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CEC Entertainment Inc. reported earnings of 23 cents per share in the second quarter of 2012, lagging the Zacks Consensus Estimate of 37 cents. Reported earnings were also below the prior-year earnings of 34 cents per share.

Total revenue also tumbled 2.0% year over year to $182.4 million in the second quarter, primarily due to lower comparable store sales (down 2.4%). Sales at company-operated restaurants dipped 2.2% to $181.2 million, while franchise fees and royalties increased 24.4% to $1.3 million.

The company’s cost structure which includes cost of food, beverage, entertainment and merchandise, decreased 30 basis points (bps) year over year to 15.6% as a percentage of company store sales. Benefiting from the decrease in certain commodity costs and pricing changes, Depreciation and amortization expense, as a percentage of company-store sales, contracted 80 bps to 10.5%. However, labor expenses nudged up 130 bps to 29.5% during the quarter as a result of rise in labor hours and a 0.7% increase in average hourly wage rates. Store rent expense, increased 60 bps to 10.5%. Other store operating expenses spiked 60 bps to $30.7 million.

Moreover, general and administrative expenses, as a percentage of revenue, inched up 10 bps to 7.2%, but fell 1.2% to $13.1 million from the prior-year quarter. Advertising expense also declined 40 bps as a percent of total revenue to 4.4%.

Total operating costs and expenses increased 230 bps, which dragged the operating margin down to 4.7% from 7.0%.

Store Update

During the reporting quarter, CEC opened 5 company-owned stores and closed 3. There was no franchised store opening in the quarter.

The company currently operates 510 company-operated stores and 50 franchised stores.

Management plans to open 12–15 company-owned stores, including approximately three relocations and one franchise acquisition.

Liquidity

At quarter end, CEC’s cash and cash equivalents were $17.4 million, while shareholders’ equity stood at $139.8 million.

For 2012, the company expects capital expenditure to be $88.0 million down from our prior estimate of $94 million to $96 million.

Outlook

For fiscal 2012, CEC trimmed its earnings per share guidance from the range of $3.00–$3.15 to $2.65–$2.75. CEC anticipates average block cheese prices to remain in the range of $1.50 to $1.70 per pound.

Our Take

CEC, which operates and franchises family dining and entertainment centers, exited the first half of 2012 on a disappointing note, resulting in a lower outlook for the remaining year. Despite a lower outlook, the company continues to make efforts to increase sales and comps but is not able to drive traffic. However, management remains keen on international exposure. In the back drop of an uncertain economic scenario, unit expansion in both domestic and international markets and improving returns to shareholders are favorable for the stock.

CEC, which competes with Cosi Inc. , currently, retains a Zacks #4 Rank, which translates into a short-term Sell rating. We are maintaining our long-term Neutral recommendation on the stock.

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