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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K/A
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Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1996
Commission file number:
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DISCOVERY ZONE, INC.
(Exact Name of Registrant as Specified in its Charter)
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DELAWARE 36-3877601
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
565 TAXTER ROAD, FIFTH FLOOR
ELMSFORD, NEW YORK 10523
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's Telephone Number, including Area Code: (914) 345-4500
Securities registered pursuant to Section 12(b) of the Act: None Securities
registered pursuant to Section 12(g) of the Act:
NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
Common Stock - $0.01 par value None
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
As of December 31, 1996, the number of shares of Common Stock
outstanding was 57,645,925.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Discovery Zone, Inc. ("DZ" or 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 which target adult customers. 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.
("Wellspring").
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. Mr.
Bernstein was hired by Wellspring in June of 1996 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, 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.
PRE-CHAPTER 11 REORGANIZATION
The Company was founded in 1989 and grew from 28 locations in 1991
to a peak of 347 locations in 1994, achieving much of its growth through the
acquisition of certain of its franchisees and other businesses.
In 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 during 1997, while under the
protection of Chapter 11 ("Chapter 11") of the United States Bankruptcy Code
(the "Bankruptcy Code").
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 par value $0.01 per share (the "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 (the "Petition Date"), 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 United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court"). After its Chapter 11 filing, the Company entered into a debtor in
possession credit facility (as amended, 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 July
29, 1997 (the "Effective Date").
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Under Bankruptcy Court supervision, the Discovery Zone Group
continued to manage and operate its businesses as debtor in possession and
developed the Third Amended Joint Plan of Reorganization (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 the 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 Chapter 11, the Company
issued $15.0 million in convertible preferred stock, par value $0.01 per
share (the "Convertible Preferred Stock") to an entity controlled by the
Wafra Investment Advisory Group, Inc. and offered and sold units (the
"Units") consisting of $85.0 million aggregate principal amount of 13 1/2%
Senior Secured Notes due 2002 (the "Private Notes") exchangeable into 13 1/2%
Senior Secured Notes due 2002 (the "Exchange Notes" and together with the
Private Notes, the "Notes") and warrants (the "Warrants") to purchase shares
of the Company's New Common Stock (as defined) at an exercise price $0.01 per
share. The net proceeds of the offering of each of the Convertible Preferred
Stock and the Units were approximately $93.8 million. Of the 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 purchase a
portfolio of securities, consisting of U.S. Treasury Securities, that were
placed into an account (the "Escrowed Interest Account") and pledged as
security for the scheduled interest payments on the Private Notes and the
Exchange 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. The Company acquired no businesses in 1997 after the
Effective Date.
BUSINESS CONCEPT
The Company's FunCenters are designed to offer
children two to 12 years old 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.
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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)
UNDER 5 5-13 TOTAL UNDER 13
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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
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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.
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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.
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
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 to assist with formulation of the Plan of
Realization 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 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.
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.
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
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
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.
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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 Chuck E. Cheese.
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.
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:
o reducing costs at the store, regional and corporate levels;
o improving the quality and consistency of the Company's existing
core soft-play products, game zone products and its food and
beverage operations;
o adding a variety of entertainment activities and new attractions
and renovating the FunCenters;
o 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
o 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. 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.
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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:
o 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.
o 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.
o 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:
o IMPLEMENT MANAGEMENT INCENTIVE PLANS.
Historically, the Company's FunCenter and regional managers
operated without goals, accountability or incentive-based
compensation plans. 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.
o 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
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the sale of Pizza Hut menu items by the end of January
1998.
o 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.
o 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-five 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
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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:
o 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.
o 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.
o 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.
o Food and beverage operations which, in most
cases, feature a selection of Pizza Hut menu
items and Pepsi beverage products.
o A game zone, featuring activities and games 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.
o 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.
o 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 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, since the Effective Date, 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.
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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.
INSURANCE
The Company carries customary insurance coverages, including
primary commercial liability insurance with limits of $1 million per
occurrence and $2 million in the aggregate, and umbrella and excess policies
aggregating $100 million per occurrence and in the aggregate, which policies
are available after the Company has paid or become legally obligated to pay
$100,000 or $250,000 per claim, depending upon the policy year. The Company
believes that it carries adequate insurance coverage for its business
activities. However, there can be no assurance that such coverage will prove
to be adequate or will continue to be available to the Company, and, in the
event that such coverage proves to be inadequate, such event may have a
material adverse effect on the financial condition or results of operations
of the Company. Claims paid to date have been within amounts accrued by the
Company using historical data based on prior experience. When the Company's
aggregate indemnity and expense amounts in any policy year exceed an
aggregate of $2.5 million, the Company's trailing self-insured retention is
reduced to $10,000 or $25,000 per occurrence, depending upon the policy year.
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.
ITEM 2. 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:
10
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
LOCATION FUNCENTERS LOCATION FUNCENTERS
- -------- ---------- -------- ----------
<S> <C> <C> <C>
Alabama.......................... 4 New Jersey.......................... 9
Arizona.......................... 1 New Mexico.......................... 1
California....................... 20 New York............................ 16
Colorado......................... 4 North Carolina...................... 2
Connecticut...................... 2 Ohio................................ 10
Delaware......................... 1 Oklahoma............................ 3
Florida.......................... 11 Oregon............................. 2
Georgia.......................... 6 Pennsylvania........................ 10
Hawaii........................... 1 Rhode Island........................ 1
Idaho............................ 1 South Carolina...................... 2
Illinois......................... 6 Tennessee........................... 4
Indiana.......................... 8 Texas............................... 20
Iowa............................. 1 Utah................................ 1
Kansas........................... 2 Virginia............................ 8
Kentucky......................... 2 Washington.......................... 2
Louisiana........................ 4 Wisconsin........................... 5
---
Maryland......................... 6 Total United States................. 198
Massachusetts.................... 8 Canada.............................. 5
Michigan......................... 5 Puerto Rico......................... 3
---
Minnesota........................ 2
Mississippi...................... 1 Total............................... 206
===
Missouri......................... 5 The Block Party Stores are located in
Indiana and New Mexico.
Nevada........................... 1
</TABLE>
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).
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
11
<PAGE>
and its telephone number is (914) 345-4500.
ITEM 3. LEGAL PROCEEDINGS
Substantially all of the claims against the Company relating to
pre-petition causes of action were discharged on the Effective Date.
The Company is involved in litigation from time to time in the
ordinary course of its business. In the opinion of the Company, any liability
that may be incurred upon the resolution of certain claims and lawsuits in which
the Company is involved at this time will not, in the aggregate, exceed the
limits of the Company's insurance policies or otherwise have a material adverse
effect upon the financial condition or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's security holders either
during the fourth quarter of 1996 or during 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the Nasdaq National
Market on June 4, 1993. Prior to that date, there was no public market for the
Common Stock. On May 22, 1996, the Common Stock was delisted from the Nasdaq
National Market. The following table sets forth the high and low prices of the
Common Stock as quoted on the Nasdaq National Market for the periods indicated:
HIGH LOW
1996
First Quarter..................................$3 7/8 $ 1/2
1995
First Quarter..................................$12 3/8 $6 3/4
Second Quarter.................................$12 1/4 $8 1/2
Third Quarter..................................$10 $4 1/8
Fourth Quarter.................................$5 6/8 $2 1/2
At December 31, 1996, there were approximately 1,270 record
holders of the Common Stock. The Company did not pay any dividends on its
Common Stock in 1996 or in 1997. Pursuant to the Plan, all of the Company's
Common Stock was cancelled. In connection with the Company's emergence from
Chapter 11, the
12
<PAGE>
Company issued new common stock, par value $0.01 per share (the "New Common
Stock") and warrants to purchase shares of New Common Stock at an exercise
price of $17.55 per share (the "Ten Year Warrants"). In addition, in
offerings closing on or about the Effective Date, the Company issued the
Convertible Preferred Stock and offered and sold the Units. Each of the New
Common Stock, the Ten Year Warrants, the Convertible Preferred Stock and the
Warrants is described in Note 21 to the Consolidated Financial Statements
below.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND LOCATION
DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Total revenue ................................... $19,593 $61,585 $180,573 $ 259,490 $ 181,725
Cost of goods sold............................... 5,696 15,131 36,858 50,227 34,276
Store operating expenses(l)(2)(3)................ 6,331 32,010 97,631 185,587 140,486
Selling, general and administrative
expenses(2) 8,750 6,300 36,451 58,201 40,779
Depreciation and amortization.................... 976 4,670 16,183 31,972 21,876
Restructuring and other charges.................. 2,486 -- 14,024 372,160 --
------- ------- -------- --------- ---------
Operating income (loss).......................... (4,586) 3,474 (20,574) (438,657) (55,692)
Interest expense................................. (489) (1,667) (5,137) (12,226) (6,277)
Other income (expense), net...................... 103 1,499 2,331 476 (580)
Minority interest................................ -- -- 256 5,162 --
Reorganization costs............................. -- -- -- -- 21,285
------- ------- -------- --------- ----------
Income (loss) before income tax, and
cumulative effect of change in accounting
method....................................... (4,969) 3,306 (23,124) (445,245) (83,834)
Income tax provision (benefit)................... -- -- (4,000) 4,000 --
Cumulative effect of change in
accounting method............................ -- -- 5,773 -- --
------- ------- -------- --------- ---------
Net income (loss) applicable to common
shareholders................................. $(4,969) $3,306 $(24,897) $(449,245) $ (83,834)
======= ======= ======== ========== ==========
Per common and common equivalent share:
Income (loss) before cumulative effect of
change in method of accounting........... $ (0.14) $ 0.08 $ (0.41) $ (8.06) $ (1.45)
Cumulative effect of change in accounting
method................................... -- -- (0.12) -- --
-------- ------- -------- --------- ----------
Net income (loss)........................... $ (0.14) $(0.08) $ (0.53) $ (8.06) $ (1.45)
======== ======= ======== ========= ==========
Weighted average number of common and common
equivalent shares outstanding............... 34,776 42,025 46,797 55,706 57,691
OTHER DATA:
Cash provided by (used in) operations........... $ (662) $19,860 $ (4,481) $ (59,103) $ (39,888)
Cash provided by (used in) investing activities. (7,791) (95,868) (121,972) (64,562) 3,805
Cash provided by financing activities........... 15,786 185,496 16,162 121,729 33,460
------- ------- -------- --------- ---------
Net cash flows.................................. 7,333 109,488 (110,291) (1,936) (2,623)
Capital expenditures............................ 6,352 88,336 119,134 51,732 2,672
STORE DATA:
Company owned stores at period-end(4)........... 19 111 318 321 212
Franchised stores at period-end (5)............. 38 57 29 15 7
------- ------- -------- --------- ----------
Total stores at period-end...................... 57 168 347 336 219
OPERATING RATIO:
Ratio of earnings to fixed charges(6)........... -- 2.8 -- -- --
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------------------------------
1992 1993 1994 1995 1996 (7)
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents (unrestricted)........ $ 8,544 $118,176 $ 7,885 $5,949 $ 3,326
Restricted cash and investments................. 437 -- -- -- --
Total assets ................................... 24,804 252,550 474,686 171,571 125,786
Long-term debt, including current portion....... 5,557 2,728 18,400 113,404 350,072
Total stockholders' equity (deficit)............ 10,636 98,091 238,963 (180,173) (263,572)
</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.
(3) For the year ended December 31, 1992, Store Operating Expenses are estimated
for stores acquired under the pooling method.
(4) Includes the Block Party Stores.
(5) The Company currently receives no royalties from its franchised stores and
rejected or terminated its arrangements with all franchises on or prior to
the Effective Date.
(6) For purposes of this item, "fixed charges" represent interest, the interest
element of rental expense, capitalized interest and amortization of debt
issuance costs, and "earnings" represent income (loss) before income taxes,
extraordinary items, cumulative effect of change in accounting method and
fixed charges. Earnings were insufficient to cover Fixed Charges by $5.0
million, $24.1 million, $445.4 million and $83.8 million in each of 1992,
1994, 1995 and 1996, respectively.
(7) Includes certain claims and other liabilities totaling $344.1 million as of
December 31, 1996, which were restricted or extinguished in connection with
the Plan of Reorganization.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is the leading owner and operator of pay-for-play
children's entertainment centers in North America, with a national network of
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
15
<PAGE>
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 post 1997 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. Management expects that as a result of these efforts,
revenues will increase on a same 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, since the Effective Date, 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.
The Company's selling, general and administrative expenses
include salaries, bankruptcy-related costs, corporate and regional management
expenses and other administrative, promotional and advertising 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. 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.
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.
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
16
<PAGE>
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 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. 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. 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 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
17
<PAGE>
its method of accounting to expense pre-opening costs when a FunCenter opens.
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. 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.
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.
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
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 the 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.
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.
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.
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.
18
<PAGE>
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.
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.
As a result of its reorganization under Chapter 11, the
Company is treated as having experienced an ownership change. Accordingly, 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. 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 New Common Stock. The reorganization value of
the Company has been allocated to the assets of the Company in conformity
with the procedures specified by Accounting Principles Board Opinion No. 16,
Business Combinations, for transactions reported on the basis of the purchase
method of accounting. 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 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.
19
<PAGE>
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 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.
20
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Certified Public Accountants for the year ended
December 31, 1996............................................ 22
Report of Independent Certified Public Accountants for the year ended
December 31, 1995............................................ 23
Report of Independent Public Accountants for the year ended
December 31, 1994............................................ 24
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 1996........................... 25
Consolidated Balance Sheets as of December 31, 1996 and 1995................ 27
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 1996........................... 28
Consolidated Statements of Equity (Deficit) for each of the three
years in the period ended December 31, 1996.................. 30
Notes to Consolidated Financial Statements.................................. 31
21
<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
22
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and
Shareholders of Discovery Zone, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the 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
[6~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
23
<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).
24
<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
--------------------------------------------------
1996 1995 1994
---- ---- ----
REVENUE:
<S> <C> <C> <C>
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)
</TABLE>
25
<PAGE>
<TABLE>
<S> <C> <C> <C>
Cumulative effect on prior years of change in method
of 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.
26
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
AS OF DECEMBER 31
----------------------------
1996 1995
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents.................................................$ 3,326 $ 5,949
Receivables, net.......................................................... 1,338 1,600
Inventories............................................................... 2,038 9,067
Deposit................................................................... 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--$.0l par value; 10,000,000 shares authorized, no shares
outstanding............................................................... -- --
Common Stock--$.0l 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.
27
<PAGE>
<TABLE>
<CAPTION>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
FOR THE YEARS ENDED DECEMBER 31
1996 1995 1994
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
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
--------- -------- ---------
</TABLE>
28
<PAGE>
<TABLE>
<S> <C> <C> <C>
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.
29
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
(In thousands, except share data)
RETAINED
ADDITIONAL EARNINGS CUMULATIVE TOTAL
COMMON TREASURY PAID-IN (ACCUMULATED TRANSLATION EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL WARRANTS DEFICIT) ADJUSTMENT (DEFICIT)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994...... 37,503,356 $ 375 -- $ -- $ 94,573 $ 715 $ 2,428 $ -- $ 98,091
Stock issued in acquisitions. 10,325,492 103 7,771 200 163,805 -- -- 164,108
Stock issued on exercise of
nonqualified stock options 894,267 9 34,064 602 1,687 -- -- 2,298
Treasury shares acquired..... -- -- (46,893) (879) 217 -- -- -- (662)
Cumulative translation
adjustment................ -- -- -- -- -- -- -- 25 25
Net loss..................... -- -- -- -- -- -- (24,897) -- (24,897)
---------- ------ ------- ------ --------- ------- ---------- ------- --------
Balance at December 31, 1994.... 48,723,115 487 (5,058) (77) 260,282 715 (22,469) 25 238,963
Stock issued in acquisitions. 200,000 2 -- -- 1,311 -- -- -- 1,313
Stock issued on exercise of
nonqualified stock options 1,377,855 14 -- -- 3,387 -- -- -- 3,401
Stock issued on exercise of
warrants.................. 7,234,500 72 -- -- 26,566 (616) -- -- 26,022
Treasury shares acquired..... -- -- (54,487) (511) -- -- -- -- (511)
Cumulative translation
adjustment................ -- -- -- -- -- -- (116) (116)
Net loss..................... -- -- -- -- -- -- (449,245) -- (449,245)
---------- ------ ------- ------ --------- ------- ----------- ------- --------
Balance at December 31, 1995.... 57,535,470 575 (59,545) (588) 291,546 99 (471,714) (91) (180,173)
Stock issued on exercise of
nonqualified stock options 170,000 2 -- -- 280 -- -- 282
Cumulative translation
adjustment................ -- -- -- -- -- -- 153 153
Net loss..................... -- -- -- -- -- -- (83,834) -- (83,834)
---------- ------ ------- ------ --------- -------- ----------- ------- ---------
Balance at December 31, 1996.... 57,705,470 $ 577 (59,545) $ (588) $ 291,826 $ 99 $ (555,548) $ 62 $(263,572)
========== ====== ======= ====== ========= ======== ========== ====== =========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
30
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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.
Certain amounts in the 1995 and 1994 consolidated financial
statements have been reclassified
31
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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
32
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
33
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 deprecation 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.
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
34
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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
$953,000 in 1995 and 1994, respectively.
35
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LOSS PER SHARE
Loss per share is calculated by dividing the net loss by the weighted
average number of shares outstanding during the period plus share equivalents,
when the share equivalents are not anti-dilutive. Share equivalents represent
options and warrants with an exercise price below fair market value for any of
the periods presented. See Note 16.
(4) LIABILITIES SUBJECT TO COMPROMISE
Under the Bankruptcy Code, certain claims against the Discovery Zone
Group arising prior to the Petition Date are automatically stayed while the
members of the Discovery Zone Group continue business operations as
debtors-in-possession. It is anticipated that these prepetition liabilities will
be compromised under a plan of reorganization and are separately classified in
the consolidated balance sheet as liabilities subject to compromise and include
the following at December 31, 1996:
Accounts payable.................................................$ 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
========
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.
(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
36
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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 $1,753,000.
37
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Revenue and net loss of the previously separate companies for the
periods before the pooling of interests business combination was consummated
(after reflecting the effect of intercompany eliminations) are as follows for
the year ended December 31, 1994:
Revenue:
Company........................................$ 179,825
Acquired businesses, net of eliminations....... 748
-------
$ 180,573
Net loss:
Company........................................$ (25,034)
Acquired businesses, net of eliminations....... 137
---------
$ (24,897)
=========
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>
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, $.01 par value
("Common Stock") were accounted for as follows:
38
<PAGE>
[6~ DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1995 1994
---- ----
<S> <C> <C>
Cash............................................................................$ -- $ 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 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. 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
39
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
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
40
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
(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
41
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
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 $544,000, respectively. Another event
of default occurred as a result of the Discovery Zone Group's bankruptcy filing.
The entire principal balance of and accrued prepetition interest on such note
were immediately due and payable. The payment of this amount is prohibited
during the pendency of the Discovery Zone Group's bankruptcy proceedings and is
included in Liabilities Subject to Compromise at December 31, 1996 (see Note 4).
The Company was required to pay a quarterly commitment fee of up to
.5% on the entire amount available under the Credit Facility. The payment of the
commitment fee is prohibited during the pendency of the Discovery Zone Group's
bankruptcy cases.
42
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Long-term obligations at December 31, 1995 consisted of the
following:
<TABLE>
<CAPTION>
<S> <C>
Payable to banks under an unsecured credit agreement, interest
at 7.49% at December 31, 1995...............................................$ 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 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
43
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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
</TABLE>
44
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<S> <C> <C> <C>
$ 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 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:
1997................................................$ 26,349
1998................................................ 26,545
1999................................................ 25,072
2000................................................ 22,775
2001................................................ 21,088
Thereafter.......................................... 53,157
-------
$ 174,986
=======
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.
45
<PAGE>
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
$1,849,000 at December 31, 1996. This amount was recorded in accrued liabilities
in the accompanying consolidated financial statements. Because this amount
represents an estimate, it is reasonably possible that a change in this estimate
may occur in the future. As discussed in Note 4, additional liabilities for
claims related to legal matters are recorded in liabilities subject to
compromise.
(14) INCOME TAXES
The federal statutory tax rate is reconciled to the effective tax
rate for the years ended December 31 as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------
<S> <C> <C> <C>
Federal statutory rate (benefit)................ (34.0)% (34.0)% (34.0)%
Tax-exempt income............................... -- -- (1.5)%
Change in valuation allowance................... 34.0% 35.0% 21.7%
------ ------ -------
Effective tax rate (benefit).................... -- 1.0% (13.8)%
===== ====== =======
</TABLE>
Income tax provision (benefit) for the years ended December 31
consists of the following:
1996 1995 1994
---- ---- ----
Current.....................$-- $ -- $ --
Deferred.................... -- 4,000 (4,000)
-- ----- ------
$-- $ 4,000 $ (4,000)
=== ======= ========
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
46
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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,
47
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(ii) first priority liens on and 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.
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.
48
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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.
(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.
49
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 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>
Current assets................................................................ $ 682 $ 772
Noncurrent assets............................................................. 3,925 4,384
Current liabilities........................................................... 144 779
Noncurrent liabilities(1)..................................................... 9,627 8,826
1996 1995 1994
------ ------ ------
Net Revenue............................................................ $6,637 $ 7,991 $2,575
Operating expenses..................................................... 7,561 12,018 2,993
Net loss............................................................... (753) (4,001) (418)
(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.
</TABLE>
(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.
50
<PAGE>
DISCOVERY ZONE, INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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.
51
<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
ALLOWANCE FOR DOUBTFUL ACCOUNTS
<S> <C> <C> <C> <C>
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.
Item 9. Changes in and Disagreements With Accountants and Accounting and
Financial Disclosures
Reference is made to the Current Report on Form 8-K dated July 9,
1997, the Current Report on Form 8-K dated June 10, 1996, the amendment to
the Current Report on Form 8-K, dated June 11, 1996 and the Current Report on
Form 8-K dated August 15, 1995.
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information concerning the
executive officers and directors of the Company and the positions they hold.
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------- ----------------------------------------------------------
<S> <C> <C>
Scott W. Bernstein.................37 Chief Executive Officer, President and Director
Sharon L. Rothstein................40 Senior Vice President, Marketing and Entertainment
Robert G. Rooney...................40 Senior Vice President, Chief Financial and
Administrative Officer
Andrew M. Smith....................45 Vice President, Real Estate, General Counsel and Secretary
Leighton J. Weiss..................46 Vice President and Controller
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. All of the named
directors were named on the Effective Date.
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)
52
<PAGE>
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 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 Andersen 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.,
and investment firm. Mr. Feldman is a member of the Board of Directors of Lionel
L.L.C. and Chartwell Re Corporation.
MR. ROTATORI was elected as a director of the Company 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 Fay Inc. and Glasstech, Inc., Chairman of the Executive
Group of The Dart Group Corporation, Chairman of the Board of Directors of
Delta-Omega Technologies, Inc. and a trustee of National Income Realty Trust.
MR. SMITH was elected as a director of the Company 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 service. 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.
SECTION 16A - BENEFICIAL OWNERSHIP COMPLIANCE
53
<PAGE>
Under the securities laws of the United States, the Company's
directors and executive officers, and persons who own more than 10% of the
Company's New Common Stock, are required to report their initial ownership of
the Company's New Common Stock and any subsequent changes in that ownership
to the Commission. The Company is currently working with its directors and
executive officers, and persons who own more than 10% of the Company's New
Common Stock to comply with Section 16a of the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
The following table and discussion summarize the compensation earned
by the Company's Chief Executive Officer, President and Director and the other
most highly compensated executive officers of the Company who earned more than
$100,000 in salary and bonuses (collectively, the "Named Executive Officers")
for services rendered in all capacities to the Company during each of the last
three years ended December 31, 1996. Mr. Bernstein became the Company's Chief
Executive Officer on December 5, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
- -----------------------------------------------------------------------------------------------------------
(A) (B) (C) (D) (E)
NAME AND ALL OTHER
PRINCIPAL COMPENSATION
POSITION YEAR SALARY($) BONUS ($) (1)($)
- -------------------------------------------------- ---- --------- --------- ------
<S> <C> <C> <C> <C>
Scott W. Bernstein, Chief......................... 1996 30,204 -- --
Executive Officer, President 1995 -- -- --
and Director(2) 1994 -- -- --
Donna Moore, President and........................ 1996 412,500 -- 2,699
Chief Executive Officer 1995 19,370 150,000 26,244
and Director(2) 1994 -- -- --
Cynthia Cook, Vice President,..................... 1996 98,077 9,500 80,655
Concept Development 1995 45,676 -- 36,883
1994 -- -- --
Stanley Gerasimczyk, Vice President,.............. 1996 135,000 25,000 --
Operations 1995 28,558 6,210 --
1994 -- -- --
David Barclay, Vice President..................... 1996 135,508 5,000 --
Legal(3) 1995 50,157 22,470 --
1994 -- -- --
</TABLE>
(1) "Other Compensation" paid by the Company was related to relocation or
severance compensation.
(2) Mr. Bernstein was hired on December 6, 1996. The amount set forth
above represents payments made to Mr. Bernstein for the period
December 6 through December 31, 1996.
(3) $22,470 of Mr. Barclay's bonus was paid by BlockBuster
pursuant to a Management Services Agreement with the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
None.
COMPENSATION OF DIRECTORS
The Directors do not receive any fee for their services; however,
they are reimbursed for all out-of-pocket expenses incurred in connection with
attending meetings of the Company's Board of Directors.
54
<PAGE>
OPTION AND SAR GRANTS IN FISCAL YEAR 1996
The Company granted no options, restricted stock awards, stock
appreciation rights or other long-term incentive payments in 1996.
OPTION AND SAR EXERCISES IN FISCAL 1996 AND YEAR-END OPTION AND SAR VALUES
In 1996, there were no exercises of options by any of the Named
Executive Officers or SARs issued by the Company.
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 and as Chief Executive Officer and President
of the Company.
STOCK INCENTIVE PLAN
The Company did not grant options to purchase shares of the
Company's New 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 357,485 shares, 89,500 shares, and 89,500 shares, respectively, of
the Company's New Common Stock at an exercise price of $11.88 per share. One
third of such options vested on January 1, 1998. One third of such options
will vest on January 1, 1999 and the remaining one third will vest on January
1, 2000. 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 New Common Stock subject to the
Stock Incentive Plan represent up to a maximum of 10% of the outstanding
shares of New 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 New Common Stock for issuance under this Stock Option Plan.
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 New 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
55
<PAGE>
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 New 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 letter of expiration of the
applicable restricted period and attainment of such performance goals, a
participant may not sell, assign, transfer, pledge or otherwise encumber
shares of Restricted Stock other than to pledge the Restricted Stock as
security for a loan to provide funds to pay the exercise price for the Stock
Options. Holders of Restricted Stock will have all of the rights of a
stockholder of the New 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 New Common Stock equal to the number of Performance Units or cash
equal to the fair market value of such number of shares of New Common Stock.
LONG-TERM INCENTIVE PLAN ("LTIP") AWARDS
The Company made no LTIP Awards in 1996 or 1997.
PENSION PLAN
The Company had no pension plan in place in 1996 or 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth certain information concerning the
beneficial ownership of shares of New Common Stock on September 30, 1997, by:
(i) each stockholder known by the Company to beneficially own more than 5% of
the outstanding New 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.
56
<PAGE>
<TABLE>
<CAPTION>
BENEFICIAL OWNER SHARES OF PERCENT
BENEFICIALLY OWNED BENEFICIALLY
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 L. 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 New 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 New 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 New
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 New 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 New Common Stock beneficially
owned by Balfour, and Mr. Feldman and Douglas W. Rotatori disclaim
voting and dispositive power over the shares of New 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
New 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).
(5) Christopher R. Smith, a director of the Company nominated by Wafra,
disclaims voting and dispositive power over the shares of New Common
Stock beneficially owned by Wafra.
57
<PAGE>
(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 all of which Mr. Kurnit is an officer. Mr. Kurnit,
individually, is the beneficial owner of less than 5.0% of the
outstanding New Common 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 New Common Stock, to Mr. Rooney with respect to
89,500 shares of New Common Stock and to Ms. Rothstein with respect
to 89,500 shares of New Common Stock, one-third of all of which
has vested.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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 $7.0 million to Griffin Bacal, for media purchases on behalf of and
creative services provided to, the Company during the nine months ended
September 30, 1997. Management believes that the terms of the agreement with
Griffin Bacal are on terms at least as favorable to the Company as the Company
could have received from an independent third party.
58
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Reference is made in the information set forth in Part II, Item 8
of this Report, which information is incorporated herein by
reference.
(a)(2) Financial Statement Schedules:
Financial Statement Schedule II, Valuation and Qualifying Accounts,
for the years ended December 31, 1996 and 1995 are submitted
herewith.
(a)(3) The exhibits to this Report are listed in the Exhibit Index which
appears elsewhere in this Report and is incorporated herein by
reference.
(a)(4) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated January 12,
1996 reporting under Item 5 that the Company obtained a $10,000,000
interim working capital loan.
The Company filed a Current Report on Form 8-K dated February 1,
1996 reporting under Item 5 that the Company is considering all
alternatives to meet its cash requirements, including a
reorganization under Chapter 11 of the United States Bankruptcy
Code, to allow it access to working capital and restructure its
indebtedness.
The Company filed a Current Report on Form 8-K dated February 6,
1996 reporting under Item 5 that the Company did not make the
scheduled repayments of principal or interest on the $10,000,000
interim working capital loan it obtained on January 12, 1996.
The Company filed a Current Report on Form 8-K dated March 1, 1996
reporting under Item 5 that Donald Flynn resigned as the
non-executive Chairman of the Company and from the Board of
Directors.
The Company filed a Current Report on Form 8-K dated March 19, 1996
reporting under Item 5 that Steven R. Berrard resigned as Chief
Executive Officer of the Company and from the Board of Directors.
The Company filed a Current Report on Form 8-K dated March 25, 1996
reporting under Item 3 that the Company and nineteen subsidiaries
filed petitions for relief under Chapter 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware.
The Company filed a Current Report on Form 8-K dated March 27, 1996
reporting under Item 5 that J. Brian McGrath resigned from the
Board of Directors.
The Company filed a Current Report on Form 8-K dated April 1, 1996
reporting under Item 5 its preliminary results for fiscal year
1995.
The Company filed a Current Report on Form 8-K dated May 7, 1996
reporting under Item 5 that the Company and its subsidiaries have
entered into a Revolving Credit Agreement.
The Company filed a Current Report on Form 8-K dated May 22, 1996
reporting under Item 5 that its common stock, par value $0.01 and
its Liquid Yield Option Notes due 2013 will be delisted from the
Nasdaq Stock Market.
The Company filed a Current Report on Form 8-K dated June 10, 1996
and an amendment on
59
<PAGE>
a Current Report on Form 8-K/A dated June 11, 1996 reporting under
Item 4 that it was informed by its independent accountants, Price
Waterhouse LLP ("PW"), that PW declined to stand for re-election as
the Company's independent accountants for the year ending December
31, 1996.
The Company filed a Current Report on Form 8-K dated June 20, 1996
reporting under Item 5 that the Company has appointed James M.
Rippe, M.D. to its Board of Directors.
The Company filed a Current Report on Form 8-K dated October 2,
1996 reporting under Item 5 that the Company intends to borrow
$19,000,000 under the Revolving Credit Agreement on October 2,
1996.
The Company filed a Current Report on Form 8-K dated November 14,
1996 reporting under Item 5 that the Company and Birch Holdings
L.L.C. filed a Joint Plan of Reorganization for the Company.
The Company filed a Current Report on Form 8-K dated July 9, 1997
reporting under Item 4 that Ernst & Young LLP was hired as the
Company's independent accountants.
The Company filed a Current Report on Form 8-K dated August 4, 1997
reporting under Item 5 the release of two press releases relating
to the effectiveness of the Plan and the cancellation of the
Company's then-existing common stock.
60
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the undersigned Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in
Elmsford, New York on January 29, 1998.
DISCOVERY ZONE, INC.
By: /s/ Scott W. Bernstein
___________________________
Name: Scott W. Bernstein
Title: CHIEF EXECUTIVE
OFFICER, PRESIDENT
AND DIRECTOR
Pursuant to the requirements of the Securities Exchange Act of 1934,
this has been signed by the following persons in the capacities indicated on
January 16, 1998.
NAME TITLE
/s/ Scott W. Bernstein
- ---------------------------------- Chief Executive Officer,
Scott W. Bernstein President and Director
/s/ Martin S. Davis
- ----------------------------------
Martin S. Davis Director
/s/ Greg S. Feldman
- ----------------------------------
Greg S. Feldman Director
/s/ Douglas W. Rotatori
- ----------------------------------
Douglas W. Rotatori Director
- ----------------------------------
L.G. Schafran Director
- ----------------------------------
Christopher R. Smith Director
- ----------------------------------
Paul D. Kurnit Director
/s/ Robert G. Rooney
- ---------------------------------- Senior Vice President, Chief
Robert G. Rooney Financial and Administrative
Officer
/s/ Leighton J. Weiss
- ----------------------------------
Leighton J. Weiss Vice President and Controller
(Chief Accounting Officer)
61
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER
+1.1 Purchase Agreement, dated July 15, 1997, between the Registrant and
Jefferies & Company, Inc., as the initial purchaser (the "Initial
Purchaser").
2.1 The Third Amended Joint Plan of Reorganization of the Registrant,
dated March 11, 1997 (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 Initial 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.
62
<PAGE>
EXHIBIT
NUMBER
+4.14 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Cook County, Illinois.
+4.15 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Cobb County, Georgia.
+4.16 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Franklin County, Ohio.
+4.17 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Macomb County, Michigan.
+4.18 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Anoka County, Minnesota.
+4.19 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Philadelphia County, Pennsylvania.
+4.20 The Mortgage, Assignment of Leases and Rents, Security Agreement and
Fixture Filing, dated as of July 29, 1997, between the Company, as
mortgagor and the Trustee, as mortgagee, related to property located
in Marion County, Indiana.
+4.21 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among the
Registrant, as grantor, Kenneth W. Pearson, as trustee and the
Trustee, as beneficiary, relating to property located in Dallas
County, Texas.
+4.22 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among the
Registrant, as grantor, Kenneth W. Pearson, as trustee and the
Trustee, as beneficiary, relating to property, located in Bexar
County (San Antonio), Texas.
+4.23 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among the
Registrant, as grantor, Kenneth W. Pearson, as trustee and the
Trustee, as beneficiary, relating to property located in Tarrant
County, Texas.
+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.
63
<PAGE>
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.
+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.
++4.39 Amended and Restated Deed of Trust, Assignment of Leases and Rents,
Security Agreement and Fixture Filing, dated as of July 29, 1997,
among the Registrant, as grantor, Kenneth W. Pearson, as trustee and
McDonald's Corporation, as beneficiary, relating to property located
in Bexar County (Leon Valley), Texas.
++4.40 Amended and Restated Deed of Trust, Assignment of Leases and Rents,
Security Agreement and Fixture
64
<PAGE>
EXHIBIT
NUMBER
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.
++4.52 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Tarrant
County, Texas.
++4.53 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Bexar County
(Leon Valley), Texas.
++4.54 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Clark County,
Washington.
++4.55 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as
65
<PAGE>
EXHIBIT
NUMBER
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.
++10.1 Employment Agreement, dated as of July 21, 1997, between the
Registrant and Scott W. Bernstein.
++10.2 Employment Agreement, dated as of August 1, 1997, between the
Registrant and Robert G. Rooney.
++10.3 Employment Agreement, dated as of August 1, 1997, between the
Registrant and Sharon L. Rothstein.
++10.4 1997 Stock Incentive Plan.
+++12.1 Statements re computation of ratios.
16.1 Letter re change in certifying accountant (incorporated by reference
from the Current Report on Form 8-K of the Registrant, dated June 3,
1996).
+21.1 List of Subsidiaries of the Registrant.
66
<PAGE>
EXHIBIT
NUMBER
+24.1 Power of Attorney (included on signature page).
++27.1 Financial Data Schedule.
- -------------------
+ Incorporated by reference from the Registration Statement on Form
S-4 of the Company, dated November 19, 1997.
++ Incorporated by reference from Amendment No. 1 to the Registration
Statement on Form S-4 of the Company, dated December 9, 1997.
+++ Incorporated by reference from Amendment No. 2 to the Registration
Statement on Form S-4 of the Company, dated January 13, 1998.
++++ Incorporated by reference from Amendment No. 3 to the Registration
Statement on Form S-4 of the Company, dated January 28, 1998.
67
