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Following the release of the third-quarter 2013 results on Oct 31, Irving, Texas-based restaurant and entertainment center operator CEC Entertainment Inc.’s share price has declined 1.8%.

CEC Entertainment’s third-quarter earnings of 43 cents per share missed the Zacks Consensus Estimate of 49 cents by 12.2% and the year-ago quarter’s earnings of 45 cents by 4.4%. Earnings in the quarter were hurt by lower top line and reduced operating margin.

Total revenue decreased 0.4% year over year to nearly $196 million in the third quarter, in line with the Zacks Consensus Estimate. The year-over-year decline in revenues was due to a 3.6% drop in food and beverage sales and 2.1% fall in comparable store sales (comps), offset somewhat by incremental revenues from seven new stores entering the system since the end of the third quarter of 2012.

Comps in the quarter were mostly hurt by an 11% decrease in birthday party sales. Further, an uncertain economic environment was also held responsible for such lower comps. Sales at company-operated restaurants dipped 0.4% year over year to $194.8 million, while franchise fees and royalties increased 20.2% to $1.1 million.

Total cost of food, beverage, entertainment and merchandise as a percentage of revenues declined 120 basis points (bps) year over year to 14.3%, gaining from the company’s cost-saving efforts and better pricing methods. A 20% reduction in dough usage owing to the launch of new crispy pizza crust also helped lower the food costs.

However, labor expenses as a percentage of revenues went up 80 bps year over year to 29.0% during the quarter as a result of rise in labor hours, a higher average hourly wage rates and increased performance bonuses. Advertising expense and general and administrative expenses both as a percentage of revenues increased 30 bps each to a respective 5.4% and 6.9%. Total operating costs and expenses increased 60 bps year over year to 93.2%, which dragged the operating margin down by 60 bps to 6.8%.

Store Update

During the reported quarter, CEC opened five company-owned stores and closed one. During the quarter, one franchisee was opened while another was closed.

At the end of the third quarter of 2013, the company had 518 company-operated stores and 53 franchised stores. For 2013, the company expects to open 13–14 company-owned stores. Additionally, the company will relocate one store and shut down five stores, thus restricting the net new openings to a range of 9–5.

CEC Entertainment is planning to unveil 12–15 stores which will include three relocations and one acquisition.

Fourth-Quarter Guidance

CEC Entertainment projects that comps will be flat in fourth-quarter 2013. Earnings per share are expected to be within 15 cents–19 cents.

Full-Year 2013 Outlook

In 2013, depreciation and amortization are expected to be flat year over year. Advertising expense is projected to increase $6 million from the year-ago quarter.

Our Take

The primary factors that affected CEC Entertainment’s third-quarter results were underperformance due to pressure on the top and bottom lines as well as margins. The company’s continued efforts to increase traffic to enhance sales and comps are yet to be fruitful.

Other Stocks to Consider

CEC Entertainment holds a Zacks Rank #4 (Sell). Some other players in the restaurant industry which look attractive at present include Red Robin Gourmet Burgers Inc. (RRGB - Analyst Report), Cracker Barrel Old Country Store, Inc. (CBRL - Snapshot Report) and Bob Evans Farms, Inc. (BOBE - Snapshot Report). While Red Robin holds a Zacks Rank #1 (Strong Buy), Cracker Barrel and Bob Evans Farms carry a Zacks Rank #2 (Buy).

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