UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

x

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

FOR THE FISCAL YEAR ENDED FEBRUARY 4, 2007

 

OR

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

FOR THE TRANSITION PERIOD FROM                  TO                  

 

Commission File No. 001-15007

Dave & Buster’s, Inc.
(Exact name of registrant as specified in its charter)

MISSOURI

 

43-1532756

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

2481 Mañana Drive

Dallas, Texas 75220

(Address of principal executive offices)

(Zip Code)

(214) 357-9588

(Registrant’s telephone number, including area code)


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o   No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o   No x

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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

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. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was zero as of July 30, 2006.

The number of shares of the Issuer’s common stock, $0.01 par value, outstanding as of May 9, 2007, was 100 shares.

 




DAVE & BUSTER’S, INC.

ANNUAL REPORT ON FORM 10-K

FOR FISCAL YEAR ENDED FEBRUARY 4, 2007

TABLE OF CONTENTS

 

 

 

 

PART I

ITEM 1.

 

BUSINESS

 

 

ITEM 1A.

 

RISK FACTORS

 

 

ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

 

 

ITEM 2.

 

PROPERTIES

 

 

ITEM 3.

 

LEGAL PROCEEDINGS

 

 

ITEM 4.

 

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

 

 

 

 

 

 

PART II

 

 

 

 

 

ITEM 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

ITEM 6.

 

SELECTED FINANCIAL DATA

 

 

ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

ITEM 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

ITEM 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

 

ITEM 9A.

 

CONTROLS AND PROCEDURES

 

 

ITEM 9B.

 

OTHER INFORMATION

 

 

 

 

 

 

 

PART III

 

 

 

 

 

ITEM 10.

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

 

ITEM 11.

 

EXECUTIVE COMPENSATION

 

 

ITEM 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

 

ITEM 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

 

ITEM 14.

 

PRINCIPAL ACCOUNTING FEES AND SERVICES

 

 

 

 

 

 

 

PART IV

 

 

 

 

 

ITEM 15.

 

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

 

 

 

 

 

 

 

 

SIGNATURE PAGE

 

 

 

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PART I

ITEM 1.      BUSINESS

Company Overview

References to “Dave & Buster’s,” the “Company,” “we,” “us,” and “our” in this Form 10-K are references to Dave & Buster’s, Inc. and its subsidiaries and any predecessor companies.  We are North America’s largest operator of large-format, high-volume restaurant/entertainment complexes.  Our complexes combine high-quality casual dining with an extensive array of entertainment attractions.  Our menu includes a wide variety of moderately-priced food and beverage offerings, and our highly-trained staff provides attentive and friendly service for our guests.  Our complexes appeal to a diverse customer base by providing a distinctive entertainment and dining experience in a high-energy, casual setting.  Founded in 1982 with a single location, we have grown to become a leader in the restaurant/entertainment industry, operating 48 restaurant/entertainment complexes (a “Complex” or “Store”) in the United States and Canada under the names “Dave & Buster’s,” “Dave & Buster’s Grand Sports Café” and “Jillian’s,” and franchising one complex under the name “Dave & Buster’s” located in Mexico.

Our complexes cater primarily to adults aged 21 to 44 and operate seven days a week, typically from 11:30 a.m. to midnight on weekdays and 11:30 a.m. to 2:00 a.m. on weekends.  Our average complex is approximately 51,000 square feet in size, but the size of the complexes can range between 28,000 and 68,000 square feet, depending on the characteristics of the markets in which they are located.  The average size of our complexes opened in fiscal years 2005 and 2006 were approximately 35,000 square feet.  We carefully select the appropriate size and location of our new complexes after thoroughly analyzing a variety of economic, demographic, and strategic considerations.

The layout of each complex is designed to maximize guest crossover between its multiple entertainment and dining areas.  Each location provides full, sit-down food service not only in the restaurant areas, but also in various locations within the complex.  Our menu places special emphasis on quality meals, including gourmet pastas, steaks, sandwiches, salads, and an outstanding selection of desserts.  We update our menus on a regular basis to reflect current trends and guest favorites.  Each of our locations offers full bar service throughout the complex, including an extensive array of beers and a wide selection of wine, spirits, and non-alcoholic beverages.

Our amusement offerings include state-of-the-art simulators, high-tech video games, traditional pocket billiards and shuffleboard, as well as a variety of redemption games, which dispense coupons that can be redeemed for prizes in our Winner’s Circle.  The redemption games include basic games of skill, such as skee-ball and basketball, and the prizes in the Winner’s Circle range from small-ticket novelty items to high-end electronics, such as flatscreen televisions.

In addition, each location has multiple special event facilities that are used for hosting private parties, business functions and other corporate sponsored events.  Each complex has a dedicated sales team responsible for selling large events to corporate, as well as individual guests.  We believe our special event facilities provide a highly attractive alternative to traditional restaurants and hotels, which generally do not offer combined entertainment and dining.  In fiscal year 2006, approximately 16.6 percent of the Company’s revenues were from special events functions.

We believe that each location’s combination of high-quality food and beverages, multiple entertainment attractions, superior service and commitment to casual fun for adults provides a unique dining and entertainment experience for our guests.

Acquisition of Certain Assets of Jillian’s Entertainment Holdings, Inc.

On November 1, 2004, we completed the acquisition of nine Jillian’s locations, related assets and equipment, and the Jillian’s trade name and related trademarks, pursuant to an asset purchase agreement.  The nine Jillian complexes acquired were located in the metropolitan areas of Minneapolis, Minnesota; Philadelphia, Pennsylvania; Concord, North Carolina; Farmingdale, New York; Nashville, Tennessee; Houston, Texas; Hanover, Maryland; Scottsdale, Arizona and Westbury, New York.

On August 28, 2005, a subsidiary closed the acquired Jillian’s complex located in Bloomington, Minnesota due to continuing operating losses attributable to this complex and unsuccessful efforts to renegotiate the terms of the related lease.  In fiscal 2005 and 2006, we converted six of the acquired Jillian’s complexes to Dave & Buster’s.

In October 2005, we acquired the general partner interest in a limited partnership which owns a Jillian’s complex in the Discover Mills Mall near Atlanta, Georgia.

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Merger with WS Midway Acquisition Sub, Inc.

Dave & Buster’s was acquired on March 8, 2006, by WS Midway Holdings, Inc. (“WS Midway”), a newly-formed Delaware corporation, through the merger (the “Merger”) of WS Midway Acquisition Sub, Inc., a newly-formed Missouri corporation and a direct, wholly-owned subsidiary of WS Midway with and into Dave & Buster’s with Dave & Buster’s as the surviving corporation.  Affiliates of Wellspring Capital Management LLC (“Wellspring”) and HBK Investments L.P. (“HBK”) control approximately 82 percent and 18 percent, respectively, of the outstanding capital stock of WS Midway.  Although we continue as the same legal entity after the merger, the accompanying consolidated statements of operations, stockholders’ equity, and cash flows present the results of operations and cash flows for us and our wholly-owned subsidiaries for the periods preceding the Merger (“Predecessor”) and the period succeeding the Merger (“Successor”), respectively.  (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Merger with WS Midway Acquisitions Sub, Inc.”).

Wellspring is a New York-based private equity firm with more than $2 billion in equity capital under management.  The firm takes controlling positions in promising middle-market companies where it can realize substantial value by contributing innovative operating and financing strategies and capital.  Wellspring’s limited partners include some of the largest and most respected institutional investors in the United States, Canada, and Europe.  The firm consistently ranks among the top-performing private equity funds specializing in the middle market.

Offerings

We offer a unique combination of high-quality casual dining with an extensive array of entertainment attractions, such as pocket billiards, video games, interactive simulators, and traditional redemption-style games of skill.

Food and Beverage

Our menu places special emphasis on quality meals, including gourmet pastas, steaks, sandwiches, salads, and an outstanding selection of desserts.  We update our menus on a regular basis to reflect current trends and guest favorites.  Each of our locations offers full bar service throughout the complex, including a wide selection of beers and wine, spirits and non-alcoholic beverages.  We also feature lunch specials with an emphasis on quality food prepared quickly and an extensive offering of buffets for special events and private parties.  We believe that each location’s combination of high-quality food and beverages and attentive and friendly service provides a unique dining experience for guests.  Approximately 55.7 percent of total revenues were derived from food and beverage during the 2006 fiscal year.

Entertainment

Our locations offer an extensive array of amusements and entertainment options including “Million Dollar Midway” games and “Traditional” games.  Furthermore, our complexes are equipped with multiple televisions and high-quality audio systems offering the guests an attractive venue for watching live sports matches and other televised events.  Approximately 42.1 percent of total revenues were derived from amusements during the 2006 fiscal year.

Million Dollar Midway games.  The largest area in each complex is the Million Dollar Midway, which is designed to provide high-energy entertainment through a broad selection of electronic, skill and sports-oriented games.  The Million Dollar Midway includes both classic midway game entertainment and high-technology games.

·                  Classic midway game entertainment includes sports-oriented games of skill, redemption-style games, and Dave & Buster’s Downs, which is one of several multiple player race games offered in each complex.  At the Winner’s Circle, players can redeem coupons won from selected games of skill for a wide variety of prizes, many of which display our logo.  The prizes include electronic equipment, sports memorabilia, stuffed animals, clothing and small novelty items.

·                  High-technology game attractions vary among the complexes and may include large screen interactive electronic games, such as the multiplayer Daytona USA racing simulator and Derby Owners Club.

A Power Card activates most midway games and can be recharged for additional play.  The Power Card enables our guests to activate games more easily and encourages extended play of games.  By replacing coin-activation, the Power Card eliminates the technical difficulties and maintenance issues associated with coin-activated equipment.  Furthermore, the Power Card increases the flexibility to adjust the pricing and promotion of the games.

4




Traditional games and entertainment.  In addition to the attractions in the Million Dollar Midway, each of our locations offers a number of traditional entertainment options.  These traditional offerings include pocket billiards, shuffleboard tables, and special event rooms, which are designed for hosting private social parties, business gatherings and sponsored events.

Strategy

The company intends to drive increase in sales and earnings by implementing the following strategies:

·      Increase our existing store sales through improved execution and marketing. The company will continue to employ national cable and local store marketing tactics to drive comparable store sales.

·                  Improve our operating margins by employing technology, refining the operating process and leveraging our economies of scale.

·                  Continue to further differentiate our product offering by introducing new food and beverage products, as well as the most current large format video entertainment games.

·                  Accelerate the development of new stores by signing leases for additional locations, refining our prototypes and building the management infrastructure to open these additional units.

Location and Development

We believe that the location of the complexes is critical to long-term success.  Significant time and resources are devoted to strategically analyze each prospective market, trade area, and site.  We continually identify, evaluate, and update our database of potential locations for expansion.  In general, we target super-regional sites within major metropolitan areas.  During the diligence process, we carefully analyze a variety of economic, psychographic, and demographic information such as income levels, residential density, daytime density, and growth rates for each prospective site.  In addition, we also consider other factors, including the following:

·                  visibility;

·                  parking and accessibility to regional highway systems;

·                  zoning;

·                  regulatory restrictions;

·                  proximity to shopping areas, office complexes, tourist attractions, theaters and other high-traffic venues;

·                  competition; and

·                  regional economic outlook.

The exterior and interior layout of our complexes is flexible and can be readily adapted to different types of buildings.  We evaluate new and existing buildings for construction and conversion; freestanding and inline opportunities are considered.  New stores are targeted to range in size from 30,000 to 40,000 square feet of enclosed space, and we consider lease and purchase structure when evaluating expansion opportunities.  We currently lease 47 of our 48 locations.  In November 2006, we completed the sale and simultaneous leaseback of the land and buildings of three owned facilities located in the states of Florida, Illinois, and Ohio. 

5




The transaction was completed at a sale price of $29.6 million.

During 2006, we opened one complex in New York City (Times Square) and one location in Maple Grove, Minnesota.  Subsequent to the end of the fiscal year, we began construction of a new complex in Tempe, Arizona.  This complex is expected to open in the third quarter of the 2007 fiscal year.

Marketing, Advertising and Promotion

Our corporate marketing department manages marketing, advertising, and promotional programs with the assistance of an external advertising agency and a national public relations firm.  In addition, our corporate marketing department is also responsible for controlling media and production costs.  We spent approximately $20.4 million in marketing efforts for fiscal year 2006 compared to approximately $16.2 million in fiscal 2005.

In order to expand the guest base, we focus marketing efforts in three key areas:

·                  advertising and system-wide promotions;

·                  field marketing and local promotions; and

·                  special events for corporate and group guests.

We conduct market research to better understand our brand and guests, and to develop engaging messages and promotional programs.  In addition, we develop marketing and media plans that are highly localized and designed to support individual market opportunities and local store marketing initiatives.  We continue to utilize in-store promotions, emails, and customer communications to increase visit frequency and average check size.

Our corporate and group sales programs are managed by our sales department, which provides direction, training, and support to the special events managers and their teams within each complex.  The primary focus for our special events sales teams is to identify and contact corporations, associations, organizations, and community groups within the team’s marketplace for purposes of booking group events.  The special events sales teams pursue corporate and social group bookings through a variety of sales initiatives including outside sales calls and cultivation of repeat business.  We have developed and continually maintain a database of corporate and group bookings.  Each of our locations hosts events for many multi-national, national, and regional businesses.  Many of our corporate and group guests schedule repeat events.  A significant number of our guests are introduced to the Dave & Buster’s concept through these special events.

Seasonality

The fourth quarter of the fiscal year achieves our highest revenue and profitability, primarily as a result of the significant special events business during the period.  This special events business is impacted by the number of holiday parties held during this time of the year.  The third quarter is normally the lowest producing quarter in terms of revenue and profitability with the first and second quarters being somewhat similar in results.

Competition

The restaurant industry is highly competitive, and competition among major companies that own or operate restaurant chains is especially intense.  Restaurants compete on the basis of name recognition and advertising; the price, quality, variety, and perceived value of their food offerings; the quality of their customer service; and the convenience and attractiveness of their facilities.  In addition, despite recent changes in economic conditions, competition for qualified restaurant-level personnel remains high.

The out-of-home entertainment market is highly competitive.  There are a large number of businesses that compete directly and indirectly with us.  Although we believe most of our competition comes from localized single attraction facilities that offer a limited entertainment package, we may encounter increased competition in the future.  In addition, we may also face increased competition from home-based forms of entertainment such as internet game play and home movie delivery.

6




Foreign Operations

We own and operate one complex outside of the United States in Toronto, Canada.  This complex generated revenue of $10.5 million in fiscal 2006, representing approximately 2.1 percent of our consolidated revenue.  As of February 4, 2007, we had less than 1.8 percent of our long-lived assets located outside the United States.  Additionally, a franchisee of ours operates one complex in Mexico City, Mexico under the terms of a franchise agreement.  We receive a royalty payable on the revenues of this complex.

The foreign activities are subject to various risks of doing business in a foreign country, including currency fluctuations, changes in laws and regulations and economic and political stability.  We do not believe there is any material risk associated with the Canadian or Mexican operations or any dependence by the domestic business upon the Canadian or Mexican operations.

Suppliers

The principal goods used by us are games, prizes and food and beverage products, which are available from a number of suppliers.  We have expanded our contacts with amusement merchandise suppliers through the direct import program.  Federal and state mandated increases in the minimum wage could have the repercussion of increasing expenses, as suppliers may be severely impacted by higher minimum wage standards.

Intellectual Property

We have registered the trademarks Dave & Buster’s®, Power Card®, Power Combo®, Eat Drink Play® and Jillian’s® with the United States Patent and Trademark Office and in various foreign countries.  We have also registered and/or applied for certain additional trademarks with the United States Patent and Trademark Office and in various foreign countries.  We consider our trade name and our signature “bulls-eye” logo to be important features of our operations and seek to actively monitor and protect our interest in this property in the various jurisdictions where we operate.

Government Regulation

We are subject to various federal, state, and local laws affecting our business.  Each complex is subject to licensing and regulation by a number of governmental authorities, which may include alcoholic beverage control, amusement, health and safety, and fire agencies in the state, county or municipality in which the complex is located.  Each complex is required to obtain a license to sell alcoholic beverages on the premises from a state authority and, in certain locations, county and municipal authorities.  Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time.  Alcoholic beverage control regulations relate to numerous aspects of the daily operations of each complex, including minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, and storage and dispensing of alcoholic beverages.  We have not encountered any material problems relating to alcoholic beverage licenses to date.  The failure to receive or retain a liquor license, or any other required permit or license, in a particular location, or to continue to qualify for, or renew licenses, could have a material adverse effect on operations and our ability to obtain such a license or permit in other locations.  The failure to comply with other applicable federal, state or local laws, such as federal and state wage and hour laws, may also materially and adversely affect our business.

We are also subject to “dram-shop” statutes in certain states in which complexes are located.  These statutes generally provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated individual.  We carry liquor liability coverage as part of existing comprehensive general liability insurance, which we believe is consistent with coverage carried by other entities in the industry.  Although we are covered by insurance, a judgment against us under a “dram-shop” statute in excess of the liability coverage could have a material adverse effect on operations.

As a result of operating certain entertainment games and attractions, including operations that offer redemption prizes, we are subject to amusement licensing and regulation by the states, counties, and municipalities in which there are complexes.  Certain entertainment attractions are heavily regulated and such regulations vary significantly between communities.  From time-to-time, existing complexes may be required to modify certain games, alter the mix of games, or terminate the use of specific games as a result of the interpretation of regulations by state or local officials.

We are subject to federal, state, and local environmental laws, regulations and other requirements, but these have not had a material adverse effect on operations.  More stringent and varied requirements of local and state governmental bodies with respect to zoning, land use, and environmental factors could delay or prevent development of new complexes in particular locations.  We are subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime, and other working conditions, along with the Americans With Disabilities Act and various family-leave mandates. 

7




Although we expect increases in payroll expenses as a result of federal and state mandated increases in the minimum wage, such increases are not expected to be material.  However, we are uncertain of the repercussion, if any, of increased minimum wages on other expenses, as suppliers may be more severely impacted by higher minimum wage standards.

Employees

As of February 4, 2007, we employed approximately 7,500 persons, approximately 200 of whom served in administrative or executive capacities, approximately 650 of whom served as management personnel, and the remainder of whom were hourly personnel.

None of our employees are covered by collective bargaining agreements, and the Company has never experienced an organized work stoppage, strike, or labor dispute.  We believe working conditions and compensation packages are competitive with those offered by competitors and consider relations with employees to be good.

Available Information

We maintain an internet website with the address of http://www.daveandbusters.com.  You may obtain, free of charge, copies of our reports filed with, or furnished to, the Securities and Exchange Commission (the “SEC”) on Forms 10-K, 10-Q, and 8-K, at our internet website.  These reports will be available as soon as reasonably practicable after filing such material with, or furnishing it to, the SEC.  In addition, you may view and obtain, free of charge, at our website, copies of our corporate governance materials, including, Audit Committee Charter, Compensation Committee Charter, Code of Business Ethics, and Whistle Blower Policy.

ITEM 1A.   RISK FACTORS

We wish to caution you that our business and operations are subject to a number of risks and uncertainties.  The factors listed below are important factors that could cause actual results to differ materially from our historical results and from those projected in forward-looking statements contained in this report, in our other filings with the SEC, in our news releases, written or electronic communications, and verbal statements by our representatives.

You should be aware that forward-looking statements involve risks and uncertainties.  These risks and uncertainties may cause our or our industry’s actual results, performance or achievements to be materially different from any future results, performances or achievements contained in or implied by these forward-looking statements.  Forward-looking statements are generally accompanied by words like “believes,” “anticipates,” “estimates,” “predicts,” “expects,” and other similar expressions that convey uncertainty about future events or outcomes.

Our level of indebtedness could adversely affect our ability to raise additional capital to fund operations, limit our ability to react to changes in the economy or industry and prevent us from meeting our financial obligations.

We are significantly leveraged and our total indebtedness was approximately $254.4 million as of February 4, 2007.  Our substantial indebtedness could have important consequences, including the following:

·                  our ability to obtain additional debt or equity financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes may be limited;

·                  a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on the indebtedness and will not be available for other purposes, including operations, capital expenditures and future business opportunities;

·                  the debt service requirements of our other indebtedness could make it more difficult for us to satisfy other financial obligations;

·                  certain of our borrowings, including borrowings under our senior credit facility, are at variable rates of interest, exposing us to the risk of increased interest rates;

8




·                  our ability to adjust to changing market conditions may be limited and may be placed at a competitive disadvantage compared to less-leveraged competitors; and

·                  we may be vulnerable in a downturn in general economic conditions or in business, or may be unable to carry on capital spending that is important to growth.

Subject to restrictions in the indenture governing the senior notes and in our senior credit facility, we may incur additional indebtedness, which could increase the risks associated with the already substantial indebtedness.  Subject to certain limitations, including compliance with debt covenants, we have the ability to borrow additional funds under the revolving credit facility.

Results of operations are dependent upon discretionary spending by consumers.

Results of operations are dependent upon discretionary spending by consumers, particularly by consumers living in the communities in which our complexes are located.  A significant weakening in any of the local economies in which we operate may cause guests to curtail discretionary spending, which in turn could have a material adverse effect on profitability.  The ongoing conflict in Iraq, potential for future terrorist attacks, the national and international responses thereto and other acts of war or hostility may create economic and political uncertainties that could have a material adverse effect on business, results of operations and financial condition in ways we currently cannot predict.  Furthermore, increases in gasoline and other energy costs could lead to a decline in discretionary spending and have a material adverse effect on profitability.

We operate a limited number of complexes, and new complexes require significant investment.

As of February 4, 2007, we operated 48 complexes.  The combination of the relatively limited number of locations and the significant investment associated with each new complex may cause operating results to fluctuate significantly.  Due to this relatively limited number of locations, poor results of operations at any single complex could materially affect profitability.  Historically, new complexes experience a drop in revenues after their first year of operation, and we do not expect that, in subsequent years, any increases in comparable revenues will be meaningful.  Additionally, because of the substantial up-front financial requirements to open new complexes, the investment risk related to any single complex is much larger than that associated with most other companies’ restaurant or entertainment venues.

We may not be able to compete favorably in the highly competitive out-of-home and home-based entertainment market.

The out-of-home entertainment market is highly competitive.  There are a great number of businesses that compete directly and indirectly with us.  Many of these entities are larger and have significantly greater financial resources and a greater number of units.  We compete for customers’ discretionary entertainment dollars with theme parks as well as with providers of out-of-home entertainment, including localizing attraction facilities such as movie theatres, bowling alleys, nightclubs, and restaurants.  We may encounter increased competition in the future, which may have an adverse effect on profitability.  In addition, the legalization of casino gambling in geographic areas near any current or future complex would create the possibility for entertainment alternatives, which could have a material adverse effect on our business and financial condition.  In addition, we may also face increased competition from home-based forms of entertainment such as internet gaming and home movie delivery.

Our operations are subject to many government laws, regulations and other requirements and if we fail to comply with them, the business and financial condition could be adversely affected.

Various federal, state and local laws and permitting and license requirements affect the business, including those enforced by alcoholic beverage control, and other amusement, environmental, health and safety and fire agencies in the state, county or municipality in which each complex is located.  See “Business – Government Regulation.”

We may face difficulties in attracting and retaining qualified employees.

The operation of the business requires qualified executives, managers, and skilled employees.  From time-to-time, there may be a shortage of skilled labor in certain of the communities in which our complexes are located.  Shortages of skilled labor may make it increasingly difficult and expensive to attract, train, and retain the services of a satisfactory number of qualified employees.  In addition, our future success will continue to depend largely on the efforts and abilities of senior management.  The ability to attract and retain qualified employees or the loss of the services of members of senior management for any reason could materially adversely affect our business, results of operations and financial condition.

9




Our growth depends upon our ability to open new complexes.

Our ability to expand depends upon obtaining sufficient capital, locating and obtaining appropriate sites, hiring and training additional management personnel and constructing or acquiring, at reasonable cost, the necessary improvements, and equipment for these complexes.  In particular, the capital resources required to develop each new complex are significant.  There is no assurance that we will be able to expand or that new complexes, if developed, will perform in a manner consistent with the most recently opened complexes or make a positive contribution to operating performance.

Local conditions, events, and natural disasters could adversely affect our business.

Certain of the regions in which our complexes are located have been, and may in the future be, subject to adverse local conditions, events, or natural disasters, such as earthquakes and hurricanes.  Depending upon its magnitude, a natural disaster could severely damage our complexes, which could adversely affect our business, financial condition, and operations.  We currently maintain property and business interruption insurance through the aggregate property policy for each of the complexes.  However, there is no assurance that the coverage will be sufficient if there is a major disaster.  In addition, upon the expiration of the current policies, there is no assurance that adequate coverage will be available at economically justifiable rates, if at all.

Our operations are susceptible to changes in product costs, which could adversely affect operating results.

Our profitability depends in part on our ability to anticipate and react to changes in product costs.  Various factors beyond our control, including adverse weather conditions, governmental regulations, production, availability, and seasonality may affect food costs or cause a disruption in supply.  The availability of new amusement offerings, the cost, and availability of redemption items that appeal to guests and the market demand for new games can adversely impact the cost to acquire and operate new amusements.  We cannot predict whether we will be able to anticipate and react to changing food, beverage, and amusements costs by adjusting purchasing practices, menu and game prices, and a failure to do so could have a material adverse effect on our operating results.

Complaints or litigation may adversely affect the business.

Occasionally, guests file complaints or lawsuits against us alleging that we are responsible for some illness or injury they suffered at or after a visit to a complex.  We are also subject to a variety of other claims in the ordinary course of business, including personal injury claims, lease and contract claims, and employment-related claims.  The restaurant industry has also been subject to a growing number of claims that the menus and actions of restaurant chains have led to the obesity of certain of their guests.  In addition, we are subject to “dram shop” statutes and are currently the subject of certain lawsuits that allege violations of these statutes.  These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person.  Recent litigation against restaurant chains has resulted in significant judgments and settlements under dram shop statutes.  Because these cases often seek punitive damages, which may not be covered by insurance, such litigation could have an adverse impact on the financial condition and results of operations.  Regardless of whether any claims against us are valid or whether we are liable, claims may be expensive to defend and may divert time and money away from operations and hurt performance.  A judgment significantly in excess of the insurance coverage could have a material adverse effect on the financial condition or results of operations.  Further, adverse publicity resulting from these allegations may materially affect us and our complexes.

We may not be able to renew real property leases on current favorable terms.

Of the 48 complexes operated by us as of February 4, 2007, 47 complexes are operated on leased premises.  Certain leases are long-term leases at rents we believe to be below current market rates.  Other such leases have rents fixed at a percentage of the revenue generated by the complexes on the leased premises.  We may choose not to renew, or may not be able to renew, certain of such existing leases if the capital investment then required to maintain the complexes at the leased locations is not justified by the return on the required investment.  If we are not able to renew the leases at rents that allow such complexes to remain profitable as their terms expire, the number of the complexes may decrease, resulting in lower revenue from operations, which may impact the ability to meet the financial goals.

10




Our success depends in part on the ability to protect our intellectual property rights, but our intellectual property may be misappropriated or may be subject to infringement claims by third parties.

We currently rely on a combination of registered and unregistered trademarks, copyrights, patent rights, and domain names to protect certain aspects of the business.  While we attempt to ensure that the intellectual property and similar proprietary rights are protected and that the third party rights needed are licensed to us when entering into business relationships, there can be no assurance that any of the applications for protection of the intellectual property rights will be approved or that third parties will not take actions that could have a material adverse effect on the rights or the value of the intellectual property, similar proprietary rights or reputation.  Furthermore, we can give no assurance that claims or litigation asserting infringement of intellectual property rights will not be initiated by third parties seeking damages, the payment of royalties or licensing fees or that we would prevail in any litigation or be successful in preventing any such judgment.  In the future, we may also rely on litigation to enforce the intellectual property rights and contractual rights, and, if not successful, we may not be able to protect the value of the intellectual property.  Any litigation could be protracted and costly and could have a material adverse effect on our business and results of operations, regardless of its outcome.  Infringement claims against us could also result in costly and burdensome litigation, require us to enter into royalty or other licensing agreements, require us to pay damages, harm our reputation, require us to redesign or rename the complexes and products, or prevent us from doing business using certain trade names.  Although we believe that the intellectual property rights are sufficient to allow us to conduct business without incurring liability, our products may infringe on the intellectual property rights of third parties, and our intellectual property rights may not have the value we believe them to have.

Increases in labor costs could harm the business.

From time-to-time, the U.S. Congress and the states consider increases in the applicable minimum wage.  Several states in which we operate have recently enacted increases in the minimum wage, which have taken or will take effect in 2007.  The out-of-home entertainment industry is intensely competitive, and we may not be able to transfer any resulting increase in operating costs to guests in the form of price increases, or to otherwise adjust to these increases, which could have a material adverse effect on our results of operations.

Increases in energy costs could harm business.

Our success depends in part on the ability to absorb increases in utility costs.  Most of the complexes have experienced increases in utility prices.  If these increases should continue, and if we are unable to transfer these cost increases to guests in the form of price increases, they will have an adverse effect on our profitability.

Our financial results are subject to quarterly fluctuations and the seasonality of our business.

Our operating results may fluctuate significantly from period to period, and the results for one period may not be indicative of results for other periods.  The operating results may also fluctuate significantly because of several factors, including the frequency and popularity of sporting events and year-end holidays (including which day of the week the events occur), new complex openings and related expenses and weather conditions.

We expect seasonality will continue to be a factor in the results of operations.  Historically, revenues have been substantially higher in the fourth quarter driven in part by the increased number of holiday parties held during that time of year.  Our revenues and profitability have been lower during the third quarter with the first and second quarter being somewhat similar in results, and we expect these trends to continue in the future.  (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Quarterly fluctuations, seasonality and inflation.”)

The timing of new complex openings may also result in significant fluctuations in quarterly performance.  We typically incur most startup costs for a new complex within the two months immediately preceding, and the month of, the complex’s opening.  In addition, the labor and operating costs for a newly opened complex during the first three to six months of operation, including startup costs, are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues.  Our growth, operating results and profitability will depend to a large degree on the ability to increase the number of complexes.

ITEM 1B.       UNRESOLVED STAFF COMMENTS

Not applicable.

11




ITEM 2.          PROPERTIES

The following table sets forth the number of complexes which we currently operate in each state/country.  Unless otherwise indicated, each of the complexes listed below is leased.

State or Country

 

Number of
Complexes

 

 

 

Arizona

 

1

California

 

6

Colorado

 

2

Florida

 

3

Georgia(a)

 

3

Hawaii

 

1

Illinois

 

2

Kansas

 

1

Maryland

 

2

Michigan

 

1

Minnesota

 

1

Missouri

 

1

Nebraska

 

1

New York

 

6

North Carolina

 

1

Ohio

 

3

Pennsylvania

 

3

Rhode Island

 

1

Tennessee

 

1

Texas(b)

 

7

Toronto, Canada

 

1

TOTAL

 

48

 


(a)                                  Includes one Jillian’s complex that operates under the terms of a limited partnership agreement for which we serve as manager and general partner.

(b)                                 One complex in the state is owned.

We also lease a 47,000 square foot office building and 30,000 square foot warehouse facility in Dallas, Texas, for use as our corporate headquarters and distribution center.  This lease expires in October 2021, with options to renew until October 2041.  We also lease a 22,900 square foot warehouse facility in Dallas, Texas, for use as additional warehouse space.  This lease expires in January 2009.

ITEM 3.          LEGAL PROCEEDINGS

We are subject to certain legal proceedings and claims that arise in the ordinary course of our business.  Two class action cases have been filed against us and one of our subsidiaries in the State of California alleging violations of California regulations concerning mandatory meal breaks and rest periods.  We are working to have these two cases consolidated and coordinated because the potential class members are virtually identical.  Therefore, settlement of one case would resolve both cases.  Various factors, including our internal policies and evidence of compliance with State of California regulations, make early resolution of these cases a possibility.

Various actions have been filed against us and certain subsidiaries based on disagreements with landlords related to the amounts of rent related obligations.  In March 2007, we entered into a confidential settlement agreement and release with the owner of the Jillian’s complex located at the Mall of America in Bloomington, Minnesota resolving all disputes arising out of our leases for space and decision to close the acquired Jillian’s complex.

We have made the appropriate provision for settlement in the above matters in our 2006 financial statements.  In the opinion of management, based upon consultation with legal counsel, the amount of ultimate liability with respect to all other actions will not materially affect the consolidated results of our operations or our financial condition.

12




ITEM 4.                             SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders during the quarter ended February 4, 2007.

PART II

ITEM 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

There is no established public trading market for our capital stock.  One hundred percent of our outstanding capital stock is owned by WS Midway.  There were no repurchases of our capital stock in the fourth quarter of 2006.

ITEM 6.                             SELECTED FINANCIAL DATA

The following selected financial data is qualified in entirety by the consolidated financial statements (and the related Notes thereto) contained in Item 8 and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.  We derived the selected financial data as of February 4, 2007 and January 29, 2006 and for the 334-day period ended February 4, 2007, 37-day period ended March 7, 2006, and the fiscal years ended January 29, 2006, and January 30, 2005, from the audited consolidated financial statements and related notes.  All references to 2006 relate to the combined 53-week period ending on February 4, 2007 while the other years presented consist of 52-weeks of operations.

 

 

334-Day Period
from March 8,
2006 to
February 4, 2007

 

 

37-Day Period
From January
30, 2006 to
March 7, 2006

 

Fiscal Year
Ended(1)
January 29, 2006

 

Fiscal Year
Ended(2)
January 30, 2005

 

Fiscal Year
Ended
February 1, 2004

 

Fiscal Year
Ended
February 2, 2003

 

(dollars in thousands)

 

(Successor)

 

 

(Predecessor)

 

(Predecessor)

 

(Predecessor)

 

(Predecessor)

 

(Predecessor)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

459,792

 

 

$

50,409

 

$

463,452

 

$

390,267

 

$

362,822

 

$

373,752

 

Operating income

 

6,409

 

 

1,557

 

12,999

 

25,391

 

23,466

 

14,823

 

Cumulative effect of a change in an accounting principle, net of income taxes(3)

 

 

 

 

 

 

 

(7,096

)

Net income (loss)

 

(12,063

)

 

486

 

4,288

 

12,880

 

10,921

 

(2,008

)

Balance sheet data (as of end of period):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

10,372

 

 

 

 

7,582

 

11,387

 

6,935

 

2,530

 

Working capital (deficit)

 

(31,430

)

 

 

 

(37,206

)

(7,656

)

(220

)

(4,231

)

Property and equipment, net

 

316,840

 

 

 

 

351,883

 

331,478

 

291,473

 

296,770

 

Total assets

 

506,813

 

 

 

 

423,062

 

401,171

 

340,201

 

338,531

 

Total debt

 

254,375

 

 

 

 

80,175

 

88,143

 

53,534

 

67,794

 

Stockholders’ equity

 

96,705

 

 

 

 

205,220

 

196,945

 

179,784

 

166,585

 

Other data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

31,943

 

 

$

10,600

 

$

62,066

 

$

34,234

 

$

24,292

 

$

22,956

 

Number of complexes at end of period

 

48

 

 

46

 

46

 

43

 

33

 

32

 

 


(1)                      On August 28, 2005, a subsidiary closed the acquired Jillian’s complex. As a result of the closing, we recorded a pre-tax charge of approximately $3,000 comprised of approximately $2,500 in non-cash charges for depreciation, amortization and asset impairment charges and approximately $500 related to severance and other costs required to close the complex.

(2)                      On November 1, 2004, we completed the acquisition of nine Jillian’s locations, pursuant to an asset purchase agreement, for cash and the assumption of certain liabilities.  The results of the acquired complexes are included in the consolidated results beginning on the date of acquisition.

(3)                      “Cumulative effect of a change in accounting principle” reflects the adoption of Statement of Financial Accounting Standards 142, “Goodwill, and Other Intangible Assets” (“SFAS 142”).  On February 4, 2002, we adopted SFAS 142, which requires annual impairment analyses of intangible assets.  In connection with the adoption of this standard, an impairment analysis was performed resulting in the write-off of goodwill to expense in the amount of $7,096.

13




ITEM 7.                            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with the audited consolidated financial statements, and related notes.  Unless otherwise specified, the meanings of all defined terms in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are consistent with the meanings of such terms as defined in the Notes to Consolidated Financial Statements.

General

Our fiscal year ends on the Sunday after the Saturday closest to January 31.  All references to 2006 relate to the combined 53-week period ending on February 4, 2007.  As discussed further below, fiscal 2006 is comprised of the 334-day period ended February 4, 2007 of the Successor and the 37-day period ended March 7, 2006 of the Predecessor, respectively.  All references to 2005 and 2004 relate to the 52-week periods ending on January 29, 2006 and January 30, 2005.  All dollar amounts are presented in thousands, unless otherwise noted, except share and per share amounts.

Merger with WS Midway Acquisition Sub, Inc.

Dave & Buster’s was acquired on March 8, 2006, by WS Midway through the Merger.  Affiliates of Wellspring and HBK control approximately 82 percent and 18 percent, respectively, of the outstanding capital stock of WS Midway.  Although we continue as the same legal entity after the Merger, the accompanying condensed consolidated statements of operations, stockholders’ equity, and cash flows present the results of operations and cash flows for us and our wholly-owned subsidiaries for the periods preceding the Merger (“Predecessor”) and the period succeeding the Merger (“Successor”), respectively.

At the effective time of the Merger discussed above, the following events occurred:

1.                                       All outstanding shares of our common stock (including those issued upon the conversion of our convertible subordinated notes), other than shares held by WS Midway, were converted into the right to receive $18.05 per share without interest, less any applicable withholding taxes;

2.                                       Holders of up to approximately 2.6 million shares exercised dissenters’ rights and initiated proceedings under Section 351.455 of the General and Business Corporation Law of Missouri to demand fair value with respect to their shares.

3.                                       All outstanding options or warrants to acquire our common stock were converted into the right to receive an amount in cash equal to the difference between the per share exercise price and $18.05, without interest, less any applicable withholding taxes; and

4.                                       To the extent not converted into shares of common stock, we redeemed for cash the convertible subordinated notes due 2008 and the indenture governing the convertible notes ceased to have any effect.

On July 10, 2006, we reached an agreement with all dissenting shareholders which provided, among other things, for the permanent and irrevocable settlement of all claims among the parties.  The terms of the settlement included the payment of approximately $51,733 to the shareholders in accordance with the terms of the settlement agreement.  Payments of the settlement were funded from borrowings under the senior credit facility and available cash.

The Merger transactions resulted in a change in ownership of 100 percent of our outstanding common stock and is being accounted for in accordance with Statement of Financial Accounting Standards 141, “Business Combinations.”  The purchase price paid in the Merger has been “pushed down” to our financial statements and is allocated to record the acquired assets and liabilities assumed based on their fair value.  The Merger and the allocation of the purchase price to the assets and liabilities as of March 8, 2006 have been recorded based on valuation studies and management estimates of fair value.  Adjustments to the purchase price allocation, if any, arising out of the finalization of the allocation of the purchase price will not impact cash flow including cash interest and rent.

14




The sources and uses of funds in connection with the Merger as of February 4, 2007 are summarized below:

Sources

 

 

 

Revolving credit facility and cash on hand

 

$

17,628

 

Senior credit facility(1)

 

100,000

 

Senior notes

 

175,000

 

Equity contribution

 

108,100

 

Total sources

 

$

400,728

 

 

 

 

 

Uses

 

 

 

Consideration paid to stockholders

 

$

264,835

 

Consideration paid to convertible note and warrant holders

 

44,390

 

Consideration paid to option holders

 

9,279

 

Payment of existing debt

 

51,137

 

Transaction costs (2)

 

31,087

 

Total uses

 

$

400,728

 

 


(1)          As of the date of the Merger, March 8, 2006, $50,000 of the senior credit facility was available and $50,000 was available on a delayed draw basis and was borrowed on August 15, 2006.

(2)          Transaction costs assumed in connection with the Merger include approximately $12,739 related to the exercise of Change in Control agreements by certain executives.

Acquisitions and Disposals

On November 15, 2006, we completed the sale and simultaneous leaseback of the land and buildings of three owned facilities located in the states of Florida, Illinois, and Ohio.  The gross proceeds of $29,600 approximated the carrying value of the assets.  Net proceeds from the transaction were used to pay down outstanding balances on the Company’s senior credit and revolving credit facilities after a $5,000 hold back for reinvestment.

We agreed to leaseback these facilities from National Retail Properties, Inc. under various operating lease agreements, which have an initial term of 17.5 years.  The leases require us to make monthly rental payments, which aggregate to $2,453 on an annual basis.  Rental payments under the leases are subject to adjustment based on defined changes in the Consumer Price Index.  In addition to the rental payments described above, we are required to pay the property taxes and certain maintenance charges related to the properties.

In October 2005, we acquired the general partner interest in a limited partnership which owns a Jillian’s complex in the Discover Mills Mall near Atlanta, Georgia.  The limited partner currently earns a preferred return on its remaining invested capital.  We currently have a 50.1 percent interest in the income or losses of the partnership.  After deducting the preferred return to the limited partner, our interest in the income or losses of the partnership is not expected to be significant to the results of operations unless the limited partner receives a full return of its invested capital and preferred return which is not expected to occur in the foreseeable future.  We also manage the complex under a management agreement and receive a fee of 4.0 percent of operating revenues annually.  We account for the general partner interest using the equity method due to the substantive participative rights of the limited partner in the operations of the partnership.

On November 1, 2004, we completed the acquisition of nine Jillian’s entertainment complexes located in major metropolitan areas in the states of Arizona, Maryland, Minnesota, North Carolina, New York, Pennsylvania, Tennessee, and Texas.  The acquisition was completed pursuant to an asset purchase agreement for $45,747 in cash.  In addition, we incurred $2,369 in costs related to the transaction.  The results of the operations of the acquired complexes have been included in the consolidated results beginning on the date of acquisition.  The historical results of operations of the acquired complexes were not significant compared to the historical consolidated results of operations.

On August 28, 2005, a subsidiary of ours closed the acquired Jillian’s complex located at the Mall of America in Bloomington, Minnesota due to continuing operating losses attributable to this complex and the unsuccessful efforts to renegotiate the terms of the related leases.  As a result of the closing, we recorded total pre-tax charges of approximately $3,000 in fiscal 2005, comprised of approximately $2,500 in non-cash charges for depreciation, amortization and asset impairment charges and approximately $500 related to severance and other costs required to close the complex.

15




We have converted six of the former Jillian’s locations to the “Dave & Buster’s Grand Sports Café” brand.  We believe this conversion has enhanced efforts to improve the operating economics of the Dave & Buster’s brand throughout the system.  We began converting the stores in September 2005, and converted five of the stores in fiscal 2005.  One additional store was converted in the first quarter of 2006.  We plan to convert two of the remaining Jillian’s locations to Dave & Buster’s during the 2007 fiscal year.

Overview

We monitor and analyze a number of key performance measures and indicators in order to manage our business and evaluate financial and operating performance.  Those indicators include:

Revenues.  We derive revenues primarily from food, beverage, and amusement sales.  For the fiscal year ended February 4, 2007, we derived 36.7 percent of our total revenue from food sales, 19.0 percent from beverage sales, 42.1 percent from amusement sales, and 2.2 percent from other sources.  We continually monitor the success of current food and beverage items, the availability of new menu offerings, the menu price structure, and our ability to adjust prices where competitively appropriate.  In the beverage component, we operate fully licensed facilities, which means we offer full beverage service, including alcoholic beverages throughout the complex.  Our complexes also offer an extensive array of amusements, including state-of-the-art simulators, high-tech video games, traditional pocket billiards and shuffleboard, as well as a variety of redemption games, which dispense coupons that can be redeemed for prizes in the Winner’s Circle.  Our redemption games include basic games of skill, such as skee-ball and basketball.  The prizes in the Winner’s Circle range from small-ticket novelty items to high-end electronics, such as flatscreen televisions.  We review the game play on existing amusements in an effort to match amusements availability with guest preferences.  We will continue to invest in new games as they become available and prove to be attractive to guests.  Exclusive of new store openings, we invested approximately $5,900 in new games during 2006.  We currently anticipate spending approximately $8,000 on new games during fiscal 2007.

We believe that special events business is a very important component of our revenue, because a significant percentage of our guests attending a special event are in a Dave & Buster’s for the first time.  This is a very advantageous way to introduce the concept to new guests.  Accordingly, a considerable emphasis is placed on this area through the in-store sales teams.

Cost of products.  Cost of products includes the cost of food, beverages, and Winner’s Circle amusement items.  During fiscal 2006, the cost of food products averaged 25.2 percent of food revenue and the cost of beverage products averaged 25.3 percent of beverage revenue.  The amusement cost of products averaged 12.7 percent of amusement revenues.  The cost of products is driven by product mix and pricing movements from third party suppliers.  We continually strive to gain efficiencies in both the acquisition and use of products while maintaining high standards of product quality.

Operating payroll and benefits.  Operating payroll and benefits consist of wages, employer taxes, and benefits for store personnel.  We continually review the opportunity for efficiencies principally through scheduling refinements.

Other store operating expenses.  Other store operating expenses consist of store-related occupancy, restaurant expenses, utilities, repair and maintenance and marketing costs.

Liquidity and cash flows.  The primary source of cash flow is from our operating activities and availability under the revolving credit facility.

Quarterly fluctuations, seasonality, and inflation.  As a result of the substantial revenues associated with each new complex, the timing of new complex openings will result in significant fluctuations in quarterly results.  We also expect seasonality to be a factor in the operation or results of the business in the future with anticipated lower third quarter revenues and higher fourth quarter revenues associated with the year-end holidays.  Additionally, we expect that volatile energy costs will continue to exert pressure on both supplier pricing and consumer spending related to entertainment and dining alternatives.  Although, there is no assurance that our cost of products will remain stable or that the federal or state minimum wage rate will not increase, the effects of any supplier price increases or minimum wage rate increases are expected to be partially offset by selected menu price increases where competitively appropriate.  We expect that its historically higher revenues during the fourth quarter due to the winter holiday season will continue to make the financial results susceptible to the impact of severe weather on customer traffic and sales during that period.

16




Results of Operations

The following table sets forth selected data in thousands of dollars and as a percentage of total revenues (unless otherwise noted) for the periods indicated.  All information is derived from the consolidated statements of operations included in this Form 10-K.

(dollars in thousands)

 

334-Day Period from
March 8, 2006 to
February 4, 2007

 

37-Day Period from
January 30, 2006 to
March 7, 2006

 

Fiscal Year
Ended
February 4, 2007

 

Fiscal Year
Ended
January 29, 2006

 

Fiscal Year
Ended
January 30, 2005

 

 

 

(Successor)

 

(Predecessor)

 

(Combined)

 

(Predecessor)

 

(Predecessor)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Food and beverage revenues

 

$

256,616

 

55.8

%

 

$

27,562

 

54.7

%

$

284,178

 

55.7

%

$

253,996

 

54.8

%

$

209,689

 

53.7

%

Amusement and other revenues

 

203,176

 

44.2

 

 

22,847

 

45.3

 

226,023

 

44.3

 

209,456

 

45.2

 

180,578

 

46.3

 

Total revenues

 

459,792

 

100.0

 

 

50,409

 

100.0

 

510,201

 

100.0

 

463,452

 

100.0

 

390,267

 

100.0

 

Cost of food and beverage (as a percentage of food and beverage revenues)

 

64,549

 

25.2

 

 

7,111

 

25.8

 

71,660

 

25.2

 

65,405

 

25.8

 

53,890

 

25.7

 

Cost of amusements and other (as a percentage of amusement and other revenues) (1)

 

28,999

 

14.3

 

 

3,268

 

14.3

 

32,267

 

14.3

 

28,723

 

13.7

 

24,344

 

13.5

 

Total cost of products

 

93,548

 

20.4

 

 

10,379

 

20.6

 

103,927

 

20.4

 

94,128

 

20.3

 

78,234

 

20.0

 

Operating payroll and benefits (1)

 

130,123

 

28.3

 

 

14,113

 

28.0

 

144,236

 

28.3

 

130,367

 

28.2

 

109,062

 

27.9

 

Other store operating expenses (1)

 

147,295

 

32.0

 

 

15,323

 

30.4

 

162,618

 

31.9

 

144,066

 

31.1

 

113,810

 

29.2

 

General and administrative expenses(1)

 

35,055

 

7.6

 

 

3,829

 

7.6

 

38,884

 

7.6

 

33,951

 

7.3

 

28,237

 

7.2

 

Depreciation and amortization expense

 

43,892

 

9.5

 

 

4,328

 

8.6

 

48,220

 

9.4

 

42,616

 

9.2

 

34,238

 

8.8

 

Startup costs

 

3,470

 

0.8

 

 

880

 

1.7

 

4,350

 

0.8

 

5,325

 

1.1

 

1,295

 

0.3

 

Total operating costs

 

453,383

 

98.6

 

 

48,852

 

96.9

 

502,235

 

98.4

 

450,453

 

97.2

 

364,876

 

93.4

 

Operating income

 

6,409

 

1.4

 

 

1,557

 

3.1

 

7,966

 

1.6

 

12,999

 

2.8

 

25,391

 

6.6

 

Interest expense, net

 

27,064

 

5.9

 

 

649

 

1.3

 

27,713

 

5.4

 

6,695

 

1.4

 

5,586

 

1.4

 

Income (loss) before provisions for income taxes

 

(20,655

)

(4.5

)

 

908

 

1.8

 

(19,747

)

(3.8

)

6,304

 

1.4

 

19,805

 

5.2

 

Provision (benefit) for income taxes

 

(8,592

)

(1.9

)

 

422

 

0.8

 

(8,170

)

(1.5

)

2,016

 

0.4

 

6,925

 

1.8

 

Net income (loss)

 

$

(12,063

)

(2.6

)%

 

$

486

 

1.0

%

$

(11,577

)

(2.3

)%

$

4,288

 

1.0

%

$

12,880

 

3.4

%

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

43,678

 

 

 

 

$

10,741

 

 

 

$

54,419

 

 

 

$

65,423

 

 

 

$

49,064

 

 

 

Investing activities

 

(341,104

)

 

 

 

(10,600

)

 

 

(351,704

)

 

 

(63,271

)

 

 

(81,772

)

 

 

Financing activities

 

299,986

 

 

 

 

89

 

 

 

300,075

 

 

 

(5,957

)

 

 

37,160

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in comparable store sales(2)

 

 

 

 

 

 

 

 

 

 

 

 

5.5

%

 

 

1.5

%

 

 

(0.2

)%

Stores open at end of period(3)

 

48

 

 

 

 

46

 

 

 

48

 

 

 

46

 

 

 

43

 

 

 

Comparable stores open at end of period

 

33

 

 

 

 

33

 

 

 

33

 

 

 

33

 

 

 

32

 

 

 

 


(1)                   Certain prior period balances have been reclassified to conform to the current period presentation and to reflect successor management’s view of store level operations, as shown below:

a)                     Costs associated with multi-unit operations personnel have been reclassified from operating expenses to general and administrative expenses.

b)                    Certain costs associated with special events revenue have been reclassified from other store operating to cost of amusements and other.

c)                     Certain costs associated with cost of goods sold have been reclassed from other store operating to cost of food and beverage and cost of amusements and other.

Amount of increase (decrease) in previously reported costs:

 

334-Day Period
from March 8,
2006 to
February 4, 2007

 

37-Day Period
From January
30, 2006 to
March 7, 2006

 

Fiscal Year
Ended
February 4, 2007

 

Fiscal Year
Ended
January 29, 2006

 

Fiscal Year
Ended
January 30, 2005

 

(dollars in thousands)

 

(Successor)

 

 

(Predecessor)

 

(Combined)

 

(Predecessor)

 

(Predecessor)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of food and beverage

 

$

 

 

$

 

$

 

$

3,587

 

$

2,523

 

Cost of amusements and other

 

 

 

85

 

85

 

3,248

 

2,640

 

Operating payroll and benefits

 

 

 

(252

)

(252

)

(2,017

)

(1,480

)

Other store operating

 

 

 

(182

)

(182

)

(7,611

)

(5,699

)

General and administrative expenses

 

 

 

349

 

349

 

2,793

 

2,016

 

Total operating costs

 

$

 

 

$

 

$

 

$

 

$

 

 

(2)                   “Comparable store sales” (year-over-year comparison of complexes open at least 18 months as of the beginning of each of the fiscal years) is a key performance indicator used within the industry and is indicative of acceptance of our initiatives as well as local economic and consumer trends.

17




(3)                   The number of stores open at February 4, 2007 includes the openings of complexes in New York Times Square on April 5, 2006, and Maple Grove, Minnesota on November 13, 2006, and the openings of complexes in Omaha, Buffalo and Kansas City in the second, third and fourth quarters of 2005, respectively.

Fiscal 2006 Compared to Fiscal 2005

Revenues

Fiscal 2006 consisted of 53-weeks compared to 52-weeks in fiscal 2005.  Where appropriate for comparative purposes, we have estimated the changes in fiscal 2006 operating results versus an estimated 53-week period for fiscal 2005.

Total revenues increased 10.1 percent, or $46,749, for the 53-weeks of 2006 compared to the 52-weeks of fiscal 2005.  We have estimated the revenues during the 53rd week of fiscal 2006 to be $9,018.  The revenue growth provided by the additional week of sales in fiscal 2006 was partially offset by a $2,367 non-cash reduction in revenue related to the deferral of amusement revenue during the 334-day period from the Merger date to February 4, 2007.  The revenue deferral represents our estimate of the amount of amusement and other revenues during the current fiscal year that will be fulfilled by customer game play in subsequent periods, and has no impact on our business or cash flow.  However, the deferral of this revenue reduced our GAAP (“Generally Accepted Accounting Principles”) amusement revenue during the current fiscal year.

We have estimated that the increases in revenues were derived from the following sources:

 

 

Impact of

 

 

 

 

 

Additional

 

Deferral of

 

 

 

 

 

 

 

Week in

 

Amusement

 

Ongoing

 

 

 

(dollars in thousands)

 

Fiscal Period

 

Revenue

 

Operations

 

Total

 

 

 

 

 

 

 

 

 

 

 

Comparable stores

 

$

6,646

 

$

(1,834

)

$

15,493

 

$

20,305

 

Non-comparable stores:

 

 

 

 

 

 

 

 

 

Stores opened or acquired prior to fiscal 2005

 

1,588

 

(357

)

4,426

 

5,657

 

Stores opened in 2005

 

316

 

(117

)

11,980

 

12,179

 

Stores opened in 2006

 

468

 

(59

)

13,652

 

14,061

 

Closed stores and other

 

 

 

(5,453

)

(5,453

)

Total

 

$

9,018

 

$

(2,367

)

$

40,098

 

$

46,749

 

 

Comparable store sales, excluding the impact of the revenue deferral described above, increased by approximately 4.1 percent in fiscal 2006 compared to an estimated 53-week fiscal 2005.  Comparable special events revenues accounted for 17.3 percent of consolidated comparable store revenue for fiscal 2006, up from 17.2 percent in fiscal 2005.

Food sales at comparable stores increased by 7.0 percent over fiscal 2005 (5.2 percent increase compared to an estimated 53-week fiscal 2005).  Our revenues were supported by 19-weeks of advertising on cable television in all of the markets and supplemental spot radio advertising in selected markets.  Our marketing efforts in 2006 focused on national cable and spot radio, which has proven more effective than the radio and print used in 2005.  The increase in food sales was accomplished in part by the continued success of the “Power Combo” promotion.  Beverage sales at comparable stores increased by 6.9 percent over fiscal 2005 (4.8 percent increase compared to an estimated 53-week fiscal 2005) as we experienced continued positive results of promotional activity around the beverage component of our business.  Comparable store amusements and other revenue in fiscal 2006 increased by 3.6 percent versus 2005.  Comparable store amusement and other revenue, excluding the impact of the revenue deferral described above, increased 2.9 percent in fiscal 2006 compared to an estimated 53-week fiscal 2005.

Our revenue mix was 55.7 percent for food and beverage and 44.3 percent for amusements and other for fiscal 2006.  This compares to 54.8 percent and 45.2 percent for fiscal 2005.  The shift in the revenue mix was operationally influenced by the success of two promotional efforts launched in the middle of the second quarter of 2005, the “Power Combo” promotion, and the “Super Charge” promotion.  The “Power Combo” promotion provides guests with a value offering that includes selected entrees and a game card at a fixed price.  The “Super Charge” promotion allows guests to increased purchased game play on certain Power Cards by twenty-five percent for a discounted amount.  The deferral of amusement revenue discussed above during the 2006 Successor operating period exaggerated the impact of the operating initiatives on our sales mix.  Our revenue mix, excluding the impact of the current year revenue deferral was 55.4 percent food and beverage, 44.6 percent amusements and other.

18




Cost of Products

Cost of food and beverage products declined 60 basis points to 25.2 percent of revenue for fiscal 2006 compared to 25.8 percent for fiscal 2005.  Decreases in dairy, meat, grocery, liquor and wine costs were offset by slight increases in the cost of beer compared to fiscal 2005.

The costs of amusements and other, as a percentage of amusements and other revenues increased 60 basis points to 14.3 percent for fiscal 2006 compared to 13.7 percent for 2005.  This increase is primarily a result of the revenue mix changes described above and increased freight charges.

Operating Payroll and Benefits

Operating payroll and benefits slightly increased as a percent of revenue at 28.3 percent for fiscal 2006 compared to 28.2 percent for fiscal 2005.

Other Store Operating Expenses

Other store operating expenses increased to 31.9 percent from 31.1 percent for fiscal 2006 compared to fiscal 2005.  The increase in other operating expenses is primarily associated with a $3,100 non-cash charge, attributable to a change in the estimate related to liabilities for general liability and workers compensation claims.  Our revised estimates were derived from an actuarial study completed in the fourth quarter of fiscal 2006.  The additional expense recorded as a result of the change in estimate is primarily attributable to open policy years prior to fiscal 2006.  We do not believe that the adjustments recorded in the fourth quarter of fiscal 2006 reflect a material difference in the historic trends of our business nor will they adversely affect our business outlook.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel, facilities, and professional expenses for the various departments of our corporate headquarters.  General and administrative expenses increased 30 basis points for fiscal 2006 compared to fiscal 2005.  Reductions in costs incurred for audit services were offset by expenses associated with the Merger transactions, including employment agreement costs triggered by the Merger transaction, litigation expenses, and provision for estimated incentive compensation programs.

Depreciation and Amortization Expense

Depreciation and amortization expense increased $5,604 primarily due to 53-weeks of depreciation in 2006 compared to 52-weeks in 2005, new store openings in 2006 and 2005, and the conversion of six of the Jillian’s locations acquired in fiscal 2004 to Dave & Buster’s Grand Sports Café brand in 2006 and 2005.  Depreciation and amortization expense in fiscal 2005 also included a $2,500 charge in the second quarter of 2005 related to the closing of the Jillian’s entertainment complex located at the Mall of America in Bloomington, Minnesota.  The $2,500 charge consisted of additional depreciation, amortization, and impairment of the assets which were abandoned and whose carrying value was not recoverable.

Startup Costs

Startup costs include costs associated with the opening and organizing of new complexes or conversion of existing complexes, including the cost of feasibility studies, staff training and recruiting, and travel costs for employees engaged in such startup activities.  All startup costs are expensed as incurred.  The decrease in startup costs is primarily attributable to the opening of the Times Square and Maple Grove locations in the first and fourth quarters of 2006, respectively, compared to the opening of the Omaha, Buffalo and Kansas City locations in the second, third and fourth quarters of 2005, respectively.  Startup costs were also impacted in the first quarter of 2006 due to the conversion of one of the Jillian’s locations to Dave & Buster’s Grand Sports Café brand.  We converted five of the Jillian’s stores in the third and fourth quarters of 2005.

Interest Expense

The increase in interest expense is attributed to borrowings of $79,375 under the senior credit facility and the private placement of $175,000 aggregate principal amount of senior notes that were issued in connection with the Merger.

Provision for Income Taxes

Our effective tax rate differs from the statutory rate primarily due to the impact of certain expenses that are not deductible for tax purposes, the deduction for FICA tip credits and state income taxes.

19




Fiscal 2005 Compared to Fiscal 2004

Revenues

Total revenues increased 18.8 percent, or $73,185, for fiscal 2005 compared to fiscal 2004.  Comparable stores revenue increased 1.5 percent, or $5,311 for fiscal 2005 compared to fiscal 2004.

The increases were derived from the following sources:

Acquired Jillian’s branded stores

 

$

48,643

 

Dave & Buster’s branded stores opened in fiscal 2004 and 2005

 

18,030

 

Comparable Dave & Buster’s branded stores

 

5,311

 

Other

 

1,201

 

Total increase

 

$

73,185

 

 

Our revenue mix was 54.8 percent for food and beverage and 45.2 percent for amusements and other.  This compares to 53.7 percent and 46.3 percent, respectively, for the comparable period in 2004.  The shift in the revenue mix was influenced by the success of the “Power Combo” and “Super Charge” promotions at our stores, partially offset by the operations of the Jillian’s branded stores, which traditionally have a larger percentage of revenue attributable to amusements.

Food sales at our comparable stores increased by 5.7 percent over sales levels achieved in the same period of 2004.  This increase in food sales was accomplished primarily by the success of the “Power Combo” promotion.  Beverage sales at the comparable stores increased by 4.3 percent over fiscal 2004 as we experienced continued success of the “Late Night Happy Hour” and other promotional activity around the beverage component of the business.  Comparable store amusements revenue in fiscal 2005 declined by 2.6 percent versus the same period of 2004, due in part to the discounted game play resulting from promotional activities.

Comparable special events revenues accounted for 16.4 percent of consolidated revenue for fiscal 2005, up from 16.1 percent in the comparable 2004 period.

Cost of Products

Cost of food and beverage products increased 10 basis points to 25.8 percent of revenue for fiscal 2005, compared to 25.7 percent for fiscal 2004.  For comparable locations, food and beverage costs as a percentage of revenue decreased 50 basis points to 24.3 percent, compared to 24.8 percent for fiscal 2004.  These decreased costs were offset by higher food and beverage costs at the Jillian’s locations, which were 26.4 percent of revenue.  Higher food and beverage costs at our Jillian’s locations were due in part to costs associated with the implementation of new menu items.

The costs of amusements and other, as a percentage of amusements and other revenue, increased 20 basis points to 13.7 percent for fiscal 2005 compared to 13.5 percent for fiscal 2004.  Margin improvements achieved by purchasing amusement redemption items directly from Asia were offset by the impact of the revenue mix changes described above.

Operating Payroll and Benefits

Operating payroll and benefits increased 30 basis points to 28.2 percent of revenue for fiscal 2005, compared to 27.9 percent for fiscal 2004.  This increase was primarily driven by additional management training costs and $400 in severance costs required to close the acquired Jillian’s complex located at the Mall of America.

Other Store Operating Expenses

Other store operating expenses increased 190 basis points to 31.1 percent for fiscal 2005, compared to 29.2 percent for the same period of 2004.  Occupancy costs as a percentage of total revenues increased 80 basis points as a result of Jillian’s higher rent and tax costs compared to their sales volumes.  Increases in utility costs (50 basis points) and restaurant expense (70 basis points) also contributed to the overall increase.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel, facilities, and professional expenses for the various departments of corporate headquarters.  General and administrative expenses, as a percentage of revenues, remained relatively flat for fiscal 2005, compared to 2004.

20




The increase in absolute dollars of approximately $5,700 was primarily attributable to increases in personnel costs and services in support of the acquired Jillian’s locations and new store growth.

Depreciation and Amortization Expense

Depreciation and amortization expense increased primarily due to ongoing expense associated with the Jillian’s locations acquired in November 2004 and the charge related to the August 28, 2005 closure of the Jillian’s complex located at the Mall of America.  We closed the complex due to continuing operating losses and unsuccessful efforts to renegotiate the terms of the related leases.  As a result of the closing, we recorded a pre-tax charge of approximately $2,500 in the second quarter of 2005.  The charge consisted of additional depreciation, amortization, and impairment of the assets which were abandoned and whose carrying value was not recoverable as of July 31, 2005.

Startup Costs

Startup costs include costs associated with the opening and organizing of new complexes or conversion of existing complexes, including the cost of feasibility studies, staff-training, and recruiting and travel costs for employees engaged in such startup activities.  All startup costs are expensed as incurred.  Through October 30, 2005, rent incurred between the time construction is substantially completed and the time the complex opens was included in startup costs.  Beginning October 31, 2005, all rent incurred during the construction period is expensed and included in startup costs.  The increase in startup costs as a percentage of revenues is primarily attributed to the opening of the Omaha, Buffalo, and Kansas City locations in the second, third, and fourth quarters of 2005 compared to the opening of the Santa Anita location in the third quarter of 2004.  Startup costs were also impacted in fiscal 2005 due to the conversion of five Jillian’s locations to our “Dave & Buster’s Grand Sports Café” brand.

Interest Expense

Interest expense as a percentage of revenues remained flat as a percentage of revenues, however increased in absolute dollars approximately $1,100.  The increase in absolute dollars is attributed to the increased borrowings under the debt facility as a result of the Jillian’s acquisition.  During fiscal year 2005, we reduced our outstanding debt by approximately $8,000.

Provision for Income Taxes

Our effective tax rate differs from the statutory rate primarily due to the deduction for FICA tip credits and state income taxes.

Liquidity and Capital Resources

Total cash requirements of the Merger of approximately $400,728 were used to (i) purchase common stock, outstanding options and warrants, and shares issued upon the conversion of convertible subordinated notes; (ii) redeem the convertible subordinated notes if not previously converted; (iii) repay in full all funds borrowed under the existing credit facility, and terminate such facility; and (iv) to pay certain fees, costs and expenses related to the Merger.  These financing requirements were financed through a cash equity contribution of $108,100 by affiliates of Wellspring and HBK, proceeds from a new $160,000 senior secured credit facility, and proceeds from the issuance of $175,000 in senior notes and cash on hand.

In connection with the Merger, we terminated the existing credit facility and entered into a senior credit facility (the “senior credit facility”) that provides a $100,000 term loan facility ($50,000 of the term loan facility was available as of the date of the Merger, March 8, 2006, and $50,000 was available on a delayed-draw basis and was borrowed on August 15, 2006) with a maturity of seven years from the closing date of the Merger and provides a $60,000 revolving credit facility with a maturity of five years from the closing date of the Merger.  The $60,000 revolving credit facility includes (i) a $20,000 letter of credit sub-facility, (ii) a $5,000 swingline sub-facility and (iii) a $5,000 (in US Dollar equivalent) sub-facility available in Canadian dollars to the Canadian subsidiary.  The revolving credit facility will be used to provide financing for working capital and general corporate purposes.  As of February 4, 2007, borrowings under the revolving credit facility and term loan facility were $0 and $79,375, respectively, and we had $6,956 in letters of credit outstanding.

The senior credit facility is secured by all of our assets.  Borrowings on the senior credit facility bear interest at a floating rate based upon the bank’s prime interest rate of 8.25 percent at February 4, 2007 or, at our option, the applicable Eurodollar rate of 5.35 percent at February 4, 2007, plus a margin, in either case, based upon financial performance, as prescribed in the senior credit facility.  Effective June 30, 2006, we entered into two interest rate swap agreements that expire in 2011, to change a substantial portion of the variable rate debt to fixed rate debt.  Pursuant to the swap agreements, the interest rate on notional amounts is fixed at 5.31 percent.

21




Interest rates on borrowings under the senior credit facility vary based on the movement of prescribed indexes and applicable margin percentages.  On the last day of each calendar quarter, we are required to pay a commitment fee of 0.5 percent on any unused commitments under the revolving credit facilities or the term loan facility.  The senior credit facility requires scheduled quarterly payments of principal on the term loans at the end of each of the fiscal quarters beginning June 2006 in aggregate annual amounts equal to 1.0 percent of the original aggregate principal amount of the term loan with the balance payable ratably over the final four quarters.  Our indebtedness increased to $254,375 as of February 4, 2007 compared to $80,175 as of January 29, 2006, as a result, the annual interest expense increased materially.

The senior credit facility and the indenture governing the senior notes contain restrictive covenants that, among other things, limit our ability and the ability of our subsidiaries to, among other things: incur additional indebtedness, make loans or advances to subsidiaries and other entities, make capital expenditures, declare dividends, acquire other businesses or sell assets.  In addition, under the senior credit facility, we are required to meet certain financial covenants, ratios, and tests, including a minimum fixed charge coverage ratio and a maximum leverage ratio.  The indenture under which the senior notes are to be issued also contains customary covenants and events of defaults.

We believe that cash flow from operations, together with borrowings under the senior credit facility, will be sufficient to cover working capital, capital expenditures, and debt service needs in the foreseeable future.  Our ability to make scheduled payments of principal or interest on, or to refinance, the indebtedness, or to fund planned capital expenditures, will depend on future performance, which is subject to general economic conditions, competitive environment and other factors as described under “Risk Factors” in this Form 10-K.

Historical Cash Flows

Fiscal 2006 Compared to Fiscal 2005

As of February 4, 2007, we had cash and cash equivalents of $10,372 and available borrowing capacity of $53,044 under the revolving credit facility of the senior credit facility.

Cash flow from operations was $54,419 for fiscal 2006 compared to $65,423 for fiscal 2005.  The decrease in cash flow from operations from 2005 is primarily due to an increase in the cash paid for interest of approximately $12,900.

Cash used in investing activities was $351,704 for fiscal 2006 compared to $63,271 for fiscal 2005.  The year-to-date investing activities include approximately $338,239 in Merger-related payments for the following: $264,835 consideration paid to stockholders, $44,390 consideration paid to convertible note and warrant holders, $9,279 consideration paid to option holders, and $19,735 in transaction costs.  Year-to-date 2006 capital expenditures totaled $42,543 which was comprised of approximately $5,900 in games, $21,700 for new store development and construction (primarily construction costs for the 2006 store openings in Times Square, New York and Maple Grove, Minnesota), normal capital expenditures at existing stores and conversion costs for one of the Jillian’s complexes to the “Dave & Buster’s Grand Sports Café” brand.  During the fourth quarter of 2006, we entered into the sale and leaseback agreements related to three properties we owned.  These transactions generated $28,357 in net proceeds.  The investing activities for fiscal 2005 included capital expenditures of $62,066 which was comprised of $8,900 in games, approximately $30,700 for new store development and construction (primarily construction costs for the 2005 store openings in Omaha, Nebraska, Buffalo, New York and Kansas City, Kansas) and normal capital expenditures at existing stores.

We plan on financing future growth through operating cash flows, debt facilities, and tenant improvement allowances from landlords.  We expect to spend approximately $38,000 ($35,000 net of tenant improvement allowances) in capital expenditures during fiscal year 2007.  The 2007 expenditures will include approximately $15,700 ($12,700 net of tenant improvement allowance) for new store construction, and $22,300 in maintenance capital and new games.

Cash provided from financing activities was $300,075 for fiscal 2006 compared to cash used in financing activities of $5,957 in fiscal 2005.  Proceeds from debt incurred in connection with the Merger aggregated $292,628 and cash equity contributions received in connection with the Merger aggregated $108,100.  These proceeds were used to acquire common stock of the Predecessor and to repay in full all obligations related to funds borrowed under our existing credit facility, and terminate such facility.

Holders of approximately 2.6 million shares exercised dissenters’ rights and initiated proceedings under Section 351.455 of the General and Business Corporation Law of Missouri to demand fair value with respect to their shares.  On July 10, 2006, we and all dissenting shareholders reached an agreement, which provided, among other things, for the permanent and irrevocable settlement of all claims between the parties associated with the Merger or the dissenting action.  We paid approximately $51,733 to the shareholders in accordance with the terms of the settlement agreement.  Payments of the settlement have been funded from borrowings under the senior credit facility.

22




On November 15, 2006, we completed the sale and simultaneous leaseback of the land and buildings of three owned facilities located in the states of Florida, Illinois, and Ohio.  The transaction was completed at a sale price of $29,600.  Net proceeds from the transaction were used to pay down outstanding balances on our senior credit and revolving credit facilities after a $5,000 hold back for reinvestment.

We agreed to leaseback these facilities under various operating lease agreements, which have an initial term of 17.5 years.  The leases require us to make monthly rental payments, which aggregate to $2,453 on an annual basis.  Rental payments under the leases are subject to adjustment based on defined changes in the Consumer Price Index.  In addition to the rental payments described above we are required to pay the property taxes and certain maintenance charges related to the properties.

Fiscal 2005 Compared to Fiscal 2004

Cash flow from operations was $65,423 for fiscal 2005 compared to $49,064 for fiscal 2004.  The increase in cash flow from operations was partially offset by $4,082 in required payments for income taxes and $4,183 in required interest payments during 2005.

Cash used in investing activities was $63,271 for 2005 compared to $81,772 for 2004.  The investing activities for 2005 included approximately $8,900 to purchase games, approximately $30,700 for new store development and construction (primarily construction costs for the new stores, which opened in Omaha, Nebraska, Buffalo, New York and Kansas City, Kansas in July, October and November 2005, respectively) and normal capital expenditures at previously existing stores.  The addition of three new complexes represents the largest new store construction effort since 2001.  We spent approximately $3,500 in capital expenditures during fiscal 2005 to convert five Jillian’s stores to our “Dave & Buster’s Grand Sports Café” brand.  The majority of the re-branding expenditures were incurred in the fourth quarter of fiscal 2005.  The investing activities for 2004 included cash of $47,876 for the acquisition of the nine Jillian’s locations.

In October 2005, we acquired the general partner interest in a limited partnership, which owns a Jillian’s complex in the Discover Mills Mall near Atlanta, Georgia.  The cost for this interest, acquired pursuant to an auction held by the bankruptcy court was $1,169.  The current agreement provides for payment of a preferred return to the limited partners and a management fee to us prior to distributions of other net operating income or losses.

Cash used from financing activities was $5,957 for fiscal 2005 and was used to reduce outstanding debt balances.  The 2004 cash provided by financing activities of $37,160 was the result of increased debt used to fund the Jillian’s acquisition.

Contractual Obligations and Commercial Commitments

The following tables set forth the contractual obligations and commercial commitments as of February 4, 2007 (excluding interest):

Payment due by period

 

 

Total

 

1 Year
or Less

 

2-3 Years

 

4-5 Years

 

After 5 
Years

 

 

 

(in thousands)

 

Senior credit facility(1)

 

$

79,375

 

$

1,000

 

$

2,000

 

$

2,000

 

$

74,375

 

Senior notes

 

175,000

 

 

 

 

175,000

 

Operating leases(2)

 

565,259

 

42,457

 

84,544

 

84,554

 

353,704

 

Other – capital leases

 

663

 

368

 

295

 

 

 

Total

 

$

820,297

 

$

43,825

 

$

86,839

 

$

86,554

 

$

603,079

 

 


(1)                                  The senior credit facility includes a $100,000 term loan facility and $60,000 revolving credit facility, with a $20,000 letter of credit sub-facility and a Canadian $5,000 revolving sub-facility.  As of February 4, 2007, borrowings under the revolving credit facility were $0; we had drawn approximately $79,375 under the term loan facility and had $6,956 in letters of credit outstanding.

(2)                                  We have an operating lease agreement for a future site located near Tempe, Arizona.  Our commitment under the Tempe, Arizona agreement is included in the table above.

23




Accounting Policies

We believe that the following critical accounting policies, among others, represent more significant judgments and estimates used in the preparation of the consolidated financial statements.

Purchase accounting – We have accounted for the Merger in accordance with Statement of Financial Accounting Standards 141, “Business Combinations,” whereby the purchase price paid is allocated to record the acquired assets and liabilities assumed at fair value on the closing date of the Merger.  The Merger and the allocation of the purchase price have been recorded as of March 8, 2006.  In connection with the purchase price allocation, we have made estimates of the fair values of the long-lived and intangible assets based upon assumptions that are reasonable related to discount rates and asset lives utilizing currently available information, and in some cases, valuation results from independent valuation specialists.  As of February 4, 2007, we recorded purchase accounting adjustments to the carrying value of property and equipment, to establish intangible assets for trade names and trademarks and to revalue rent liability, among other matters.  The adjustments, if any, arising out of the finalization of the allocation of the purchase price will not impact cash flow including cash interest and rent.

Property and equipment - Expenditures that substantially increase the useful lives of the property and equipment are capitalized, whereas costs incurred to maintain the appearance and functionality of such assets are charged to repair and maintenance expense.  Interest costs incurred during construction are capitalized and depreciated based on the estimated useful life of the underlying asset.  These costs are depreciated over various methods based on an estimate of the depreciable life, resulting in a charge to the operating results.  Our actual results may differ from these estimates under different assumptions or conditions.

Reviews are performed regularly to determine whether facts or circumstances exist that indicate the carrying values of property and equipment are impaired.  We assess the recoverability of property and equipment by comparing the projected future undiscounted net cash flows associated with these assets to their respective carrying amounts.  Impairment, if any, is based on the excess of the carrying amount over the estimated fair market value of the assets.  Changes in the estimated future cash flows could have a material impact on the assessment of impairment.

Income taxes – We use the liability method for recording income taxes which recognizes the amount of current and deferred taxes payable or refundable at the date of the financial statements as a result of all events that are recognized in the financial statements and as measured by the provisions of enacted tax laws.

The calculation of tax liabilities involves significant judgment and evaluation of uncertainties in the interpretation of complex tax regulations.  As a result, we have established reserves for taxes that may become payable in future years as a result of audits by tax authorities.  Tax reserves are reviewed regularly pursuant to Statement of Financial Accounting Standard 5 “Accounting for Contingencies.”  Tax reserves are adjusted as events occur that affect the potential liability for additional taxes, such as the expiration of statutes of limitations, conclusion of tax audits, identification of additional exposure based on current calculations, identification of new issues, or the issuance of statutory or administrative guidance or rendering of a court decision affecting a particular issue.  Accordingly, we may experience significant changes in tax reserves in the future, if or when, such events occur.

Accounting for amusement operations – The majority of our amusement revenue is derived from the customer purchase of game play credits which allow our guests to play the video and redemption games in our midways.  We have recognized a liability for estimated amount of unused game play credits which we believe our guests will utilize in the future.  Certain midway games allow guests to earn coupons, which may be redeemed for prizes.  The cost of these prizes is included in the cost of amusement products and is generally recorded when coupons are utilized by the customer by either redeeming the coupons for a prize in our Winner’s Circle or storing the coupon value on a Power Card for future redemption.  We have accrued a liability for the estimated amount of outstanding coupons that will be redeemed in subsequent periods.

Accounting for smallware supplies - Prior to the Merger, smallware supplies inventories, consisting of china, glassware and kitchen utensils were capitalized at the store opening date, or when the smallwares inventory is increased due to changes in the menu, and are reviewed periodically for valuation.  Smallware replacements are expensed as incurred.  Through the purchase price allocation, smallwares inventory was reclassified to property and equipment.  Smallwares are now recorded as fixed assets and amortized over the estimated useful life of 7 years.

Insurance reserves – We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities for workers’ compensation, healthcare benefits, general liability, property insurance, director and officers’ liability insurance and vehicle liability.  Liabilities associated with the risks that are retained by us are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.  The estimated accruals for these liabilities, portions of which are calculated by third party actuarial firms, could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

24




Loss contingencies – We maintain accrued liabilities and reserves relating to the resolution of certain contingent obligations.  Significant contingencies include those related to litigation.  We account for contingent obligations in accordance with SFAS 5, “Accounting for Contingencies,” as interpreted by FASB Interpretation 14 which requires that we assess each contingency to determine estimates of the degree of probability and range of possible settlement.  Contingencies which are deemed probable and where the amount of such settlement is reasonably estimable are accrued in our financial statements.  If only a range of loss can be determined, we accrue to the best estimate within that range; if none of the estimates within that range is better than another, we accrue to the low end of the range.

The assessment of loss contingencies is a highly subjective process that requires judgments about future events.  Contingencies are reviewed at least quarterly to determine the adequacy of the accruals and related financial statement disclosure.  The ultimate settlement of loss contingencies may differ significantly from amounts we have accrued in the financial statements.

Recent Accounting Pronouncements

In March 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (That Is, Gross Versus Net Presentation).  A consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis.  If taxes are significant, an entity should disclose its policy of presenting taxes and the amounts of taxes.  The guidance is effective for periods beginning after December 15, 2006.  We present revenues net of sales taxes.  This issue will not impact the method for presenting these sales taxes in the consolidated financial statements.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109” (“FIN 48”).  FIN 48 requires companies to determine whether it is more likely than not that, a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements.  This interpretation also provides guidance on derecognition, classification, accounting in interim periods, and expanded disclosure requirements.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We do not believe that the implementation of FIN 48 will have a material effect on our consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements.  This statement is effective for fiscal years beginning after November 15, 2007.  We are currently in the process of assessing the impact that SFAS 157 will have on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”).  This statement permits entities to choose to measure many financial instruments and certain other items at fair value.  If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of this adoption on our consolidated financial statements.

ITEM 7A.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have market risk relating to changes in the general level of interest rates.  Earnings are affected by changes in interest rates due to the impact of those changes on interest expense from variable rate debt.  Effective June 30, 2006, we entered into two interest rate swap agreements that expire in 2011, to change a substantial portion of the variable rate debt to fixed rate debt.  Pursuant to the swap agreements, the interest rate on notional amounts is fixed at 5.31 percent.  Agreements to fix a portion of the variable rate debt mitigate the interest rate risk.

We have market risk associated with foreign operations.  Our market risk associated with foreign operations arises from one unit that we operate in Canada and one unit that is operated by a franchisee in Mexico.  Management considers the currency risk associated with these operations to be immaterial to our portfolio of operating restaurant/entertainment complexes.  The result of an immediate 10.0 percent devaluation of the U.S. dollar in 2007 from February 4, 2007 levels relative to foreign currency translation would result in a decrease in the U.S. dollar-equivalent of foreign currency denominated net income and would be insignificant.

25




ITEM 8.                             FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company and supplementary data are included as pages F-1 through F-21 in this Annual Report on Form 10-K.

ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

 

Not applicable.

 

ITEM 9A.                    CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Based on their evaluation of our disclosure controls and procedures as defined in Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective.

Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting during our fourth quarter ended February 4, 2007, that had materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.                    OTHER INFORMATION

Not applicable

PART III

ITEM 10.                      DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Directors and Executive Officers

Each of our directors and officers holds office until a successor is elected or qualified or until his earlier death, resignation, or removal.  Pursuant to a shareholders agreement, Wellspring has the right to designate all but one of the directors, and HBK has the right to designate, at its option, one observer or one director, in each case reasonably acceptable to Wellspring, to observe or serve, as applicable, on our board of directors for so long as HBK owns 50 percent of the common stock of WS Midway Holdings, Inc. to which it initially subscribed.  In addition, Wellspring and HBK have the right to remove any or all of the directors that they appointed.  As two of the members of the Board of Directors (Mr. King and Ms. Johnson) are employees of the Company and as the remaining members of the Board of Directors are employees of an affiliate of the owner of the majority interest in WS Midway, none of the directors are “independent” as such term is defined by the listing standards of the New York Stock Exchange and the rules of the SEC.

Set forth below is biographical information regarding the directors and executive officers:

Mike Flesch, 43, has served as Senior Vice President of Operations since September 2006.  After joining the Company in 1999, Mr. Flesch served in various operating positions of increasing responsibilities including Regional Operations Director from February 2002 until June 2003 and Vice President of Operations from June 2003 until September 2006.

Brian A. Jenkins, 45, joined the Company in December 2006, as Senior Vice President and Chief Financial Officer.  From 1996 until August of 2006, he served in various capacities (most recently as Senior Vice President – Finance) with Six Flags, Inc.

Starlette Johnson, 44, has served as President, Chief Operating Officer, and Director of the Company since April 2007.  From June 2006 until April 2007, Ms. Johnson served as Senior Vice President and Chief Strategic Officer of the Company.  From 2004 to June 2006, she was an independent consultant to restaurant, retail, and retail services companies. 

26




From 1995 to 2004, she served in various capacities (most recently as Executive Vice President and Chief Strategic Officer) of Brinker International, Inc.

Stephen M. King, 49, has served as Chief Executive Officer and Director of the Company since September 2006.  From March 2006 until September 2006, Mr. King served as Senior Vice President and Chief Financial Officer of the Company.  From 1984 to 2006, he served in various capacities for Carlson Restaurants Worldwide, including Chief Financial Officer, Chief Administrative Officer, Chief Operating Officer and most recently as President and Chief Operating Officer of International.

Margo Manning, 42, has served as Senior Vice President of Training and Special Events since September 2006.  Prior to that, she served as Vice President of Training and Sales from June 2005 until September 2006 and as Vice President of Management Development from September 2001 until June 2005.  From December 1999 to September 2001, she served as Assistant Vice President of Team Development and from 1991 to December 1999, she served in various positions of increasing responsibility for us and our predecessors.

Michael J. Metzinger, 50, has served as Vice President—Accounting and Controller since January 2005.  From 1986 until January 2005, Mr. Metzinger served in various capacities (most recently as Executive Director—Financial Reporting) with Carlson Restaurants Worldwide, Inc.

Maria M. Miller, 50, has served as Senior Vice President and Chief Marketing Officer since May 2003.  From 2000 to 2003, she was principal and co-founder of a marketing consulting firm and engaged with an internet start-up company.

J. Michael Plunkett, 56, has served as Senior Vice President of Purchasing and International Operations since September 2006.  Previously, he served as Senior Vice President—Food, Beverage and Purchasing/Operations Strategy from June 2003 until June 2004 and from January 2006 until September 2006.  Mr. Plunkett also served as Senior Vice President of Operations for Jillian’s from June 2004 to January 2006, as Vice President of Kitchen Operations from November 2000 to June 2003, as Vice President of Information Systems from November 1996 to November 2000, as Vice President and Director of Training from November 1994 until November 1996.  From 1982 to November 1994, he served in operating positions of increasing responsibility for us and our predecessors.

Jay L. Tobin, 49, has served as Senior Vice President and General Counsel since May 2006.  From 1988 to 2005, he served in various capacities (most recently as Senior Vice President and Deputy General Counsel) of Brinker International, Inc.

Jeffrey C. Wood, 44, has served as Senior Vice President and Chief Development Officer since June 2006.  Mr. Wood previously served as Vice President of Restaurant Leasing for Simon Property Group from April 2005 until June 2006 and in various capacities (including Vice President of Development—Emerging Concepts and Vice President of Real Estate and Property Development) with Brinker International from 1993 until November 2004.

Greg S. Feldman, 50, became a Director and Chairman of the Board of Directors upon consummation of the Merger in March 2006.  Mr. Feldman is a Partner of Wellspring, which he co-founded in January 1995.

Daniel Y. Han, 29, became a Director of the Company on November 15, 2006.  He has served as a Vice President of Wellspring Capital Management, LLC since May 2006 and prior to that date he served in various other capacities with Wellspring from September 2002.  From July 2000 until September 2002, Mr. Han was an Analyst in the Mergers and Acquisitions Group of J.P. Morgan Securities, Inc.

Carl M. Stanton, 39, became a Director upon consummation of the Merger.  Mr. Stanton is a Partner at Wellspring, which he joined in 1998.

Corporate Governance

The Board of Directors met four times in fiscal 2006, including regular and special meetings.  During this period, no individual director attended fewer than 75 percent of the aggregate of (1) the total number of meetings of the Board of Directors and (2) the total number of meetings held by all committees on which such director served.  With the exception of one pre-Merger director who did not attend one meeting of the Board of Directors, as a group, our directors attended 100 percent of the total number of meetings of the Board of Directors and committees on which they served while they were members during fiscal 2006.

Members of the post-Merger Board of Directors do not get compensated for service on the Board of Directors.

27




Code of Business Ethics and Whistle Blower Policy

In April 2006, the Board of Directors adopted a Code of Business Ethics that applies to its directors, officers (including its chief executive officer, chief financial officer, controller and other persons performing similar functions), and management employees generally.  The Code of Business Ethics is available on our website at www.daveandbusters.com/about/codeofbusinessethics.aspx.  In addition, our Whistle Blower Policy is available on our website at www.daveandbusters.com/about/whistleblowerpolicy.aspx.

Communications with the Board of Directors

If you wish to communicate with the Board of Directors or with an individual director, you may direct such communications in care of the General Counsel, 2481 Mañana Drive, Dallas, Texas 75220.  The communication must be clearly addressed to the Board of Directors or to a specific director.  The Board of Directors has instructed the General Counsel to review and forward any such correspondence to the appropriate person or persons for response.

Committees of the Board of Directors

The Board of Directors has an Audit Committee and Compensation Committee.  The charters for each of these committees are posted on our website at www.daveandbusters.com/about/corporategovernance.aspx.  The Board of Directors does not have a Nominating Committee or committee performing similar functions.  As all of our Common Stock is owned by WS Midway, the Board of Directors has determined that it is not necessary for us to have a Nominating Committee.  The Board of Directors does not have a policy with regard to the consideration of any director candidates recommended by our debt holders or other parties.

The Audit Committee, comprised of Messrs. Feldman, Han and Stanton, and chaired by Mr. Han, recommends to the Board of Directors the appointment of the Company’s independent auditors, reviews and approves the scope of the annual audits of the Company’s financial statements and internal control over financial reporting, reviews and approves any non-audit services performed by the independent auditors, reviews the findings and recommendations of the internal and independent auditors and periodically reviews and approves major accounting policies and significant internal accounting control procedures.  It operates pursuant to a charter that was amended and restated in December 2006.  The Audit Committee met two times during fiscal 2006.

In addition, the Board of Directors has determined that each of the members of the Audit Committee is qualified as a “financial expert” under the provisions of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the SEC.

The Compensation Committee comprised of Messrs. Feldman, Han and Stanton and chaired by Mr. Feldman, reviews the Company’s compensation philosophy and strategy, administers incentive compensation and stock option plans, reviews the CEO’s performance and compensation, reviews recommendations on compensation of other executive officers, and reviews other special compensation matters, such as executive employment agreements.  It operates pursuant to a charter that was amended and restated in December 2006.  The Compensation Committee met one time during fiscal 2006.

ITEM 11.       EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

This section describes our compensation program for executive officers.  The following discussion focuses on the program and decisions for 2006 and we address why we believe the program is right for our Company.  All dollar amounts are presented in whole dollars, unless otherwise noted.

Compensation Philosophy and Overall Objectives of Executive Compensation Programs

It is our philosophy to link executive compensation to corporate performance and to create incentives for management to enhance the value of the Company.  The following objectives have been adopted by the Compensation Committee as guidelines for compensation decisions:

·                  Provide a competitive total executive compensation package that enables us to attract, motivate, and retain key executives.

28




·                  Integrate all pay programs with our annual and long-term business objectives and strategy, and focus executives on the fulfillment of these objectives.

·                  Provide variable compensation opportunities that are directly linked with our financial and strategic performance.

Cash Compensation

Cash compensation includes base salary and annual incentive plan awards.  The base salary of each of our executive officers is determined by an evaluation of the responsibilities of that position and by comparison to the level of salaries paid in the competitive market in which we compete for comparable executive ability and experience.  Annually, the performance of each Named Executive Officer is reviewed by the Compensation Committee using information and evaluations provided by the Chief Executive Officer and the President taking into account our operating and financial results for the year, a subjective assessment of the contribution of each executive officer to such results, the achievement of strategic and other individual goals established for each such executive officer at the beginning of each year, and competitive salary levels for persons in those positions in the markets in which we compete.

Our annual bonus plan (the “Bonus Plan”) is designed to recognize and reward our employees for contributing towards the achievement of our annual business plan.  The Compensation Committee believes the Bonus Plan serves as a valuable short-term incentive program for providing cash bonus opportunities for the Company’s employees upon achievement of targeted operating results as determined by the Compensation Committee and the Board of Directors.  The fiscal 2006 Bonus Plan was based on our targeted earnings before interest, taxes, depreciation, and amortization (“EBITDA”) for the year.  For 2007, the Bonus Plan has been modified for certain of our Executive Officers.  Most employees will continue to receive a bonus based on achievement of targeted EBITDA for the year.  However, substantially all of the Executive Officers will receive a bonus based on an achievement of various corporate objectives (including items such as EBITDA, total sales, comparable store sales, and similar measures) and other individual performance objectives unique to an individual executive officer’s role, as determined by the Compensation Committee prior to the beginning of the 2007 fiscal year.  The Compensation Committee will continue to review and modify the performance goals for the Bonus Plan as necessary to ensure reasonableness, achievability, and consistency with our overall objectives.

In 2006, annual base salary increases and incentive compensation awards for all of the Named Executive Officers were approved by the Compensation Committee and reported to the Board of Directors.

The Compensation Committee believes the recommended salary levels and incentive awards were warranted and consistent with the performance of such executives during fiscal year 2006 based on the Compensation Committee’s evaluation of each individual’s overall contribution to accomplishing our fiscal year 2006 corporate goals and of each individual’s achievement of strategic and individual performance goals during the year.

In reviewing fiscal year 2006 Bonus Plan results, the Compensation Committee recognized that the Company exceeded the EBITDA target for financial performance, which resulted in an award above target level performance for all employees, including the Named Executive Officers.  Overall, employees were paid on average 110 percent of their target bonus opportunity for fiscal 2006 performance.

Long-Term Incentives

The Compensation Committee believes that it is essential to align the interests of the executives and other key management personnel responsible for our growth with the interests of our stockholder.  The Compensation Committee has also identified the need to retain tenured, high performing executives.  The Compensation Committee believes that these objectives are accomplished through the provision of stock-based incentives that align the interests of management personnel with the objectives of enhancing our value, as set forth in the WS Midway Stock Option Plan.

The Committee awarded stock options to the Named Executive Officers during fiscal 2006.  The WS Midway Stock Option Plan was established, generally, to compensate option recipients for working to increase our value.  A portion of the stock options granted have time-based vesting.  However, the majority of the stock options granted have a performance-based vesting feature.  The options do not have any value to the recipient until the sale of the Company by WS Midway (or other defined liquidity event).  The options with performance-based vesting require an increase in the value of the Company above a stipulated internal rate of return before there is any benefit to the recipient.  All options to be granted under the WS Midway Stock Option Plan have been granted.  The only option grants that can be made in the future would be the re-allocation of options forfeited by a participant.  After taking into account the value of these awards, the Named Executive Officers’ actual long-term incentive compensation generally continues to fall below comparable market total direct compensation.

29




The Compensation Committee will continue to review long-term incentives and make recommendations, where it deems appropriate, to the Company’s Board of Directors, from time-to-time, to assure that our executive officers and other key employees are appropriately motivated and rewarded based on our long-term financial success.

Deductibility of Executive Compensation

Section 162(m) of the Internal Revenue Code under the Omnibus Budget Reconciliation Act of 1993 limits the deductibility of compensation over $1 million paid by a company to an executive officer.  The Compensation Committee will take action to qualify most compensation approaches to ensure deductibility, except in those limited cases in which the Compensation Committee believes stockholder interests are best served by retaining flexibility.  In such cases, the Compensation Committee will consider various alternatives to preserving the deductibility of compensation payments and benefits to the extent reasonably practicable and to the extent consistent with its compensation objectives.

Summary

As a result of pay-for-performance concepts incorporated in our executive compensation program, the Compensation Committee believes that the total compensation program for executive officers is competitive with the compensation programs provided by other companies with which we compete and emulates programs of high-performing companies.  The Compensation Committee also believes this program will provide opportunities to participants that are consistent with the expectations of the Board of Directors and our debt holders.

Compensation Committee Report

The Compensation Committee of the Board of Directors has furnished the following report:

The Committee has reviewed and discussed the Compensation Discussion and Analysis (“CD&A”) with the management of the Company.  Based on that review and discussion, the Committee has recommended to the Board of Directors that the CD&A be included in this Annual Report on Form 10-K for 2006.

Greg S. Feldman, Chair

 

Daniel Y. Han

 

Carl M. Stanton

 

30




2006 SUMMARY COMPENSATION TABLE

The following table sets forth information concerning all compensation paid or accrued by the Company during fiscal 2006 to or for each person serving as our Chief Executive Officer and Chief Financial Officer in 2006, each of the three most highly compensated executive officers serving at the end of 2006, and two additional persons serving as executive officers during the year for whom disclosure would be required but for the fact that such persons were not serving as executive officers at the end of 2006 (collectively the “Named Executive Officers”).

Name and Principal Position

 

Year

 

Salary ($)

 

Bonus ($)

 

Option
Awards
($)

 

Non-Equity
Incentive Plan
Compensation
($)

 

Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings
($)

 

All Other
Compensation(7)
($)

 

Total
($)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

James W. Corley(1)
(CEO & COO)

 

2006

 

370,193

 

 

 

 

 

6,123,980

 

6,494,173

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stephen M. King
(CEO, CFO)

 

2006

 

338,462

 

 

102,072

 

220,000

 

2,784

 

24,768

 

688,086

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

William C. Hammett, Jr.(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Senior Vice President and Chief Financial Officer)

 

2006

 

50,192

 

 

 

 

 

1,419,091

 

1,469,283

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Brian A. Jenkins

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Senior Vice President and Chief Financial Officer)

 

2006

 

42,308

 

 

39,745

 

22,377

 

4

 

2,970

 

107,404

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

David O. Corriveau(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(President)

 

2006

 

560,577

 

875,000

 

 

 

 

1,449,803

 

2,885,380

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Starlette Johnson

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(President and Chief Operating Officer)

 

2006

 

246,634

 

 

87,491

 

206,250

 

585

 

17,472

 

558,432

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling R. Smith(4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Senior Vice President,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operations)

 

2006

 

236,461

 

174,000

 

 

 

2,004

 

1,145,041

 

1,557,506

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nancy Litzler(5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Senior Vice President, Human Resources)

 

2006

 

131,924

 

 

 

 

(1,088

)

1,057,898

 

1,188,734

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bryan L. Spain(6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Senior Vice President,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real Estate Development)

 

2006

 

47,250

 

 

 

 

(640

)

1,144,699

 

1,191,309

 

 


(1)        Mr. Corley departed from the Company in September 2006.  Pursuant to an Executive Retention Agreement, dated April 3, 2000, between Mr. Corley and the Company, Mr. Corley received termination pay equal to (a) two times the sum of his annual salary and maximum bonus payable under our bonus plan, (b) a special bonus equal to the sum of his annual salary and the maximum bonus payable under our bonus plan, (c) accrued and unpaid vacation pay, (d) a prorated annual bonus (calculated at the maximum rate payable under our bonus plan) for the 2006 fiscal year, and (e) a continuation of certain employee benefits until February 2009.

(2)        Mr. Hammett departed from the Company in March 2006 following the consummation of the Merger and received severance payments equal to (a) two times the sum of his annual salary and maximum bonus payable under our bonus plan, (b) a prorated annual bonus payable under our bonus plan for the 2006 fiscal year, and (c) a continuation of certain employee benefits through February 2010.

(3)        Mr. Corriveau departed from the Company on March 16, 2007, subsequent to the end of our 2006 fiscal year.  Pursuant to the Employment Agreement and Executive Retention Agreement, each dated April 3, 2000, by and between Mr. Corriveau and the Company, Mr. Corriveau received subsequent to the end of our 2006 fiscal year, a special bonus equal to the sum of annual salary and the maximum bonus payable under our bonus plan for the 2006 fiscal year which has been included under “All Other Compensation.”

31




              In addition, Mr. Corriveau received termination pay subsequent to the end of our 2006 fiscal year.  These payments included termination pay equal to (a) two times the sum of his annual salary and maximum bonus payable under our bonus plan, (b) a prorated annual bonus (calculated at the maximum rate payable under our bonus plan) for the 2007 fiscal year, and (c) the value of certain employee benefits for the period commencing on March 16, 2007 and ending March 2009.  These payments are not reported in the table and will be disclosed as compensation in the 2007 fiscal year Summary Compensation Table.

(4)        Mr. Smith’s employment with the Company was terminated in February 2007.  Pursuant to the Executive Retention Agreement, dated June 11, 2001, by and between Mr. Smith and the Company, Mr. Smith received certain payments subsequent to the end of our 2006 fiscal year.  These payments are included under “All Other Compensation,” and included termination pay equal to (a) two times the sum of his annual salary and maximum bonus payable under our bonus plan, (b) accrued and unpaid vacation, (c) a prorated annual bonus (calculated at the maximum rate payable under our bonus plan) for the 2007 fiscal year, and (d) the continuation of certain other employee benefits until February 2010.

(5)        Ms. Litzler’s employment with the Company was terminated in June 2006.  Pursuant to the Executive Retention Agreement, dated as of June 6, 2001, by and between Ms. Litzler and the Company, Ms. Litzler received severance payments equal to (a) two times the sum of her annual salary and maximum bonus payable under our bonus plan, (b) accrued and unpaid vacation, (c) a prorated annual bonus (calculated at the maximum rate payable under our bonus plan) for the 2006 fiscal year, and (d) the continuation of certain employee benefits until February 2010.

(6)        Mr. Spain’s employment with the Company was terminated in April 2006.  Pursuant to the Executive Retention Agreement, dated as of June 8, 2001, between Mr. Spain and the Company, Mr. Spain received severance payments equal to (a) two times the sum of his annual salary and maximum bonus payable under our bonus plan, (b) accrued and unpaid vacation, (c) a prorated annual bonus (calculated at the maximum rate payable under our bonus plan) for the 2006 fiscal year, and (d) the continuation of certain employee benefits until February 2010.

(7)        The following table sets forth the components of All Other Compensation:

Name

 

Year

 

Car
Allowance($)

 

Financial
Planning/
Legal
Fees($)

 

Club
Dues($)

 

Supplemental
Medical($)

 

Demutualization
Payment($)

 

Insurance
Premiums($)

 

Company
Contributions
to Retirement
& 401(K)
Plans($)

 

Severance
Payments/
Accruals($)

 

Total ($)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

James W. Corley

 

2006

 

6,731

 

 

3,366

 

13,051

 

922

 

9,617

 

 

6,090,293

 

6,123,980

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stephen M. King

 

2006

 

8,462

 

 

2,640

 

3,512

 

 

 

10,154

 

 

24,768

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

W. C. Hammett, Jr.

 

2006

 

1,731

 

 

917

 

1,692

 

 

 

 

1,414,751

 

1,419,091

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Brian A. Jenkins

 

2006

 

1,538

 

 

480

 

 

 

 

952

 

 

2,970

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

David O. Corriveau

 

2006

 

10,193

 

189

 

5,096

 

1,357

 

 

7,968

 

 

1,425,000

 

1,449,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Starlette Johnson

 

2006

 

6,577

 

2,953

 

2,052

 

2,862

 

 

 

3,028

 

 

17,472

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling R. Smith

 

2006

 

10,193

 

3,000

 

3,180

 

8,997

 

 

 

7,750

 

1,111,921

 

1,145,041

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nancy Litzler

 

2006

 

6,731

 

3,000

 

2,100

 

17,425

 

1,140

 

 

5,009

 

1,022,493

 

1,057,898

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bryan L. Spain

 

2006

 

2,500

 

 

780

 

1,273

 

2,742

 

 

1,653

 

1,135,751

 

1,144,699

 

 

32




GRANTS OF PLAN-BASED AWARDS IN 2006

The following table shows the grants of plan-based awards to the named executive officers in 2006.

 

 

 

 

 

 

Estimated Future Payouts Under

 

Estimated Future Payments Under

 

Exercise or Base

 

Grant Date Fair
Value of Stock

 

 

 

Grant

 

Approval

 

Non-Equity Incentive Plan Awards(1)

 

Equity Incentive Plan Awards(2)

 

Price of Option

 

and Option

 

Name

 

Date

 

Date

 

Threshold ($)

 

Target ($)

 

Maximum ($)

 

Target (#)

 

Awards(3) ($/Sh)

 

Awards(4) ($)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

James W. Corley

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stephen M. King

 

03/24/06

 

03/24/06

 

100,000

 

200,000

 

300,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stephen M. King

 

12/11/06

 

12/11/06

 

 

 

 

4,574.80

 

1,000

 

1,211,270

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

William C. Hammett, Jr.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Brian A. Jenkins

 

12/11/06

 

12/11/06

 

10,171

 

20,342

 

30,513

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Brian A. Jenkins

 

12/11/06

 

12/11/06

 

 

 

 

1,254.10

 

1,000

 

379,930

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

David O. Corriveau

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Starlette Johnson

 

06/09/06

 

06/09/06

 

93,750

 

187,500

 

281,250

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Starlette Johnson

 

12/11/06

 

12/11/06

 

 

 

 

3,921.28

 

1,000

 

1,038,238

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling R. Smith

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nancy Litzler

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bryan L. Spain

 

 

 

 

 

 

 

 

 

 


(1)             All such payouts are pursuant to our fiscal 2006 Bonus Plan, as more particularly described under “Executive Compensation – Compensation Discussion and Analysis – Cash Compensation” above and actual payouts are recorded under “Non-Equity Incentive Plan Compensation” in the 2006 Summary Compensation Table.

(2)             The listed equity incentive plan awards are grants of stock options under the WS Midway Stock Option Plan as more particularly described under “Executive Compensation – Compensation Discussion and Analysis – Long-Term Incentives” above.  The options include both those with performance-based vesting and those with time-based vesting.

(3)             There is no market for the shares of WS Midway.  The exercise price was established by the Board of Directors of the Company and supported by an independent valuation.

(4)             Shown is the aggregate grant date fair value computed in accordance with SFAS 123R for option awards in 2006.

33




OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2006

 

Number of
Securities Underlying
Unexercised Options
(#)

 

Option
Exercise

 

Option
Expiration

 

Name

 

Unexercisable(1)

 

Price ($)

 

Date

 

 

 

 

 

 

 

 

 

James W. Corley

 

 

 

 

 

 

 

 

 

 

 

 

Stephen M. King

 

4,574.80

 

1,000

 

03/08/2016

 

 

 

 

 

 

 

 

 

William C. Hammett, Jr.

 

 

 

 

 

 

 

 

 

 

 

 

Brian A. Jenkins

 

1,254.10

 

1,000

 

03/08/2016

 

 

 

 

 

 

 

 

 

David O. Corriveau

 

 

 

 

 

 

 

 

 

 

 

 

Starlette Johnson

 

3,921.30

 

1,000

 

03/08/2016

 

 

 

 

 

 

 

 

 

Sterling R. Smith

 

 

 

 

 

 

 

 

 

 

 

 

Nancy Litzler

 

 

 

 

 

 

 

 

 

 

 

 

Bryan L. Spain

 

 

 

 

 


(1)                      The listed options were granted under the WS Midway Stock Option Plan.  Of the time-based portions of such options, 20 percent vested on March 8, 2007, and an additional 20 percent vest on each of March 8, 2008, March 8, 2009, March 8, 2010, and March 8, 2011.

2006 OPTION EXERCISES AND STOCK VESTED

The following table lists the number of shares acquired and the value realized as a result of option exercises by the Named Executive Officers in 2006 and the value of any restricted stock awards that vested in 2006 by virtue of the Merger.  All of the stock options and shares of restricted stock were granted under the Dave & Buster’s 1995 Stock Incentive Plan, as amended.