunCenters and to reposition and relaunch the DZ brand
through a comprehensive new marketing strategy. These goals are expected to
be accomplished primarily through: (i) adding a variety of new entertainment
activities and attractions; (ii) improving the quality and consistency of
the Company's existing core soft-play products, food and beverage operations
and game zones; (iii) increasing the appeal of the Company's food operations
through conversion to the widely recognized Pizza Hut brand; (iv)
developing, both internally and through strategic alliances with content
providers, periodic theme-based entertainment experiences to complement the
Company's entertainment activities; and (v) introducing interactive
parent-child play programs for preschoolers during the off-peak weekday
period.
The Company has already taken a number of steps to improve the quality
and variety of its product offerings and revitalize the brand:
- An important part of the Company's Turnaround Plan is to renovate
substantially all of its FunCenters, to broaden their entertainment
offerings and upgrade their facilities. The Company expects to have
approximately 60% of the FunCenters renovated by the end of January 1998,
including the addition of designated areas for laser tag, arts and crafts,
stage events and promotional activities.
- 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, to provide joint promotions and increase the
appeal and quality of its food service. Approximately 80% of its
7
<PAGE>
FunCenters are expected to be converted to permit the sale of Pizza Hut
menu items by the end of January 1998.
- Due to DZ's national market presence and the strength of its brand name,
the Company believes that it is well positioned to act as a platform for
future promotional and product "tie-ins" with children's entertainment and
consumer product companies. The Company believes such alliances will
provide significant competitive advantages in the form of marketing
support and theme-based promotions to periodically refresh its product
offerings and stimulate repeat customer visits on a cost-effective basis.
In keeping with this strategy, the Company has begun negotiations with a
number of possible promotional partners, including toy, television, film,
media and consumer product companies and, to date, has entered into
arrangements with Hasbro, Sony Entertainment, New Line Cinema, the Hearst
Corporation, Worldwide Wrestling Federation and the Nabisco Foods Group
for a variety of promotional programs and activities.
- As part of its strategy to develop its weekday business, the Company
entered into an agreement in April 1997 with a co-creator of the Gymboree
program and the creators of Playorena to develop a structured toddler play
program for DZ to better utilize its facilities during off-peak weekday
periods. Twenty-five FunCenters began offering these new weekday programs
in September 1997 and twenty-seven additional FunCenters began offering
these programs in January 1998.
PHASE 3--GROWTH. Upon the restoration of DZ's core business and the
repositioning of its brand, management expects to commence a controlled
expansion program to develop new FunCenter locations.
PLAN OF REORGANIZATION AND EXIT FINANCING
In November 1996, the Company and Wellspring filed a Joint Plan of
Reorganization (the "Plan") with the U.S. Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court") 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 in each class and confirmed by the Bankruptcy Court. The Plan became
effective and the Company emerged from bankruptcy on the Effective Date.
The Plan provided, among other things, 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
pre-petition liabilities subject to compromise (excluding taxes payable, lease
assumption payments and certain other pre-petition liabilities permitted under
the Plan) to equity interests in the Company, and (iii) cancellation of all of
the pre-petition equity interests in the Company, all as more fully described in
the Plan.
In connection with its emergence from bankruptcy, the Company raised $100
million by issuing $15 million of convertible redeemable preferred stock (the
"Convertible Preferred Stock") and $85 million aggregate principal amount of the
Private Notes with warrants (the "Unit Warrants") to purchase 805,154 shares of
Common Stock (the "Warrant Shares"), resulting in $93.8 million of net proceeds
to the Company after deducting selling commissions and estimated fees and
expenses. Of those net proceeds, the Company used (i) approximately $21.6
million to purchase a portfolio of Pledged Securities, consisting of U.S.
Treasury Securities, that were pledged as security for the scheduled interest
payments on the Notes through August 1, 1999 and (ii) approximately $45.5
million to repay all outstanding borrowings under the DIP Facilities and pay
certain other bankruptcy-related claims and expenses. The remaining net proceeds
of approximately $26.7 million will be used to finance capital expenditures, for
working capital and for general corporate purposes. See "Company Background" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
8
<PAGE>
SUMMARY OF TERMS OF EXCHANGE OFFER
On July 22, 1997, the Company issued $85 million principal amount of Private
Notes pursuant to exemptions from, or in transactions not subject to, the
registration requirements of the Securities Act and applicable state securities
laws. The Exchange Offer relates to the exchange of $85 million aggregate
principal amount of Exchange Notes for an equal aggregate principal amount of
Private Notes. The Exchange Notes will be obligations of the Company entitled to
the benefits of the Indenture relating to the Private Notes. The form and terms
of the Exchange Notes are the same as the form and terms of the Private Notes,
except that the Exchange Notes, having been registered under the Securities Act,
(i) will not contain terms with respect to transfer restrictions and (ii) will
not bear legends restricting their transfer. In addition, following completion
of the Exchange Offer, none of the Exchange Notes will be entitled to the
benefits of the Registration Rights Agreement (as defined herein) relating to
certain contingent increases in the interest rates provided pursuant thereto.
See "The Exchange Offer."
<TABLE>
<S> <C>
THE EXCHANGE OFFER.............. Pursuant to the Exchange Offer, up to $85 million
aggregate principal amount of Exchange Notes will be
issued in exchange for up to $85 million principal amount
of Private Notes validly tendered pursuant to the Exchange
Offer. As of the date hereof, $85 million in aggregate
principal amount of Private Notes are outstanding. The
Company will issue the Exchange Notes to tendering holders
of Private Notes on or promptly after the Expiration Date.
The terms of the Exchange Notes and the Private Notes are
identical, except that the Exchange Notes have been
registered under the Securities Act and, therefore, will
not bear legends restricting their transfer.
RESALE OF THE EXCHANGE NOTES.... Based on an interpretation by the Commission's staff set
forth in interpretive letters issued to third parties
unrelated to the Company, the Company believes that the
Exchange Notes issued pursuant to the Exchange Offer
generally will be freely transferable by the holders
thereof without registration or any prospectus delivery
requirement under the Securities Act. See "The Exchange
Offer--Purpose and Effect of the Exchange Offer."
EXPIRATION DATE................. The Exchange Offer will expire at 5:00 p.m., New York City
time, on February 27, 1998, unless the Exchange Offer is
extended, in which case the term "Expiration Date" means
the latest date and time to which the Exchange Offer is
extended. See "The Exchange Offer--Expiration Date;
Extensions; Amendments." The Company will accept for
exchange any and all Private Notes which are properly
tendered in the Exchange Offer prior to 5:00 p.m., New
York City time, on the Expiration Date. If any tendered
Private Notes are not accepted for exchange because of an
invalid tender or the occurrence of certain other events
set forth herein, such unaccepted Private Notes will be
returned, without expense, to the tendering Holder thereof
as promptly as practicable after the Expiration Date.
</TABLE>
9
<PAGE>
<TABLE>
<S> <C>
ACCRUED INTEREST ON THE EXCHANGE
NOTES AND THE PRIVATE NOTES... Interest will be paid on the Private Notes on February 1,
1998 to Holders of record of the Private Notes on January
15, 1998. The Exchange Notes will bear interest from
February 1, 1998 (the last Interest Payment Date upon
which interest was paid on the Private Notes surrendered).
Holders who exchange their Private Notes for Exchange
Notes will receive the same interest payment on May 1,
1998 (the first interest payment date with respect to the
Private Notes and the Exchange Notes) that they would have
received had they not accepted the Exchange Offer. In the
event that the Exchange Offer is extended beyond May 1,
1998 or is not consummated, Holders of Private Notes will
receive the interest payments set forth on the face of
such notes, together with Additional Interest, if any, as
set forth in the Registration Rights Agreement. See "The
Exchange Offer--Interest on the Exchange Notes."
TERMINATION OF THE EXCHANGE
OFFER......................... The Company may terminate the Exchange Offer if it
determines that its ability to proceed with the Exchange
Offer could be materially impaired due to any injunction,
order or decree by any court or governmental agency, any
new law, statute, rule or regulation or any interpretation
of the staff of the Commission of any existing law,
statute, rule or regulation, or the failure to obtain any
necessary approvals of governmental agencies or Holders of
the Private Notes. The Company does not expect any of the
foregoing conditions to occur, although there can be no
assurance that such conditions will not occur. Holders of
Private Notes will have certain rights against the Company
under the Registration Rights Agreement should the Company
fail to consummate the Exchange Offer. See "The Exchange
Offer--Termination."
PROCEDURES FOR TENDERING PRIVATE
NOTES......................... Each Holder of Private Notes wishing to accept the
Exchange Offer must complete, sign and date the Letter of
Transmittal, or a copy thereof, in accordance with the
instructions contained herein and therein, and mail or
otherwise deliver such Letter of Transmittal, or such
copy, together with any corresponding certificate or
certificates representing the Private Notes to be
exchanged (if in certificated form) and any other required
documentation, to State Street Bank and Trust Company, as
Exchange Agent, at the address set forth herein and
therein.
Persons holding Private Notes through the Depository Trust
Company ("DTC") and wishing to accept the Exchange Offer
must do so pursuant to the DTC's Automated Tender Offer
Program ("ATOP"), by which each tendering participant will
agree to be bound by the Letter of Transmittal.
</TABLE>
10
<PAGE>
<TABLE>
<S> <C>
By executing or agreeing to be bound by the Letter of
Transmittal, each Holder will represent to the Company
that, among other things, (i) the Exchange Notes acquired
pursuant to the Exchange Offer are being acquired in the
ordinary course of business of the person receiving such
Exchange Notes, whether or not such person is the Holder
of the Private Notes, (ii) neither the Holder nor any such
other person has or intends to have an arrangement or
understanding with any person to participate in the
distribution of such Exchange Notes, (iii) neither the
Holder nor any such other person is an "affiliate," as
defined in Rule 405 under the Securities Act, of the
Company, or if it is such an affiliate, that it will
comply with the registration and prospectus delivery
requirements of the Securities Act to the extent
applicable to it, and (iv) if such Holder is a
broker-dealer, that it acquired the Private Notes as a
result of market making activities or other trading
activities. Pursuant to the Registration Rights Agreement,
the Company is required to file a registration statement
for an offering to be made on a continuous basis pursuant
to Rule 415 under the Securities Act in respect of the
Private Notes of any Holder that is not eligible to
participate in the Exchange Offer or does not receive
freely tradeable Exchange Notes in the Exchange Offer and
so requests that it wishes to have its Private Notes
registered under the Securities Act. See "The Exchange
Offer--Procedures for Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS............. Any owner of a beneficial interest in an Old Global Note
holding through a broker, dealer, commercial bank, trust
company or other nominee and who wishes to tender in the
Exchange Offer should contact such entity through which it
holds such beneficial interest promptly and instruct such
entity to tender on his behalf.
GUARANTEED DELIVERY
PROCEDURES.................... Holders of Private Notes who wish to tender their Private
Notes and whose Private Notes are not immediately
available or who cannot deliver their Private Notes (or
who cannot complete the procedure for book-entry transfer
on a timely basis) and a properly completed Letter of
Transmittal or any other documents required by the Letter
of Transmittal to the Exchange Agent prior to the
Expiration Date may tender their Private Notes according
to the guaranteed delivery procedures set forth in "The
Exchange Offer-- Guaranteed Delivery Procedures."
WITHDRAWAL RIGHTS............... Tenders of Private Notes pursuant to the Exchange Offer
may be withdrawn at any time prior to 5:00 p.m., New York
City time, on the Expiration Date. See "The Exchange
Offer--Withdrawal of Tenders."
</TABLE>
11
<PAGE>
<TABLE>
<S> <C>
ACCEPTANCE OF PRIVATE NOTES AND
DELIVERY OF EXCHANGE NOTES.... Subject to certain conditions (as summarized above in
"Termination of the Exchange Offer" and described more
fully under" The Exchange Offer--Termination"), the
Company will, unless such Private Notes are withdrawn in
accordance with the withdrawal rights specified in
"--Withdrawal Rights" above, accept for exchange any and
all Private Notes which are properly tendered in the
Exchange Offer prior to 5:00 p.m., New York City time, on
the Expiration Date. See "The Exchange Offer--Expiration
Date."
CERTAIN FEDERAL INCOME TAX
CONSIDERATIONS................ The exchange pursuant to the Exchange Offer should not be
a taxable event for U.S. federal income tax purposes. See
"Certain U.S. Federal Income Tax Considerations."
EXCHANGE AGENT.................. State Street Bank and Trust Company, the Trustee under the
Indenture, is serving as exchange agent (the "Exchange
Agent") in connection with the Exchange Offer. The mailing
address of the Exchange Agent is: State Street Bank and
Trust Company, P.O. Box 778, Attention: Corporate
Trust/Transfer Unit, Boston, Massachusetts 02102. Hand
deliveries should be delivered to State Street Bank and
Trust Company, Two International Place, 4th Floor, Boston,
Massachusetts 02110, Attention: Corporate Trust
Department/Transfer Unit. For information with respect to
the Exchange Offer, the telephone number for the Exchange
Agent is (617) 664-5326 and the facsimile number for the
Exchange Agent is (617) 664-5371.
CONSEQUENCES OF FAILURE TO
EXCHANGE...................... Private Notes that are not tendered or that are not
properly tendered will, following the completion of the
Exchange Offer, continue to be subject to the existing
restrictions upon transfer thereof under the Securities
Act and, upon consummation of the Exchange Offer, certain
registration rights under the Registration Rights
Agreement will terminate. Such Private Notes will,
following consummation of the Exchange Offer, bear
interest at the same rate as the Exchange Notes. The
liquidity of the market for a Holder's Private Notes could
be adversely affected upon completion of the Exchange
Offer if such Holder does not participate in the Exchange
Offer. See "Risk Factors--Failure to Exchange Private
Notes."
</TABLE>
12
<PAGE>
SUMMARY OF MATERIAL TERMS OF THE EXCHANGE NOTES
<TABLE>
<S> <C>
SECURITIES OFFERED................ $85,000,000 of 13 1/2% Senior Notes due 2002.
USE OF PROCEEDS................... The Company will not receive any proceeds from the
issuance of the Exchange Notes pursuant to the Exchange
Offer. In consideration for issuing the Exchange Notes
as contemplated in this Prospectus, the Company will
receive in exchange Private Notes in like principal
amount, the term and form of which are identical in all
material respects to the Exchange Notes. The Private
Notes surrendered in exchange for Exchange Notes will be
retired and cancelled and cannot be reissued.
Accordingly, issuance of the Exchange Notes will not
increase the indebtedness of the Company. See "Plan of
Reorganization" and "Use of Proceeds."
MATURITY.......................... August 1, 2002.
INTEREST RATE AND PAYMENT DATES... The Exchange Notes will bear interest at a rate of
13 1/2% per annum, payable quarterly in cash in arrears
on each February 1, May 1, August 1 and November 1
commencing February 1, 1998. In addition to stated
interest, for U.S. federal income tax purposes,
purchasers of the Exchange Notes will be required to
include amounts attributable to original issue discount,
if any, in their gross income in advance of receipt of
cash payment to which such income is attributable. For a
discussion of the U.S. federal income tax treatment of
the Exchange Notes under the original issue discount
rules, see Certain U.S. Federal Income Tax
Considerations.
ESCROWED INTEREST ACCOUNT......... As security for the scheduled interest payments on the
Exchange Notes through August 1, 1999, a portion of the
net proceeds from the offering of the Private Notes in
an amount of approximately $21.6 million (subject to
reduction in the event of a redemption of the Exchange
Notes pursuant to a Primary Offering) was invested in
U.S. Treasury securities and placed in the Escrowed
Interest Account and is being held by the Trustee for
the ratable benefit of the holders of the Exchange
Notes, subject to the terms and conditions of the
Indenture and the Escrow and Security Agreement (each as
defined herein). See Description of Exchange Notes --
Escrowed Interest Account.
GUARANTEES........................ The Exchange Notes will be guaranteed on a full,
unconditional, and joint and several senior secured
basis by all present and future Subsidiaries (as defined
herein) of the Company (other than Block Party and the
Limited Investment Subsidiaries (each, as defined
herein)).
</TABLE>
13
<PAGE>
<TABLE>
<S> <C>
OPTIONAL REDEMPTION............... The Exchange Notes will be redeemable, at the option of
the Company, in whole or in part, at any time on or
after August 1, 1999, at the redemption prices set forth
herein, plus accrued and unpaid interest to the date of
redemption. In addition, at any time prior to August 1,
1999, the Company may redeem up to 35% of the original
principal amount of the Exchange Notes with the proceeds
of one or more Primary Offerings at 115% of the
aggregate principal amount thereof, together with
accrued and unpaid interest to the redemption date. See
Description of Exchange Notes -- Optional Redemption.
SECURITY.......................... The Exchange Notes will be initially secured by a first
priority security interest in certain assets of the
Company (including cash, accounts receivable, inventory,
equipment, general intangibles, intellectual property
rights and certain other fixed assets (except for real
estate, leasehold interests existing prior to the
Effective Date and certain real property, fixtures and
leasehold improvements)), by a pledge of the capital
stock of all current and future Subsidiaries and by a
subordinate lien on certain of the Company's real
property and improvements thereon. The Company has
agreed to use its commercially reasonable efforts to
obtain a first priority mortgage lien in favor of the
Collateral Agent (as defined herein) on all leasehold
interests in new store locations acquired after the
Effective Date. The Company will be permitted under
certain circumstances to enter into a new credit
facility (in a principal amount not to exceed $10.0
million), in which case the first priority security
interest in certain collateral securing the Exchange
Notes will be subordinated to a lien securing such
credit facility. See Description of Exchange Notes --
Security and Intercreditor Agreement.
RANKING........................... The Exchange Notes will be senior secured indebtedness
of the Company, will rank PARI PASSU in right of payment
with all unsubordinated indebtedness of the Company and
will be senior in right of payment to all subordinated
indebtedness of the Company. On September 30, 1997, the
Company had $88.3 million of long-term debt (including
current portion) outstanding, of which $83.3 million was
secured indebtedness (including the Private Notes). See
Risk Factors -- Substantial Leverage and Ability to
Service Debt.
CHANGE OF CONTROL................. Upon a Change of Control (as defined herein), the
Company will be required to make an offer to repurchase
all outstanding Exchange Notes at a purchase price equal
to 101% of the principal amount thereof, together with
accrued and unpaid interest to the date of repurchase.
See Description of Exchange Notes -- Repurchase upon
Change of Control.
</TABLE>
14
<PAGE>
<TABLE>
<S> <C>
FORM OF EXCHANGE NOTES............ Exchange Notes will be represented by one or more
permanent global Notes in definitive, fully registered
form without interest coupons, each deposited with the
Trustee as custodian for, and registered in the name of
Cede & Co., as nominee of, the DTC. Beneficial interests
in such global Notes will be shown on, and transfers
thereof will be effected only through, the book-entry
records maintained by the DTC and its direct and
indirect participants, including Euroclear and Cedel
Bank. See Description of the Exchange Notes -- New
Global Notes.
CERTAIN COVENANTS................. The indenture governing the Exchange Notes (the
Indenture) restricts the ability to, among other things,
incur additional indebtedness, create liens, engage in
sale-leaseback transactions, pay dividends or make
distributions in respect of its capital stock, make
investments or certain other restricted payments, sell
assets, issue or sell stock, enter into transactions
with stockholders or affiliates or effect a
consolidation or merger. The Company is also required to
maintain key man life insurance and to use its
commercially reasonable efforts to obtain leasehold
mortgages on all new store locations. These limitations
are, however, subject to important qualifications and
exceptions. See Description of Exchange Notes -- Certain
Covenants.
</TABLE>
RISK FACTORS
See "Risk Factors," immediately following this Summary, for a discussion of
certain information that should be considered in evaluating the Company, its
business and the Exchange Notes.
15
<PAGE>
SUMMARY HISTORICAL FINANCIAL DATA
The following summary of certain historical financial data of the Company
for each of the years in the five-year period ended December 31, 1996 and
historical balance sheet data as of December 31, 1996 have been derived from the
historical audited consolidated financial statements of the Company. The
consolidated financial data as of and for the nine months ended September 30,
1996, the seven months ended July 31, 1997 and the two months ended September
30, 1997 have been derived from unaudited consolidated financial statements of
the Company and, in the opinion of the Company's management, have been prepared
on a basis consistent with the audited financial statements and include all
adjustments that are considered by management to be necessary for a fair
presentation of such financial information. Historical data and interim results
are not necessarily indicative of future results, and interim data are not
necessarily indicative of results for a full year. In accordance with Fresh
Start Accounting under generally accepted accounting principles ("GAAP"), the
Company restated its balance sheet accounts to reflect an estimated fair market
value upon its emergence from bankruptcy. As a result, the Company does not
believe that its historical results of operations are necessarily indicative of
its results of operations as an ongoing entity after the Effective Date. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Changes in Method of Accounting." The information set forth below
should be read in conjunction with the discussion under "Selected Historical
Financial Data" and "Management's Discussion and Analysis of Financial Condition
<TABLE>
<CAPTION>
and Results of Operations."
<S> <C> <C> <C> <C> <C> <C> <C>
(PREDECESSOR COMPANY)
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
NINE SEVEN
MONTHS MONTHS
ENDED ENDED
SEPTEMBER 30, JULY 31,
1996 1997
------------- -----------
STATEMENT OF OPERATIONS DATA:
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total revenue.......................... $ 19,593 $ 61,585 $ 180,573 $ 259,490 $ 181,725 $ 147,848 $ 82,537
Cost of goods sold..................... 5,696 15,131 36,858 50,227 34,276 27,059 14,136
Store operating expenses(1)(2)(3)...... 6,331 32,010 97,631 185,587 140,486 112,741 60,192
Selling, general and administrative
expenses(2).......................... 8,750 6,300 36,451 58,201 40,779 33,230 10,235
Depreciation and amortization.......... 976 4,670 16,183 31,972 21,876 16,204 11,920
Restructuring and other charges........ 2,486 -- 14,024 372,160 -- -- --
--------- --------- --------- --------- --------- ------------- -----------
Operating income (loss)................ (4,586) 3,474 (20,574) (438,657) (55,692) (41,386) (13,946)
Reorganization costs................... -- -- -- -- 21,285 12,436 12,165
Extraordinary item-gain on discharge of
debt................................. -- -- -- -- -- -- 332,165
Net income (loss) applicable to common
shareholders......................... (4,969) 3,306 (24,897) (449,245) (83,834) (58,365) 302,256
Per common and common equivalent share:
Income (loss) before cumulative
effect of change in method of
accounting and extraordinary
item............................... $ (0.14) $ 0.08 $ (0.41) $ (8.06) $ (1.45) $ (1.01) $ (0.52)
Cumulative effect of change in
accounting method.................. -- -- (0.12) -- -- -- --
Extraordinary item-gain on discharge
of debt............................ -- -- -- -- -- -- 5.76
--------- --------- --------- --------- --------- ------------- -----------
Net income (loss).................... $ (0.14) $ 0.08 $ (0.53) $ (8.06) $ (1.45) $ (1.01) $ 5.24
--------- --------- --------- --------- --------- ------------- -----------
--------- --------- --------- --------- --------- ------------- -----------
Weighted average number of common and
common equivalent shares
outstanding.......................... 34,776 42,025 46,797 55,706 57,691 57,698 57,705
--------- --------- --------- --------- --------- ------------- -----------
--------- --------- --------- --------- --------- ------------- -----------
<CAPTION>
(SUCCESSOR
COMPANY)
TWO MONTHS
ENDED
SEPTEMBER 30,
1997
-------------
STATEMENT OF OPERATIONS DATA:
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
Total revenue.......................... $ 19,914
Cost of goods sold..................... 3,057
Store operating expenses(1)(2)(3)...... 16,879
Selling, general and administrative
expenses(2).......................... 3,872
Depreciation and amortization.......... 3,981
Restructuring and other charges........ --
-------------
Operating income (loss)................ (7,875)
Reorganization costs................... --
Extraordinary item-gain on discharge of
debt................................. --
Net income (loss) applicable to common
shareholders......................... (9,784)
Per common and common equivalent share:
Income (loss) before cumulative
effect of change in method of
accounting and extraordinary
item............................... $ (2.45)
Cumulative effect of change in
accounting method.................. --
Extraordinary item-gain on discharge
of debt............................ --
-------------
Net income (loss).................... $ (2.45)
-------------
-------------
Weighted average number of common and
common equivalent shares
outstanding.......................... 4,000
-------------
-------------
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
(PREDECESSOR COMPANY)
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
NINE SEVEN
MONTHS MONTHS
ENDED ENDED
SEPTEMBER 30, JULY 31,
1996 1997
------------- -----------
OTHER DATA:
<S> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Cash provided by (used in)
operations........................... $ (662) $ 19,860 $ (4,481) $ (59,103) $ (39,888) $ (32,014) $ (12,118)
Cash provided by (used in)
investing activities................. (7,791) (95,868) (121,972) (64,562) 3,805 4,760 (468)
Cash provided by financing
activities........................... 15,786 185,496 16,162 121,729 33,460 26,736 51,798
--------- --------- --------- --------- --------- ------------- -----------
Net cash flows 7,333 109,488 (110,291) (1,936) (2,623) (518) 39,212
EBITDA(4).............................. (1,183) 8,144 (4,391) (406,685) (55,101) (37,618) (14,191)
Capital expenditures................... 6,352 88,336 119,134 51,732 2,672 1,717 567
STORE DATA:
Company-owned stores at
period-end(5)........................ 19 111 318 321 212 232 210
Franchised stores at period-end(6)..... 38 57 29 15 7 7 --
--------- --------- --------- --------- --------- ------------- -----------
Total stores at period-end............. 57 168 347 336 219 239 210
OPERATING RATIO:
EBITDA/total interest expense(7)....... -- 4.88 -- -- -- -- --
Ratio of earnings to fixed
charges(8)........................... -- 2.8 -- -- -- -- --
<CAPTION>
(SUCCESSOR
COMPANY)
TWO MONTHS
ENDED
SEPTEMBER 30,
1997
-------------
OTHER DATA:
<S> <C>
(DOLLARS IN THOUSANDS)
Cash provided by (used in)
operations........................... $ (12,036)
Cash provided by (used in)
investing activities................. (262)
Cash provided by financing
activities........................... 0
-------------
Net cash flows (12,298)
EBITDA(4).............................. (3,894)
Capital expenditures................... 218
STORE DATA:
Company-owned stores at
period-end(5)........................ 208
Franchised stores at period-end(6)..... --
-------------
Total stores at period-end............. 208
OPERATING RATIO:
EBITDA/total interest expense(7)....... --
Ratio of earnings to fixed
charges(8)........................... --
</TABLE>
<TABLE>
<CAPTION>
(PREDECESSOR COMPANY) (SUCCESSOR COMPANY)
AS OF DECEMBER 31, AS OF
----------------------------------------------------- SEPTEMBER 30, 1997
1992 1993 1994 1995 1996(9) (10)(11)
--------- --------- --------- --------- --------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
(DOLLARS IN THOUSANDS)
Cash and cash equivalents (unrestricted)........ $ 8,544 $ 118,176 $ 7,885 $ 5,949 $ 3,326 $ 30,240
Restricted cash and investments................. 437 -- -- -- -- 21,706
Total assets.................................... 24,804 252,550 474,686 171,571 125,786 190,171
Long-term debt, including current portion....... 5,557 2,728 18,400 113,404 350,072 88,298
Redeemable Convertible Preferred Stock(12)...... -- -- -- -- -- 13,839
Total stockholders' equity (deficit) (excluding
Redeemable Convertible Preferred Stock)....... 10,636 98,091 238,963 (180,173) (263,572) 60,394
</TABLE>
- ------------------------
(1) Excludes depreciation and amortization and certain unallocated expenses.
(2) Net of $22.2 million, $13.6 million and $200,000 of capitalized costs
related to the Company's expansion for the years 1994, 1995 and 1996,
respectively, and $0.0 million, $0.0 million and $0.2 million for the nine
months ended September 30, 1996, the seven months ended July 31, 1997 and
the two months ended September 30, 1997, respectively.
(3) For the year ended December 31, 1992, Store Operating Expenses are estimated
for stores acquired under the pooling method.
(4) EBITDA represents net earnings (losses) before interest, income taxes,
depreciation and amortization, other income and expense, including minority
interest, extraordinary item and change in accounting method. EBITDA is
presented here to provide additional information about the Company's ability
to service the Exchange Notes. The Company believes that EBITDA provides
significant information with respect to the Company's capacity to make
payments on the Exchange Notes because it indicates the amount of cash
before non-cash charges against earnings, which would have been available to
pay the Company's obligations during the years indicated, which is not
indicated by the ratio of earnings to fixed charges. While providing useful
information, EBITDA should not be considered in isolation or as a substitute
measure of liquidity as determined under GAAP. EBITDA does not represent
funds available for dividends, reinvestment or other discretionary uses.
EBITDA is not a measure of financial performance under GAAP and should not
be considered as an alternative to (i) net income (loss) as a measure of
performance (or any other measure of performance under GAAP) or (ii) cash
flows from operating, investing or financing activities as an indicator of
cash flows or as a measure of liquidity. Additionally, because EBITDA is not
a measure of financial performance under GAAP, it may not be comparable to
similarly titled measures of other companies.
(5) Includes the Block Party Stores.
(6) The Company currently receives no royalties from its franchised stores and
rejected or terminated its arrangements with all franchisees on or prior to
the Effective Date.
(7) EBITDA was insufficient to cover the full amount of total interest expense
by $1.7 million, $9.5 million, $418.9 million and 61.4 million in each of
1992, 1994, 1995 and 1996, respectively, and $42.6 million, $18.1 million
and $6.4 million for the nine months ended September 30, 1996, the seven
months ended July 31, 1997 and the two months ended September 30, 1997,
respectively. Total interest expense does not include all fixed expenses of
the Company. See Note 12 to the Financial Statements.
(8) 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 $5.0
million, $24.1 million, $445.4 million, $83.8 million, $58.4 million, $29.9
million and $9.7 million in each of 1992, 1994, 1995 and 1996, the nine
months ended September 30, 1996, the seven months ended July 31, 1997 and
the two months ended September 30, 1997.
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(9) Includes certain claims and other liabilities totaling $344.1 million as of
December 31, 1996 in connection with the Plan of Reorganization. See "Plan
of Reorganization."
(10) The balance sheet as of September 30, 1997 gives effect to the offering of
the Private Notes and the Plan of Reorganization, including application of
Fresh Start Accounting under GAAP. Fresh Start Accounting requires a
restatement of the Company's balance sheet accounts to reflect the estimated
fair market value of the Company on a going concern basis following the
reorganization upon its emergence from bankruptcy. See "Plan of
Reorganization" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method of Accounting."
(11) Under GAAP, $7.1 million of the proceeds of the offering of the Private
Notes were allocated to the Unit Warrants and $77.9 million of the proceeds
were allocated to the Private Notes.
(12) Reflects 1,000 shares of Convertible Preferred Stock of the Company.
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RISK FACTORS
AN INVESTMENT IN THE EXCHANGE NOTES DISCUSSED HEREIN INVOLVES A HIGH DEGREE
OF RISK AND THUS IS NOT APPROPRIATE FOR INVESTORS WHO CANNOT AFFORD THE LOSS OF
THEIR ENTIRE INVESTMENT. PROSPECTIVE INVESTORS SHOULD GIVE CAREFUL CONSIDERATION
TO THE SPECIFIC FACTORS SET FORTH BELOW AND THE OTHER INFORMATION SET FORTH
HEREIN, BEFORE PURCHASING THE EXCHANGE NOTES OFFERED HEREBY. CERTAIN INFORMATION
CONTAINED IN THIS PROSPECTUS, INCLUDING INFORMATION RELATING TO THE COMPANY'S
EXPECTED OPERATIONS, ITS STRATEGY FOR MARKETING AND INVESTING IN STORE
FACILITIES AND RELATED FINANCING ACTIVITIES, CONTAINS FORWARD-LOOKING STATEMENTS
THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THE RESULTS ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF NUMEROUS FACTORS, INCLUDING, BUT NOT LIMITED TO, THE FACTORS DISCUSSED
IN "RISK FACTORS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS" AND "BUSINESS."
SUBSTANTIAL LEVERAGE; NEGATIVE EBITDA AND ABILITY TO SERVICE DEBT AND OTHER
OBLIGATIONS
As a result of the Private Note offering, the Company has indebtedness that
is substantial in relation to stockholders' equity. As of September 30, 1997,
the Company had an aggregate of $88.3 million of long-term debt (including
current portion), of which $83.3 million was secured indebtedness (including the
Private Notes).
The Company's high degree of leverage could have important consequences to
the holders of the Exchange Notes, including the following: (i) the Company's
ability to obtain additional financing for working capital, capital
expenditures, acquisitions or general corporate or other purposes may be
impaired in the future; (ii) a substantial portion of the Company's cash flow
from operations must be dedicated to the payment of principal and interest on
its indebtedness, thereby reducing the funds available to the Company for other
purposes; (iii) the Company may be substantially more leveraged than certain of
its competitors, which may place the Company at a competitive disadvantage; and
(iv) the Company's ability to adjust rapidly to changing market conditions may
be hindered and could make the Company more vulnerable to losses and possible
defaults on outstanding indebtedness in the event of a downturn in general
economic conditions or its business.
The Company's ability to make scheduled payments of principal and interest
or to refinance its obligations with respect to its indebtedness will depend on
its financial and operating performance, which, in turn, will be subject to
prevailing economic conditions and to certain financial, business and other
factors beyond its control. For 1995 and 1996 and the first seven months of
1997, the Company had operating losses of $(438,657), $(55,692) and $(13,946),
respectively, and net income (losses) of $(449,245), $(83,834) and $302,256. For
1995 and 1996 and the first seven months of 1997, the Company had negative
EBITDA of $406.7 million, $55.1 million and $14.1 million, respectively. For the
two months ended September 30, 1997, the Company had operating losses of $7.9
million, net losses of $9.8 million and negative EBITDA of $4.0 million. The
Company historically has experienced negative operating results, net losses and
negative EBITDA during the last quarter of the year. In addition, for 1994, 1995
and 1996 and the first seven months of 1997, the Company's earnings were
insufficient to cover Fixed Charges by $24.1 million, $445.4 million, $83.8
million and $29.9 million. For the two months ended September 30, 1997, the
Company's earnings were insufficient to cover Fixed Charges by $9.7 million. If
the Company's cash flow and capital resources are insufficient to fund its debt
service obligations, the Company may be forced to reduce or delay planned
expansion and capital expenditures, sell assets, obtain additional equity
capital or restructure its indebtedness. There can be no assurance that the
Company's operating results, cash flow and capital resources will be sufficient
for payment of its indebtedness and other capital requirements in the future.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
SUCCESSFUL EXECUTION OF TURNAROUND PLAN
The company is currently in the process of implementing its Turnaround Plan,
which consists of a number of cost-cutting and revenue enhancing initiatives.
The Company is undertaking a significant
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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 Turnaround
Plan 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 and this trend has continued since the
Effective Date. If the Company is not successful in attracting additional
customers and reversing this trend, it will not be able to fully implement the
Turnaround Plan without additional financing (which may not be available) and
the improvement in the Company's results of operation would not materialize. If
the Turnaround Plan 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 will have an adverse affect on the availability of cash and other financial
resources necessary for the implementation of the Turnaround Plan. Further, if
the implementation of the Turnaround Plan is not successful and the Company is
unable to generate sufficient operating funds to pay the interest on the
Exchange Notes and fund its other capital requirements, including current and
future operating losses, 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. The Company is limited by
the terms of the Indenture to permitted borrowings of up to $10 million of
senior secured indebtedness and up to $5 million of new indebtedness from sale
and leaseback transactions, capital lease obligations or purchase money
obligations. If it becomes necessary for the Company to raise additional
capital, it would be limited by the terms of the Indenture to issuing additional
equity. There can be no assurance that capital would be available from any of
these permitted sources. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-- Overview," "Business--Business Strategy
and Turnaround Plan" and "Description of Exchange Notes."
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 Company's
bankruptcy case, including the costs and expenses relating thereto, 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."
SECURITY FOR THE EXCHANGE NOTES; EXCHANGE NOTES UNDERSECURED
The Exchange Notes will be initially secured by a first priority security
interest in certain assets of the Company (including cash, accounts receivable,
inventory, equipment, general intangibles, intellectual property rights and
certain other fixed assets (except for real estate leasehold interests existing
prior to the Effective Date and certain real property, fixtures and leasehold
improvements)), by a pledge of the capital stock of all present and future
Subsidiaries and by a subordinate lien on certain of the Company's real property
and improvements thereon. The Company has agreed to use its commercially
reasonable efforts to obtain in favor of the Collateral Agent a first priority
mortgage lien on all leasehold interests in new store locations acquired after
the Effective Date. While the Company has agreed to use its best efforts to
grant to the holders of Exchange Notes valid, first priority security interests
in each class of collateral
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identified above that is included in the security package granted under the
Indenture, the granting of certain of such security interests may require the
cooperation of third parties in order to be perfected, or may not be susceptible
of perfection for legal or other logistical reasons. Accordingly, investors in
of the Exchange Notes should not assume that valid first priority security
interests will be obtained with respect to all or substantially all of the
identified classes of collateral that are entitled to such security interests.
In the event of a default on the Exchange Notes, the proceeds from the sale of
the collateral securing the Exchange Notes will likely be insufficient to
satisfy in full the Company's obligations under the Exchange Notes. The amount
to be received upon such a sale would be dependent upon numerous factors
including the condition, age and useful life of the collateral at the time of
such sale, as well as the timing and the manner of such sale. A significant
portion of the Company's assets consist of leasehold improvements, and most of
the Company's assets are located on leaseholds. Because leasehold improvements
may be deemed to be a part of either the real property covered by the lease
(which real property is not owned by the Company) or the Company's real estate
leasehold interests (which interests are not included in the collateral
available for the Exchange Notes), there can be no assurances as to whether or
to what extent such improvements would be available as collateral security for
the Exchange Notes. Moreover, the ability of the Collateral Agent to obtain
possession of collateral located on leaseholds may be subject to conflicting
claims of landlords. Given the intangible nature of certain of the collateral,
any sale of collateral separately from the Company as a whole may not be
feasible. Additionally, the inclusion of the Company's fixtures in the
collateral securing the Exchange Notes will be limited by the extent to which
such fixtures (a) are deemed not to be personal property and (b) any applicable
state laws that require that the Collateral Agent make certain filings in
applicable real estate land records for the purpose of perfecting security
interests in fixtures.
Except during the continuance of a Default or Event of Default, the
Collateral Agent (as defined herein) is required under certain circumstances, as
set forth in "Description of Exchange Notes-- Possession, Use and Release of
Collateral," to release its liens on property or assets proposed to be sold by
the Company, which may further reduce the sufficiency of the collateral securing
the Exchange Notes. In the event the Company enters into an Eligible Credit
Facility, the security interest with respect to the Exchange Notes would become
subordinated to the security interest with respect to such credit facility. See
"Description of Exchange Notes -- Security."
EFFECT OF BANKRUPTCY UPON EXERCISE OF REMEDIES
The right of the Collateral Agent to repossess and dispose of the collateral
upon the occurrence of an Event of Default is likely to be significantly
impaired by applicable bankruptcy law if a bankruptcy proceeding were to be
commenced by or against the Company prior to the Collateral Agent having
repossessed and disposed of the collateral. Under the Bankruptcy Code, a secured
creditor such as the Collateral Agent is prohibited from repossessing its
security from a debtor in a bankruptcy case or from disposing of security
repossessed from such debtor without bankruptcy court approval. Moreover, the
Bankruptcy Code permits the debtor to continue to retain and to use collateral
even though debtor is in default under the applicable debt instruments; PROVIDED
that secured creditors are given "adequate protection" as such term is
interpreted by the relevant bankruptcy court.
RESTRICTIVE DEBT COVENANTS
The Indenture contains a number of covenants which will impose significant
operating and financial restrictions on the Company and its subsidiaries. Such
restrictions affect, and in many respects significantly limit or prohibit, among
other things, the ability of the Company and its subsidiaries to incur
additional indebtedness, pay dividends, repay other indebtedness prior to stated
maturities or amend other debt instruments, create liens on assets, make
investments or acquisitions, engage in mergers or consolidations, make capital
expenditures, or engage in certain transactions with subsidiaries and affiliates
and otherwise restrict corporate activities. These restrictions could limit the
ability of the Company and its subsidiaries to effect future financings, make
needed capital expenditures, withstand a future downturn in the Company's
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business or the economy in general, or otherwise conduct necessary corporate
activities. A failure by the Company or its subsidiaries to comply with these
restrictions could lead to a default under the Indenture and the Exchange Notes,
notwithstanding the ability of the Company to meet its debt service obligations.
Upon the occurrence of an Event of Default, the holders of the Exchange Notes
could elect to declare all such indebtedness, together with accrued and unpaid
interest thereon, to be due and payable, and there can be no assurance that the
Company and its subsidiaries would be able to make such payments or borrow
sufficient funds from alternative sources to make such payments. Even if
additional financing could be obtained, there can be no assurance that it would
be available on commercially reasonable terms. See "Description of Exchange
Notes."
REPURCHASE OF EXCHANGE NOTES UPON A CHANGE OF CONTROL
In the event of a Change of Control, the Company must offer to purchase the
Exchange Notes at a purchase price equal to 101% of the principal amount
thereof, plus accrued and unpaid interest, if any, to the date of purchase. See
"Description of Exchange Notes--Repurchase upon Change of Control" and
"--Certain Definitions." In the event that the Company is required to make an
offer to purchase the Exchange Notes upon the occurrence of a Change of Control,
there can be no assurance that it would have sufficient funds available to
purchase any Exchange Notes tendered, and the Company would likely be required
to refinance the Exchange Notes. There can be no assurance that the Company
would be able to accomplish such refinancing or, if such refinancing were to
occur, that it would be accomplished on commercially reasonable terms.
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
implementation of the Turnaround Plan and on the Company in general.
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 and the holders of the Exchange Notes.
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 1996, the Company's FunCenters generated 32% of their revenue in the
first quarter versus 23%, 24% and 21% in the second, third and fourth quarters,
respectively. These fluctuations in revenues are primarily influenced by the
school year and the weather.
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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 one location 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, its ability to pay
interest and principal on the Exchange Notes and the value of the Warrants (as
defined herein) and the Warrant Shares.
FRAUDULENT CONVEYANCE
If a court, in a lawsuit brought by an unpaid creditor of the Company or a
representative of creditors, such as a trustee in bankruptcy, or the Company as
a debtor-in-possession, were to find under relevant federal or state fraudulent
conveyance statutes that the Company did not receive fair consideration or
reasonably equivalent value for incurring debt, including the Exchange Notes,
and that, at the time of such incurrence, the Company: (i) was insolvent; (ii)
was rendered insolvent by reason of such incurrence; (iii) was engaged in a
business or transaction for which the assets remaining with the Company
constituted unreasonably small capital; or (iv) intended to incur, or believed
that it would incur, debts beyond its ability to pay such debts as they matured,
such court could void the Company's obligations under the Exchange Notes,
subordinate the Exchange Notes to other indebtedness of the Company or take
other action detrimental to the holders of the Exchange Notes.
The measure of insolvency for these purposes would vary depending upon the
law of the jurisdiction being applied. Generally, however, a company would be
considered insolvent for these purposes if the sum of such company's liabilities
(including a fair estimate of the likely amount payable in respect of contingent
liabilities) were greater than the fair saleable value of all such company's
property, or if the present fair saleable value of such company's assets were
less than the amount that would be required to pay its probable liability on its
existing debts as they become absolute and matured. Moreover, regardless of
solvency or the adequacy of consideration, a court could void the Company's
obligations under the Exchange Notes, subordinate the Exchange Notes to other
indebtedness of the Company or take other action detrimental to the holders of
the Exchange Notes if such court determined that the incurrence of debt,
including the Private Notes, was made with the actual intent to hinder, delay or
defraud creditors.
The Company believes that the indebtedness represented by the Private Notes
was incurred for proper purposes and in good faith without any intent to hinder,
delay or defraud creditors, that the Company received reasonably equivalent
value or fair consideration for incurring such indebtedness, that the Company,
after giving effect to the issuance of the Private Notes and the use of proceeds
therefrom,
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continues to be solvent under the applicable standards that it has and will have
sufficient capital for carrying on its businesses and will be able to pay its
debts as they mature. The exchange of the Private Notes for the Exchange Notes
does not represent any additional indebtedness for the Company.
FRAUDULENT TRANSFER CONSIDERATIONS RELATING TO SUBSIDIARY GUARANTEES
The obligations of any Subsidiary Guarantor (as defined herein) under its
Subsidiary Guarantee and the grant by any Subsidiary Guarantor of a security
interest under the Collateral Agreements (as defined herein) may be subject to
review under applicable fraudulent conveyance statutes in the event of the
bankruptcy or other financial difficulty of any such Subsidiary Guarantor. Under
such laws, if a court in a lawsuit by an unpaid creditor or representative of
creditors of any such person, such as a trustee in bankruptcy of any such person
as debtor in possession, were to find that at the time such person incurred its
obligations under its guarantee or pledged its assets, it: (i) received less
than fair consideration or reasonably equivalent value therefor; and (ii)
either, (a) was insolvent, (b) was rendered insolvent by such guarantee or
pledge, (c) was engaged in a business or transaction for which its remaining
unencumbered assets constituted unreasonably small capital, or (d) intended to
incur or believed that it would incur debts beyond its ability to pay such debts
as they matured, such court could void such obligations under its guarantee
and/or the security interest in its assets and direct the return of any amounts
paid with respect thereto. Moreover, regardless of the factors identified in the
foregoing clauses (i) and (ii), a court could take such action if it found that
the guarantee was entered into or the security interest granted with actual
intent to hinder, delay, or defraud creditors. The measure of insolvency for
purposes of the foregoing will vary depending on the law of the jurisdiction
being applied. Generally, however, an entity would be considered insolvent if
the sum of its debts (including contingent or unliquidated debts) were greater
than all of its property at a fair valuation or if the present fair salable
value of its assets is less than the amount that would be required to pay its
probable liability on its existing debts as they become absolute and matured.
ABSENCE OF PUBLIC MARKET
The NASD has designated the Private Notes as securities eligible for trading
in the PORTAL market of the NASD. However, the Exchange Notes are new securities
for which there is currently no active trading market. The Company does not
intend to list the Exchange Notes on any national securities exchange or to seek
the admission thereof to trading in the Nasdaq National Market System, and there
can be no assurance as to the development of any market or liquidity of any
market that may develop for the Exchange Notes. If a market for the Exchange
Notes develops, the price of such Exchange Notes may fluctuate and liquidity may
be limited. If a market for the Exchange Notes does not develop purchasers may
be unable to resell such Exchange Notes for an extended period of time, if at
all. Historically, the market for non-investment grade debt has been subject to
disruptions that have caused substantial volatility in the prices of securities
similar to the Exchange Notes. There can be no assurance that, if a market for
the Exchange Notes were to develop, such market would not be subject to similar
disruptions.
LIMITATION ON USE OF NET OPERATING LOSSES AND BUILT-IN LOSSES
The Company was required to reduce its Net Operating Loss carryforwards
("NOL") as a result of the cancellation of indebtedness pursuant to the
confirmation of the Plan.
Under the Internal Revenue Code of 1986, as amended (the "Code"), the
utilization of NOLs against future taxable income is subject to limitation if a
company is treated as having experienced "ownership change" as defined in the
Code (the "Section 382 limitation"). Moreover, if an ownership change has
occurred, the ability to use recognized "built-in losses" to offset other income
may also be subject to the Section 382 limitation. The Section 382 limitation
applies to the recognition of any portion of a company's built-in loss (defined
as the excess of such company's tax basis in its assets over the fair market
value of such assets as of the time of the ownership change) during the
five-year period after the change in control that results from, among other
things, the sale or exchange of the company's built-in loss assets. This built-
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in loss change of control limitation also limits a company's ability to take
depreciation or amortization charges with respect to its built-in loss assets.
As of July 31, 1997, the Company estimates that it had available
approximately $160.0 million of NOLs, the availability of which may be limited
as described below. As a result of its reorganization under Chapter 11, the
Company is treated as having experienced an ownership change. Thus, after
emerging from Chapter 11, the Company's ability to offset income in each
post-reorganization taxable year by its then 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) will be 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. It is estimated that the use
of the Company's NOLs will be limited to approximately $4.0 million per year.
ORIGINAL ISSUE DISCOUNT CONSEQUENCES
The Private Notes were issued with original issue discount for U.S. federal
income tax purposes. The Exchange Notes should be treated as a continuation of
the Private Notes. Consequently, Holders of the Exchange Notes generally will be
required to include amounts in gross income for U.S. federal income tax purposes
in advance of receipt of the cash payments to which the income is attributable.
See "Certain U.S. Federal Income Tax Considerations" for a more detailed
discussion of the U.S. federal income tax consequences for the Company and the
beneficial owners resulting from the Exchange Offer.
FAILURE TO EXCHANGE PRIVATE NOTES
The Exchange Notes will be issued in exchange for Private Notes only after
timely receipt by the Exchange Agent of such Private Notes, a properly completed
and duly executed Letter of Transmittal and all other required documentation.
Therefore, holders of Private Notes desiring to tender such Private Notes in
exchange for Exchange Notes should allow sufficient time to ensure timely
delivery. Neither the Exchange Agent nor the Company is under any duty to give
notification of defects or irregularities with respect to tenders of Private
Notes for exchange. Private Notes that are not tendered or are tendered but not
accepted will, following consummation of the Exchange Offer, continue to be
subject to the existing restrictions upon transfer thereof. In addition, any
holder of Private Notes who tenders in the Exchange Offer for the purpose of
participating in a distribution of the Exchange Notes will be required to comply
with the registration and prospectus delivery requirements of the Securities Act
in connection with any resale transaction. Each broker-dealer who holds Private
Notes acquired for its own account as a result of market making or other trading
activities and who receives Exchange Notes for its own account in exchange for
such Private Notes pursuant to the Exchange Offer, must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. To
the extent that Private Notes are tendered and accepted in the Exchange Offer,
the trading market for untendered and tendered but unaccepted Private Notes
could be adversely affected due to the limited amount, or "float," of the
Private Notes that are expected to remain outstanding following the Exchange
Offer. Generally, a lower "float" of a security results in less demand to
purchase such security and could, therefore, result in lower prices for such
security. For the same reason, to the extent that a large amount of Private
Notes are not tendered or are tendered and not accepted in the Exchange Offer,
the trading market for the Exchange Notes could be adversely affected. See "Plan
of Distribution" and "The Exchange Offer."
In the event the Exchange Offer is consummated, the Company will not be
required to register any Private Notes not tendered and accepted in the Exchange
Offer. In such event, holders of Private Notes seeking liquidity in their
investment would have to rely on exemptions to the registration requirements
under the securities laws, including the Securities Act. Following the Exchange
Offer, none of the Private Notes will be entitled to the contingent increase in
interest rate provided (in the event of a failure to consummate the Exchange
Offer in accordance with the terms of the Registration Rights Agreement)
pursuant to the Private Notes.
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THE EXCHANGE OFFER
This summary of the material provisions of the Registration Rights Agreement
does not purport to be complete and is subject to, and is qualified in its
entirety by reference to, all the provisions of the Registration Rights
Agreement, a copy of which has been filed as an exhibit to the Registration
Statement of which this Prospectus is a part and is available from the Company
upon request.
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Company sold the Private Notes to Jefferies & Company, Inc. (the
"Initial Purchaser") on July 22, 1997 (the "Issue Date") pursuant to the terms
of the Purchase Agreement dated July 15, 1997 between the Initial Purchaser and
the Company (the "Purchase Agreement"). The Initial Purchaser subsequently
resold the Private Notes to "qualified institutional buyers" in reliance on Rule
144A under the Securities Act and to a limited number of institutional
"accredited investors" (as defined in Rule 501(A)(1), (2), (3) or (7) under the
Securities Act). In connection with the offering of the Private Notes, the
Company and the Initial Purchaser entered into a Registration Rights Agreement
dated as of July 22, 1997 (the "Registration Rights Agreement").
The Company agreed with the Initial Purchaser pursuant to the Registration
Rights Agreement, for the benefit of the Holders, that it would use its best
efforts, at its cost, after the Issue Date to file and cause to become effective
a registration statement with respect to a proposed offer (the "Exchange Offer
Registration Statement") to exchange the Private Notes for an issue of notes
with terms identical in all material respects to the Private Notes (except that
the Exchange Notes will not contain terms with respect to transfer
restrictions). As soon as practicable after such registration statement is
declared effective, the Company intends to offer the Exchange Notes in return
for surrender of the Private Notes. Such offer will remain open for not less
than 30 calendar days after the date notice of the Exchange Offer is mailed to
holders of the Private Notes. For each of the Private Notes surrendered to the
Company under the Exchange Offer, the Holder will receive Exchange Notes of
equal principal amount. Interest on each Exchange Note shall accrue from the
last Interest Payment Date on which interest was paid on the Private Notes so
surrendered. In the event that applicable interpretations of the staff of the
Commission do not permit such an Exchange Offer, or under certain other
circumstances set forth in the Registration Rights Agreement, the Company shall,
at its cost, use its best efforts to cause to become effective a shelf
registration statement (the "Shelf Registration Statement") with respect to
resales of the Private Notes and to keep such registration statement effective
until the expiration of the time period referred to in Rule 144(k) under the
Securities Act, as in effect from time to time. The Company shall, in the event
of such a shelf registration, provide to each Holder copies of the prospectus,
notify each Holder when a registration statement for the Private Notes has
become effective and take certain other actions as are required to permit
resales of the Private Notes. A Holder that sells its Private Notes pursuant to
a Shelf Registration Statement generally will be required to be named as a
selling security holder in the related prospectus and to deliver a prospectus to
purchasers, will be subject to certain of the civil liability provisions under
the Securities Act in connection with such sales and will be bound by the
provisions of the Registration Rights Agreement that are applicable to such a
holder (including certain indemnification obligations).
In the event that neither the Exchange Offer Registration Statement nor the
Shelf Registration Statement has been filed on or prior to the 120th day after
the Issue Date, then commencing on the day after the 120th day after the Issue
Date, additional interest shall accrue on the Private Notes over and above any
stated interest at a rate of 0.25% per annum of the principal amount of such
Private Notes for the first 90 days commencing on the 120th day after the Issue
Date, such additional interest rate increasing by an additional 0.25% per annum
at the beginning of each subsequent 90-day period. If neither the Exchange Offer
Registration Statement nor the Shelf Registration Statement is declared
effective on or prior to the 180th day after the Issue Date, then commencing on
the 180th day after the Issue Date, additional interest shall accrue on the
Private Notes over and above any stated interest at a rate of 0.25%
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<PAGE>
per annum of the principal amount of such Private Notes for the first 90 days
immediately following the 120th day after the Issue Date, such additional
interest rate increasing by an additional 0.25% per annum at the beginning of
each subsequent 90-day period. If (A) the Company has not exchanged Exchange
Notes for all Private Notes validly tendered in accordance with the terms of the
Exchange Offer on or prior to the 210th day after the Issue Date, (B) if
applicable, a Shelf Registration Statement has been declared effective and such
Shelf Registration Statement ceases to be effective at any time prior to the
date which is 36 months after the Issue Date and is not declared effective again
within 5 business days, (C) pending the announcement of a material corporate
transaction, the Company issues a written notice that a Shelf Registration
Statement or Exchange Offer Registration Statement is unusable and the aggregate
number of days in any 365-day period for which all such notices issued or
required to be issued, have been, or were required to be, in effect exceeds 120
days in the aggregate or 30 days consecutively, in the case of a Shelf
Registration Statement, or 15 days in the aggregate in the case of an Exchange
Offer Registration Statement, then additional interest shall accrue on the
Private Notes over and above any stated interest at a rate of 0.25% per annum of
the principal amount of such Private Notes for the first 90 days commencing on
the (x) 210th day after the date hereof, in the case of (A) above, (y) the day
such Shelf Registration Statement ceases to be effective without being declared
effective again within 5 business days in the case of (B) above, or (z) the day
the Exchange Offer Registration Statement or Shelf Registration Statement ceased
to be usable in case of clause (C) above, such additional interest rate
increasing by an additional 0.25% per annum at the beginning of each such
subsequent 90-day period; PROVIDED, HOWEVER, that the additional interest rate
on the Private Notes may not exceed at any one time in the aggregate 1.00% per
annum; and PROVIDED, FURTHER, that (1) upon the filing of the Exchange Offer
Registration Statement or Shelf Registration Statement (in the case of (i)
above), (2) upon the effectiveness of the Exchange Offer Registration Statement
or Shelf Registration Statement (in the case of (ii) above), or (3) upon the
exchange of Exchange Notes for all Private Notes tendered (in the case of (iii)
(A) above), or upon effectiveness of a Shelf Registration Statement which had
ceased to remain effective (in the case of (iii) (B) above), additional interest
on the Private Notes as a result of such clause (or the relevant subclause
thereof), as the case may be, shall cease to accrue.
If the Company effects the Exchange Offer Registration Statement, it will be
entitled to close the Exchange Offer Registration Statement 30 calendar days
after the commencement thereof; PROVIDED that it has accepted all Private Notes
theretofore validly surrendered in accordance with the terms of the Exchange
Offer Registration Statement. Private Notes not tendered in the Exchange Offer
Registration Statement will bear interest at the rate set forth on the cover
page of the Offering Circular dated July 15, 1997 and be subject to all of the
terms and conditions specified in the Indenture and to the transfer restrictions
described therein under the caption "Notice to Investors."
Following the completion of the Exchange Offer, Holders of the Private Notes
not tendered will not have any further registration rights and those Private
Notes will continue to be subject to certain restrictions on transfer.
Accordingly, the liquidity of the market for a Holder's Private Notes could be
adversely affected upon completion of the Exchange Offer if such Holder does not
participate in the Exchange Offer. See "Risk Factors -- Failure to Exchange
Private Notes."
Each Holder participating in the Exchange Offer Registration Statement shall
be required to represent to the Company that at the time of the consummation of
the Exchange Offer Registration Statement (i) any Exchange Notes received by
such Holder will be acquired in the ordinary course of its business, (ii) such
Holder will have no arrangements or understanding with any person to participate
in the distribution of the Private Notes or Exchange Notes within the meaning of
the Securities Act, (iii) such Holder is not an "affiliate" (as defined in Rule
405 of the Securities Act) of the Company, or if it is an affiliate, such Holder
will comply with the registration and prospectus delivery requirements of the
Securities Act to the extent applicable, (iv) if such Holder is not a
broker-dealer, that it is not engaged in, and does not intend to engage in, the
distribution of the Exchange Notes and (v) if such Holder is a broker-dealer,
that it will receive Exchange Notes for its own account in exchange for Private
Notes that
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<PAGE>
were acquired as a result of market-making activities or other trading
activities and that it will be required to acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes.
Under existing Commission interpretations, the Exchange Notes would, in
general, be freely transferable after the Exchange Offer without further
registration under the Securities Act; PROVIDED that, in the case of
broker-dealers participating in the Exchange Offer, a prospectus meeting the
requirements of the Securities Act is delivered upon resale by such
broker-dealers in connection with resales of the Exchange Notes. The Company has
agreed, for a period of 180 days after the consummation of the Exchange Offer,
to make available a prospectus meeting the requirements of the Securities Act to
any such broker-dealer for use in connection with any resale of any Exchange
Note acquired in the Exchange Offer. A broker-dealer which delivers such a
prospectus to purchasers in connection with such resales will be subject to
certain of the civil liability provisions under the Securities Act and will be
bound by the provisions of the Registration Rights Agreement, including certain
indemnification obligations. Any Holder who tenders in the Exchange Offer for
the purpose of participating in a distribution of the Exchange Notes cannot rely
on this interpretation by the Commission's staff and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with a secondary resale transaction.
This Prospectus, together with the accompanying Letter of Transmittal, is
being sent to all registered Holders of Private Notes as of January 15, 1998
(the "Record Date"). The Company intends to conduct the Exchange Offer in
accordance with the applicable requirements of the Exchange Act and the rules
and regulations of the Commission promulgated thereunder.
The Company shall be deemed to have accepted validly tendered Private Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. See "-- Exchange Agent." The Exchange Agent will act as agent
for the tendering Holders for the purpose of receiving Exchange Notes from the
Company and delivering Exchange Notes to such Holders.
If any tendered Private Notes are not accepted for exchange because of an
invalid tender or the occurrence of certain other events set forth herein, such
unaccepted Private Notes will be returned, without expense, to the tendering
Holder thereof as promptly as practicable after the Expiration Date.
Holders who tender Private Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Private
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than certain applicable taxes, in connection with the Exchange
Offer. See "-- Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 5:00 p.m., New York City time, on
February 27, 1998, unless the Company, in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date and time to which the Exchange Offer is extended. In the event that the
Exchange Offer is extended, it will remain in effect for a minimum of an
additional five business days and a maximum of an additional 10 business days.
In order to extend the Expiration Date, the Company will notify the Exchange
Agent of any extension by oral or written notice and will mail to the registered
Holders of Private Notes an announcement thereof, each prior to 5:00 p.m., New
York City time, on the next business day after the previously scheduled
Expiration Date. Such announcement may state that the Company is extending the
Exchange Offer for a specified period of time.
The Company reserves the right, in its sole discretion, (i) to delay
acceptance of any Private Notes, to extend the Exchange Offer or to terminate
the Exchange Offer and to refuse to accept Private Notes not previously
accepted, if any of the conditions set forth herein under "-- Termination" shall
have occurred and shall not have been waived by the Company (if permitted to be
waived by the Company), by giving oral
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<PAGE>
or written notice of such delay, extension or termination to the Exchange Agent,
and (ii) to amend the terms of the Exchange Offer in any manner. Any such delay
in acceptance, extension, termination or amendment will be followed as promptly
as practicable by oral or written notice thereof. If the Exchange Offer is
amended in a manner determined by the Company to constitute a material change,
the Company will promptly disclose such amendment in a manner reasonably
calculated to inform the Holders of such amendment.
Without limiting the manner in which the Company may choose to make public
announcements of any delay in acceptance, extension, termination or amendment of
the Exchange Offer, the Company shall have no, and as required by the Securities
Act, obligation to publish, advertise, or otherwise communicate any such public
announcement, other than by making a timely release to the Dow Jones News
Service.
INTEREST ON THE EXCHANGE NOTES
Interest will be paid on the Private Notes on February 1, 1998 to Holders of
record of the Private Notes on January 15, 1998. Interest on the Exchange Notes
will accrue from February 1, 1998 (the last Interest Payment Date on which
interest was paid on the Private Notes so surrendered). Holders who exchange
their Private Notes for Exchange Notes will receive the same interest payment on
May 1, 1998 (the first interest payment date with respect to the Exchange Notes
assuming the Expiration Date is not extended beyond such date) that they would
have received had they not accepted the Exchange Offer. In the event that the
Exchange Offer is extended beyond May 1, 1998 or is not consummated, Holders of
Private Notes will receive the interest payments set forth on the face of such
notes, together with Additional Interest, if any, as set forth in the
Registration Rights Agreement.
PROCEDURES FOR TENDERING
Only a Holder of Private Notes may tender its Private Notes in the Exchange
Offer, except as set forth in the following two paragraphs. To tender in the
Exchange Offer, a Holder must complete, sign and date the Letter of Transmittal,
or a copy thereof, have the signatures thereof guaranteed if required by the
Letter of Transmittal, and mail or otherwise deliver such Letter of Transmittal
or such copy, together with any corresponding certificate or certificates
representing the Private Notes (unless such tender is being effected pursuant to
the procedure for book-entry transfer described below) and any other required
documents, to the Exchange Agent, prior to 5:00 p.m., New York City time, on the
Expiration Date.
Any financial institution that is a participant in DTC's Book-Entry Transfer
Facility system may make book-entry delivery of the Private Notes by causing DTC
to transfer such Private Notes into the Exchange Agent's account in accordance
with the DTC's procedure for such transfer. Although delivery of Private Notes
may be effected through book-entry transfer into the Exchange Agent's account at
the DTC, the Letter of Transmittal (or copy thereof) with any required signature
guarantees and any other required documents, must, in any case, be transmitted
to and received or confirmed by the Exchange Agent at its addresses set forth
herein under "-- Exchange Agent" prior to 5:00 p.m., New York City time, on the
Expiration Date. DELIVERY OF DOCUMENTS TO DTC IN ACCORDANCE WITH ITS PROCEDURES
DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE AGENT.
If delivery of the Private Notes is to be made by book-entry transfer to the
account maintained by the Exchange Agent at the DTC, the Letter of Transmittal
need not be manually executed; PROVIDED, HOWEVER, that tenders of Private Notes
must be effected in accordance with the procedures mandated by ATOP. To tender
Private Notes through ATOP, the electronic instructions sent to DTC and
transmitted by DTC to the Exchange Agent must contain the character by which the
participant acknowledges its receipt of and agrees to be bound by the Letter of
Transmittal.
The tender by a Holder of Private Notes will constitute an agreement between
such Holder and the Company in accordance with the terms and subject to the
conditions set forth herein and in the Letter of Transmittal.
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Delivery of all documents must be made to the Exchange Agent at its address
set forth herein. Holders may also request that their respective brokers,
dealers, commercial banks, trust companies or nominees effect such tender for
such Holders.
The method of delivery of Private Notes and the Letter of Transmittal and
all other required documents to the Exchange Agent is at the election and risk
of the Holders. Instead of delivery by mail, it is recommended that Holders use
an overnight or hand delivery service. In all cases, sufficient time should be
allowed to assure timely delivery. No Letter of Transmittal or Private Notes
should be sent to the Company.
Any owner of a beneficial interest in an Old Global Note holding through a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender in the Exchange Offer should contact such entity through which it
holds such beneficial interest promptly and instruct such entity to tender on
his behalf.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by a member firm of a registered national securities
exchange or of the National Association of Securities Dealers, Inc., a
commercial bank or trust company having an office or correspondent in the United
States or an "eligible guarantor institution" within the meaning of Rule 17Ad-15
under the Exchange Act (an "Eligible Institution") unless the Private Notes
tendered pursuant thereto are tendered (i) by a registered Holder who has not
completed the box entitled "Special Issuance Instructions" or "Special Delivery
Instructions" of the Letter of Transmittal or (ii) for the account of an
Eligible Institution.
If the Letter of Transmittal is signed by a person other than the registered
Holder listed therein, such Private Notes must be endorsed or accompanied by
appropriate bond powers which authorize such person to tender the Private Notes
on behalf of the registered Holder, in either case signed as the name of the
registered Holder or Holders appears on the Private Notes.
If the Letter of Transmittal or any Private Notes or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with this Letter of Transmittal.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of the tendered Private Notes will be
determined by the Company in its sole discretion, which determination will be
final and binding. The Company reserves the absolute right to reject any and all
Private Notes not property tendered or any Private Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the absolute right to waive any defects,
irregularities or conditions of tender as to particular Private Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Private Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify Holders of
defects or irregularities with respect to tenders of Private Notes, neither the
Company, the Exchange Agent nor any other person shall be under any duty to give
notification of defects or irregularities with respect to tenders of Private
Notes nor shall any of them incur any liability for failure to give such
notification. Tenders of Private Notes will not be deemed to have been made
until such irregularities have been cured or waived. Any Private Notes received
by the Exchange Agent that are not properly tendered and as to which the defects
or irregularities have not been cured or waived will be returned without cost by
the Exchange Agent to the tendering Holder unless otherwise provided in the
Letter of Transmittal, as soon as practicable following the Expiration Date.
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<PAGE>
In addition, the Company reserves the right in its sole discretion to
purchase or make offers for any Private Notes that remain outstanding subsequent
to the Expiration Date, or, as set forth under "-- Termination," to terminate
the Exchange Offer.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Private Notes and (i) whose Private Notes
are not immediately available, or (ii) who cannot deliver their Private Notes,
the Letter of Transmittal or any other required documents to the Exchange Agent
prior to the Expiration Date, or cannot complete the procedure for book-entry
transfer on a timely basis, may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent received from such
Eligible Institution a properly completed and duly executed Letter of
Transmittal and Notice of Guaranteed Delivery, substantially in the form
provided by the Company (by facsimile transmission, mail or hand delivery)
setting forth the name and address of the Holder of Private Notes, the
certificate number or numbers, if any, of such Holder's Private Notes and
the principal amount of such Private Notes tendered, stating that the tender
is being made thereby, and guaranteeing that, within five business days
after the Expiration Date, the Letter of Transmittal (or copy thereof),
together with the certificate(s) representing the Private Notes to be
tendered in prior form for transfer and any other documents required by the
letter of Transmittal, will be deposited by the Eligible Institution with
the Exchange Agent; and
(c) such properly completed and executed Letter of Transmittal (or copy
thereof), together with the certificate(s) representing all physically
tendered Private Notes in proper form for transfer (or confirmation of a
book-entry transfer into the Exchange Agent's account at the DTC of Private
Notes delivered electronically) and all other documents required by the
Letter of Transmittal are received by the Exchange Agent within five
business days after the Expiration Date.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Private Notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the Expiration
Date.
To withdraw a tender of Private Notes in the Exchange Offer, a written,
facsimile or electronic ATOP (for DTC participants) transmission notice of
withdrawal must be received by the Exchange Agent at its address set forth
herein prior to 5:00 p.m., New York City time, on the Expiration Date and prior
to acceptance for exchange thereof by the Company. Any such notice of withdrawal
must (i) specify the name of the person having deposited the Private Notes to be
withdrawn (the "Depositor"), (ii) identify the Private Notes to be withdrawn
(including the certificate number or numbers and principal amount of such
Private Notes), (iii) be signed by the Depositor in the same manner as the
original signature on the Letter of Transmittal by which such Private Notes were
tendered (including any required signature guarantee) or be accompanied by
documents of transfer sufficient to permit the Trustee with respect to the
Private Notes to register the transfer of such Private Notes into the name of
the Depositor withdrawing the tender and (iv) specify the name in which any such
Private Notes are to be registered, if different from that of the Depositor. All
questions as to the validity, form and eligibility (including time of receipt)
of such withdrawal notices will be determined by the Company, whose
determination shall be final and binding on all parties. Any Private Notes so
withdrawn will be deemed not to have been validly tendered for purposes of the
Exchange Offer and no Exchange Notes will be issued with respect thereto unless
the Private Notes so withdrawn are validly tendered as set forth under
"--Procedures for Tendering." Any Private Notes that have been tendered for
exchange but are not accepted for exchange will be returned to the Holder
thereof without cost to such Holder as soon as practicable after withdrawal,
rejection of tender or termination of the Exchange Offer. Properly withdrawn
Private Notes may be rendered by following one of the procedures described above
under "-- Procedures for Tendering" at any time prior to the Expiration Date.
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TERMINATION
Notwithstanding any other term of the Exchange Offer, the Company will not
be required to accept for exchange, or exchange Exchange Notes for, any Private
Notes not theretofore accepted for exchange, and may terminate or amend the
Exchange Offer as provided herein before the acceptance of such Private Notes if
(i) any injunction, order or decree shall have been issued by any court or by or
before any governmental agency with respect to the Exchange Offer, which, in the
Company's judgment, would materially impair the Company's ability to proceed
with the Exchange Offer, or (ii) any law, statute, rule or regulation is
proposed, adopted or enacted, or any existing law, statute, rule or regulation
is interpreted by the staff of the Commission in a manner which, in the
Company's sole judgment, might materially impair the Company's ability to
proceed with the Exchange Offer, or (iii) any governmental approval or approval
by Holders has not been obtained, which approval the Company shall, in its
reasonable judgment, deem necessary for the consummation of the Exchange Offer
as contemplated hereby.
If the Company determines that it may terminate the Exchange Offer, as set
forth above, the Company may (i) refuse to accept any Private Notes and return
any Private Notes that have been tendered to the Holders thereof, (ii) extend
the Exchange Offer and retain all Private Notes tendered prior to the Expiration
Date of the Exchange Offer, subject to the rights of such Holders of tendered
Private Notes to withdraw their tendered Private Notes, or (iii) waive such
termination event with respect to the Exchange Offer and accept all properly
tendered Private Notes that have not been withdrawn. If such waiver constitutes
a material change in the Exchange Offer, the Company will disclose such change
by means of a supplement to this Prospectus that will be distributed to each
registered Holder, and the Company will extend the Exchange Offer for a period
of five to ten business days, depending upon the significance of the waiver and
the manner of disclosure to the registered Holders, if the Exchange Offer would
otherwise expire during such period.
Holders of Private Notes will have certain rights against the Company under
the Registration Rights Agreement should the Company fail to consummate the
Exchange Offer.
EXCHANGE AGENT
All executed Letters of Transmittal should be directed to the Exchange
Agent. State Street Bank and Trust Company, the Trustee under the Indenture, has
been appointed as Exchange Agent for the Exchange Offer. Questions and requests
for assistance should be directed to the Exchange Agent as follows:
<TABLE>
<S> <C>
BY MAIL: BY HAND OR OVERNIGHT COURIER:
State Street Bank and Trust Company State Street Bank and Trust Company
P.O. Box 778 Two International Place, 4th Floor
Boston, Massachusetts 02102 Boston, Massachusetts 02110
Attention: Corporate Trust/Transfer Unit Attention: Corporate Trust
Telephone: (617) 664-5326 Department/Transfer
Unit
Telephone: (617) 664-5326
</TABLE>
Questions and requests for assistance and requests for additional copies of
this Prospectus or of the Letter of Transmittal should be directed to the
Company as follows:
BY MAIL, HAND OR OVERNIGHT COURIER:
Discovery Zone, Inc.
565 Taxter Road, Fifth Floor
Elmsford, New York 10523
Attention: Andrew M. Smith
Telephone: (914) 345-4500
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FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Company. The principal solicitation for tenders pursuant to the
Exchange Offer is being made by mail. Additional solicitations may be made by
officers and regular employees of the Company and their affiliates in person, by
facsimile, telegraph, telephone or telecopier.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or other
persons soliciting acceptances of the Exchange Offer. The Company, however, will
pay the Exchange Agent reasonable and customary fees for its services and will
reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith. The Company may also pay brokerage houses and other
custodians, nominees and fiduciaries the reasonable out-of-pocket expenses
incurred by them in forwarding copies of this Prospectus, Letters of Transmittal
and related documents to the beneficial owners of the Private Notes and in
handling or forwarding tenders for exchange.
The expenses to be incurred in connection with the Exchange Offer, including
fees and expenses of the Exchange Agent and Trustee and accounting and legal
fees, will be paid by the Company.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Private Notes pursuant to the Exchange Offer. If, however, certificates
representing Exchange Notes or Private Notes for principal amounts not tendered
or accepted for exchange are to be delivered to, or are to be registered or
issued in the name of, any person other than the registered Holder of the
Private Notes tendered, or if tendered Private Notes are registered in the name
of any person other than the person signing the Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of Private Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering Holder. If satisfactory evidence of payment of such taxes or
exemption therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to such tendering Holder.
CONSEQUENCES OF FAILURE TO EXCHANGE
The Private Notes that are not exchanged for Exchange Notes pursuant to the
Exchange Offer will remain restricted securities within the meaning of Rule 144
of the Securities Act. Accordingly, such Private Notes may be resold only (i) to
the Company or any subsidiary thereof, (ii) inside the United States to a
qualified institutional buyer in compliance with Rule 144A, (iii) inside the
United States to an institutional accredited investor that, prior to such
transfer, furnishes to the Trustee a signed letter containing certain
representations and agreements relating to the restrictions on transfer of the
Private Notes (the form of which letter can be obtained from the Trustee) and,
if such transfer is in respect of an aggregate principal amount of Private Notes
at the time of transfer of less than $100,000, an opinion of counsel acceptable
to the Company that such transfer is in compliance with the Securities Act, (iv)
outside the United States in compliance with Rule 904 under the Securities Act,
(v) pursuant to the exemption from registration provided by Rule 144 under the
Securities Act (if available), or (vi) pursuant to an effective registration
statement under the Securities Act. The liquidity of the Private Notes could be
adversely affected by the Exchange Offer. Following the consummation of the
Exchange Offer, holders of the Private Notes will have no further registration
rights under the Registration Rights Agreement and will not be entitled to the
contingent increase in the interest rate provided for in the Private Notes.
ACCOUNTING TREATMENT
The Exchange Notes would be recorded at the same carrying value as the
Private Notes, as reflected in the Company's accounting records on the date of
the exchange. Accordingly, no gain or loss for accounting purposes will be
recognized by the Company upon the consummation of the Exchange Offer.
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The costs of the Exchange Offer and the unamortized expenses related to the
issuance of the Private Notes will be amortized over the term of the Exchange
Notes.
USE OF PROCEEDS
The Company will not receive any proceeds from the issuance of the Exchange
Notes pursuant to the Exchange Offer. In consideration for issuing the Exchange
Notes as contemplated in this Prospectus, the Company will receive in exchange
Private Notes in like principal amount, the term and form of which are identical
in all material respects to the Exchange Notes. The Private Notes surrendered in
exchange for Exchange Notes will be retired and cancelled and cannot be
reissued. Accordingly, issuance of the Exchange Notes will not increase the
indebtedness of the Company.
The net proceeds from the offering of the Private Notes together with the
proceeds from the offering of Convertible Preferred Stock were $93.8 million
after deducting selling commissions and estimated fees and expenses. Of those
net proceeds, the Company used (i) approximately $21.6 million to purchase a
portfolio of Pledged Securities, which consists of U.S. Treasury Securities that
were pledged as security for the scheduled interest payments on the Notes
through August 1, 1999, and (ii) approximately $45.5 million to repay all
outstanding borrowings under the DIP Facilities and pay certain other
bankruptcy-related claims and expenses. The remaining net proceeds of
approximately $26.7 million will be used to finance capital expenditures, for
working capital and for general corporate purposes. See "Company Background" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
34
<PAGE>
COMPANY BACKGROUND
PRE-CHAPTER 11 REORGANIZATION
Discovery Zone, Inc. 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 1994 the Company acquired, among other businesses: (i) the 48-store Leaps
and Bounds, Inc. ("Leaps and Bounds"), a wholly owned subsidiary of McDonald's
Corporation ("McDonald's"); (ii) the Blockbuster Children's Amusement
Corporation, the Tumble For Fun Limited Partnership and Blockbuster Children's
Amusement Canada Corporation which, together, operated 60 franchised locations;
and (iii) Semborg Corp., a company that developed robotics and interactive
technology. 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 in the first nine months of 1997.
The Company financed its growth, including the acquisitions described above,
primarily through the issuance of debt securities, including an offering of
4.75% Liquid Yield Option Notes (the "LYONs") for net proceeds of $111 million
and the incurrence of a $175 million five-year revolving credit facility in
December 1994. In addition, the Company raised net proceeds of $55 million in
June 1993 through an initial public offering of its common stock. Just prior to
such offering, Blockbuster acquired 19.9% of the Company's common stock
(subsequently increased to 49.9% through the exercise of stock options). In
September 1994, Blockbuster 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 January 12, 1996, the Company received an interim working capital loan
from one of its lenders of up to $10.0 million, guaranteed by Viacom, to finance
the Company's working capital needs. Upon maturity on February 6, 1996, the
Company did not repay when due outstanding principal of $7.5 million and accrued
interest on such loan, which amount was paid by Viacom pursuant to its
guarantee.
On March 25, 1996, Discovery Zone, Inc. and all of its domestic subsidiaries
(collectively, for the period during which the Company was under Chapter 11, the
"Discovery Zone Group") filed voluntary petitions for relief under Chapter 11 of
the Bankruptcy Code in the Bankruptcy Court. After its Chapter 11 filing, the
Company entered into a debtor in possession credit facility (as amended, the
"DIP Facility") to provide working capital during its reorganization. The DIP
Facility was secured by substantially all of the Company's assets, provided
borrowing capacity of up to $30.0 million and required the Company to maintain
certain financial ratios. On June 6, 1997 the Discovery Zone Group and Birch
Holdings, L.L.C. ("Birch Holdings") entered into a supplemental DIP facility
(the "Supplemental DIP Facility" and, together with the DIP Facility, the "DIP
Facilities") which provided additional borrowing capacity of up to $5.0 million.
The Company repaid all indebtedness under the DIP Facilities on the Effective
Date.
Under Bankruptcy Court supervision, the Discovery Zone Group continued to
manage and operate its businesses as debtor in possession and developed the Plan
to restructure its financial affairs, including assuming or rejecting executory
contracts and leases.
EMERGENCE FROM CHAPTER 11
In November 1996, the Company and Wellspring filed the Plan with the
Bankruptcy Court which set forth a plan for repaying or otherwise compensating
the Company's creditors in order of relative seniority
35
<PAGE>
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 in each class and confirmed by the Bankruptcy Court. The Plan became
effective and the Company emerged from bankruptcy on the Effective Date.
The Plan provided, among other things, 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
pre-petition liabilities subject to compromise (excluding taxes payable, lease
assumption payments and certain other pre-petition liabilities permitted under
the Plan) to equity interests in the Company, and (iii) cancellation of all of
the pre-petition equity interests in the Company, all as more fully described in
the Plan.
The net proceeds of the issuance of the Convertible Preferred Stock and the
offering of the Private Notes were approximately $93.8 million. Of those net
proceeds, the Company (i) used approximately $45.5 million to repay all
outstanding borrowings under the DIP Facilities and pay certain other
bankruptcy-related claims and expenses, (ii) used approximately $21.6 million to
fund the Escrowed Interest Account from which the Company will pay the scheduled
interest payments on the Notes through August 1, 1999 and (iii) will use
approximately $26.7 million to finance capital expenditures, for working capital
and for general corporate purposes.
36
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
The following selected historical financial data of the Company for each of
the years in the five-year period ended December 31, 1996 and historical balance
sheet data as of December 31, 1996 have been taken or derived from the
historical audited consolidated financial statements of the Company. The
consolidated financial data as of and for the nine months ended September 30,
1996, the seven months ended July 31, 1997 and the two months ended September
30, 1997 have been derived from unaudited consolidated financial statements of
the Company and, in the opinion of the Company's management, have been prepared
on a basis consistent with the audited financial statements and include all
adjustments that are considered by management to be necessary for a fair
presentation of such financial information. Historical data and interim results
are not necessarily indicative of future results, and interim data are not
necessarily indicative of results for a full year. In accordance with Fresh
Start Accounting under GAAP, the Company restated its balance sheet accounts to
reflect an estimated fair market value upon its emergence from bankruptcy. As a
result, the Company does not believe that its historical results of operations
are necessarily indicative of its results of operations as an ongoing entity
after the Effective Date. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method of Accounting." The
information set forth below should be read in conjunction with the discussion
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
<TABLE>
<CAPTION>
(PREDECESSOR COMPANY)
NINE SEVEN
MONTHS MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED
----------------------------------------------------- SEPTEMBER 30, JULY 31,
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
(DOLLARS IN THOUSANDS EXCEPT PER SHARE
AMOUNTS)
Total revenue......................... $ 19,593 $ 61,585 $ 180,573 $ 259,490 $ 181,725 $ 147,848 $ 82,537
Cost of goods sold.................... 5,696 15,131 36,858 50,227 34,276 27,059 14,136
Store operating expenses(1)(2)(3)..... 6,331 32,010 97,631 185,587 140,486 112,741 60,192
Selling, general and administrative
expenses(2)......................... 8,750 6,300 36,451 58,201 40,779 33,230 10,235
Depreciation and amortization......... 976 4,670 16,183 31,972 21,876 16,204 11,920
Restructuring and other charges....... 2,486 -- 14,024 372,160 -- -- --
--------- --------- --------- --------- --------- ------------- -----------
Operating income (loss)............... (4,586) 3,474 (20,574) (438,657) (55,692) (41,386) (13,946)
Interest expense...................... (489) (1,667) (5,137) (12,226) (6,277) (4,978) (3,957)
Other income (expense), net........... 103 1,499 2,331 476 (580) 435 159
Minority interest..................... -- -- 256 5,162 -- -- --
Reorganization costs.................. -- -- -- -- 21,285 12,436 12,165
--------- --------- --------- --------- --------- ------------- -----------
Income (loss) before income tax,
cumulative effect of change in
accounting method, extraordinary
item and accretion of Preferred
Stock............................... (4,969) 3,306 (23,124) (445,245) (83,834) (58,365) (29,909)
Income tax provision (benefit)........ -- -- (4,000) 4,000 -- -- --
Cumulative effect of change in
accounting method................... -- -- 5,773 -- -- -- --
Extraordinary item-gain on discharge
of debt............................. -- -- -- -- -- -- 332,165
Accretion of convertible redeemable
preferred stock to redemption
value............................... -- -- -- -- -- -- --
--------- --------- --------- --------- --------- ------------- -----------
Net income (loss) applicable to common
shareholders........................ $ (4,969) $ 3,306 $ (24,897) $(449,245) $ (83,834) $ (58,365) $ 302,256
--------- --------- --------- --------- --------- ------------- -----------
--------- --------- --------- --------- --------- ------------- -----------
Per common and common equivalent
share:
Income (loss) before cumulative
effect of change in method of
accounting and extraordinary
item.............................. $ (0.14) $ 0.08 $ (0.41) $ (8.06) $ (1.45) $ (1.01) $ (0.52)
Cumulative effect of change in
accounting method................. -- -- (0.12) -- -- -- --
Extraordinary item--gain on
discharge of debt................. -- -- -- -- -- -- 5.76
--------- --------- --------- --------- --------- ------------- -----------
Net income (loss)................... $ (0.14) $ 0.08 $ (0.53) $ (8.06) $ (1.45) $ (1.01) $ 5.24
--------- --------- --------- --------- --------- ------------- -----------
--------- --------- --------- --------- --------- ------------- -----------
Weighted average number of common and
common equivalent shares
outstanding......................... 34,776 42,025 46,797 55,706 57,691 57,698 57,705
<CAPTION>
(SUCCESSOR
COMPANY)
TWO MONTHS
ENDED
SEPTEMBER 30,
1997
-------------
<S> <C>
STATEMENT OF OPERATIONS DATA:
(DOLLARS IN THOUSANDS EXCEPT PER SHARE
AMOUNTS)
Total revenue......................... $ 19,914
Cost of goods sold.................... 3,057
Store operating expenses(1)(2)(3)..... 16,879
Selling, general and administrative
expenses(2)......................... 3,872
Depreciation and amortization......... 3,981
Restructuring and other charges....... --
-------------
Operating income (loss)............... (7,875)
Interest expense...................... (2,468)
Other income (expense), net........... 598
Minority interest..................... --
Reorganization costs.................. --
-------------
Income (loss) before income tax,
cumulative effect of change in
accounting method, extraordinary
item and accretion of Preferred
Stock............................... (9,745)
Income tax provision (benefit)........ --
Cumulative effect of change in
accounting method................... --
Extraordinary item-gain on discharge
of debt............................. --
Accretion of convertible redeemable
preferred stock to redemption
value............................... (39)
-------------
Net income (loss) applicable to common
shareholders........................ $ (9,784)
-------------
-------------
Per common and common equivalent
share:
Income (loss) before cumulative
effect of change in method of
accounting and extraordinary
item.............................. $ (2.45)
Cumulative effect of change in
accounting method................. --
Extraordinary item--gain on
discharge of debt................. --
-------------
Net income (loss)................... $ (2.45)
-------------
-------------
Weighted average number of common and
common equivalent shares
outstanding......................... 4,000
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
(PREDECESSOR COMPANY)
NINE SEVEN
MONTHS MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED
----------------------------------------------------- SEPTEMBER 30, JULY 31,
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER DATA:
(DOLLAR IN THOUSANDS)
Cash provided by (used in)
operations.......................... $ (662) $ 19,860 $ (4,481) $ (59,103) $ (39,888) $ (32,014) $ (12,118)
Cash provided by (used in) investing
activities.......................... (7,791) (95,868) (121,972) (64,562) 3,805 4,760 (468)
Cash provided by financing
activities.......................... 15,786 185,496 16,162 121,729 33,460 26,736 51,798
--------- --------- --------- --------- --------- ------------- -----------
Net cash flows........................ 7,333 109,488 (110,291) (1,936) (2,623) (518) 39,212
EBITDA(4)............................. (1,183) 8,144 (4,391) (406,685) (55,101) (37,618) (14,191)
Capital expenditures.................. 6,352 88,336 119,134 51,732 2,672 1,717 567
STORE DATA:
Company owned stores at
period-end(5)....................... 19 111 318 321 212 232 210
Franchised stores at period-end(6).... 38 57 29 15 7 7 --
--------- --------- --------- --------- --------- ------------- -----------
Total stores at period-end............ 57 168 347 336 219 239 210
OPERATING RATIO:
EBITDA/total interest expense(7)...... -- 4.88 -- -- -- -- --
Ratio of earnings to fixed
charges(8).......................... -- 2.8 -- -- -- -- --
<CAPTION>
(SUCCESSOR
COMPANY)
TWO MONTHS
ENDED
SEPTEMBER 30,
1997
-------------
<S> <C>
OTHER DATA:
(DOLLAR IN THOUSANDS)
Cash provided by (used in)
operations.......................... $ (12,036)
Cash provided by (used in) investing
activities.......................... (262)
Cash provided by financing
activities.......................... 0
-------------
Net cash flows........................ (12,298)
EBITDA(4)............................. (3,894)
Capital expenditures.................. 218
STORE DATA:
Company owned stores at
period-end(5)....................... 208
Franchised stores at period-end(6).... --
-------------
Total stores at period-end............ 208
OPERATING RATIO:
EBITDA/total interest expense(7)...... --
Ratio of earnings to fixed
charges(8).......................... --
</TABLE>
<TABLE>
<CAPTION>
(SUCCESSOR
(PREDECESSOR COMPANY) COMPANY)
AS OF DECEMBER 31, AS OF
------------------------------------------------------------- SEPTEMBER 30, 1997
1992 1993 1994 1995 1996(9) (10)(11)
--------- --------- --------- --------- ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
(DOLLARS IN THOUSANDS)
Cash and cash equivalents (unrestricted)..... $ 8,544 $ 118,176 $ 7,885 $ 5,949 $ 3,326 $ 30,240
Restricted cash and investments.............. 437 -- -- -- -- 21,706
Total assets................................. 24,804 252,550 474,686 171,571 125,786 190,171
Long-term debt, including current portion.... 5,557 2,728 18,400 113,404 350,072 88,298
Redeemable Convertible Preferred Stock(12)... -- -- -- -- -- 13,839
Total stockholders' equity (deficit)
(excluding Redeemable Convertible Preferred
Stock)..................................... 10,636 98,091 238,963 (180,173) (263,572) 60,394
</TABLE>
- ------------------------
(1) Excludes depreciation and amortization and certain unallocated expenses.
(2) Net of $22.2 million, $13.6 million and $200,000 of capitalized costs
related to the Company's expansion for the years 1994, 1995 and 1996,
respectively, and $0.0 million, $0.0 million and $0.2 million for the nine
months ended September 30, 1996, the seven months ended July 31, 1997 and
the two months ended September 30, 1997, respectively.
(3) For the year ended December 31, 1992, Store Operating Expenses are estimated
for stores acquired under the pooling method.
(4) EBITDA represents net earnings (losses) before interest, income taxes,
depreciation and amortization, other income and expense, including minority
interest, extraordinary item and change in accounting method. EBITDA is
presented here to provide additional information about the Company's ability
to service the Exchange Notes. The Company believes that EBITDA provides
significant information with respect to the Company's capacity to make
payments on the Exchange Notes because it indicates the amount of cash
before non-cash charges against earnings, which would have been available to
pay the Company's obligations during the years indicated, which is not
indicated by the ratio of earnings to fixed charges. While providing useful
information, EBITDA should not be considered in isolation or as a substitute
measure of liquidity as determined under GAAP. EBITDA does not represent
funds available for dividends, reinvestment or other discretionary uses.
EBITDA is not a measure of financial performance under GAAP and should not
be considered as an alternative to (i) net income (loss) as a measure of
performance (or any other measure of performance under GAAP) or (ii) cash
flows from operating, investing or financing activities as an indicator of
cash flows or as a measure of liquidity. Additionally, because EBITDA is not
a measure of financial performance under GAAP, it may not be comparable to
similarly titled measures of other companies.
(5) Includes the Block Party Stores.
(6) The Company currently receives no royalties from its franchised stores and
rejected or terminated its arrangements with all franchisees on or prior to
the Effective Date.
(7) EBITDA was insufficient to cover the full amount of total interest expense
by $1.7 million, $9.5 million, $418.9 million and $61.4 million in each of
1992, 1994, 1995 and 1996, respectively, and $42.6 million, $18.1 million
and $6.4 million for the nine months ended September 30, 1996, the seven
months ended July 31, 1997 and the two months ended September 30, 1997,
respectively. Total interest expense does not include all fixed expenses of
the Company. See Note 12 to the Financial Statements.
(8) 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 $5.0
million, $24.1 million, $445.4 million, $83.8 million, $58.4 million, $29.9
million and $9.7 million in each of 1992, 1994, 1995 and 1996, the nine
months ended September 30, 1996, the seven months ended July 31, 1997 and
the two months ended September 30, 1997.
(9) 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 of Reorganization. See "Plan of Reorganization."
38
<PAGE>
(10) The balance sheet as of September 30, 1997 gives effect to the offering of
the Private Notes and the Plan of Reorganization, including application of
Fresh Start Accounting under GAAP. Fresh Start Accounting requires a
restatement of the Company's balance sheet accounts to reflect the estimated
fair market value of the Company on a going concern basis following the
reorganization upon its emergence from bankruptcy. See "Plan of
Reorganization" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method of Accounting."
(11) Under GAAP, $7.1 million of the proceeds of the offering of the Private
Notes were allocated to the Unit Warrants and $77.9 million of the proceeds
were allocated to the Private Notes.
(12) Reflects 1,000 shares of Convertible Preferred Stock of the Company.
39
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS RELATES TO THE COMPANY'S HISTORICAL
FINANCIAL RESULTS OF OPERATIONS AND FINANCIAL CONDITION, WITHOUT GIVING PRO
FORMA EFFECT TO THE RESTRUCTURING OF THE COMPANY WHICH OCCURRED IN CONNECTION
WITH THE PLAN OF REORGANIZATION AND THE IMPLEMENTATION OF THE TURNAROUND PLAN,
EXCEPT TO THE EXTENT THAT SUCH RESTRUCTURING HAD OCCURRED PRIOR TO THE END OF
THE PERIODS DISCUSSED. AS A RESULT, MANAGEMENT DOES NOT BELIEVE THAT RESULTS OF
OPERATIONS IN FUTURE PERIODS WILL BE COMPARABLE TO PRIOR PERIODS. THIS
DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE "SELECTED
HISTORICAL FINANCIAL DATA" AND THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS
AND THE NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS.
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 206
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 was
established in 1989 and grew from 28 FunCenters in 1991 to 336 company-owned and
franchised FunCenters by the end of 1995, primarily as a result of acquisitions
of competitors and construction of new FunCenters financed with bank debt and
public offerings of debt and equity securities. This rapid expansion resulted in
a loss of control over costs and quality at both the store and corporate levels
which diminished customer service, reduced store operating margins and caused
selling, general and administrative expenses to increase dramatically.
The Company generates revenue primarily from the operation of 206
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 has
continued since the Effective Date. Among other factors, comparable store
revenues declined because (i) the Company shortened FunCenter operating hours by
approximately 18% to curtail operations during unprofitable time periods, (ii)
the Company reduced its marketing expenditures (see below) and (iii) the Company
did not update its product offering during the Company's reorganization in
bankruptcy.
The Company believes that growth in its revenues will eventually result from
enhanced entertainment value provided by new product offerings, improvement in
food and beverage offerings, increased utilization of FunCenters during weekdays
and other off-peak times and, to a lesser extent, from the construction or
acquisition of new FunCenters. The Company expects to renovate approximately 60%
of its FunCenters and convert approximately 80% of its FunCenters to permit the
sale of Pizza Hut menu items by the end of January 1998, and relaunch the brand
during the first quarter of 1998. See "Business -- Business Strategy and
Turnaround Plan." Management expects that as a result of these efforts, revenues
will increase on a comparable store basis.
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 has
generated additional annual cost savings at the store level through cost
management measures and improved financial controls implemented in connection
with Phase 1 of the Turnaround Plan. See "Business -- Business Strategy and
Turnaround Plan."
The Company's selling, general and administrative expenses include salaries,
bankruptcy-related costs, corporate and regional management expenses and other
administrative, promotional and advertising
40
<PAGE>
expenses. In connection with the Turnaround Plan, the Company expects to reduce
its annual selling, general and administrative expenses in 1997 to a level which
is approximately $20 million less than in 1996. See "Business -- Business
Strategy and Turnaround Plan -- Phase 1." Interest expense (including
contractual interest on the Pre-petition Indebtedness (as defined below)) has
declined substantially during the seven months ended July 31, 1997 from prior
years as a result of the discharge or restructuring of substantially all of the
Pre-petition Indebtedness in connection with the Plan of Reorganization. See
"Plan of Reorganization."
The Company accrued substantial restructuring costs, including costs related
to the relocation of the Company's headquarters, the termination of certain
managers and employees and the rejection of certain store leases. A portion of
these restructuring costs were discharged in connection with the Plan of
Reorganization and other amounts were repaid with the proceeds of the offering
of the Private Notes and the Convertible Preferred Stock. See "Plan of
Reorganization."
RESULTS OF OPERATIONS
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996.
Upon emergence from its Chapter 11 proceeding, the Company adopted fresh
start accounting. See "Changes in Method of Accounting." 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 nine months ended September 30, 1997 include the results of the
Predecessor Company for the seven months ended July 31, 1997 and the Successor
Company for the two months ended September 30, 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. Total revenue was $102.4 million versus $147.8 million during the
nine months ended September 30, 1997 and 1996, respectively. The decline during
the 1997 period as compared to the 1996 period was attributable to a reduction
in the number of FunCenters in operation and a reduction in average sales per
FunCenter. The decrease in same store average sales per FunCenter of
approximately 15% was primarily due to disruptions in the business associated
with the Company's bankruptcy filing, reduced and ineffective marketing programs
and a lack of new attractions at the FunCenters.
COST OF GOODS SOLD. Costs of goods sold which consists primarily of the
cost of food, redemption merchandise and other product sales, was $17.2 million
in the nine months ended September 30, 1997 as compared with $27.0 million in
the nine months ended September 30, 1996. As a percentage of revenue, costs of
goods sold declined from 18.3% in the 1996 period to 16.8% in the 1997 period.
This reduction was primarily attributable to simplified product offerings and
better cost management during the 1997 period.
STORE OPERATING EXPENSES. Store operating expenses, which consist primarily
of compensation and benefits for FunCenter operating personnel, occupancy
expenses and facility repair and maintenance expenses were $77.1 million in the
nine months ended September 30, 1997 as compared with $112.8 million in the nine
months ended September 30, 1996. As a percentage of total revenues, store
operating expenses increased from 75.2% in the 1996 period to 76.3% in the 1997
period. The increase as a percentage of revenue is due to a decline in revenues
offset by the implementation of labor planning, lower rent from renegotiated
leases, reductions in central reservation expenses and other cost savings
generated through Phase I of the Company's Turnaround Plan.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $14.1 million versus $33.2 million in the nine
months ended September 30, 1997 and 1996, respectively. As
41
<PAGE>
a percentage of revenue, selling, general and administrative expenses declined
from 22.5% in the 1996 period to 13.7% in the 1997 period. The decrease reflects
the reduction in corporate staff, and related expenses and lower marketing
expenses, combined with a general reduction in spending due to a reduction in
the number of FunCenters, as implemented in Phase 1 of the Company's Turnaround
Plan. See "Business -- Business Strategy and Turnaround Plan."
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense was $15.9 million for the nine months ended September 30, 1997 as
compared with $16.2 million for the nine months ended September 30, 1996. The
decline resulted primarily from a reduction in the number of FunCenters in
operation, offset by an increase during the two months ended September 30, 1997,
attributable to an increase in the Company's plant and equipment as a result of
adopting Fresh Start Accounting for the Successor Company.
INTEREST EXPENSE. Interest expense consisted primarily of accrued interest
on (i) the outstanding LYONS, the Company's subordinated convertible debt and
borrowings under the Company's Pre-petition credit facility (collectively, the
"Pre-petition Indebtedness") through March 25, 1996, (ii) borrowings under the
DIP Facilities, and (iii) after the Effective Date, borrowings under the Private
Notes, the McDonald's Notes and the Pre-petition Taxes Payable obligations, and
was $6.4 million for the nine months ended September 30, 1997 as compared with
$5 million for the nine months ended September 30, 1996. These amounts do not
reflect interest on the Pre-petition Indebtedness which was suspended during the
Company's reorganization under Chapter 11. Had these payments not been
suspended, interest expense would have been $15.6 million and $13.0 million for
the 1997 and 1996 periods, respectively.
REORGANIZATION COSTS. Reorganization costs of $12.2 million versus $12.4
million were incurred by the Company during its reorganization under Chapter 11
for the nine months ended September 30, 1997 and 1996, respectively, including
$3.2 million and $5.2 million incurred for professional fees in the 1997 and
1996 periods, respectively. The remainder was primarily attributable to losses
on asset disposals associated with the closing of FunCenters, write-off of
deferred financing costs on certain Pre-petition Indebtedness and expenses
associated with the Plan of Reorganization.
EXTRAORDINARY ITEM. In July 1997, the Company recognized an extraordinary
gain of $332.2 million resulting from the cancellation of indebtedness pursuant
to the Plan.
COMPARISON OF YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994.
REVENUE. Total revenue was $181.7 million, $259.5 million and $180.6
million in 1996, 1995 and 1994, respectively. The decrease of 30% in 1996 from
1995 resulted primarily from the decrease in the number of FunCenters in
operation and a reduction in average sales per FunCenter. The decrease in same
store average sales per FunCenter of approximately 17% was primarily due 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 at the FunCenters. The increase of 44% in total revenue
from 1994 to 1995 resulted primarily from the increased number of FunCenters in
operation during 1995.
COST OF GOODS SOLD. Cost of goods sold, which consists primarily of the
cost of food, redemption merchandise and other product sales and the cost of
equipment sold to franchisees, was $34.3 million, $50.2 million and $36.9
million in 1996, 1995 and 1994, respectively. As a percentage of total revenues,
cost of goods sold was 19%, 19% and 20% in 1996, 1995 and 1994, respectively.
STORE OPERATING EXPENSE. Store operating expense, which consists primarily
of compensation and benefits for FunCenter operating personnel, occupancy
expenses and facility repair and maintenance expenses, were $140.5 million,
$185.6 million and $97.6 million in 1996, 1995 and 1994, respectively. As a
percentage of total revenues, store operating expenses were 77%, 72% and 54% in
1996, 1995 and 1994, respectively. The increases as a percentage of total
revenue for the periods presented were due largely to
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the Company's signing of above market leases and reduced oversight of store
expenses in connection with the Company's aggressive expansion program. In
addition, the Company experienced lower than anticipated revenue, particularly
in 1996, due to disruptions in the business related to the Company's bankruptcy
filing.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and
administrative expenses were $40.8 million, $58.2 million and $36.5 million in
1996, 1995 and 1994, respectively. As a percentage of total revenues, selling,
general and administrative expenses were 22%, 22% and 20% in 1996, 1995 and
1994, respectively. The decrease of 30% in 1996 from 1995 reflects the reduction
in corporate staff, the elimination of regional offices and a general reduction
in spending due to the reduction in the number of FunCenters. See "Business --
Business Strategy and Turnaround Plan -- Phase 1." The increase of 59% in 1994
from 1995 reflects the increase in overhead expenses associated with the
Company's expansion programs.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense was $21.9 million, $32.0 million and $16.2 million in 1996, 1995 and
1994, respectively. These changes resulted primarily from the overall changes in
the number of Company-owned stores and in property and equipment subject to
depreciation, which, in turn, resulted from the decrease in the number of
FunCenters in 1996. In addition, the Company recorded increased goodwill
amortization in 1995 related to goodwill recorded in connection with the
acquisitions of businesses during 1994 and 1995. The carrying values of such
goodwill was written off at the end of 1995, as described below, resulting in no
goodwill amortization in 1996.
INTEREST EXPENSE. Interest expense, which primarily consisted of accrued
interest on the outstanding LYONs, the Company's subordinated convertible debt,
and borrowings under the Company's pre-petition credit facility, was $6.3
million, $12.2 million and $5.1 million in 1996, 1995 and 1994, respectively.
The decrease of 48% in 1996 from 1995 resulted primarily from a suspension of
interest payments under the Company's indebtedness obligations during the
Company's reorganization under Chapter 11. Had these payments not been
suspended, interest expense for 1996 would have been approximately $18.2
million. The increase in 1995 from 1994 was primarily the result of an increase
in the average indebtedness under the Company's pre-petition revolving credit
facility.
OTHER INCOME (EXPENSE), NET. The Company recorded other income (expense),
including minority interest, net, of ($600,000), $5.6 million and $2.6 million
in 1996, 1995 and 1994, respectively. The decline in other income, net, is
primarily attributable to a decrease in interest income associated with lower
amounts 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. See "-- Changes
in Method of Accounting." In 1995, the Company also recognized other charges
relating to the reduction in the carrying values of certain assets. Such
reductions were not materially different from the charges that would have
resulted from the application of SFAS No. 121. Those charges, which totalled
approximately $44.0 million, resulted primarily from the write-down of certain
entertainment facility equipment and, to a lesser extent, from the write-down of
property and equipment related to a relocation of the Company's headquarters.
Additionally, because of an inability to terminate certain previously closed
FunCenter leases on favorable terms, the Company recognized other charges of
approximately $10.6 million related to the provision of additional lease
commitment reserves. In connection with a change in management and relocation of
its corporate headquarters, the Company also incurred certain restructuring
costs, including employee termination benefits of approximately $7.9 million and
facility lease termination costs of approximately $3.5 million. In connection
with the Company's termination of approximately 300 management and
administrative employees, the Company incurred an expense of $6.6 million in
1995. During 1994, the Company recognized other charges of $14.0 million
relating to a writedown of property and
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equipment and a provision of lease commitment reserves resulting from the
elimination of certain duplicative facilities.
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.
EXTRAORDINARY ITEMS -- CHANGE IN METHOD OF ACCOUNTING. In 1994, the Company
changed its method of accounting for certain pre-opening store costs.
Previously, the Company capitalized all pre-opening costs, which included
salaries and other direct costs of opening FunCenters, and amortized these costs
over periods of up to two years. As a result of the acquisitions made in 1994,
the Company changed its method of accounting to expense pre-opening costs when a
FunCenter opens. See "-- Changes in Method of Accounting."
LIQUIDITY AND CAPITAL RESOURCES
The Company does not have significant receivables or inventory and receives
trade credit based upon negotiated terms in purchasing food products and other
supplies. Therefore, the Company's business has not required significant working
capital to operate. The Company has required cash primarily to finance capital
expenditures to maintain and upgrade existing stores and to fund operating
losses and debt service. Following completion of certain programs to improve
operating cash flow under its Turnaround Plan, 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. See
"Description of Certain Indebtedness" and "Plan of Reorganization." The Company
holds for sale certain parcels of undeveloped land which secure the McDonald's
Notes. To the extent closings on such sales occur prior to the due date for debt
services, the net proceeds for such sales would be available to be applied on
account of such payments.
For the seven months ended July 31, 1997, and the two months ended September
30, 1997, the Company generated cash of $47,000, and used cash of $12.1 million,
respectively, from operations before reorganization expenses. In 1995, the
Company's operations used approximately $59.1 million of cash, which decreased
in 1996 to a net cash use of $36.2 million before reorganization costs. This
decrease can be attributed primarily to the Company's net losses and changes in
working capital. During 1997, the Company had operating losses and the changes
in cash generated (used in) operations primarily resulted from changes in other
working capital items. The reduction in cash used by operations during the 1997
periods is primarily attributable to Phase 1 of the Company's Turnaround Plan.
See "Business -- Business Strategy and Turnaround Plan."
The Company will use approximately $26.7 million received from the offering
of the Private Notes and the Convertible Preferred Stock to finance capital
expenditures, for working capital and for general corporate purposes. The
Company expects to make approximately $20-$25 million in capital expenditures in
the eighteen-month period following the Effective Date in connection with its
capital improvement program under the Turnaround Plan, depending upon the
success of the Turnaround Plan. Following completion of certain programs
expected to increase its operating cash flow under the Turnaround Plan, the
Company also expects to use cash to build new FunCenters. See "Company
Background."
In 1995, the Company made capital expenditures of approximately $51.7
million related to the purchase of fixed assets for FunCenters, acquisitions of
new FunCenters and the normal replacement of
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older equipment and property. During the Company's reorganization under Chapter
11, capital expenditures contracted significantly. As a result, 1996 capital
expenditures declined to $2.7 million, related primarily to capital charges
incurred in connection with the closing of certain underperforming FunCenters.
The Company expects to use cash going forward primarily to finance capital
expenditures and meet its limited working capital requirements.
The Company expects to make approximately $20 million in capital
expenditures during the fourth quarter of 1997 and first quarter of 1998 in
connection with its capital improvement program under the Turnaround Plan. The
cash necessary to complete the Company's capital expenditure program has been
and is expected to be provided by the proceeds from the sale of Private Notes
and Convertible Preferred Stock, cash generated from operations and equipment
financing. Should operating cash flow of existing FunCenters increase as a
result of the Turnaround Plan, the Company also expects to use cash to build new
FunCenters. See "Use of Proceeds" and "Business -- Turnaround Plan."
If the Company's renovation program is delayed or costs more than expected,
or if results of operations as a result of the Turnaround Plan do not improve
sufficiently to generate positive cash flow from operations, later phases of the
renovation program would be delayed and the Company would require additional
financing for working capital and to complete the renovation program. See "Use
of Proceeds" and "Business--Turnaround Plan."
On September 30, 1997, the Company had an unrestricted cash balance of
approximately $30.2 million. The Company also had $21.7 million in cash and
investments in the Escrowed Interest Account on September 30, 1997, which amount
is dedicated to making scheduled payments of interest on the Private Notes and
the Exchange Notes through August 1, 1999. Subject to the Company's ability to
generate positive cash flow from operations as a result of the successful
implementation of the Turnaround Plan, the Company believes that its existing
capital resources will provide sufficient funds, for twelve months following the
Exchange Offer, 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.
If the Company continues to generate negative EBITDA, less capital will be
available for the renovation program under the Turnaround Plan, which may in
turn adversely impact implementation of the Turnaround Plan and thus future
operating results. In the event that the results from the Turnaround Plan 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."
While the Company's Private Notes contain restrictions on additional
indebtedness, the Company is permitted to borrow 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. If the implementation of the Turnaround Plan is not successful and
the Company is unable to generate sufficient operating funds to pay the interest
on the Exchange Notes and to fund its other capital requirements, 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 to issuing additional equity. There can
be no assurance that capital would be available from any of the sources
permitted under the Indenture. See "Risk Factors--Substantial Leverage; Negative
EBITDA and Ability to Service Debt and Other Obligations," "--Successful
Execution of Turnaround Plan" and "Description of Exchange Notes."
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
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facilities are located in cold weather regions where children are unable to play
outside during this time of year. In 1996, the Company's FunCenters generated
32% of their revenue in the first quarter versus 23%, 24% and 21% in the second,
third and fourth quarters, respectively. These fluctuations in revenues are
primarily influenced by 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. This standard requires, among other things, the
recognition of future tax benefits, measured by enacted tax rates, attributable
to deductible temporary differences between financial reporting and income tax
reporting bases for assets and liabilities, and net operating loss and tax
credit carryforwards for tax purposes. 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, 1996, 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.
The Company was required to reduce its NOL as a result of the cancellation
of indebtedness pursuant to the confirmation of the Plan. As a result of its
reorganization under Chapter 11, the Company is treated as having experienced an
ownership change. Thus, after emerging from Chapter 11, the Company's ability to
offset income in each post-reorganization taxable year by its then 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) will be
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 in such
calculation, however, any increase in value resulting from any surrender or
cancellation of creditors' claims in connection with the Plan of Reorganization)
multiplied by the long-term tax-exempt rate published monthly by the Internal
Revenue Service. At July 31, 1997, the Company's NOLs were approximately $160.0
million. It is estimated that the use of the Company's NOLs will be limited to
approximately $4.0 million per year.
CHANGES IN METHOD OF ACCOUNTING
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 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. In this allocation,
identifiable assets have been valued at estimated fair values, and excess
reorganization value has been recorded as "reorganization value in excess of
amounts allocated to identifiable assets" (a long-term intangible asset similar
to "goodwill").
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" ("SFAS No. 121"), which was issued in March 1995. This
Statement requires that long-lived assets and certain identifiable intangibles
be held and used by an entity and 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
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Statement requires that long-lived assets and certain identifiable intangibles
to be disposed of be reported at the lower of their carrying amount or fair
value less cost to sell.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," issued by the Financial Accounting Standards
Board ("FASB"), became effective January 1, 1996. The new standard defines a
fair value method of accounting for issuance of stock options and other equity
instruments. Under the fair value method, compensation cost is measured at the
grant date based on the fair value of the award and is recognized over the
service period, which is usually the vesting period. Pursuant to SFAS No. 123,
companies are encouraged, but are not required, to adopt the fair value method
of accounting for employee stock-based transactions. Companies are also
permitted to continue to account for such transactions under Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," (APB
Opinion 25) but are required to disclose in a note to the consolidated financial
statements pro forma net income and per share amounts as if the Company had
applied the new method of accounting. The Company applies APB Opinion 25 and
Related Interpretations in Accounting for its employee stock-based transactions
and has complied with the disclosure requirements of SFAS No. 123 where
material.
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 plans to adopt SFAS No. 128 and
SFAS No. 129 in 1997 and expects 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 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," and amends SFAS No.
94, "Consolidation of all Majority-Owned Subsidiaries." This statement requires
annual financial statements to disclose information about products and services,
geographic areas and major customers based on a management approach, along with
interim reports. The 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 were not
consolidated. This new management approach 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 with
impact only to the Company's disclosure information and not its results of
operation.
In the third quarter of 1994, the Company changed its method of accounting
for certain pre-opening costs. Previously, the Company capitalized all
pre-opening costs, which included salaries and other direct costs of opening a
facility, and amortized those costs over periods of up to two years. As a result
of the
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acquisitions of Leaps and Bounds and the Blockbuster Entities, and the
considerable growth of the Company during 1994, the Company now expenses
pre-opening costs when a facility opens.
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.
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 after. Certain software used by the
Company is licensed from third party vendors who have planned releases
addressing 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.
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BUSINESS
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 206
FunCenters in 39 states, Canada and Puerto Rico, targeted at children ages two
to 12. The Company also operates two Block Party Stores. The Company emerged
from protection under Chapter 11 on the Effective Date and, in connection
therewith, was acquired by an affiliate of Wellspring Associates L.L.C.
The Company's FunCenters are designed to offer children a unique
entertainment experience while meeting their parents' needs for value and
convenience. FunCenters are generally located in strip shopping centers and, to
a lesser extent, in shopping malls, and currently include the following
features: (i) "soft play" zones consisting of a series of tubes, slides, ball
bins, climbing mountains, air and water 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 believes it is well positioned to capitalize on a variety of
favorable demographics in its customer base, including projected growth over the
next fifteen years in the population of children under the age of 13, which
management expects will lead to increased spending on children's leisure
activities. Management estimates that in 1996 DZ hosted over 21 million visits
by children and adults in the 206 FunCenters.
NEW OWNERSHIP AND MANAGEMENT
Wellspring is a private investment firm focused on indentifying, acquiring
and turning around underperforming companies. Scott W. Bernstein was hired by
Wellspring in June of 1996 as an industry consultant to assist with formulation
of the Plan of Reorganization and became President and Chief Executive Officer
of the Company in December 1996. He has extensive experience in the family
entertainment business, having served as a senior executive at Time Warner and
Six Flags, including: Senior Vice President of Time Warner Enterprises, a
strategic and business development unit of Time Warner; Senior Vice President
and chief administrative and legal officer of the Six Flags theme park chain;
and, most recently, President of Six Flags' Northeast operations, where he led a
turnaround of the Six Flags Great Adventure theme park in New Jersey.
Wellspring and Mr. Bernstein have recruited two new senior managers to the
Company, Sharon Rothstein and Robert Rooney. Ms. Rothstein joined the Company
March 24, 1997 as Senior Vice President of Marketing and Entertainment. Ms.
Rothstein is a marketing executive with thirteen years experience in the
consumer packaged goods business, most recently serving as Vice President, New
Business for the National Biscuit Company ("Nabisco"). In this capacity, Ms.
Rothstein was responsible for developing new long-term business strategies in
addition to overseeing all licensing and future marketing efforts. Her
accomplishments at Nabisco included the development of the Oreo and Kids
revitalization plan, the planning of the "Breakfast Snacks" initiative and the
launch of the Snackwell brand, for which she was awarded Advertising Age's Top
100 Marketers award.
Mr. Rooney joined the Company in December 1996 and was elected Senior Vice
President -- Chief Financial and Administrative Officer in February 1997. He has
11 years' experience as a senior finance executive, having most recently served
as Senior Vice President and Chief Financial Officer of Victory Capital LLC, a
venture capital group (formerly known as Forschner Enterprises, Inc.) and as
Managing Director and Chief Financial Officer of The Signature Group, a merchant
banking group specializing in restructuring over-leveraged real estate. Mr.
Rooney also served as Senior Vice President, Chief Financial Officer and
Treasurer of Imagine Films Entertainment, Inc., a publicly-held film and
television production company, from December 1986 through December 1989, and
prior to that time had nine years of audit experience at Ernst & Young.
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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 of approximately 0.2% and 0.4%, respectively).
U.S. POPULATION BY AGE GROUP
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNDER 5 5-13 TOTAL UNDER 13
----------- --------- ---------------
<S> <C> <C> <C>
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
</TABLE>
- ------------------------
Source: Mid-range of U.S. Bureau of the Census estimates.
Management believes that the Baby Boomer parents of these children are
entering their peak earning years, which it expects to lead to increased
spending on children over the next decade.
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-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 one location 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 McDonald's franchisees, which 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.
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To a more limited extent, the Company competes against indoor/outdoor family
entertainment centers, theme parks and other themed restaurant chains. Such
entertainment centers offer an entertainment experience 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.
BUSINESS STRATEGY AND TURNAROUND PLAN
BUSINESS STRATEGY
The Company believes that it has significant potential to enhance
profitability and increase attendance by executing a business strategy that
exploits favorable industry demographics and positive Company attributes that
were not capitalized on by prior management.
FAVORABLE DEMOGRAPHICS. Management expects that favorable demographics
relating to the Company's target customer base should positively impact the
Company's business over the next fifteen years. There are currently more than 54
million children under the age of 13, a number projected to increase by the year
2000 as "Baby Boomer" families contribute to an increase in DZ's target market.
In addition, the Company believes that there is a continuing trend toward
increased spending on leisure activities, especially spending on children.
STRONG BRAND RECOGNITION AND CONTINUED POPULARITY OF THE DZ CONCEPT. DZ
remains a highly recognized brand name with significant market appeal, with
approximately 21 million visits in 1996 at the Company's 206 remaining
FunCenters. As more fully described herein, a survey by the Gallup Organization
of consumers in the Company's target demographic groups revealed that the
Company's total brand awareness is 95%. In addition, a survey by Kids Research
Unlimited in 1996 revealed that 56% of 288 children surveyed between ages five
and 11 preferred playing at DZ as compared to playing video games (32%) and
watching television (12%). This survey also revealed that DZ remains the
children's "favorite indoor play place," named by 35% of respondents as compared
to Chuck E. Cheese, which was named by 32% of respondents. The survey indicated
that DZ was the preferred site for such children's next birthday party among
directly competing indoor play concepts, with 40% of respondents choosing DZ as
compared with 29% of respondents choosing Chuch E. Cheese. See "Business --
Market Research."
LEADING NATIONAL PRESENCE IN A HIGHLY FRAGMENTED MARKET. Due to the
fragmented nature of the pay-for-play children's entertainment industry and the
strength of the DZ brand name, the Company believes that it is uniquely
positioned to become a cross-promotional platform for strategic alliances with
children's entertainment and consumer product companies.
SIGNIFICANT OPERATING LEVERAGE AND OPPORTUNITIES FOR PROFIT
IMPROVEMENT. Because the Company's cost structure includes a high proportion of
fixed costs (such as rent, utilities and core staffing requirements) relative to
variable costs, each incremental customer visit contributes disproportionately
to a FunCenter's operating profit. As more fully described below, the Company
believes that it has identified a number of opportunities to increase attendance
and take advantage of the operating leverage inherent in the business.
51
<PAGE>
TURNAROUND PLAN
The Company has begun to implement the Turnaround Plan, which is designed to
reduce costs, enhance core product offerings and reposition the Company from an
operator of indoor playgrounds to the leading national provider of high quality
children's indoor entertainment. This is expected to be accomplished primarily
through:
- reducing costs at the store, regional and corporate levels;
- improving the quality and consistency of the Company's existing
core soft-play products, game zone products and its food and
beverage operations;
- adding a variety of entertainment activities and new attractions
and renovating the FunCenters;
- developing, both internally and through strategic partnerships with
content providers, periodic story-line based entertainment
experiences which complement the Company's traditional
entertainment activities; and
- introducing interactive parent-child play programs for the off-peak
weekday period.
Management believes that these strategic initiatives will serve to increase
attendance, in-store spending and operating cash flow, although there can be no
assurance that this will occur. See "Risk Factors". By virtue of the national
prominence of the DZ brand name, its leading market share position and its
national network of FunCenters, management believes that the Company is well
positioned within its industry to successfully implement this strategy and
profitably expand a revised and rejuvenated DZ concept.
The Company's business strategy is being implemented in three phases: "Phase
1 -- Restore Core Business," "Phase 2 -- Improve Product and Reposition/Relaunch
DZ Brand" and "Phase 3 -- Growth." Key elements of each phase of the Turnaround
Plan are as follows:
PHASE 1 -- RESTORE CORE BUSINESS. The Company has implemented a broad
cost-reduction program to rationalize its expenses relative to revenues and
to increase efficiency. The four key components of this program are:
- CLOSE UNDERPERFORMING FUNCENTERS. 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.
- REDUCE OVERHEAD EXPENSES. New management has implemented a
variety of cost reduction initiatives to reduce annual selling, general
and administrative expenses, including: (i) a substantial reduction in
the Company's corporate and regional management; (ii) a reduction in
expenditures for corporate support functions; and (iii) elimination of
expenses related to certain discontinued operations.
- INCREASE FUNCENTER OPERATING MARGINS. The Company has initiated
programs which it believes will result in significant annual cost
savings, based on changes in labor planning, food and beverage
operations, birthday party reservations and renegotiated store lease
terms.
PHASE 2 -- IMPROVE PRODUCT AND REPOSITION/RELAUNCH DZ BRAND. Management
is currently implementing the following programs designed to increase
attendance and in-store spending:
- IMPLEMENT MANAGEMENT INCENTIVE PLANS. Historically, the
Company's FunCenter and regional managers operated without goals,
accountability or incentive-based compensation plans.
52
<PAGE>
To support the Turnaround Plan and to create a stronger sense of
ownership and accountability, management has established an
incentive-based compensation plan tied to EBITDA and service quality
measures.
- UPGRADE AND EXPAND PRODUCTS. The Company plans to selectively
undertake initiatives to improve and supplement existing products,
enhance food and beverage offerings through the introduction of branded
products and upgrade and broaden the appeal of its games. The Company
expects to invest approximately $20-$25 million by the end of 1998 to add
new attractions, improve the appearance of its FunCenters, enhance the
quality and consistency of its core soft-play and games products, add
periodic theme-based attractions and promotional activities to enhance
the entertainment experience of its customers and expand weekday
programming.
During the fourth quarter of 1997, the Company began a FunCenter
renovation program, pursuant to which the Company expects to renovate
substantially all of its FunCenters, broaden their entertainment
offerings, upgrade their facilities and give them a "new look" consistent
with its brand repositioning (see below). The Company expects to have
approximately 60% of the FunCenters renovated by the end of January 1998,
including the addition of designated areas for laser tag, arts and
crafts, stage events and promotional activities.
In April and June 1997, the Company entered into marketing and
product agreements with Pizza Hut and Pepsi to provide joint promotions
and increase the appeal and quality of its food service. Approximately
80% of the FunCenters are expected to be converted to permit the sale of
Pizza Hut menu items by the end of January 1998.
- IMPLEMENT NEW MARKETING STRATEGY. Management has developed a
new marketing strategy based on the following key components:
-- REPOSITION/RELAUNCH "NEW DZ" BRAND. Building on its new and
revamped product offerings, the Company intends to launch the "New
DZ" brand through a new advertising campaign.
-- REORIENT MARKETING TO REGIONAL/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." To complement this focus, management plans to establish
cross-promotional alliances with local and regional businesses, such
as supermarkets, convenience stores and malls, as well as national
retailers.
-- FORM STRATEGIC MARKETING PARTNERSHIPS. Management intends to
establish strategic marketing and product relationships with
children's entertainment and consumer product companies such as its
relationships with Pepsi and Pizza Hut to take advantage of joint
marketing and cross-promotional opportunities.
Due to DZ's national market presence and the strength of its brand
name, the Company believes that it is well positioned to act as a
platform for future promotional and product "tie-ins" with children's
entertainment and consumer product companies. The Company believes such
alliances will provide significant competitive advantages in the form of
marketing support and theme-based promotions to periodically refresh its
product offerings and stimulate repeat customer visits on a
cost-effective basis.
In keeping with this strategy, the Company has begun negotiations
with a number of possible promotional partners, including toy,
television, film, media and consumer product companies and, to date, has
entered into arrangements with Hasbro, Sony Entertainment, New Line
Cinema, the Hearst Corporation, the National Hockey League, CCM,
Worldwide Wrestling Federation and the Nabisco Foods Group, for a variety
of promotional programs and activities.
53
<PAGE>
- INTRODUCE WEEKDAY PROGRAMS. The Company intends to increase
revenue by better utilizing DZ's facilities during weekdays. The Company
has developed interactive parent-child play programs for preschoolers,
which include tumbling, climbing, exercising and singing. These products
are being offered under the "Discovery Zone University" and "DZU" brand
names.
Twenty FunCenters began offering these new weekday programs in
September 1997 and twenty-seven additional FunCenters began offering
these programs in January 1998. In the future, the Company expects to
consider expanding these programs to include after school programs for
older children.
PHASE 3 -- GROWTH. Upon the restoration of DZ's core business and the
repositioning of its brand image, management expects to commence a
controlled expansion program to develop new FunCenters.
CURRENT FUNCENTER OPERATIONS
The current FunCenters are indoor pay-for-play entertainment centers for
children. In keeping with its philosophy of attracting younger children, patrons
must be 12 years of age or younger, and be accompanied by an adult, to be
admitted to a FunCenter. Adults are not permitted entry without a child.
Discovery Zone encourages the participation of parents and other accompanying
adults, and the 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:
- A play zone which averages approximately 3,500-4,000 square feet,
referred to as the "Mega Zone," composed of a series of tubes,
slides, ball bins, climbing mountains, air and water trampolines,
obstacle courses, ramps, stairs and other devices for crawling,
jumping, running, swinging and climbing.
- A separate "Mini Zone" for toddlers which averages approximately
1,000-1,500 square feet and contains many of the same features as
the Mega Zone, but on a smaller scale. Access to the Mini Zone is
limited to children under a certain height, which provides younger
and smaller children their own, less boisterous play area.
- An open play area, referred to as the "Starter Zone," with a
mini-ball bin, colorful cushions and toys for infants and very
small toddlers.
- Food and beverage operations which, in most cases, feature a
selection of Pizza Hut menu items and Pepsi beverage products.
- A game zone, featuring activities and games for which children are
awarded tickets for successful play. These tickets can be redeemed
for a variety of small toys and prizes. FunCenters typically do not
have conventional video game machines, distinguishing them from
most other child-oriented entertainment facilities.
- Several 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 food and
beverage services, with access to the Mega and Mini Zones and
tokens for use in the game zone for each child attending the party.
- A redemption counter where awards for games, as well as Discovery
Zone apparel, toys and other products are sold.
DZ currently targets children 12-years old and younger, with the highest
concentration of visitors being one to eight years old. The FunCenters are
designed and constructed with an emphasis on safety and security. Each customer
is given a name tag for identification purposes and to promote interaction with
54
<PAGE>
FunCenter staff. At each FunCenter, an identification bracelet is also 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 FunCenters are
strategically positioned and 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 a high standard of cleanliness.
FunCenters charge a general admission fee for each child, with prices
currently ranging from $4.99 to $7.99, depending on location. 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 are 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. DZ generates most of its weekly revenue on
weekends.
PROPERTIES
The Company currently operates 206 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 DZ's FunCenters by
location:
<TABLE>
<CAPTION>
NUMBER OF
LOCATION FUNCENTERS
- ----------------------------------------- ---------------
<S> <C>
Alabama.................................. 4
Arizona.................................. 1
California............................... 20
Colorado................................. 4
Connecticut.............................. 2
Delaware................................. 1
Florida.................................. 11
Georgia.................................. 6
Hawaii................................... 1
Idaho.................................... 1
Illinois................................. 6
Indiana.................................. 8
Iowa..................................... 1
Kansas................................... 2
Kentucky................................. 2
Louisiana................................ 4
Maryland................................. 6
Massachusetts............................ 8
Michigan................................. 5
Minnesota................................ 2
Mississippi.............................. 1
Missouri................................. 5
Nevada................................... 1
<CAPTION>
NUMBER OF
LOCATION FUNCENTERS
- ----------------------------------------- ---------------
<S> <C>
New Jersey............................... 9
New Mexico............................... 1
New York................................. 16
North Carolina........................... 2
Ohio..................................... 10
Oklahoma................................. 3
Oregon................................... 2
Pennsylvania............................. 10
Rhode Island............................. 1
South Carolina........................... 2
Tennessee................................ 4
Texas.................................... 20
Utah..................................... 1
Virginia................................. 8
Washington............................... 2
Wisconsin................................ 5
---
Total United States...................... 198
Canada................................... 5
Puerto Rico.............................. 3
---
Total.................................... 206
---
---
The Block Party Stores are located in
Indiana and New Mexico.
</TABLE>
55
<PAGE>
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). See
"Description of Certain Indebtedness." The Company currently leases all but one
of the remaining sites of the FunCenters. The Company believes that it could
find alternative space at competitive market rates if it were unable to renew
the lease on any of the sites of the Company-owned FunCenters. If the Company
deems it advantageous to do so, it may from time to time in the future 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 secure the McDonald's Note and McDonald's Rent Deferral Secured
Notes.
The Company currently subleases approximately 30,000 square feet of office
space from Blockbuster (the "Blockbuster Space") at an annual cost of
approximately $600,000. A division of Blockbuster currently occupies
approximately 7,500 square feet of this space, thereby mitigating a portion of
the Company's cost. Blockbuster has informed the Company that it plans to
relocate and will terminate its lease no later than June 30, 1998. Pursuant to
an agreement with Viacom and Blockbuster, Blockbuster has agreed to allow the
Company to remain in such space on a month-to-month basis through June 30, 1998.
The Company plans to move from the Blockbuster Space in January 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 house its finance, purchasing, MIS and other administrative functions. 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.
The Company's executive offices are located at 565 Taxter Road, Fifth Floor,
Elmsford, New York 10523 and its telephone number is (914) 345-4500.
TRADEMARKS AND SERVICE MARKS
The names "Discovery Zone," "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.
LITIGATION
Substantially all of the claims against the Company relating to pre-petition
causes of action were discharged on the Effective Date. See "Plan of
Reorganization."
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.
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 on 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
56
<PAGE>
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. 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 on the policy year.
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.
EMPLOYEES
At September 30, 1997, the Company had approximately 5,950 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, party hosts and a reservationist, 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.
57
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
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
Stan Gerasimczyk..................................... 43 Vice President, Store Operations
David Nicholson...................................... 44 Vice President, Construction and Facilities
Maintenance
Martin S. Davis...................................... 70 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 on the Effective Date. Mr.
Bernstein was hired by Wellspring in June of 1996 to assist with formulation of
the Plan of Reorganization. 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 24, 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 1, 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
58
<PAGE>
Financial Officer and Treasurer of Imagine Entertainment, Inc., a publicly held
film and television production company. Mr. Rooney is a certified public
accountant.
MR. SMITH joined the Company as Vice President-Real Estate and General
Counsel on October 20, 1997 and has served as Secretary since November 14, 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 Anderson LLP, where he achieved the position of manager in the audit
and financial consulting division.
MR. GERASIMCZYK joined the Company in October 1995 as Vice President of
Store Operations. From February 1995 to October 1995 he worked for Liz
Clairborne Retail Division. From October 1994 to February 1995 he was the Vice
President--Director of Stores for The Nature Co. From June 1987 to October 1994
he was Regional Director of Operation--East for the Disney Store, Inc.
MR. NICHOLSON joined the Company in July 1997 as Vice President of
Construction and Facilities Maintenance. From 1992 to 1997, he served as
Director of Construction with Barnes & Noble Inc., the largest U.S. book
retailer, where he led the design, construction and maintenance functions during
a four-year development of over 300 stores. From 1984 to 1992, he was the
Architectural Manager in various design and development positions of Toys "R" Us
and Kids "R" Us. Mr. Nicholson is a Registered Architect.
MR. DAVIS was elected as a director of the Company on the Effective Date.
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., the Western NIS Enterprise Fund (U.S.
Government funded) and SLM International, Inc.
MR. FELDMAN was elected as a director of the Company on the Effective Date.
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 co-founder of Clegg Industries, Inc., an
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 on the Effective Date.
Mr. Rotatori has been a principal of Wellspring since September 1995. From 1991
until 1995, Mr. Rotatori was an Associate Director in the investment banking
department of Bear, Stearns & Co. 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 on the Effective Date.
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 Faye 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.
59
<PAGE>
MR. SMITH was elected as a director of the Company on the Effective Date.
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 services. Prior to joining Kouri Capital Group,
Mr. Smith served as Assistant Vice President of Direct Equity Investment at
Lambert Brussels Capital Corporation and, before 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 of Reorganization as representative of the committee of pre-petition
unsecured creditors of the Company. He will serve for a term of three years from
the Effective Date. 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.
LIMITATIONS ON LIABILITY; INDEMNIFICATION
The Certificate of Incorporation provides that a director of the Company
shall not be personally liable to it or its stockholders for monetary damages to
the fullest extent permitted by the General Corporation Law of the State of
Delaware (the "DGCL"). In accordance with the DGCL, the Certificate of
Incorporation does not eliminate or limit the liability of a director for acts
or omissions that involve intentional misconduct by a director or a knowing
violation of law by a director for voting or assenting to an unlawful
distribution, or for any transaction from which the director will personally
receive a benefit in money, property or services to which the director is not
legally entitled. The DGCL does not affect the availability of equitable
remedies such as an injunction or rescission based upon a director's breach of
his duty of care. Any amendment to these provisions of the DGCL will
automatically be incorporated by reference into the Certificate of Incorporation
and the By-laws, without any vote on the part of its stockholders, unless
otherwise required.
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 Board of Directors.
COMPENSATION OF EXECUTIVE OFFICERS
The following table and discussion summarize the compensation earned by the
two individuals who have served as the Company's Chief Executive Officer and the
other most highly compensated executive officers of the Company who earned more
than $100,000 in salary and bonuses (collectively, the "Named Executive
Officers") for services rendered in all capacities to the Company during each of
the last three years ended December 31, 1997.
60
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
--------------------------
AWARDS
--------------------------
NUMBER OF
SECURITIES
ANNUAL COMPENSATION OTHER UNDERLYING
------------------------------------------------------------ ANNUAL RESTRICTED OPTIONS/
NAME POSITION YEAR SALARY ($) BONUS ($) COMPENSATION(1) STOCK AWARDS SAR'S
- ------------------- ------------------------ --------- ---------- ----------- ----------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Scott W. Bernstein President/CEO 1997 416,667 200,000 37,862 0 357,845
1996 30,204 0 0 0 0
Donna Moore President/CEO(2) 1997 115,962 0 900 0 0
1996 412,500 0 0 0 0
1995 145,594 150,000 0 0 0
Robert Rooney SVP--CFO 1997 185,000 45,000 4,615 0 89,500
1996 8,538 0 0 0 0
Sharon Rothstein SVP--Marketing 1997 136,923 75,000 4,615 0 89,500
Leighton Weiss VP--Finance 1997 126,969 12,000 0 0 0
1996 115,987 23,356 0 0 0
1995 41,887 17,756 0 0 0
Stan Gerasimczyk VP--Store Operations 1997 147,115 12,500 2,400 0 0
1996 135,000 27,000 0 0 0
1995 28,558 26,210 0 0 0
<CAPTION>
PAYOUTS
--------- ALL
LTIP OTHER
NAME PAYOUTS COMPENSATION
- ------------------- --------- -------------
<S> <C> <C>
Scott W. Bernstein 0 0
0 0
Donna Moore 0 300,000
0 2,699(3)
0 26,224(3)
Robert Rooney 0 75,000(4)
0 0
Sharon Rothstein 0 0
Leighton Weiss 0 50,000(5)
0 0
0 0
Stan Gerasimczyk 0 30,000(5)
0 0
0 0
</TABLE>
- ------------------------------
(1) Represents payments made by the Company for auto allowances and other
perquisites pursuant to employment contracts.
(2) 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 of Reorganization was not approved by
the Company's creditors in which case Mr. Bernstein would cease 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 $300,000 upon the
Company's emergence from bankruptcy.
(3) Represents reimbursement for relocation expenses.
(4) Represents a one-time bonus awarded by the Company to Mr. Rooney in
recognition of his efforts in connection with the reorganization of the
Company and its successful emergence from Chapter 11.
(5) Represents payments made in accordance with the Company's Employee Retention
Program included in the Plan of Reorganization.
OPTION AND SAR GRANTS IN FISCAL YEAR 1997
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE
VALUE AT
ASSUMED
RATES OF
INDIVIDUAL GRANTS STOCK
------------------------------------------------------------------------------------ APPRECIATION
NUMBER OF % OF TOTAL FOR
SECURITIES OPTIONS/ SAR'S OPTION
UNDERLYING GRANTED TO EXERCISE OR TERM(2)
OPTIONS/ EMPLOYEES BASE PRICE EXPIRATION ---------
NAME POSITION SAR'S GRANTED IN FISCAL YEAR ($/SH)(1) DATE 5%
- ----------------- ------------------------------------- ------------- --------------- ------------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Scott W.
Bernstein President/CEO 357,845 66.7% 11.88 7/31/07 2,673,556
Robert Rooney SVP--CFO 89,500 16.7% 11.88 7/31/07 668,678
Sharon Rothstein SVP--Marketing 89,500 16.7% 11.88 7/31/07 668,678
Donna Moore President/CEO 0 0.00% n/a n/a n/a
Leighton Weiss VP--Finance 0 0.00% n/a n/a n/a
<CAPTION>
NAME 10%
- ----------------- -----------
<S> <C>
Scott W.
Bernstein 6,775,315
Robert Rooney 1,694,563
Sharon Rothstein 1,694,563
Donna Moore n/a
Leighton Weiss n/a
</TABLE>
- ------------------------------
(1) The exercise price of each of the Company's outstanding stock options equals
the fair market value of the Company's 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 stock options immediately prior to the expiration of their
term assuming the specified compounded 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.
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<PAGE>
OPTION AND SAR EXERCISES IN FISCAL 1997 AND YEAR-END OPTION AND SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE MONEY
OPTIONS/SAR'S AT OPTIONS/SAR AT
SHARES FY- END 1997 FY-END 1997
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME POSITION EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE(1)
- --------------------- ----------------------------- ----------- --------- ------------------- -----------------------
<S> <C> <C> <C> <C> <C>
Scott W. Bernstein President/CEO 0 0 0/357,845 0/0
Robert Rooney SVP--CFO 0 0 0/89,500 0/0
Sharon Rothstein SVP--Marketing 0 0 0/89,500 0/0
Donna Moore President/CFO 0 0 0/0 0/0
Leighton Weiss VP--Finance 0 0 0/0 0/0
</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.
EMPLOYMENT AGREEMENTS
On July 21, 1997, the Company entered into an employment agreement with Mr.
Bernstein providing for his employment as Chief Executive Officer, President and
Director. The agreement with Mr. Bernstein expires on January 1, 2001. The
agreement provides for a 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 EBITDA, with a minimum guaranteed amount for 1997
of $200,000, and 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 a base salary of $185,000 per year (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 a base salary of $185,000 per year
(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 as a whole is responsible for
determining executive compensation matters. Mr. Bernstein serves on the
Company's Board of Directors as Chief Executive Officer and as President of the
Company.
STOCK INCENTIVE PLAN
The Company did not grant options to purchase shares of the Company's Common
Stock to any of the Named Executive Officers in 1996. All of the Company's
option plans and equity securities in existence prior to the Effective Date were
cancelled pursuant to the Plan of Reorganization. The Company adopted the 1997
Stock Incentive Plan in connection with the Plan of Reorganization. Pursuant to
their respective employment agreements, the Company granted to Mr. Bernstein,
Ms. Rothstein and Mr. Rooney options to purchase 357,845 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
62
<PAGE>
third of such options will vest on January 1, 1999 and the remaining one third
will vest on January 1, 2000. 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 Unit Warrants. The Company has reserved 715,692 shares of
Common Stock for issuance under this Stock Option Plan. See "Principal
Stockholders."
The Stock Incentive Plan is administered by the Board of Directors (the
"Board") and provides for the grant to eligible officers and employees of
"Incentive Stock Options" or "NonQualified Stock Options" (together, the "Stock
Options"), or both, to purchase shares of the Company's 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. Pursuant to the Stock Incentive Plan, the Board may
also grant Stock Appreciation Rights. The Board will fix the term of each Stock
Option; provided that no Incentive Stock Option 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 cash out a portion of the shares of Common Stock upon exercise
of the Stock Options. The Stock Incentive Plan allows the optionee to demand
cash for its option upon a Change of Control (as defined therein) of the
Company.
The Stock Incentive Plan also provides for grants of Restricted Stock (as
defined therein). The Board may designate an award of Restricted Stock (an
"Award") which vests upon the attainment of certain specified performance goals
set by the Board. Prior to the latter 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 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 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.
LONG-TERM INCENTIVE PLAN ("LTIP") AWARDS
The Company made no LTIP Awards in 1997.
PENSION PLAN
The Company had no pension plan in place in 1997.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information concerning the beneficial
ownership of shares of Common Stock on September 30, 1997, 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 (2)
- ---------------------------------------------------------------------------------- ----------------- -------------
<S> <C> <C>
Birch Holdings L.L.C. (3)......................................................... 2,229,622 55.7%
Martin S. Davis (3)............................................................... 2,229,622 55.7
Greg S. Feldman (3)............................................................... -- --
Douglas W. Rotatori (3)........................................................... -- --
Balfour Investors Incorporated (3)................................................ 607,154 13.9
L.G. Schafran (3)................................................................. -- --
Wafra Investment Advisory Group, Inc. (4)......................................... 1,191,626 23.0
Christopher R. Smith (5).......................................................... -- --
Paul D. Kurnit (6)................................................................ 48,931 1.2
Scott W. Bernstein (7)............................................................ 119,282 2.9
Robert G. Rooney (7).............................................................. 29,833 .7
Sharon L. Rothstein (7)........................................................... 29,833 .7
Directors and executive officers as a group (3)(5)(6)(7).......................... 3,649,129 67.9
</TABLE>
- ------------------------
(1) 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 date hereof are deemed outstanding.
(2) 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 date hereof are deemed outstanding. Such shares,
however, are not deemed outstanding for the purpose of computing the
percentage ownership of any other person.
(3) 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
co-managed by Mr. Davis and Greg S. Feldman. In his capacity as 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 and dispositive power 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.
(4) 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 Unit Warrants and the Ten
Year Warrants, but before giving effect to the Stock Options expected to be
granted under the Stock Incentive Plan).
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<PAGE>
(5) 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.
(6) 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. See
"Description of Capital Stock."
(7) 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 with respect to 357,845 shares of Common Stock, to
Mr. Rooney with respect to 89,500 shares of Common Stock and to Ms.
Rothstein with respect to 89,500 shares of Common Stock, one-third of all of
which has vested. See "Management -- Stock Incentive Plan."
65
<PAGE>
CERTAIN TRANSACTIONS WITH AFFILIATES
As required under the Plan, the Company reimbursed Wellspring $1.1 million
in connection with out-of-pocket expenses 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 Successor Company. The Company
paid Griffin Bacal for media purchases on behalf of, and creative services
provided to, the Company $4,316,000 during the seven months ended July 31, 1997
and $2,705,000 during the two months ended September 30, 1997. Management
believes that the terms of the agreement with Griffin Bacal are at least as
favorable to the Company as the Company could have received from an independent
third party.
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<PAGE>
DESCRIPTION OF EXCHANGE NOTES
GENERAL
The Exchange Notes will be issued pursuant to an Indenture (the "Indenture")
between the Company and State Street Bank and Trust Company, as trustee (the
"Trustee"). The terms of the Notes include those stated in the Indenture and
those made part of the Indenture by reference to the Trust Indenture Act of 1939
(the "Trust Indenture Act"). The Exchange Notes and the Registration Rights
Agreement are subject to all such terms, and holders of the Exchange Notes are
referred to the Indenture, the Registration Rights Agreement and the Trust
Indenture Act for a statement thereof. The following summary of the material
provisions of the Indenture and the Registration Rights Agreement does not
purport to be complete and is subject to and qualified in its entirety by
reference to the Indenture and the Registration Rights Agreement, including the
definitions contained therein. Copies of the Indenture and Registration Rights
Agreement are available from the Company upon request. The definitions of
certain terms used in the following summary are set forth below under "Certain
Definitions."
The Exchange Notes will be senior secured indebtedness of the Company and
will rank senior in right of payment to all present and future subordinated
indebtedness of the Company and PARI PASSU in right of payment with all present
and future unsubordinated indebtedness of the Company (subject to a prior lien
securing an Eligible Credit Facility which may be entered into in the future).
As of September 30, 1997, the Company had $88.3 million of long-term
indebtedness (including current portion) outstanding, of which $83.3 million was
secured indebtedness.
Principal of, premium, if any, and interest on the Exchange Notes will be
payable at the office or agency of the Company in the Borough of Manhattan, the
City of New York (which initially will be the corporate trust office of the
Trustee at State Street Bank and Trust Company, N.A., 61 Broadway, 15th Floor,
New York, New York 10006, Attention: Corporate Trust Department); PROVIDED that,
at the option of the Company, payment of interest may be made by check mailed to
the address of the holder of the Exchange Notes as such address appears in the
security register.
The Exchange Notes will be issued only in registered form, without coupons,
in denominations of $1,000 and integral multiples thereof.
SECURITY
Pursuant to the terms of the Collateral Agreements (as defined), all of the
obligations under the Exchange Notes and the Indenture will be secured initially
by a first priority lien and security interest in certain assets of the Company
(including cash, accounts receivable, inventory, equipment, general intangibles,
intellectual property rights and certain other fixed assets (except real estate
leasehold interests existing on the Issue Date and certain real property,
fixtures and leasehold improvements)) and by a pledge of the capital stock of
all present and future Subsidiaries. The Exchange Notes will also be secured by
a lien on certain Company-owned real estate parcels and improvements thereon
that will be subordinated to a first mortgage lien in favor of McDonald's
Corporation. See "Description of Certain Indebtedness -- McDonald's Note." The
Company will also be required under the Indenture to use its commercially
reasonable efforts to deliver Mortgages (as hereinafter defined), in form and
substance satisfactory to the Trustee and its counsel, for purposes of securing
a first priority mortgage lien in leasehold interests of the Company acquired
after the Issue Date.
The Company will be permitted under certain circumstances to enter into an
Eligible Credit Facility, in which case the first priority security interest
securing the Exchange Notes will be subordinated to a lien securing such credit
facility. See "Description of Exchange Notes -- Intercreditor Agreement."
Upon an Event of Default, the proceeds from the sale of collateral securing
the Exchange Notes will likely be insufficient to satisfy the Company's
obligations under the Exchange Notes. No appraisals of any of the collateral
have been prepared in connection with the Exchange Offer. Moreover, the amount
to be
67
<PAGE>
received upon such a sale would be dependent upon numerous factors, including
the condition, age and useful life of the collateral at the time of such sale,
as well as the timing and manner of such sale. By its nature, all or some of the
collateral will be illiquid and may have no readily ascertainable market value.
Accordingly, there can be no assurance that the collateral, if saleable, can be
sold in a short period of time.
A significant portion of the Company's assets consists of leasehold
improvements, and most of the Company's assets are located on leaseholds.
Because leasehold improvements may be deemed to be a part of either the real
property covered by the lease (which real property is not owned by the Company)
or the Company's real estate leasehold interests (which interests are not
included in the collateral available for the Notes), there can be no assurances
as to whether or to what extent such assets would be available as collateral
security for the Exchange Notes. Moreover, the ability of the Collateral Agent
to obtain possession of collateral located on leaseholds may be subject to
conflicting claims of landlords. The Company believes, however, that the
realizable value of such leasehold interests upon a liquidation of the Company
would not be material.
To the extent third parties hold Permitted Liens (as defined herein), such
third parties may have rights and remedies with respect to the property subject
to such Liens that, if exercised, could adversely affect the value of the
collateral. Given the intangible nature of certain of the collateral, any such
sale of such collateral separately from the Company as a whole may not be
feasible. Additionally, the inclusion of the Company's fixtures in the
collateral securing the Exchange Notes will be limited by the extent to which
such fixtures (a) are deemed not to be personal property, and (b) any applicable
state laws would, for purposes of perfecting security interests with respect
thereto, require that the Collateral Agent effectuate certain filings in
applicable real estate land records. The ability of the Company to grant a first
priority security interest in certain collateral may be limited by legal or
other logistical considerations. The ability of the holders of Exchange Notes to
realize upon the collateral may be limited by the terms of an intercreditor
agreement relating to an Eligible Credit Facility and may be subject to certain
bankruptcy law limitations in the event of a bankruptcy. See "-- Certain
Bankruptcy Limitations."
The Company is permitted to form new Subsidiaries and to transfer all or a
portion of the collateral to one or more of its Subsidiaries; PROVIDED that the
Company's rights to transfer collateral to Block Party and Limited Investment
Subsidiaries (as defined) will be restricted, and each of the Company's
Subsidiaries (other than Block Party and Limited Investment Subsidiaries) will
be required to execute a guarantee of the Company's obligations under the
Exchange Notes and the Indenture and a security agreement granting to the
Collateral Agent a security interest in substantially all of the assets of such
Subsidiary (other than real estate leasehold interests and certain real
property, fixtures and leasehold improvements). See "-- Certain Covenants --
Subsidiary Guarantees."
Subject to the restrictions on incurring Indebtedness and Liens set forth
herein, the Company and its Subsidiaries will have the right to grant (and
suffer to exist) Purchase Money Liens against fixed assets of the Company or
such Subsidiaries and to acquire any such assets subject to Purchase Money
Liens. The Collateral Agent's Liens are intended to be, and shall be, at all
times automatically subordinate in priority to all such Purchase Money Liens.
The collateral release provisions of the Indenture permit the release of
collateral without substitution of collateral of equal value under certain
circumstances, including assets sales made in compliance with the Indenture. The
Net Cash Proceeds of such Asset Sales may be required to be utilized to make an
offer to purchase a portion of the Exchange Notes.
Notwithstanding anything herein to the contrary, neither the Company nor any
of its Subsidiaries (other than Block Party and Limited Investment Subsidiaries)
will encumber any asset or property of the Company or such Subsidiaries or
suffer to exist any Lien thereon, other than as expressly permitted herein.
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<PAGE>
So long as no Event of Default shall have occurred and be continuing, and
subject to certain terms and conditions in the Indenture, the Eligible Credit
Facility, the Collateral Agreements and the Intercreditor Agreement (as defined
herein), the Company will be entitled to receive all cash dividends, interest
and other payments made upon or with respect to the capital stock of any
Subsidiary and to exercise any voting, consensual rights and other rights
pertaining to such collateral pledged by it. Upon the occurrence and during the
continuance of an Event of Default, (a) all rights of the Company to exercise
such voting, consensual rights, or other rights shall cease upon notice from the
Trustee, and all such rights shall become vested in the Collateral Agent, which,
to the extent permitted by law, shall have the sole right to exercise such
voting, consensual rights or other rights, (b) all rights of the Company to
receive all cash dividends, interest and other payments made upon or with
respect to the collateral shall cease, and such cash dividends, interest and
other payments shall be paid to the Collateral Agent, and (c) the Collateral
Agent may sell the collateral or any part thereof in accordance with and subject
to the terms of the Collateral Agreements; PROVIDED, HOWEVER, that while
Indebtedness is outstanding under an Eligible Credit Facility, rights of the
holders of the Exchange Notes and the Collateral Agent will be subordinate to
the Liens of the Eligible Credit Facility and subject to the terms of the
Intercreditor Agreement. All funds distributed under the Collateral Agreements
and received by the Collateral Agent for the ratable benefit of the holders of
the Exchange Notes shall be distributed by the Collateral Agent in accordance
with the provisions of the Indenture.
Upon the full and final payment and performance of all obligations of the
Company under the Indenture and the Exchange Notes, the Collateral Agreements
shall terminate and the pledged collateral shall be released.
ESCROWED INTEREST ACCOUNT
In order to secure the Company's obligations under the Exchange Notes, the
Company deposited in the Escrowed Interest Account held by the Trustee pursuant
to the terms and conditions of the Indenture and the Escrow Agreement (as
defined) certain Pledged Securities (as defined), consisting of United States
Treasury Securities, acquired by the Company from a portion of the net proceeds
of the Private Notes in an amount equal to approximately $21.6 million. The
Escrow Funds which remain subject to the Escrow Agreement have been invested in
Pledged Securities held in the Escrowed Interest Account.
Immediately prior to any of the scheduled Interest Payment Dates through
August 1, 1999, the Company may either, (i) deposit with the Trustee from funds
otherwise available to the Company cash sufficient to pay the interest scheduled
to be paid on such date, or (ii) direct the Trustee to release from the Escrowed
Interest Account proceeds sufficient to pay interest then due on the Notes. In
the event the Company exercises the former option, the Company may direct the
Trustee to release a like amount of proceeds from the Escrowed Interest Account
for the benefit of the Company. In the event that the Company optionally redeems
Exchange Notes with the net proceeds of a Primary Offering, the Company may
direct the Trustee to release from the Escrowed Interest Account an amount of
proceeds which bears the same proportion to the aggregate value of the Escrowed
Interest Account immediately prior to the release of such proceeds as the
aggregate principal amount of the Exchange Notes so redeemed by the Company
bears to the aggregate principal amount of Exchange Notes outstanding
immediately prior to such redemption. The amount of proceeds that may be
released by the Trustee to the Company in connection with any such optional
redemption shall be net of any costs, fees and expenses (such as breakage fees)
incurred to permit such release.
Interest earned on the Pledged Securities will be added to the Escrowed
Interest Account. The Pledged Securities and Escrowed Interest Account will also
secure the repayment of the principal amount and premium, if any, on the
Exchange Notes.
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<PAGE>
Under the Escrow Agreement, after making the scheduled interest payments on
the Exchange Notes through August 1, 1999, all of the remaining Pledged
Securities, if any, will be released from the Escrowed Interest Account and paid
to the Company.
INTERCREDITOR AGREEMENT
The Company will be permitted under certain circumstances to enter into an
Eligible Credit Facility (as defined) with a Lender (as defined); PROVIDED that
(i) entering into the Eligible Credit Facility is not prohibited by the
"Limitation on Incurrence of Additional Indebtedness and Issuance of Preferred
Stock" covenant of the Indenture and (ii) the security interests and liens upon
any property or assets of the Company securing Indebtedness under the Eligible
Credit Facility are Permitted Liens (as defined hereinafter), in each case, as
evidenced to the Trustee in an officers' certificate of the Company delivered to
the Trustee.
The Trustee will be authorized to enter into an intercreditor agreement with
the Lender providing the Eligible Credit Facility (an "Intercreditor
Agreement"). The Intercreditor Agreement will provide, among other things, that
(i) such Lender's security interest in certain of the assets of the Company
shall be senior to the Collateral Agent's security interest in such assets, (ii)
during any insolvency proceedings, the Lender and the Collateral Agent will
coordinate their efforts to give effect to the relative priority of their
security interests in such properties and assets, and (iii) following an Event
of Default (as defined hereinafter), all decisions with respect to such
properties and assets, including the time and method of any disposition thereof,
will be made in accordance with the terms of such Intercreditor Agreement, in
each case, subject to the terms and provisions of the Indenture and the
Collateral Agreements. The Intercreditor Agreement will also provide that the
Trustee and the Lender will provide notices to each other with respect to
acceleration of the Exchange Notes or the Indebtedness outstanding under the
Eligible Credit Facility, as the case may be.
If the Exchange Notes become due and payable prior to the stated maturity
thereof for any reason or are not paid in full at the stated maturity thereof at
a time during which Indebtedness is outstanding under an Eligible Credit
Facility, the Collateral Agent will not have the right to foreclose upon the
collateral that is subject to the Eligible Credit Facility unless the Lender
forecloses upon such collateral. Thereafter, the Collateral Agent has the right
to foreclose upon such collateral, which may be in instructions from the holders
of a majority of the principal amount of Exchange Notes then outstanding or, in
the absence of such instructions, in such manner as the Collateral Agent deems
appropriate in its sole and absolute discretion. Proceeds from the sale of
collateral that is subject to the Eligible Credit Facility will first be applied
to repay Indebtedness outstanding under the Eligible Credit Facility, if any,
and thereafter paid to the Trustee. The proceeds received by the Trustee will be
applied by the Trustee first to pay the expenses of any foreclosure and fees and
other amounts then payable to the Trustee under the Indenture and, thereafter,
to pay all amounts owing to the holders of the Exchange Notes (with any
remaining proceeds to be payable to the Company or as may otherwise be required
by law).
GUARANTEE
The full and prompt payment of the Company's payment obligations under the
Exchange Notes and the Indenture will be guaranteed, jointly and severally, by
all present and future Subsidiaries (other than Block Party and Limited
Investment Subsidiaries (collectively, the "Subsidiary Guarantors"). Each
Subsidiary Guarantor will fully and unconditionally guarantee on a senior
secured basis (secured initially by certain of such Subsidiary Guarantor's
assets, including cash, accounts receivable, inventory, equipment, general
intangibles, intellectual property rights and certain other fixed assets (except
real estate leasehold interests existing on the Issue Date and certain real
property, fixtures and leasehold improvements of such Subsidiary) (the
"Subsidiary Guarantee"), jointly and severally, to each Holder and the Trustee,
the full and prompt performance of the Company's obligations under the Indenture
and the Exchange Notes, including the payment of principal of and interest on
the Exchange Notes. The Subsidiary Guarantee of
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<PAGE>
each Subsidiary Guarantor will rank PARI PASSU in right of payment to all
existing and future unsubordinated Indebtedness of such Subsidiary Guarantor.
The Company will be permitted under certain circumstances to enter into an
Eligible Credit Facility in which case the first priority security interest in
certain collateral securing the Notes will be subordinated to a lien securing
such credit facility. The obligations of each Subsidiary Guarantor are limited
to the maximum amount which, after giving effect to all other contingent and
fixed liabilities of such Subsidiary Guarantor and after giving effect to any
collections from or payments made by or on behalf of any other Subsidiary
Guarantor in respect of the obligations of such other Subsidiary Guarantor under
its Subsidiary Guarantee or pursuant to its contribution obligations under the
Indenture, will result in the obligations of such Subsidiary Guarantor under the
Subsidiary Guarantee not constituting a fraudulent conveyance or fraudulent
transfer under federal or state law. The net worth of any Subsidiary Guarantor
for such purpose shall include any claim of such Subsidiary Guarantor against
the Company for reimbursement and any claim against any other Subsidiary
Guarantor for contribution. Each Subsidiary Guarantor may consolidate with or
merge into or sell its assets to the Company or another Subsidiary Guarantor
without limitation, or with other Persons upon the terms and conditions set
forth in the Indenture. See "-- Certain Covenants -- Mergers, Consolidations and
Sale of Assets" and "-- Asset Sales." In the event all of the Capital Stock of a
Subsidiary Guarantor is sold (including by way of merger or consolidation) by
the Company and the sale complies with the provisions set forth in "-- Certain
Covenants -- Asset Sales," the Subsidiary Guarantee with respect to such
Subsidiary Guarantor will be released.
PRINCIPAL, MATURITY AND INTEREST
The Exchange Notes are limited in aggregate principal amount to $85.0
million and will mature on August 1, 2002. Interest will be payable on the
Exchange Notes in cash at the rate of 13 1/2% per annum, quarterly in arrears,
on each August 1, November 1, February 1 and May 1, commencing on February 1,
1998, to holders of record on the immediately preceding July 15, October 15,
January 15 and April 15. Cash interest will be computed on the basis of a
360-day year comprised of twelve 30-day months. Interest on the Exchange Notes
will increase if the Company fails to fulfill its obligations under the
Registration Rights Agreement. See "Exchange Offer; Purpose and Effect of the
Exchange Offer." The Exchange Notes will be payable both as to principal and
interest at the office or agency of the Company, or, at the option of the
Company, payment of interest may be made by check mailed to the holders of the
Exchange Notes at their respective addresses set forth in the register of
holders of Exchange Notes. Until otherwise designated by the Company, the
Company's office or agency will be the office of the Trustee maintained for such
purpose.
OPTIONAL REDEMPTION
The Exchange Notes are not entitled to any mandatory redemption or sinking
fund payments. Except as described below, the Exchange Notes are not redeemable
at the Company's option prior to August 1, 1999. Thereafter, the Exchange Notes
will be subject to redemption at the option of the Company, in whole or in part,
upon not less than 15 nor more than 60 days' notice, at the redemption prices
(expressed as percentages of principal amount at maturity) set forth below, plus
accrued and unpaid interest thereon to the applicable redemption date, if
redeemed during the twelve month period beginning on August 1, of the years
indicated below through but not including the Maturity Date:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- ---------------------------------------------------------------------------------- -----------
<S> <C>
1999.............................................................................. 113.000%
2000.............................................................................. 108.667%
2001.............................................................................. 104.333%
</TABLE>
Notwithstanding the foregoing, prior to August 1, 1999, the Company may
redeem up to 35% of the original principal amount of the Exchange Notes at a
redemption price equal to 115% of the principal
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amount thereof on the redemption date, plus accrued interest thereon to the
redemption date, with the net proceeds of a Primary Offering; PROVIDED that (i)
such offering results in net proceeds to the Company of at least $20 million,
and (ii) such redemption shall occur within 30 days of the date of the closing
of such offering. Nothing in the Indenture, including the restrictions on
optional redemptions, limits the Company's right to make open market or
privately negotiated purchases of the Exchange Notes from time to time on or
after the first anniversary of the date hereof.
If fewer than all of the Exchange Notes are to be redeemed at any time,
selection of Exchange Notes for redemption will be made by the Trustee in
compliance with the requirements of the national securities exchange, if any, on
which the Exchange Notes are listed, or, if the Exchange Notes are not so
listed, on a pro rata basis, by lot or by such method as the Trustee deems to be
fair and appropriate; PROVIDED that Exchange Notes of $1,000 or less may not be
redeemed in part. Notice of redemption will be mailed by first class mail at
least 15 days but not more than 60 days before the redemption date to each
holder to be redeemed at such holder's registered address. If any Exchange Note
is to be redeemed in part only, the notice of redemption that relates to such
Exchange Note will state the portion of the principal amount thereof to be
redeemed. A new Exchange Note in principal amount equal to the unredeemed
portion thereof will be issued in the name of the holder thereof upon
cancellation of the original Exchange Note. On and after the date of redemption,
interest will cease to accrue on the Private Notes or portions of Exchange Notes
called for redemption.
REPURCHASE UPON CHANGE OF CONTROL
Upon the occurrence of a Change of Control, the Company will be required to
notify the Trustee in writing thereof and to offer to repurchase all or any part
(equal to $1,000 of principal at maturity or an integral multiple thereof) of
each holder's Exchange Notes pursuant to the offer described below (the "Change
of Control Offer") at a purchase price equal to 101% of the principal amount
thereof on the date of purchase, plus accrued interest thereon, if any, through
the date of purchase (the "Change of Control Payment"). Within 40 days following
any Change of Control, the Company shall mail a notice to each holder stating:
(1) that the Change of Control Offer is being made pursuant to the covenant
entitled "Limitation on Change of Control" in the Indenture and that all
Exchange Notes tendered will be accepted for payment; (2) the purchase price and
the purchase date, which shall be no earlier than 30 days nor later than 60 days
from the date such notice is mailed (the "Change of Control Payment Date"); (3)
that any Exchange Note not tendered will continue to accrue interest; (4) that,
unless the Company defaults in the payment of the Change of Control Payment, all
Exchange Notes accepted for payment pursuant to the Change of Control Offer
shall cease to accrue interest on and after the Change of Control Payment Date;
(5) that holders electing to have any Exchange Notes purchased pursuant to a
Change of Control Offer will be required to surrender the Exchange Notes, with
the form entitled "Option of Holder to Elect Purchase" on the reverse of the
Exchange Notes completed, to the Paying Agent at the address specified in the
notice prior to the close of business on the third Business Day preceding the
Change of Control Payment Date; (6) that holders will be entitled to withdraw
their election if the Paying Agent receives, not later than the close of
business on the second Business Day preceding the Change of Control Payment
Date, a telegram, telex, facsimile transmission or letter setting forth the name
of the holder, the principal amount of Exchange Notes delivered for purchase,
and a statement that such holder is withdrawing his election to have such
Exchange Notes purchased; and (7) that holders whose Exchange Notes are being
purchased only in part will be issued new Exchange Notes equal in principal
amount to the unpurchased portion of the Exchange Notes surrendered; PROVIDED
that each Exchange Note purchased and each new Exchange Note issued shall be in
a principal amount of $1,000 or an integral multiple thereof. The Company will
comply with the requirements of Rule 14e-1 under the Exchange Act and any other
securities laws and regulations thereunder to the extent such laws and
regulations are applicable in connection with the repurchase of the Exchange
Notes in connection with a Change of Control. To the extent that the provisions
of any securities laws or regulations conflict with the "Limitation on Change of
Control" covenant of the Indenture, the Company shall comply with the applicable
securities laws and
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regulations and shall not be deemed to have breached its obligations under the
"Limitation on Change of Control" covenant of the Indenture by virtue thereof.
On or before the Change of Control Payment Date, the Company will, to the
extent lawful, (1) accept for payment Exchange Notes or portions thereof
tendered pursuant to the Change of Control Offer, (2) deposit with the Paying
Agent an amount equal to the Change of Control Payment in respect of all
Exchange Notes or portions thereof so tendered and (3) deliver or cause to be
delivered to the Trustee the Exchange Notes so accepted together with an
Officers' Certificate stating the amount of the Exchange Notes or portions
thereof tendered to the Company. The Paying Agent shall promptly mail to each
holder of the Exchange Notes so accepted payment in an amount equal to the
purchase price for such Exchange Notes, and the Trustee shall promptly
authenticate and mail to each holder a new Exchange Note equal in principal
amount to the unpurchased portion of the Exchange Notes surrendered, if any, to
the Change of Control Payment Date; PROVIDED that each such new Exchange Note
shall be in a principal amount of $1,000 or an integral multiple thereof. The
Company will publicly announce the results of the Change of Control Offer on or
as soon as practicable after the Change of Control Payment Date.
There can be no assurance that sufficient funds will be available at the
time of any Change of Control Offer to make required repurchases. The Company's
failure to comply with the covenant described above, including failure to pay
the repurchase price, will be an Event of Default under the Indenture.
CERTAIN BANKRUPTCY LIMITATIONS
The right of the Collateral Agent to repossess and dispose of the collateral
upon the occurrence of an Event of Default is likely to be significantly
impaired by applicable bankruptcy law if a bankruptcy proceeding were to be
commenced by or against the Company or any of its Subsidiaries prior to the
Collateral Agent having repossessed and disposed of the collateral. Under the
Bankruptcy Code, a secured creditor such as the Collateral Agent is prohibited
from repossessing its security from a debtor in a bankruptcy case or from
disposing of security repossessed from such debtor without bankruptcy court
approval. Moreover, the Bankruptcy Code permits the debtor to continue to retain
and to use collateral even though the debtor is in default under the applicable
debt instruments; PROVIDED that secured creditors are given "adequate
protection." The meaning of the term "adequate protection" may vary according to
circumstances, but it is intended in general to protect the value of the secured
creditor's interest in the collateral and may include cash payments or the
granting of additional security, if and at such times as the court in its
discretion determines, for any diminution in the value of the collateral as a
result of the stay of repossession or disposition or any use of the collateral
by the debtor during the pendency of the bankruptcy case. In view of the lack of
a precise definition of the term "adequate protection" and the broad
discretionary powers of a bankruptcy court, it is impossible to predict how long
payments under the Exchange Notes could be delayed following commencement of a
bankruptcy case, whether or when the Collateral Agent could repossess or dispose
of the collateral or whether or to what extent holders of the Exchange Notes
would be compensated for any delay in payment or loss of value of the collateral
through the requirement of "adequate protection."
CERTAIN COVENANTS
RESTRICTED PAYMENTS. The Company will not, and will not permit any of its
Subsidiaries to, directly or indirectly: (i) declare or pay any dividend or make
any distribution on account of the Company's or any of its Subsidiaries' Equity
Interests (other than dividends or distributions payable in Equity Interests
(other than Disqualified Stock) of the Company or dividends or distributions
payable to the Company or any Wholly-Owned Subsidiary of the Company); (ii)
purchase, redeem or otherwise acquire or retire for value any Equity Interests
of the Company or any Subsidiary or other Affiliate of the Company (other than
any such Equity Interests owned by the Company or any Wholly-Owned Subsidiary of
the Company); (iii) voluntarily purchase, redeem, defease or otherwise acquire
or retire for value any Indebtedness that is PARI PASSU with or subordinated to
the Exchange Notes; or (iv) make any Restricted Investment (all such payments
and other actions set forth in clauses (i) through (iv) above being collectively
referred to as "Restricted Payments") unless, at the time of such Restricted
Payment:
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(a) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof;
(b) immediately after giving effect to such transaction, on a pro forma
basis as if such transaction had occurred at the beginning of the applicable
four-quarter period, the Company would be permitted to incur at least $1.00
of additional Indebtedness pursuant to the Fixed Charge Coverage Ratio test
set forth in the first paragraph of the covenant entitled "-- Incurrence of
Additional Indebtedness and Issuance of Preferred Stock" below; and
(c) the amount of such Restricted Payment, together with the aggregate
amount of all other Restricted Payments made by the Company and its
Subsidiaries after the date of the Indenture, is less than the sum of (x)
25% of the Consolidated Net Income of the Company for the period (taken as
one accounting period) from the beginning of the first quarter next
succeeding the quarter ended June 30, 1998 to the end of the Company's most
recently ended fiscal quarter for which internal financial statements are
available at the time of such Restricted Payment (or, if such Consolidated
Net Income for such period is a deficit, 100% of such deficit), plus (y)
100% of the aggregate net cash proceeds received by the Company from the
issuance or sale of Equity Interests of the Company (other than Equity
Interests sold to a Subsidiary of the Company and other than Disqualified
Stock) since the date of the Indenture, plus (z) 100% of the Net Cash
Proceeds received by the Company from the issuance or sale, other than to a
Subsidiary of the Company, of any debt security of the Company that has been
converted into Equity Interests of the Company (other than Disqualified
Stock) since the date of the Indenture. For purposes of this clause (c) the
amount of any Restricted Payment paid in property other than cash shall be
the fair market value of such property as determined reasonably and in good
faith by the Board of Directors of the Company.
If no Default or Event of Default shall have occurred and be continuing, the
foregoing provisions will not prohibit: (i) the payment of any dividend within
60 days after the date of declaration thereof, if at said date of declaration
such payment would have complied with the provisions of the Indenture; (ii) the
redemption, repurchase, retirement or other acquisition of any Indebtedness or
Equity Interests of the Company in exchange for, or solely out of the proceeds
of, the substantially concurrent sale (other than to a Subsidiary of the
Company) of other Equity Interests of the Company (other than any Disqualified
Stock); (iii) the redemption, repurchase or payoff of Purchase Money
Obligations; (iv) the redemption, repurchase or payoff of any Indebtedness with
proceeds of any Refinancing Indebtedness permitted to be incurred under "Certain
Covenants -- Incurrence of Indebtedness and Issuance of Preferred Stock"; (v)
the repurchase, redemption or other acquisition or retirement for value of any
Equity Interests of the Company held by any officer or employee of the Company
or its Subsidiaries; PROVIDED, HOWEVER, that the aggregate amount of all such
repurchases, redemptions and other acquisitions and retirements under this
clause (v) on or after the date of the Indenture shall not exceed $1 million;
(vi) the voluntary purchase, redemption, defeasance or other acquisition or
retirement of all or any portion of the Indebtedness represented by the McDonald
Note with the Net Cash Proceeds of an Asset Sale that (A) is permitted under the
restriction on "Asset Sales" below and (B) relates solely to collateral for the
McDonald Note in the form of undeveloped real estate not used or, in the
reasonable judgment of the Board of Directors, useful in the Company's business;
(vii) the purchase, redemption, defeasance or other acquisition or retirement of
Unit Warrants required by the terms of the Unit Warrant Agreement described
below under "Description of Capital Stock -- Warrants"; (viii) distributions
required under the Plan of Reorganization but only in the manner and to the
extent contemplated thereby; and (ix) payments or distributions to dissenting
stockholders (it being understood that such dissenting stockholders shall not
include any Class 14 Interests (as defined in the Plan of Reorganization))
required by applicable law pursuant to or in connection with a consolidation,
merger or Asset Sale that complies with all applicable provisions of the
Indenture.
Not later than the date of making any Restricted Payment, the Company shall
deliver to the Trustee an Officers' Certificate stating that such Restricted
Payment is permitted and setting forth the basis upon
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which the calculations required by the "Restricted Payments" covenant were
computed, which calculations may be based upon the Company's latest available
quarterly financial statements.
INCURRENCE OF ADDITIONAL INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK. The
Company will not, and will not permit any of its Subsidiaries to, directly or
indirectly, create, incur, issue, assume, guaranty or otherwise become directly
or indirectly liable with respect to (collectively, "incur") any Indebtedness
(other than Permitted Indebtedness), and the Company will not issue any
Disqualified Stock and will not permit any of its Subsidiaries to issue any
shares of Preferred Stock; PROVIDED, HOWEVER, that the Company may incur
Indebtedness or issue shares of Disqualified Stock, if (i) no Default or Event
of Default shall have occurred and be continuing or would occur as a consequence
thereof and (ii) the Fixed Charge Coverage Ratio for the Company's most recently
ended four full fiscal quarters for which internal financial statements are
available immediately preceding the date on which such additional Indebtedness
is incurred or such Disqualified Stock is issued would have been at least equal
to 3.0:1, determined on a pro forma basis as if the additional Indebtedness had
been incurred, or the Disqualified Stock had been issued, as the case may be, at
the beginning of such four-quarter period.
ASSET SALES. The Company will not, and will not permit any of its
Subsidiaries to, consummate an Asset Sale unless: (i) the Company or the
applicable Subsidiary, as the case may be, receives consideration at the time of
such Asset Sale in an amount at least equal to the fair market value of the
assets sold or otherwise disposed of (as determined in good faith by the
Company's Board of Directors); (ii) at least 85% of the consideration received
by the Company or the Subsidiary, as the case may be, from such Asset Sale shall
be in the form of cash or Cash Equivalents and is received at the time of such
disposition; and (iii) upon the consummation of an Asset Sale, the Company
either (A) shall apply, or cause such Subsidiary to apply, the Net Cash Proceeds
relating to such Asset Sale within 180 days of such Asset Sale either (1) to
repay any Indebtedness secured by the assets involved in such Asset Sale
together with a concomitant permanent reduction in the amount of such
Indebtedness (including a permanent reduction in the committed amounts therefor
in the case of any revolving credit facility so repaid), (2) to make an
investment in properties and assets that replace the properties and assets that
were the subject of such Asset Sale or in properties and assets that will be
used in the business of the Company and its Subsidiaries as existing on the
Effective Date or in businesses reasonably related thereto ("Replacement
Assets"), or (3) a combination of repayment and investment permitted by the
foregoing clauses (iii)(A)(1) and (iii)(A)(2) or (B) shall (1) within 150 days
of such Asset Sale enter into a definitive written agreement committing it,
subject to no material conditions other than conditions customary in such
agreements, to make an investment in Replacement Assets within 270 days of such
Asset Sale and (2) apply, or cause such Subsidiary to apply, the Net Cash
Proceeds relating to such Asset Sale within 270 days of such Asset Sale to an
investment in Replacement Assets. On (i) the 181st day after an Asset Sale, or
(ii) such earlier date as the Board of Directors of the Company or of such
Subsidiary determines to apply the Net Cash Proceeds relating to such Asset Sale
as set forth in clauses (iii)(A)(1), (iii)(A)(2) and (iii)(A)(3) of the
immediately preceding sentence, or (iii) if a definitive written agreement
relating to an investment in Replacement Assets was entered into within 150 days
of such Asset Sale, on the 271st day after such Asset Sale or such earlier date
on which such definitive written agreement is for any reason terminated (each, a
"Net Proceeds Offer Trigger Date"), such aggregate amount of Net Cash Proceeds
which has not been applied on or before such Net Proceeds Offer Trigger Date as
permitted in clauses (iii)(A) or (iii)(B) of the immediately preceding sentence
(each a "Net Proceeds Offer Amount") shall be applied by the Company or such
Subsidiary to make an offer to purchase (the "Net Proceeds Offer"), on a date
(the "Net Proceeds Offer Payment Date") not less than 30 nor more than 60 days
following the applicable Net Proceeds Offer Trigger Date, from all holders of
Notes on a PRO RATA basis that amount of Exchange Notes equal to the Net
Proceeds Offer Amount at a price equal to 100% of the aggregate principal amount
of the Exchange Notes to be purchased, plus accrued and unpaid interest thereon,
if any, to the date of purchase; PROVIDED, HOWEVER, that if at any time any
non-cash consideration received by the Company or any Subsidiary of the Company,
as the case may be, in connection with any Asset Sale is converted into or sold
or otherwise disposed of for cash (other than interest received with respect to
any such non-cash consideration), then
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such conversion or disposition shall be deemed to constitute an Asset Sale
hereunder, and the Net Cash Proceeds thereof shall be applied in accordance with
this covenant. The Company may defer the Net Proceeds Offer until there is an
aggregate unutilized Net Proceeds Offer Amount equal to or in excess of $5
million resulting from one or more Asset Sales (at which time, the entire
unutilized Net Proceeds Offer Amount, and not just the amount in excess of $5
million, shall be applied as required pursuant to this paragraph).
In the event of the transfer of substantially all (but not all) of the
property and assets of the Company and its Subsidiaries as an entirety to a
Person in a transaction permitted under "-- Merger, Consolidation or Sale of
Assets" below, the successor corporation shall be deemed to have sold the
properties and assets of the Company and its Subsidiaries not so transferred for
purposes of this covenant, and shall comply with the provisions of this covenant
with respect to such deemed sale as if it were an Asset Sale. In addition, the
fair market value of such properties and assets of the Company or its
Subsidiaries deemed to be sold shall be deemed to be Net Cash Proceeds for
purposes of this covenant.
Subject to the deferral of the Net Proceeds Offer Trigger Date, each notice
of a Net Proceeds Offer will be mailed to the record holders of Exchange Notes
as shown on the register of holders within 25 days following the Net Proceeds
Offer Trigger Date, with a copy to the Trustee, and shall comply with the
procedures set forth in the Indenture. Upon receiving notice of the Net Proceeds
Offer, holders may elect to tender their Exchange Notes in whole or in part in
integral multiples of $1,000 in exchange for cash. To the extent holders
properly tender Exchange Notes in an amount exceeding the aggregate Net Proceeds
Offer Amount, Exchange Notes of tendering holders will be purchased on a PRO
RATA basis (based on amounts tendered). A Net Proceeds Offer shall remain open
for a period of 20 business days or such longer period as may be required by
law.
The Company will comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations thereunder to the
extent such laws and regulations are applicable in connection with the
repurchase of Exchange Notes pursuant to a Net Proceeds Offer. To the extent
that the provisions of any securities laws or regulations conflict with the
"Limitation on Asset Sale" provisions of the Indenture, the Company shall comply
with the applicable securities laws and regulations and shall not be deemed to
have breached its obligations under the "Limitation on Asset Sales" provisions
of the Indenture by virtue thereof.
LIMITATIONS ON ISSUANCES AND SALES OF CAPITAL STOCK OF SUBSIDIARIES. The
Company will not cause or permit any of its Subsidiaries to issue or sell any
Capital Stock (other than to the Company or to a Wholly-Owned Subsidiary of the
Company) or permit any Person (other than the Company or a Wholly-Owned
Subsidiary of the Company) to own or hold any Capital Stock of any Subsidiary of
the Company or any Lien or security interest therein; PROVIDED, HOWEVER, such
covenant shall not prohibit the disposition (by sale, merger or otherwise) of
all of the Capital Stock of a Subsidiary of the Company; PROVIDED any Net Cash
Proceeds therefrom are applied in accordance with the covenants described under
"-- Asset Sales."
LIENS. The Indenture will provide that neither the Company nor any of its
Subsidiaries may, directly or indirectly, incur any Lien, except Permitted
Liens, against or upon any property or assets now owned or hereafter acquired by
the Company or any of its Subsidiaries, or any income or profits therefrom, or
assign or convey any right to receive income or profits therefrom.
LIMITATION ON DIVIDENDS AND OTHER PAYMENT RESTRICTIONS AFFECTING
SUBSIDIARIES. The Company will not, and will not permit any of its Subsidiaries
to, directly or indirectly, create or otherwise cause or suffer to exist or
become effective any encumbrances or restrictions on the ability of any such
Subsidiary to (a) pay dividends or make any other distributions to the Company
or any of its Subsidiaries (A) on such Subsidiary's Capital Stock or (B) with
respect to any other interest or participation in, or measured by, its profits,
or pay any Indebtedness owed to the Company or any of its Subsidiaries or (b)
make loans or advances to the Company or any of its Subsidiaries or (c) transfer
any of its properties or assets to the
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Company or any of its Subsidiaries, except for such encumbrances or restrictions
existing under or by reasons of (1) applicable law; (2) the Indenture and
Exchange Notes; (3) customary non-assignment provisions of any contract or any
lease governing a leasehold interest of any Subsidiary of the Company; (4)
agreements existing on the Issue Date to the extent and in the manner such
agreements are in effect on the Issue Date; or (5) an agreement governing
Indebtedness incurred to refinance the Indebtedness issued, assumed or incurred
pursuant to an agreement referred to in clause (2) or (4) above; PROVIDED,
HOWEVER, that the provisions relating to such encumbrance or restriction
contained in any such Indebtedness are no less favorable to the Company in any
material respect as determined by the Board of Directors of the Company in their
reasonable and good faith judgment than the provisions relating to such
encumbrance or restriction contained in agreements referred to in such clause
(2) or (4).
MERGER, CONSOLIDATION OR SALE OF ASSETS. The Company will not, in a single
transaction or series of related transactions, consolidate or merge with or into
(whether or not the Company is the surviving corporation), or sell, assign,
transfer, lease, convey or otherwise dispose of all or substantially all of its
properties or assets to, another corporation, Person or entity unless: (i) the
Company is the surviving corporation, or the entity or the person formed by or
surviving any such consolidation or merger (if other than the Company) or to
which such sale, assignment, transfer, lease, conveyance or other disposition
shall have been made is a corporation organized or existing under the laws of
the United States, any state thereof or the District of Columbia; (ii) the
entity or person formed by or surviving any such consolidation or merger (if
other than the Company) or to which such sale, assignment, transfer, lease,
conveyance or other disposition will have been made assumes all the obligations
of the Company under the Collateral Agreements, the Registration Rights
Agreement, the Unit Warrant Agreement, the Intercreditor Agreement and all
obligations of the Company under the Exchange Notes and the Indenture, pursuant
to a supplemental indenture in a form reasonably satisfactory to the Trustee;
(iii) immediately after such transaction (including giving effect to any
Indebtedness and Acquired Debt incurred or expected to be incurred in connection
with or in respect of such transaction and to any assumption required by clause
(ii) above) no Default or Event of Default exists; (iv) the Company or any
corporation formed by or surviving any such consolidation or merger, or to which
such sale, assignment, transfer, lease, conveyance or other disposition will
have been made (A) will have Consolidated Net Worth (immediately after the
transaction but prior to any purchase accounting adjustments resulting from the
transaction) equal to or greater than the Consolidated Net Worth of the Company
immediately preceding the transaction and (B) will, at the time of such
transaction and after giving PRO FORMA effect thereto as if such transaction had
occurred at the beginning of the applicable four quarter period, be permitted to
incur at least $1.00 of additional Indebtedness pursuant to the Indenture and
will have a Fixed Charge Coverage Ratio, determined on a PRO FORMA basis,
greater than or equal to the Fixed Charge Coverage Ratio of the Company
immediately prior to the transaction; and (v) the Company or the entity or
Person formed by or surviving any such consolidation or merger, or to which such
sale, assignment, transfer, lease, conveyance or other disposition will have
been made shall have delivered to the Trustee an officer's certificate and an
opinion of counsel, each stating that such consolidation, merger, sale,
assignment, transfer, lease, conveyance or other disposition and any
supplemental indenture required in connection with such transaction comply with
the applicable provisions of the Indenture and that all conditions precedent in
the Indenture relating to such transaction have been satisfied.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all of the properties or assets of one or more Subsidiaries of the
Company, the Capital Stock of which constitutes all or substantially all of the
properties and assets of the Company, shall be deemed to be the transfer of all
or substantially all of the properties and assets of the Company.
The Indenture will provide that upon any consolidation, combination or
merger or any transfer of all or substantially all of the assets of the Company
in accordance with the foregoing, in which the Company is not the continuing
corporation, the successor Person formed by such consolidation or into which the
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Company is merged or to which such conveyance, lease or transfer is made shall
succeed to, and be substituted for, and may exercise every right and power of,
the Company under the Indenture and the Notes, the Collateral Agreements, the
Registration Rights Agreement and the Unit Warrant Agreement with the same
effect as if such surviving entity had been named as such.
Each Subsidiary Guarantor (other than any Subsidiary Guarantor whose
Subsidiary Guarantee is to be released in accordance with the terms of the
Guarantee and the Indenture in connection with any transaction made in
compliance with the provisions of "-- Asset Sales") will not, and the Company
will not cause or permit any Subsidiary Guarantor to, consolidate with or merge
with or into any Person, or sell, assign, transfer, lease, convey or otherwise
dispose of all or substantially all of its assets, other than the Company or any
other Subsidiary Guarantors unless: (i) the entity formed by or surviving any
such consolidation or merger (if other than the Subsidiary Guarantor), or to
which such disposition shall have been made, is a corporation organized and
existing under the laws of the United States, any state thereof or the District
of Columbia; (ii) such entity assumes by supplemental indenture all of the
obligations of the Subsidiary Guarantor on the Subsidiary Guarantee; (iii)
immediately after giving effect to such transaction, no Default or Event of
Default shall have occurred and be continuing; and (iv) immediately after giving
effect to such transaction and the use of any net proceeds therefrom on a pro
forma basis, the Company could satisfy the provisions of clause (iv) of the
first paragraph of this covenant. Any merger or consolidation of a Subsidiary
Guarantor with and into the Company (with the Company being the surviving
entity) or another Subsidiary Guarantor need only comply with clause (iv) of the
first paragraph of this covenant.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. The Company will not, and will
not permit any of its Subsidiaries to, directly or indirectly, enter into or
permit to exist any transaction or series of related transactions (including,
without limitation, the purchase, sale, lease or exchange of any property or the
rendering of any services) with, or for the benefit of, any of its Affiliates
(each an "Affiliate Transaction"), other than (x) Affiliate Transactions
permitted under the next succeeding paragraph and (y) Affiliate Transactions on
terms that are no less favorable than those that might reasonably have been
obtained in a comparable transaction at such time on an arm's-length basis from
a Person that is not an Affiliate of the
Company or such Subsidiary. All Affiliate Transactions (and each series of
related Affiliate Transactions which are similar or part of a common plan)
involving aggregate payments or other property with a fair market value in
excess of $2 million shall be approved by a majority of the disinterested
members of the Board of Directors of the Company, such approval to be evidenced
by a Board Resolution stating that such Board of Directors has determined that
such transaction complies with the foregoing provisions. If the Company or any
such Subsidiary enters into an Affiliate Transaction (or a series of related
Affiliate Transactions which are similar or part of a common plan) that involves
an aggregate fair market value of more than $5 million, the Company shall, prior
to the consummation thereof, obtain a favorable opinion as to the fairness of
such transaction or series of related transactions to the Company from a
financial point of view from an Independent Financial Advisor and deliver such
opinion to the Trustee.
The restrictions set forth in the preceding paragraph shall not apply to:
(i) reasonable fees and compensation paid to, and indemnity provided on behalf
of, officers, directors, employees or consultants of the Company or any
Subsidiary as determined in good faith by the Company's Board of Directors or
senior management; (ii) transactions exclusively between or among the Company
and any of its Wholly-Owned Subsidiaries or exclusively between or among such
Wholly-Owned Subsidiaries, provided such transactions are not otherwise
prohibited by the Indenture; and (iii) Restricted Payments not prohibited by the
Indenture.
SUBSIDIARY GUARANTEES. Each Subsidiary Guarantor shall: (i) execute and
deliver to the Collateral Agent a supplemental indenture in a form reasonably
satisfactory to the Collateral Agent pursuant to which such Subsidiary Guarantor
shall unconditionally guarantee on a senior secured basis (secured initially by
certain of such Subsidiary Guarantor's assets, including cash, accounts
receivable, inventory, equipment, general intangibles, intellectual property
rights and certain other fixed assets (except real
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property, real estate leasehold interests, certain fixtures and leasehold
improvements) all of the Company's obligations under the Exchange Notes and the
Indenture; (ii) take all necessary action to cause the Lien on such collateral
in favor of the Collateral Agent to remain in full force and effect at all
times; (iii) deliver to the Collateral Agent an opinion of counsel that such
supplemental indenture and any other documents required to comply with clause
(ii) above have been duly authorized, executed and delivered by such Subsidiary
Guarantor, and the supplemental indenture and each such other document
constitutes a legal, valid, binding and enforceable obligation of such
Subsidiary Guarantor; and (iv) take such further action and execute and deliver
such other documents specified in the Indenture or otherwise reasonably
requested by the Collateral Agent to effectuate the foregoing. The Company may
transfer, in any one transaction or a series of related transactions, any
collateral to any Subsidiary Guarantor if such transferee Subsidiary Guarantor
shall have complied with the requirements of clauses (i) through (iv) above;
provided that the guarantee referred to in clause (i) above shall be secured by,
in addition to any collateral existing in such Subsidiary Guarantor, the
collateral so transferred.
IMPAIRMENT OF SECURITY INTEREST. Subject to the Intercreditor Agreement,
neither the Company nor any of its Subsidiaries will take or omit to take any
action which would adversely affect or impair the Security Interests in favor of
the Trustee, on behalf of itself and the holders of the Exchange Notes, with
respect to the Collateral, the Subsidiary Collateral, the Pledged Collateral or
the Pledged Subsidiary Collateral. Neither the Company nor any of its
Subsidiaries shall grant to any Person, or permit any Person to retain (other
than the Trustee), any interest whatsoever in the Collateral, the Subsidiary
Collateral, the Pledged Collateral or the Pledged Subsidiary Collateral other
than Liens on certain of the Collateral securing an Eligible Credit Facility and
Permitted Liens. Neither the Company nor any of its Subsidiaries will enter into
any agreement that requires the proceeds received from any sale of Collateral,
the Subsidiary Collateral, the Pledged Collateral or the Pledged Subsidiary
Collateral to be applied to repay, redeem, defease or otherwise acquire or
retire any Indebtedness of any Person, other than as permitted by the Indenture,
the Exchange Notes, the Intercreditor Agreement and the Collateral Agreements.
CONDUCT OF BUSINESS. Neither the Company nor any of its Subsidiaries will
engage in any businesses other than the business of operating family
entertainment centers or any activity related or ancillary thereto.
REPORTS. So long as any Notes are outstanding, the Company will furnish to
the holders of Exchange Notes all quarterly and annual financial information and
other reports filed with the Commission pursuant to the Exchange Act. From and
after the date of effectiveness of any registration statement filed with the
Commission with respect to the Notes, the Company will file with the Commission
such Forms 10-Q and 10-K and any other information required to be filed by it.
The Company will provide a copy of the Registration Rights Agreement and the
Unit Warrant Agreement to prospective holders of Exchange Notes upon request.
KEY MAN LIFE INSURANCE. The Company shall, not later than 60 days after the
Issue Date and for so long as the Exchange Notes are outstanding, maintain life
insurance upon the life of Scott W. Bernstein, the Company's Chief Executive
Officer, and any successor chief executive officer of the Company or other
senior executive officer of the Company performing similar functions, with the
death benefit thereunder payable to the Company in an amount not less than $10.0
million. The Company shall at all times retain all the incidents of ownership of
such insurance and shall not borrow upon or otherwise impair its right to
receive the proceeds of such insurance.
LEASEHOLD MORTGAGES AND FILINGS. The Company and each of its Subsidiaries
shall use commercially reasonable efforts to deliver Mortgages substantially in
the form attached to the Indenture with respect to the Company's leasehold
interests in the premises (the "Leased Premises") occupied by the Company
pursuant to leases of new store properties entered into after the Issue Date
(collectively, the "Leases," and individually, a "Lease"). Prior to the
effective date of any Lease, the Company and such Subsidiaries shall provide to
the Trustee all of the items described in the "Real Estate Mortgages and
Filings" covenant of
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the Indenture and in addition shall provide an agreement substantially in the
form attached to the Indenture and executed by the lessor of the Lease, whereby
the lessor consents to the Mortgage. The Company and such Subsidiaries shall
perform all of their obligations required hereunder at their sole cost and
expense.
RATING OF EXCHANGE NOTES. The Company shall cooperate with the Initial
Purchaser at any time and from time to time for a period of 18 months after the
Issue Date to obtain a rating for the Exchange Notes from at least one
nationally recognized rating agency and to keep a rating with respect to the
Exchange Notes continuously in effect through the Maturity Date.
PAYMENTS FOR CONSENT. Neither the Company nor any of the Company's
Subsidiaries (including, for this purpose only, Block Party and all Permitted
Investment Subsidiaries) shall, directly or indirectly, pay or cause to be paid
any consideration, whether by way of interest, fee or otherwise, to any holder
of any Exchange Notes for, or as inducement to, any consent, waiver or amendment
of any of the terms or provisions of the Indenture or the Exchange Notes unless
such consideration is offered to be paid or agreed to be paid to all holders of
Exchange Notes then outstanding that consent, waive or agree to amend any of
such terms or provisions in the time frame set forth in the solicitation
documents relating to such consent, waiver or agreement.
EVENTS OF DEFAULT AND REMEDIES
The Indenture will provide that each of the following constitutes an Event
of Default: (i) for any Interest Payment Date occurring on or prior to August 1,
1999, the Company fails to pay interest on any Exchange Notes when the same
become due and payable, and for any Interest Payment Date occurring after August
1, 1999, the Company fails to pay interest on any Exchange Notes when the same
becomes due and payable and the Default continues for a period of 10 days; (ii)
default by the Company in payment of principal (or premium, if any) on any
Exchange Notes at maturity, upon redemption, by acceleration or otherwise
(including the failure to make a payment to purchase Exchange Notes tendered
pursuant to a Change of Control Offer or a Net Proceeds Offer); (iii) failure by
the Company or any of its Subsidiaries (in each case, to the extent a party to
the Collateral Agreements) to comply with any of its other agreements or
covenants in, or provisions of, the Indenture, the Exchange Notes, or any of the
Collateral Agreements (to the extent such default of the Company, directly or
indirectly, adversely affects (or with respect to any such Subsidiary,
materially adversely affects) the Security Interests in the Collateral or the
rights and benefits of the holders under the Indenture or the Exchange Notes),
which default continues for a period of 30 days after the Company has received
written notice specifying the default; (iv) default under (after giving effect
to any applicable grace periods or any extension of any maturity date) any
mortgage, indenture or instrument under which there may be issued or by which
there may be secured or evidenced any Indebtedness of the Company or any of its
Subsidiaries (the payment of which is guaranteed by the Company or any
Subsidiary) whether such Indebtedness now exists, or is created after the date
of the Indenture, if (a) either (A) such default results from the failure to pay
principal of or interest on such Indebtedness or (B) as a result of such default
the maturity of such Indebtedness may be accelerated, and (b) the principal
amount of such Indebtedness, together with the principal amount of any other
such Indebtedness with respect to which a default (after the expiration of any
applicable grace period or any extension of the maturity date) has occurred, or
the maturity of which may be so accelerated, exceeds $2 million in the
aggregate, and the Default continues for a period of ten days after the Company
has received written notice specifying the default; (v) failure by the Company
or any of its Subsidiaries to pay final judgments (other than any judgment as to
which a reputable insurance company has accepted full liability in writing)
aggregating in excess of $2.0 million which judgments are not stayed within 60
days after their entry; (vi) certain events of bankruptcy or insolvency with
respect to the Company, any Subsidiary Guarantor or any of the Company's
Subsidiaries; and (vii) any Subsidiary Guarantee for any reason ceases to be in
full force and effect or becomes or is declared to be null and void,
unenforceable or invalid or any Subsidiary Guarantor denies its obligations
under its Subsidiary Guarantee.
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If any Event of Default occurs and is continuing, the Trustee or the holders
of at least 25% in principal amount of the then outstanding Exchange Notes may
by written notice declare all the Exchange Notes to be due and payable
immediately. Notwithstanding the foregoing, in the case of an Event of Default
arising from certain events of bankruptcy or insolvency, all outstanding
Exchange Notes will become immediately due and payable without further action or
notice. Holders may not enforce the Indenture or the Exchange Notes except as
provided in the Indenture. Subject to certain limitations, holders of a majority
in principal amount of the then outstanding Exchange Notes may direct the
Trustee in its exercise of any trustee power. The Trustee may withhold from
holders of the Exchange Notes notice of any continuing Default or Event of
Default (except a Default or Event of Default relating to the payment of
principal or interest) if it determines that withholding notice is in their
interest.
The holders of a majority in aggregate principal amount of the Exchange
Notes then outstanding, by written notice to the Trustee, may on behalf of the
holders of all the Exchange Notes (a) waive any existing Default or Event of
Default and its consequences under the Indenture except a continuing Default or
Event of Default in the payment of interest on, or the principal of, the
Exchange Notes, or (b) rescind an acceleration and its consequences if the
rescission would not conflict with any judgment or decree and if all existing
Events of Default (except nonpayment of principal or interest that has become
due solely because of the acceleration) have been cured or waived.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No past, present or future director, officer, employee, incorporator or
stockholder of the Company or any Subsidiary Guarantor, as such, shall have any
liability for any obligations of the Company or any Subsidiary Guarantor under
the Exchange Notes, the Indenture, the Unit Warrant Agreement, the Registration
Rights Agreement or any Collateral Agreement or for any claim based on, in
respect of, or by reason of, such obligations or their creations. Each holder by
accepting a Exchange Note waives and releases all such liability. The waiver and
release are part of the consideration for issuance of the Exchange Notes. Such
waiver may not be effective to waive certain liabilities under the federal
securities laws, and it is the view of the Commission that such a waiver is
against public policy and is, therefore, unenforceable.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have its
obligations discharged with respect to the outstanding Exchange Notes ("Legal
Defeasance"). Such Legal Defeasance means that the Company shall be deemed to
have paid and discharged the entire Indebtedness represented by the outstanding
Exchange Notes, except for (i) the rights of holders to receive payments in
respect of the principal of, premium, if any, and interest on the Exchange Notes
when such payments are due, (ii) the Company's obligations with respect to the
Exchange Notes concerning issuing temporary Exchange Notes, registration of
Exchange Notes, mutilated, destroyed, lost or stolen Exchange Notes and the
maintenance of an office or agency for payments, (iii) the rights, powers,
trust, duties and immunities of the Trustee and the Company's obligations in
connection therewith and (iv) the Legal Defeasance provisions of the Indenture.
In addition, the Company may, at its option and at any time, elect to have the
obligations of the Company released with respect to certain covenants that are
described in the Indenture ("Covenant Defeasance") and thereafter any omission
to comply with such obligations shall not constitute a Default or Event of
Default with respect to the Exchange Notes. In the event Covenant Defeasance
occurs, certain events (not including non-payment, bankruptcy, receivership,
reorganization and insolvency events) described under "Events of Default" will
no longer constitute an Event of Default with respect to the Exchange Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit of
the holders, cash in U.S. dollars, non-callable U.S. government obligations, or
a combination thereof, in such amounts as will be sufficient, in the opinion of
a nationally recognized firm of independent public accountants, to pay the
principal of,
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premium, if any, and interest on the Exchange Notes of the stated date for
payment thereof or on the applicable redemption date, as the case may be; (ii)
in the case of Legal Defeasance, the Company shall have delivered to the Trustee
an opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that (A) the Company has received from, or there has been published
by, the Internal Revenue Service a ruling or (B) since the date of the
Indenture, there has been a change in the applicable federal income tax law, in
either case to the effect that, and based thereon such opinion of counsel shall
confirm that, the holders will not recognize income, gain or loss for federal
income tax purposes as a result of such Legal Defeasance and will be subject to
federal income tax on the same amounts, in the same manner and at the same times
as would have been the case if such Legal Defeasance had not occurred; (iii) in
the case of Covenant Defeasance, the Company shall have delivered to the Trustee
an opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that the holders will not recognize income, gain or loss for federal
income tax purposes as a result of such Covenant Defeasance and will be subject
to federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if such Covenant Defeasance had not occurred;
(iv) no Default or Event of Default shall have occurred and be continuing on the
date of such deposit or insofar as Events of Default from bankruptcy or
insolvency events are concerned, at any time in the period ending on the 91st
day after the date of deposit; (v) such Legal Defeasance or Covenant Defeasance
shall not result in a breach or violation of, or constitute a default under the
Indenture or any other material agreement or instrument to which the Company or
any of its Subsidiaries is a party to or by which the Company or any of its
Subsidiaries is a party or by which it or any of its property or assets is
bound; (vi) the Company shall have delivered to the Trustee an officers'
certificate stating that the deposit was not made by the Company with the intent
of preferring the holders over any other creditors of the Company or with the
intent of defeating, hindering, delaying or defrauding any other creditors of
the Company or others; (vii) the Company shall have delivered to the Trustee an
officer's certificate and an opinion of counsel, each stating that all
conditions precedent provided for or relating to the Legal Defeasance or the
Covenant Defeasance have been complied with; (viii) the Company shall have
delivered to the Trustee an opinion of counsel to the effect that after the 91st
day following the deposit, the trust funds will not be subject to the effect of
any applicable bankruptcy, insolvency, reorganization or similar laws affecting
creditors' rights generally; and (ix) certain customary conditions precedent are
satisfied.
POSSESSION, USE AND RELEASE OF COLLATERAL
Unless an Event of Default shall have occurred and be continuing, the
Company shall have the right to remain in possession and retain exclusive
control of the collateral securing the Exchange Notes (other than as set forth
in the Collateral Agreements), to freely operate the collateral and to collect,
invest and dispose of any income therefrom.
RELEASE OF COLLATERAL. Upon compliance by the Company with the conditions
set forth below in respect of any release of items of collateral, and upon
delivery by the Company to the Collateral Agent of an opinion of counsel to the
effect that such conditions have been met, the Collateral Agent will release the
Released Interests (as hereinafter defined) from the Lien of the Collateral
Agreements and reconvey the Released Interests to the Company.
ASSET SALE RELEASE. The Company has the right to obtain a release of items
of collateral (the "Released Interests") subject to an Asset Sale upon
compliance with the condition that the Company deliver to the Collateral Agent
the following:
(a) A notice from the Company requesting the release of Released
Interests: (i) describing the proposed Released Interests; (ii) specifying
the value of such Released Interests on a date within 60 days of such notice
(the "Valuation Date"); (iii) stating that the purchase price received is at
least equal to the fair market value of the Released Interests; (iv) stating
that the release of such Released Interests would not be expected to
interfere with the Collateral Agent's ability to realize the value of the
remaining collateral and will not impair the maintenance and operation of
the remaining
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collateral; and (v) certifying that such Asset Sale complies with the terms
and conditions of the Indenture with respect thereto;
(b) An Officers' Certificate of the Company stating that: (i) such Asset
Sale covers only the Released Interests and complies with the terms and
conditions of the Indenture with respect to Asset Sales; (ii) all Net Cash
Proceeds from the sale of any of the Released Interests will be applied
pursuant to the provisions of the Indenture in respect of Asset Sales; (iii)
there is no Default or Event of Default in effect or continuing on the date
thereof, the Valuation Date or the date of such Asset Sale; (iv) the release
of the collateral will not result in a Default or Event of Default under the
Indenture; and (v) all conditions precedent in the Indenture relating to the
release in question have been or will be complied with; and
(c) The Net Cash Proceeds and other non-cash consideration from the
Asset Sale required to be delivered to the Collateral Agent pursuant to the
Indenture.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a holder, among other things, to
furnish appropriate endorsements and transfer documents, and the Company may
require a holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Exchange Note
selected for redemption in whole or in part pursuant to the Indenture, except
the unredeemed portion of any Note being redeemed in part. Also, the Company is
not required to transfer or exchange any Exchange Note commencing at the opening
of business 15 days before the day of any selection of Exchange Notes to be
redeemed and ending at the close of business on such day of selection. The
registered holder of a Exchange Note will be treated as the owner of such
Exchange Note for all purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next succeeding paragraph, the Indenture or the
Exchange Notes may be amended or supplemented with the consent of the holders of
at least a majority in principal amount of the Exchange Notes then outstanding
(including consents obtained in connection with a tender offer or exchange offer
for Exchange Notes) and any existing Default or Event of Default or compliance
with any provision of the Indenture or the Exchange Notes may be waived with the
consent of the holders of a majority in principal amount of the then outstanding
Exchange Notes (including consents obtained in connection with a tender offer or
exchange offer for Exchange Notes).
Without the consent of each holder affected, an amendment or waiver may not
(with respect to any Exchange Notes held by a non-consenting holder of the
Exchange Notes): (i) reduce the principal amount of Exchange Notes whose holders
must consent to an amendment, supplement or waiver; (ii) reduce the principal
of, or the premium on, or change the fixed maturity of any Exchange Note or
alter the provisions with respect to the redemption of the Exchange Notes or
alter the provisions with respect to repurchases or redemptions of the Exchange
Notes with Net Cash Proceeds from Asset Sales or upon a Change of Control; (iii)
reduce the rate of or change the time for payment of interest, including default
interest, on any Exchange Note; (iv) waive a Default or Event of Default in the
payment of principal of or premium, if any, or interest on any Exchange Note
(other than a Default in the payment of an amount due as a result of an
acceleration, where such acceleration is rescinded pursuant to the Indenture);
(v) make any Exchange Note payable in money other than that stated in the
Exchange Notes; (vi) make any change in the provisions of the Indenture relating
to waivers of past Defaults or the rights of holders of Exchange Notes to
receive payments of principal of or interest on the Exchange Notes; (vii) waive
a redemption payment with respect to any Exchange Note; or (viii) modify or
change any provision of the Indenture affecting the ranking of the Exchange
Notes in a manner which adversely affects the holders of Exchange Notes.
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Notwithstanding the foregoing, without the consent of any holder of the
Exchange Notes, the Company may amend or supplement the Indenture or the
Exchange Notes to cure any ambiguity, defect or inconsistency, to provide for
uncertificated Exchange Notes in addition to or in place of certificated
Exchange Notes, to provide for the assumption of the Company's obligations to
holders of the Exchange Notes in the case of a merger or consolidation, to make
any change that would provide any additional rights or benefits to the holders
of the Exchange Notes or that does not adversely affect the legal right under
the Indenture of any such holder, or to comply with the requirements of the
Commission in order to effect or maintain the qualification of the Indenture
under the Trust Indenture Act.
CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any such
claim as security or otherwise. The Trustee will be permitted to engage in other
transactions; however, if it acquires any conflicting interest it must eliminate
such conflict within 90 days, apply to the Commission for permission to continue
or resign.
The holders of a majority in principal amount of the then outstanding
Exchange Notes will have the right to direct the time, method and place of
conducting any proceeding for exercising any remedy available to the Trustee,
subject to certain exceptions. The Indenture provides that in case an Event of
Default shall occur (which shall not be cured), the Trustee will be required, in
the exercise of its power, to use the degree of care of a prudent person in the
conduct of his own affairs. Subject to such provisions, the Trustee will be
under no obligation to exercise any of its rights or powers under the Indenture
at the request of any holder of the Exchange Notes, unless such holder shall
have offered to the Trustee an indemnity satisfactory to it against any loss,
liability or expense.
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Indenture
without charge by writing to Discovery Zone, Inc., 565 Taxter Road, Fifth Floor,
Elmsford, New York 10523, Attention: General Counsel.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definitions are provided.
"ACQUIRED DEBT" means, with respect to any specified Person, Indebtedness of
any other Person existing at the time such other Person merged with or into or
became a Subsidiary of such specified Person, excluding Indebtedness incurred in
connection with, or in contemplation of, such other Person merging with or into
or becoming a Subsidiary of such specified Person.
"AFFILIATE" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any specified Person,
shall mean the possession, directly or indirectly, of the power to direct or
cause the direction of the management of policies of such specified Person,
whether through the ownership of voting securities, by agreement or otherwise;
PROVIDED, HOWEVER, that beneficial ownership of 10% or more of the aggregate
voting power of the voting securities of a Person shall be deemed to be control.
"ASSET SALE" means any direct or indirect sale, issuance, conveyance,
transfer, lease (other than operating leases entered into in the ordinary course
of business), assignment or other transfer for value by
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the Company or any of its Subsidiaries (including any Sale and Leaseback
Transaction) to any Person other than the Company or a Wholly-Owned Subsidiary
of the Company of (a) any Capital Stock of any Subsidiary of the Company; or (b)
any other property or assets of the Company or any Subsidiary of the Company
other than in the ordinary course of business; PROVIDED, HOWEVER, that Asset
Sales shall not include (i) a transaction or series of related transactions for
which the Company or its Subsidiaries receive aggregate consideration of less
than $500,000 and (ii) the sale, lease, conveyance, disposition or other
transfer of all or substantially all of the assets of the Company as permitted
under "Merger, Consolidation or Sale of Assets."
"BANKRUPTCY LAW" means Title 11, U.S. Code or any similar Federal, state or
foreign law for the relief of debtors.
"BLOCK PARTY" means DZ Party, Inc.
"BOARD OF DIRECTORS" means, as to any Person, the board of directors of such
Person or any duly authorized committee thereof.
"BOARD RESOLUTION" means, with respect to any Person, a copy of a resolution
delivered to the Trustee and certified by the secretary or an assistant
secretary of such Person to have been duly adopted by the Board of Directors of
such Person and to be in full force and effect on the date of such
certification.
"CAPITAL LEASE OBLIGATION" means, as to any Person, the obligations of such
Person under a lease that are required to be classified and accounted for as
capital lease obligations under GAAP and, for purposes of this definition, the
amount of such obligations at any date shall be the capitalized amount of such
obligations at such date, determined in accordance with GAAP.
"CAPITAL STOCK" means, with respect to any Person, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock and any and all warrants, options and rights with respect
thereto, including, without limitation, each class of common stock and preferred
stock, partnership interests and other indicia of ownership of such Person.
"CASH EQUIVALENTS" means: (i) obligations issued or unconditionally
guaranteed by the United States of America or any agency thereof, or obligations
issued by any agency or instrumentality thereof and backed by the full faith and
credit of the United States of America; (ii) commercial paper rated the highest
grade by Moody's Investors Service, Inc. and Standard & Poor's Ratings Group and
maturing not more than one year from the date of creation thereof; (iii) time
deposits with, and certificates of deposit and banker's acceptances issued by,
any bank having capital surplus and undivided profits aggregating at least $500
million and maturing not more than one year from the date of creation thereof;
(iv) repurchase agreements that are secured by a perfected security interest in
an obligation described in clause (i) and are with any bank described in clause
(iii); (v) money market accounts with any bank having capital surplus and
undivided profits aggregating at least $500 million; (vi) readily marketable
direct obligations issued by any state of the United States of America or any
political subdivision thereof having one of the two highest rating categories
obtainable from either Moody's Investors Service, Inc. or Standard & Poor's
Ratings Group; and (vii) money market funds investing only in U.S. Government
Obligations.
"CHANGE OF CONTROL" means the occurrence of one or more of the following
events:
(i) the Permitted Holder ceases to be the direct or indirect beneficial
owner (as defined below) of Voting Stock of the Company representing an
amount of such Voting Stock greater than the amount beneficially owned by
any other Person or Group (as defined below);
(ii) the Permitted Holder ceases to be the direct or indirect beneficial
owner of interests or participations in, or measured by the profits of, the
Company representing an amount of such interests or participations greater
than the amount beneficially owned by any other Person or Group;
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(iii) any sale, lease, exchange or other transfer (in one transaction or
in a series of related transactions) of all or substantially all of the
assets of the Company to any Person or Group, together with any Affiliates
thereof (whether or not otherwise in compliance with the provisions of the
Indenture) that is not beneficially owned or controlled, directly or
indirectly, by the Permitted Holder; or
(iv) the Permitted Holder ceases to have the right or ability, by voting
power, control, contract or otherwise, to control a majority of the Board of
Directors of the Company.
The terms "beneficially own," "beneficial owner" and "Group" shall have the
meanings ascribed to such terms in Sections 13(d) and 14(d) of the Exchange Act;
PROVIDED, HOWEVER, that, for the purposes of this definition of "Change of
Control" only, any Person or Group other than the Permitted Holder shall be
deemed to be the current beneficial owner of any shares of Voting Stock of the
Company, or any interests or participations in, or measured by the profits of,
the Company, that are issuable upon the exercise of any option, warrant or
similar right, or upon the conversion of any convertible security, in either
case owned by such Person or Group without regard to whether such option,
warrant or convertible security is currently exercisable or convertible or will
become convertible or exercisable within 60 days if the exercise or conversion
price thereof at the time of grant was lower than the fair market value of the
underlying security at the time of grant.
"COLLATERAL" shall have the meaning assigned to such term in the Security
Agreement.
"COLLATERAL AGENT" shall have the meaning assigned to such term in the
Security Agreement.
"COLLATERAL AGREEMENTS" means, collectively, the Escrow Agreement, the
Pledge Agreement, the Subsidiary Pledge Agreements, the Security Agreement, the
Subsidiary Security Agreements, the Trademark Assignment, in each case, as the
same may be in force from time to time.
"COMMON STOCK" of any Person means any and all shares, interests or other
participations in, and other equivalents (however designated and whether voting
or non-voting) of such Person's common stock, whether outstanding on the Issue
Date or issued after the Issue Date, and includes, without limitation, all
series and classes of such common stock.
"CONSOLIDATED CASH FLOW" means, with respect to any Person for any period,
the Consolidated Net Income of such Person for such period plus (without
duplication) (a) an amount equal to any extraordinary loss plus any net loss
realized in connection with an Asset Sale (to the extent such losses were
deducted in computing Consolidated Net Income), (b) provision for taxes based on
income or profits to the extent such provision for taxes was included in
computing Consolidated Net Income, (c) consolidated interest expense of such
Person for such period, whether paid or accrued (including deferred financing
costs, non-cash interest payments and the interest component of capital lease
obligations), to the extent such expense was deducted in computing Consolidated
Net Income, (d) accretion of deferred rent expense under the McDonald's Rent
Deferral Secured Notes, to the extent such expense was deducted in computing
Consolidated Net Income, and (e) depreciation and amortization (including
amortization of goodwill and other intangibles) for such period to the extent
such depreciation or amortization were deducted in computing Consolidated Net
Income, in each case, on a consolidated basis and determined in accordance with
GAAP.
"CONSOLIDATED NET INCOME" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Subsidiaries for such
period, on a consolidated basis, determined in accordance with GAAP; provided
that: (i) the Net Income of any Person that is not a Subsidiary or that is
accounted for by the equity method of accounting shall be included only to the
extent of the amount of dividends or distributions paid to the referent Person
or a Wholly-Owned Subsidiary thereof; (ii) the Net Income of any Person that is
a Subsidiary (other than a Subsidiary of which at least 80% of the Capital Stock
having ordinary voting power for the election of directors or other governing
body of such Subsidiary is owned by the referent Person directly or indirectly
through one or more Subsidiaries) shall be included
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only to the extent of the amount of dividends or distributions paid to the
referent Person or a Wholly-Owned Subsidiary thereof; (iii) for the purpose of
determining whether the Company may make a Restricted Payment under clause (c)
of the "Restricted Payments" covenant only, the Net Income of any Person
acquired in a pooling of interests transaction for any period prior to the date
of such acquisition shall be excluded; and (iv) the cumulative effect of a
change in accounting principles shall be excluded.
"CONSOLIDATED NET WORTH" means, with respect to any Person, the sum of (i)
the consolidated equity of the common stockholders of such Person and its
consolidated Subsidiaries plus (ii) the respective amounts reported on such
Person's most recent balance sheet with respect to any series of preferred stock
(other than Disqualified Stock) that by its terms is not entitled to the payment
of dividends unless such dividends may be declared and paid only out of net
earnings in respect of the year of such declaration and payment, but only to the
extent of (a) any cash received by such Person upon issuance of such preferred
stock and (b) the fair market value of any non-cash consideration received by
such Person upon issuance of such preferred stock PROVIDED that such value has
been determined in good faith by a nationally recognized investment bank, less
(x) all write-ups, subsequent to the date of the Indenture, in the book value of
assets owned by such Person or a consolidated Subsidiary of such Person, other
than (a) write-ups resulting from foreign currency translations and (b)
write-ups upon the acquisition of assets acquired in a transaction to be
accounted for by purchase accounting under GAAP, (y) all investments in
unconsolidated Subsidiaries and in Persons that are not Subsidiaries (except, in
each case, a Permitted Investment), and (z) all unamortized debt discount and
expense and unamortized deferred financing charges (except such amounts arising
from the issuance of the Exchange Notes), all of the foregoing determined in
accordance with GAAP.
"CUSTODIAN" means any receiver, trustee, assignee, liquidator, sequestrator
or similar official under any Bankruptcy Law.
"DEFAULT" means any event known to the Company or which should have been
known to the Company after due inquiry that is, or with the passage of time or
the giving of notice or both would be, an Event of Default.
"DEPOSITORY" means The Depository Trust Company (or DTC), its nominees and
successors.
"DISQUALIFIED STOCK" means any Capital Stock which, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable at
the option of the holder thereof, in whole or in part, on or prior to the
Maturity Date.
"ELIGIBLE CREDIT FACILITY" means a credit facility (and any permitted
refinancing or replacement thereof) between the Company and a Lender, including
any related notes, guarantees, collateral documents, instruments and agreements
executed in connection therewith, and in each case as amended, modified,
renewed, refunded, replaced or refinanced from time to time as permitted herein,
which credit facility (and any permitted refinancing or replacement thereof) (i)
has terms and conditions (including with respect to applicable interest rates
and fees) customary for similar facilities extended to borrowers comparable to
the Company, (ii) does not permit the Company to incur Indebtedness thereunder
at any time outstanding in excess of $10.0 million in principal amount, and
(iii) may be secured by certain assets of the Company, subject to the terms and
conditions of an Intercreditor Agreement.
"EQUITY INTERESTS" means Capital Stock or warrants, options or other rights
to acquire Capital Stock (but excluding any debt security that is convertible
into, or exchangeable for, Capital Stock).
"ESCROW AGREEMENT" means the Escrow and Security Agreement, dated as of even
date herewith, between the Company and the Trustee, substantially in the form
attached to the Indenture, as amended and supplemented from time to time in
accordance with its terms.
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"ESCROW FUNDS" means approximately $21.4 million of net proceeds from the
sale of Private Notes deposited in the Escrowed Interest Account pursuant to the
terms of the Escrow Agreement to, among other things, pay interest on the
Exchange Notes that accrues and is unpaid from the Issue Date through and
including the Interest Payment Date on August 1, 1999.
"ESCROWED INTEREST ACCOUNT" means one or more accounts established with the
Trustee pursuant to the terms of the Escrow Agreement for the deposit of the
Escrow Funds and the Pledged Securities.
"EXCHANGE OFFER" means the offer that may be made by the Company, pursuant
to the Registration Rights Agreement, to exchange for any and all of the Private
Notes a like aggregate principal amount of Exchange Notes.
"FIXED CHARGE COVERAGE RATIO" means, with respect to any Person for any
period, the ratio of the Consolidated Cash Flow of such Person for such period
to the Fixed Charges of such Person for such period. In the event that the
Company or any of its Subsidiaries incurs, assumes, guarantees, repays,
repurchases or redeems any Indebtedness (other than revolving credit borrowings)
or issues or redeems Preferred Stock subsequent to the commencement of the
period for which the Fixed Charge Coverage Ratio is being calculated but prior
to the event for which the calculation of the Fixed Charge Coverage Ratio is
made, then the Fixed Charge Coverage Ratio (both the numerator and the
denominator therein) shall be calculated giving pro forma effect to such
incurrence, assumption, guarantee, repayment, repurchase or redemption of
Indebtedness, or such issuance or redemption of Preferred Stock, as if the same
had occurred at the beginning of the applicable period; PROVIDED that pro forma
effect shall be given to repayments, repurchases or redemptions of Indebtedness
or Preferred Stock only to the extent such Indebtedness or Preferred Stock is
permanently retired (and, in the case of the Exchange Notes, surrendered to the
Trustee for cancellation). For purposes of making the computation referred to
above, in the event that acquisitions, divestitures, mergers or consolidations
have been made by the Company or any of its Subsidiaries subsequent to the
commencement of the four-quarter period over which the Fixed Charge Coverage
Ratio is being calculated, but prior to the event for which the calculation of
the Fixed Charge Ratio is being made, then the Fixed Charge Coverage Ratio shall
be calculated giving pro forma effect to such acquisitions, divestitures,
mergers and consolidations as if such transactions had occurred at the beginning
of the applicable period.
"FIXED CHARGES" means, with respect to any Person for any period, the sum of
(a) consolidated interest expense of such Person for such period, whether paid
or accrued, to the extent such expense was deducted in computing Consolidated
Net Income (including amortization of non-cash interest payments and the
interest component of capital leases but excluding amortization of deferred
financing fees) and (b) the product of (i) all dividend payments, whether paid
in cash, assets, securities or otherwise, in the case of a Person that is a
Subsidiary of the Company, on any series of preferred stock of such Person, and
all dividend payments in respect of any series of preferred stock of the
Company, whether paid in cash, assets, securities or otherwise (other than
dividends payable in additional shares of the preferred stock on which such
dividends are paid), times (ii) a fraction, the numerator of which is one and
the denominator of which is one minus the then current combined federal, state
and local statutory tax rate of such Person, expressed as a decimal, in each
case, on a consolidated basis and in accordance with GAAP.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as approved by a significant segment of the accounting profession,
which are in effect on the date of the Indenture.
"HOLDER" OR "HOLDER" means the Person in whose name a Note is registered on
the Registrar's books.
"INDEBTEDNESS" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced by
bonds, notes, debentures or similar instruments
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or letters of credit (or reimbursement agreements in respect thereof) or
representing the balance deferred and unpaid of the purchase price of any
property (including pursuant to capital leases) or representing any Interest
Swap Obligations, except any such balance that constitutes an accrued expense or
trade payable, if and to the extent any of the foregoing Indebtedness (other
than Interest Swap Obligations) would appear as a liability upon a balance sheet
of such Person prepared in accordance with GAAP, and also includes, to the
extent not otherwise included, the guarantee (other than by endorsement of
negotiable instruments for collection in the ordinary course of business),
direct or indirect, by such Person in any manner (including, without limitation,
letters of credit and reimbursement agreements in respect thereof), of all or
any part of any of the items which would be included within this definition.
"INDEPENDENT FINANCIAL ADVISOR" means an investment banking firm (i) which
does not, and whose directors, officers and employees or Affiliates do not, have
a direct or indirect financial interest in the Company or any of its
Subsidiaries and (ii) which, in the judgment of the Board of Directors of the
Company, is otherwise independent and qualified to perform the task for which it
is to be engaged.
"INTERCREDITOR AGREEMENT" means an agreement between the Trustee and a
Lender, substantially in the form attached to the Indenture, to be entered into
after the Issue Date, if the Company and such Lender enter into an Eligible
Credit Facility.
"INTEREST SWAP OBLIGATIONS" means the obligations of any Person pursuant to
any arrangement with any other Person, whereby, directly or indirectly, such
Person is entitled to receive from time to time periodic payments calculated by
applying either a floating or a fixed rate of interest on a stated notional
amount in exchange for periodic payments made by such other Person calculated by
applying a fixed or a floating rate of interest on the same notional amount and
shall include, without limitation, interest rate swaps, caps, floors, collars
and similar agreement.
"INVESTMENTS" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the form of loans (including
direct or indirect guarantees), advances or capital contributions (excluding
commission, travel and similar advances to officers and employees made in the
ordinary course of business), purchases or other acquisitions for consideration
of Indebtedness, Equity Interests or other securities and all other items that
are or would be classified as investments on a balance sheet prepared in
accordance with GAAP.
"ISSUE DATE" means the date of original issuance of the Private Notes under
the Indenture.
"LENDER" means a Person that is not an Affiliate of the Company and is a
lender in an Eligible Credit Facility.
"LIEN" means, with respect to any asset, mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset, whether
or not filed, recorded or otherwise perfected under applicable law (including
any conditional sale or other title retention agreement, any lease in the nature
thereof, any option or other agreement to sell or give a security interest in
and any filing of or agreement to give any financing statement under the Uniform
Commercial Code (or equivalent statutes) of any jurisdiction, excluding true
lease and consignment filings).
"LIMITED INVESTMENT SUBSIDIARY" means, with respect to the Company or any
Subsidiary of the Company, any corporation, partnership, joint venture,
association or other business entity in which the Company or any Subsidiary of
the Company (i) has at any time made an Investment permitted by clause (viii) of
the definition of Permitted Investment and (ii) has not at any time made any
other Investment.
"MATURITY DATE" means August 1, 2002.
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"MORTGAGES" means the mortgages, deeds of trust, deeds to secure debt or
other similar documents securing liens on the Premises and/or the Leased
Premises, as well as the other collateral secured by and described in the
mortgages, deeds of trust, deeds to secure debt or other similar documents.
"NET CASH PROCEEDS" means, with the respect to any Asset Sale, the proceeds
in the form of cash or Cash Equivalents including payments in respect of
deferred payment obligations when received in the form of cash or Cash
Equivalents (other than the portion of any such deferred payment constituting
interest) received by the Company or any of its Subsidiaries from such Asset
Sale net of (a) reasonable out-of-pocket expenses and fees relating to such
Asset Sale (including, without limitation, legal, accounting and investment
banking fees and sales commissions), (b) taxes paid or payable after taking into
account any reduction in consolidated tax liability due to available tax credits
or deductions and any tax sharing arrangements, (c) repayment of Indebtedness
that is required to be repaid in connection with such Asset Sale and (d)
appropriate amounts to be provided by the Company or any Subsidiary, as the case
may be, as a reserve, in accordance with GAAP, against any liabilities
associated with such Asset Sale and retained by the Company or any Subsidiary,
as the case may be, after such Asset Sale, including, without limitation,
pension and other post-employment benefit liabilities, liabilities related to
environmental matters and liabilities under any indemnification obligations
associated with such Asset Sale.
"NET INCOME" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP, excluding, however, any gain
(but not loss), together with any related provision for taxes on such gain (but
not loss), realized in connection with any Asset Sale (including, without
limitation, dispositions pursuant to sale and leaseback transactions), and
excluding any extraordinary gain (but not loss), together with any related
provisions for taxes on such extraordinary gain (but not loss).
"OBLIGATIONS" means any principal, premium, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"OFFICER" means, with respect to any Person, the chief executive officer,
the president, any vice president, the chief financial officer, the treasurer,
the controller, or the secretary of such Person, or any other officer designated
by the Board of Directors to serve in a similar capacity.
"PERMITTED HOLDER" means Birch Acquisition L.L.C. so long as such entity is
directly or indirectly controlled by Martin S. Davis or, in the event of his
death, by Greg S. Feldman.
"PERMITTED INDEBTEDNESS" means each of the following:
(a) Indebtedness incurred by the Company or its Subsidiaries in
connection with or arising out of Sale and Leaseback Transactions, Capital
Lease Obligations or Purchase Money Obligations; PROVIDED that the aggregate
principal amount at any one time outstanding of all such Sale and Leaseback
Transactions, Capital Lease Obligations and Purchase Money Obligations does
not exceed $5 million;
(b) Indebtedness of the Company represented by the Notes (whether
incurred on the Issue Date or in connection with the Exchange Offer);
(c) Indebtedness owed by the Company to any of its Wholly-Owned
Subsidiaries for so long as such Indebtedness is held by a Wholly-Owned
Subsidiary of the Company, in each case subject to no Lien; PROVIDED that
(i) any such Indebtedness of the Company is unsecured and subordinated,
pursuant to a written agreement, to the Company's obligations under the
Indenture and the Exchange Notes and (ii) if as of any date any Person other
than a Wholly-Owned Subsidiary of the Company owns or holds any such
Indebtedness or any such Person holds a Lien in respect of such
Indebtedness, such date shall be deemed the date of incurrence of
Indebtedness not constituting Permitted Indebtedness of the Company;
(d) Indebtedness of a Wholly-Owned Subsidiary of the Company to the
Company or to a Wholly-Owned Subsidiary of the Company for so long as such
Indebtedness is held by the Company
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or a Wholly-Owned Subsidiary of the Company and, if such Indebtedness from
the Company to any Subsidiary exceeds $500,000 in aggregate principal
amount, evidenced by a written promissory note or other instrument in form
and substance reasonably satisfactory to the Trustee, in each case subject
to no Lien held by a Person other than the Company or a Wholly-Owned
Subsidiary of the Company; PROVIDED that if, as of any date any Person other
than the Company or a Wholly-Owned Subsidiary of the Company owns or holds
such Indebtedness or holds a Lien in respect of such Indebtedness, such date
shall be deemed the date of incurrence of Indebtedness not constituting
Permitted Indebtedness by the issuer of such Indebtedness;
(e) the incurrence by the Company and its Subsidiaries of Indebtedness
issued in exchange for, or the proceeds of which are contemporaneously used
to extend, refinance, renew, replace, or refund (collectively, "Refinance")
Permitted Indebtedness referred to in clauses (a), (b) and (c) above and
outstanding Indebtedness incurred in accordance with the "Incurrence of
Indebtedness and Issuance of Preferred Stock" covenant (other than pursuant
to this definition of Permitted Indebtedness except to the extent provided
in clauses (a), (b) and (c) thereof) (the "Refinancing Indebtedness");
PROVIDED, HOWEVER, that (i) the principal amount of such Refinancing
Indebtedness shall not exceed the principal amount of Indebtedness so
refinanced (plus the amount of reasonable expenses incurred in connection
therewith); (ii) the Refinancing Indebtedness shall rank in right of payment
no more senior (and at least as subordinated) to the Notes than did the
Indebtedness being refinanced; (iii) if the Indebtedness being refinanced is
Indebtedness of the Company, then such Refinancing Indebtedness shall be
Indebtedness solely of the Company; (iv) such Refinancing Indebtedness shall
have a Weighted Average Life longer, and a stated maturity which is later
than, that of the Indebtedness being refinanced; and (v) the Indebtedness so
refinanced is permanently retired (and, in case of the Notes, surrendered to
the Trustee for cancellation);
(f) Interest Swap Obligations of the Company covering Indebtedness of
the Company or any of its Subsidiaries and Interest Swap Obligations of any
Subsidiary covering Indebtedness of such Subsidiary; PROVIDED, HOWEVER, that
such Interest Swap Obligations are entered into to protect the Company and
its Subsidiaries from fluctuations in interest rates on Indebtedness
incurred in accordance with the Indenture to the extent the notional
principal amount of such Interest Swap Obligation does not exceed the
principal amount of the Indebtedness to which such Interest Swap Obligation
relates;
(g) Indebtedness of the Company outstanding on the Issue Date pursuant
to the McDonald's Note, the McDonald's Rent Deferral Secured Notes
(including Indebtedness resulting from future rent deferrals to the extent
and in the manner contemplated by the McDonald's Rent Deferral Secured Notes
as in effect on the Issue Date) and the Pre-petition Tax Payables, as
reduced by the amount of any prepayments permitted by the Indenture or
scheduled amortization payments when actually paid or by any permanent
reductions thereof; and
(h) other Indebtedness of the Company in an aggregate amount not to
exceed $10 million at any one time outstanding, which Indebtedness may
include Indebtedness evidenced by an Eligible Credit Facility.
"PERMITTED INVESTMENTS" means: (i) Investments by the Company or any of its
Subsidiaries in any Person that is or will become immediately after such
Investment a Wholly-Owned Subsidiary of the Company or that will merge or
consolidate into the Company or a Wholly-Owned Subsidiary of the Company, (ii)
Investments in the Company by any Subsidiary of the Company; PROVIDED that any
Indebtedness evidencing such Investment is unsecured and subordinated, pursuant
to a written agreement, to the Company's obligations under the Exchange Notes
and the Indenture; (iii) investments in cash and Cash Equivalents; (iv) Interest
Swap Obligations entered into in the ordinary course of the Company's or its
Subsidiaries' businesses and otherwise in compliance with the Indenture; (v)
Investments in securities of trade creditors or customers received pursuant to
any plan of reorganization or similar arrangement upon
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the bankruptcy or insolvency of such trade creditors or customers solely in
exchange for a claim against any such trade creditor or customer; (vi)
Investments in the Exchange Notes; (vii) Investments made by the Company or its
Subsidiaries as a result of an Asset Sale made in compliance with the "Asset
Sales" covenant; and (viii) other Investments in joint ventures, corporations,
limited liability companies or partnerships formed by the Company, which joint
ventures, corporations, limited liability companies or partnerships engage in
businesses which are the same as, or similar or related to, the business of the
Company as contemplated by this Prospectus; PROVIDED, HOWEVER, that the amount
which may be invested pursuant to this clause (viii) shall not exceed, in the
twelve-month period commencing on the Issue Date, $500,000 and in any successive
twelve-month period commencing on the Issue Date thereafter, $500,000 plus any
cumulative, unutilized portion of such amounts which could have been invested
pursuant to this clause (viii) during any of the prior twelve-month periods.
"PERMITTED LIENS" means the following types of Liens:
(i) Liens for taxes, assessments or governmental charges or claims
either (a) not delinquent or (b) contested in good faith by appropriate
proceedings and as to which the Company or its Subsidiaries shall have set
aside on its books such reserves as may be required pursuant to GAAP;
(ii) statutory Liens of landlords and Liens of carriers, warehousemen,
mechanics, suppliers, materialmen, repairmen and other Liens imposed by law
incurred in the ordinary course of business for sums not yet delinquent or
being contested in good faith, if such reserve or other appropriate
provision, if any, as shall be required by GAAP shall have been made in
respect thereof;
(iii) Liens incurred or deposits made in the ordinary course of business
in connection with workers' compensation, unemployment insurance and other
types of social security, including any Lien securing letters of credit
issued in the ordinary course of business consistent with past practice in
connection therewith, or to secure the performance and return-of-money bonds
and other similar obligations (exclusive of obligations for the payment of
borrowed money);
(iv) judgment Liens not giving rise to an Event of Default so long as
such Lien is adequately bonded and any appropriate legal proceedings which
may have been duly initiated for the review of such judgment shall not have
been finally terminated or the period within which such proceedings may be
initiated shall not have expired;
(v) easements, rights-of-way, zoning restrictions and other similar
charges or encumbrances in respect of real property not interfering in any
material respect with the ordinary conduct of the business of the Company or
any of its Subsidiaries;
(vi) any interest or title of a lessor under any Capital Lease
Obligation; PROVIDED that such Liens do not extend to any property or assets
which are not leased property subject to such Capital Lease Obligation;
(vii) Purchase Money Liens of the Company or any Subsidiary of the
Company acquired in the ordinary course of business; PROVIDED, HOWEVER, that
(A) the related Purchase Money Obligation shall not exceed the cost of such
property or assets and shall not be secured by any property or assets of the
Company or any Subsidiary of the Company other than the property and assets
so acquired and (B) the Lien securing such Indebtedness shall be created
within 90 days of such acquisition;
(viii) Liens securing reimbursement obligations with respect to commercial
letters of credit which encumbered documents and other property relating to
such letters of credit and products and proceeds thereof;
(ix) Liens encumbering deposits made to secure obligations arising from
statutory, regulatory, contractual, or warranty requirements of the Company
or any of its Subsidiaries, including rights of offset and set-off;
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(x) Liens securing Interest Swap Obligations, which Interest Swap
Obligations relate to Indebtedness that is otherwise permitted under the
Indenture;
(xi) Liens securing Acquired Debt incurred in accordance with the
"Limitation on Incurrence of Additional Indebtedness" covenant; PROVIDED
that (A) such Liens secured such Acquired Debt at the time of and prior to
the incurrence of such Acquired Debt by the Company or a Subsidiary of the
Company and were not granted in connection with, or in anticipation of, the
incurrence of such Indebtedness by the Company or a Subsidiary of the
Company and (B) such Liens do not extend to or cover any property or assets
of the Company or of any of its Subsidiaries other than the property or
assets that secured the Acquired Debt prior to the time such Indebtedness
became Acquired Debt of the Company or a Subsidiary of the Company and are
no more favorable to the lienholders than those securing the Acquired Debt
prior to the incurrence of such Acquired Debt by the Company or a Subsidiary
of the Company;
(xii) Liens existing on the Issue Date but only to the extent such Liens
are in effect on the Issue Date;
(xiii) Liens securing Indebtedness of the Company under an Eligible Credit
Facility;
(xiv) Liens in favor of the Company or a Wholly-Owned Subsidiary of the
Company on assets of any Subsidiary of the Company; and
(xv) Liens securing Refinancing Indebtedness which is incurred to
refinance any Indebtedness which has been secured by a Lien permitted under
the Indenture and which has been incurred in accordance with the provisions
of the Indenture; PROVIDED, HOWEVER, that such Liens (a) are no less
favorable to the Holders and are not more favorable to the lienholders with
respect to such Liens than the Liens in respect of the Indebtedness being
refinanced and (b) do not extend to or cover any property or assets of the
Company or any of its Subsidiaries not securing the Indebtedness so
refinanced.
"PERSON" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust, unincorporated organization or
government or any agency or political subdivision thereof.
"PLAN OF REORGANIZATION" or "PLAN" means the Third Amended Joint Plan of
Reorganization of Discovery Zone, Inc., dated March 11, 1997, as amended.
"PLEDGE AGREEMENT" means the Pledge Agreement, dated as of even date
herewith, between the Company and the Trustee, substantially in the form
attached to the Indenture, as amended or supplemented from time to time in
accordance with its terms.
"PLEDGED COLLATERAL" shall have the meaning assigned to such term in the
Pledge Agreement.
"PLEDGED SECURITIES" means the U.S. Government Obligations to be purchased
by the Company and held in the Escrowed Interest Account in accordance with the
Escrow Agreement.
"PLEDGED SUBSIDIARY COLLATERAL" shall have the meaning ascribed to such term
in the Subsidiary Pledge Agreements.
"PREFERRED STOCK" means, with respect to any Person, any Capital Stock of
such Person or its Subsidiaries in respect of which a holder thereof is entitled
to receive payment upon dissolution or otherwise before any payment may be made
with respect to any other Capital Stock of such Person or its Subsidiaries.
"PRIMARY OFFERING" means an underwritten public offering of Qualified
Capital Stock of the Company pursuant to a registration statement filed with and
declared effective by the Commission pursuant to the Securities Act (other than
a registration statement on Form S-8 or otherwise relating to equity securities
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under any employee benefit plans) or pursuant to an exemption from the
registration requirements thereof.
"PURCHASE AGREEMENT" means the Purchase Agreement relating to the purchase
and sale of the Private Notes, entered into among the Company and the Initial
Purchaser.
"PURCHASE MONEY LIENS" means (i) Liens to secure or securing Purchase Money
Obligations permitted to be incurred under the Indenture and (ii) Liens to
secure Refinancing Indebtedness incurred solely to refinance Purchase Money
Obligations, PROVIDED that such Refinancing Indebtedness is incurred no later
than six (6) months after the satisfaction of such Purchase Money Obligations
and such Lien extends to or covers only the asset or property securing the
Purchase Money Obligations being refinanced.
"PURCHASE MONEY OBLIGATIONS" means Indebtedness representing, or incurred to
finance, the cost of acquiring any assets (including Purchase Money Obligations
of any other Person at the time such other Person is merged with or into or is
otherwise acquired by the Company or any of its Wholly-Owned Subsidiaries);
PROVIDED that (i) the principal amount of such Indebtedness does not exceed 100%
of such cost, (ii) any Lien securing such Indebtedness does not extend to or
cover any other asset or property other than the asset or property being so
acquired and (iii) such Indebtedness is incurred, and any Liens with respect
thereto are granted, within 90 days of the acquisition of such property or
asset.
"QUALIFIED CAPITAL STOCK" means any Capital Stock that is not Disqualified
Capital Stock.
"QUALIFIED INSTITUTIONAL BUYER" or "QIB" shall have the meaning specified in
Rule 144A under the Securities Act.
"REGISTRATION RIGHTS AGREEMENT" means the Registration Rights Agreement,
dated as of even date herewith, between the Company and the Initial Purchaser,
as the same may be amended or modified from time to time in accordance with the
terms thereof.
"RESTRICTED INVESTMENT" means an Investment other than a Permitted
Investment.
"RULE 144A" means Rule 144A under the Securities Act.
"SALE AND LEASEBACK TRANSACTION" means any direct or indirect arrangement
with any Person or to which any such Person is a party providing for the leasing
to the Company or a Subsidiary of the Company of any property, whether owned by
the Company or any Subsidiary of the Company at the Issue Date or later
acquired, which has been or is to be sold or transferred by the Company or such
Subsidiary to such Person or to any other Person from whom funds have been or
are to be advanced by such Person on the security of such Property.
"SECURITIES ACT" means the Securities Act of 1933, as amended, and the rules
and regulations of the SEC promulgated thereunder.
"SECURITY AGREEMENT" means the Security Agreement, dated as of even date
herewith, between the Company and the Trustee, as amended or supplemented from
time to time in accordance with its terms, substantially in the form attached to
the Indenture.
"SECURITY INTERESTS" means the Liens on the Collateral created by the
Indenture and the Collateral Agreements in favor of the Collateral Agent for the
benefit of the Collateral Agent and the Holders.
"SIGNIFICANT SUBSIDIARY" means any Subsidiary which would be a "significant
subsidiary" as defined in Article One, Rule 1-02 of Regulation S-X, promulgated
pursuant to the Securities Act, as such Regulation is in effect on the date
hereof.
"SUBSIDIARY" means, with respect to any Person, any corporation, association
or other business entity of which more than 50% of the total voting power of
shares of Capital Stock entitled (without regard to the occurrence of any
contingency) to vote in the election of directors, managers or trustees thereof
is at the time owned or controlled, directly or indirectly, by such Person or
one or more of the other Subsidiaries of
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that Person or a combination thereof; PROVIDED, HOWEVER, that the term
Subsidiary shall not include Block Party or any Limited Investment Subsidiary.
"SUBSIDIARY COLLATERAL" shall have the meaning assigned to such term in the
Subsidiary Security Agreements.
"SUBSIDIARY GUARANTEES" means, individually, the guarantee and,
collectively, the guarantees given by the Subsidiary Guarantors pursuant hereto
or pursuant to supplemental indentures executed by Subsidiaries formed after the
Issue Date pursuant to which such Subsidiaries agree to be bound by the terms of
the Indenture.
"SUBSIDIARY GUARANTOR" means each of Discovery Zone (Canada) Limited,
Discovery Zone (Puerto Rico), Inc., Discovery Zone (Nevada) Licensing, Inc. and
all future Subsidiaries of the Company other than (a) any Limited Investment
Subsidiary or (b) Block Party.
"SUBSIDIARY PLEDGE AGREEMENTS" means the Subsidiary Pledge Agreements to be
entered into between the Subsidiary Guarantors and the Trustee, substantially in
the form attached to the Indenture, as amended or supplemented from time to time
in accordance with its terms.
"SUBSIDIARY SECURITY AGREEMENTS" means, individually, the subsidiary
security agreement and, collectively, the subsidiary security agreements
executed by each Subsidiary Guarantor in favor of the Trustee on the Issue Date
and after the Issue Date in accordance with the Indenture, pursuant to which
such Subsidiary Guarantor grants a security interest in and lien on its
properties and assets as collateral security for the debts, liabilities and
obligations of such Subsidiary Guarantor under its Subsidiary Guarantee, as the
same may be amended or modified from time to time in accordance with its terms.
"TRADEMARK ASSIGNMENT" means the Collateral Assignment of Trademarks
(Security Agreement), dated as of even date herewith, by the Company in favor of
the Trustee, substantially in the form attached to the Indenture, as amended and
supplemented from time to time in accordance with its terms.
"TRUST OFFICER" means any officer of the Trustee assigned by the Trustee to
administer the Indenture, or in the case of a successor trustee, an officer
assigned to the department, division or group performing the corporation trust
work of such successor and assigned to administer the Indenture.
"UNIT WARRANT AGREEMENT" means the Unit Warrant Agreement, dated as of even
date herewith, between the Company and the Trustee, as Warrant Agent, pursuant
to which the Unit Warrants are issued, as amended and supplemented from time to
time in accordance with its terms.
"UNIT WARRANTS" means the warrants to purchase shares of the Company's
common stock, par value $0.01 per share, issued by the Company contemporaneously
with the Private Notes pursuant to the terms and conditions of the Unit Warrant
Agreement.
"U.S. GOVERNMENT OBLIGATIONS" means non-callable direct obligations of, and
non-callable obligations guaranteed by, the United States of America for the
payment of which the full faith and credit of the United States of America is
pledged.
"U.S. LEGAL TENDER" means such coin or currency of the United States of
America as at the time of payment shall be legal tender for the payment of
public and private debts.
"VOTING STOCK" means, with respect to any Person, one or more classes of the
Capital Stock of such Person having general voting power under ordinary
circumstances to elect at least a majority of the Board of Directors, managers
or trustees of such Person (irrespective of whether or not at the time Capital
Stock of any other class or classes shall have or might have voting power by
reason of the happening of any contingency).
"WEIGHTED AVERAGE LIFE" means, as of the date of determination, with respect
to any Indebtedness, the quotient obtained by dividing (i) the sum of the
products of the numbers of years from the date of
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determination to the date of each successive scheduled principal payment of such
Indebtedness multiplied by the amount of such principal payment by (ii) the sum
of all such principal payments.
"WHOLLY-OWNED SUBSIDIARY" means, with respect to any Person, any Subsidiary
of such Person of which all the voting Capital Stock (other than directors'
qualifying shares) is owned by such Person or any Wholly-Owned Subsidiary of
such Person.
SAME-DAY SETTLEMENT AND PAYMENT
Secondary trading in long-term notes and debentures of corporate issuers is
generally settled in clearing-house or next-day funds. In contrast, the Exchange
Notes are expected to be eligible to trade in the Depository's Same-Day Funds
Settlement System, and any permitted secondary market trading activity in the
Exchange Notes will therefore be required by the Depository to be settled in
immediately available funds. No assurance can be given as to the effect, if any,
of such settlement arrangements on trading activity in the Exchange Notes.
REGISTRATION RIGHTS
Pursuant to the Registration Rights Agreement, the Company agreed, for the
benefit of the Holders, that it would use its best efforts, at its cost, to
consummate this Exchange Offer. In satisfaction of this obligation, the Company
is hereby offering the Exchange Notes in return for surrender of the Private
Notes. It is intended by the Company that the Exchange Offer will satisfy these
registration rights, which will terminate upon the consummation of the Exchange
Offer. For each Private Note surrendered to the Company pursuant to the Exchange
Offer, the Holder will receive a Exchange Note of equal principal amount at
maturity. Interest on each Exchange Note shall be calculated and paid in the
same manner as interest on the Private Notes so surrendered and exchanged
therefor.
BOOK-ENTRY DELIVERY AND FORM
Exchange Notes issued in exchange for the Private Notes currently
represented by one or more fully registered global notes will be represented by
one or more fully registered global notes (collectively, the "New Global Note"),
and will be deposited upon issuance with the Depository or an agent of the
Depository and registered in the name of the Depository or a nominee of the
Depository (the "New Global Note Registered Owner"). Except as set forth below,
the New Global Note may be transferred, in whole and not in part, only to
another nominee of the Depository or to a successor of the Depository or its
nominee.
As described below under "-- Certificated Exchange Notes," owners of
beneficial interests in a New Global Note may receive physical deliver of
certificated Exchange Notes only in the limited circumstances described therein.
The Exchange Notes are not issuable in bearer form.
The Depository has advised the Company that the Depository is a
limited-purpose trust company created to hold securities for its participating
organizations (collectively, the "Participants") and to facilitate the clearance
and settlement of transactions in those securities between Participants through
electronic book-entry changes in the accounts of its Participants. The
Participants include securities brokers and dealers, banks, trust companies,
clearing corporations and certain other organizations. Access to the
Depository's system is also available to other entities such as banks, brokers,
dealers and trust companies that clear through or maintain a custodial
relationship with a Participant, either directly or indirectly (collectively,
the "Indirect Participants"). Persons who are not Participants or Indirect
Participants may beneficially own securities held by or on behalf of the
Depository only through the Participants or the Indirect Participants. The
ownership interests and transfer of ownership interests of such persons held by
or on behalf of the Depository are recorded on the records of the Participants
and Indirect Participants.
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The Depository has also advised the Company that pursuant to procedures
established by it, (i) upon deposit of the New Global Note, the Depository will
credit the accounts of its Participants with portions of the principal amount of
the New Global Note representing the Exchange Notes issued in exchange for the
Private Notes that each such Participant has instructed the Depository to
surrender for exchange and (ii) ownership of such interests in the New Global
Note will be shown on, and the transfer of ownership thereof will be effected
only through, records maintained by the Depository (with respect to the
Participants) or by the Participants and the Indirect Participants (with respect
to other owners of beneficial interests in the New Global Note).
Under the terms of the Indenture, the Company and the Trustee will treat the
persons in whose names the Exchange Notes, including the New Global Note, are
registered as the owners thereof for the purpose of receiving payments in
respect of the principal of and premium, if any, and interest on any Exchange
Notes and for any and all other purposes whatsoever. Payments on any Exchange
Notes registered in the name of the New Global Note Registered Owner will be
payable by the Trustee to the New Global Note Registered Owner in its capacity
as the registered holder under the Indenture. Consequently, neither the Company,
the Trustee nor any agent of the Company or the Trustee has or will have any
responsibility or liability for (i) any aspect of the Depository's records or
the records of any Participant or Indirect Participant relating to or payments
made on account of beneficial ownership interests in the New Global Note, or for
maintaining, supervising or reviewing any of the Depository's records or records
of any Participant or Indirect Participant relating to the beneficial ownership
interests in the New Global Note or (ii) any other matter relating to the
actions and practices of the Depository or any of its Participants or Indirect
Participants. The Depository has advised the Company that its current practice,
upon receipt of any payment in respect of securities such as the Exchange Notes
(including principal and interest), is to credit the accounts of the relevant
Participants with the payment on the payment date, in amounts proportionate to
their respective holdings in principal amount of beneficial interests in the
relevant security as shown on the records of the Depository unless the
Depository has reason to believe it will not receive payment on such payment
date. Payments by the Participants and the Indirect Participants to the
beneficial owners of Exchange Notes will be governed by standing instructions
and customary practices and will be the responsibility of the Participants or
the Indirect Participants and will not be the responsibility of the Depository,
the Trustee or the Company. Neither the Company nor the Trustee will be liable
for any delay by the Depository or any of its Participants or Indirect
Participants in identifying the beneficial owners of the Exchange Notes, and the
Company and the Trustee may conclusively rely on and will be protected in
relying on instructions from the New Global Note Registered Owner for all
purposes.
CERTIFICATED EXCHANGE NOTES
If (i) the Company notifies the Trustee in writing that the DTC is no longer
willing or able to act as a depository and the Company does not appoint a
qualified successor within 90 days or (ii) the Company, at its option, notifies
the Trustee in writing that it elects to cause the issuance of Exchange Notes in
definitive form under the Indenture, then, upon surrender by the relevant New
Global Registered Owner of its New Global Note, Certificated Exchange Notes in
such form will be issued to each person that such New Global Registered Owner
and the DTC identify as the beneficial owner of the related Notes. In addition,
subject to certain conditions, any person having a beneficial interest in the
New Global Note may, upon request to the Trustee, exchange such beneficial
interest for Exchange Notes in the form of Certificated Exchange Notes. Upon any
such issuance, the Trustee is required to register such Certificated Exchange
Notes in the name of, and cause the same to be delivered to, such person or
persons (or the nominee of any thereof) in fully registered form.
None of the Company nor Trustee shall be liable for any delay by the related
New Global Registered Owner or the DTC in identifying the beneficial owners of
the related Exchange Notes and each such person may conclusively rely on, and
shall be protected in relying on, instructions from such New Global Registered
Owner or of the DTC for all purposes (including with respect to the registration
and delivery, and the principal amount of the Exchange Notes to be issued).
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company's amended and restated Certificate of Incorporation and By-laws
authorize capital stock consisting of 10,000,000 shares of Common Stock, par
value $.01 per share, and 4,000,000 shares of preferred stock, par value $.01
per share (the "Preferred Stock"). The following summaries of the material
provisions of the Common Stock, Preferred Stock and warrants exercisable into
shares of Common Stock do not purport to be complete and are subject to, and
qualified by, the provisions of the Company's Amended and Restated Certificate
of Incorporation (the "Certificate of Incorporation") and By-laws, and to the
applicable provisions of the General Corporation Law of the State of Delaware
(the "DGCL").
PREFERRED STOCK
Preferred Stock may be issued from time to time by the Board of Directors as
shares of one or more classes or series. Subject to the provisions of the
Certificate of Incorporation and certain limitations prescribed by the DGCL, the
Board of Directors is expressly authorized to adopt resolutions to fix the
voting rights, if any, designations, powers, preferences and the relative,
participation, optional or other rights, if any, and the qualifications,
limitations or restrictions of any unissued series of Preferred Stock, to fix
the number of shares constituting such series, and to increase or decrease the
number of shares of any such series (but not below the number of shares thereof
then outstanding), in each case without any further action or vote by the
stockholders. Although the Company has no present plans to issue any shares of
Preferred Stock, the issuance of shares of Preferred Stock, or the issuance of
rights to purchase such shares could have the effect of delaying, deferring or
preventing a change of control of the Company or an unsolicited acquisition
proposal.
CONVERTIBLE PREFERRED STOCK
The Company issued an aggregate of 1,000 shares of Series A Convertible
Redeemable Preferred Stock (the "Convertible Preferred Stock").
CONVERSION
The Convertible Preferred Stock shall be convertible into 1,191,626 shares
of Common Stock at any time at the option of the holders of Convertible
Preferred Stock, subject to adjustment under certain circumstances.
LIQUIDATION PREFERENCE
Upon any liquidation, dissolution, or winding-up of the Company, the holders
of Convertible Preferred Stock, before any distribution to the holders of
securities junior in right of payment to the Convertible Preferred Stock, are
entitled to be paid out of the assets of the Company available for distribution
to its stockholders an amount equal to the aggregate stated value of shares of
Convertible Preferred Stock then outstanding (the "Liquidation Preference"),
based on an aggregate initial stated value of $15.0 million. If the assets of
the Company available for distribution to the holders of Convertible Preferred
Stock are holders of outstanding shares of Convertible Preferred Stock, then the
holders of Convertible Preferred Stock shall share ratably in such distribution
of assets.
DIVIDENDS
The holders of Convertible Preferred Stock are not entitled to any dividends
or other distributions payable in respect of the shares of Convertible Preferred
Stock. No dividends or distributions shall be made by the Company on the Common
Stock or other securities junior in right of payment to the Convertible
Preferred Stock without the written consent of all of the holders of Convertible
Preferred
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Stock, and then only if holders of Convertible Preferred Stock receive a pro
rata share of any and all such dividends or distributions as if such shares of
Convertible Preferred Stock had been fully converted into shares of Common
Stock.
REDEMPTION OPTION
The Convertible Preferred Stock is redeemable at the option of the holders
thereof: (i) upon the earlier to occur of a merger, sale of substantially all of
the assets or Common Stock of the Company or other Change of Control; or (ii)
upon 180 days' prior written notice (the "Redemption Notice") from any holder of
Convertible Preferred Stock at any time 62 months after the offering of the
Private Notes, in each case, at a price equal to the greater of (A) an amount
equal to the Liquidation Preference; and (B) if there is no established market
for the Common Stock on a national securities exchange or other nationally
recognized automated quotation system, the fully converted value of the
Convertible Preferred Stock based on the appraised value of the Company as
determined by a qualified independent appraiser (selected by the Company and
acceptable to the holders of Convertible Preferred Stock) as of the date that is
90 days after the date of delivery of the Redemption Notice and assuming that
the Company had consummated an initial public offering of Common Stock in which
Wafra had participated on the date of such Redemption Notice.
VOTING RIGHTS AND BOARD REPRESENTATION
Holders of Convertible Preferred Stock have voting rights with respect to
any and all matters presented to the Company's stockholders for their action or
consideration commensurate with the percentage of Common Stock into which such
shares of Convertible Preferred Stock are convertible, as if such shares of
Convertible Preferred Stock had been fully converted. Holders of the Convertible
Preferred Stock will vote together with holders of Common Stock as a single
class. In addition, pursuant to the terms of an agreement between the Company,
Birch and Wafra, the holders of Convertible Preferred Stock have the right to
nominate to the Board, and the Company and Birch shall take all action within
their respective powers, including (with respect to Birch), but not limited to,
the voting of all shares of Common Stock then held by Birch and entitled to
vote, required to cause the Board to consist of, such number of directors as
shall constitute the nearest whole number equal to the quotient obtained by
dividing (x) the number of shares of Common Stock beneficially owned by the
holders of the Convertible Preferred Stock by (y) the number of shares of Common
Stock then outstanding on a fully diluted basis (without giving effect to the
exercise of any options granted pursuant to the Stock Incentive Plan), but, in
any event, not less than one director for so long as the holders of the
Convertible Preferred Stock shall beneficially own at least 5% of the then
outstanding shares of Common Stock on a fully diluted basis (without giving
effect to the exercise of any options granted pursuant to the Stock Incentive
Plan).
OTHER RIGHTS
Holders of Convertible Preferred Stock are entitled to certain additional
rights, in each case as set forth in and subject to the certificate of
designations (the "Certificate of Designations") governing the powers,
preferences and relative, participating, optional or other special rights and
qualifications, limitations or restrictions relating to the Convertible
Preferred Stock, including, but not limited to, the following: (i) the right to
approve Company transactions with affiliates of the Company; (ii) standard
anti-dilution protection upon the occurrence of certain events; (iii) preemptive
rights; (iv) the right to one demand that the Company register the Common Stock
issuable upon conversion of the Convertible Preferred Stock and use its best
efforts to cause a registration statement with respect thereto to become
effective; provided, further, that, if less than all the shares of such Common
Stock are sold in such offering, the holders of Convertible Preferred Stock
shall be entitled to one additional demand to register all of the remaining
shares of such Common Stock (unless such shares of Common Stock represent less
than 5% of the fully diluted number of shares of such Common Stock, in which
case the Company may elect to effect a shelf
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registration statement (which will remain effective for one year) in lieu of
such additional demand registration); and (v) all other applicable rights
granted to the holders of Unit Warrants and the Ten Year Warrants.
COMMON STOCK
There are approximately 1,000 holders of the 4,000,000 shares of Common
Stock outstanding. In addition, the Company has reserved (i) 715,692 shares of
Common Stock for issuance under the Stock Incentive Plan, (ii) 805,154 shares of
Common Stock for issuance upon exercise of the Warrant Shares, (iii) 444,444
shares of Common Stock for issuance upon exercise of the Ten Year Warrants and
(iv) 1,191,626 shares of Common Stock for issuance upon conversion of the
Convertible Preferred Stock. The holders of the Common Stock are entitled to one
vote for each share of Common Stock on all matters voted upon by stockholders,
including the election of directors. Subject to the rights of holders of any
then outstanding shares of Preferred Stock, holders of the Common Stock are
entitled to such dividends as may be declared in the discretion of the Board of
Directors out of funds legally available therefor. The Company currently does
not pay any dividends on the Common Stock. Holders of the Common Stock are
entitled to share ratably in the net assets of the Company upon liquidation
after payment or provision for all liabilities and any preferential liquidation
rights of any shares of Preferred Stock then outstanding. The Common Stock has
no preemptive rights to purchase shares of capital stock of the Company, is not
subject to any redemption provisions and is not convertible into any other
securities of the Company. All outstanding shares of Common Stock are fully paid
and nonassessable. The Common Stock does not trade on any established public
trading market.
WARRANTS
GENERAL
In connection with the Plan of Reorganization, the Company issued
approximately 444,444 units, each consisting of nine shares of Common Stock and
one Ten Year Warrant, entitling the holder thereof to purchase one share of
Common Stock at an Exercise Price of $17.55. The Ten Year Warrants expire on
July 29, 2007. The Ten Year Warrants were issued in registered form pursuant to
a warrant agreement, as amended (the "Ten Year Warrant Agreement"), dated as of
the Effective Date, between the Company and the warrant agent named therein (the
"Warrant Agent"). In addition, the Company issued to purchasers approximately
85,000 units, each consisting of $1,000 principal amount of Private Notes and
one warrant (the "Unit Warrants" and, together with the Ten Year Warrants, the
"Warrants") to purchase 9.4724 shares of Common Stock. The Unit Warrants were
issued in registered form pursuant to a warrant agreement dated as of the July
22, 1997 (the "Unit Warrant Agreement" and together with the Ten Year Warrant
Agreement, the "Warrant Agreements"), between the Company and the Warrant Agent.
The following summary of the material provisions of the Warrant Agreements do
not purport to be complete and is qualified in its entirety by reference to the
Warrant Agreements including the definitions therein of certain terms.
The Warrants may be exercised by surrendering to the Warrant Agent the
definitive Warrant certificates evidencing such Warrants (or, if the Warrant
certificate has not been issued in respect of such Warrant, the related Note, if
applicable), with the accompanying form of election to purchase properly
completed and executed, together with payment of the Exercise Price. Payment of
the Exercise Price may be made in the form of cash or by certified or official
bank check payable to the order of the Company. Upon surrender of the Warrant
certificate (or Note, as the case may be) and payment of the Exercise Price, the
Warrant Agent will deliver or cause to be delivered to or upon the written order
of such holder, stock certificates representing the number of whole shares of
Common Stock or other securities or property to which such holder is entitled.
If less than all of the Warrants evidenced by a Warrant certificate are to be
exercised, a new Warrant certificate will be issued for the remaining number of
Warrants.
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No fractional shares of Common Stock will be issued upon exercise of the
Warrants. The Company shall pay to holders of the Warrants at the time of
exercise an amount in cash equal to the same fraction of the current market
price of a share of Common Stock less the Exercise Price. The holders of the
Warrants have no right to vote on matters submitted to the shareholders of the
Company, have no right to receive dividends and no right to receive notice of
any meeting of the shareholders, consent to any action of the stockholders,
receive notice of any other stockholders proceedings or any other rights as
shareholders of the Company. The holders of the Warrants are not entitled to
share in the assets of the Company in the event of liquidation, dissolution or
the winding up of the affairs of the Company.
ADJUSTMENTS
If the Company (i) pays a dividend in shares of Common Stock or makes a
distribution on its Common Stock in shares of its Common Stock or other shares
of its capital stock, (ii) subdivides its outstanding shares of Common Stock
into a greater number of shares, (iii) combines its outstanding shares of Common
Stock into a smaller number of shares or (iv) issues by reclassification of its
Common Stock any shares of its capital stock, then the number of shares of
Common Stock issuable upon exercise of the Warrant immediately prior to such
action shall be proportionately adjusted so that the holder of any Warrant
thereafter exercised may receive the aggregate number and kind of shares of
capital stock of the Company that such holder would have owned immediately
following such action if such Warrant had been exercised immediately prior to
such action.
If the Company distributes to all holders of its Common Stock any of its
assets (including but not limited to cash), securities (other than capital
stock), or any rights or Warrants to purchase securities (including but not
limited to Common Stock) of the Company, the Company will make the same
distribution to holders of the Warrants as though, immediately prior to the
record date with respect to such distribution, each such holder owned the number
of shares of Common Stock such holder could have purchased upon the exercise of
the Warrants held by such holder.
Subject to certain exceptions set forth in the Warrant Agreement, if the
Company issues (i) shares of Common Stock for a consideration per share less
than the current market price per share or (ii) any securities convertible into
or exchangeable for Common Stock for a consideration per share of Common Stock
initially deliverable upon conversion or exchange of such securities that is
less than the current market price per share of Common Stock on the date of
issuance of such securities, the Company shall offer to sell to each holder of
Warrants, at the same price and on the same terms offered to all other
prospective buyers (provided that the holders of Warrants shall not be required
to buy any other securities in order to buy such Common Stock or convertible
securities), a portion of such Common Stock or convertible securities that is
equal to such holder's portion of the Common Stock then outstanding if
immediately prior thereto all the Warrants had been exercised. Each such holder
may elect to buy all or any portion of the Common Stock or convertible
securities offered or may decline to purchase any.
Notwithstanding the foregoing, no adjustment or action need be made for (i)
a change solely in the par value or no par value of the Common Stock; provided
that the Company shall not increase the par value to exceed the Exercise Price,
(ii) the conversion or exchange (other than pursuant to a reclassification), in
any case on a share-for-share basis, of Common Stock for non-voting stock for
Common Stock, (iii) shares of Common Stock (or options to purchase such shares)
issued to employees of the Company or any of its Subsidiaries pursuant to the
stock option plans or similar plans of the Company, to the extent that shares of
Common Stock or other securities issued or granted under such plans are issued
or granted at a price, or with an exercise price, that is no less than the fair
market value of the Common Stock at the date of grant and such grant or
issuance, together with all previous grants and issuances under all such plans,
represent 10% of the fully diluted Common Stock at the time of such grant or
issuance, or (iv) the exercise of the Warrants.
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In case of certain consolidations or mergers of the Company, or the sale of
all or substantially all of the assets of the Company to another corporation,
each Warrant will thereafter be exercisable for the right to receive the kind
and amount of shares of stock or other securities or property to which such
holder would have been entitled as a result of such consolidation, merger or
sale had the Warrants been exercised immediately prior thereto.
THE TEN YEAR WARRANTS
The Common Stock and Ten Year Warrants became separately transferable on the
Effective Date. Each Ten Year Warrant, when exercised, will entitle the holder
thereof to receive the number of shares of Common Stock set forth on such Ten
Year Warrant at an exercise price of $17.55 per share (the "Ten Year Exercise
Price"). The number of Warrant Shares and the Ten Year Exercise Price are
subject to adjustment in certain cases referred to below. The Ten Year Warrants
are exercisable at any time on or after the date of issuance and, unless
exercised, will automatically expire at 5:00 p.m. Eastern Standard Time on July
29, 2007. The Ten Year Warrants entitle the holders thereof to purchase an
aggregate of 444,444 shares of Common Stock.
THE UNIT WARRANTS
The Private Notes and Unit Warrants became separately transferable on the
date 45 days following the Effective Date. Each Unit Warrant, when exercised,
will entitle the holder thereof to receive the number of shares of Common Stock
set forth on such Unit Warrant at an exercise price of $.01 per share (the "Unit
Exercise Price"). The number of Warrant Shares and the Unit Exercise Price are
subject to adjustment in certain cases referred to below. The Unit Warrants are
exercisable at any time on or after the date of issuance and, unless exercised,
will automatically expire at 5:00 p.m. Eastern Standard Time on August 1, 2007.
The Unit Warrants entitle the holders thereof to purchase an aggregate of
805,154 shares of Common Stock. The Unit Warrants and the Warrant Shares have
not been registered under the Securities Act and are subject to certain transfer
restrictions.
TAG-ALONG RIGHTS
If at any time during the Tag Along Period (as defined below), Birch
Holdings, Birch Acquisition or certain related parties propose to sell, exchange
or otherwise dispose of or transfer shares of Common Stock held by it to any
Person, Birch Holdings or Birch Acquisition, as the case may be, and the Company
will notify each holder of Unit Warrants or Warrant Shares of the proposed sale,
exchange, disposition or transfer and, upon written notice to Birch Holdings or
Birch Acquisition, as the case may be, and the Company, the holders of Unit
Warrants and Warrant Shares shall have the right to sell, exchange, dispose of
or transfer, at the same price and upon the same terms and conditions (subject
to certain limitations) as such proposed sale, exchange, disposition or
transfer, the number of Warrant Shares owned by all such holders equal to (x)
the total number of shares of Common Stock proposed to be sold, exchanged,
disposed of or transferred by Birch Holdings or Birch Acquisition, as the case
may be, multiplied by (y) a fraction, the numerator of which is the aggregate
number of Warrant Shares which are then outstanding and which could then be
acquired upon exercise of Unit Warrants by all holders of Unit Warrants and the
denominator of which is the sum of (i) the total number of Warrant Shares which
are then outstanding and which could then be acquired upon exercise of Unit
Warrants by all holders of Unit Warrants, plus (ii) the total number of shares
of Common Stock then outstanding which were previously issued upon conversion of
Convertible Preferred Stock and which could then be acquired upon conversion of
Convertible Preferred Stock by all holders of Convertible Preferred Stock plus
(iii) the total number of shares of Common Stock then owned by Birch Holdings or
Birch Acquisition (or both Birch Holdings and Birch Acquisition if each of them
proposes to sell shares of Common Stock). The term "Tag Along Period" means the
period commencing on the Effective Date and ending on the date the Common Stock
is quoted
102
<PAGE>
for trading on any tier of the National Association of Securities
Dealers--Automated Quotation System or listed on a national securities exchange.
EXCHANGE RIGHTS OF HOLDERS
If either Birch Holdings or Birch Acquisition shall consummate a public or
private offering of shares of Common Stock or any security convertible into
Common Stock, the holders of the Unit Warrants or the Warrant Shares shall have
the right to convert the Unit Warrants or Warrant Shares into such number of
shares of Common Stock of Birch Holdings or Birch Acquisition LLC, as the case
may be, as have an equivalent fair market value to the fair market value of the
number of Warrant Shares outstanding or issuable upon the exercise of
outstanding Unit Warrants as of the date of such offering, as determined by an
Independent Financial Advisor.
REPURCHASE
If the Company merges or consolidates with or into, or sells all or
substantially all of its assets to, a Person that does not have publicly traded
common equity for which the Unit Warrants become exercisable and the
consideration for such transaction does not consist solely of cash, the Company
must offer to repurchase all Unit Warrants at the value (as determined by
Jefferies & Company, Inc.) of the Common Stock issuable upon exercise thereof,
less the Exercise Price.
REGISTRATION RIGHTS
Except under certain circumstances including, without limitation, an
underwriter's market cut-back and registration of shares to be offered pursuant
to an employee benefit plan, an exchange offer or certain merger transactions,
whenever the Company proposes to register any shares of its Common Stock under
the Securities Act, the Company will notify each holder of the Unit Warrants or
Warrant Shares of the proposed filing and if so requested by such holders, the
Company will use its best efforts to register Warrant Shares under the
Securities Act.
On or prior to 90 days (or, in certain circumstances up to 180 days) after
the effective date of a registration statement filed with the Commission in
connection with an initial public offering of the Common Stock, the Company is
required to use its best efforts to file a registration statement for the
benefit of the holders of Unit Warrants and covering resales of the Warrant
Shares and to keep such registration statement effective until the earlier of
either the tenth anniversary of the Effective Date or such time as all Unit
Warrants have been exercised.
RULE 144A INFORMATION REQUIREMENT
The Company has agreed that, for so long as any of the Unit Warrants or
Warrant Shares remain outstanding, it will make available to any prospective
purchaser of the Unit Warrants or Warrant Shares or beneficial owner of the Unit
Warrants or Warrant Shares in connection with any sale thereof the information
required to be delivered pursuant to Rule 144A(d)(A) under the Securities Act,
until such time as such Warrant Shares have been registered for resale under the
Securities Act.
REPORTS
Whether or not required by the rules and regulations of the Commission, so
long as any Unit Warrants are outstanding, the Company will furnish to the
holders of Unit Warrants all quarterly and annual financial information that
would be required to be contained in the filing with the Commission on Forms
10-Q and 10-K if the Company were required to file such Forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, a report thereon
by the Company's certified independent accountants. In addition, whether or not
required by the rules and regulations of the Commission, after the date the
Company has an effective
103
<PAGE>
registration statement on file with the Commission and so long as any Unit
Warrants are outstanding, the Company will file a copy of all such financial and
other information with the Commission for public availability.
CERTAIN PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND BY-LAWS
CLASSIFICATION OF THE BOARD OF DIRECTORS AND RELATED PROVISIONS
The Company's Board of Directors consists of at least five members, of which
four were initially nominated by holders of claims in respect of the Company's
pre-petition Revolving Credit Facility and one was initially nominated by the
creditor's committee during the Company's reorganization under Chapter 11 of the
Bankruptcy Code. These directors have the right to remain in office until
successors are elected by holders of a plurality of the Common Stock of the
Company or until they are removed by the stockholders of the Company, in either
case in accordance with the Certificate of Incorporation and By-laws of the
Company; PROVIDED, HOWEVER, that the single director nominated by the creditors'
committee will serve for a term of at least three years from the Effective Date.
Subject to the rights of holders of any outstanding Preferred Stock, vacancies
on the Board of Directors may be filled only by the Board of Directors or the
Company's stockholders acting at an annual meeting.
INDEMNIFICATION
The Certificate of Incorporation and By-laws provide that the Company shall
advance expenses to and indemnify each director and officer of the Company to
the fullest extent permitted by law.
LIMITATIONS ON DIRECTORS' LIABILITY
The Certificate of Incorporation provides that no director of the Company
shall be personally liable to the Company or its stockholders for monetary
damages for any breach of fiduciary duty as a director, except to the extent
such exemption from liability or limitation thereof is not permitted under the
DGCL. These provisions do not limit the liability of directors under federal
securities laws and do not affect the availability of equitable remedies such as
an injunction or rescission based upon a director's breach of his or her duty of
care.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
Section 203 of the DGCL prohibits certain transactions between a Delaware
corporation and an "interested stockholder," which is defined as a person who,
together with any affiliates and/or associates of such person, beneficially
owns, directly or indirectly, 15% or more of the outstanding voting shares of a
Delaware corporation. This provision prohibits certain business combinations
(defined broadly to include mergers, consolidations, sales or other dispositions
of assets having an aggregate value of 10% or more of the consolidated assets of
the corporation, and certain transactions that would increase the interested
stockholder's proportionate share ownership in the corporation) between an
interested stockholder and a corporation for a period of three years after the
date the interested stockholder acquired its stock, unless: (i) the business
combination is approved by the corporation's board of directors prior to the
date the interested stockholder acquired shares; (ii) the interested stockholder
acquired at least 85% of the voting stock of the corporation in the transaction
in which it became an interested stockholder; or (iii) the business combination
is approved by a majority of the board of directors and by the affirmative vote
of two-thirds of the outstanding voting stock owned by disinterested
stockholders at an annual or special meeting. A Delaware corporation, pursuant
to a provision in its certificate of incorporation or by-laws, may elect not to
be governed by Section 203 of the DGCL. The Company [did not] make such an
election, and, as a result, the Company is subject to the provisions of Section
203 of the DGCL.
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<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
THE FOLLOWING IS A DESCRIPTION OF CERTAIN INDEBTEDNESS OF THE COMPANY,
INCLUDING CERTAIN PRE-PETITION TAX CLAIMS, THE MCDONALD'S NOTE, THE MCDONALD'S
RENT DEFERRAL SECURED NOTES AND THE PRIVATE NOTES.
PRE-PETITION TAX CLAIMS
The pre-petition tax claims, which were restructured pursuant to the Plan of
Reorganization as "Pre-petition Tax Payables," have an estimated aggregate
principal amount of $5 million, subject to the final resolution of federal,
state and local tax audits for periods prior to March 25, 1996. The claims
originated as taxes assessed prior to the Company's filing under Chapter 11. The
Pre-petition Tax Payables have maturities of up to six years from the original
date of assessment and require principal payments in equal annual installments.
The majority of the Pre-petition Tax Payables accrue simple interest at 10% per
annum (payable with each annual principal installment) from the Effective Date.
A small portion of the Pre-petition Tax Payables accrue simple interest at 12%
per annum (payable with each annual principal installment) from the Effective
Date (the "Alternative Pre-petition Tax Payables"). Pre-petition tax claims held
by the United States Internal Revenue Service accrue interest in the manner
specified in Code Sections 6621 and 6622.
The first payment on the majority of the Pre-petition Tax Payables is
payable one year after the Effective Date or, if the pre-petition tax claim is
not "allowed" by the Bankruptcy Court within one year after the Effective Date,
as soon as practicable after such claim becomes allowed. The first payment on
the Alternative Pre-petition Tax Payables is payable on the Effective Date or,
if the pre-petition tax claim is not "allowed" by the Bankruptcy Court on the
Effective Date, as soon as practicable after such claim becomes allowed.
Interest will be due and payable on the date on which each annual installment of
principal is due. The Company may elect to prepay, without penalty, all or any
portion of any pre-petition tax claim.
MCDONALD'S NOTE
The McDonald's Secured Rejection Note (the "McDonald's Note") represents
restructured secured claims against the Company in an aggregate principal amount
of $4,416,238. This note is payable in six equal annual installments of $736,040
beginning on the first anniversary of the Effective Date and thereafter on the
five subsequent anniversaries of the Effective Date, and accrues simple interest
from the Effective Date on the unpaid balance at a 12% annual interest rate. The
McDonald's Note is secured by mortgages on fourteen Company-owned parcels of
real property.
The amount owing with respect to the McDonald's Note may be prepaid by the
Company in full or in part at any time without penalty. In the event that the
Company sells any property that is subject to a valid and enforceable mortgage
held by McDonald's, the proceeds of such sale must be immediately applied, to
the extent available, to repay the principal amount and any accrued and unpaid
interest on the McDonald's Note. The Company currently is holding three
properties for sale with an aggregate book value of $2.7 million.
The McDonald Note contains cross-defaults to any other debt issued, or
credit obtained, by the Company which has an aggregate principal amount equal to
or greater than $2.5 million. The Company will be in default on the McDonald's
Note in the event that McDonald's terminates any two subleases where McDonald's
is the sublessor as a result of the Company's breach of such subleases.
MCDONALD'S SECURED RENT DEFERRAL NOTES
McDonald's also holds the "McDonald's Secured Rent Deferral Notes," which
represent restructured rent deferrals which McDonald's granted to the Company
during the bankruptcy proceedings in an aggregate principal amount of $265,466
as of the Effective Date. After the Effective Date, the principal amount of each
McDonald's Secured Rent Deferral Note is scheduled to increase by an amount
equal to
105
<PAGE>
the rent deferral for each month between the Effective Date and the termination
of the sublease which gave rise to the McDonald's secured claim with respect to
such rent deferral. As with the McDonald's Note, the McDonald's Secured Rent
Deferral Notes are secured by mortgages on the same fourteen Company-owned
parcels of real property.
Each McDonald's Secured Rent Deferral Note will become due and payable on
the date on which the current term of the sublease giving rise to such
McDonald's Secured Rent Deferral Note expires, without giving effect to any
unexercised right to extend, or option to renew, such sublease.
Each McDonald's Secured Rent Deferral Note bears interest at a rate equal to
12%. Interest is payable upon maturity or acceleration of each McDonald's
Secured Rent Deferral Note. On each anniversary of the Effective Date, all
accrued interest not previously paid or capitalized will be capitalized and
added to the outstanding principal amount of each McDonald's Secured Rent
Deferral Note. These Notes expire between August 31, 2002 and December 31, 2004.
The scheduled rent deferrals on the McDonald's Secured Rent Deferral Notes
currently total $398,196 per year and, when combined with the principal balance
thereof at the Effective Date, total approximately $2,567,000 over the remaining
lease term.
The McDonald's Secured Rent Deferral Notes contain cross-defaults to any
other debt issued, or credit obtained, by the Company, the aggregate principal
amount of which is equal to or greater than $2.5 million. The Company will be in
default on the McDonald's Secured Rent Deferral Notes in the event that
McDonald's terminates any two subleases, where McDonalds is the sublessor, as a
result of the Company's breach of those subleases. In addition, the McDonald's
Secured Rent Deferral Notes contain certain other standard terms, conditions and
covenants as required by the Plan of Reorganization.
PRIVATE NOTES
On July 29, 1997, the Company received approximately $80.0 million of net
proceeds from the sale of $85.0 million aggregate principal amount of the
Company's Private Notes. For a description of the material terms of the Private
Notes, see "Description of the Exchange Notes."
106
<PAGE>
PLAN OF DISTRIBUTION
This Prospectus, as it may be amended or supplemented from time to time, may
be used by a broker-dealer in connection with resales of any Exchange Notes
received in exchange for Private Notes acquired by such broker-dealer as a
result of market-making or other trading activities. Each broker-dealer that
receives Exchange Notes for its own account in exchange for such Private Notes
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. The Company has
agreed that for a period of up to 180 days after the closing of the Exchange
Offer, it will make this Prospectus, as amended or supplemented, available to
any such broker-dealer that requests copies of this Prospectus in the Letter of
Transmittal for use in connection with any such resale.
The Company will not receive any proceeds from any sale of Exchange Notes by
broker-dealer or any other persons. Exchange Notes received by broker-dealers
for their own account pursuant to the Exchange Offer may be sold from time to
time in one or more transactions in the over-the-counter market, in negotiated
transactions or through the writing of options on the Exchange Notes, or a
combination of such methods of resale, at market prices prevailing at the time
of resale or negotiated prices. Any such resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such broker-dealer and/or the
purchasers of any such Exchange Notes. Any broker-dealer that resells Exchange
Notes that were received by it for its own account pursuant to the Exchange
Offer in exchange for Private Notes acquired by such broker-dealer as a result
of market-making or other trading activities and any broker-dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit on any
such resale of Exchange Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will deliver
and by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act.
The Company has agreed to pay all expenses incident to the Company's
performance of, or compliance with, the Registration Rights Agreement and will
indemnify the holders of Private Notes (including any broker-dealers), and
certain parties related to such holders, against certain liabilities, including
liabilities under the Securities Act.
107
<PAGE>
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the material U.S. federal income tax
consequences of the exchange of the Private Notes for the Exchange Notes. The
discussion is based on provisions of the Code, its legislative history, judicial
authority, current administrative rulings and practice, and Treasury
Regulations. Legislative, judicial or administrative changes or interpretations
after the date hereof could alter or modify the validity of the statements and
conclusions set forth below. Any such changes or interpretations may be
retroactive and could adversely affect a holder of the Private Notes or the
Exchange Notes.
This discussion does not purport to deal with all aspects of U.S. federal
income taxation that might be relevant to particular Holders in light of their
personal investment or tax circumstances or status, nor does it discuss the U.S.
federal income tax consequences to certain types of Holders subject to special
treatment under the U.S. federal income tax laws, such as financial
institutions, insurance companies, dealers in securities or foreign currency,
tax-exempt organizations, foreign corporations or nonresident alien individuals,
or persons holding Private Notes or Exchange Notes that are a hedge against, or
that are hedged against, currency risk or that are part of a straddle or
conversion transaction, or persons whose functional currency is not the U.S.
dollar. Moreover, the effect of any applicable state, local or foreign tax laws
is not discussed.
EACH HOLDER OF A PRIVATE NOTE THAT IS PARTICIPATING IN THE EXCHANGE OFFER IS
STRONGLY URGED TO CONSULT WITH ITS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF
SUCH HOLDER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES,
INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN OR OTHER TAX LAWS, OF
THE EXCHANGE OF THE PRIVATE NOTES FOR THE EXCHANGE NOTES PURSUANT TO THE
EXCHANGE OFFER.
EXCHANGE OFFER
The exchange of the Private Notes by any Holder for the Exchange Notes
pursuant to the Exchange Offer should not be treated as an "exchange" for
federal income tax purposes because the Exchange Notes should not be considered
to differ materially in kind or in extent from the Private Notes. Rather, the
Exchange Notes received by any Holder should be treated as a continuation of the
Private Notes in the hands of such Holder. As a result, there should be no
federal income tax consequences to Holders exchanging the Private Notes for the
Exchange Notes pursuant to the Exchange Offer, and the federal income tax
consequences of holding and disposing of the Exchange Notes should be the same
as the federal income tax consequences of holding and disposing of the Private
Notes. In addition, a Holder's adjusted tax basis in the Exchange Notes will be
the same as its adjusted tax basis in the Private Notes exchanged therefor and
its holding period for the Private Notes will be included in its holding period
for the Exchange Notes. Further, the determination of gain on a sale or other
disposition of the Exchange Notes will be the same as for the Private Notes.
Moreover, the Holders must, among other things, continue to include original
issue discount on the Exchange Notes in gross income as interest as if the
exchange had not occurred.
LEGAL MATTERS
The validity of the Exchange Notes will be passed upon for the Company by
Shearman & Sterling, 599 Lexington Avenue, New York, New York.
EXPERTS
The consolidated financial statements of the Company as of December 31, 1996
and for the year then ended, included in this Prospectus, have been audited by
Ernst & Young LLP, independent certified public accountants, as set forth in
their report thereon appearing elsewhere herein (which report contains an
explanatory paragraph relating to the Company's ability to continue as a going
concern). Such consolidated
108
<PAGE>
financial statements are included elsewhere herein in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Discovery Zone, Inc. as of December
31, 1995 and the year ended December 31, 1995, included in this Prospectus, have
been so included in reliance on the report (which contains an explanatory
paragraph relating the ability of Discovery Zone, Inc. to continue as a going
concern as described in Notes 2, 13 and 16 (this Note is not included in the
current financial statements) to the consolidated financial statements of
Discovery Zone, Inc. as of and for the year ended December 31, 1995) of Price
Waterhouse LLP, independent accountants, given upon the authority of said firm
as experts in auditing and accounting. Such consolidated financial statements
are included elsewhere herein in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
The consolidated financial statements of the Company as of December 31,
1994, and for the years ended December 31, 1994 and 1993, included in this
Prospectus, have been audited by Arthur Andersen LLP, independent certified
public accountants, as stated in their report thereon appearing elsewhere
herein. Such consolidated financial statements are included elsewhere herein in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
109
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
TWO MONTHS ENDED SEPTEMBER 30, 1997, SEVEN MONTHS ENDED JULY 31, 1997
AND NINE MONTHS ENDED SEPTEMBER 30, 1996
Unaudited Condensed Consolidated Statements of Operations................................................ F-2
Unaudited Condensed Consolidated Balance Sheets.......................................................... F-4
Unaudited Condensed Consolidated Statements of Cash Flows................................................ F-5
Notes to Unaudited Condensed Consolidated Financial Statements........................................... F-6
THREE YEARS ENDED DECEMBER 31, 1996
Report of Independent Certified Public Accountants for the year ended
December 31, 1996...................................................................................... F-14
Report of Independent Certified Public Accountants for the year ended
December 31, 1995...................................................................................... F-15
Report of Independent Public Accountants for the year ended
December 31, 1994...................................................................................... F-16
Consolidated Statements of Operations for each of the three years in the period ended December 31,
1996................................................................................................... F-17
Consolidated Balance Sheets as of December 31, 1996 and 1995............................................. F-18
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
1996................................................................................................... F-19
Consolidated Statements of Equity (Deficit) for each of the three years in the period ended December 31,
1996................................................................................................... F-20
Notes to Consolidated Financial Statements............................................................... F-21
</TABLE>
F-1
<PAGE>
DISCOVERY ZONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
COMPANY COMPANY
--------------- ------------------------------
TWO MONTHS THREE MONTHS
ENDED ONE MONTH ENDED
SEPTEMBER 30, ENDED SEPTEMBER 30,
1997 JULY 31, 1997 1996
--------------- ------------- ---------------
<S> <C> <C> <C>
NET REVENUE................................. $ 19,914 $ 10,786 $ 39,788
COST OF GOODS SOLD.......................... 3,057 1,537 7,856
STORE OPERATING EXPENSES.................... 16,879 8,765 32,059
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSE................................... 3,872 1,579 8,336
DEPRECIATION AND AMORTIZATION............... 3,981 1,705 5,572
------- ------------- ---------------
OPERATING LOSS.............................. (7,875) (2,800) (14,035)
OTHER INCOME (EXPENSES):
Interest expense (see Note 1)............. (2,468) (1,430) (497)
Interest income........................... 529 73 13
Other, net................................ 69 41 65
------- ------------- ---------------
Total other expense, net................ (1,870) (1,316) (419)
------- ------------- ---------------
LOSS BEFORE REORGANIZATION COSTS AND
EXTRAORDINARY ITEM........................ (9,745) (4,116) (14,454)
REORGANIZATION COSTS........................ -- (8,060) (4,310)
------- ------------- ---------------
LOSS BEFORE EXTRAORDINARY ITEM.............. (9,745) (12,176) (18,764)
EXTRAORDINARY ITEM-GAIN ON DISCHARGE OF
DEBT...................................... -- 332,165 --
------- ------------- ---------------
NET INCOME (LOSS)........................... (9,745) 319,989 (18,764)
ACCRETION OF CONVERTIBLE REDEEMABLE
PREFERRED STOCK TO REDEMPTION VALUE....... (39) -- --
------- ------------- ---------------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS.............................. $ (9,784) $ 319,989 $ (18,764)
------- ------------- ---------------
------- ------------- ---------------
Per common and common equivalent share:
Loss before extraordinary item............ $ (2.45) $ (0.21) $ (0.33)
Extraordinary item-gain on discharge of
debt.................................... -- 5.76 --
------- ------------- ---------------
Net income (loss)......................... $ (2.45) $ 5.55 $ (0.33)
------- ------------- ---------------
------- ------------- ---------------
Weighted average number of common and common
equivalent shares outstanding............. 4,000 57,705 57,705
------- ------------- ---------------
------- ------------- ---------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-2
<PAGE>
DISCOVERY ZONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
COMPANY COMPANY
--------------- --------------------------------
TWO MONTHS NINE MONTHS
ENDED SEVEN MONTHS ENDED
SEPTEMBER 30, ENDED SEPTEMBER 30,
1997 JULY 31, 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
NET REVENUE................................ $ 19,914 $ 82,537 $ 147,848
COST OF GOODS SOLD......................... 3,057 14,136 27,059
STORE OPERATING EXPENSES................... 16,879 60,192 112,741
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSE.................................. 3,872 10,235 33,230
DEPRECIATION AND AMORTIZATION.............. 3,981 11,920 16,204
------- --------------- ---------------
OPERATING LOSS............................. (7,875) (13,946) (41,386)
OTHER INCOME (EXPENSES):
Interest expense (see Note 1)............ (2,468) (3,957) (4,978)
Interest income.......................... 529 86 53
Other, net............................... 69 73 382
------- --------------- ---------------
Total other expense, net............... (1,870) (3,798) (4,543)
------- --------------- ---------------
LOSS BEFORE REORGANIZATION COSTS AND
EXTRAORDINARY ITEM....................... (9,745) (17,744) (45,929)
REORGANIZATION COSTS....................... -- (12,165) (12,436)
------- --------------- ---------------
LOSS BEFORE EXTRAORDINARY ITEM............. (9,745) (29,909) (58,365)
EXTRAORDINARY ITEM-GAIN ON DISCHARGE OF
DEBT..................................... -- 332,165 --
------- --------------- ---------------
NET INCOME (LOSS).......................... (9,745) $ 302,256 $ (58,365)
ACCRETION OF CONVERTIBLE REDEEMABLE
PREFERRED STOCK TO REDEMPTION VALUE...... (39) -- --
------- --------------- ---------------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS............................. $ (9,784) $ 302,256 $ (58,365)
------- --------------- ---------------
------- --------------- ---------------
Per common and common equivalent share:
Loss before extraordinary item........... $ (2.45) $ (0.52) $ (1.01)
Extraordinary item-gain on discharge of
debt................................... -- 5.76 --
------- --------------- ---------------
Net income (loss)........................ $ (2.45) $ 5.24 $ (1.01)
------- --------------- ---------------
------- --------------- ---------------
Weighted average number of common and
common equivalent shares outstanding..... 4,000 57,705 57,698
------- --------------- ---------------
------- --------------- ---------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
DISCOVERY ZONE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
COMPANY COMPANY
--------------- --------------
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 30,240 $ 3,326
Restricted cash and investments........................... 12,856 --
Receivables, net.......................................... 757 1,338
Inventories............................................... 1,132 2,038
Prepaid expenses and other current assets................. 7,513 2,784
--------------- --------------
TOTAL CURRENT ASSETS.................................... 52,498 9,486
RESTRICTED CASH AND INVESTMENTS............................. 8,850 --
PROPERTY AND EQUIPMENT, net................................. 118,853 110,381
LAND HELD FOR SALE.......................................... 3,635 3,635
OTHER ASSETS................................................ 6,335 2,284
--------------- --------------
TOTAL ASSETS............................................ $ 190,171 $ 125,786
--------------- --------------
--------------- --------------
LIABILITIES AND EQUITY (DEFICIT)
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Accounts payable and accrued liabilities.................. $ 20,501 $ 15,321
Due to affiliate.......................................... -- 903
Accrued interest.......................................... 2,089 614
Current portion of long-term debt......................... 1,395 --
Debtor-in-possession credit facility...................... -- 22,448
--------------- --------------
TOTAL CURRENT LIABILITIES............................... 23,985 39,286
LONG-TERM DEBT.............................................. 86,903 4,666
OTHER LONG-TERM LIABILITIES................................. 5,050 498
LIABILITIES SUBJECT TO COMPROMISE........................... -- 344,908
CONVERTIBLE REDEEMABLE PREFERRED STOCK...................... 13,839 --
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
and 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 September 30, 1997................... 40 --
Treasury stock (Predecessor Company)- 59,545 shares at
cost.................................................... -- (588)
Additional paid-in capital................................ 70,160 291,925
Cumulative translation adjustment......................... (22) 62
Accumulated deficit....................................... (9,784) (555,548)
--------------- --------------
TOTAL NON-REDEEMABLE PREFERRED STOCK, COMMON STOCK AND
OTHER EQUITY (DEFICIT)................................ 60,394 (263,572)
--------------- --------------
TOTAL LIABILITIES AND EQUITY (DEFICIT).................. $ 190,171 $ 125,786
--------------- --------------
--------------- --------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
DISCOVERY ZONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
COMPANY COMPANY
------------- ----------------------------
TWO MONTHS SEVEN MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, JULY 31, SEPTEMBER 30,
1997 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................... $ (9,745) $ 302,256 $ (58,365)
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities before reorganization costs:
Reorganization costs............................................. -- 12,165 12,436
Extraordinary item-gain on discharge of debt..................... -- (332,165) --
Amortization of discount on Senior Secured Notes................. 190 -- --
Depreciation and amortization.................................... 3,929 11,920 16,204
Interest on subordinated convertible debt........................ -- -- 1,383
Loss on disposal of property and equipment....................... -- -- 1,010
Changes in operating assets and liabilities:
Receivables, net............................................... 139 442 724
Inventories.................................................... 182 724 2,433
Prepaid expenses and other assets.............................. (3,339) (962) (7,442)
Accounts payable and accrued liabilities....................... (3,392) 5,667 3,073
Net cash (used in) provided by operating activities before
reorganization costs............................................... (12,036) 47 (28,544)
Reorganization costs................................................. -- (12,165) (12,436)
Adjustments to reconcile reorganization costs to cash used by
reorganization costs:
Loss on asset disposals.......................................... -- -- 2,873
Write-off of deferred debt costs................................. -- -- 4,340
Accrued bankruptcy expenses...................................... -- -- --
Proceeds from sale of property and equipment..................... -- -- 1,753
------------- ------------- -------------
Net cash used by reorganization costs................................ -- (12,165) (3,470)
------------- ------------- -------------
Net cash used in operating activities................................ (12,036) (12,118) (32,014)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.................................. (262) (567) (1,717)
Proceeds from sale of property and equipment......................... -- 99 6,477
------------- ------------- -------------
Net cash (used in) provided by investing activities.................. (262) (468) 4,760
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from debtor-in-possession credit facilities............. $ -- $ -- $ 15,724
Net repayment of debtor-in-possession credit facilities.............. -- (22,448) --
Proceeds from short-term borrowings.................................. -- -- 7,500
Repayment of short-term borrowings................................... -- -- (7,500)
Advances from affiliate, net......................................... -- -- 10,730
Proceeds from the exercise of options and warrants................... -- -- 282
Proceeds from Senior Secured Notes with Warrants..................... -- 85,000 --
Proceeds from Redeemable Convertible Preferred Stock................. -- 13,800 --
Payment of financing costs........................................... -- (2,800) --
Escrow of restricted cash............................................ -- (21,754) --
------------- ------------- -------------
Net cash provided by financing activities............................ -- 51,798 26,736
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents................. (12,298) 39,212 (518)
Cash and cash equivalents, beginning of period....................... 42,538 3,326 5,949
------------- ------------- -------------
Cash and cash equivalents, end of period............................. $ 30,240 $ 42,538 $ 5,431
------------- ------------- -------------
------------- ------------- -------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest............................................... $ 291 $ 3,957 $ 633
------------- ------------- -------------
------------- ------------- -------------
Cash paid for professional fees in connection with Chapter 11
Proceeding......................................................... $ 143 $ 3,128 $ 2,419
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(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 206 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 unaudited condensed consolidated financial statements of
the Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with generally accepted accounting principles have been condensed
or omitted pursuant to those rules and regulations. However, the Company
believes that the disclosures contained herein are adequate to make the
information presented not misleading. It is suggested that these condensed
consolidated financial statements be read in conjunction with the Company's 1996
consolidated financial statements and notes thereto included in the Company's
registration statement on Form S-4.
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"), which became effective on July
29, 1997 (the "Effective Date" or "Emergence Date").
As a result of the reorganization proceedings, the unaudited condensed
consolidated financial statements and notes thereto were subject to material
uncertainties, the outcome of which were not then determinable. The Company's
unaudited condensed consolidated financial statements for periods prior to the
Effective Date were prepared on a going concern basis and do not include any
adjustments for the effect of any changes which were made in connection with the
Company's recapitalization or operations resulting from a plan of
reorganization.
The unaudited condensed 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 during bankruptcy 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
nine-month period ended September 30, 1996 was approximately $9,176,000 and
$7,963,000, 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.
F-6
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(1) ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED)
The financial statements reflect, in the opinion of management, all
adjustments, which are of a normal recurring nature, and those adjustments
required to adopt fresh-start reporting as described below which are necessary
to present fairly the Company's financial position and results of operations.
Capitalized terms have the meanings defined throughout the Notes to Condensed
Consolidated Financial Statements.
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
the year. Operating results of interim periods are not necessarily indicative of
results that may be expected for the year ending December 31, 1997.
(2) JOINT PLAN OF REORGANIZATION AND EXIT FINANCING
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 in each class 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
pre-petition liabilities permitted under the Plan) to an equity interest in the
Company, and (iii) cancellation of all of the prepetition equity interests in
the Company, all 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 444,444 shares of Common Stock
have been reserved for issuance in connection with the warrants. 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 condensed consolidated statements of operations, of
approximately $332,165,000. 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 $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 4) 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 condensed consolidated financial statements. The Senior
Secured Note holders also
F-7
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(2) JOINT PLAN OF REORGANIZATION AND EXIT FINANCING (CONTINUED)
received warrants (the "Warrants") to purchase 805,154 shares of Common Stock at
$.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 5).
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.
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.
As part of the Plan, a stock option plan was established. Pursuant to
certain executive employment contracts, options to purchase shares of Common
Stock have been granted to senior executives of the Company at an exercise price
of $11.88 per share. A total of 715,692 shares of Common Stock have been
reserved for issuance under the Company's stock option plan.
(3) FRESH START REPORTING
Upon emergence from its Chapter 11 proceedings, the Company adopted fresh
start reporting pursuant to the provisions of SOP 90-7. 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
condensed consolidated balance sheet as of September 30, 1997 reflects a new
reporting entity (the "Successor Company") and is not comparable to prior
periods (the "Predecessor Company"). Furthermore, the accompanying condensed
consolidated statements of operations and cash flows of the Predecessor Company
reflect operations prior to the Company's emergence from bankruptcy 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 by reliance on various valuation methods, including discounted
projected cash flow analyses, price/earnings ratios, and other applicable ratios
and economic and industry information relevant to the operations of the Company,
and through negotiations with the various parties in interest. While the
estimated reorganization value of the Company has been preliminarily allocated
to specific asset categories pursuant to fresh-start reporting, the effects of
such are subject to further refinement or adjustment.
F-8
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(3) FRESH START REPORTING (CONTINUED)
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):
<TABLE>
<CAPTION>
PRE- EXIT FRESH-START
EMERGENCE DISCHARGE OF FINANCING ADJUSTMENTS REORGANIZED
BALANCE SHEET DEBT (1) (2) (3) BALANCE SHEET
------------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.................. $ 1,712 $ (33,811) $ 74,637 $ 42,538
Restricted cash and investments............ 391 10,302 10,693
Receivables, net........................... 896 896
Inventories................................ 1,314 1,314
Prepaid expenses and other current
assets................................... 3,804 (569) 697 3,932
------------- ------------ ----------- ----------- -------------
TOTAL CURRENT ASSETS................... 8,117 (33,811) 84,370 697 59,373
RESTRICTED CASH AND INVESTMENTS.............. -- 11,061 11,061
PROPERTY AND EQUIPMENT, net.................. 98,929 23,591 122,520
LAND HELD FOR SALE........................... 3,635 3,635
OTHER ASSETS................................. 2,233 5,000 (704) 6,529
------------- ------------ ----------- ----------- -------------
TOTAL ASSETS........................... 112,914 (33,811) 100,431 23,584 $ 203,118
------------- ------------ ----------- ----------- -------------
------------- ------------ ----------- ----------- -------------
LIABILITIES AND EQUITY (DEFICIT)
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Accounts payable and accrued liabilities... $ 16,793 (1,368) 1,631 (8,783) $ 25,839
Current portion of long-term debt.......... 186 186
Debtor-in-possession credit facility....... 30,895 (30,895) --
------------- ------------ ----------- ----------- -------------
TOTAL CURRENT LIABILITIES.............. 47,874 (32,263) 1,631 8,783 26,025
LONG-TERM DEBT............................... 4,681 5,000 77,950 87,631
OTHER LONG-TERM LIABILITIES.................. 450 5,012 5,462
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........................ (576,107) 332,165 243,942 --
------------- ------------ ----------- ----------- -------------
TOTAL COMMON STOCK AND OTHER EQUITY
(DEFICIT)............................ (284,161) 332,165 7,050 15,146 70,200
------------- ------------ ----------- ----------- -------------
------------- ------------ ----------- ----------- -------------
TOTAL LIABILITIES AND EQUITY
(DEFICIT)............................ $ 112,914 $ (33,811) $ 100,431 $ 23,584 $ 203,118
------------- ------------ ----------- ----------- -------------
------------- ------------ ----------- ----------- -------------
</TABLE>
- ------------------------
(1) To record the discharge or reclassification of prepetition obligations
(liabilities subject to compromise) and debtor-in-possession credit
facilities pursuant to the Plan.
(FOOTNOTES CONTINUED ON NEXT PAGE)
F-9
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(3) FRESH START REPORTING (CONTINUED)
(2) To record the Exit Financing and related costs.
(3) To record assets and liabilities at their fair value pursuant to fresh-start
reporting and eliminate the existing accumulated deficit.
(4) DEBTOR-IN-POSSESSION CREDIT FACILITIES
At July 29, 1997, the Company had outstanding borrowings under its
debtor-in-possession credit facility with Perry Partners L.P. ("Perry Partners")
(the "Replacement Credit Facility") of $27,808,000. Those borrowings bore
interest at prime plus 3.5% (11.75% at July 29, 1997) payable monthly. The
Replacement Credit Facility also required payment of certain fees as defined in
the agreement as 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). At the
Effective Date, additional fees and interest of $1,800,000 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).
In June and July 1997, the U.S. Bankruptcy Court issued orders permitting
the Company to borrow $5 million 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 $2.5 million under this facility which was repaid with interest
and fees of $82,000 upon emergence from bankruptcy with the proceeds from the
Exit Financing.
F-10
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(5) LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
COMPANY COMPANY
--------------- ---------------
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- ---------------
(UNAUDITED)
<S> <C> <C>
13.5% Senior Secured Notes due 2002, net of unamortized
discount of $6,860 (1)..................................... $ 78,140 $ --
Secured Rejection Note (2).................................. 4,416 4,666
Secured Rent Deferral Notes (2)............................. 332 --
Prepetition Tax Claims (3).................................. 5,000 --
Other notes payable......................................... 410 --
--------------- ------
88,298 4,666
Less current portion........................................ (1,395) --
--------------- ------
Long-term debt.............................................. $ 86,903 $ 4,666
--------------- ------
--------------- ------
</TABLE>
- ------------------------
(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 approximately $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. The Notes
are secured by substantially all the assets of the Company and interest is
payable quarterly beginning November 1, 1997. A separate interest escrow
account was established with the trustee to fund interest payments through
August 1, 1999. The interest escrow account balance totaled $21,706,000,
consisting of treasury securities and accrued interest thereon, at September
30, 1997.
The Notes contain restrictions on 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 conjunction with its emergence from bankruptcy, the Company completed the
documentation of the notes and mortgages securing McDonald's Corporations'
("McDonald's") damage claims as approved by the Bankruptcy Court in November
1996 pursuant to the McDonald's Stipulation (see Note 7 to the annual
audited financial statements).
McDonald's claim for damages arising from rejected leases totaled
approximately $4,416,000 at the Emergence Date 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 12% payable annually.
The Company's obligations to repay certain rent deferrals granted by
McDonald's pursuant to the McDonald's Stipulation are evidenced by nine
notes due upon the expiration of each initial sublease term (the "Secured
Rent Deferral Notes"). The rent deferrals total currently $398,196 per year
and, when combined with the initial Emergence Date principal balance of
approximately $266,000, will
F-11
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(5) LONG-TERM DEBT (CONTINUED)
total approximately $2,567,000 over the next eight years. The notes bear
interest at 12% 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 September 30, 1997, which are included in Land Held for Sale
in the Company's Consolidated Balance Sheet. 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 million. 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.
(6) EARNINGS (LOSS) PER COMMON SHARE
Earnings (loss) per common and common equivalent shares is calculated based
upon the weighted average number of common and common equivalent shares
outstanding during the periods presented. Common equivalents outstanding during
the period and common shares issuable upon assumed conversion of the Preferred
Stock have not been included in the computation of 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 and common equivalent shares outstanding in the
accompanying unaudited condensed consolidated statement of operations for the
two-month period ended September 30, 1997.
(7) LEGAL MATTERS
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 $2,790,000 at
September 30, 1997 and $1,849,000 at December 31, 1996. These amounts were
recorded in accrued liabilities and other long-term liabilities in the
accompanying condensed consolidated balance sheets. Because these amounts
represent estimates, it is reasonably possible that a change in these estimates
may occur in the future.
(8) RELATED PARTY TRANSACTIONS
On May 7, 1997, the Bankruptcy Court issued an order providing for the
settlement of all of Viacom Inc.'s ("Viacom") 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
F-12
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(8) RELATED PARTY TRANSACTIONS (CONTINUED)
under the Plan. In exchange for this treatment, the Group (i) satisfied in full
a claim which Iwerks Studios, Inc. held against the Group, and which was
guaranteed by Blockbuster Entertainment Group ("Blockbuster"), an affiliate of
Viacom, in the amount of $61,500, (ii) assumed approximately thirty leases of
the Group, which were guaranteed by Viacom, and assign them to Blockbuster and
(iii) paid Viacom's postpetition administrative claims for expenses advanced by
Viacom on behalf of the Group of approximately $991,000 and obligations incurred
under the Management Services Agreement ("MSA") between the Company and Viacom
subject to any setoff paid on behalf of Viacom. In connection with this
settlement, the MSA was terminated.
As required under the Plan, the Company reimbursed Wellspring $1,078,000 for
its out-of-pocket expenses incurred in connection with sponsoring the Plan.
An officer of Griffin Bacal, Inc., the Company's advertising agency, serves
as a director of the Successor Company. The Company paid Griffin Bacal for media
purchases on behalf of, and creative services provided to, the Company
$4,316,000 during the seven months ended July 31, 1997 and $2,705,000 during the
two months ended September 30, 1997.
(9) SUBSEQUENT EVENTS
During the fourth quarter of 1997, the Company began 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. The Company
estimates that approximately 60% of its FunCenters will be renovated pursuant to
this plan by the end of January 1998 at a cost of approximately $20 million. The
Company also expects to complete the conversion of its food service operations
to offer Pizza Hut products in approximately 80% of its FunCenters by the end of
January 1998. Approximately $2,274,000 of prepaid expenses and other current
assets represent deposits or advances made in anticipation of these changes.
F-13
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Discovery Zone, Inc.
(Debtor-In-Possession)
We have audited the accompanying consolidated balance sheet of Discovery
Zone, Inc. and subsidiaries (Debtor-In-Possession) (the Company) as of December
31, 1996, and the related consolidated statements of operations, deficit and
cash flows for the year then ended. Our audit also included the financial
statement schedule for 1996 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Discovery Zone, Inc. and subsidiaries (Debtor-In-Possession) at December 31,
1996, and the consolidated results of their operations and their cash flows for
the year then ended 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 the Company will continue as a going concern. As discussed in Note 1,
on March 25, 1996, the Company filed a petition for reorganization relief under
Chapter 11 of the United States Bankruptcy Code. The Company's recent history of
operating losses, together with the uncertainties inherent in the bankruptcy
process, raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are discussed in
Note 16. The Company's ability to continue as a going concern is dependent upon
acceptance of the plan of reorganization discussed in Note 16 by the United
States Bankruptcy Court and the Company's creditors, securing on-going
debtor-in-possession or additional exit financing, compliance with all debt
covenants under the existing debtor-in-possession financing, and the success of
future operations. The ultimate outcome of these matters is not presently
determinable. 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 2, 1997
F-14
<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 aspects, the financial
position of Discovery Zone, Inc. and its subsidiaries (the "Company") at
December 31, 1995 and the results of their operations and their cash flows for
the year then ended 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 and 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 2, 13 and 16
(this Note is not included in the current 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, 1996 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 (this Note is not included in the current
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
F-15
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Discovery Zone, Inc.:
We have audited the accompanying consolidated statements of operations,
equity and cash flows of DISCOVERY ZONE, INC. (a Delaware corporation) AND
SUBSIDIARIES for the year ended December 31, 1994. 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 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 statements of operations, equity and cash
flows. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Discovery
Zone, Inc. and Subsidiaries for the year ended December 31, 1994, in conformity
with generally accepted accounting principles.
As explained in Note 20 to the financial statements, effective January 1,
1994, the Company changed its method of accounting for preopening costs.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II, Valuation and Qualifying
Accounts, is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois,
March 21, 1995 (except with respect
to the Company's bankruptcy filing
discussed in Note 1 as to which
the date is March 25, 1996).
F-16
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
-----------------------------------
<S> <C> <C> <C>
1996 1995 1994
---------- ----------- ----------
REVENUE:
Company location sales...................................................... $ 181,699 $ 257,839 $ 162,792
Franchise-related revenue................................................... 26 1,651 17,781
---------- ----------- ----------
Total revenue........................................................... 181,725 259,490 180,573
COST OF GOODS SOLD.......................................................... 34,276 50,227 36,858
STORE OPERATING EXPENSES.................................................... 140,486 185,587 97,631
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE................................. 40,779 58,201 36,451
DEPRECIATION AND AMORTIZATION............................................... 21,876 31,972 16,183
OTHER CHARGES............................................................... -- 360,803 14,024
RESTRUCTURING COSTS......................................................... -- 11,357 --
---------- ----------- ----------
OPERATING LOSS.............................................................. (55,692) (438,657) (20,574)
OTHER INCOME (EXPENSES):
Interest expense (contractual interest $18,177 in 1996)................... (6,277) (12,226) (5,137)
Interest income........................................................... -- 323 2,004
Minority interest......................................................... -- 5,162 256
Other, net................................................................ (580) 153 327
---------- ----------- ----------
Total other expense, net................................................ (6,857) (6,588) (2,550)
---------- ----------- ----------
LOSS BEFORE REORGANIZATION COSTS, INCOME TAX PROVISION (BENEFIT)AND
CUMULATIVE EFFECT OF CHANGE IN METHOD OF ACCOUNTING....................... (62,549) (445,245) (23,124)
REORGANIZATION COSTS:
Professional fees......................................................... (7,076) -- --
Loss on asset disposals................................................... (8,867) -- --
Other, net................................................................ (5,342) -- --
---------- ----------- ----------
Total reorganization costs.............................................. (21,285) -- --
---------- ----------- ----------
LOSS BEFORE INCOME TAX PROVISION (BENEFIT) AND CUMULATIVE EFFECT OF CHANGE
IN METHOD OF ACCOUNTING................................................... (83,834) (445,245) (23,124)
INCOME TAX PROVISION (BENEFIT).............................................. -- 4,000 (4,000)
---------- ----------- ----------
LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN METHOD OF ACCOUNTING............. (83,834) (449,245) (19,124)
CUMULATIVE EFFECT ON PRIOR YEARS OF CHANGE IN METHOD OF ACCOUNTING.......... -- -- 5,773
---------- ----------- ----------
NET LOSS.................................................................... $ (83,834) $ (449,245) $ (24,897)
---------- ----------- ----------
---------- ----------- ----------
Loss before cumulative effect of change in method of accounting per common
and common equivalent share............................................... $ (1.45) $ (8.06) $ (0.41)
Cumulative effect on prior years of change in method of accounting per
common and common equivalent share........................................ -- -- (0.12)
---------- ----------- ----------
Loss per common and common equivalent share................................. $ (1.45) $ (8.06) $ (0.53)
---------- ----------- ----------
---------- ----------- ----------
Weighted average common and common equivalent shares outstanding............ 57,691 55,706 46,797
---------- ----------- ----------
---------- ----------- ----------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-17
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
AS OF DECEMBER 31
------------------------
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................................. $ 3,326 $ 5,949
Receivables, net...................................................................... 1,338 1,600
Inventories........................................................................... 2,038 9,067
Deposits.............................................................................. 1,360 --
Prepaid expenses and current assets................................................... 1,424 1,191
----------- -----------
TOTAL CURRENT ASSETS.............................................................. 9,486 17,807
PROPERTY AND EQUIPMENT, net............................................................. 110,381 147,740
PROPERTY AND EQUIPMENT AWAITING DISPOSITION............................................. 3,635 1,564
OTHER ASSETS............................................................................ 2,284 4,460
----------- -----------
TOTAL ASSETS...................................................................... $ 125,786 $ 171,571
----------- -----------
----------- -----------
LIABILITIES AND DEFICIT
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Accounts payable...................................................................... $ 7,518 $ 24,324
Due to affiliate...................................................................... 903 12,931
Accrued liabilities:
Duplicate facilities................................................................ -- 16,395
Other............................................................................... 8,417 27,838
Current portion of long-term obligations.............................................. -- 113,390
Debtor-in-possession credit facility.................................................. 22,448 --
----------- -----------
TOTAL CURRENT LIABILITIES......................................................... 39,286 194,878
LONG-TERM OBLIGATIONS, EXCLUDING CURRENT PORTION........................................ -- 14
DEFERRED RENT........................................................................... -- 14,865
OTHER LONG TERM LIABILITIES............................................................. 498 14,624
SUBORDINATED CONVERTIBLE DEBT........................................................... -- 127,259
MINORITY INTEREST IN SUBSIDIARIES....................................................... -- 104
NONCURRENT NOTE PAYABLE................................................................. 4,666 --
LIABILITIES SUBJECT TO COMPROMISE....................................................... 344,908 --
----------- -----------
TOTAL LIABILITIES................................................................. 389,358 351,744
COMMITMENTS AND CONTINGENCIES
DEFICIT:
Preferred stock--$.01 par value; 10,000,000 shares authorized, no shares outstanding.... -- --
Common Stock--$.01 par value; 100,000,000 shares authorized, 57,705,470 and 57,535,470
shares issued and 57,645,925 and 57,475,925 shares outstanding at December 1996 and
1995, respectively.................................................................... 577 575
Treasury stock--59,545 shares at cost................................................... (588) (588)
Warrants................................................................................ 99 99
Additional paid-in capital.............................................................. 291,826 291,546
Cumulative translation adjustment....................................................... 62 (91)
Accumulated deficit................................................................... (555,548) (471,714)
----------- -----------
TOTAL DEFICIT..................................................................... (263,572) (180,173)
----------- -----------
TOTAL LIABILITIES AND DEFICIT..................................................... $ 125,786 $ 171,571
----------- -----------
----------- -----------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-18
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
-------------------------------
<S> <C> <C> <C>
1996 1995 1994
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................................... $ (83,834) $(449,245) $ (24,897)
Adjustments to reconcile net loss to net cash used in operating activities before
reorganization costs:
Reorganization costs........................................................... 21,285 -- --
Depreciation and amortization.................................................. 21,876 31,972 16,183
Interest on subordinated convertible debt...................................... 1,383 5,863 5,667
Provision for bad debts........................................................ 1,093 2,149 --
Other charges.................................................................. -- 360,803 14,024
Restructuring costs............................................................ -- 11,357 --
Provision (benefit) for deferred taxes......................................... -- 4,000 (4,000)
Loss on asset disposals........................................................ 1,010 -- --
Cumulative effect of change in method of accounting............................ -- -- 5,773
Changes in operating assets and liabilities, net of effects from purchase
transactions:
Receivables.................................................................... (831) 6,463 (618)
Inventories.................................................................... 1,998 254 (3,950)
Prepaid expenses and other assets.............................................. (3,757) (3,830) (8,328)
Accounts payable............................................................... 8,792 (17,703) 4,740
Accrued liabilities............................................................ (5,193) (9,954) (7,259)
Other.......................................................................... -- (1,232) (1,816)
--------- --------- ---------
Net cash used in operating activities before reorganization costs................ (36,178) (59,103) (4,481)
Reorganization costs........................................................... (21,285) -- --
Adjustments to reconcile reorganization costs to cash used by reorganization
costs:
Loss on asset disposals........................................................ 8,867 -- --
Write-off of deferred debt costs............................................... 4,340 -- --
Accrued bankruptcy expenses.................................................... 2,615 -- --
Proceeds from sale of property and equipment................................... 1,753 -- --
--------- --------- ---------
Net cash used by reorganization costs............................................ (3,710) -- --
--------- --------- ---------
Net cash used in operating activities............................................ (39,888) (59,103) (4,481)
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash used in acquisitions and investments, net................................... -- (5,300) (4,727)
Expenditures for intangibles and other assets, net............................... -- (4,344) (1,401)
Minority interest in subsidiaries................................................ -- (3,186) 3,290
Purchases of property and equipment.............................................. (2,672) (51,732) (119,134)
Proceeds from sale of property and equipment..................................... 6,477 -- --
--------- --------- ---------
Net cash provided by (used in) investing activities.............................. 3,805 (64,562) (121,972)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock....................................................... $ -- $ (511) $ (663)
Proceeds from issuance of long-term obligations.................................. -- 626,200 18,000
Repayment of long-term obligations............................................... -- (544,411) (5,377)
Net proceeds from debtor-in-possession credit facilities......................... 22,448 -- --
Proceeds from short-term borrowings.............................................. 7,500 -- --
Repayment of short-term borrowings............................................... (7,500) -- --
Advances from affiliate, net..................................................... 10,730 11,028 1,903
Proceeds from the exercise of options and warrants............................... 282 29,423 2,299
--------- --------- ---------
Net cash provided by financing activities........................................ 33,460 121,729 16,162
--------- --------- ---------
Net decrease in cash and cash equivalents........................................ (2,623) (1,936) (110,291)
Cash and cash equivalents, beginning of year..................................... 5,949 7,885 118,176
--------- --------- ---------
Cash and cash equivalents, end of year........................................... $ 3,326 $ 5,949 $ 7,885
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest........................................................... $ 844 $ 3,021 $ 146
--------- --------- ---------
--------- --------- ---------
Cash paid for professional fees in connection with Chapter 11 Proceeding......... $ 5,461 $ -- $ --
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-19
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
RETAINED
COMMON TREASURY ADDITIONAL EARNINGS
---------------------- ---------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL WARRANTS DEFICIT)
--------- ----------- --------- ----------- ----------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994.......... 37,503,356 $ 375 -- $ -- $ 94,573 $ 715 $ 2,428
Stock issued in acquisitions...... 10,325,492 103 7,771 200 163,805 -- --
Stock issued on exercise of
nonqualified stock options...... 894,267 9 34,064 602 1,687 -- --
Treasury shares acquired.......... -- -- (46,893) (879) 217 -- --
Cumulative translation
adjustment...................... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- (24,897)
--------- ----- --------- ----- ----------- ----- ------------
Balance at December 31, 1994........ 48,723,115 487 (5,058) (77) 260,282 715 (22,469)
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 (616) --
Treasury shares acquired.......... -- -- (54,487) (511) -- -- --
Cumulative translation
adjustment...................... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- (449,245)
--------- ----- --------- ----- ----------- ----- ------------
Balance at December 31, 1995........ 57,535,470 575 (59,545) (588) 291,546 99 (471,714)
Stock issued on exercise of
nonqualified stock options...... 170,000 2 -- -- 280 -- --
Cumulative translation adjustment -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- (83,834)
--------- ----- --------- ----- ----------- ----- ------------
Balance at December 31, 1996........ 57,705,470 $ 577 (59,545) $ (588) $ 291,826 $ 99 $ (555,548)
--------- ----- --------- ----- ----------- ----- ------------
--------- ----- --------- ----- ----------- ----- ------------
<CAPTION>
CUMULATIVE TOTAL
TRANSLATION EQUITY
ADJUSTMENT (DEFICIT)
------------- ---------
<S> <C> <C>
Balance at January 1, 1994.......... $ -- $ 98,091
Stock issued in acquisitions...... -- 164,108
Stock issued on exercise of
nonqualified stock options...... -- 2,298
Treasury shares acquired.......... -- (662)
Cumulative translation
adjustment...................... 25 25
Net loss.......................... -- (24,897)
----- ---------
Balance at December 31, 1994........ 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........................ -- 26,022
Treasury shares acquired.......... -- (511)
Cumulative translation
adjustment...................... (116) (116)
Net loss.......................... -- (449,245)
----- ---------
Balance at December 31, 1995........ (91) (180,173)
Stock issued on exercise of
nonqualified stock options...... -- 282
Cumulative translation adjustment 153 153
Net loss.......................... -- (83,834)
----- ---------
Balance at December 31, 1996........ $ 62 $(263,572)
----- ---------
----- ---------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-20
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
The accompanying financial statements present the consolidated financial
position and results of operations of Discovery Zone, Inc. and its subsidiaries
(collectively, the "Company"). The Company's primary business is the operation
of children's indoor entertainment facilities principally in the United States.
All material intercompany accounts and transactions have been eliminated.
Discovery Zone, Inc. and its nineteen domestic subsidiaries (collectively,
the "Discovery Zone Group") 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"). The Company's subsidiary in Canada, which
had 1996 revenues of approximately $3,500,000 and assets of approximately
$2,200,000 at December 31, 1996, did not file for protection under Chapter 11 of
the Bankruptcy Code. As a result of reorganization proceedings, the consolidated
financial statements and notes thereto are subject to material uncertainties,
the outcome of which is presently not determinable. The Company's consolidated
financial statements are prepared on a going concern basis and do not include
any adjustments that might result from the outcome of these uncertainties or the
effect of any changes which may be made in connection with the Company's
capitalization or operations resulting from a plan of reorganization.
Additionally, the Company may sell additional assets or otherwise realize assets
and liquidate or settle liabilities and contingencies for amounts other than
those reflected on the consolidated financial statements and notes thereto. 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." SOP 90-7 provides guidance for financial reporting by
entities that have filed voluntary petitions for relief under, and anticipate
reorganizing in accordance with, the Bankruptcy Code. See Note 2, Bankruptcy
Matters.
The Company's recent history of operating losses, together with the
uncertainties inherent in the bankruptcy process, raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are discussed in Note 16. The Company's ability to
continue as a going concern is dependent upon acceptance of the plan of
reorganization discussed in Note 16 by the United States Bankruptcy Court and
the Company's creditors, securing on-going debtor-in-possession or additional
exit financing, compliance with all debt covenants under the existing debtor-in-
possession financing and the success of future operations.
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.
The financial statements reflect, in the opinion of management, all material
adjustments necessary to present fairly the Company's financial position and
results of operations.
The accompanying consolidated financial statements of the Company have been
restated to include the accounts and operations of certain business acquisitions
accounted for under the pooling of interests method of accounting, as more fully
described in Note 5, Business Combinations, Sales and Disposals. Additionally,
the Company changed its method of accounting for certain preopening costs as
more fully described in Note 20, Cumulative Effect of Change in Method of
Accounting.
F-21
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED)
Certain amounts in the 1995 and 1994 consolidated financial statements have
been reclassified to conform with the presentation in the 1996 financial
statements.
(2) BANKRUPTCY MATTERS
On the Petition Date, each member of the Discovery Zone Group filed a
voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the
Bankruptcy Court. These cases are being jointly administered for procedural
purposes. None of the cases has been substantively consolidated. Under the
Bankruptcy Code, the members of the Discovery Zone Group will continue to manage
their respective affairs and operate their businesses as debtors-in-possession.
As a debtor-in-possession under the Bankruptcy Code, no member of the Discovery
Zone Group may engage in any transaction outside the ordinary course of business
without the approval of the Bankruptcy Court. The following discussion describes
certain aspects of the Bankruptcy Code and its application to Chapter 11 cases
of the Discovery Zone Group (the "Chapter 11 Cases"), but it is not intended to
be a complete summary.
Pursuant to Section 362 of the Bankruptcy Code, the commencement of the
Chapter 11 Cases created an automatic stay, applicable generally to creditors
and other parties in interest, of: (i) the commencement or continuation of a
judicial, administrative or other actions or proceedings against the Discovery
Zone Group that was or could have been commenced prior to the commencement of
the Chapter 11 Cases, (ii) the enforcement against the Discovery Zone Group or
their property of any judgments obtained prior to the commencement of the
Chapter 11 Cases, (iii) the taking of any action to obtain possession of
property of the Discovery Zone Group or to exercise control over such property,
(iv) the creation, perfection or enforcement of any lien against the property of
the bankruptcy estates of the Discovery Zone Group, (v) any act to create,
perfect or enforce against the property of the Discovery Zone Group any lien
that secures a claim against the Discovery Zone Group that arose prior to the
commencement of the Chapter 11 Cases, (vi) the taking of any action to collect,
assess or recover claims against the Discovery Zone Group that arose before the
commencement of the Chapter 11 Cases, (vii) the set off of any debt owing to the
Discovery Zone Group that arose prior to the commencement of the Chapter 11
Cases against any claim against the Discovery Zone Group, or (viii) the
commencement of the continuation of a proceeding before the United States Tax
Court concerning any member of the Discovery Zone Group. Any entity may apply to
the Bankruptcy Court, upon appropriate showing of cause, for relief from the
automatic stay to exercise the foregoing remedies.
As noted above, the members of the Discovery Zone Group are authorized to
manage their respective properties and operate their respective businesses
pursuant to Sections 1107 and 1108 of the Bankruptcy Code. During the course of
the Chapter 11 Cases, the Discovery Zone Group will be subject to the
jurisdiction and supervision of the Bankruptcy Court.
Under Section 1121 of the Bankruptcy Code, for 120 days following the
Petition Date, only the debtor-in-possession has the right to propose and file a
plan of reorganization with the Bankruptcy Court. If a debtor-in-possession
files a plan of reorganization during this 120-day exclusivity period, no other
party may file a plan of reorganization until 180 days following the Petition
Date, during which period the debtor-in-possession has the exclusive right to
solicit acceptances of the proposed plan. If a debtor-in-possession fails to
file a plan during the 120-day exclusivity period or such additional period as
may be ordered by the Bankruptcy Court or, after such plan has been filed, fails
to obtain acceptance of such plan from impaired classes of creditors and equity
security holders during the exclusive solicitation period, any party in
interest, including a creditors' committee, an equity security holders'
committee, a creditor or an
F-22
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) BANKRUPTCY MATTERS (CONTINUED)
equity security holder, may file a plan of reorganization for such debtor.
Additionally, if the Bankruptcy Court were to appoint a trustee, the exclusivity
period, if not previously terminated, would terminate.
After a plan of reorganization has been filed with the Bankruptcy Court, it
is sent, together with a disclosure statement approved by the Bankruptcy Court
following a hearing, to members of all classes of impaired creditors and equity
security holders for acceptance or rejection. Following acceptance or rejection
of any plan by impaired classes of creditors and equity security holders, the
Bankruptcy Court, after notice and a hearing, would consider whether to confirm
the plan. A joint plan of reorganization was mailed to creditors for approval on
March 26, 1997 (see Note 16).
Among other things, to confirm a plan, the Bankruptcy Court is required to
find: (i) with respect to each class of impaired creditors and equity security
holders, that each holder of a claim or interest of such class either (A) will,
pursuant to the plan, receive or retain property of a value, as of the effective
date of the plan, that is at least as much as such holder would have received in
a liquidation on such date of the members of the Discovery Zone Group or (B) has
accepted the plan, (ii) with respect to each class of claims or equity security
holders, that such class has accepted the plan or is not impaired under the
plan, and (iii) confirmation of the plan is not likely to be followed by the
liquidation or need for further financial reorganization of the Company or any
successor unless such liquidation or reorganization is proposed in the plan.
If any impaired class of creditors or equity security holders does not
accept a plan and assuming that all of the other requirements of Section 1129(a)
of the Bankruptcy Code are met, the proponent of the plan may invoke the
so-called "cramdown" provisions of Section 1129(b) of the Bankruptcy Code. Under
these provisions, the Bankruptcy Court may confirm a plan, notwithstanding the
non-acceptance of the plan by an impaired class of creditors or equity security
holders, if certain requirements of the Bankruptcy Code are met. These
requirements include that (i) the plan does not discriminate unfairly and (ii)
the plan is fair and equitable, with respect to each class of claims or
interests that is impaired under, and has not accepted, the plan. As used in the
Bankruptcy Code, the phrases "discriminate" and "fair and equitable" have narrow
and specific meanings, and their use herein is qualified in its entirety by
reference to the Bankruptcy Code.
The Consolidated Financial Statements represent the financial activity of
Discovery Zone, Inc. (Debtor-in-Possession), including all members of the
Discovery Zone Group which filed a voluntary petition for relief under Chapter
11 of the Bankruptcy Code, as well as the Canadian subsidiary not seeking such
relief.
(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.
RECEIVABLES
The Company has recorded a reserve for uncollectible accounts of
approximately $974,000 and $2,185,000 at December 31, 1996 and 1995,
respectively. The Company believes that the carrying amount of accounts
receivable at December 31, 1996 and 1995 approximates the fair value at such
date.
F-23
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories, consisting primarily of equipment, facility operating supplies,
food and apparel items, are valued at the lower of cost (first in, first out) or
market.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization
expense is provided using the straight-line method over the lesser of the
estimated lives of the related assets or the lease term. Property and equipment
at December 31 consists of the following:
<TABLE>
<CAPTION>
LIFE (IN YEARS) 1996 1995
--------------- ---------- ----------
<S> <C> <C> <C>
Land...................................................................... -- $ 8,164 $ 16,325
Building and improvements................................................. 20-40 9,190 8,926
Equipment, furniture and fixtures......................................... 3-12 74,533 80,978
Leasehold improvements.................................................... 5-20 42,094 44,104
Computer equipment and software........................................... 3-5 7,705 8,539
---------- ----------
141,686 158,872
Less accumulated depreciation and amortization............................ (31,305) (11,132)
---------- ----------
Property and equipment, net............................................... $ 110,381 $ 147,740
---------- ----------
---------- ----------
</TABLE>
Depreciation and amortization expense related to property and equipment was
approximately $21,876,000, $28,466,000 and $14,846,000 in 1996, 1995 and 1994,
respectively. Additions to property and equipment are capitalized and include
costs to design, acquire and install property and equipment, costs incurred in
the location, development and construction of new facilities, major improvements
to existing property and direct incremental costs incurred in the development of
management information systems. As property and equipment is sold or retired,
the applicable cost and accumulated depreciation and amortization are eliminated
from the accounts and any gain or loss thereon is recorded.
In 1995, the Company elected early adoption of Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for 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. See Note 17, Other Charges for further
discussion.
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 the 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 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.
F-24
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT AWAITING DISPOSITION
Property and equipment awaiting disposition is stated at the lower of
depreciated cost or fair value less costs to sell. The classification of
property and equipment awaiting disposition is based upon management's decision
to dispose and represents undeveloped land held for sale at December 31, 1996
and indoor playground equipment, kitchen equipment, furniture and fixtures, and
leasehold improvements of duplicate facilities which have been closed or sold at
December 31, 1995. Early adoption of SFAS No. 121 had no cumulative effect on
property and equipment awaiting disposition at January 1, 1995.
INTANGIBLE ASSETS
Intangible assets consisted primarily of the cost of acquired business in
excess of the market value of net tangible and identifiable intangible assets
acquired and the cost of territory rights acquired. Territory rights include
amounts paid to former franchisees to reacquire development rights in market
areas previously granted to them under area development agreements. The
reacquisition of these territories gives 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
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 indicate the remaining
estimated useful life or cost of acquired businesses in excess of the market
value 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. See Note 17,
Other Charges, for a discussion of the events and circumstances resulting in
impairment losses recognized. The Company does not believe any impairment in the
costs of acquired businesses in excess of the market value of net tangible and
identifiable intangible assets occurred as of December 31, 1994 under the
Company's policy of evaluating the recoverability of these assets because
substantially all of the related acquisitions occurred in 1994.
Amortization expense related to intangible assets was approximately
$3,506,000 and $1,337,000 in 1995 and 1994, respectively.
See Note 20, Cumulative Effect of Change in Method of Accounting, for a
discussion of the Company's change in method of accounting for certain
preopening costs.
REVENUE RECOGNITION
Revenue from Company-owned facilities is recognized at the time of sale.
Revenue from franchisees is recognized when all material services or conditions
required under the Company's franchise agreement have been performed by the
Company.
F-25
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED INTEREST
Interest costs have been capitalized on facility expenditures during the
construction period in accordance with Statement of Financial Accounting
Standards No. 34, "Capitalization of Interest Costs". Interests costs
capitalized as an offset to interest expense were approximately $197,000 and
$953,000 in 1995 and 1994, respectively.
LOSS PER SHARE
Loss per share is calculated by dividing the net loss by the weighted
average number of shares outstanding during the period plus share equivalents,
when the share equivalents are not anti-dilutive. Share equivalents represent
options and warrants with an exercise price below fair market value for any of
the periods presented. See Note 16.
(4) LIABILITIES SUBJECT TO COMPROMISE
Under the Bankruptcy Code, certain claims against the Discovery Zone Group
arising prior to the Petition Date are automatically stayed while the members of
the Discovery Zone Group continue business operations as debtors-in-possession.
It is anticipated that these prepetition liabilities will be compromised under a
plan of reorganization and are separately classified in the consolidated balance
sheet as liabilities subject to compromise and include the following at December
31, 1996:
<TABLE>
<S> <C>
Accounts payable.................................................................. $ 27,213
Accrued liabilities............................................................... 27,446
Lease rejection claims (see Note 12).............................................. 18,767
Note payable to affiliate (see Notes 5 and 6)..................................... 13,215
Other amounts payable to affiliate (see Note 6)................................... 22,724
Priority tax claims............................................................... 5,000
Payable under credit agreement with banks (see Note 8)............................ 101,900
Subordinated convertible debt (see Note 9)........................................ 128,643
---------
Total liabilities subject to compromise........................................... $ 344,908
---------
---------
</TABLE>
Accrued liabilities includes amounts accrued for claims related to lawsuits
and other legal matters and represents management's best estimate of the allowed
amounts of those claims. See further discussion in Note 2, Bankruptcy Matters.
Additional claims may arise from the termination of contracts entered into
by any member of the Discovery Zone Group prior to the Petition Date and the
allowances or settlement of disputed claims. All such claims will be liabilities
subject to compromise and, consequently, the amounts included in the
consolidated balance sheet as liabilities subject to compromise may be subject
to further adjustments.
The Company has not accrued interest under the bank credit agreement (see
Note 8), its subordinated convertible debt (see Note 9) and its note payable to
affiliate (see Note 6) as it is unlikely such interest will be paid under the
Plan of Reorganization (see Note 16). The amount of contractual interest on such
obligations during the period from March 25, 1996 to December 31, 1996 which was
not accrued was approximately $11,900,000.
F-26
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) BUSINESS COMBINATIONS, SALES AND DISPOSALS
During 1993, the Company acquired 27 franchised Discovery Zone facilities
and all of the outstanding capital stock of I&S Consultants, Inc. ("I&S") and
VLT, Inc. ("VLT"), which together own an approximately 42,000 square foot family
entertainment center and restaurant known as "Enchanted Castle."
During 1994, the Company acquired several businesses and joint venture
interests for an aggregate of $4,727,000 in cash and 10,387,999 shares of common
stock, which included: (i) Leaps and Bounds, Inc. ("Leaps & Bounds"), a wholly
owned subsidiary of McDonald's Corporation ("McDonald's"), which owned 48
children's indoor entertainment and fitness facilities; (ii) Blockbuster
Children's Amusement Corporation, Tumble For Fun Limited Partnership and
Blockbuster Children's Amusement Canada Corporation (collectively, the
"Blockbuster Entities"), each a subsidiary of Blockbuster Entertainment
Corporation (prior to its merger with Viacom, Inc. ("Viacom") in September 1994,
"BEC") which owned 60 franchised Discovery Zone entertainment facilities; (iii)
Wright Entertainment Group, Inc. ("WEGI"), which owned three family
entertainment facilities; (iv) Jungle Junction, Inc. ("JJI") and Kids Playworld,
Inc. ("KPI"), each of which owned a children's indoor entertainment and fitness
facility; and (v) companies which owned nine additional franchised Discovery
Zone entertainment facilities. The Company also acquired a controlling interest
in Semborg Corp. ("Semborg"), a developer of interactive environments and
characters. See Note 6, Related Party Transactions, for further discussion of
transactions with Viacom.
The acquisitions of I&S, VLT, JJI and the businesses which operated 18
Discovery Zone facilities were accounted for under the pooling of interests
method of accounting and accordingly, the Company's consolidated financial
statements and notes thereto have been restated as if the companies had operated
as one entity since inception. Prior to such acquisition, the acquired Companies
utilized depreciation methods and lives which differed from those used by the
Company. Accordingly, the consolidated financial statements reflect adjustments
to conform the depreciation methods and lives to those used by the Company, as
well as certain straight-line rental adjustments. The amount of these
adjustments was not significant. In addition, certain eliminations, primarily
related to franchise fees and royalties and the sale of equipment to former
franchisees, have been reflected in these financial statements.
The acquisitions of Leaps & Bounds, the Blockbuster Entities, WEGI, Semborg,
KPI and the entities that operated 23 Discovery Zone entertainment facilities
were accounted for under the purchase method of accounting and are included in
the Company's consolidated financial statements from the dates of acquisition.
The purchase price in each of these acquisitions was allocated to the net
tangible and identifiable intangible assets acquired based on their estimated
fair market values. In each case, the cost of the intangible assets of such
business acquired was amortized over 40 years on a straight-line basis.
On May 24, 1995, 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". 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 6, 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
F-27
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) BUSINESS COMBINATIONS, SALES AND DISPOSALS (CONTINUED)
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 $8,867,000. Proceeds from sale of
property and equipment at these locations totaled $1,753,000.
Revenue and net loss of the previously separate companies for the periods
before the pooling of interests business combination was consummated (after
reflecting the effect of intercompany eliminations) are as follows for the year
ended December 31, 1994:
<TABLE>
<S> <C>
Revenue:
Company......................................................... $ 179,825
Acquired businesses, net of eliminations........................ 748
---------
$ 180,573
---------
---------
Net loss:
Company......................................................... $ (25,034)
Acquired businesses, net of eliminations........................ 137
---------
$ (24,897)
---------
---------
</TABLE>
The Company's consolidated results of operations for the years ended
December 31, 1995 and 1994 prepared on an unaudited pro forma basis assuming
businesses acquired and accounted for as purchases in 1995 and 1994 had occurred
as of January 1, 1994 are as follows:
<TABLE>
<CAPTION>
1995 1994
----------- ----------
<S> <C> <C>
Revenues as reported..................................................................... $ 259,490 $ 180,573
Revenue of purchased businesses for the period prior to acquisition, net of
eliminations........................................................................... 3,170 41,056
----------- ----------
Pro forma revenue........................................................................ $ 262,660 $ 221,629
----------- ----------
----------- ----------
Net loss as reported..................................................................... $ (449,245) $ (24,897)
Net loss of purchased businesses for period prior to acquisition......................... (238) (12,269)
Adjustment for interest and goodwill amortization........................................ (494) (2,171)
----------- ----------
Pro forma loss........................................................................... $ (449,977) $ (39,337)
----------- ----------
----------- ----------
Loss per share as reported............................................................... $ (8.06) $ (0.53)
Effect of purchased businesses prior to acquisition...................................... (0.01) (0.31)
----------- ----------
Pro forma loss per share................................................................. $ (8.07) $ (0.84)
----------- ----------
----------- ----------
</TABLE>
F-28
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) BUSINESS COMBINATIONS, SALES AND DISPOSALS (CONTINUED)
Business acquisitions and investments during the years ended December 31,
1995 and 1994 which included the use of cash were accounted for as follows:
<TABLE>
<CAPTION>
1995 1994
---------- ---------
<S> <C> <C>
Property and equipment....................................................................... $ 1,276 $ 1,654
Intangibles.................................................................................. 31,657 2,982
Other assets................................................................................. 16 1,201
Working capital deficiency, excluding cash acquired.......................................... (956) (944)
Long-term obligations........................................................................ (13,215) (141)
Other noncurrent liabilities................................................................. (13,478) --
---------- ---------
$ 5,300 $ 4,752
---------- ---------
---------- ---------
</TABLE>
Business acquisitions during the years ended December 31, 1995 and 1994
which involved the issuance of the Company's common stock, $.01 par value
("Common Stock") were accounted for as follows:
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
Cash...................................................................................... $ -- $ 25
Working capital deficiency, excluding cash acquired....................................... -- (22,130)
Property and equipment.................................................................... -- 102,819
Intangibles............................................................................... 1,313 97,443
Other assets.............................................................................. -- 675
Long-term obligations..................................................................... -- (1,855)
Other noncurrent liabilities.............................................................. -- (12,869)
---------- ----------
$ 1,313 $ 164,108
---------- ----------
---------- ----------
Common stock issuance allocated to:
Common stock.............................................................................. $ 2 $ 103
Treasury stock............................................................................ -- 200
Additional paid-in-capital................................................................ 1,311 163,805
---------- ----------
$ 1,313 $ 164,108
---------- ----------
---------- ----------
</TABLE>
(6) RELATED PARTY TRANSACTIONS
On September 2, 1994, the Company acquired the Blockbuster Entities from
Blockbuster Fun & Fitness Holding Corporation, an indirect wholly-owned
subsidiary of 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 the 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
F-29
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
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 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. McCarthy, John J. Melk, Peer Pedersen and Gerald F. Seegers).
The MSA has an initial term of five years and thereafter will 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 is 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 11, 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 operations 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., Philippe 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 owns 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 the
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 a 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 Discovery
Zone, Inc., 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 Moore, John Muething, Dr.
James Rippe and Adam Phillips were the Company's directors.
On January 12, 1996, Discovery Zone, Inc. 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
F-30
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
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 a result of its performance as guarantor, Viacom is subrogated to the
lender's right to receive payments of such amounts from the Company.
In summary, at December 31, 1996 the Company has a prepetition amount due to
Blockbuster/ Viacom, excluding the principal amount of the BFF Note, for
approximately $22,725,000, relating primarily to $5,663,000 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 will be determined during the
Discovery Zone's bankruptcy proceedings. Accordingly, these amounts are included
in liabilities subject to compromise. See Note 4, Liabilities Subject to
Compromise, for further discussion of these matters.
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 paid on behalf of the Company, of which $1,424,000 was incurred and
$521,000 was paid after March 25, 1996.
In settlement of all of Viacom's prepetition general unsecured claims
against the Discovery Zone Group and all claims which the Discovery Zone Group
or the holder of the claims against the Discovery Zone Group may hold against
Viacom, the Discovery Zone Group and Viacom have agreed, subject to Bankruptcy
Court approval, that Viacom's prepetition unsecured claims shall entitle Viacom
to receive no property under a plan of reorganization. In exchange for this
treatment, the Discovery Zone Group will (i) satisfy in full a claim which
Iwerks Studios, Inc. holds against the Discovery Zone Group, and which is
guaranteed by Blockbuster, in the amount of $61,500, (ii) assume thirty leases
of the Discovery Zone Group, which are 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 Discovery Zone Group of
approximately $903,000 and obligations incurred under the MSA subject to any
setoff paid on behalf of Viacom. In connection with this settlement, the MSA
will be terminated.
The Company currently subleases approximately 30,000 square feet of office
space from Blockbuster at an annual cost of approximately $600,000. A division
of Blockbuster currently occupies approximately 7,500 square feet of this space
thereby mitigating approximately $128,000 of the Company's cost. Blockbuster has
informed the Company that it is relocating and will be terminating its lease no
later than June 30, 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 and $180,000 in 1995 and 1994,
respectively, for consulting and related services. In addition, the Company paid
to this corporation approximately $59,000 and $98,000 in 1995 and 1994,
respectively, 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, $468,000, and $358,000
during 1996, 1995 and 1994, respectively, for such services.
During 1994, the Company earned revenue of approximately $15,000,000 from
the Blockbuster Entities relating to equipment sales, franchise fees, royalties,
and franchise-related fees.
F-31
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) NOTE PAYABLE
In connection with the 1994 acquisition of Leaps & Bounds, the Company,
through a wholly owned subsidiary, received fee simple ownership of certain
parcels of real property. See Note 5, Business Combinations, Sales and
Disposals, for a discussion of the Leaps & Bounds acquisition. 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. Notwithstanding the Company's bankruptcy proceedings, in
the event the Company does not discharge its indemnity obligations, McDonald's
may be permitted to foreclose on its mortgage or deed of trust and become the
owner of one or more of such parcels of real property.
By order dated November 15, 1996, the Discovery Zone 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 Debtors arising from
the rejection and assumption of the L&B Subleases, as well as the future rent
deferrals to be granted in respect of certain of the L&B Subleases.
The McDonald's Stipulation provided that Leaps & Bounds assume L&B Subleases
with respect to 21 FunCenters (the "Assumption Locations") and to reject to the
L&B Subleases with respect to 17 FunCenters, which the Discovery Zone Group also
requested the Court's authority to close. The Discovery Zone 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 total approximately $528,000. McDonald's
rejection claims related to the 17 closed FunCenters totaled $4,666,000. The
McDonald's Stipulation provides that McDonald's will receive cash payments in
equal installments over six years beginning on the first anniversary of the
effective date of the confirmation of the reorganization plan with simple
interest from that date on the unpaid balance at the prime rate (or upon such
other terms determined by the Bankruptcy Court such that the note will have a
value, as of the effective date, equal to $4,666,000).
McDonald's also granted the Discovery Zone Group rent deferrals (the "Rent
Deferrals") under the L&B Subleases totaling $398,000 annually for nine
Assumption Locations representing a total rent deferral of approximately
$2,840,000 over the next eight years. Pursuant to the McDonald's Stipulation,
McDonald's will have an undisputed allowed administrative claim with respect to
Rent Deferrals which accrue prior to the effective date of the Discovery Zone
Group's Plan of Reorganization which claim is secured by real property owned by
Leaps & Bounds.
(8) LONG TERM OBLIGATIONS
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. As such, the total
F-32
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) LONG TERM OBLIGATIONS (CONTINUED)
principal and interest related to such debt of $100,000,000 and $2,108,000,
respectively, at December 31, 1995 was classified as current liabilities on the
Company's balance sheet at December 31, 1995.
Another event of default occurred under the Credit Facility on the Petition
Date when the Discovery Zone Group filed voluntary petitions for relief under
the Bankruptcy Code in the Bankruptcy Court. Consequently, all unpaid principal
of, and accrued pre-petition interest on, amounts outstanding under the Credit
Facility became immediately due and payable. The payment of such debt and
accrued but unpaid interest thereon is prohibited during the pendency of the
Discovery Zone Group's bankruptcy cases other than pursuant to a court order. At
the Petition Date, these amounts totaling $101,900,000 were classified as
liabilities subject to compromise at December 31, 1996. Their ultimate outcome
will be determined during the bankruptcy proceedings. See Note 4, Liabilities
Subject to Compromise, for further discussion.
In connection with the Company's acquisition of substantially all assets
pertaining to the operation of two family entertainment centers operating under
the name "Block Party", the Company issued the BFF Note (see Note 5). At
December 31, 1995, the Company was in default under the BFF Note due to
nonpayment of interest, and as a result, the entire principal balance of, and
accrued interest on, such note was immediately due and payable. As such, these
amounts were classified as current liabilities on the Company's balance sheet as
of December 31, 1995. At December 31, 1995, the total principal and interest
related to such debt were $13,215,000 and $544,000, respectively. Another event
of default occurred as a result of the Discovery Zone Group's bankruptcy filing.
The entire principal balance of and accrued pre-petition interest on such note
were immediately due and payable. The payment of this amount is prohibited
during the pendency of the Discovery Zone Group's bankruptcy proceedings and is
included in Liabilities Subject to Compromise at December 31, 1996 (see Note 4).
The Company was required to pay a quarterly commitment fee of up to .5% on
the entire amount available under the Credit Facility. The payment of the
commitment fee is prohibited during the pendency of the Discovery Zone Group's
bankruptcy cases.
Long-term obligations at December 31, 1995 consisted of the following:
<TABLE>
<S> <C>
Payable to banks under an unsecured credit agreement, interest at 7.49% at
December 31, 1995.............................................................. $ 100,000
Subordinated note payable to affiliate, interest at LIBOR plus .75% (6.38% at
December 31, 1995), due beginning in 1999...................................... 13,215
Capitalized lease obligations.................................................... 189
---------
Total obligations................................................................ 113,404
Less current portion............................................................. (113,390)
---------
$ 14
---------
---------
</TABLE>
(9) SUBORDINATED CONVERTIBLE DEBT
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 a principal amount due at maturity of $1,000 (representing a
yield to maturity of 4.75% per annum
F-33
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) SUBORDINATED CONVERTIBLE DEBT (CONTINUED)
computed on a semi-annual bond equivalent basis). Each LYON was convertible into
13.485 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.
As a result of the Discovery Zone Group's bankruptcy filing, the Company is
currently in default 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 is immediately due
and payable. The payment of such amount is prohibited during the pendency of the
Discovery Zone Group's bankruptcy case other than pursuant to a Bankruptcy Court
order. As of December 31, 1996, the Accreted Value was $128,643,000. At the
Petition Date this obligation became subject to compromise (see Note 4) and its
ultimate outcome will be determined during the bankruptcy proceedings.
(10) EQUITY (DEFICIT)
During the third quarter of 1995, the Company amended and restated its
certificate of incorporation and bylaws. As a result, the Company is authorized
to issue 100,000,000 shares of Common Stock and up to 10,000,000 shares of
preferred stock, $.01 par value ("Preferred Stock"). The Board of Directors may
issue such Preferred Stock at such time or times, in such series, with such
designations, preferences, special rights, limitations or restrictions thereof
as it may determine. The Board of Directors has designated a series of the
Preferred Stock as Series A Convertible Voting Participating Preferred Stock,
$.01 par value, 473,463 shares authorized, and none outstanding ("Series A
Preferred Stock"). Each share of Series A Preferred Stock will automatically
convert into 24 shares of Common Stock, subject to adjustments, immediately but
only following a sale of the Series A Preferred Stock, to a person unaffiliated
with Viacom. See Note 16.
(11) WARRANTS AND OPTIONS
Three warrants were issued to DKB during 1992. The first warrant ("Warrant
A") to acquire 48,000 general and 4,696,800 limited partner units in Discovery
Zone L.P. ("DZLP"), a Delaware limited partnership, at a price of approximately
$.95 per unit became exercisable in February 1993. This warrant was contributed
to the Company along with $4.5 million in exchange for 4,744,800 shares of
Common Stock in 1993. The second warrant ("Warrant B") to acquire 24,000 general
and 2,376,000 limited partner units in DZLP at a price of $2.50 per unit became
exercisable in May 1993 and will expire in May 1998. The third warrant ("Warrant
C") to acquire 60,000 general and 5,940,000 limited partner units in DZLP at a
price of approximately $4.165 per unit became exercisable in June 1994 and will
expire in June 1999. Warrants B and C allow the holder thereof to elect to
receive from the Company, in lieu of units of interest in DZLP, that number of
shares of Common Stock equal to the number of units of interest in DZLP such
holder would otherwise have been entitled to receive upon exercise of the
warrant. DKB and BEC have entered into an agreement pursuant to which each of
DKB and BEC agreed that if it exercises Warrant B or Warrant C, it will elect to
receive shares of Common Stock upon exercise.
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 2,067,000 and 5,167,500
F-34
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) WARRANTS AND OPTIONS (CONTINUED)
warrants of Warrants B and C, respectively, which were exchanged for an
aggregate of 7,234,500 shares of Common Stock. The Company used the proceeds
from exercise of these warrants to reduce debt.
On the MSA Effective Date (see Note 6, Related Party Transactions), 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 vest
on the first, second and third anniversaries of the MSA Effective Date,
respectively. All such vested warrants become exercisable on or after December
16, 1998, although such exercisability may be accelerated in certain
circumstances. Each warrant entitles 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 is convertible are $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 have been 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.
The following summarizes stock option transactions for the years ended
December 31 (see Note 16):
<TABLE>
<CAPTION>
1996 1995 1994
---------- ----------- ----------
<S> <C> <C> <C>
Options outstanding at beginning of year................................... 2,924,802 3,805,191 3,783,171
Granted.................................................................... -- 794,861 1,589,676
Exercised.................................................................. (170,000) (1,377,855) (928,331)
Canceled................................................................... -- (297,395) (639,325)
---------- ----------- ----------
Options outstanding at end of year......................................... 2,754,802 2,924,802 3,805,191
---------- ----------- ----------
---------- ----------- ----------
Weighted average price of options outstanding at beginning of year......... $ 10.47 $ 7.92 $ 4.64
Weighted average price of options exercised................................ $ 1.66 $ 2.47 $ 2.48
Prices of options outstanding at end of year............................... $ 1.67 to $ 1.67 to $ 1.67 to
$ 24.63 $ 24.63 $ 24.63
Weighted average price of options outstanding at end of year............... $ 11.01 $ 10.47 $ 7.92
Vested options at end of year.............................................. 2,754,802 2,924,802 451,347
Options available for future grants at end of year......................... 129,351 129,351 1,083,351
</TABLE>
(12) COMMITMENTS AND CONTINGENCIES
In accordance with the Bankruptcy Code, the members of the Discovery Zone
Group can seek court approval for the rejection of pre-petition executory
contracts and real property leases. Any such rejection may give rise to a
pre-petition claim for damages pursuant to the Bankruptcy Code. In connection
with the
F-35
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) COMMITMENTS AND CONTINGENCIES (CONTINUED)
bankruptcy proceedings, the Discovery Zone Group rejected 91 real property
leases during 1996 and one lease through March 1997. Additional real property
leases and certain other executory contracts may be rejected in the future
subject to Bankruptcy Court approval.
Future minimum lease payments, where applicable, under noncancelable
operating leases entered into and not rejected prior to December 31, 1996, are
as follows:
<TABLE>
<S> <C>
1997.............................................................. $ 26,349
1998.............................................................. 26,545
1999.............................................................. 25,072
2000.............................................................. 22,775
2001.............................................................. 21,088
Thereafter........................................................ 53,157
---------
$ 174,986
---------
---------
</TABLE>
Rental expense for operating leases during the years ended December 31,
1996, 1995 and 1994 amounted to approximately $41,137,000, $52,716,000 and
$28,379,000, respectively.
(13) LEGAL MATTERS
On November 28, 1994, Robert Kahn and Randy Stark, and on November 30, 1994,
Robert Friedman, and on March 27, 1995, Bernard Weisburgh, on behalf of
themselves and alleged classes of the Company's public stockholders, filed
actions in the United States District Court for the Northern District of
Illinois, against the Company and certain of the Company's former directors and
officers and Donald F. Flynn (such directors, officers and Donald F. Flynn are
collectively referred to herein as the "Individual Defendants"). Subsequently,
the three actions were consolidated. The consolidated amended complaint alleges,
among other things, that the Company and the Individual Defendants violated
Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder by
improperly capitalizing preopening expenses, by failing to timely make public
the anticipated costs to the Company of its acquisition of Leaps & Bounds and
the Blockbuster Entities and the change in the method of accounting for
preopening expenses, and by disseminating other releases and reports allegedly
omitting or misrepresenting certain related information. As a result of the
Discovery Zone Group's bankruptcy filing, the consolidated amended complaint was
dismissed without prejudice on March 27, 1996. On April 5, 1996, the plaintiffs
filed a motion to reinstate the litigation against the Company and Individual
Defendants. The motion was denied with respect to the Company.
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 March 25, 1996
and which are not covered by insurance to be approximately $1,849,000 at
December 31, 1996. This amount was recorded in accrued liabilities in the
accompanying consolidated financial statements. Because this amount represents
an estimate, it is reasonably possible that a change in this estimate may occur
in the future. As discussed in Note 4, additional liabilities for claims related
to legal matters are recorded in liabilities subject to compromise.
F-36
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) INCOME TAXES
The federal statutory tax rate is reconciled to the effective tax rate for
the years ended December 31 as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Federal statutory rate (benefit)................................................... (34.0)% (34.0)% (34.0)%
Tax-exempt income.................................................................. -- -- (1.5)%
Change in valuation allowance...................................................... 34.0% 35.0% 21.7%
--------- --------- ---------
Effective tax rate (benefit)....................................................... -- 1.0% (13.8)%
--------- --------- ---------
--------- --------- ---------
</TABLE>
Income tax provision (benefit) for the years ended December 31 consists of
the following:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Current $ -- $ -- $ --
Deferred.............................................................................. -- 4,000 (4,000)
--------- --------- ---------
$ -- $ 4,000 $ (4,000)
--------- --------- ---------
--------- --------- ---------
</TABLE>
The primary components that comprise the deferred tax assets and deferred
tax liabilities at December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Net operating loss carryforwards........................................................ $ 170,000 $ 54,000
Difference between book and tax bases of acquired net assets............................ 18,500 18,500
Noncurrent asset revaluations........................................................... 86,500 125,900
Other assets............................................................................ 6,000 18,200
Other liabilities....................................................................... (19,500) (7,600)
----------- -----------
Net deferred tax asset before valuation allowance....................................... 261,500 209,000
Valuation allowance..................................................................... (261,500) (209,000)
----------- -----------
Net deferred tax asset.................................................................. $ -- $ --
----------- -----------
----------- -----------
</TABLE>
The valuation allowance increased approximately $52,500,000 and $164,800,000
in 1996 and 1995, respectively. The Company has net operating loss carryforwards
for federal tax purposes totaling approximately $458,650,000 which will expire
as follows: $41,750,000 in 2008, $70,700,000 in 2009, $62,200,000 in 2010 and
$184,000,000 in 2011. Due to an ownership change as defined by Section 382 of
the Internal Revenue Code, a portion of the Company's operating loss
carryforwards is subject to an annual limitation for the purpose of offsetting
future taxable income.
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. Moreover, the net operating loss
carryforwards will likely be reduced, and/or their use significantly limited,
subsequent to the effective date of the Company's Plan of Reorganization (see
Note 16) resulting from the discharge of indebtedness and an ownership change as
defined under Section 382 of the Internal Revenue Code. 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.
F-37
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) INCOME TAXES (CONTINUED)
At December 31, 1996 and 1995, 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 asset will
not be realized.
The Company made no federal or state income tax payments in 1996, 1995 or
1994.
(15) DEBTOR-IN-POSSESSION CREDIT FACILITY
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, as
borrower, the other members of the Discovery Zone 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 Discovery Zone Group, (ii) first priority liens on and security interests
in all of the Discovery Zone 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, the Discovery Zone Group requested that Madeleine make available
additional funds to insure the Discovery Zone 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 Discovery Zone 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 Discovery Zone Group, with the consent of
Madeleine, withdrew the motion requesting authority to enter into the Proposed
Second Amendment at the hearing held on September 13, 1996.
By Order dated October 25, 1996, the Discovery Zone Group obtained authority
from the Bankruptcy Court to enter into a Replacement Revolving Credit Agreement
(the "Replacement Credit Agreement"), among Discovery Zone, as borrower, the
other members of the Discovery Zone 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 Discover Zone Group, (ii) first priority liens on
and
F-38
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) DEBTOR-IN-POSSESSION CREDIT FACILITY (CONTINUED)
security interests in all of the Discovery Zone Group's owned or subsequently
acquired unencumbered assets, (iii) liens on and security interests senior to
any liens on or security interests in all owned or subsequently acquired
encumbered 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 contains 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 Discovery Zone Group has 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, has 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 Discovery Zone 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 Discovery Zone 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 which may be advanced to the Discovery Zone 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 Discovery Zone 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. Those borrowings bear interest at
prime plus 3.5% payable monthly (weighted average interest rate for 1996 and
interest rate at December 31, 1996, of 11.75%). However, the Replacement Credit
Facility also requires payment of certain fees as defined in the agreements plus
an amount to be determined such that Perry Partners earns an internal rate of
return, determined on an annualized basis, of 21% on all borrowings (which
return will take into account all interest and fees). This additional interest
of approximately $364,000 over fees and interest accrued at the stated rate is
included as a post petition liability in the accompanying consolidated balance
sheet at December 31, 1996, and is due and payable upon repayment of the loan.
(16) JOINT PLAN OF REORGANIZATION
In November 1996, the Company filed with the U.S. Bankruptcy Court a Joint
Plan of Reorganization (the "Plan") with Birch Holdings LLC ("Birch") which sets
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. Specifically, the Plan provides for (i) the
payment in full of certain administrative claims against the Company (those
claims which arose after Petition Date); (ii) conversion of substantially all of
the Company's liabilities subject to compromise, excluding taxes payable, to an
equity interest in the Company, and (iii) cancellation of all of the prepetition
equity interests in the Company, all as more fully described in the Plan. Among
other things, the Plan is subject to approval by certain creditors, final
confirmation by the Bankruptcy Court and the raising of approximately $70
million of exit financing to effectuate the terms of the Plan.
F-39
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) JOINT PLAN OF REORGANIZATION (CONTINUED)
The disclosure statement describing the Plan was mailed to creditors on
March 26, 1997. If approved by the requisite number of creditors and confirmed
by the Bankruptcy Court, the holders of the prepetition payable under the bank
credit agreement will hold the majority of the outstanding new common shares of
the Company. Birch has purchased certain of these prepetition claims from the
original banks providing the credit facility. It is anticipated that Birch will
hold more than 50% of the reorganized Company's new common shares.
(17) 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
Discovery Zone 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 writedown 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 believes
will 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 writedown of certain
entertainment facility equipment and, to a lesser extent, the writedown 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.
During the third quarter of 1994, the Company recognized other charges of
$14,024,000 relating to the writedown of property and equipment and the
provision of lease commitment reserves resulting from the elimination of certain
duplicate entertainment facilities.
F-40
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) 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 consist of employee
termination benefits of approximately $7,903,000 and 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.
(19) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is an analysis of certain items in the Consolidated Statements
of Operations by quarter for 1995:
<TABLE>
<CAPTION>
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER TOTAL
----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Revenue......................................... $ 81,903 $ 62,836 $ 62,375 $ 52,376 $ 259,490
Other charges................................... -- 54,591 -- 306,212 360,803
Restructuring costs............................. -- 11,357 -- -- 11,357
Operating income (loss)......................... 5,676 (91,437) (18,473) (334,423) (438,657)
Net income (loss)............................... 3,602 (98,115) (19,933) (334,799) (449,245)
Income (loss) per common and common equivalent
share......................................... $ 0.07 $ (1.85) $ (0.35) $ (5.83) $ (8.06)
</TABLE>
The sum of quarterly net income amounts, which assume full dilution where
applicable, may not equal the full year since the computations of the weighted
average number of common and common equivalent shares outstanding for each
quarter and the full year are made independently.
(20) CUMULATIVE EFFECT OF CHANGE IN METHOD OF ACCOUNTING
In 1994, the Company changed its method of accounting for certain
pre-opening costs from one generally accepted accounting principle to another
generally accepted accounting principle. Previously, the Company capitalized all
pre-opening costs, which included salaries and other direct costs of opening a
facility and amortized these costs over periods of up to two years. As a result
of the acquisitions of Leaps and Bounds and the Blockbuster Entities, and the
considerable market penetration by the Company during 1994 in a majority of the
major domestic markets, the Company began expending pre-opening costs at the
time of facility opening.
(21) 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 Note 22). Separate financial
statements of these subsidiary guarantors are not included as the subsidiaries
guarantee the Senior
F-41
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(21) SUMMARIZED COMBINED FINANCIAL INFORMATION (CONTINUED)
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.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Current assets................................................................................. $ 682 $ 772
Noncurrent assets.............................................................................. 3,925 4,384
Current liabilities............................................................................ 144 779
Noncurrent liabilities(1)...................................................................... 9,627 8,826
</TABLE>
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Net revenue......................................................................... $ 6,637 $ 7,991 $ 2,575
Operating expenses.................................................................. 7,561 12,018 2,993
Net loss............................................................................ (753) (4,001) (418)
</TABLE>
- ------------------------
(1) Includes $9,175 and $8,583 of intercompany liabilities at December 31, 1996
and 1995, respectively, that eliminate in the respective accompanying
consolidated balance sheets.
(22) EVENTS (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
On July 18, 1997, the Company's Joint Plan of Reorganization with Birch was
approved by the creditors and confirmed by the Bankruptcy Court. The Plan became
effective on July 29, 1997 (the "Effective Date") and the Company emerged from
bankruptcy as of that date. The Plan provides 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 pre-petition liabilities permitted under the Plan) to
an equity interest in the Company, and (iii) cancellation of all of the
prepetition equity interests in the Company, all 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 (the "New 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 New Common Stock and a ten-year warrant to purchase one share of New
Common Stock at a price of $17.55 (the "Ten Year Warrants"). Such unsecured
creditors will receive 4,000,000 shares of New Common Stock and 444,444 shares
of New Common Stock have been reserved for issuance in connection with the Ten
Year Warrants. As a result of the transactions which occurred on the Effective
Date, indebtedness of $332,165,000 was discharged, resulting in an extraordinary
gain of approximately $332,165,000.
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 $93.8 million of net proceeds to the Company after
deducting related offering costs (the "Exit Financing"). The proceeds were used
to repay the
F-42
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(22) EVENTS (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS (CONTINUED)
Company's debtor-in-possession credit facilities and certain bankruptcy
administrative claims and reorganization costs incurred in connection with the
Company's emergence from bankruptcy. The Senior Secured Note holders also
received warrants (the "Warrants") to purchase 805,154 shares of New Common
Stock at $.01 per share exercisable through August 1, 2007, which represent
approximately 12.5% of the fully diluted shares of New Common Stock after giving
effect to the exercise of the Warrants and the Ten Year Warrants and conversion
of the Preferred Stock. The Preferred Stock is convertible at anytime into
1,191,626 shares of New common Stock at an effective conversion price of $12.59
per common share, representing approximately 18.5% of the fully diluted shares
of New Common Stock after giving effect to the exercise of the Warrants and the
Ten Year Warrants.
F-43
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS AMOUNTS BALANCE AT
BEGINNING CHARGED TO WRITTEN END OF
DESCRIPTION OF YEAR EXPENSE OFF YEAR
- ------------------------------------------------------------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
1995.............................................................. $ 36 $ 2,149 $ -- $ 2,185
1996.............................................................. 2,185 1,093 2,304 974
RESERVE FOR OBSOLESCENCE
1995.............................................................. 259 766 -- 1,025
1996.............................................................. 1,025 -- 317 708
</TABLE>
Note: No amounts have been presented for the year ended December 31, 1994 since
these amounts were either immaterial to the consolidated financial
statements or disclosed in the footnotes thereto.
F-44
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.
UNTIL APRIL 30, 1998 ALL DEALERS EFFECTING TRANSACTIONS IN THE EXCHANGE NOTES,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Available Information.......................... 5
Prospectus Summary............................. 6
Risk Factors................................... 19
The Exchange Offer............................. 26
Use of Proceeds................................ 34
Company Background............................. 35
Selected Historical Financial Data............. 37
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 40
Business....................................... 49
Management..................................... 58
Principal Stockholders......................... 64
Certain Transactions with Affiliates........... 66
Description of Exchange Notes.................. 67
Description of Capital Stock................... 98
Description of Certain Indebtedness............ 105
Plan of Distribution........................... 107
Certain U.S. Federal Income Tax
Considerations............................... 108
Legal Matters.................................. 108
Experts........................................ 108
Index to Financial Statements.................. F-1
</TABLE>
OFFER TO EXCHANGE
13 1/2% SENIOR SECURED NOTES DUE 2002
FOR ALL OUTSTANDING
13 1/2% SENIOR SECURED NOTES DUE 2002
($85,000,000 PRINCIPAL AMOUNT
OUTSTANDING)
OF
DISCOVERY ZONE, INC.
JANUARY 30, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article Eight Section 2(a) of the Registrant's Certificate of Incorporation,
as amended (the "Certificate of Incorporation"), provides that each person who
was or is made a party or is threatened to be made a party to or is involved in
any action, suit or proceeding, whether civil, criminal, administrative or
investigative (hereinafter a "proceeding"), by reason of the fact that he or
she, or a person of whom he or she is the legal representative, is or was a
director or officer of the Registrant or is or was serving at the request of the
Registrant as a director or officer of another corporation or of a partnership,
joint venture, trust or other enterprise, including service with respect to
employee benefit plans, whether the basis of such proceeding is alleged action
in an official capacity as a director or officer or in any other capacity while
serving as a director or officer, shall be indemnified and held harmless by the
Registrant to the fullest extent authorized by the General Corporation Law of
the State of Delaware against all expense, liability and loss (including
attorneys' fees, judgments, fines, amounts paid or to be paid in settlement, and
excise taxes or penalties arising under the Employee Retirement Income Security
Act of 1974) reasonably incurred or suffered by such person in connection
therewith and such indemnification shall continue as to a person who has ceased
to be a director or officer and shall inure to the benefit of his or her heirs,
executors and administrators; PROVIDED, HOWEVER, that the Registrant shall
indemnify any such person seeking indemnification in connection with a
proceeding (or part thereof) initiated by such person only if such proceeding
(or part thereof) was authorized by the Board of Directors.
Article Eight Section 2(c) of the Registrant's Certificate of Incorporation
provides that the right to indemnification conferred in Certificate of
Incorporation shall not be exclusive of any other right which any person may
have or hereafter acquire under any statute, provision of the Certificate of
Incorporation, By-law, agreement, vote of stockholders or disinterested
directors or otherwise.
Article Eight Section 2(d) of the Registrant's Certificate of Incorporation
further provides that the Registrant may maintain insurance, at its expense, to
protect itself and any director or officer of the Registrant or another
corporation, partnership, joint venture, trust or other enterprise against any
such expense, liability or loss, whether or not the Registrant would have the
power to indemnify such person against such expense, liability or loss under the
General Corporation Law of the State of Delaware.
Section 145 of the Delaware General Corporation Law makes provision for the
indemnification of officers and directors in terms sufficiently broad to
indemnify officers and directors of the Company under certain circumstances from
liabilities (including reimbursement for expenses incurred) arising under the
Securities Act.
See Item 22 of this Registration Statement regarding the position of the
Securities and Exchange Commission on indemnification for liabilities arising
under the Securities Act.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
See Index to Exhibits.
ITEM 22. UNDERTAKINGS
1. The undersigned Registrant hereby undertakes as follows: that prior to
any public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
Registrant undertakes that such reoffering prospectus will contain the
information called for by the
II-1
<PAGE>
applicable registration form with respect to reofferings by persons who may be
deemed underwriters, in addition to the information called for by the other
items of the applicable form.
2. The Registrant undertakes that every prospectus: (i) that is filed
pursuant to paragraph (1) immediately preceding; or (ii) that purports to meet
the requirements of Section 10(a)(3) of the Securities Act and is used in
connection with an offering of securities subject to Rule 415, will be filed as
a part of an amendment to the registration statement and will not be used until
such amendment is effective, and that, for purposes of determining any liability
under the Securities Act, each such post-effective amendment shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
beneficial offering thereof.
3. The Registrant undertakes to register securities pursuant to Rule 415
under the Securities Act and the Registrant undertakes to file, during any
period in which offers or sales are being made, a post-effective amendment to
this Registration Statement: (a) to include any prospectus required by section
10(a)(3) of the Securities Act; (b) to reflect in the prospectus any facts or
events arising after the effective date of the registration statement (or the
most recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in the
registration statement; and (c) to include any material information with respect
to the plan of distribution not previously disclosed in the registration
statement or any material change to such information in the registration
statement. The Registrant further undertakes, that for purposes of determining
any liability under the Securities Act, each such post-effective amendment shall
be deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof. The Registrant further undertakes to
remove from registration by means of a post-effective amendment any of the
securities being registered which remain unsold at the termination of such
offering.
4. The undersigned Registrant hereby undertakes that insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers and controlling persons of the Registrant
pursuant to the foregoing provisions, or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim of indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
5. The undersigned Registrant hereby undertakes that, for the purposes of
determining any liability under the Securities Act, each post-effective
amendment that contains a form of prospectus shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
6. The Registrant undertakes to respond to requests for information that is
incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11 or
13 of this Registration Statement, including information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request, within one business day of receipt of such
request, and to send the incorporated documents by first class mail or other
equally prompt means.
7. The Registrant undertakes to supply by means of a post-effective
amendment all information concerning a transaction that was not the subject of
and included in the registration statement when it became effective.
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Registrant has duly caused this amendment to the registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in Elmsford,
New York on January 29, 1998.
<TABLE>
<S> <C> <C>
DISCOVERY ZONE, INC.
By: /s/ SCOTT W. BERNSTEIN
-----------------------------------------
Name: Scott W. Bernstein
Title: CHIEF EXECUTIVE OFFICER, PRESIDENT
AND DIRECTOR
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this amendment
to the registration statement has been signed by the following persons in the
capacities indicated on January 29, 1998.
NAME TITLE
- ------------------------------ --------------------------
/S/ SCOTT W. BERNSTEIN
- ------------------------------ Chief Executive Officer,
Scott W. Bernstein President and Director
*
- ------------------------------ Director
Martin S. Davis
*
- ------------------------------ Director
Greg S. Feldman
*
- ------------------------------ Director
Douglas W. Rotatori
*
- ------------------------------ Director
L.G. Schafran
*
- ------------------------------
Christopher R. Director
Smith
*
- ------------------------------ Director
Paul D. Kurnit
/S/ ROBERT G. ROONEY Senior Vice President,
- ------------------------------ Chief Financial and
Robert G. Rooney Administrative Officer
/S/ LEIGHTON J. WEISS Vice President and
- ------------------------------ Controller
Leighton J. Weiss (Chief Accounting Officer)
*By: /S/ SCOTT W. BERNSTEIN
-------------------------
Scott W. Bernstein
ATTORNEY-IN-FACT
II-3
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
<C> <S> <C>
+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
(incorporated by reference from the Current Report on Form 8-K of the Registrant, dated July 9,
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
Inital Purchaser Inc. 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.
+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.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
+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.
<C> <S> <C>
+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.
+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.
</TABLE>
ii
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
+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.
<C> <S> <C>
+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, among 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, among 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, among
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, among 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, among 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, among 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, among the Registrant, as mortgagor and McDonald's
Corporation, as mortgagee, relating to property in Philadelphia County, Pennsylvania.
+4.36 Amended and Restated Mortgage, Assignment of Leases and Rents, Security Agreement and Fixture
Filing, dated as of July 29, 1997, among 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.
</TABLE>
iii
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
+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.
<C> <S> <C>
+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.
+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.
</TABLE>
iv
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
+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.
<C> <S> <C>
+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.
+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.
5.1 Opinion and Consent of Shearman & Sterling regarding validity of the Exchange Notes.
+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.
</TABLE>
v
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -----------
+16.1 Letter re change in certifying accountant (incorporated by reference from the Current Report on
Form 8-K of the Registrant, dated June 3, 1996).
<C> <S> <C>
+21.1 List of Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent public accountants for the Registrant.
23.2 Consent of Price Waterhouse LLP, independent public accountants for the Registrant.
23.3 Consent of Arthur Andersen LLP, independent public accountants for the Registrant.
23.4 Consent of Shearman & Sterling (included in exhibit 5.1).
+24.1 Power of Attorney (included on signature page).
+25.1 Statement of Eligibility of the Trustee, on Form T-1.
+27.1 Financial Data Schedule.
+99.1 Form of Letter of Transmittal.
+99.2 Form of Notice of Guaranteed Delivery.
+99.3 Form of Exchange Agent Agreement.
</TABLE>
- ------------------------
+ Previously filed.
vi
<PAGE>
EXHIBIT 5.1
January 27, 1998
Discovery Zone, Inc.
565 Taxter Road, Fifth Floor
Elmsford, New York 10523
Ladies and Gentlemen:
We are acting as counsel to Discovery Zone, Inc. (the "Company"), a Delaware
corporation, in connection with the filing by the Company of a Registration
Statement on Form S-4 (the "Registration Statement") with the Securities and
Exchange Commission (the "Commission"). Pursuant to the Registration Statement,
the Company offers to exchange (the "Exchange Offer") $85,000,000 aggregate
principal amount of its outstanding 13 1/2% Senior Secured Notes due 2002 (the
"Private Notes") for $85,000,000 aggregate principal amount of its 13 1/2%
Senior Secured Notes due 2002 (the "Exchange Notes" and together with the
Private Notes, the "Notes"). The Private Notes were, and the Exchange Notes will
be, issued under an indenture (the "Indenture") dated as of July 22, 1997 among
the Company, the guarantors named therein and State Street Bank and Trust
Company, as trustee (the "Trustee").
In this capacity, we have examined the Registration Statement, the Indenture
filed as Exhibit 4.1 to the Registration Statement, the Private Notes, a form of
the Exchange Notes contained in the Indenture and originals or copies certified
or otherwise identified to our satisfaction of such documents as we have deemed
necessary or appropriate to enable us to render the opinions expressed below.
Based upon the foregoing and assuming the due authorization, execution and
delivery of the Indenture by the Trustee, it is our opinion that the Exchange
Notes to be exchanged for the Private Notes as contemplated in the Registration
Statement, when duly authorized, executed and delivered by the Company and duly
authenticated by the Trustee, in each case in accordance with the provisions of
the Indenture, will constitute the legal, valid and binding obligations of the
Company entitled to the benefits of the Indenture, except as enforcement thereof
may be limited by bankruptcy, insolvency (including, without limitation, all
laws relating to fraudulent transfer), reorganization, moratorium and other
similar laws relating to or affecting enforcement of creditors' rights generally
and by general principles of equity (regardless of whether the issue of
enforceability is considered in a proceeding in equity or at law).
We are attorneys admitted to practice law in the State of New York and we do
not express herein any opinion as to any matters governed by or involving
conclusions under the laws of any other jurisdiction other than the laws of the
State of New York and the federal laws of the United States of America.
We are aware that we are referred to under the heading "Legal Matters" in
the prospectus forming a part of the Registration Statement, and we hereby
consent to such use of our name therein and the filing of this opinion as
Exhibit 5.1 to the Registration Statement. In giving this consent, we do not
hereby admit that we are within the category of persons whose consent is
required under Section 7 of the Securities Act of 1933, as amended, or the rules
and regulations of the Commission promulgated thereunder.
Very truly yours,
/s/ Shearman & Sterling
STG/TJF/DEG/JA
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated April 2, 1997, in Amendment No. 4 to the
Registration Statement (Form S-4 No. 333-40551) and related Prospectus of
Discovery Zone, Inc. for the registration of $85,000,000 13 1/2% Senior Secured
Notes.
/s/ Ernst & Young LLP
West Palm Beach, Florida
January 28, 1998
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-4 of Discovery Zone, Inc. of our report dated
April 13, 1996 relating to the financial statements of Discovery Zone, Inc.,
which appears in such prospectus. We also consent to the application of such
report to the Financial Statement Schedule II for the year ended December 31,
1995 listed under Item 16(b) of this Registration Statement when such schedule
is read in conjunction with the financial statements referred to in our report.
The audit referred to in such report also included this schedule. We also
consent to the reference to us in the heading "Experts" in such Prospectus.
PRICE WATERHOUSE L.L.P.
Miami, Florida
January 28, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent public accountants, we consent to the reference to our firm
under the caption "Experts" and to the use of our report dated March 21, 1995
(except with respect to the Company's bankruptcy filing discussed in Note 1 as
to which the date is March 25, 1996), in Amendment No. 4 to the Registration
Statement on Form S-4 No. 333-40551 and related Prospectus of Discovery Zone,
Inc. for the registration of $85,000,000 13 1/2% Senior Secured Notes.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois,
January 28, 1998
