CEC Entertainment's CEO Discusses Q3 2013 Results - Earnings Call Transcript

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CEC Entertainment, Inc. (CEC) Q3 2013 Earnings Conference Call October 31, 2013 4:30 PM ET


Mike Magusiak - President and CEO

Tiffany Kice - EVP and CFO

Dick Frank - Executive Chairman


Mike Gallow

J. R. Bisel [ph]

Michael Halen


Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter Earnings Call. At this time, all participants are in a listen-only mode and later we will conduct the question-and-answer session and instructions will be given at that time. (Operator Instructions). And as a reminder, the conference is being recorded.

I would now like to turn the conference over to our host Mr. Mike Magusiak. Please go ahead sir.

Mike Magusiak

Thank you. 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 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 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. Reconciliation information related to non-GAAP financial measures discussed on this call may be found in the Company's third quarter earnings release and on the Company's website under Investor Information.

Tiffany will begin today’s call with an overview of our financial performance during the third quarter of 2013. I will then discuss our sales performance to-date, our strategic plan and our growth opportunities. Tiffany will then go over our business outlook for the remainder of 2013 and finally, Dick will provide concluding remarks before we open the call for Q&A. Tiffany?

Tiffany Kice

Thank you, Mike, and good afternoon everyone. For the third quarter total revenues were $195.9 million, a decrease of $0.7 million or 0.4% from $196.6 million in the prior year. Diluted EPS decreased $0.02 to $0.43 for the third quarter of 2013, as compared to $0.45 in the same period of the prior year.

The decrease in total revenues was primarily due to a decrease in comparable store sales of 2.1% or $4 million, substantially offset by an increase of $3.3 million related to the opening of seven net new stores since the end of the prior year third quarter.

The decline of 2.1% in comparable store sales was primarily related to an approximate 11% decline in birthday party sales during the third quarter, which has historically generated approximately 15 to 20% of comparable store sales. The decrease in birthday party sales contributed approximately 1.5% of the 2.1% decline in third quarter comparable store sales. Additionally we believe that the overall political and economic uncertainties and increased competition from kids' movies negatively impacted comparable store sales during the third quarter.

Comparable store sales by period were as follows. July down 2.3%, August down 1.8%, September down 2.4%. Comparable store sales by region during the third quarter were as follows; the central down 6.4%, the northeast down 2.6%, the southeast down 1% and the west up 1.6% for a total of 2.1% down.

Cost of food, beverage, entertainment and merchandize as a percentage of company store sales benefitted 120 basis points when compared to the prior year third quarter. We believe this benefit was primarily attributable to changes in our pricing strategy and our cost savings initiatives, including an approximate 20% reduction in dough usage as a result of our new thinner, more crispy pizza crust and the modification of our price and merchandize category.

Labor expenses as a percentage of company store sales increased 80 basis points to 29%, related to an increase in labor hours, the average hourly wage rate of higher performance bonuses, partially offset by a decrease in workers compensation cost during the third quarter of 2013.

Other store operating costs as a percentage of company stores sales increased 60 basis points to 17.7%, primarily due to an increase in self insurance reserves associated with unfavorable development of certain general liability claims and an increase in pre opening expenses to support new store development.

Advertising expense increased $0.6 million or 30 basis points as a percentage of total revenues to 5.4%. The increase is primarily related to an increase in national television advertising, partially offset by a reduction in production expenses.

General and administrative expenses increased $0.6 million to $13.5 million from the prior year third quarter. The increase primarily related to increases in various corporate costs, partially offset by a decrease in the management bonus accrual driven by the current quarter sales and profit performance.

Interest expense decreased $0.7 million to $1.3 million from the prior year third quarter. The decrease primarily related to the settlement of specific uncertain tax positions. On a year-to-date basis, to the end of the third quarter of 2013 we note the following.

Total revenues increased 2.8% or $17.5 million to $643.2 million. Net new store revenue increased $12.5 million. Comparable store sales increased 0.8% or $5 million. Store level margins improved 120 basis points. Net income increased 8.4% to $47.9 million from $44.2 million. Diluted earnings per share increased to $2.78 from $2.50, primarily due to the increase in net income along with the decreased in the number of weighted average diluted shares outstanding between period, benefitting diluted EPS by approximately $0.07 per share.

Let’s now turn to a few highlights from our cash flow statement and balance sheet. During the first nine months of 2013, we generated $123.8 million of operating cash flow. We utilized this cash by investing $51.4 million primarily in new existing stores paying $8.4 million in cash dividends repurchasing $18.1 million of our common stock and reducing our outstanding borrowings on a revolving credit facility by $41 million.

We ended the quarter with a balance of $348.5 million on the company’s revolving credit facility. Our leverage ratio is 2.15 to 1 as defined in our credit facility agreement which is well within our debt covenant restriction of 3 to 1.

On October 29, 2013, our Board declared our fourth quarter 2013 dividend with a 13% increase to $0.27 per share from $0.24 per share. The dividend will be paid in the December 2013. We did not repurchase any additional shares of common stock during the third quarter of 2013 and therefore continue to have a 128.9 million remaining of through this for future share repurchases to be utilized on an opportunist basis.

We remain committed to returning capital to shareholders, since the beginning of our fiscal 2010, we have repurchased $189.9 million or 5.4 million shares of our common stock, and we have paid $39.8 million in cash dividends for a total return of capital shareholders of $229.7 million or 39% of the $595 million in operating cash flow generated over the same period.

I'll now turn the call over to Mike to discuss our third quarter sales performance, as well as an update on our strategic plan and growth opportunities.

Mike Magusiak

Thanks, Tiffany. We believe that we have developed and are executing on a very solid strategic plan to increase comparable store sales, grow our concept with both domestic and international new locations and improve our profit margins. I believe that these strategies in combination with returning capital shareholders will enhance long term shareholder value. After posing positive same store sales of 1.6% and 2.9% in both Q1 and Q2 respectively with 5 out of 6 being positive, sales declined in Q3 by 2.1%.

We attribute the decline in the third quarter primarily to a significant decrease in birthday party sales and secondarily to increase competition from kids’ movies along with overall political and economic uncertainties for our guest. To address declining birthday sales, we have modified our marketing plan to include a newly developed birthday commercial. It’s started airing two weeks ago with increased birthday media weights.

In regards to kids’ movies during the third quarter, revenue from kids’ movies rated G&PG increased by approximately 65% or 320 million compared to the same period in the prior year and primarily during the first part of the third quarter. This increase in kids’ movies is significant considering that our total revenue during the quarter was 196 million. On a year-to-date basis, we believe that movies have not materially impacted sales.

Comparable store sales for the third quarter declined in both absolute dollars in compared to the positive sales trend through the first half of the year; however, comparable store sales in the first three quarters of 2013, remain positive for each of our four regions. In the first four weeks of the fourth quarter, sales trends have turned positive, increasing 0.4%.

Now, I would like to share with you the key enhancements to our plan to increase comparable store sales. First, an enhanced strategy of capital reinvestment in which we will impact each company own store on average every two years; second, the evolution of our concept with major attractions; third, the continued refinement of our pricing strategy the testing of increased token prices for games and rides; and fourth, an enhanced marketing plan that will be fully implemented at the beginning of 2014.

We have recently enhanced our existing store capital strategy by utilizing transferred games from existing stores and used games in combination with new games and rides. This substantially reduces the cost of game enhancements on a first store basis and enables us to impact each of our stores more frequently. This strategy was fully implemented in the third quarter of this year as demonstrated by the significant increase in the number of stores impacted by capital in the third quarter.

During the first half of 2013, we impacted 34 stores with capital improvements. This compares to 63 stores in the third quarter and a projected 60 to 70 stores in the fourth quarter. In summary, the 2013 capital plan will impact approximately 160 to 170 stores in the form of game enhancements, major remodels and store expansions for total cost of approximately $20 million. Our existing store capital plan for 2014 is projected to impact 260 to 270 stores at a cost of approximately $27 million to $29 million.

In addition, to improving approximately half of our store base, we’re also committed to the evolution of our entertainment attraction. We are currently testing two different major attractions that received very positive guest feedback and are installing a third major attraction within the next two weeks. We currently plan to spend 3 million to 4 million on new major attractions in 2014 which are included in the projected existing store capital spend of $27 million to $29 million; we believe that our capital plan to impact more stores, more frequently combined with expenditures on major attractions will positively improve future comparable store sales.

The next component of our plan to increase sales, while improving margins is the implementation of a refined value strategy. We implemented new menu boards in all domestic company owned stores during October of last year, featuring reduced price points for value deals including pizza, drinks and tokens at very attractive price points of $19.99. $29.99, $39.99 and $49.99 for families of all sizes.

In conjunction with our new menu pricing, we implemented a revised coupon strategy with reduced discounts compared to our coupon offerings in the prior year and incorporated additional coupon offers to provide more flexibility to our guests. We believe that this pricing strategy was very effective based on a significant increase in sales of value deals and improved margins resulted from reduced discounting.

We continue to believe that we offer our guests great value based on the number of metrics, including consumer research and guest feedback. In fact all of our games require only token to play and tokens can be purchased for as low as $0.20 each, representing a value that we believe is approximately three to four times better than our competitors pricing.

To capitalize on our great value we have recently implemented a test in four markets, reducing the number of tokens included in value deals, token deals and coupon offers. Essentially we're testing a price increase in these four markets and still believe that our game value remains significantly better than our competitors.

The next primary component of our plan, increase comparable store sales is implementation of a refined marketing plan. We implemented a number of marketing initiatives during 2012 and 2013 and believe that we continue to learn and refine our strategies to increase sales. Key lessons learned and current conclusions are; first creative messaging should combine both brand and reasons to visit. Second both kids and moms creative must continue to evolve and change. Third, there is a strong correlation between kids television birthday media weights and fresh and compelling commercials to birthday sales and finally we believe digital branding via banner ads to moms was ineffective in driving guest traffic.

With these refinements, we believe that we have developed a strong marketing plan for 2014. Plan highlights include; a reallocation of adverting expenditures from digital branding to television, which will result in a preliminary total budget of $42 million to $43 million in 2014, compared to $42 million in 2013; total advertising media weights to increase approximately 10% to 15% with over 80% of our spots directed at kids; birthday party advertising television media weights to increase by approximately 50%; moms television weights were more than double focusing on value in emotional messaging; and finally a re-work of our website to improve communication of great value, including package deals, Chuck E-Club offerings, All Games Are One Token and Chuck E live performance with tickets splash giveaways every hour.

In addition to developing what we believe is a strong sales plan; we have also implemented a fairly significant cost reduction program. The impact of this cost reduction program is evident in our store margins benefiting by 120 basis points through the third quarter of 2013. A majority of this benefit was in the 80 basis point improvement in cost of sales through the first three quarters of the year, compared to the same quarters last year.

As Tiffany noted earlier, the primary drivers of improved cost of sales margins include the implementation of a revised pricing structure, as well as modifications to our ticket categories and refined pizza dough with a thinner crispier crust.

Margin improvement initiatives that we are currently testing or implementing include, but are not limited to one additional pricing test that have been recently implemented in four markets, that effectively raise the price of games and rides; second, the installation of energy efficient thermostats in approximately 200 stores resulting in improved utility margins; third the requirement of non-slip footwear for all employees; fourth, holding store management accountable through incentive compensation programs for workers compensation and general liability claims, which we believe reduces incidents; and finally changing the sourcing of games and rides parts, as well as increasing the spacing of games within our stores, which improves the guest experience and reduces repair and maintenance attributable to fewer games.

And finally, the next significant component of our strategic plan is the growth of our concept with domestic company owned locations and international franchise locations. We accelerated both domestic and international growth last year and now new domestic locations are a significant contributor to revenue growth.

Total revenue in the first three quarters of this year increased $17.5 million, representing a 2.8% increase compared to the same quarters last year. Comparable store sales contributed $5 million or 8:10s of a percent of the revenue growth and domestic new units contributed $12.5 million or 2.0% of the revenue growth.

Starting with domestic growth, in 2013 we anticipate opening 13 to 14 new stores, including one relocation. We anticipate closing five stores including the relocated store resulting in the net addition of eight to nine company owned stores.

In 2014, we anticipate opening 12 to 15 locations, including three relocations and one franchise acquisition. From 2007 through 2011 we opened a total of 27 new and relocated stores. These stores averaged over $2 million sales during 2012 and produced an average cash return on investment over 20%.

Switching now to international development, we continue to believe that we have an excellent long term growth opportunity. Currently excluding Canada, we have 19 international stores open with an additional two stores under construction in Mexico City and Riyadh, Saudi Arabia. We have already executed 13 development agreements with high quality franchise partners that have purchased the rights to open approximately 70 additional locations.

Our belief that international development provides our company with an excellent growth vehicle is primarily based on the high sales volume of international locations, coupled with significant interest from existing and potential franchise partners. We currently project that there could be more than two times the number of our domestic locations internationally over the long term and we remain very excited and committed to this long term growth initiative.

With that I’ll turn the call back to Tiffany to go over our business outlook for the year.

Tiffany Kice

Thank you, Mike. Through the end of October our comparable store sales are positive 0.8%. At this time, we expect comparable store sales to be relatively flat for the fourth quarter and the related diluted EPS for that period to be in a range of $0.15 to $0.19.

Additionally in regards to 2013, we expect to open eight to nine net new company owned stores. We have opened eight new stores through the third quarter, including one relocation and have closed three stores and anticipate opening five to six more in the latter part of the fourth quarter and closing one additional store.

Average cheese block prices to be in the range of $1.75 to $1.85 per pound for the fourth quarter; depreciation and amortization for the year remain relatively flat with the prior year; rent expense for the year to increase approximately 4% to 5% from the prior year; advertising expense for the year to increase approximately $6 million from the prior year; capital expenditures to range from approximately $75 million to $80 million; and payment of four quarterly dividends totaling approximately $17.3 million.

In regards to fiscal 2014, we intend to open $12 to $15 new stores including three relocations and one franchise acquisition; capital expenditures are expected to range from approximately $70 million to $75 million and advertising expenses anticipate to increase approximately $1 million from the prior year.

I will now turn the call over to Dick for some concluding remarks.

Dick Frank

Thanks Tiffany. Although we are disappointed with our comparable store sales performance in the quarter, we are somewhat encouraged by the early sales results of the fourth quarter. More importantly we believe in our plan and continue to evaluate and enhance our strategies to further drive future performance. Enhancements to our plan to increase comparable store sales include; a revised strategy of capital reinvestment in which we will impact each company location every two years. The introduction of new major entertainment attractions; the continued execution and involvement of our value proposition; and a revised marketing plan for 2014 based upon our lessons learned in 2013.

Highlights on a year-to-date basis for 2013 through the end of the third quarter include; total revenues increasing 2.8% or $17.5 million to $643.2 million; net new store revenue increasing $12.5 million; comparable store sales increasing $5 million or 8:10s of 1%; store level margins increasing 120 basis points; and finally earnings per share increased 11.2% to $2.78 a share.

On October 29, 2013, our Board declared our fourth quarter dividend with a 13% increase to $0.27 per share. We remain committed to returning capital to our shareholders and note since beginning of fiscal 2010 we have returned through dividends and our share repurchase program approximately $230 million or 39% of the $595 million in operating cash flow generated over the same period of time.

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

Question-and-Answer Session


(Operator Instructions). Our first question comes from the line of Mike Gallow. Please go ahead sir.

Mike Gallow

Mike, can I just dig in a little bit on some of the pricing and promotional adjustments? How much is average ticket op as a result of that? And how do you know or do you have any research that indicates that those adjustments haven’t hurt your customer traffic? Thanks.

Mike Magusiak

I’ll take the broader approach first on customer traffic. I don’t believe that it has hurt customer traffic. What we’ve tried to do there Mike is we’ve looked back on any price changes and it’s always difficult to isolate one specific initiative with everything else that’s going on with sales. But as we’ve looked at that the stores that we’ve taken up the highest prices are not significantly higher prices seem to be doing the best from both a sales and the profit perspective.

And then other thing that I would really base it on is we do extensive brand tracking research with our guests that talk about the value. We ask questions about our value deals in the stores and we get very good from my perspective feedback on the values that we offer our guests.

Mike Gallow

Great. In terms of just the price increase that you’re testing, could you elaborate at all on when you think that would roll out, if it’s still preliminary what you’re see in the test et cetera? Is it simply just a reduction of the number of tokens and packages? Are there other elements to it as well?

Mike Magusiak

Yes, we’ve had that pricing test in four fairly significant markets. For now it’s the fourth week I believe that it’s been in and the primary components of that pricing test is we used to give out 40 tokens for $10. Now we’re giving out 33 tokens, $20 we reduced it from 90 to 80 and for $30 we kept at the same at 150 tokens. And the significance is, is if you buy $10, your average price per token is $0.30, $20, it’s $0.25 per token and $30 it’s $0.20 a token. So all are great value, but the more you buy the more you save and we believe that all games be in one token, whether it’s $0.30 a token, $0.25 or $0.20 a token, all three represent good value.

In addition to that, we have also in one of the markets reduced the number of tokens in value deals. So it’s the same prices, same pizza product and drinks but with fewer tokens. And then finally we’re implementing in the four test markets an actual reduction in coupons or tokens included in coupons along with a higher price token coupon for $25 that you can purchase tokens at $0.20 each. So we’re excited about the test. Tiffany and I recently visited number of our stores out in California. We went through competitor stores and we believe that we have an excellent value as it relates to the overall product, but especially on the game side of our business.

Mike Gallow

Great and then just can I just drill in the birthday parties, little more on what’s happened there? If I go back a couple of years ago with ticket blaster, you had a lot of momentum and it seems like you’ve really lost that momentum. So help me with that a little bit. Obviously that’s really not susceptible as much, at least the kid’s movie calendar. So help us one with what you think happened there and a two little more detail on what you’re doing to improve that side of the business?

Mike Magusiak

That’s a great question. First of all, we are incredibly disappointed with our birthday sales so far this year. It was difficult to read at the beginning of the year because as the payroll tax changed and then income tax refunds were late, we had a lot of volatility in the first half of the year and then a flip in the Easter holiday between quarters.

But the bottom line is our birthday parties were down about 5.5% in the first half of this year. In the third quarter, as Tiffany has stated, they are down approximately 11%, and so a significant decline here in the third quarter.

And when we look at it, one of the strategies that we implemented was to reduce the advertising of birthday parties on TV with a focus of advertising more to everyday walk-in business. And in the first two quarters of this year, we actually reduced our trip levels down to about 50% in next year. As birthday sales dropped we looked at two different things. First of all, we raised the trip levels recently and then the other thing that we looked at is our Creative. Our Creative was initial Creative that’s been going on for 10 months and in the past we’ve switched that Creative more regularly for birthday parties in six months intervals. So we’ve changed the Creative and that’s been in effect for two weeks. We increased the trips on birthday parties and we have seen over a very short period of time our birthday sales trends have improved and over the last couple of weeks, and this very, very short period of time but our reservations are very close to being flat. So we’ve made those adjustments. I believe that that will help our birthday parties, but that's the two primary components that at least I believe that's impacted our birthday sales.


And our next question comes from the line of Will Slabow. Please go ahead.

J. R. Bisel

Hey guys this is J. R. Bisel here on the call for Will. Digging deeper on these birthday sales, I'm wondering Tiffany mainly if you saw a deceleration in specific months or was it steady throughout the quarter, these sales trends for the birthday parties.

Tiffany Kice

In third quarter, period 7 was down 11.1%, July sorry, August was down 12%, September was down 9.5%. So I'd say pretty consistent over that quarter, first half.

J. R. Bisel

And switching gears here, you know, I know you just spoke to the additional sales, sorry the additional advertising spend in the last couple of weeks and you saw a nice acceleration in the first few weeks of 4Q, outside of those birthday, those bookings being flat did you see anything else that kind of helps you get into that positive territory?

Tiffany Kice

When I look at, you're meaning in October?

J. R. Bisel

Yes, in October, sorry.

Tiffany Kice

I'm feeling pretty good about October. I mean it’s just four weeks. So you got to kind of take that in perspective and we're going into a holiday season with low volume. But when you kind of back out your birthday parties and you look at just your comparable store sales of everyday that was positive more than the 0.4. The birthdays were down about 8%.

Mike Magusiak

And then the reservations have come back a lot stronger than that the last couple of weeks. And then this is at least may be a factor for positive October. As you're probably aware, we have a promotion with Freebirds, that is animated movie and we started our advertising of Freebirds on September 15th, that whenever you buy a value deal or a large pizza you get a free Freebirds bracelet and larger the package you buy, the more bracelets that you get and the national movie start date is this Friday, November 1st, and they started fairly heavy national advertising of the Freebirds movie on the October 6th.

And so we're hopeful that if there was momentum that would start, we would think that it would start around the advertisement of the movie tied with our advertising. Now that's very, very early we only have four weeks into October but we are excited about this movie tie in.

J. R. Bisel

And can you remind us how long this promotion is going to run in the stores?

Mike Magusiak

It runs through Thanksgiving and I should know this exactly but it may be a couple of weeks past that time period.


(Operator Instructions), our next question in queue comes from the line of Michael Halen. Please go ahead, sir.

Michael Halen

What percentage of customers came to play games only in the quarter?

Tiffany Kice

Well if you look, basically 54.9% is entertainment and merchandise sales. Game only is typically what - around 10% - 12%.

Mike Magusiak

Not even -- it's actually been declining and I think it's a lot closer Tiffany to the 6% - 7% range. We do guest surveys and that is one of the questions that we ask our guests and that's actually been steady over the last year or so, and with our value deals it may have actually dropped here a little bit.

Michael Halen

Okay, that's a positive. I think the Freebirds promotion makes a lot of sense. You can possibly mitigate some lost business due to some of these kid movies. Do you have any additional movie tie-ins planned for 2014?

Mike Magusiak

No, we do not at this point in time.

Michael Halen

Okay, and finally can you please give us some color on how you expect the 2014 unit openings to shake out throughout the year?

Mike Magusiak

Yes, we sure can. As we've said, we have a pipeline right now of 13 stores that are definitely in the pipeline and we have one, probably two stores in the first quarter and this can always change with new store development and then when you look at the second quarter, there should be another three stores or so in the second quarter and then it picks up fairly even for the rest of the year.


And at this point we have no more questions in queue.

Mike Magusiak

We appreciate your participation and if you have any additional questions, please feel free to call Dick, Tiffany or myself. Thank you.


That does conclude our conference for today. Thank you for your participation and for using AT&T's Executive Teleconference Service. You may now disconnect.

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