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CEC Entertainment, Inc. (CEC)

Q2 2010 Earnings Call

August 5, 2010 04:30 pm ET

Executives

Mike Magusiak - President and Chief Executive Officer

Darin Harper – Vice President and Controller

Dick Frank - Executive Chairman

Analysts

Brad Ludington - KeyBanc Capital Markets

Michael Gallo - C.L. King & Associates

Michael Wolleben - Sidoti & Co.

Robert Derrington - Morgan Keegan & Co.

Greg Schroeder - Wisco Research

Zev Nissionson [ph] – PCC [ph]

Greg Ruedy - Stephens Inc.

Robert Derrington - Morgan Keegan & Co.

Michael Wolleben - Sidoti & Co.

Operator

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

And also as a reminder, this teleconference is being recorded. At this time I will turn the conference over to your host, President and CEO Mr. Mike Magusiak. Please go ahead sir.

Mike Magusiak

Thank you. Welcome to our conference call. I am Mike Magusiak, President and CEO of the company, and I am joined by Dick Frank, our Executive Chairman and Darin Harper, our Vice President and controller.

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 in this call may be found in the company’s Q2 earnings release and on the company’s Web site under Investor Information

The primary objectives for today’s call are first, to discuss our financial performance during the second quarter. Next, I will present our strategic plan to increase comparable store sales and earnings per share in the second half of 2010 and 2011. Third, Darin will discuss our business outlook and finally Dick will provide some concluding remarks and then open the lines for question and answer session.

Now I’ll turn the call over to Darin who will review our financial performance.

Darin Harper

Thank you Mike, good afternoon everyone. As we look at the results for the second quarter, we know that two primary factors weigh negatively on our earnings. First, unexpectedly soft sales and second, an unfavorable adjustment to income tax expense associated with our most recent IRS examination of prior tax years. This tax adjustment and related interest expense, reduced our diluted earnings per share for the second quarter of 2010 by $.13.

Now let’s discuss the results in more detail. From a top line perspective, revenues in the second quarter decreased 2.1% to $181 million primarily due to a 3.6% decline in fiscal week comparable store sales. On a same calendar week basis, which we believe to be more indicative of the health of our business, comparable store sales decreased 2.2%.

Mike will discuss the factors that we believe impacted our sales performance in detail later in this conference call. Partially offsetting the decrease in comparable store sales was a weighted average increase of approximately three stores as compared to the second quarter of 2009. Cost of food and beverage as a percentage of food and beverage sales, decreased 20 basis points to 22.4% during the second quarter compared to prior year. Decreases in beverage and paper costs were partially offset by higher cheese prices.

Quarter over quarter cheese costs increased $0.24 cents or 20% per pound. Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales decreased 50 basis points to 8.5% during the second quarter of 2010 from 9% in the second quarter of 2009, primarily due to a birthday party promotion during the second quarter of 2009 that resulted in additional price merchandise costs from increased ticket redemption.

Also in the second quarter of 2009, we incurred additional costs associated with an attraction dispensing novelty photo cards. Labor expense as a percentage of company store sales increased 20 basis points to 28.7% during the second quarter of 2010 compared to 28.5% in the second quarter of 2009, primarily due to higher workers compensation claims, unemployment taxes and other benefits.

Also improved labor productivity from our hourly workforce partially offset a 3.7% increase in average hourly wage rates at our stores. Depreciation and amortization expense increased 4.2% to $19.8 million primarily due to the ongoing capital investment initiatives occurring at our existing stores and new store development. Store rent expense increased 4.3% to $17.4 million primarily due to an increase in the number of leased properties resulting from new store development and expansions of existing stores.

Other store operating expenses as a percentage of company store sales remained unchanged at 16.5% quarter over quarter. A deleveraging effect associated with the decline in revenues was offset by a reduction in other store operating costs during the quarter.

Advertising expenses as a percentage of total revenues decreased 10 basis points to 4.6% in the current year from 4.7% in the prior year primarily due to lower television media costs partially offset by an increase in television spending in certain local markets.

General administrative expenses as a percentage of total revenues remained generally flat quarter over quarter. Interest expense increased to $3.4 million during the second quarter of 2010 compared to $3.1 million in the second quarter of 2009, primarily due to interest charges of $700,000 in current pursuant to additional tax reserves established during the second quarter of 2010. This increase was partially offset by lower interest expense associated with our outstanding debt.

During the second quarter of 2010, the average debt balance outstanding under our revolving credit facility was $317.2 million compared to $337.6 million during the second quarter of 2009 and our weighted average interest rate including our interest rate hedge was relatively unchanged at approximately 3% quarter over quarter.

Our effective tax rate increased to 57.6% during the second quarter of 2010 compared to 35.1% in the second quarter of 2009, primarily due to unfavorable discreet adjustments of $2.4 million. We recorded income tax expense during the second quarter of 2010 associated with issues identified in connection with an IRS examination for 2006 and 2007 tax years.

These issues relate primarily to an overstatement of tax depreciation for refurbished games and rides. Book depreciation for these assets was recorded appropriately. As mentioned earlier, the total impact of these adjustments and the related interest expense unfavorably impacted our diluted EPS in the second quarter by $0.13.

From a bottom line perspective, net income decreased to $4.8 million in the second quarter 2010 compared to $9 million in Q2 2009 and diluted earnings per share decreased to $0.22 in the current year from $0.39 in the prior year, partially offsetting the negative impact of the comparable sale decline and the tax adjustments was a 7% decline in diluted shares outstanding, primarily attributable to our share repurchases.

On a year to date basis through the second quarter, same calendar comparable store sales declined one half of 1%. Debt income declined $4.4 million to $38.6 million and diluted earnings per share decreased $0.09 to $1.77 a share. A repurchase of approximately 2.7 million shares since the beginning of the first quarter of 2009 has helped to mitigate the negative impacts from the $0.13 tax adjustment and a decline in comparable store sales during 2010.

Let’s now review a few highlights from our cash flow statement and balance sheet. During the first six months of 2010 we generated approximately $101 million of operating cash flow. We invested $3 million in new and existing stores, reduced the outstanding balance on our line of credit by $23 million and used $36 million to repurchase approximately 922,000 shares of company stock, bringing the outstanding balance at the end of the second quarter of 2010 under share repurchase authorization to 183.2 million.

We ended the quarter with a balance of approximately $331 million on the company’s revolving line of credit reflecting a leverage ratio of 1.8 to 1. With that I’ll now turn it over to Mike.

Mike Magusiak

Thanks Darin. My presentation will primarily focus on a detailed analysis of our second quarter sales performance followed by discussion of our strategic plan to increase comparable store sales and earnings per share in the second half of 2010 and fiscal 2011. Before I discuss sales, I would like to comment on my disappointment regarding the higher than expected tax rate in the second quarter.

While depreciation on our financial statements was properly recorded, we over depreciated certain refurbished games and rides on our tax return. This inadvertent error which created a tax liability was identified late in the second quarter. Our effective tax rate in the second half of this year is not expected to be impacted by this tax issue and is projected at 38%.

We’re very disappointed with the 2.2% percent decrease in same week comparable store sales during the second quarter, particularly since we had weak comps during the second quarter of last year attributable to the H1N1 Swine Flu outbreak. As stated in last year’s second quarter conference call, we believe that the swine flu unfavorably impacted our sales results last year primarily from the last week of April through the first week of June.

Same week comparable store sales this quarter are down 0.1% in April, down 1.1% in May and down 4.7% in June. Year to date same week comparable same week store sales through the end of the second quarter have decreased 0.5%. Same week comparable store sales results by region for the first half of 2010 are as follows. The Western region is positive 1.1%, the Central region is flat, the Northern region is down 1.2%, the Southeast is down 2.2 for company average of 0.5% down.

Since the end of the second quarter, sales have improved fairly significantly. Same week comparable store sales during the first four weeks of the third quarter have increased 2.1% with each of the four weeks being positive. This results in a year to date comparable store sales to 30 weeks being down 0.2%. We believe that there were a number of factors that accounted for our weak sales performance during the second quarter. Pinpointing the exact causes for poor or for that matter good sales performance is always a challenging exercise. Nonetheless we’ve drawn some preliminary conclusions.

The first factor that we believe may have negatively impacted our sales during the second quarter was a reduction of discounts in many of our coupon offers. During our last conference call, we shared with you a comprehensive pricing strategy to reduce the discount percent in coupons through the Sunday newspaper, cross promotions, online advertising and Chuck E-Club.

These revised coupon offers reduced the discount by approximately 10% to 12% on most coupon offers. We tested this initiative beginning January 3rd of this year in stores representing about 35% of our store base and expanded the tests to Los Angeles and Chicago effective March 28th. Based on our evaluation of coupon sales and comparable store sales data, we then made the decision to implement this pricing strategy for all stores effective April 25th.

At that point in time, year to date comparable store sales on a same week basis through 17 weeks were positive 0.5%. During our earnings conference call, we further stated that despite the continuing economic headwind carry over from 2009, we were moderately pleased with the sales performance in the first four months of the year and we’re assuming a moderate improvement in economy for the remainder of 2010.

Looking back, we believe our pricing strategy to reduce coupon discounts at a time when the economy not only did not improve, but may have in fact softened somewhat per our top line sales. Although coupon sales as a percentage of total sales slightly increased each month of the second quarter, the number of coupon redemptions decreased by approximately 7% in April and May and 13% in June. We believe that a portion of the reduced number of redemptions negatively impacted guest counts.

During June, the month that we were budgeted to earn slightly more than 50% of our earnings during the quarter, our comparable store sales declined 4.7%. This decline correlates to a month to month 20% drop in the adjusted consumer confidence index of 50.4 and a 5% decline in housing sales during June.

We further believe the economy was negatively impacted by the Gulf oil spill, most specifically in the Southeastern part of the country. Comparable store sales on a same week basis in quarter one for Tampa, Orlando and Miami were positive 9.4%, 2.6% and 11.9% respectively. In quarter two, sales for the same markets were negative 10.2%, 9.9% and 3.0% respectively.

With sales swings from quarter one to quarter two ranging from negative 12.5% to negative 19.6% for these three markets, the impact of the oil spill seems evident. Although it’s early, all three markets have begun to rebound in the July period. A third factor that we believe negatively impacted sales was very strong box office receipts for kids and family movies in the second quarter led by Toy Story 3 and Shrek Forever.

Box office sales for G and PG movies were up 40%, $988 million versus $706 million in the second quarter compared to prior year and were up 75% in June, $578 million versus 330 million. The $248 million increase in box office receipts during June alone were higher than our entire second quarter revenues of $181 million.

We believe that the timing of our reduced coupon discounts in a weakened economic environment when combined with strong movie box office receipts resulted in the soft sales performance experienced in the second quarter. Based on this assessment, we have done a comprehensive review of our sales strategies and have already moved to make the following changes.

We offered 3.5 million Chuck E-Club members 20 bonus tokens with redemption of any food coupon offer. This coupon offer was distributed to our Chuck E-Club members on July the first. Second, we started airing on July 17th a national television commercial featuring a $9.99 summer special large cheese pizza. This television ad is supported by our website and by an email campaign.

Third, we’re improving our offers on website and potential online advertising to include bonus tokens with food packages effective in early August and finally we’re changing our Sunday coupons to include bonus tokens with pizza package offers in a majority of our stores effective September 26th.

In summary, we believe that the modification of some of these sales [inaudible] in July has somewhat contributed to our 2.1% positive same week comparable store sales during the first four weeks of the third quarter. Before we discuss our strategic plan to increase long term sales range per share, we thought it would be beneficial to share with you our 2008 and 2009 sales trend by quarter. The sales data indicates the relative difficulty of sales comparisons by quarter and is only one factor that potentially could influence future sales trends.

The two-year sales trend for 2008 and 2009 by quarter is as follows. The first quarters’ two-year sales trend is positive 3.5%. The second quarters’ two year sales trend is positive 0.3%, the third quarters’ sales trend for the past two years is negative 2.0% and the fourth quarter’s two year sales trend is negative 3.5%. Based on this historical sales data, comparable store sales comparisons for the remainder of 2010 are significantly easier than the first half of the year. Many factors can impact future sales including the economic environment in which we operate.

We believe that we have a number of impactful initiatives that will position the company for long term sales and earnings per share growth. These strategies are summarized as follows: first a strong existing store capital plan that will impact approximately 257 stores this year representing approximately 51% of our store base.

Second the continued focus of increasing birthday party sales. Third an enhanced marketing plan that incorporates brand messaging along with specific new product advertising including a national advertising campaign, supporting ticket blasters and local television advertising supporting new games and rides.

Fourth, our continued focus on increasing weekday sales with school fundraising and other non-profit charitable organizations. And finally the continued implementation of our modified coupon discount strategy that I discussed earlier in the conference call.

The net effect of the modified pricing strategy is that our modified coupon offers will more closely reflect a greater discount than our most recent coupons but will still be less than the discounts at year end 2009.

Our first sales initiative is a strong existing store capital plan that totals approximately $67 million to $68 million. This capital plan is projected to impact 257 stores including 32 expansions, 15 major remodels, 210 game enhancements and includes the capital cost for the ticket blasters in all company stores.

We believe that this capital plan will strengthen our leadership position in the family restaurant and entertainment industry and result in long term sales increases in conjunction with an improved economy.

Our second initiative is the continued focus of increasing Birthday Party sales by improving the overall reserve Birthday Party experience. We’ve improved the value and overall birthday party experience by implementing the following strategies: first we introduced ticket blasters to all locations in June, second we extended the length of birthday parties from an hour and a half to two hours with the implementation of ticket blasters. Third, we implemented a hundred bonus token promotion to shift parties from our peak period on Saturday to Friday and Sunday, and finally we enhanced the Birthday Party package and Super Star Upgrade package with new components.

As a result of these strategies along with the price increase and birthday party pricings in the vast majority of our stores by $0.50 to $1 per child in conjunction with the implementation of Ticket Blasters, Birthday Party sales increased approximately 15% in the second quarter.

Our third initiative to increase sales and earnings is an enhanced marketing plan. A TV media plan which typically relies primarily on brand advertising to kids has been expanded to include new creative to promote new exciting products like ticket blasters or new games and rides. We believe that our national TV advertising of Ticket Blasters was a primary factor in increasing Birthday Party sales by 19.5% in June.

In addition, our marketing campaign included the testing of incremental local television advertising in support if new games and rides which were installed in every store in Los Angeles and San Diego at the end of the first quarter. Comparable store sales in LA and San Diego increased 1.5% during the second quarter.

We recently completed the installation of new games and rides in every store in Chicago and Philadelphia and started advertising these new games and rides on local television two weeks ago.

Our fourth sales initiative to increase sales and earnings is an expanded strategy to increase weekday sales. Fundraising sales increased from $1.6 million in the second quarter of 09 to $2.4 million in the second quarter of 2010.

Our next opportunity for growth is to accelerate the development of new domestic company stores. Since 2006 we’ve opened a total of 32 new or relocated company stores including three new stores in 2009. These stores’ average annual sales exceed 2 million and on average have earned a pretax cash on cash return exceeding 25%. We anticipate opening or acquiring franchises approximately 9 stores in 2010 and seven to eight stores in 2011. We’ll continue to focus our development on stores that produce a high return on investment.

The final component of our growth strategy is the development of Chuck E. Cheese’s around the world. During our year end 2009 conference call we stated that we believe that international development of our concept provides shareholders with a significant long-term growth opportunity.

We have developed a comprehensive international strategic plan and are actively searching and interviewing partners in Mexico, Columbia, Brazil, Argentina, Peru, Panama and Costa Rica. As stated in prior calls international development will not materially impact earnings the next several years. However, we believe that our focus of attracting quality international partners provides our shareholders with a solid, long term growth opportunity. Our focus is the development of one great concept, Chuck E. Cheese’s.

Our last strategy to enhance shareholder value is the continuation of our stock repurchase plan. During 2009 we repurchased $52.6 million of treasury stock, or 1,775,089 shares which represents 7.7% of fully diluted shares outstanding at year end 2009. During the first half of this year we repurchased 921,989 additional shares or 4.3% of diluted shares outstanding at the end of the quarter.

Despite a very disappointing second quarter that resulted in comparable store sales decline of 0.5% during the first half of the year, our business continues to generate significant cash flow.

Net cash provided by operating activities increased to $100.9 million. We utilized this cash to purchase property and equipment totaling $43.1 million, repurchased treasury stocks totaling $35.6 million and reduced our credit facility borrowing $22.9 million.

Darin will now provide you with an overview of our business outlook.

Darin E. Harper

Thanks Mike. Considering the economic environment with unemployment at rates near 10% we remain cautious in our near term outlook for the business and this makes it difficult to estimate sales.

However our best estimates of comparable store sales on a same week basis for the second half of 2010 is a range of flat to up 2%. We based this estimate on basically flat sales or down 0.2% during the first 30 weeks of the year and on the first four weeks of July during which comparable store sales have increased approximately 2%.

We considered several factors in our sales estimates including the following. First, significantly easier sales comparisons in the second half of 2010 versus the first half of the year. Second, continued strong increases in Birthday Party sales which represented approximately 11% and 15% of total sales in the third and fourth quarter of last year respectively. Third, a solid existing store capital plan and finally our belief that our modified coupon and discount pricing strategy will be effective in the second half of the year.

Our sales estimates assume no immaterial deterioration in the economy. If the economic environment does deteriorate, we believe that our business will be adversely impacted because even though we consider our overall relative value to be good, our experience is largely discretionary in nature.

Based on same weeks comparable store sales ranging from flat to positive 2% in the second half of 2010, we are estimating 2010 fiscal diluted earnings per share to be in a range of $2.52 to $2.62. This represents a growth rate of approximately 6% to 10% excluding the additional operating week of fiscal year 2009 and the $0.13 tax charge this quarter.

Incorporated into this guidance are the following assumptions: First, we’re assuming cheese prices will average $1.57 to $1.65 per pound for the second half of the year as compared to $1.38 in the second half of 2009. Recall that every $0.10 change in cheese prices is estimated to impact annual pretax income by approximately $700,000 to $800,000.

We’re estimating fiscal year 2010 depreciation and the rent expense will increase 4% and 3% respectively. We are expecting approximately a 28 basis point reduction in fiscal year 2010 advertising expense as a percentage of total revenue. We are assuming an effective tax rate of 38% for the second half of the year. Also we’re currently estimating 2010 fiscal year capital expenditures to be in the range of $100 million to $103 million. We also expect to open eight new company owned locations during the last six months of the year inclusive of 2 franchise locations that were acquired in July and one relocation.

Lastly, we intend to repurchase shares on an opportunistic basis during the second half of the year. With that I’ll now turn the call over to Dick.

Richard M. Frank

Thanks Darin. After starting the first quarter with comparable store sales on a same week basis of positive 0.7% of 1% comparable store sales were a disappointing 2.2% negative for the second quarter of the year.

As Mike already walked you through, we believe the sales shortfall experience was largely the result on a change in our coupon discount strategy, a somewhat softer economic environment particularly in period six and strong box office receipts for kids’ and family movies.

Additionally we have an unfavorable adjustment to the company’s tax expense which reduced our diluted earnings per share for the quarter by $0.13.

Since the end of Q2 we have made changes to our coupon offerings and commenced national TV in support of $9.99 Summer Pizza promotion. We believe these changes have somewhat contributed to our 2.1% positive comparable store sales during the first four weeks of the third quarter.

As we move to the last half of 2010, we expect the economic environment to be challenging. We intend to continue and in fact expand our new modified coupon discount strategy while continuing to execute on the strategies and future growth plans which Mike has outlined for you. Our revised coupon offerings and the quality execution of our strategy coupled with the easier comparable store sales comparisons for the last half of the year is our basis for projecting comparable store sales of flat to up 2% for the last half of 2010.

At this time Mike, Darin and myself will be glad to answer any questions that you may have.

Operator

(Operator Instructions) We get our first cue from Brad Ludington with Keybanc Capital Markets, please go ahead.

Brad Ludington – Keybanc Capital Markets

Thank you, I wanted to start off with the clarification on the guidance. I was trying to keep up and fell a little behind when you talked about a 4% increase and a 3% increase respectively on two different line items, what was that?

Darin E. Harper

Yeah, the 4% increase on a fiscal year basis for 2010 we expect depreciation to increase 4% and rent expense to increase 3%.

Brad Ludington – Keybanc Capital Markets

Okay, thank you very much. And then just looking at what happened in July when you talked about the comps going up 2.2% versus what we saw in the second quarter, it seems that you had a pretty quick improvement before some of the changes that Mike went through had been rolled out. You’re said anything coming out in August and September, was there anything else you saw besides just the change on some of the marketing and promotions or any environment or do you think it was just response to that change?

Michael H. Magusiak

I think there were two major things that occurred. First we have been on national TV for the past three weeks with our $9.99 Summer Special and that is representing about 40% of our advertising. And what we have seen with that $9.99 Summer Special is a significant increase week by week of those coupon redemptions, a $9.99 compared with a $14.99 coupon to suggest combine those two coupon offers and we’ve seen that consistently increase in each of the past three weeks.

The other thing that we’ve seen is because we’re promoting that on national TV our online advertising and our web advertising, those coupon redemptions have also gone up materially. So we think that we’ve set the value message within the market place that has really helped us.

The other thing that has continued for us into July is our strong birthday sales. In June our birthdays were up 19.5% and that has continued into July. Our birthday sales continue to be up 20% or so and when you couple that with the $9.99 and then the coupon changes we did in our $3.5 million Chuck E. club we think that those have contributed to the sales so far in the first four weeks of the year.

And one of the things that we mentioned on the conference call was that every week was positive but from our perspective what we really like seeing is that every region within the first four weeks of the quarter is positive. And they’re positive from anywhere from 1% to almost 3% and that’s--we feel good that it's not just up to 2.1% but it's been consistent throughout at least the first four weeks of the quarter.

Brad Ludington – Keybanc Capital Markets

Okay, and then finally I just wanted to ask back on the – when you’re looking at the second quarter revenues, the food and beverage sales were pretty close to what we expected. A majority of the – we’re a good enough 2 high on games and merchandise were, you’re seeing the parties just weren’t spending as much on the games, were the attendance down at parties? What were you seeing there?

Michael H. Magusiak

We did not see a noticeable change on that. Our food and beverage and the games were pretty close obvious both were down from what we expected going into the quarter but the percentage change, at least from what we expected was above what we expected

Brad Ludington – Keybanc Capital Markets

Okay, thank you.

Operator

Thank you, and the next question in cue that will come from the line of Michael Gallo with C.L. King, please go ahead.

Mike Gallo – CL King

Hi good afternoon, my question is just on the promotional spend obviously noted in the quarter that you’ve reduced some of the coupon. I was wondering whether as you started the ship things back whether you’d think we should see some pressure on margins from the change back the original strategy or is it something that was more than being offset by the gas counts and Q2. So you don’t expect to see that kind of pressure. Thank you.

Mike Magusiak

That’s a good question. We do believe that we went to far on our discount reducing the discounts and if you take a free standing insert our discount at year end 2009 was about a 43% off the regular manual and you could buy a value menu for 20% discount. So in essence it was about a 23% discount off of the menu if you bought a value meal. But we’ve reduced that 43% to on average down to about a 32% discount. So we knocked it down about 10% or so. What we have done with our modified coupon pricing that we changed in July with a 20 free bonus tokens and what we intend to do for the majority of our system going forward is a discount of a 38%. So that 38% is actually a lower discount than what we had at 2009 and so far what we have seen when we gone to that change in the discount not being so aggressive that our coupons have started to increase.

Mike Gallo – CL King

So I guess just to come back to that same point then, when I look on a year-over-year basis if you were using the 43%-ish call it discount in the third quarter of last year, on a year-over-year basis that should actually be somewhat beneficial to your margins assuming that your guest counts hold up. Is that fair to look at it that way?

Mike Magusiak

That is and you know the one thing that we didn’t talk about discounts so you are correcting that is the $9.99 offer the large cheese pizza when coupled with a 1499 coupon offer which includes 4 drinks and 50 tokens that is a discount of 31 to 32%. So that national advertising offer promoting value is actually even a little bit lower than our FSI offer.

Mike Gallo – CL King

Okay thanks a lot.

Mike Magusiak

You are welcome.

Operator

Thank you, (operator instructions). Our next question in queue will come from Michael Wolleben with Sidoti & Company. Please go ahead.

Michael Wolleben – Sidoti & Company

Hey good afternoon guys. I just wanted to clarify a couple of things here. You mentioned a couple of times here the back half of this year is easier comparable sales hurdles to go over. Is that excluding the impact of swine flu in the second quarter of last year, is that how you are coming to that easier comparison?

Mike Magusiak

No it’s not it includes the swine flu. If you go back we look at 2 year trend and if you look at the first quarter of 2008 it was positive 3.6% and the first quarter of 2009 it was negative point 1. So the 2 year trend is a positive 3.5% in the 1st quarter. In the 2nd quarter in 2008 we were positive 5.6%, so we had a great second quarter in 2008. And last year it was negative five four. So the 2nd quarter is positive point 2%. Then when we do the same exact thing in the third and fourth quarters we are going up against a negative trend of 2% and the third quarter and 3.5% negative in the 4th quarter. So we look at the last 2 year trend for the ease of the difficulty of going against comparable store sales.

Michael Wolleben – Sidoti & Company

Okay, back to that couponing strategy again as well. When you see that -- the rollback of some of the taking a little bit more price there, is there any thought on further rolling that back and trying to more aggressively get some people that you may have lost there? Or do you guys think that you have the right discount period at this point for where the consumer is?

Mike Magusiak

Well we missed at the first time. I say that from what we believe but we do believe we still have a good value in our overall product and we base that on the number of redemptions with the Chuck E Club members and online advertising. And so we think that that’s the right mix. And then one thing that is very difficult for us to monitor but we think that is something to do with summer time when mums have more time with their kids and there is more free activities and the economy is slowing down in June. We think that just the combination of the summer of a slow down in economy and the change in the discount. The consolidation of those three factors impacted our redemptions. But we think that the revised pricing is a very good value for gas.

Michael Wolleben – Sidoti & Company

Okay, I want to circle back on the tax charge as well. Can you just walk me through that again? What happened there back in 2007, 2008, I think you said and it’s not expected to recur here?

Darin Harper

Yeah that’s correct yeah the issue arose pursuing to the current IRS examination of our 2006 and 2007 tax years. So basically for a period of time the company would transfer games and rides use games and rides from its stores to a company owned warehouse to be refurbished. And subsequently this games and rides were redeployed to our stores. And the basis and the asset for tax reporting purposes inadvertently became over stated and as a result two much depreciation was deducted for tax purposes and the cumulative adjustments for this air is the 2.4 million dollar adjustment. And again just to clarify for financial reporting purposes the appreciation expenses was accurate. So we believe this $2.4 million charge we’ve captured the issue and do not expect any further impact on this going fourth.

Michael Wolleben – Sidoti & Company

That 2.4 million is all on your tax line here this quarter. Was there, did you say that there was something on the interest line as well?

Darin Harper

That’s correct. The $700,000 charge on the interest line that is tax effected if you want to compute to the $0.13.

Michael Wolleben – Sidoti & Company

Okay, and just to clarify that new guidance it’s a GAAP guidance that includes $0.13.

Darin Harper

That’s correct yes.

Michael Wolleben – Sidoti & Company

Okay and then just lastly here, looking at the commodities, wheat prices are still are through the roof here. What is your, are you guys locked in prices, your concerns on it?

Mike Magusiak

I don’t believe we are locked in the largest component of our pricing is cheese and there you might give an overview $0.10 change in cheese price what that would cost. That’s by far our largest exposure on the commodity side.

Darin Harper

Yeah we definitely are mindful of our dough cost but it definitely don’t have much of an impact as cheeses does and again to reiterate every $0.10 change in the block cheese price impacts EPS by about $0.02. And so when we look at the second half of the year you know cheese price is in a range from 57 bucks to a buck 65 against the dollar at 38 in prior year. What we’ll definitely have some pressure there. But dough prices right now we are not too concerned and don’t anticipate that that’s going to apply to much pressure on our margins for the 2nd half of the year.

Michael Wolleben – Sidoti & Company

Okay, thank you.

Operator

Thank you. Our next question in queue that will come from the line of Robert Derrington with Morgan Keegan. Please go ahead.

Robert Derrington – Morgan Keegan

Yeah thank you. Mike the $9.99 cheese pizza promotion that you have been running recently, how long will you run that?

Mike Magusiak

Right now Rob we are planning on running that through August and we are going to continue to monitor that promotions. If it continues to go good even thou you know we are going up against Labor Day there we may actually run it a little bit longer. But right now it’s through the end of August.

Robert Derrington – Morgan Keegan

You know typically back to school time you know consumers are squeezing every dollar they have I’m just wondering is there some way to position that as an ongoing offer to keep everyday traffic coming in the door.

Mike Magusiak

There may well be Rob, I’ll tell you we were surprised that the redemptions dropped as much as they have and we’ve looked at a lot of different alternatives to offer value and one of the things that marketing came up with was 20 bonus tokens with any coupon offer including food. And what that has done for us is just something new, something different. And if you take that 20 bonus tokens and add that on to the old coupon prices that we are offering with that, it’s still it’s a good value but it’s actually a little lower discount that what we offered at year end 2009. And so we’ve really put on or thinking caps on how do we change up our coupon offers to give the guest an additional incentive to come in to Chuckie Cheese.

Robert Derrington – Morgan Keegan

Well, it certainly sounds like your birthday business is doing well and you know I don’t know, do you have a perspective on your fundraising program as we come into the fall or is it too early to say on that?

Mike Magusiak

You know our fundraisings from a percentage stand point is actually stronger than anything else. Sometimes you can get at least from our perspective or my perspective get you know put too much on to fundraising because on a year to date basis it’s up 31% and it’s 6.2 million versus 4.7 last year. So you know that helps us.

The thing that we are really excited about is the ticket blasters and you know we are so disappointed in the 2nd quarter comparable store sales. But the one strategy that has taken off and is doing as well or probably better than what we anticipated is the birthday parties. And you know you see that in the second quarter that birthday parties were up about 15%, that accelerated to almost 20% in June and that trend continues into July and I think it’s a combination of the National advertising of the ticket blasters and then just the excitement in our stores. So you know the birthday business for us we can see you know real positive sales trend there.

Robert Derrington – Morgan Keegan

Well, the good news is, the birthday business as well as the fundraising is doing really well; it sounds as though it’s the walk up business where you are weakest, is that right?

Mike Magusiak

That’s absolutely correct.

Robert Derrington – Morgan Keegan

And so the $9.99 coupons or promotion I assume it’s geared for that.

Mike Magusiak

It is geared to the walking traffic as well as the 20 bonus tokens.

Robert Derrington – Morgan Keegan

Got you, okay very good. Thanks Mike.

Mike Magusiak

Thank you.

Operator

Our next question in queue that will come from Greg Schroeder with Wisco Research. Please go ahead.

Greg Schroeder with Wisco Research

Hi, thank you. Two questions, first one, I just wanted to be sure the IRS examination, that’s fully complete at this point?

Darin Harper

Well, the examination is still technically open, but we would anticipate actually closing out those tax years hopefully here in the 3rd quarter. So while we believe we’ve captured all issues associated with that examination, you know until the examination officially comes to a conclusion we won’t know for sure but we feel like we have captured the total issue here in Q2.

Greg Schroeder with Wisco Research

Okay. And then, Mike, the capital initiatives for 2010, I think you are now touching 257 restaurants, I think three months ago you said 235, so that is over half of your system. So you are really aggressive on these capital initiatives this year. Could you maybe elaborate a little bit on what the change was and are you -- why you are increasing your capital allocation to remodel versus building new restaurants?

Mike Magusiak

Now, that’s a good question, Greg. The biggest impact from, if I look at our budget at the beginning of the year, for existing stores, we anticipated spending 65 million, a little short of 65 million. Now we are going to spend 65 to 66 million and that increase is attributable to our game enhancements that only cost on average 50 to say 75,000 for the market such as Los Angeles, San Diego, Chicago and Philadelphia. That we put games in every one of those stores and then we are advertising it on spot television. So we just see an opportunity to put games in and then advertising it on a local basis so we may learn in the future on whether we can drive sales with spot television or local advertising. But that is the primary increase in a number of stores is the Chicago and the Philadelphia that we did not have in the budget at the beginning of the year and those were just completed Greg about 2 weeks ago. As far as the new stores you bring up a good point, we anticipate opening a total of 9 stores, including the franchise acquisitions. We continue to get good sales results there and you know I would like to open 7, 8 very high volume stores every year.

Greg Schroeder with Wisco Research

Okay, thank you.

Mike Magusiak

You’re welcome.

Operator

Our next question in queue that will come from the line of Zev Nissionson [ph] from PCC [ph] and your line is open.

Zev Nissionson - PCC

Hey guys thanks for taking my call. I was hoping that you could remind me last year what you attributed -- how much of the decline in Q2 you attributed to the swine flu

Mike Magusiak

We did not quantify that. It’s difficult to know the number of people that didn’t come into our stores. So what we did was we just provided on a month by month basis what comparable store sales were but you know it’s almost impossible to try quantify what Swine flu did to us last year.

Zev Nissionson - PCC

Coz I’m thinking about we had expected a fairly significant bounce back this quarter obviously in the easy compare and you posted a negative number. So if you take the swine flu, add that to the negative number from this quarter, I’m trying to bridge you know how you got to either such a volume decline or pricing decline; it wasn’t a pricing decline because you actually took away some of the coupons. So I’m just unclear of how volume could have dropped that significantly year over year.

Mike Magusiak

That’s a really good question and I think there is really three major factors. One, and I don’t mean to put it all on coupons because I don’t believe it was. You never know those reduced coupons what percentage would have come anyway. But we do believe if you look at June, the P and PG movies, the increase June alone that we see as direct competition to us, family doesn’t typically take their sons or daughters to Toy Story and to Shriek or you know to Chuck E Cheese and Shriek and Toy Story, and the increase in June alone in movies exceeded our total revenue in the second quarter.

And so we just see that as very significant; it was also up in April and May and the combination with that, the coupons and what we believe the economy and really the Florida markets that we disclose, we just we can’t explain why Miami, Orlando and Tampa were so strong in the first quarter and were so weak in the second quarter. And we believe and we don’t have anything to back this up other than the sales results that all the TV advertising about people not going on vacation and Florida being somewhat volatile in its economy; we just think people, the consumers just stop spending. And we don’t, we can quantify that but we do know the sales change between the first and second quarter. So yours is a good question, we anticipated stronger sales the second quarter also.

Zev Nissionson- PCC

Okay and on the movie because I’d also read in your press release about the slate and we had spoken to Chris about this a couple of weeks ago and he’s essentially said that that was red herring and that we shouldn’t look at the movie slate as a correlating factor but it sounds like if it’s particularly strong, it can affect things one way or another, is that fair?

Mike Magusiak

It can and I believe that movies over the course of the year to two years has no impact on our business, it evens out. In the first quarter we did not mention that G and PG movies were up by our calculations 77%. The issue is, is the total dollars in the first quarter for the whole quarter increased 292 million. In June alone in the second quarter, they increased 248 million. So it’s just a, every once in a while, the movies can help or hurt you. We believe that Shrek and Toy Story really hurt our volume engine.

Zev Nissionson – PCC

Okay I appreciate the answer.

Mike Magusiak

Thank you.

Operator

Thank you. Our next in queue that will come from Greg Rudy with Stevens. Please go ahead.

Greg Ruedy- Stephens Inc

Follow up on the movie; if they do in fact smooth out over a year or two, is there some incremental headwind from the use of 3D in the movies?

Mike Magusiak

It could be.

Greg Ruedy- Stephens Inc

Question on the G&A, any pushes and pulls you can discuss there where are we at with bonus accruals year to date and then anyone timers from the examination and executive turnover?

Darin Harper

In G&A no expenses associated with the examination. You do have number items moving around in there kind of upsetting each other. We had some reductions overall which helped offset some of the deleveraging due to a lower sales base but overall I wouldn’t say how many things significant as well on the executive turnover, no significant tick ups on that side as well. A little bit as would be expected on some equity and incentive compensation but nothing that really moved the needle.

Greg Ruedy- Stephens

Okay. Back on the couponing casual diners have systematically been offering discounts at peach or $10 or less price points. Just wondering if maybe they’ve conditioned your guest to respond to sub $10 that leading digit basically?

Mike Magusiak

I think there is some of that and we believe that one of the things that we believe we have a slight advantage although we for sure didn’t take advantage of much in the second quarter but if you look at our 9.99 summer special, people aren’t going to just come in for a large cheese pizza and we’ve offered that as I said earlier with the 14.99 coupon. The combination of the 9.99 and the 14.99 is about a 31%, 32% discount and we still have very good margins when you combine that pizza, soft drinks and tokens and I think we, hopefully we’ve learned something from that value offering on national TV.

Greg Ruedy- Stephens Inc

Thanks for taking my questions.

Mike Magusiak

You’re welcome.

Operator

Thank you. We do have a follow up in queue from Robert Derrington –Keegan. Please go ahead.

Robert Derrington – Morgan Keegan

Yeah Mike. Hey can you give a little bit of color on your new CFO that you named today?

Mike Magusiak

Sure can. First we wish Chris all the best on at On Border and we’re very, very excited to bring Tiffany on board. Tiffany has about 22 years of experience and the last 14 years she’s been with KPMG one of the big four accounting auditing firms. She’s been a partner since 2006 and Tiffany has very good technical skills but from my perspective and she’s interviewed with a number of our executives here. I think she has some very good communication, team building and leadership skills that I think that she’ll do a really good job continue to grow our accounting finance and we’re really excited to have her on in the next two weeks.

Robert Derrington – Morgan Keegan & Co

So she starts looking at the release the 16th of August?

Mike Magusiak

That’s right, in two weeks.

Robert Derrington – Morgan Keegan & Co

Okay, at what point can we start torturing her?

Mike Magusiak

You know what; I bet you Tiffany is listen to this call now.

Robert Derrington – Morgan Keegan & Co

Okay, alright. Really good, we’ll follow up. Thanks Mike.

Mike Magusiak

Alright.

Operator

Thank you. Our next question in queue is also a follow up from Michael Wolleben with Sidoti and Company. Please go ahead.

Michael Wolleben – Sidoti & Company

Thanks. Sorry if I missed this before but birthdays been up 15% in the quarter. Is that, that’s largely attributed to that 0.50 to a $1.00 for kid increase correct?

Mike Magusiak

No, that’s just a percentage of the increase. If you take the average, if you said it was a 0.50 increase off of an 11.99, that’s 4%.

Michael Wolleben – Sidoti & Company

Okay.

Mike Magusiak

So it is part of it, what we’ve been able to do is because we’ve improved that experience so much, we’ve been able to increase the price but a very good percentage of that is just traffic.

Michael Wolleben – Sidoti & Company

Okay and then did you guys quantify the, what you think the couponing strategy I guess miscue was an impact, did you quantify that earlier?

Mike Magusiak

No, all we did was we quantified the reduction in the number of redemptions in the second quarter month by month. It’s possible to quantify what it did to comparable store sales because we’re not sure how many of those of guest still came to Chuck E. Cheese without a coupon.

Michael Wolleben – Sidoti & Company

Okay, got it. Thanks.

Operator

The next question is also a follow up from Mike Gallo with CL King. Please go ahead.

Mike Gallo – CL King

Just couple of follow up questions as they relate to birthday blaster; I was wondering what you’ve seen in trends in booking because obviously it hadn’t been in place for that long and it takes a while for people to actually schedule parties, you’re seeing a significant increase in your trends and birthday party booking since birthday blast was rolled up?

Mike Magusiak

I don’t have, I know we tracked that in marketing, I, we track on week by week basis what birthday sales are and over the last eight to nine weeks our birthday sales have been typically between 18% and 22% or so and we think that is the advertising on TV and then it’s just the excitement if you’re a kid attending a birthday party, your friend’s birthday party and you see you see your friend in there having a blast grabbing all these tickets I think it’s just incentivizing kids to have their birthday party at Chuck E. Cheese.

Mike Gallo – CL King

I guess that’s part of my question to the extent that it rolls out in June, kid goes to a party, maybe his birthday doesn’t occur for another six months or something, we would expect to build over time. In the stores you having test what kind of increases have you seen that where it’s been in place for sometime?

Mike Magusiak

We have tracked that earlier I couldn’t tell you what that may grow or where it may settle out; it hasn’t been in test long enough.

Mike Gallo – CL King

Okay, thanks a lot.

Mike Magusiak

Welcome

Operator

Thank you. Your next question queue is also a follow up from Zev Nissionson with PCC and your line is open.

Zev Nissionson – PCC

Hey I, with regarding the comment’s that you made about July, I’m going back to April and you guys were also fairly positive about the April results on the call on May and then I’m looking here and it looks like April was down and I’m just trying to, maybe I just did the math wrong when you guys did your call last time but what, is it possible then that July is going to be down as well?

Mike Magusiak

Well now July is complete.

Zev Nissionson- PCC

Okay.

Mike Magusiak

July has seven or five, four weeks into it and that is already complete and the first week that we had in April was positive and then it went negative after the first week.

Zev Nissionson – PCC

But you did your call in May so I would have, we would have a full April by the time you did your call as well, correct?

Mike Magusiak

I’m sorry I was looking at actually May’s numbers. April was two tenths negative and when we did our call we had the first quarter comparable store sales were positive 0.7% and then when we had April, we we’re negative 0.2 and that dropped it down to a 0.5.

Zev Nissionson – PCC

Okay, maybe I just did my math wrong when you guys did your call last time.

Mike Magusiak

That, April was down 0.2 and then the first week of May was up 27 and then the, then it started going negative from there.

Zev Nissionson – PCC

Okay, thanks.

Operator

Thank you. At this time we have no additional questions in queue. Please continue.

Mike Magusiak

We appreciate your participation. If you have any additional questions please call Darren, Dick or myself. Thanks a lot, bye

Operator

Thank you ladies and gentlemen that does conclude your conference call for today; we do thank you for your participation and for using AT&T to.

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Source: CEC Entertainment Q2 2010 Earnings Call Transcript
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