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Mike Magusiak - President and Chief Executive Officer

Chris Morris - Executive Vice President and Chief Financial Officer

Dick Frank - Executive Chairman


Michael Gallo - CL King

Greg Ruedy - Stephens, Inc.

Bob Derrington - Morgan Keegan

William Hamilton - SMH Capital

CEC Entertainment Inc. (CEC) Q4 2008 Earnings Call February 19, 2009 4:30 PM ET


Ladies and gentlemen, thank you for standing by. Welcome to the CEC Entertainment teleconference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session (Operator Instructions).

I’d now like to turn the conference over to our host, Mike Magusiak.

Mike Magusiak

Good morning. Welcome to our conference call. I’m Mike Magusiak, President and CEO of the company and I’m joined by Dick Frank our Executive Chairman and Chris Morris, our Executive Vice President and Chief Financial Officer.

Before we begin today’s discussion, I’d like to make you aware that some of the information presented today may contain forward-looking statements that 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. The primary objectives for today’s call are first, to discuss our financial performance during the fourth quarter and fiscal 2008.

Next, we will provide you with an in-depth review of the effectiveness of our sales initiatives, an analysis of sales trends by geographic area and our thoughts regarding 2009 sales. Third, Chris will discuss our outlook for the business during 2009 and finally, Dick will provide some concluding remarks and then open the lines for a question-and-answer session.

Now I’d like to the turn the call over to Chris Morris, who will review our financial performance for the fourth quarter.

Chris Morris

Thank you, Mike and good morning everyone. Before specifically discussing the fourth quarter, I think it’s important to briefly review our accomplishments for the full year. Total revenue for the year grew 3.7% in 2008 from $785 million in fiscal year ‘07 to $815 million in fiscal year ‘08 due to an increase in comparable store sales of 2.3% and an increase of approximately five units in our weighted average unit base representing a 1% increase in store operating weeks.

Net income increased to $56.5 million in ‘08, from $55.9 million in ‘07 and diluted earnings per share increased to $2.37 in ‘08 from $1.76 in ‘07 reflecting a growth rate just shy of 35%. This growth benefited from the company’s cumulative share repurchases of $409 million during the ‘07 and ‘08 fiscal years.

When we look back at 2008 we see a year full of challenges, both from a top-line and a bottom-line perspective. Needless to say the economic climate was increasingly difficult during the year and commodity prices were at historical highs for a significant portion of the year. Given these challenges, we are pleased with the financial results we delivered during ‘08.

Now let’s move on to the fourth quarter. Total revenue for the quarter decreased slightly from $175.1 million in Q4, ‘07 to $175 million in Q4, ‘08 primarily due to decline in comparable store sales of 1.5% partially offset by an increase of approximately six units in our weighted average unit base reflecting a 1.2% increase in operating weeks.

Cost of sales as a percent of company store sales decreased 30 basis points, from 16.9% to 16.6%. This decrease is primarily due to a $0.26 reduction in cheese prices and a 50 basis point reduction in total pizza cost resulting from an enhanced cheese blend and the resizing of large and medium pizzas as discussed in previous calls.

These reductions were partially offset by 24% increase in dough cost and a 30 basis points increase in prize and merchandise costs. Labor expenses as a percent of company store sales increased 50 basis points from 29.2% to 29.7% primarily due to higher group medical cost compared to the prior year.

Depreciation and amortization expenses increased from $18.8 million to $19.5 million, representing a 40 basis point increase as a percent of revenue. Rent expense increased from $15.9 million to $16.4 million representing a 30 basis point increase as a percent of revenue. Other company store operating expenses, as a percent of company store sales increased 190 basis points from 14.5% to 16.4% primarily due to a 50 basis point increase in insurance costs in Q4, ‘08 compared to Q4,’07 and the de-leveraging effects associated with negative comparable store sales.

In addition, the fourth quarter and the prior year benefited 80 basis points from the receipt of $1.5 million in business interruption proceeds, related to store closures caused by hurricanes Katrina and Rita. Advertising expenses as a percent of total revenue increased 60 basis points from 4% to 4.6% due to our enhanced marketing plan.

General and administrative expenses as a percent of total revenue decreased 80 basis points from 8% in Q4, ‘07 to 7.2% in Q4, ‘08, primarily due to a $1.7 million favorable adjustment to the company’s contingency reserve for ongoing litigation matters.

Interest expense was $4.4 million in both Q4 ‘08 and ‘07. Net income increased to $2.4 million in Q4, ‘08 compared to a net loss $564,000 in Q4, ‘07. Diluted earnings per share were $0.11 in Q4, ‘08 compared to loss of $0.002 in the same period of the prior year. Now let’s move on to our cash flow and financial position.

During 2008, the business generated $144 million in operating cash flow. We invested $85 million in new and existing stores and used $161 million to repurchase 4.9 million shares of company stock, bringing the outstanding balance on the share repurchase authorization to $71.4 million. We ended the year with a balance of $402 million on the company’s revolving line of credit reflecting a leverage ratio of 2.2 to 1, well below the leverage ratio cap of 3 to 1 as required by our revolving credit agreement.

As expected, our debt balance slightly increased during the low seasonal fourth quarter. However, during the first seven weeks of the first quarter of ‘09, a high seasonal quarter we have reduced our balance on the line of credit by $37 million, bringing our balance on the line of credit to $365 million.

Mike will now update you on our strategies to drive shareholder values.

Mike Magusiak

Thanks, Chris. As everyone is aware the marketplace in which we operate changed dramatically in the latter part of 2008 and has continued into 2009. This morning we hope to communicate what this change in the economic environment has meant to us from a top line perspective, and share our thoughts relative of how to we intend to respond. The obvious place to begin is with our recent sales performance.

We are going to share a significant amount of sales information with our objectives being; first, to quantify the effectiveness of our sales initiatives; second, to analyze our sales trends by geographic area and provide insight into the effect the economy is having in different regions of the country; and third and finally, to provide our methodology and thought process regarding how we built our 2009 sales forecasts by quarter. The first component of our sales analysis is the evaluation of our strategies to increase comparable store sales.

Throughout 2008, we provided you with five specific sales initiatives; first, multiple strategies to increase birthday sales; second, strategies to increase school fund raising; third, a focused effort on suggestive selling; fourth, a strong capital plan for existing stores; and fifth, an enhanced multi-media marketing plan directed to moms and kids. We believe that these strategies were effective throughout 2008 and early 2009.

Specifically, sales results attributable to these strategies include, core birthday sales increased $8.3 million or 9.5% in 2008 compared to 2007. Fourth quarter core store birthday sales increased $1.9 million or 8.4%. This momentum has continued into 2009 with comparable store birthday sales increasing approximately 6%. In May of 2008, we eliminated the birthday cake from our standard birthday package and introduced a new Hershey cake as an add-on to our birthday package.

Birthday cake sales increased by $2.2 million in 2008, with the momentum continuing with an increase of $600,000 in the fourth quarter, period one birthday cake sales have increased from two tenths of a percent of sales in 2008 to four tenths of sales in 2009. Second, core store weekday school fundraising sales totaled $6.6 million in 2008 representing a 28% increase over 2007.

Fourth quarter 2008 fundraising sales totaled $2.2 million, representing a 52% increase over the fourth quarter of 2007. Fundraising sales, as a percentage of total sales have increased to eight tenths of 1% in 2009 compared to seven tenths of 1% during the same period of 2008.

Next, we focused our efforts to develop a culture suggestive selling in our restaurants. To that end we implemented two nationwide suggestive sales campaigns last year and initiated a new campaign two weeks ago. We are continuing with extensive sales training of our cashiers and birthday hostesses and have introduced new food products for our team members to sell. The results have been dramatic.

During the second quarter of last year, we implemented food platters system-wide. Food platter sales increased from $2.1 million in ‘07 to $10.8 million in ‘08. Fourth quarter food platter sales increased from $0.9 million in ‘07 to $3.3 million in ‘08. The sales momentum continues into 2009 with period one sales increasing from 0.4 million in 2008 to 1.3 million in 2009.

The four sales initiatives to impact core sales is a very strong capital plan. During 2008, we completed 20 store expansions, 15 major remodels and 125 game enhancements. Last year we increased our focus on store expansions because they have produced the best financial results. We completed 15 store expansions in 2006, 19 in 2007 and 20 in 2008. Stores expanded in 2006 benefited from an increase in comparable store sales exceeding 20% during the first 12 months following the expansion.

Stores expanded in 2007 benefited from an increase in comparable store sales, exceeding 25% for the first 12 months following the expansion. This strong sales performance has continued in 2009. Stores expanded in 2008 have generated comparable store sales growth of approximately 20% for the first seven weeks of 2009.

In addition, we’ve enhanced our 2009 capital plan by increasing the number of store expansions to at least 25 stores. The last major sales initiative that we believe positively impacted comparable store sales is our enhanced marketing plan with increased television impressions to kids and moms and the implementation of significant online media plan targeting moms.

This sales initiative is difficult if not impossible to quantify, but based on feedback from focus groups and years of evaluating, changes in media weights, impact on sales we believe that we have a very solid and effective advertising plan. From our perspective, it’s clear that the sales strategies which worked so well in the first half of 2008 are still appropriate and effective.

Yet our sales performance has softened and we believe it’s a direct result of the deterioration in the environment in which we operate. This is apparent when reviewing our sales results by quarter for the last year and first seven weeks of 2009. Quarter one of 2008 was positive 3.6%; quarter two was positive 5.6%; quarter three, was positive 1.1%; in the fourth quarter, we were negative 1.5% and in the first seven weeks of 2009, we are negative 1.4%.

January comparable store sales decreased 1.9% and February has decreased 0.6%. Clearly, the economy is impacting comparable store sales, but from our perspective given the economic environment our sales are holding up reasonably as well and we believe this is a direct result of our sales building initiatives. Further, simply reviewing quarter-by-quarter sales in the first seven weeks of 2009 do not tell the entire story as the economy appears to be impacting Chuck E. Cheese differently in various regions of the country.

Sales by region, in fiscal 2008 were; our central region was positive 5.2%; our northeast region was positive 3.8%; our southeast region was positive 1.3%; and our Western region was negative 0.6%. During 2008 we had seven major markets, defined as five or more stores with comparable store sales over 5%. These markets were Baltimore, Boston, Denver, Nashville, New York, Pittsburgh and San Antonio. No major market during fiscal 2008 had sales worse than 5% negative.

Our worst performing markets in 2008 were Orlando and Sacramento, both with markets declining 4% in comps. Other notable markets in 2008 with negative comparable sales were Los Angeles, negative 2% and San Diego and Tampa both negative 1%. Now let’s shift to the fourth quarter.

Sales by region in the fourth quarter of 2008 were; the central region was positive 2.5%, the northeast region was positive 0.1%, the southeast region was negative 0.7% and the western region was negative 7.3%. Clearly the western region had the weakest sales during the fourth quarter. In addition, the southeast region was negatively impacted by Florida sales results.

A similar pattern is revealed in the first seven weeks of 2009. The central region remains strong with comparable store sales increasing 2.7%, the southeastern region turned positive 0.4% despite soft sales in Florida, the northeast region is slightly negative at 0.7% which we believe has been negatively impacted by weather, and the western region remained very soft with negative comps of 7.6%.

Our obvious conclusion regarding recent sales trends is that the economy, especially in California and Florida is negatively impacting our performance. While California and Florida are soft Chuck E. Cheese is experiencing strong sales results in a number of other markets. In markets where we have at least five stores in the market, we had five markets in both the fourth quarter and year-to-date 2009 with comparable store sales increasing 5% or better.

We are always disappointed with negative comparable store sales. However, we believe that given the current economic environment our sales are holding up reasonably well. Recognizing the challenging operating environment and even though we believe our sales strategies are sound, we constantly are revisiting what we can do differently to improve our sales performance. First, however let’s cover what we are not going to change.

We are not going to change our sales strategies relating to birthdays, fundraisers and suggestive sales. These strategies are working and we intend to execute these strategies to the highest extent possible. Next we will execute our capital expenditure plan of spending approximately $44 million in 2009 to complete 25 store expansions, eight major remodels and 105 game enhancements.

However, in addition to moving forward with these existing strategies, we will look for opportunities. We will start with California and Florida. Within the next three weeks our executive team will visit essentially all of our stores in Los Angeles and San Diego.

Our focus will then shift to Florida with our store visits focused on ensuring that we have an excellent facility and entertainment product, obtain input from our operators and guests and seek to identify opportunities for increasing sales in these markets.

Next, we’ll continue to evaluate the effectiveness of our television advertising. We conducted focus groups in Los Angeles, approximately five weeks ago. Based on feedback from moms and kids, we modified our television creative by adding three of our most impactful commercials that we produced last year. In addition, we slightly modified the mix of media messaging, targeted to kids and moms.

We implemented both of these changes two weeks ago and are encouraged by the recent results with comparable store sales being positive in both of the last two weeks. Third, we will continue to enhance our coupon strategy. Our focus groups in Los Angeles reaffirmed results from previous focus groups, that Chuck E. Cheese is a very good value. Despite being a good value, we believe that improving value in a very difficult economy will improve guest traffic.

Specific value initiatives include; increase in the frequency of coupons distributed to our email database of approximately 500,000 consumers in California and Florida and potentially select other markets; second increasing our online media to provide parents with coupon offers and incentives to join our E-club; and finally, we are lowering the prices for certain coupon offers.

As stated earlier, we believe that our strategies are sound and these tweaks to our media buy and coupon strategy should only serve to enhance our sales initiatives. Sales are difficult to predict in any environment and especially in our current economic environment. However, the last objective we had regarding our sales update was to share our thoughts in how we built our sales forecast for 2009.

First, we evaluated comparable store sales performance by quarter for 2008 and 2007. We netted comparable store sales for each of the quarters in 2008 and 2007 to obtain a relative performance measure over the past two years. For example, comparable store sales in the first quarter of 2008 and 2007 were positive 3.6% and 0.5% respectively. Net compatible store sales are therefore 4.1% in the first quarter.

Net comparable store sales for the past two years by quarter are; quarter one, positive 4.1%; quarter two, positive 4.1%; quarter three, negative 1.4%; and quarter four, negative 4.0%. Based on our sales performance over the past two years, which incorporates much easier sales comparisons in the second half of 2009 for California and Florida, we built our sales forecast by quarter for 2009 as follows.

Quarter one and two with comps negative 2% to 3%, and quarters three and four flat sales to negative 1%. There can be no assurance that this sales performance will be achieved or potentially exceeded. However, this is currently our thought regarding 2009 sales. Before I turn the call over to Chris, I want to conclude with several observations, past sales regarding the financial strength of our company.

In such a difficult economic environment, we built our 2009 strategic plan on a few guiding principles. First and foremost, we are protecting our core stores with a strong capital plan. Next, we build a plan to maximize free cash flow which provides us with significant financial flexibility. We did this by tightening down on our costs and by planning to develop only five high volume new stores.

Assuming that comparable store sales and our costs are reasonably close to our projections, we anticipate that operating cash flow will exceed capital expenditures by approximately $75 million to $80 million. Currently we are utilizing our free cash flow to reduce debt and we’ve already reduced our debt by $37 million this year. However, we will continue to monitor our sales in the economic environment and will evaluate opportunities to repurchase our stock and enhance shareholder value.

Chris will now review with you our current outlook for our business.

Chris Morris

As we begin the 2009 fiscal year, the outlook for the consumer economic environment remains extremely negative. We believe we have developed a strong strategic plan for 2009 in which we will build upon the ‘08 sales initiatives that have proven to be successful and are hopeful that our plan will work to mitigate the negative impact associated with the weakening consumer environment.

However, given the unprecedented challenges facing our customers, it is difficult to forecast ‘09 with any meaningful degree of certainly. However, based on everything discussed today, our best estimate at this point in time is comparable store sales will decline approximately 1% to 2% in fiscal year 2009 and diluted EPS will be in the range of $2.53 to $2.65, reflecting a growth rate of 7% to 12%.

Incorporated into this estimate are the following items. We are assuming cheese price will average $1.40 to $1.45 for the fiscal year. We are targeting approximately five new company units, including one relocation and two new franchise stores in ‘09. We are currently estimating total capital expenditures to be in the range of $70 million to $75 million. Fiscal year 2009 will be a 53 week year. We currently expect the addition of this extra week to benefit ‘09 diluted EPS by approximately $0.10.

We are assuming an effective tax rate of 38.5% for the year and we are assuming free cash flow will be used to pay down debt. However, as we move forward into 2009, we will continue to evaluate the economic climate, as well as our sales and cash flow trends. Based on the results of this evaluation, we may build cash reserves or repurchase shares and paying down debt. During our last conference call we stated that if comparable store sales were flat, diluted EPS would be in the range of $2.72 to $2.78.

Since this time, cheese prices and interest rates have declined, offsetting the negative effects associated with our lower sales outlook. As a result, the principle difference between the guidance we provided in October to today’s guidance is our assumption that we’ll use free cash flow to pay down debt versus repurchasing shares.

With that I would now like to turn the call over to Dick.

Dick Frank

As Mike shared with you, after a great start in 2008, comparable store sales softened in the last half of the year resulting in comparable store sales actually turning negative by the fourth quarter. This sales trend is carried into 2009 with same-store sales being down 1.4% for the first seven weeks of the year. We believe that this shift in sales trends is largely attributable to the dramatic changes in the economic environment in which we operate and has occurred despite what we believe are solid and effective sales building strategies.

These strategies include a strong capital plan with respect to our existing stores, an enhanced marketing plan and focused sales efforts regarding birthday parties and school fundraising events. We intend to continue to evolve and build upon these strategies throughout 2009 while looking for additional opportunities to drive top-line sales.

The marketplace is obviously challenging, especially in California and Florida, but we believe in the strength of the Chuck E. Cheese brand and are confident in our long-term business outlook. The company remains financially strong as we project operating cash flow will exceed capital expenditures by approximately $75 million to $80 million. We recognize the challenges ahead may be significant, but we intend to stay focused, evolve and execute our strategies in a high-quality manner and enhance long-term shareholder value.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from Michael Gallo -CL King.

Michael Gallo - CL King

The question I have is on birthday parties. I was wondering as the economy is continuing to get worse here early in ‘09, whether you’ve seen any change in trends toward parents booking birthday parties? Obviously that business held up pretty well in 2008.

I guess, as we start to dissect the traffic and the comps a little bit further, what you’re seeing on the birthday party business versus what you are seeing in the everyday traffic?

Mike Magusiak

As we stated, our birthday sales and this is just core stores, comparable store birthday sales on a year-to-date basis are positive approximately 6%. So we feel that initiative is working. With comps being negative 1.4% on a year-to-date basis, we are losing it on the typical walk in business.

Michael Gallo - CL King

Coming back to the trends, I think my recollection was earlier in 2008, that the trends toward birthday parties had been even stronger. My guess is, has that trend held pretty constant throughout the quarter or has it that gotten tougher heading into ‘09? Just trying to get a feel for whether you are starting to see that area become more difficult or whether that just continues to hold pretty steady?

Mike Magusiak

You would think that the economy would impact birthday sales, but really throughout all of 2008 when we implemented our revised birthday party we saw strong birthday sales throughout 2008, including the fourth quarter. We feel good about our birthday sales year to date this year and we are actually rolling out a new birthday package in May, June of this year 2009 to hopefully kick birthday sales even a little bit higher.


Your next question comes from Greg Ruedy - Stephens Inc.

Greg Ruedy - Stephens Inc.

Your plans to remodel expand and enhance the games; I don’t think it has changed material from the last quarter. Do you project the returns continuing to stay here given the macro and what other factors are in play to gives you confidence to move forward with your CapEx guidance versus maybe reduce the debt load further?

Mike Magusiak

That is a good question. First of all, I would believe that if the economy is weak it would impact remodels or expansions or any part of the business, but at the same time we are very encouraged by our capital expenditure results early in 2009. We expanded 20 stores last year and year to date 2009 those 20 stores are averaging about 20% up in sales.

So when we look at our capital expenditures, we really see that as a long-term investment to have the best product in the marketplace and we feel that is really necessary in good times, in difficult economic times that with the economy improving, when it does improve we really believe that that great product in the marketplace is going to benefit us.

Greg Ruedy - Stephens Inc.

Switching to the cost side of the equation, you’re getting help on the dairy side of it, but are there any cost-saving initiatives that you can discuss that you’re putting in place. It looks like comps are going to be maybe a little softer here in the first half?

Chris Morris

Greg, this is Chris. There is nothing specific that we’ve implemented, but what I will tell you that we are very focused on controlling costs. Not only at the field, but here in the support center we’ve had a number of meetings as we developed our 2009 plan and we have an incredibly sharp focus on controlling cost in this environment. So, I’d say it is more than a broad initiative, but nothing specific.

Mike Magusiak

One thing I would add to what Chris said is we built our 2009 plan. We really did try to tighten our costs from every aspect in the company, our departmental and operational department expenditures are below last year and that’s 53 weeks versus 52 weeks and then as you are aware we pay our operators and our executives off of increased sales and profit. When we look at actual expenditures in ‘09 versus budgeted expenditures in ‘08 versus budgeted ‘09, we actually see the compensation for the operators and the executives based off of our plan down about $4 million and that’s built into our earnings guidance that we are providing you.

Greg Ruedy - Stephens Inc.

Okay. Last one and I will pass it on. The game merchandise is ticking up, what’s the inflation on those costs and then do you adjust the number of tickets needed for redemption or is there a way to push the children to certain prizes?

Chris Morris

First, the 30 basis-point increase that we saw in the fourth quarter, that’s not a trend that we expect to continue throughout all of 2009. It relates to a specific initiative in the fourth quarter of 2008 to liquidate certain components of our prize and merch inventory.

There may be a slight increase in the first-quarter of 2009, but once we get through Q1 of ‘09, we expect pricing in merch to return to historical levels. In terms of adjusting the number of tickets per game, yes we do have that ability to adjust our tickets per game at the store level. I don’t know, Mike if you want to comment.

Mike Magusiak

No, that’s good direction, Chris.


Your next question comes from Bob Derrington - Morgan Keegan.

Bob Derrington - Morgan Keegan

Mike, could you tell us a little bit about how the TV plan changed. That’s obviously benefiting sales here in the first quarter to date?

Mike Magusiak

Yes, I sure can Bob. I think first of all, we are encouraged by the last two weeks of sales, specifically if you look at so far the numbers we are up against with some strong performance in the first quarter of last year and so we are encouraged by that. What I would tell you is it is only two weeks.

There are a lot of variables that can potentially can change over such a short period of time, but we do believe that the fine tuning that we made to our advertising plan has benefited sales over the last two weeks.

We had some focus groups in Los Angeles. We reviewed those commercials as we always do and what we did was we changed three commercials back to very, very strong commercials that produced last year and then what we also did we changed the mix of targeting moms and kids to go a little bit higher targeting kids. That happened two weeks ago and the results are early, but we are encouraged with that change to our advertising plan.

Bob Derrington - Morgan Keegan

Did the message change, Mike? In other words, did you push something, all games own token or something or--?

Mike Magusiak

It was really the TV creative that changed, Bob. We do have a value message in the marketplace. All games are won token and $0.25 tokens and so that message is there, but what we did was we brought back three very strong TV messages that we aired last year.

Bob Derrington - Morgan Keegan

Then, Mike when you look at menu where do we stand on menu pricing? I think you had about 1.8% at the end of January last year. Effectively, where will we be for Q1 of this year?

Mike Magusiak

About 1.5%, Bob.

Bob Derrington - Morgan Keegan

Okay, all right. So your year-over-year menu pricing was a little bit less as a percent?

Mike Magusiak

That is exactly right, Bob.

Bob Derrington - Morgan Keegan

As we move into the new suggestive selling program Mike, what is that program at this point and what’s your expectation around that?

Mike Magusiak

Our program is focused on three specific areas; our value meals, token deals at the front order counter, and we really like those two packages because we have a higher ticket average, and by the packaging of value meals and token deals, we are giving an excellent value to our guests.

So, we are driving the value meals from token deals and then we are also on the birthday’s driving food platters, birthday cakes. We’ve got a great Hershey’s birthday cake and any incremental sales, whether it be token deals or value meals also at the birthday parties.

Bob Derrington - Morgan Keegan

And if could, one last one Chris. Can you help us understand, in your release you talked about the company store operating cost for the fourth quarter increased $5 million. Can you kind of parse this between the adjustments to the self-insured reserve, the increased merged cost and versus the adjustment last year?

Chris Morris

Can you just elaborate on that, Bob?

Bob Derrington - Morgan Keegan

Well, yes I’m just wondering how much of the $5 million higher year-over-year for the store operating cost related to the insurance reserves?

Chris Morris

Okay, no problem. Relative to ‘07, we did see an increase in our self-insurance reserves or in other words group medical claims, general liability and worker’s comp claims, on all three. In the fourth quarter, increases in group medical expenses and general liability and worker’s comp increased in the aggregate of approximately $1.3 million or $0.04.

Bob Derrington - Morgan Keegan

Yes, is that because of increased incidents?

Chris Morris

Well, it’s a combination of two things. I would say on a general liability on workers comp, it’s a result of increase in claims, as well as a shift in claims that result in a higher reserve. On group medical, it’s more of a function of what we are comparing against. In other words, in 2007 we just had an exceptional year for group medical claims. So ‘08 we are not seeing an increase in costs, it’s more just compared to a favorable year in ‘07.


Your next question comes from Will Hamilton - SMH Capital.

William Hamilton - SMH Capital

Chris, first I was wondering if you can talk about flour and whether you renewed that contract and how that compares to last year now.

Chris Morris

Yes, dough costs for 2009 compared to 2008, we are expecting dough to be approximately 10% below ‘08 levels. We did lock in dough prices in the last six months of the year. Our purchasing department is in the process of evaluating what steps we want to take in 2009 to potentially lock in prices, but at this point in time we have not executed.

William Hamilton - SMH Capital

Okay, and then on the cheese front, I know you were contemplating the idea of looking at a contract, any update on that? Certainly at this point you’re not, but what’s the thought in terms of potentially doing a contract going forward?

Chris Morris

It’s something that we always evaluate and you’re absolutely right Will. At the very beginning of the year we were exploring the idea of hedging cheese during the 2009 year. Coming off a year where cheese prices averaged $1.86 and then we saw prices drop fairly dramatically, we wanted to just explore that idea.

As you said we have not executed a hedge and at this point in time we don’t intend to do so in 2009, and it really just comes down to cheese costs as a percent of our total sales, it represents about 2% of total of sales and our cash flow margins are so strong that it affords us the luxury of being able to weather the storm like we did in 2008 and then likewise benefit when cheese prices come down in a year like 2009. So over a long period of time, a hedging strategy would cost slightly more than a non-hedged strategy.

William Hamilton - SMH Capital

Right, okay sounds good. Mike, I was wondering just with the marketing budget you made some changes, but by and large it sounds like it should stay roughly the same. Can you give us a sense on the dollar budget that you plan for this year or maybe how much up versus I guess it was the $34 million, $35 million you spent in 2008?

Mike Magusiak

Yes, we are going to spend just a little bit over $35 million in 2009 and with that we have increase in our TV weights of about 7% and then we have about 50 weeks where we have a strong online advertising campaign targeting moms and the value of taking your kids to Chuck E. Cheese.


(Operator Instructions) Your next question comes from Bob Derrington - Morgan Keegan.

Bob Derrington - Morgan Keegan

Chris, could you give us within your earnings guidance what’s the share count assumption in that EPS guidance?

Chris Morris

Well, as we said Bob, we are assuming that free cash flow would be simply used to pay down debt. Our share count, our total shares outstanding at the beginning of the year, just shy of $23 million, $22.7 million.

Bob Derrington - Morgan Keegan

Okay, alright and then how should we think in terms of the growth in the G&A line? Should we think of it in terms of expressed as a percent of revenue, can you give us any kind of guidance there, any kind of color?

Chris Morris

I think the best way to looking at it is just based on a pure absolute dollar standpoint. As Mike said, we believe in 2009 compared to 2008 there will be a benefit simply because we are expecting the performance based compensation in ‘09 to be lower than ‘08.

Bob Derrington - Morgan Keegan

So the likelihood is that on an absolute dollar basis we are looking at less dollars in that line?

Chris Morris

Basically I would assume that would be flat.


And at this time, there are no further questions.

Mike Magusiak

Chris made one minor change that’s going to go down slightly on the G&A, Chris.

Chris Morris

Yes Bob, actually I went and looked back at my schedule, and incorporated into our EPS guidance is an assumption that G&A dollars will decline approximately $2 million in ‘09 compared to 2008. Sorry for the confusion.

Mike Magusiak

Thanks, Chris. If there are no further questions, please feel free to call Dick, Chris or myself. We appreciate your participation. Thank you.


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

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Source: CEC Entertainment Inc. Q4 2008 Earnings Call Transcript

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