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Executives

Michael Magusiak - President and Chief Executive Officer

Tiffany Kice - Executive Vice President and Chief Financial Officer

Analysts

Michael Gallo - CL King

CEC Entertainment, Inc. (CEC) Q4 2012 Earnings Call February 21, 2013 4:30 PM ET

Operator

Welcome to the CEC Entertainment, Inc. fourth quarter earnings call. (Operator Instructions) I would now like to turn the conference over to, Mr. Mike Magusiak.

Michael Magusiak

Thank you. Welcome to our conference call. I'm Mike Magusiak, President and CEO of the company, and I'm joined by Tiffany Kice, our Executive Vice President and Chief Financial Officer.

Before we begin today's discussion, I would like to make you aware that some of the information presented today contains forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those implied in the forward-looking statements. Information regarding the company's risk factors was included in our press release and is also included in the Company's filings with the SEC. Reconciliation information related to non-GAAP financial measures discussed on this call may be found in the company's fourth quarter earnings releases and on the company's website under Investor Information.

First, Tiffany will review our financial performance during the fourth quarter and fiscal 2012. Then I will take you through our fiscal 2013 sales performance to date, our strategic plan and growth strategies. And lastly, Tiffany will discuss our business outlook, and then we will open it up to Q&A.

Tiffany Kice

Thank you, Mike, and good afternoon. Comparable store sales for the fourth quarter were down 2.2% and in line with our internal expectations. This resulted in comparable store sales for the year being down 2.9%. Excluding the asset impairment charges and cost associated with Hurricane Sandy, our operating profit was also in line with our internal expectations.

We reported a diluted loss per share of $0.03 as compared to diluted earnings per share of $0.15 in the prior year. Our net loss included approximately $2 million net of tax related to asset impairment charges taken during the fourth quarter. For fiscal 2012, we reported diluted EPS of $2.47.

I will now take you through the details of our financial results for the fourth quarter. Company store sales decreased $0.9 million or 0.5% to $176.7 million in the fourth quarter of 2012. This is primarily due to the 2.2% decline in comparable store sales, substantially offset by additional revenues from new store openings.

Cost of food, beverage, entertainment and merchandise as a percentage of company store sales increased 10 basis points to 16.2%. The increase primarily related to an increase in cheese prices. Labor expenses increased 20 basis points as a percent of company store sales to 30.2%. This increase is reflected primarily of an increase of 0.7% in labor hours, partially offset by a decrease in estimated workers compensation insurance reserves.

Other store operating expenses increased 70 basis points as a percentage of company store sales to 17.6%. This increase is made up of a number of expense items that are now individually significant with the largest being a loss recorded for one store in relation to Hurricane Sandy.

Advertising expense increased 60 basis points as a percentage of company store sales to 4.8%. The increase is primarily related to investments associated with our new advertising campaign, including the quality of creative and production for new commercials and incremental digital advertising cost, partially offset by reductions in the cost and circulation of free-standing inserts.

We recognized an asset impairment charge of $3.2 million in the fourth quarter of 2012 relating to seven stores. This non-cash charge was to write-down the carrying amount of the impaired stores to their estimated fair value.

Interest expense increased $1 million to $3.3 million. The increase primarily relates to reclassification adjustment of expense to capitalize lease for one of our stores. Excluding the impact of this adjustment, interest expense would have been relatively flat compared to 2011.

From income tax perspective, we recognize benefits primarily related to decreases in our uncertain tax position resulting from favorable settlements and the expiration of the statute supplementation. We also recorded favorable adjustments for additional state-wage based tax credit. The benefits were partially offset by the unfavorable impact in 2012 of the expiration of certain federal-wage based tax credits at the end of 2011.

For the full 2012 fiscal year, we note the following: total revenues decreased 2.2% to $803.5 million; comparable store sales decreased 2.9%; net income decreased to $43.6 million from $55 million in the prior year; diluted earnings per share decreased to $2.47 for 2012 as compared to $2.88 for 2011, this decrease is primarily due to the increase in net income and was offset by benefit of $0.17 from share repurchases since the beginning of 2011.

Let's now turn to our cash flow statement and balance sheet. For the 2012 fiscal year, we generated $137.1 million of operating cash flow. We utilized this cash by investing $99.5 million primarily in new and existing stores; repurchasing approximately 4,700 share of our common stock for $14.4 million and paying $19.8 million in cash dividend.

We ended the year with a balance of $389.5 million on the company's revolving credit facility. Our leverage ratio was 2.4 to 1 as defined in our credit facility agreement, which is within our debt covenant restriction of 3 to 1. Our revolver balance has decreased by approximately $23 million since yearend through today.

We did not repurchased any of our shares of common stock during the fourth quarter of 2012 and continue to have $47 million authorized and available for share repurchase in the future, which we intend to utilize on an opportunistic basis. On February 19, 2013, our Board approved a quarterly dividend of $0.24 per share to be paid in April of 2013.

I will now turn it over to Mike to go through our sales performance thus far in 2013, our strategic plan and our growth opportunities.

Michael Magusiak

Thanks Tiffany. We continue to believe that we've developed a very solid sales plan for 2013. The primary components of the plan which I will go through in detail are comprised of the following: first, a strong marketing plan focused to both kids and moms with an increase of approximately $6 million in our advertising budget in 2013 as compared to 2012, including a television media plan with increased weights across for a year, a strong digital advertising plan, and enhanced creative plan with both brand and promotional advertising; second, implementation of our value strategy; and third, a continuation of our capital reinvestment strategy.

We were pleased with the solid start in January with comparable store sales up 2.1% and continue to believe in our sales strategies. However, in early February we experienced a complete reversal. Sales during the first few weeks of February declined 16.3%, 12.3% and 0.7% respectively. This leaves year-to-date comparable store sales through the first seven weeks of 2013 declining 3.2%.

We believe that the primary factors negatively impacting sales in February are external in nature. We've made no significant operational, pricing, marketing or strategic shifts since the beginning of the year that we believe could explain the sales decline from January to February.

Our belief is that three external factors likely in combination that negatively impacted our sales: first, delayed tax returns by three to four weeks because of the late release of tax forms; second, the expiration of the payroll tax break at the beginning of 2013 causing Americans to pay 2% more in social security taxes; third, increased gas prices throughout the month of February.

We believe that the delay in income tax refunds, the expiration of the payroll tax holiday and the increase in gas prices have a disproportionate punitive impact on our guest, which are typically young families with lower incomes.

Our sales trends did improve throughout February. If we are correct in our assessment, the delayed tax returns have negatively impacted sales during February, we should benefit from the delayed returns during the remainder of February and March including the most recent week in February in which sales were relatively flat.

Our sales continue to be very difficult to predict in such a challenging macro economic environment. However, based on the combination of a sales decline of 8.6% in March of 2012, due to very warm temperatures in the Upper Midwest and Northeast last year and the expected positive impact of tax returns to be received during the next few weeks, we believe that March 2013 sales should rebound and be positive.

The long-term impact of the expiration of the payroll tax break and increased gas prices are unknown at this time. Despite, our disappointment in our sales performance in February, we continue to believe that we have a solid plan to increase sales and earnings in 2013.

The main components of our plan include: first, strong marketing plan focused both kids and moms with the objective of increasing customer traffic; second, the continued implementation of our value proposition supported by new advertising; and third, the reinvestment in our facilities and entertainment attractions.

As stated earlier, our marketing expenditures are expected to increase $6 million to $41.4 million in 2013 from $35.4 million in 2012. The primary components of this plan include: first, a strong television media plan that increases our media by approximately 27% compared to 2012; second, a strong digital plan of approximately $5.5 million, which encompasses search, plan, value and promotional elements. We're doubling the budget and have committed to a 52-week digital plan for 2013; and finally, an enhanced creative plan that is a combination of brand advertising and promotional advertising providing families with reasons to visit our locations.

We are very excited about what we believe are two very significant promotions starting in April and June of this year. We're not releasing the details of these promotions for competitive reasons and will discuss our April promotion with you on our next earnings conference call. We believe that these promotions supported by increased TV and digital media will increase customer traffic.

The next component of our plan to increase sales is continued implementation of our value strategy. We implemented new menu boards in all company stores during October of last year. We believe the new menu boards offer a good value for both food and entertainment, including reduced prices for pizza and value deals. We believe that our revised menu pricing provides us with a strong base to market everyday great value.

In addition, we have implemented revised coupon offers in the third and fourth quarters of last year to provide greater flexibility to our guests with package deals, a pizza, drinks and tokens, at very affordable price points and various coupon offers for salads, sandwiches, buffalo wings and tokens. This coupon offers are supported with our new website, digital advertising and imprint. And finally, we're supporting our value initiatives with a television commercial featuring our new value deals that started airing Monday, February 18.

The last significant component of our sales strategy is continued reinvestment in our facilities and entertainment attractions. Because of our strong commitment to reinvesting in our stores over the past few years, we are able to significantly reduce future capital expenditures on our stores and still maintain outstanding facilities, games and rides.

We anticipate that our existing store capital plan in 2013 will approximate $27 million and will impact 120 stores, including 100 game enhancements, eight major remodels, and 12 expansions. This existing store capital plan of approximately $28 million compares to approximately $40 million in 2012 and $65 million in 2011.

In addition to developing what we believe is a strong sales plan that we anticipate will gain traction is discretionary spending of our guest improve. We have also implemented a fairly significant cost reduction program to offset a portion of our cost increases.

Our profitability plan includes: first, we've modified our price and merchandise ticket categories from eight different categories to seven different categories, resulting in an annual cost reduction of approximately $1.2 million. The roll out of the modified ticket categories is anticipated to be completed in mid March.

Second, we've refined out pizza dough resulting in what we believe is an enhanced product with a crispier crust and reduced sodium content. The roll out will be complete by the end of this month and the annual cost reduction will approximate $1.2 million. Third, our reduced existing store capital expenditures, excluding new stores, will result in reduction in comparable store depreciation expense by approximately $1.5 million in 2013 versus 2012.

Fourth, our revised pricing structure, including our menu boards and coupon offers is projected to reduce cost to sales by approximately $1.5 million in 2013. Reduced food prices had been more than offset by reduced tokens resulting in a slight price increase. This pricing structure was implemented primarily in September and October of last year.

Now, I would like to discuss the growth of our concept through new locations, both domestically and internationally. Starting with domestic growth, during 2012 we've opened 12 new locations, including three relocations and we acquired one franchise store. We closed six stores, including the three relocated stores, resulting in the net addition of seven company stores.

For 2013, we anticipate opening approximately 15 new stores, including one relocation. We anticipate closing approximately four stores, including the one relocated store, resulting in net addition of approximately 11 stores. From 2007 through 2010, we opened a total of 25 new and relocated stores. These stores averaged over $2 million sales during 2012 and produced a cash return on investment of slightly over 20%.

Internationally, we currently have 16 franchise stores open, including eight stores that have been opened since the fourth quarter of 2010. We have increased our international prospect significantly in the last two years, signing 10 development agreements, providing the franchise partners with the rights to open a total of 61 stores.

In 2012 alone, we signed seven new development agreements for the development of 42 stores in Mexico, Peru, the Philippines, Trinidad, Bahrain, Saudi Arabia and Untied Arab Emirates. I believe that we have an excellent international development concept as evidence by the significant average unit sales volume of our stores overseas.

In addition, I am also extremely excited to announce that Roger Cardinale, an Executive Vice President and 25-year veteran of our company has expanded his role, and is now President of our international division. Roger significantly strengthens our international team, built by Mark Gordon, our Senior Vice President, International.

In summary, I believe that we have an excellent long-term growth vehicle with a specific growth emphasis in Latin America, Asia and the Middle East, and I'd look forward to reporting our progress of realizing this growth potential.

I'll now turn the call over to Tiffany to go over our business outlook.

Tiffany Kice

Thank you, Mike. As Mike outlined for you, we have experienced an increase in comparable store sales of 2.1% for January and a decline in the third of February of 9.4%, leaving us down 3.2% through week seven of 2013. With only three weeks of sales results in February, it's difficult to interpret any meaningful or sustained trend.

However, we do believe the comparable store sales have been negatively impacted by the elimination of the 2% payroll tax holiday, the delay in the federal income tax refunds as compared to the prior year, and the increasing gasoline prices.

Although, the current economic environment is challenging, we continue to believe in our strategic plan that we've laid out for 2013. And borrowing these external factors being prolonged in nature, we believe that comparable store sales should benefit over the long-term. On our last call we provided guidance of 2% to 3% increase in comparable store sales for fiscal 2013 with the diluted EPS range of $2.80 to $3.

Given the uncertainty surrounding the potential longer-term impacts to comparable store sales that I've just noted and very limited sales data at this point in time, we estimate that as comparable store sales are up 1% to 2%, we will expect diluted EPS be in a range of $2.70 to $2.85, assuming 15 new company-owned stores, including one store relocation.

Average cheese block prices in the range of $1.70 to $1.80 per pound; depreciation and amortization to remain relatively flat; rent expense to increase approximately 4% to 5% from the prior year; advertising expense to increase approximately $6 million from the prior year to support our comprehensive and multi-faceted advertising plan; capital expenditures to range from approximately $82 million to $84 million; and payment of four quarterly dividends totaling approximately $17 million.

At this time, Mike and I will be glad to take any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Michael Gallo with CL King.

Michael Gallo - CL King

Mike, I guess couple of questions. As you refine some of the advertising, obviously you had some mismatches as you made the changeover. Are you still tweaking the mix between your traditional kid's television media and what you're doing it in the radio, or do you feel you've got that figured out? And then on that same front, when you look year-to-date in the fourth quarter, I was wondering how much of the year-over-year increase in advertising, have you spent already? And how do you expect that to be spread throughout the year?

Michael Magusiak

I'll try to remember all this questions there. But first of all, we do believe we have very strong plan that our average trips, are national TV buy is up about 27% for the year. And if you look at the first quarter, we're up about 35% versus last year. Now, if you compare that to the fourth quarter of last year, we were down about 15%. So the fourth quarter of last year we were down about 15%. In the first half or the first quarter this year, we're up about 35%.

The heaviest quarter that we have on a comparison basis, this year versus last year from a TV perspective, is the third quarter because if you remember we cut dramatically TV trips in the third quarter of last year, although we have a solid plan of TV across the board.

Then if you look at the digital plan, we are branding, we are in search, and we're also going to support our two major promotions not only on TV but digital.

We would have crossed all 52 weeks for 2013. I mean, we didn't start that until the third quarter of last year. So on a broad basis, we're strong across each quarter on a national TV and digital. As far as radio, we did have radio in February and March of this year, that's not part of our plan for 2013 because we believe that the TV and digital are more than offsets the radio that we had in the first quarter of last year.

Michael Gallo - CL King

And, Mike, can you comment although what you're seeing in the birthday party business. Obviously, you had made some changes around Ticket Blaster last year, and I was wondering if you could just give us an update on whether you've been able to regain some momentum and growth there? And what do you see in terms of bookings as you look forward.

Michael Magusiak

On birthday party is actually, Michael are off to a greater extent than our average comparable store sales. And it's always difficult to break out birthdays versus regular walk-in traffic. But we attribute part of that to tightening of discretionary income, and that that to be a little bit of a larger check and maybe that's impacting it. And then we're also going against last year when we rolled out the Magic Ticket.

Michael Gallo - CL King

Any changes you're making in the packages this year to kind of keep it fresh? It would seem like, with Ticket Blaster out there for a couple of years now, it's kind of lost a little of the newness, obviously the kid has the birthday party there one year, and they intend to want to vary it up the next year. So are you making any changes this year to the birthday package?

Michael Magusiak

Yes, we have some, what I would consider fairly significant changes that are rolling out in the third quarter of last year, and I still believe, we still have an opportunity to continue to promote that Ticket Blaster. I spent about five to six hours at one of our stores a couple of weekends ago, and what I would tell you, Michael, is kid's loved that Ticket Blaster. There is an incredible excitement for not only the kid's in there, but adults and kids outside the Ticket Blaster. And I still, continue to believe that as we promote that we offer guests a very good birthday value and just an incredible experience for that birthday kid.

Operator

At this time there are no further questions in queue, please continue.

Michael Magusiak

We appreciate your participation and our web listeners. As always if you have any questions, please feel free to call Tiffany, Dick Frank, our Executive Chairman, or myself, and we'd be happy to review our strategies in 2013. Again, thank you for your participation.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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