Tag Archives: DAVE & BUSTERS

SHAKE SHACK (SHAK) RAISES $75M OF EQUITY – BANK COVENANT “CONCERNS”

SHAKE SHACK (SHAK) RAISES $75M OF EQUITY – BANK COVENANT “CONCERNS”

A lifetime ago, on April 3rd, we wrote an article “MICRO meets MACRO”. Among other things we talked about the new “going concern” language in Dave & Buster’s (PLAY) most recent filing. It wasn’t a particular knock on PLAY, more a commentary that the whole world has taken on going concern considerations. Since then, on April 14th, PLAY raised $75M of equity and amended their bank covenants.  In the case of PLAY, with the current valuation, that amounted to about 20% equity dilution.

Shake Shack (SHAK) today announced a $75M equity offering. The good news is that this only amounts to about 6% equity dilution, since SHAK still has a valuation above $1.5 billion. This additional equity provides SHAK with total liquidity approaching $200M, which should tide them over for a while, considering that the weekly burn rate, as they described it this morning, is $1.3-$1.5M per week.  There is more to the release, which you can read elsewhere, describing the current situation relative to store closures and the decline in sales as the pandemic rolled through their system.

For our purposes this morning, we thought readers would find interesting the following language from their 8-K filing. We present this information not as a particular negative for SHAK, since this kind of filing is likely to become the norm rather than the exception. We want our readers to know what to expect as more companies come public with adjustments to their business plan.

Quoting this morning’s 8-K filing: (Bold Italics are ours.)

“As previously disclosed, on August 2, 2019, we entered into a credit facility with Wells Fargo Bank, National Association (“Wells Fargo”), providing for a $50.0 million senior secured revolving credit facility with the ability to increase available borrowings under the credit facility by up to an additional $100.0 million through incremental term and/or revolving credit commitments, subject to the satisfaction of certain conditions set forth in the facility. In March 2020, we drew down the full $50.0 million available to us under the credit facility…. as a result of the COVID-19 outbreak. We are required to comply with maximum net lease adjusted leverage and minimum fixed charge coverage ratios, in addition to other customary affirmative and negative covenants, including those which (subject to certain exceptions and dollar thresholds) limit our ability to incur debt; incur liens; make investments; engage in mergers, consolidations, liquidations or acquisitions; dispose of assets; make distributions on or repurchase equity securities; engage in transactions with affiliates; and prohibits us, with certain exceptions, from engaging in any line of business not related to our current line of business. As of December 25, 2019, we were in compliance with all covenants. However, as a result of the COVID-19 outbreak, our total revenues have decreased significantly and we have implemented certain operational changes in order to address the evolving challenges presented by the global pandemic on our domestic and licensed operations. While we expect to be in compliance with the financial covenants for the first quarter, due to the impacts of COVID-19, our financial performance in the first quarter was, and in future fiscal quarters will be, negatively impacted. As a result, it is likely that we will be unable to continue to comply with certain covenants contained in the credit facility, potentially as early as the second quarter compliance date. We are in discussions with Wells Fargo regarding potential modifications to our covenants, and/or temporary waivers, but there is no guarantee that we will be able to reach any such agreement. A failure to comply with the financial covenants under our credit facility would give rise to an event of default under the term of the credit facility, allowing the lenders to refuse to lend additional available amounts to us and giving them the right to terminate the facility and accelerate repayment of any outstanding debt under the credit facility. As a result, we may need to access other capital to address our liquidity needs rather than relying on our credit facility. As of April 16, 2020, we had approximately $112.0 million in cash and marketable securities on hand, excluding foreign currency and certain reconciling items such as deposits in transit. Our cash resources and liquidity would be substantially impaired by an acceleration of the debt under our credit facility.”

We expect that the banks will have been made comfortable by the $75M of new stock sold by SHAK, and, just as with Dave & Buster’s, covenants will be waived and adjusted. The commercial banks don’t want to run the stores. The good news for SHAK is that much less equity dilution is involved than was the case at PLAY. However, it’s a new world. All of this is becoming commonplace. Almost everyone, in and out of the restaurant industry, will be spending a great deal more time negotiating with bankers.

Roger Lipton

DAVE & BUSTER’S (PLAY) REPORTS Q3 – STOCK DOWN 6% TODAY – WHAT TO LEARN? – WHAT TO DO ??

DAVE & BUSTER’S (PLAY) REPORTS Q3 – STOCK DOWN 6% TODAY – WHAT TO DO ??

CONCLUSION

While PLAY may seem statistically cheap at 13x this year’s earnings estimate and 7.5x trailing EBITDA, there seems to be very limited visibility regarding stabilization and then improvement in sales and cost trends. Especially with a company such as Dave & Buster’s, EBITDA is far less of a measure of free cash flow than at most restaurants and retailers. Depreciation should be banked and reinvested in the concept at some point, and that is increasingly clear in this situation. Hundreds of millions of dollars were spent a decade ago to refresh the brand before it came public again, that effort paid off in positive comps for a number of years, but that effect has apparently run its course, and a great deal of maintenance capex is likely in the cards if the concept is to regain its competitive position. Ongoing unit growth has not increased absolute total earnings power over the last several years, and we doubt that this will change any time soon. Even a shrinking stock base has not been sufficient to increase earnings per share, return on invested capital is declining and we are not convinced of the appeal of PLAY at the current time.

BRIEF BACKGROUND

Dave and Buster’s Entertainment (PLAY) reported Q3, stock traded up 4-5% in aftermarket as management confirmed guidance, has given the gain back and is now trading down 5-6% from yesterday’s close.

PLAY stock came public, after being taken private several years earlier, in late 2014, moved from the teens to a high of $70/share by mid 2017, fell back to about $40 by mid 2018 as comps moderated, rallied back to $65 with a major stock buyback implemented and the promise of their new Virtual Reality platform. The stock trading now at about $38. is at a multi-year low, statistically intriguing but many fundamental trends are heading in the wrong direction. We have written, at length, many times about this situation over the last two years, and those articles can be accessed through our SEARCH function.

RECENT DEVELOPOMENTS – PER Q3 REPORT AND CONFERENCE CALL

In a nutshell, while still generating a great deal of cash flow, almost every aspect of this brand has to be reinvented: the food, the games, the physical facilities, the consumer facing technology (the mobile app and loyalty platform). This once debt free company is now levered up by $640M, today considered a “modest” 2.3x trailing EBITDA, and we can expect further borrowings to finance stock buybacks, new stores and renovation capex. Earnings per share have gone from $2.84 in calendar 2017 (ending 2/4/18) to an estimated $2.85 in the FY 1/31/20 but the fully diluted share count was 42.6M two years ago and is now 26% lower. Relative to the stock buyback, $97M was purchased in Q3 and $187M remains to be bought. We can’t resist suggesting that, knowing that sales and profits were not turning around, or even maintaining, we would have held off buying stock in the mid $40 range, with a high likelihood of paying less than $40. Oh, well, it was only 2.4M shares bought back, and perhaps (the possibility of) saving $10M or so is hardly worth the bother 😊.

Third quarter overall comp sales were down 4.1%. Within that, Amusements was down 3.9%, F&B was down 4.4%. Special Events was up 0.7%. Amusements, as a percentage of total revenues, continued to grow, to 58.4% of total revenues, so PLAY continues to be more of an indoor amusement park than a restaurant. Expense lines included Cost of F&B up 60 bp to 26.8%, Cost of Amusement flat at 10.8%, Operating Payroll with Benefits up 10 bp to 25.4%, Other Store Operating Expense up 300 bp to 37.1%. This large increase was attributed to higher rent expense with lease renewals and higher marketing expenses associated with TV and digital marketing to drive traffic and promote the new mobile app (discussed below).  Store level EBITDA was down 320 bp to 20.1%. Below the store level, G&A was up 10 bp to 5.4%, D&A was up 30 bp to 11.1%, pre-opening was down 30 bp to 1.4%. Operating Income was down 330 bp to 2.2%. Interest Expense was up 90 bp to 2.1%. Income after minimal taxes was 0.2%, down from 4.2%, $0.02 per share vs. $0.30 per share a year earlier.

The conference call provided the most candid description of the state of the business that we can recall from this management team. An increasing amount of competition was again cited as a headwind, along with cannibalization. Food & Beverage improvement is still an opportunity but previous attempts have not gained traction. A new 43-foot Wow Wall LED TV installation has been installed in a total of 48 stores by now (35 at 10/31), and the Company, optimistic about the long term effect,  declined to describe specifics about the sales lift so far. New games are being developed that encourage social interaction, and the Virtual Reality platform is being expanded. Management referenced the fact that this year’s Amusement comps are going up against the supposedly difficult comparison of the Virtual Reality introductions a year ago, but Amusements was only up 1.5% in Q3’18.

Other than the Wow Wall, perhaps the brightest specific development was the development of a new Mobile App, which signed up over 600,000 new guests in the two months ending November, purchasing $14M worth of digital power cards. For context, since there were previously less than 800,000 active guests using the mobile app, there seems to be clear opportunity in this area.

CONCLUSION: Provided above

DAVE & BUSTER’S (PLAY) TAKEN OUT AND SHOT (AGAIN) – WHAT’S GOING ON ??

DAVE & BUSTER’S (PLAY) TAKEN OUT AND SHOT (AGAIN) – WHAT’S GOING ON ??

This situation, as it is playing out, is no surprise to our readers. The Q2’19 release met the earnings expectations but missed on the comps, and the company lowered guidance by 5-10% for the current full year, implying a relatively weak second half. You can read all the details elsewhere, including the conference call transcript, but a summary of Q2 includes:

Operating Income was up 0.6%, Net Income  was down 4.1% but EPS was up 7.1% on fewer shares outstanding. Corporate EBITDA was up 5.3% but down 60 basis points as a percentage of sales (still an impressive 22.9%, down from 33.5%). Store Operating Income (EBITDA) was up 4.8%, but down 90 bp as a percentage of sales (still an impressive 28.9%, down from 29.8%). Food & Beverage comps were down 3.2%. Amusements & Other were down 0.8%. Amusements and Other now represents 60% of total sales, up 80 bp from ’18. It continues to be the case that Dave & Buster’s is more of an indoor amusement park than a restaurant. It  is worth noting the lackluster comps were attributed largely to the difficult comparisons with the rollout a year ago of the Virtual Reality platform.  While we can’t know how much of the Amusement comp in ’18 came from the heavily promoted Virtual Reality, the Amusement comp in Q 2’18 was down 1.2%, the Food and Beverage comp was down 4.1%.

Management adjusted guidance for all of ’19. Comp Sales will be down 2.0-3.5% (vs. -1.5 to +0.5). Net income will be $91-$100M (vs. $103-113M). The tax rate will be (unchanged from prior guidance) at 22.0-22.5%. The shares outstanding will be about 34.0M instead of 36.5M, as a result of share repurchases. EBITDA will be $272-282M ($274-284M excluding $2M in one time charges), (vs. 283-$295M previously) . Capex will be $200-210M (vs $190-200M). In summary, comps will be a point or two less than previously expected, Net Income will be about 10% less, EBITDA will be about 4% less. EPS expectations will approximately unchanged, up about 10%, protected mostly by the large stock buyback.

CONCLUSION

We have written extensively about Dave & Buster’s over the last two years, and we provide below the most recent articles. The sum and substance of this situation is that the Company is spending hundreds of millions of dollars but is barely increasing corporate EBITDA.  The chart below shows how the incremental return on the dollars spent continues to deteriorate. Management continues to do their best to get a better return from the square footage dedicated to Food & Beverage, as well as re-invigorate the Amusement offerings. The “culture” within a restaurant chain is a challenge to improve and Amusements is basically a “hit driven” business with a high level of unpredictability. Considering the above, and the information provided in our previous discussions, though PLAY is down 8% today and down about 40% from its high of 2017 and 2018, we don’t view PLAY as a bargain at $40/share.

Roger Lipton

JUNE 12, 2019

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DAVE & BUSTER’S (PLAY) – TAKEN OUT AND SHOT, IS IT REALLY THIS BAD?

Dave & Buster’s reported first quarter, ending 4/30, results last evening and their stock is trading down 22% this morning. The results were only modestly disappointing, and guidance was lowered just slightly, so the stock market reaction could be considered severely overdone. However, as our readers have been informed for almost two years now, the underlying business has been deteriorating for quite some time and that is now becoming clear to almost all observers. First, the Q1 results, not so bad:

EPS was $1.13 vs $1.04 last year. EBITDA was up 3.2%, adjusted EBITDA up 2.4%. Total revenues were up 9.5%. Same store sales were up 0.3%, a point or so less than expected, which management attributed to weather and disappointment related to sales over the Easter holiday. Seven new stores were opened, and “new store performance remained strong”. Previous trends relating to increased sales at Amusements (comps up 1.8%) and decreased sales at Food & Beverage (comps down 3.3%) continued. The details were less comforting, to be sure. Operating Income was down 1.5%, down 170bp to 15.9%. Net Income $42.4M vs. $42.2M, so EPS was higher due to a lower share count. Though EBITDA was up 3.2%, it was down 150bp to a still impressive 24.4% of revenues. Adjusted EBITDA was down 290bp to 27.0%. Store Operating Income was up 3.6%, but down 180 bp to a still impressive 31.0%.

Guidance was lowered just slightly for all of fiscal 2019, ending 2/2/20: Revenues will be $1.365-1.39B, vs. $1.37-1.4B previously. Comps will be -1.5 to +0.5 instead of Flat to +1.5%. Net Income will be $103-113M instead of $105-117M. EBITDA will be $283-295M instead of $285-300M.

So: on the surface, results were affected by weather and a calendar shift, and the full year is adjusted mostly to reflect the first quarter shortfall.

However: there is no tangible reason to think that trends will improve. As discussed on the conference call: The second quarter has started off “choppy”. Virtual Reality has not provided much of a lift, extra labor is involved, volatility is to be expected in this “hit driven” area, and pricing of this attraction is still a question mark of sorts. Food & Beverage initiatives, including a Fast Casual test, haven’t paid off yet even if customer surveys are promising. Competition was called out, once again, as a negative factor, and is not expected to abate.

There is a lot more detail we could provide, but, in the interest of getting this summary out as promptly as possible, you get the picture.

Conclusion:

PLAY may now seem like an attractive turnaround speculation since it now trades near its lowest price in several years, and the valuation does not seem expensive at about 13.5x ’19 earnings and 6.5x trailing EBITDA. New store returns continue to be attractive and the Company as a whole throws off a great deal of apparent free cash flow which can be used  for new stores, dividends and stock buybacks. However, as we have described several times over the last two years, the underlying long term trends are challenging and expected to remain so. Earnings and EBITDA have been essentially flat for several years now, the Company has spent over half a billion dollars to keep it that way, and there is no predictable reason to expect improvement. Deteriorating returns on investment do not make for a premium valuation so we considered PLAY adequately valued at the current time.

 

REPRINTED BELOW FROM 4/15/19 – DAVE & BUSTER’S (PLAY) – REPORTS Q4 AND ’18 YEAR – IMPORTANT OVERVIEW !!

We take a long term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

 

 

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

REPRINTED BELOW FROM 9/17/18 – DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET ON VIRTUAL REALITY DOING?

Dave & Buster’s Entertainment reported their Q2, ending 8/5/18, last Thursday, and the stock responded positively, up 7-8% on the slight sales “beat”, the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.

Conclusion: The upward move in PLAY stock was mostly a function of “beating” expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the Company, but the amounts were modest, and were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.  On the positive side, initiation of a dividend, providing a yield of about  1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as “fairly priced”, with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however,  is offset by the risk element of the “fashion driven” Amusement segment that is the main driver of profitability and cash flow.

REPRINTED BELOW FROM 12/11/2017 – DAVE & BUSTER’S (PLAY) – THE BATTLE OF THE BULLS AND BEARS !

The Positives:

  • (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
  • (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
  • (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : https://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.

 

DAVE & BUSTER’S (PLAY) – TAKEN OUT AND SHOT (- 22%), IS IT REALLY THIS BAD?

DAVE & BUSTER’S (PLAY) – TAKEN OUT AND SHOT, IS IT REALLY THIS BAD?

Dave & Buster’s reported first quarter, ending 4/30, results last evening and their stock is trading down 22% this morning. The results were only modestly disappointing, and guidance was lowered just slightly, so the stock market reaction could be considered severely overdone. However, as our readers have been informed for almost two years now, the underlying business has been deteriorating for quite some time and that is now becoming clear to almost all observers. First, the Q1 results, not so bad:

EPS was $1.13 vs $1.04 last year. EBITDA was up 3.2%, adjusted EBITDA up 2.4%. Total revenues were up 9.5%. Same store sales were up 0.3%, a point or so less than expected, which management attributed to weather and disappointment related to sales over the Easter holiday. Seven new stores were opened, and “new store performance remained strong”. Previous trends relating to increased sales at Amusements (comps up 1.8%) and decreased sales at Food & Beverage (comps down 3.3%) continued. The details were less comforting, to be sure. Operating Income was down 1.5%, down 170bp to 15.9%. Net Income $42.4M vs. $42.2M, so EPS was higher due to a lower share count. Though EBITDA was up 3.2%, it was down 150bp to a still impressive 24.4% of revenues. Adjusted EBITDA was down 290bp to 27.0%. Store Operating Income was up 3.6%, but down 180 bp to a still impressive 31.0%.

Guidance was lowered just slightly for all of fiscal 2019, ending 2/2/20: Revenues will be $1.365-1.39B, vs. $1.37-1.4B previously. Comps will be -1.5 to +0.5 instead of Flat to +1.5%. Net Income will be $103-113M instead of $105-117M. EBITDA will be $283-295M instead of $285-300M.

So: on the surface, results were affected by weather and a calendar shift, and the full year is adjusted mostly to reflect the first quarter shortfall.

However: there is no tangible reason to think that trends will improve. As discussed on the conference call: The second quarter has started off “choppy”. Virtual Reality has not provided much of a lift, extra labor is involved, volatility is to be expected in this “hit driven” area, and pricing of this attraction is still a question mark of sorts. Food & Beverage initiatives, including a Fast Casual test, haven’t paid off yet even if customer surveys are promising. Competition was called out, once again, as a negative factor, and is not expected to abate.

There is a lot more detail we could provide, but, in the interest of getting this summary out as promptly as possible, you get the picture.

Conclusion:

PLAY may now seem like an attractive turnaround speculation since it now trades near its lowest price in several years, and the valuation does not seem expensive at about 13.5x ’19 earnings and 6.5x trailing EBITDA. New store returns continue to be attractive and the Company as a whole throws off a great deal of apparent free cash flow which can be used  for new stores, dividends and stock buybacks. However, as we have described several times over the last two years, the underlying long term trends are challenging and expected to remain so. Earnings and EBITDA have been essentially flat for several years now, the Company has spent over half a billion dollars to keep it that way, and there is no predictable reason to expect improvement. Deteriorating returns on investment do not make for a premium valuation so we considered PLAY adequately valued at the current time.

 

REPRINTED BELOW FROM 4/15/19 – DAVE & BUSTER’S (PLAY) – REPORTS Q4 AND ’18 YEAR – IMPORTANT OVERVIEW !!

We take a long term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

 

 

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

REPRINTED BELOW FROM 9/17/18 – DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET ON VIRTUAL REALITY DOING?

Dave & Buster’s Entertainment reported their Q2, ending 8/5/18, last Thursday, and the stock responded positively, up 7-8% on the slight sales “beat”, the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.

Conclusion: The upward move in PLAY stock was mostly a function of “beating” expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the Company, but the amounts were modest, and were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.  On the positive side, initiation of a dividend, providing a yield of about  1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as “fairly priced”, with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however,  is offset by the risk element of the “fashion driven” Amusement segment that is the main driver of profitability and cash flow.

REPRINTED BELOW FROM 12/11/2017 – DAVE & BUSTER’S (PLAY) – THE BATTLE OF THE BULLS AND BEARS !

The Positives:

  • (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
  • (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
  • (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : https://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.

DAVE & BUSTER’S (PLAY) – REPORTS Q4 AND ’18 YEAR – IMPORTANT OVERVIEW !!

 

Dave & Buster’s (PLAY) –  reports Q4 and full ’18 – IMPORTANT OVERVIEW !!

Dave & Buster’s (PLAY) reported their fourth quarter and full calendar ’18, ending 2/3/19.

I should preface the following remarks with the fact neither I nor my affiliates are currently long or short PLAY at the current time, which of course could change at any time.

Rather than rehash the quarter line by line, and make projections that are largely guided by management, we try here (as usual) to provide what we call an unfiltered commentary, in the hope of providing insights that other analysts and money managers hesitate to provide.

The results were slightly better than analysts expected so the stock has rallied several points in a market that is seemingly unforgiving and/or representing a “relief rally”. In a nutshell, comps firmed up a bit in Q4 but operating results were still down for the quarter and the year. Management reiterates that new stores are doing well, the runway for growth is still long, the new virtual reality platforms are promising, and improvements are coming for both Food & Beverages as well as Amusements. Management guidance for calendar ’19 is for results down modestly in terms of pretax income, EBITDA, post tax earnings down somewhat  more because of a higher tax rate.

We take a longer term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

For more information, readers can access our full previous writeups using the “Search” function on our home page.

Roger Lipton

DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET ON VIRTUAL REALITY DOING?

DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET (VIRTUAL REALITY) DOING?

Dave & Buster’s Entertainment reported their Q2, ending 8/5/18, last Thursday, and the stock responded positively, up 7-8% on the slight sales “beat”, the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.

Conclusion: The upward move in PLAY stock was mostly a function of “beating” expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the Company, but the amounts were modest, and were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.  On the positive side, initiation of a dividend, providing a yield of about  1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as “fairly priced”, with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however,  is offset by the risk element of the “fashion driven” Amusement segment that is the main driver of profitability and cash flow.

The most pertinent details of the Q1 report are as follows:

Comp store sales were down 2.4% (estimates were for down 2.7%), on top of a 1.1% increase in ’17. “adjusted” earnings per share was $0.84 vs. $0.59 a year earlier and $0.67 which was the latest analyst estimate.  Adjusted Corporate EBITDA was  up 7.4% on a comp week basis, excluding a litigation settlement in 2017. The comp store decline was driven by 2.6% decrease in walk-in sales, 0.1% increase in special events, negative 1.2% in Amusements and Other, and negative 4.1% in Food & Beverage. Since there were price increases of 1.1% in Beverages and 1.9% in Food, traffic in F&B was negative by 5.5-6.0%.  On a line by line basis: Total cost of sales was 10 bp higher in Q2, reflecting a decline in both F&B and Amusement margins, but helped by the higher percentage of the more profitable Amusement sector. Amusements and Other comprised 59.2% of total revenues up 150 bp YTY, continuing the long term trend toward becoming an Amusement Park rather than a Restaurant. F&B costs were 40 bp higher, Cost of Amusement and Other was 30 bp higher. Payroll and Benefits was 10 bp higher, at 23.1%, due to “deleverage in our comp stores (on the lower comps), the unfavorable impact of about 4% wage inflation and incremental payroll supporting the Virtual Reality launch”. This was partially affset by YTY improvements in the non-comp store set.” Other store operating expenses were up 40 bp, due to higher occupancy costs at non-comp stores, slightly higher marketing expenses that include tests in the digital media space. Management pointed out on the conference call, explaining the slightly higher labor component, that “newer stores tend to be less efficient from a labor  perspective relative to mature stores”. We have to interject here that this has been the case for many years now, and the number of stores opening (versus the mature base) is not rising. We conclude that new stores are therefore costing more per store in opening “inefficiencies”, probably including heavier marketing. Indeed, the strong performance of the newest stores, as described by management, has been a positive recent feature of this situation, and, overall, that’s a good thing. Overall store level EBITDA was down 60 bp YTY, resulting in a still very impressive 29.8%

Wrapping up the P&L discussion of Q2, it seems to us that the fundamentals were “acceptable”, modest sequential improvement, most impressive because of the estimate “beat”. In essence, actual results beat expectations for relatively flat operating income.

Of course, the introduction of the new Virtual Reality platform, the reception of the ride/game, and the general effect on the overall business were very much on everyone’s mind. On the conference call, management indicated that “guest response has been strong and bodes well for future game releases on this platform”. Just as we, and some other observers, had predicted, the Jurassic Park based Virtual Reality ride/game only seemed to help by a point or so (two at the most), and if guests stayed longer, came more frequently, or spent more, neither the Amusement or F&B comps demonstrated it.   We stand by our discussions over the last six months, to which we have linked below, that Virtual Reality is unlikely to be a “game changer” and materially change the lackluster trajectory of comp sales. The Company confirmed what we pointed out months ago, that there is a labor content to this ride/game/platform  because the attraction must be attended to with at least one crew person. The profitability of  this offering may or may not enhance overall margins, because higher margin activities would be taking place in the same space, and it may take more than a point or two of incremental sales to offset the higher labor component. The Jurassic Park Virtual Reality experience was introduced midway through Q2, and Q2 showed higher labor expense. Our observation, about which we have written before, is that the VR platform is one of the quieter places in the  facility. Even when occupied by “riders”, there is very little “energy” in the immediate vicinity, compared to almost all of the rest of the Amusement area. We also question the notion, as suggested by management, that the ride doesn’t have to be attended to at all times. Our observation is that, most of the time, the ride/game has to be “sold” by a well trained attendant. The attendant (or two) that manage this platform, has to be personable, attentive, and diligent in efficiently loading and  unloading riders, as well as cleaning the viewing goggles and seats.

Also on the Conference Call, an intensified focus on the F&B side of the business was described, including a fast casual taco concept that will be installed at a Dallas location this fall. It makes sense to us that many PLAY customers don’t want to sit down for a full fledged meal, but could respond to a taco offering, “on the run”.  It’s possible that  a “food court” of sorts could replace at least part of the current “Bar & Grill” area, and success with this experiment would be a major positive development.

Other than the above, it is more or less “business as usual”, opening stores as planned, the latest class of stores doing well, more Virtual Reality games (and others) to come, more effective promotions, better training. No details were provided as far as the cost of developing Virtual Reality or other games,  the incremental traffic necessary to justify that expense, or the expected lifespan of these offerings. Clearly, though, as we have described before, PLAY is more of an Amusement Park than a Restaurant. With Amusements & Other at almost 60% of total sales, and Alcoholic Beverages about a third of the remaining 40%, only 26-27% is from Food. Since a great deal of capital (the amount not disclosed) is being spent on “proprietary” game content, PLAY becomes dependent on the ability to correctly predict gaming trends, an order of magnitude more risky, than most restaurant/retail operations we can think of.

Conclusion: Stated at the beginning of this discussion

Below are links to our most recent writeups on PLAY

DAVE & BUSTER’S (PLAY) – VIRTUAL REALITY GAME/RIDE – WILL IT BE A “GAME CHANGER”

DAVE & BUSTER’S ENTERTAINMENT

 

 

DAVE & BUSTER’S (PLAY) – VIRTUAL REALITY GAME/RIDE – WILL IT BE A “GAME CHANGER”

DAVE & BUSTER’S (PLAY) – VIRTUAL REALITY GAME/RIDE (based on Jurassic Park) – WILL IT BE A “GAME CHANGER”

Our full descriptive report dated May 3rd

DAVE & BUSTER’S ENTERTAINMENT

and our update on June 19th  (   https://www.liptonfinancialservices.com/2018/06/dave-busters-play-up-38-in-one-month-whats-going-on/ )

after PLAY stock had run up 38% in one month, presumably because of enthusiasm from the Virtual Reality introduction, can be reviewed.

It seems to us that the hope surrounding a recovery in both amusement and F&B comps revolves around the recent introduction of the Virtual Reality game/ride based on Jurassic Park, and timed to coincide with the latest movie. Now that the game/ride has been in the stores for about a month, we have visited locations at both peak and light dayparts, so we present here our “anecdotal” observations.

In general, the game/ride is often located on the periphery of the amusement section, manned by at least one attendant to check people in with their special $5 ride card (which inconveniently has to be purchased separately at the front desk), seat them, and help them adjust their helmet/goggle. While many riders express enthusiasm as they are bounced around, “scan”, not “kill” the dinosaurs, and get wind blown on their face, we don’t find a great level of excitement by the onlookers. It seemed to us that the “buzz” seems less around this particular attraction than around many other amusements, even if there is a waiting line. While the attendants have indicated that some do come back, the departing riders seemed to have enjoyed it, but don’t seem to be wild about another ride immediately. Quite a few people wander by, look it over, and keep walking. Not many are intrigued enough to linger, though no doubt some will buy their $5 card and come back.

On June 19th, we went through a calculation to show that, based on four sessions per hour ($20.00 for the four seats) and five hours per day, $146,000 per year could be generated or 1.5% of sales in a $10M location. We have observed a waiting line at peak periods, but much lighter use at mid-week times (both day and evening) and some locations are closing it down at 8pm. (This possibly conflicts with a report by SunTrust Robinson Humphrey last week that their field research shows “PLAY is offering this game every day and most hours”, whatever “most” means.) Since the ride is only 5 minutes, we think more like eight sessions per hour (including changeover) is realistic at peak times, but we think an average usage of perhaps 2.5 hours per day (with all four seats occupied) would be a reasonable approximation. That would be 32 riders per hour for 2.5 hours or 80 riders per day generating $400 per day or the same $146,000 per year. We could obviously be off in this rough approximation, but we believe the order of magnitude is close enough. Even if we are low with this approximation over the first several weeks, and we might be, considering the successful Jurassic Park movie premier and the TV support from PLAY, we doubt that it will be any higher than this just a few months from now. One of the key observations by an attendant was that the frequency of use is not building materially, so the necessary word of mouth to build long term usage doesn’t seem to be in play. The “game” aspect of this game/ride does not seem compelling. Riders can “scan” the dinosaurs, and create a personal competition to outscore your co-riders, but the skill level or satisfaction from this aspect is hard to pinpoint. We have taken the ride, and the visuals are impressive. We are admittedly far from the “target audience” but feel like “you’ve seen one dinosaur, you’ve seen them all”.

An important consideration here is whether this new amusement, the updated software when it comes, and other Virtual Reality offerings will reverse the now established negative trend in the amusement section. Management also hopes that customers will stay longer, and spend more, as they wait for their turn with the VR experience. Our guess is NO and NO. Management, and optimistic analysts, have expectations that an exclusive “Halo” game (not VR) to be introduced in late July and additional chapters of Jurassic Park (for late summer and early fall) will re-establish momentum. We have no insight relative to amusements to come, but we don’t believe the Jurassic Park Virtual Reality game/ride, and its future iterations, if they are comparable to what has so far been introduced, will prove to be a “game changer”.

One last thought: Neither management, nor the analytical community, is talking about what the new VR platform has cost to develop, and what the depreciation schedule looks like. There is also a labor component on an hourly basis that is not a factor with most of the other amusements. An attendant, or even two, at peak times, is not a huge factor, but the necessary attendant even when there is light usage becomes a noticeable expense. There has to be an obvious attendant standing by, at virtually every moment of operation.

Roger Lipton

DAVE & BUSTER’S ENTERTAINMENT

Conclusion:

Dave & Buster’s stock has become a bit of a “battleground” over the last six months, since operating results have not been as impressive as over the last several years when the Company was consistently meeting and beating expectations. Investors can judge for themselves the relative merits of the bull and bear case and whether the stock, now in the low 40s, down from about 70 a year ago, adequately discounts the uncertainties.

The Positives:

  • (1) Cash on cash returns are still attractive, even if overstated by non-inclusion of pre-opening expenses, which have been increasing.
  • (2) There is a very long runway for future growth, which has been extended by virtue of the new 17K format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial liquidity from operating cash flow and borrowing power, to fund unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential for improvement in the Food & Beverage segment, including a Fast Casual approach to be tested in ’18.
  • (5) The potential for a “blockbuster” amusement offering exists, including the virtual reality platform currently in development, which could spark a new round of same store sales growth.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment.
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements, continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  No one can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length later in this article. We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided, we welcome further discussion of this issue by the company or the money management community.
  • (6) Insider selling, and relatively small stock ownership by top management is a continuous feature of this situation. The largest shareholder among executives is CEO, Stephen King, who “controls” only 1.1% of the O/S shares, about 77% of which are through options. Numerous executives, including King, have immediately sold stock after exercising options.

PLAY: Company Overview

Source of Revenues

Dave & Buster’s Entertainment, Inc. is the Dallas-based owner and operator of 106 dining and amusement venues in North America as of July 2017.  The company aims for a distinctive experience with stores designed to “Eat Drink Play and WatchAll Under One Roof.”  In what we refer as “2017”, which is the 53 week ending 1/31/18, its stores generated revenues of $1.14B, of which “amusements and other” (“A&O”) sales contributed 56.6% of revenues, food and beverage sales contributing the balance. The A&O portion of revenues has grown steadily in recent years. Redemption games represented 75.7% of A&O revenues in 2017. Video and simulation games, many of which can be played by multiple players, represented 21.5% of A&O revenues, up from 17% in 2016.  The remainder of the games are “traditional”, such as billiards. A&O offerings have very low variable costs, producing a gross margin of 89.3% in 2017, so contribute a much higher than proportionate share of corporate gross margin.

Eat Drink Play Watch

D&B’s refers to its menu as “Fun American New Gourmet”.  It features classic casual dining entrees and appetizers ranging from choice-grade steaks, gourmet pastas, and premium sandwiches to snacks, health-conscious options and less healthy desserts.  Menu items are presented with a flamboyant “fun twist,” and served in dining areas adjacent to the “Midway“ games and “D&B Sports” large screen viewing areas.  Each location features a full-service bar and beverage service throughout the amusement areas.  The beverages range from a variety of beers and traditional cocktails and spirits to novelty items such as “Luxe Patron LITs”, “Smash tails” and “Glow Kone’s.”  Both the food and beverage offerings are updated with new items three times each year.  Food (including non-alcoholic beverages) comprised 67.9% of food and beverage revenues (29.5% of total revenues) in 2017, while alcoholic beverages accounted for 32.1% of food and beverage revenues (13.9% of total revenues).

The Midway section of D&B locations typically offers over 150 games designed to create a high energy social experience. Almost 80% of amusement revenues are derived from games in which customers can win prizes ranging from branded novelties to high-end electronic items (redeemable in a retail-like “Win!” booth). The company aims to keep its games fresh, including offering some of the latest high-tech games commercially available.

The D&B Sports section of the stores are designed to provide customers with an immersive environment for watching live sports and other televised events.  Stores typically have 40 large screen TV’s with high quality sound systems, including a 100” HD set. The D&B Sports venue is relatively new feature of the D&B experience, having been included in remodels and new stores since 2010.

Company Strategy

D&B has been a public company twice, the first from 1997 to 2006, when it foundered following some operational missteps, including an ill-advised acquisition. It was taken private and operated by several private equity entities until October 2014 when it was re-launched as a public company.   Stephen King, the current CEO, has lead D&B since 2006, during which time many of the elements of the company’s strategy were put into place.  Possibly chief among them has been the expansion of the higher margin amusements category to its 56.6% of revenues (in calendar 2017, up from the previous level of only 44%.  A second key initiative has been the extensive remodeling of its stores, transforming them throughout as a vivid statement of its Eat Drink Play Watch promise.  With the remodeling program substantially complete, the company has stepped up new store growth from 2 stores in 2011 to 11 stores in 2016, 14 in 2017, and 14-15 in 2018.

The company’s customer mix is young adults (~54% male), families (household income $75K+), tourists and corporate & social special events (~10% revenues).  About 3.5% of revenues are spent on marketing and the promotional initiatives to target these demographics. Messaging aims to build awareness of D&B as the “best place to watch sports” or “the only place to watch the games and play the games,” and otherwise reinforce its multivariate Eat Drink Play Watch offerings that complement each other in a way that cannot be replicated at home.  Further, many promotional initiatives (such as “Eat & Play Combo”) offer discounts to drive a value positioning.

D&B envisions the potential for about 230 stores in North America, including the new 15-20,000 sq ft (“17K format”), with over 57% of new units in existing markets and the remainder in new markets.  Internationally, the company is pursuing franchise and joint venture opportunities and has signed a licensing agreement for 7 locations in the Middle East.  It expects the first store under the agreement to open in Dubai in 2018.

Long term the company targets 10% annual store growth and comps of about 2%, though guidance is for negative LSD comps in ’18.  At this level of revenue growth it expects that leverage of G&A and marketing expense will result in low double digit EBITDA growth over the long term.

Unit Level Economics

D&B stores are deployed in a large and small format, depending on the market and site availability.  The smaller stores range from 25K to 30K square feet with target year 1 revenues of $8.7M, while the larger stores range from 30K+ to 45K square feet, with target year 1 revenues of $10-12.2M. The newest 17K version is targeting $4.5-5.0M in year 1. The potential number of stores suggested by third party research is over 230 in the US and Canada, including the current locations. The new 17K version should allow entry into smaller markets, the first of which opened recently in Rogers, Arkansas. It is expected that 20% of future stores will be the 17K version, with the balance split between the other two formats.

The development costs net of landlord allowances and pre-opening expense is $6.8M and $8.3-8.8M for small and large stores, respectively, and less than $5M for the new 17k version.  In their first year, the company targets store-level EBITDA margins of about 29%, a cash-on-cash returns at 35% for both the large and small format stores, and a 5-year average cash-on-cash return greater than 25%. It is worth noting that, per the 2017 10k, the 48 stores opened since the beginning of 2008, opened for a full year as of 2/1/18, have generated an average year one return of 49.6%. The forty stores opened after fiscal 2010 have generated 53.5% C/C in year one.  However, the 5-year target is provided because the D&B stores typically enjoy a particularly strong year 1 honeymoon, generating cash-on-cash returns of 40%-50%, well in excess of targets, as demonstrated by the above disclosure. Predictably, the lower AUVs in years 2 and beyond (down 10-20% in year 2) have lower margins as well. However, since overall store level margins have been steadily rising, hitting a peak of 30.8% of sales in 2017, virtually flat from 2016, it appears that the margin declines in year two and three of younger stores may not be weighing as heavily on overall margins as the stated model implies. All the returns quoted above do not include the investment in pre-opening expenses, currently running about $1.5M per location, obviously reducing the above stated returns materially. The stated returns are also before depreciation & amortization of leasehold improvements and it remains an open question as to how much should be “reserved” to refresh the critical A&O segment, as discussed below.

Operating Metrics

The company has made enormous strides under the 12 years of Mr. King’s leadership.  Net income has grown over $130M to $91M in 2017 up from prior losses of $10M, while EBITDA margins have increased by over 1,200 bps.  Comps have been consistently positive (though slowing recently) since the IPO, averaging over 5%, driven to a great extent by games.  In the same period, restaurant-level EBITDA margins have increased 420 bps to 30.8%, while company EBIT margins have increased 460 bps to 14.5% in 2017 (down 50 bps from 2016) from 9.9% in 2014.

A hardly discussed metric relates to the critical A&O segment. D&B’s model relies on maintaining customer interest with relevant and fresh games.  As such the company’s projected 5-20 year useful life of its games (per its depreciation schedule) can be questioned.  Even a 5-year life, the lower end of the range, seems questionable in an age when mobile phones are replaced every 2-3 years.  If so, a more rapid replace/refresh pace would necessitate an increase in annual games investment, reducing free cash flows.  On the other hand, a replacement rate at the current pace or slower risks a decline in game productivity. Indeed, an inappropriately long game replace/refresh rate contributed to the company’s troubles in its previous foray as a public entity. The vulnerability of this portion of revenues was demonstrated recently, in Q4’17 when an unexpectedly difficult comparison to last year’s more dynamic game offerings affected results negatively.

The Depreciation Issue – Further

Nobody can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. The last time PLAY was public, ending 2006, the useful life was considered five years. Today the Company does not provide the periodic depreciation amounts on the Amusement portion alone, so we cannot determine the average useful life that is assumed today. However, the gross investment (before depreciation) in games is provided and it seems like the productivity of those games is consistently declining, just as in 2000-2006. For example, at 1/31/12 the investment in “Games” was $60.9M and generated $310M of A&O revenues in the following 12 months, or $5.08 per undepreciated balance sheet Games Asset. This “return on investment” has declined each year to $4.00 (from $5.08) for the FY ending 1/31/17 and $3.74 in the FY ending 1/31/18.  As previously stated, the same pattern prevailed in the 6 years prior to going private in 2006 as the “ROI” declined from $2.52 to $2.12. Though old D&B’s games operated at a much lower level of productivity, the steady progression of deterioration is the same. There may be other causes for these patterns than declining sales productivity, but lacking better insight, game asset turnover seems an important metric to monitor. Of course, the Company’s overall Return on Invested Capital has increased in recent years, even while the return on Amusement Investment has apparently declined. This is no doubt a function of the very high profitability of Amusements and the large amount of capital that has been poured into this segment (including store renovations), outweighing the 26.4% (from $5.08 to $3.74) smaller “return per dollar invested” over the last five years. However, on a much larger base, a continued decline in the productivity of existing investment, even if new Games are successful, could affect total results more materially.

We have not seen this issued addressed in either company documents or analyst discussions. It’s entirely possible that our concerns are misguided, so we would welcome further discussion of this issue by either the company or the money management community.

Balance Sheet Considerations

In the 2 years ending 12/16 the company aggressively paid down $165.3M of legacy debt incurred prior to the IPO, but the long term debt increased by $95M in 2017, paying for the stock repurchased as described below.  As of the end of 2017 its ratio of long term debt to TTM EBITDA was a modest 1.4X. In 2017 the company generated an operating FCF margin of $44M or 3.9% of sales (Net Cash Provided by Operating Activities of $264M less $220M of Capex). The $152M spent on stock repurchase was financed by the increase in long term debt of $95M, the $44M of operating cash flow, and working capital changes.

Shareholder Returns

Since the IPO in October’14 at $16.00, the stock has appreciated by 162%. The company does not pay a dividend but in 2016 spent $38.8M, and $152M in 2017 repurchasing common shares.

Recent Developments – Per Q4’17 Report and Conference Call on 4/3/18

It is hard to say that that Q4 results were anything but disappointing to both the investment community and the company. Earnings per share met Street estimates, but only with the benefit of a 10.6% tax rate versus 36.7% a year ago. Overall comp sales were down 5.9%, vs. +3.2% a year ago. Comps in Amusements & Other were down 4.2%, Food & Beverage was down 7.8%, Walk-in sales were down 6.4%, Special Events were down 2.9%. Considering the sales trends, the still impressive store level EBITDA margin of 30.9% was well controlled, down from 32.3%. Five stores were opened in Q4, in Tampa, FL: in Woodbridge, NJ: Auburn, WA: Baltimore, MD: and Bayamon, PR, fourteen openings for the full year.

Guidance for calendar ’18 was adjusted downward in terms of total revenues, with a negative comp of low to mid single digits, net income of $95-110M (vs.$121M in 2017), after an effective tax rate of 23-24% (vs.22.7%) and EBITDA of $255-275M (vs.Adjusted EBITDA of $303M). 14-15 openings are planned, 8 stores in new markets, 11 large format, 2 small, and 2 @ 17K. Note that calendar ’18 is a 52 week year, vs. 53 weeks in ’17. Part of the possibly conservative outlook is the indication given that the first quarter of ’18 has started off slowly.

Per the conference call:

Management indicated that the big surprise in Q4’7 was the slowdown in A&O revenues, getting worse through the quarter and continuing in ’18. The comparison with a year earlier “Rock ‘em, Sock ‘em” turned out to be a problem. Directionally, the biggest factors were “number one, content: number two was weather: number three was increase in competitive intrusion”.  A&O revenues grew as a percentage of total revenues in Q4 by 110 bps to 54.5%, continuing the long term trend away from Food & Beverage.  The 2018 game lineup provides high hope, including a proprietary virtual reality platform being developed in conjunction with a “very well known Hollywood film franchise”. As of 4/3, it is “currently being written. We have the agreement for the IP so we’re confident we are going to deliver it in midyear, but exact timing is something that we’ll wait until we have a 100% line of sight”. In terms of pricing the offering: “we have priced VR in cash as a separate item…without the ability to utilize it on your Power Card. …..we tested it at $5 per person….we may offer some promotional ways… but our thought is that we put it out at $5 per person and kind of see what demand it generates”.

On the food and beverage side, an intensified effort is being made. There was discussion that Eat & Play Combo (“EPC”) is “not resonating with the guests as well as they once were”, so a new version is being tested. Also, the Happy Hour offering “isn’t resonating quite as well” so that is being restructured as well. A new VP of Food and Beverage Development has been hired. New burgers have recently been introduced, with chicken and steak to follow. Speed of service is being emphasized, with ordering kiosks being deployed, and a Fast Casual approach will be tested in H2’18.

Management reiterated how profitable the store model is, saying that the 2016 class generated first year C/C returns of more than 50%. (That is store level EBITDA compared to net cash investment, not including pre-opening expense.) As discussed above, under our “operating metrics” section, pre-opening expense for the year, no doubt affected by the timing of openings, was $23.5M, or over $1.5M per store with 14-15 locations opening per year, that is obviously a more than material increment over the stated “net cash investment” per store of $6.8M and $8.6M per small and large store respectively.  It was pointed out that the higher labor at new stores, combining with higher occupancy expenses, higher marketing and the generally higher wage rate contributed to the margin deterioration YTY. During Q4, depreciation was lower by 140 bps (a “sensitive” subject, relative to our discussion of depreciation above), G&A expenses decreased by 60 bps, pre-opening expenses were up 110 bps (which relates to our discussion of $1.5M/store, above). Corporate EBITDA was up by 4.3%, down 190 bps as a % of sales to a still admirable 23.2%.

Conclusion: Stated at the Beginning of this Article

 

 

DAVE & BUSTER’S (PLAY) – THE BATTLE OF THE BULLS AND BEARS!

Dave & Busters’s – (PLAY) – The Battle of the Bulls & Bears!

Recent Development: Per Q3’17 Company Release and Conference Call

http://ir.daveandbusters.com/news-releases/news-release-details/dave-busters-announces-third-quarter-results-and-introduces-new

http://public.viavid.com/player/index.php?id=127327

Dave & Buster’s continued to perform well in a difficult restaurant spending environment, no doubt due to the “experiential” nature of their concept. 56.9% of revenues now comes from Amusements, with about 15% from alcoholic beverages, so slightly less than 30% comes from food.

Comparable stores, 75 out of 101 current locations, showed decreased sales of 1.3%, very close to the 1.1% decrease estimated by analysts, and the storms were responsible for 50 bp of that decrease. The EPS result exceeded analysts estimates by $0.03 per share, but the tax was only 28.7% vs. 37.1% YTY. Pretax income was flat YTY. Corporate operating EBITDA margin was flat at 18.2% of revenues, up 9.8% YTY. Store level operating EBITDA margin was down 20 bp, to a still impressive 25.9% of revenues.

Comp stores sales in Amusements increased 1.1% and in Food & Beverage decreased 4.2%, a continuation of recent trends. It is noteworthy that these results were against a strong quarter a year earlier when overall comps were up 5.9%, including Amusements at 10.4%.

Operating costs were well controlled, total cost of sales down 60 bp, F&B costs up 10 bp with 2.3% in food pricing, 0.8% in beverage pricing, slight commodity inflation. Cost of Amusements was down 80 bp. Labor with benefits was 90 bp better, from lower incentive pay, favorable medical claims, and the leverage from higher Amusement sales. It’s worth noting that average hourly wage inflation was 4.4%. Other store operating expenses were up by 170 bp, driven by higher rent and more marketing. As noted above, store level EBITDA margin was down only 20 bp, to 25.9%.

The balance sheet remained strong, with $316M of debt, just over one time TTM EBITDA. In the current YTD $123.4M of stock has been repurchased, at an average price of $58.76. There remains $147 million available under the current authorization.

Guidance for all of ’17 was adjusted slightly to include a decrease of corporate EBITDA growth to “low to mid teens”. This reflects the impact of the three storms, a delayed opening in Puerto Rico, the challenging macro environment, and pre-opening expenses. Since Adjusted EBITDA was up 17.6% for nine months and EBITDA was up 15.7%, that guidance implies Q4 EBITDA somewhere south of 15%. Corporate EBITDA for Q3 was up 10.8% and Adjusted EBITDA was up 12.0%. Comp sales expectations are being guided lower by about a point to “flat to up 0.75%” for all of ’17, and, importantly, management noted that Q4 has started “slower than expected”.  It was noted that this year includes 53 weeks that helps revenues by about $20M and EBITDA by $4M. It’s unclear whether the Q4 guidance has been “adjusted” for the extra week this year.

Relative to longer term expectations, management discussed at some length that increasing competition is affecting sales, in particular from TopGolf and Main Event, both of whom are expanding aggressively. There is also a cannibalization effect as PLAY opens additional stores in existing markets. As management pointed out, these elements were less prevalent even a couple of years ago. Also, analysts expressed some concern that non-comp units seem to be doing less well lately, relative to the existing comp base.  Management responded that some of the recent stores, while categorized as “large” are not at the top of the size range and with the size mix trending lower, the AUVs should be expected to decline as well. In terms of margin contraction to be expected in Q4 (and perhaps beyond), higher rents higher marketing expense, and higher commodity costs are expected to affect results.

Management declined, until early in ’18 (presumably with final fiscal 1/31/18 results) to provide guidance for next year.

Management described at some length its intention to build a smaller format store, sized from 15k to 20k square feet, with the possibility of 20-40 locations, in smaller markets, over the long term. It is expected that this format, with a cash investment of $5M (excluding Tenant Improvement Allowance) would generate $4-5M revenues, with a “steady state” C/C return in the low 20s. Management emphasized that, while the expected ROIC will be attractive, it is expected to be less than the current legacy locations. The first location would open in Rogers, AK in early ’18. This smaller format provides some extra runway for future growth, above the previously stated 200 or so US locations.

The Positives:

  • (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
  • (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
  • (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : https://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.