CEC Beats; Outlook Weak

CEC Entertainment Inc. ( CEC - Snapshot Report ) has recently reported second quarter 2011 earnings of 34 cents per share, which surpassed the Zacks Consensus Estimate by 2 cents. Reported earnings were also ahead of the prior-year earnings of 22 cents. The substantial growth in earnings was backed by the company’s share repurchase activity.

Total revenue increased 2.9% year over year to $186.2 million, primarily on an uptick in comparable store sales (up 0.3%) as well as nine more new stores from the year-ago period. Sales at company-operated restaurants rose 2.8% to $185.2 million and franchise fees and royalties grew 18.1% to $1.0 million.

Turning to the cost structure, cost of food and beverage, as a percentage of food and beverage sales, spiked 260 basis points (bps) to 25.0% due to higher cheese prices. The average per-pound price of cheese increased approximately 36 cents or 25.1% from the prior-year quarter. Labor expense, as a percentage of company-store sales, also declined 50 bps to 28.2%, on the back of improved hourly labor productivity, which was partially offset by an increase in the average hourly wage rate of approximately 1.4%.

Depreciation and amortization expense, as a percentage of company-store sales, increased 30 bps to 11.3% on account of the ongoing capital investment initiatives at existing stores and new store development. Store rent expense upped 20 bps to 9.9% due to a rise in leased stores, following new store development. As a consequence, operating income declined 110 basis points year over year to 7.0%.

Store Update

At quarter end, CEC had 507 company-operated stores and 48 franchised stores.

Financials

At quarter end, CEC’s cash and cash equivalents were $17.4 million, while outstanding debt stood at $356.5 million. During the quarter, cash provided by operating activities was $111.6 million and capital expenditure was $46.8 million.

CEC continued to enhance shareholder value through the repurchase of around 2.8 million shares.

Outlook

For fiscal 2011, Texas-based CEC lowered its earnings outlook to $2.75–$2.95 from $3.00–$3.10. The company also lowered its expectation for same-store sales from up 1% to 2% to down 2% to flat.

For 2011, the company expects capital expenditure in the range of $92.0 million to $93.0 million.

Our Take

We expect estimates to go down in the coming days, given the company’s weaker-than-expected guidance. Same store sales dropped a drastic 7.9% during the first four weeks of the third quarter of 2011 hurt by faltering consumer confidence. According to the Thomson Reuters University of Michigan consumer sentiment index, confidence among U.S. consumers in July dropped to the lowest level in 2 years.

Additionally, increased competition from certain PG-13 movies this year also marred the results. However, in this uncertain scenario, unit expansion in both domestic and international markets and improving returns to shareholders remained the bright spots.

CEC, which operates and franchises family dining and entertainment centers, currently, retains a Zacks #3 Rank, which translates into a short-term Hold rating. We are also maintaining our long-term Neutral recommendation on the stock.

One of its peers Domino's Pizza Inc. ( DPZ - Analyst Report ) reported second quarter 2011 earnings of 40 cents per share, which also surpassed our estimate.