Good day, and welcome to the Dave and Buster's Incorporated Third Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jay Tobin, Senior Vice President and General Counsel. Please go ahead, sir.
Thank you, Melissa, and thank you all for joining us. On the call today are Steve King, Chief Executive Officer and Brian Jenkins, Chief Financial Officer. After comments from Mr. King and Mr. Jenkins, we will be happy to take your questions.
This call is being recorded on behalf of Dave and Buster's Entertainment and is copyrighted. Before we begin our discussion of the company's results, I would like to call your attention to the fact that in our remarks and our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered forward looking statements and relating to future events within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward looking statements are subject to risks and uncertainties, which could cause actual results to differ from those anticipated. Information on the various risk factors and uncertainties has been published in our filings with the SEC, which are available on our website at Daveinvestors dot com under the Investor Relations section.
In addition, our remarks today will include references to EBITDA, adjusted EBITDA and store operating income before depreciation and amortization, which are financial measures that are not defined under generally accepted accounting principles. Investors reconciliation of these non GAAP measures to the comparable GAAP results contained in our earnings announcement released this afternoon, which is also available on our website. Now I'll turn
the call over to Steve. Thank you, Jay, and good afternoon, everyone. We appreciate your participation in our quarterly conference call. Today, I'll review our Q3 performance, highlight our key strategic priorities and update you on our strong new store pipeline and significant white space opportunity. Brian will walk you through the key financial highlights, and I'll conclude by updating you on our development efforts before we open it up to your questions.
Let me begin by sharing a few high level thoughts on our 4 strategic priorities before I dive into the quarter itself. First on amusements. The category continues to be the primary reason for the visit and is growing, but we remain focused on continually strengthening our content portfolio and differentiating it from our competition. Our 2018 games lineup is shaping up to be the best shot, and I'll talk about that a little more later. 2nd, we're committed to reigniting the momentum in our F and B segment by improving product alignment and speed of service.
3rd, we're taking steps to remove friction in the guest experience. And 4th, bolstered by strong new store returns, we want to continue to drive unit growth over the long term. Now for a few highlights from the quarter. While the Q3 had its challenges, including weather and difficult comparisons, our team pulls through remarkably well. I'm incredibly proud and grateful for all their hard work.
We grew revenue by approximately 9% and EBITDA by about 10%. Excluding the estimated impact of Hurricanes Harvey and Irma on the mainland and Maria on Puerto Rico, where we had a store scheduled to open during the quarter, revenue was up double digits. Q3 comps were down 1.3%, which included includes an estimated 50 basis points from the impact of the storm. Our stores in the Houston and Florida markets remained closed for several days following the hurricane. In addition, our stores in other parts of Texas experienced temporary softness as consumers were distracted by gas shortages.
You may recall during Q3, we lapped our toughest same store sales comparison in the year, up 5.9%, including amusement comp of 10.4%. This year's Q3 same store sales performance on a 2 year and a 3 year stack basis was in fact an improvement relative to Q2 trends. Our special events category did see significant pressure following the hurricanes as businesses redirected some of their discretionary dollars towards relief and rescue efforts. In addition, special events faced a tough comparison to last year. The business is rebounding and bookings look good for the seasonally strong Q4.
Our non comp and new store performance remains impressive. Of the 101 stores we operated during the Q3, 25 were non comp from new stores. Their strong performance and contribution to our overall revenue growth once again demonstrates the broad appeal of our brand, giving us continued confidence in our model. Next, I'll touch on some of the key drivers in the quarter. Our summer games lineup this year was comprised of highly recognized and marketable content, including Spider Man, Aliens, Physical Meat, Space Invaders and the world's largest Pac Man among others.
Also, we ran our all you can eat wings promotion for 1st 6 Sundays, Mondays and Thursdays of the NFL season for $19.99 with a $20 Power Card. As you'll recall, last year, we ran a similar promotion at $29.99 with a $20 Power Card. Not surprisingly, we saw higher incidents this year due to the lower price point, but our gross profit dollars from the promotion were essentially flat on a year over year basis. In October, we successfully launched the Injustice Arcade on an exclusive basis ahead of the November release of 1 of the most anticipated movies of the year, Justice League. This non redemption game is quite engaging as it features interactive collection of cards that control the on screen action.
In terms of our guidance for 2017, broadly speaking, we continue to expect low mid teens growth in revenue and EBITDA. However, to reflect the impact of the 3 storms during the quarter, including the delayed Puerto Rico opening, a still soft overall environment and additional investments in pre opening for new stores are lowering our guidance slightly. Brian will elaborate on these changes and provide a more detailed financial update in his prepared remarks. Brian? Thank you,
Steve, and good afternoon, everyone. Well, let me begin by thanking our team members across the country for their relentless focus on execution that enabled us to deliver strong financial performance while also improving the guest experience. Excluding the hurricane headwinds, both revenue and EBITDA would have been up low double digits. Also, we were able to maintain EBITDA margins despite a slight decline in comparable store sales. Now here are some of the other highlights for the Q3.
Total revenues in the quarter increased 9.3% to $250,000,000 that's up from $228,700,000 in the prior year due to strong contributions from newer stores. Revenues from our 76 comparable stores fell 1.3% to $196,400,000 while revenues from our 25 non comp stores, including one that opened during the quarter, increased to $52,400,000 That's up from $29,500,000 in the prior year. These results include an estimated unfavorable impact from hurricanes during the quarter of 50 basis points on comp sales and $2,000,000 on total revenue. Please note that the following disruption that following the disruption caused by Hurricane Maria, we delayed the opening of our Puerto Rico store from early October to mid January, which cost us an estimated $1,000,000 in sales for the quarter and $4,500,000 for the year. Turning to category sales, the mix shift to our more profitable entertainment business continued as total amusement and other sales grew 11.8%, while food and beverage sales collectively increased 6.3%.
During the Q3, amusement and other represented 56.9% of total revenues, reflecting 120 basis point increase from the prior year period, continuing a long term trend and reflecting the primary focus of our promotional strategy. Now breaking down the 1.3% decrease in comp sales, our walk in sales fell point 9%, essentially in line with NAPTRAK, while our special events business was down 4.8%. Now as I mentioned, this includes an estimated 50 basis points of unfavorable impact from weather as several of our stores in the Texas and Florida markets remain closed following hurricanes Harvey and Irma respectively. In addition, many of our Texas stores, which while not directly impacted by the hurricanes, experienced temporary softness as consumers grappled with gas shortages. Excluding the impact of hurricanes, these two markets outperformed the system.
In addition, wildfires had an unfavorable impact on some of our California stores. Our special events business began the quarter on a strong note. However, following the hurricanes, the segment softened significantly, likely due to its more discretionary nature and it took a bit longer for the business to bounce back. Special events was also lapping a difficult comparison of a positive 7.6% from the prior year. In terms of category sales, amusements rose 1.1%, while our food and bar business was down 4.2% percent and 4.1 percent respectively.
Again, to put this in perspective, in Q3 this year, we left our strongest comp from last year of 5.9%. And as Steve mentioned, we lapped over 10% comp in our amusements category. During the Q3, the impact of cannibalization and competition on our system, while significant, was stable and in line with our expectations. In terms of cost, total cost of sales was $44,600,000 in the 3rd quarter and as a percentage of sales improved 60 basis points, reflecting a slight decline in F and D margins, improved amusement margins and higher amusement sales mix. Food and beverage costs as a percentage of food and beverage sales increased 20 basis points compared to last year as approximately 2.3% in food pricing, 1.8% in bev pricing was more than offset by slight commodity and a growing mix of new stores.
For the full year 2017, we expect slight commodity inflation. Cost of amusement as a percentage of amusement and other sales was 80 basis points lower than last year. This was driven by a shift in gameplay towards simulation games and a moderate price increase in our Wynn merchandise. Total store operating expenses, which includes operating payroll and benefits and other store operating expenses, were $140,700,000 and as a percentage of revenue, store operating expenses were 56.3% or 80 basis points higher year over year. Our operating payroll and benefit costs was 90 basis points better year over year, lower incentive comp, favorable medical claims, a strong focus on hourly labor and leverage on higher amusement sales mix were the key drivers underlying this improvement.
This was partially offset by higher excuse me, offset by hourly wage inflation of about 4.4% and the typical inefficiency at our non comp stores. Our non comp stores representing 25% of our store base continue to perform well and are generating excellent returns, but are not as efficient as our mature comp store base from a labor perspective. Other store operating expenses were 170 basis points higher year over year, primarily driven by higher occupancy costs at our non comp stores as well as higher marketing expenses. Store operating income before depreciation and amortization was 64 point $6,000,000 for the quarter, reflecting growth of 8.5% compared to $59,600,000 last year. And as a percentage of sales, this was a decrease of 20 basis points year over year to 25.9%.
G and A expenses were $13,400,000 essentially flat versus prior year as increased headcount to support our growing store base and higher share based compensation was more than offset by lower incentive compensation. As a percentage of revenues, G and A expenses were 50 basis points lower year over year due to leverage on overall sales growth. Preopening costs increased to $5,600,000 That's up from $4,600,000 in 2016, primarily due to the impact of spending related to our Q4 store openings as well as openings planned for next year. Our EBITDA grew 9.8 percent to 45,600,000 dollars Margins were flat, while adjusted EBITDA grew 12.1 percent to 54,100,000 dollars Net interest expense for the quarter increased to $2,200,000 that's up from 1,600,000 dollars last year, driven by higher cost of debt due to increases in the underlying LIBOR rate as well as higher average debt levels. In addition, we incurred approximately $700,000 in expenses related to our debt refinancing during the quarter.
Our effective tax rate for the quarter was 28.7% compared to 37.1% in the Q3 of last year. The decrease in the effective rate reflected a favorable 7.5 percentage point impact from the adoption of the new accounting standard related to share based payment transactions, which reduced our income tax provision by 1,300,000 and increased shares outstanding by 304,000 compared to the prior year quarter. As a reminder, the implementation of this new standard does not have any incremental effect on our cash taxes. However, as we have indicated on prior calls this year, it does increase our diluted share count and can significantly reduce our effective tax rate depending on the magnitude and the timing of stock option exercises. We generated net income of $12,100,000 or $0.29 per share on a diluted share base of 42,300,000 shares.
This compared to net income of $10,800,000 or $0.25 per share in the Q3 of last year on a diluted share base of 43,300,000 shares. EPS, excluding the $0.03 favorable impact of the new accounting standard for share based payments and the $0.01 unfavorable impact of the debt refinancing would have been $0.27 per share.
Turning to
the balance sheet just for a minute. At the end of the quarter, we had $316,000,000 of outstanding debt on our credit facility, resulting in low leverage of just over 1x With our recent refinancing, which expanded our borrowing capacity by over $300,000,000 we are in the fortunate position to have both a strong balance sheet as well as healthy cash flows to pursue our investment and growth via high risk return new store development. At the same time, we also have the flexibility to return value to shareholders. Year to date, as of last week, we had repurchased approximately 2,100,000 shares of our common stock for 123,400,000 This brings our inception to date total repurchases to 2,600,000 shares for 152,200,000 dollars with $147,000,000 still available under our buyback program. Turning now to our outlook.
Before I update you on some of the key elements of our guidance, let me highlight 2 critical points. 1st, our full year guidance now includes an estimated unfavorable impact from hurricanes Harvey, Irma and Maria of $5,500,000 on sales $2,000,000 on EBITDA and excludes any potential recoveries from business interruption insurance. 2nd, this guidance now includes an additional $2,000,000 dollars in preopening expenses compared to our September update, driven primarily by our strong 28 pipeline of new stores. Due in part to these items, we are revising our full year EBITDA guidance to range from $268,000,000 to $272,000,000 which at the midpoint of the range is down $3,000,000 from our prior guidance. However, in light of the impact of the hurricanes and our higher investment in preopening expenses, we are pleased with this revised guidance and believe it reflects our team's strong focus on execution and ability to respond swiftly in a challenging environment.
Now the details. Total revenues are expected to range from $1,480,000,000 to $1,152,000,000 compared to our prior guidance of $1,160,000,000 to $1,170,000,000 reflecting the impact of hurricanes, including the delayed Puerto Rico opening and reduced comp sales guidance. Comp store sales growth on a comparable 52 week basis is now projected to be flat to up 0.75% for the year, down from prior guidance of between 1% 2%. This reflects the impact of hurricanes during the 3rd quarter and a slower than expected start to the Q4. Trends in our special events bookings appear to be recovering and look solid ahead of some of our seasonally strongest weeks of the year.
From a development perspective, we are still targeting 14 new store openings, including a projected mid January opening of our Puerto Rico store. As expected, our 2017 class has skewed toward large format stores and new markets for our brand. We've already opened 13 stores so far this year and have 11 under construction at this point. We are projecting net income of $110,000,000 to $112,000,000 based on an effective tax rate of 29.5% to 30%. This guidance includes the year to date impact of the new accounting standard related to share based payments.
However, we have excluded any potential future tax benefits in Q4 of 2017 since the timing and magnitude is largely out of our control and could exhibit some volatility. We also estimate a diluted share count of approximately 42,600,000 shares at the low end of our prior guidance due to the impact of additional share repurchases. We project net capital additions after tenant allowances and other landlord payments of $195,000,000 to 200,000,000 That's up from prior guidance of $182,000,000 to $192,000,000 driven by additional pre spend on our strong pipeline of new stores planned for next year. Finally, while we are not yet in a position to provide detailed guidance for 2018, I would like to share our preliminary high level view on the upcoming year. First, as you think about next year, please recall that we will have one 18 compared to our 53 week year in 2017.
This unfavorably impacts revenue and EBITDA by approximately $24,000,000 respectively. Next, we are very excited to have a strong new store pipeline. We plan to open and add 14 to 15 new stores in 2018. Also, as you might have seen in our press release and as you will hear from Steve shortly, our 2018 plan includes 2 of the exciting new smaller format stores at 15,000 to 20,000 square feet. For modeling purposes, please keep in mind that this format is smaller than our typical small store and as a result is expected to generate lower revenue per unit.
Finally, we expect to deliver low double digit revenue growth and high single to low double digit EBITDA growth in 2018. With that, I'll turn the call back over to Steve to make some final remarks.
Thank you, Brian. I'd now like to review our recent and upcoming store development activities and our long term opportunity in that area. We're very pleased with the response to our recent store openings. As we mentioned in the press release, during the Q3, we opened 1 new store in Pineville, North Carolina. In the Q4 so far, we've opened 4 stores, including 1 in Brandon, Florida, located just east of Tampa Woodridge, New Jersey and just yesterday, 2 stores, 1 in Auburn, which is near Seattle, Washington and 1 in White Marsh, which is near Baltimore, Maryland.
New Jersey and Washington, by the way, are new states for us. As Brian mentioned, we'll round out the year with our Puerto Rico store, which is now scheduled to open in mid January. The 14 stores we opened this year, representing about 15% unit growth, are comprised of 8 stores in new markets for D and B, 6 stores located in markets where we already have a brand presence. In terms of the square footage, we expect 10 large stores in this year's class, including 8 that approximately 40,000 square feet, 2 that are in between 30000 and 40000 square feet, with the remaining 4 stores being that 30,000 square feet or less are small stores as we characterize them. We currently have 11 stores under construction and a total of 27 signed leases, providing us significant visibility on our new store growth well into 2018 2019.
Next, I'll expand a bit on our 4 strategic priorities that I mentioned at the beginning of my prepared remarks. We will continue to differentiate our amusement offering by adding titles on a proprietary exclusive as well as non exclusive basis. In 2018, we'll focus on strengthening our offering with particular emphasis on exclusive and proprietary games. We have great visibility into our offerings through the first half of twenty eighteen and our game lineup is shaping up to be our best yet It includes a proprietary virtual reality platform that will enable us to rotate content and capitalize on this emerging opportunity for several years. We will use this platform to feature a couple of titles that incorporate VR experience tied to well known properties in 2018.
Turning now to our F and B strategy. Q3 was really about conducting in-depth qualitative and quantitative research and testing with focus groups to determine the right path forward. The good news is the initial research confirms that a vast majority of our guests enjoy a full service dining experience. However, they do expect greater speed of service, more value and a simpler offering from us. Our guests, particularly the young ones that we call Play Together Young Adult, prefer a menu that focuses on items that are shareable and snackable.
We're in the midst of testing a pared down menu in several of our stores. With respect to value, we are emphasizing promotions such as the Eat and Play combo, which we advertised on television during the quarter. We are improving speed of service through menu redesign and process simplification in the kitchen area. In addition, we're testing new technologies such as pay at the table and pay by smartphones that can improve table terms and reduce wait time. Separately, while the vast majority of our guests enjoy a full service casual dining experience, we believe that offering a quick casual as an alternative delivery mechanism inside our box is a potential unlock for us.
We'll begin testing this next year. And given the size of our box, we're in the fortunate position to be able to offer both options under the same roof if the test is successful. I think fully implementing this SMB strategy and realizing the payoff will likely take some time, but this is clearly a focus for us. The 3rd strategic priority for us is removing friction in the guest experience. We've identified several friction points that cost our guests time, including buying power cards at the front desk, waitlist for seating in the dining room, ordering food, paying their check, as well as activating games in the arcade area.
We want to implement solutions, including leveraging technology that enable our guests to better control the flow of their visit and frees up our staff to have more personalized and meaningful touch points with our guests. And the 4th strategic priority is one that continues for us, and that is to drive 10% or more unit growth over the long term. Our new stores continue to generate strong cash on cash returns. Our 2016 class of stores is performing very well for us in its 1st year, essentially in line with the strong performance of our classes of stores in recent years. Also, we're pleased with our 2017 store openings to date.
This has bolstered our confidence in the long term target of 211 locations in the United States and Canada alone. By the end of fiscal 2017, we'll have 106 stores operating across 36 stores, Puerto Rico and Canada, and that's right at half of our addressable market excluding our newest our new small format store that we highlighted in our earnings press release. Speaking of which, we're excited to announce today a new store format that will help us capitalize on demand in some of the smaller markets who are not included in our original plan of 211. This store format at 15,000 to 20000 square feet will be smaller than our typical, what we currently call small, which ranges from 25,000 to 30,000 square feet. Preliminarily, we see the potential for 20 to 40 such locations over the long term.
We anticipate AUVs of $4,000,000 to $5,000,000 store level EBITDA margins around 25%, cash investment excluding TI of less than $5,000,000 and a steady state cash on cash return in the low 20s for this format. In fact, we're right on track to open our 1st store under this new format in Rogers, Arkansas, which is Northwest Arkansas, early next year. We will apply our typical disciplined approach to execution in order to mitigate risk and are optimistic with respect to the incremental opportunity that this presents. Our primary growth vehicle continues to be building stores that have industry leading average unit volume, great store level margins and outstanding cash on cash returns, Including the new smaller store format that I mentioned, our white space opportunity is now even larger and our pipeline is stronger than ever before. We'll continue to open new stores at a measured pace and ensures continued solid execution.
We're confident that we have a strong and dedicated team needed to execute our vision. So in conclusion, we are uniquely positioned as an experiential brand and have a large white space opportunity. Our competitive advantage is having an unbeatable combination of a strong new store pipeline, a differentiated offering, the necessary human capital and a very healthy balance sheet to execute on our vision. Our 4 strategic priorities include accelerated momentum in our amusement category, reinvigorating our food and beverage business and removing friction in the guest experience while driving 10% unit growth over the long term. Thank you.
We always appreciate your continued support. And at this point, operator, would you turn the lines open to for Q and A?
And our first question will come from Jake Bartlett from SunTrust.
Great. Thanks for taking the question. First, I'm wondering if you could help us out a little bit on the Q4, the implied guidance of the same store sales. It looks like it's pretty wide range, 300 basis points range roughly and could be in pretty deep negative territory or low single digits. Help us understand what your expectations are that narrowed down in the Q4?
And then also just the comments about a kind of slow start to the quarter. I mean, just kind of any help on what you can attribute that to?
Well, Jake, I think you have it right. I mean, our guide for the Q4 implies sort of slightly positive to low single digit decline and it's driven by a slow start kickoff to the quarter. We ended Q3 with storms and some of that stuff. It was a bit softer. So we have brought our guidance down.
As we look at it, our business, we've got if you look and date back 3 years 2014 to 2016, we are a comp grower of 20% magnitude over that period of time. Casual dining is down 0.5%. So we've had 3 years straight of very, very strong collector performance, outperformance to NAP, averaging about 7% a year in comp over those 3 years. So we have some pretty tough compares. So we have some big weeks to go.
Bookings our sales bookings are right now recovering and solid. But these are some of the biggest weeks that we have coming up here around the holidays and we're trying to give ourselves some range of performance in that guide.
Okay. And then when I think about the holidays, I know there's you get a Saturday back for Christmas and also for New Year's. I mean, how material should impact should that be in thinking about Halloween that was seemed to be about 150 basis points good guy last year. So maybe help us out there and I know there's the Super Bowl as well kind of trailing in the last day of the quarter. So maybe just help us understand how that's going to play out or impact your comps for the rest of the quarter?
Well, Jake, I'm not going to get into specifics of the impact. We have indicated that the move of Christmas and New Year's away from the weekend is helpful to us. Again, these are some big weeks. There is some weather dependency. So but those are that's a positive impact that's in front of us coming up here in December early January.
So, but I don't want to specify a specific number on that.
Okay. And real quick, on the movement towards a smaller box, you tried that before as I recall, I believe, that it didn't quite work as well. You moved away from the very smaller box that you had tried a number of years ago. What's different this time around? And then also what is the impetus for doing it?
It seems like you're in the sweet spot for new available locations, developers are wanting you to be kind of an anchor for them now to drive traffic. Why the shift now towards the smaller box?
Well, let me answer your first question first, which was what's different about this time compared to last time? And I think that one of the things we're excited about is it is different in terms of the way that we've laid out the building this time around. Last time, essentially, we just took everything and proportionately shrunk it. So we had special event space in there. We had a dining room.
We had everything that you had in a traditional 5 stores, just everything was smaller. And what that manifested itself in is the Midway or the arcade was about 5,500 Square Feet. In this new format that we are doing, we are going to have an arcade of 10,000 square feet, which is essentially the same size as what we have in our current smalls. And instead of doing a separate dining room and special events and all the rest of that, we're going with a straight sports theme or essentially D and B Sports. We will have some dining oriented towards the arcade like we have in most of our stores.
But we're really going to focus on D and B Sports attached to a 10,000 square foot Midway. And we just think
it's going to be
a much better and more effective way for us to try to tackle those smaller markets. And in terms of kind of why now, I think we want to make sure that we have a model that's thoroughly embedded, and that's why we're doing a couple of them and want to see what kind of returns we or what kind of volumes, in particular, we can generate in this size store so that we can see exactly how large the addressable market is for this.
Great. I appreciate it.
Our next question will come from Jeff Farmer from Wells Fargo.
Thank you. You guys did mention several food and beverage strategies, but can you just highlight what you see as the mobile order and pay opportunity and how quickly
you guys think you can execute on
that, if there's I think we see it as a 2 step process, Jeff. I think
I think we see it
as a 2 step process, Jeff.
I think that, first of all, the adoption rate on mobile kind of pay at the table and stuff like that, truly mobile on your phone, it's pretty low. But we're testing that just to make sure that we understand that. But we think the bigger short term opportunity is really pay at the table. And so we've begun testing that. We have it on some tables as we speak.
Our view of that is that others have seen adoption rates 50%, 60%, 70% of people paying on that, which is going to create an opportunity for a number of different things. It's going to enable us to go faster in terms of the checkout process. Obviously, it will enable us to do some things, maybe not obviously, but it will also enable us to do some things with ordering, surveys, even alerting our staff. And one of the things we're particularly excited about is because of the size of our space that the ability for the guests to alert somebody that they are sitting in an area that may not have someone right on top of them, I think is an important element of what we're looking for as well. So we're excited about what those that technology can do in the short term.
And then I think in the longer term, our vision would be there are a number of things that could be enabled by smartphone, including kind of activating the games. And really, it's a question of kind of how do you get it so that you get the real estate on somebody's phone in order to enable that process.
All right. Thank you. Just one unrelated follow-up. So it sounded like you pointed to a pretty stable encroachment and cannibalization same store sales headwind quarter over quarter. But can you give us any color in terms of the sense of the magnitude of those two things?
Are they 100 basis points combined, 150 basis points? Any color would be helpful.
Yes, Jeff. We've hesitated to call out and start providing those numbers each quarter because it is an imprecise science. It's somewhat difficult to measure the impact competition cannibalization. We often have both happening at the same time in the same market. So there's a little gray to the estimate.
So we're we spent a lot of time trying to analyze it, but we're hesitant to just start quoting a scientific number on this. The reality is that it's a significant headwind for us. And to give you some perspective that I think might help, if you dial back from Q3 of 'sixteen through Q3 of 'seventeen, You've heard us talk about Topgolf Main Event and of course we have ourselves opening stores in our own market. About a third of our comp base is being impacted by one of those 2 competitors who are ourselves. So about it, I mean that's a significant number of stores where either Topgolf Main Event or D and B is open.
So it's not an insignificant headwind. It is a headwind that has grown over the years. A few years ago, we weren't even talking about this. We don't feel like it's going to moderate in the near term. We have one of our competitors that has slowed down, at least announced they're going to slow down some, but Topgolf is still growing hard.
And there is more money being invested in the dining and entertainment space, not just those 2 guys. So and I think part of it is we keep showing our 50% year 1 returns and it attracts money. And I think there are more competitors coming in the space. We don't think it's going to moderate. That said, I think we feel like we are best in class.
We have the industry leading AUVs and I'm not going to put Topgolf in that. That's a sort of a different beast. We have what we feel like are the best operators in the country running these stores and we think most of these folks have lower ROIs. That doesn't mean it's not going to attract capital. So I don't think it's going to go away, but we feel like we have the team to respond, but we're going to feel the competition, I think, for some time.
Yes, I apologize. Just a quick follow-up on that. So you said a third of the system theoretically or roughly has been impacted over the trailing 4 quarter period. Sounds like you expect it to be a similar level moving forward. But if we were to take this back a year or 2, would this been a quarter of the system impacted by either cannibalization or encroachment?
Shoot, I have those numbers somewhere. It would be we started talking about this last year when really Topgolf and Main Event really started to expand their store growth in, I would say, back half of twenty fifteen. So it was not a this was not on our I'd say it went on our radar. We've been tracking the composition, but it was not a meaningful topic in 'twelve, 'thirteen kind of years, even 'fourteen. So it and right now, I think Steve mentioned it in his remarks, but next year, we're going to skew slightly towards existing markets and our store base for next year.
So slight which is a little bit different this year. So there's a little more cannibalization headwind moving into next year if you look at our remarks. And again, I don't think we see competition declining going forward.
Okay. Thank you.
Our next question will come from Andy Barish from Jefferies.
Hey, guys. There's some expense shifting
kind of in
the quarter. I mean, you actually got labor leverage with negative comps and all the disruption, but other operating, other store operating went the other way. Is there anything other than kind of the inefficiencies? Or what did you do on the labor line to kind of get that leverage year over year?
A lot of focus. As I said in the remarks, I mean, we've been working hard and our COO, Margo Manning, the operations team did a really a fantastic job dialing in hourly labor in the quarter. So we actually were favorable year over year on an hourly line and that hadn't been the case in any quarter really as much this year. So the 4.4 percent, especially with the comp decline. So fantastic work and as I mentioned in my remarks, guest satisfaction, guest pulse went up, we improved.
So we're not trying to burn furniture here, but we did dial it in, particularly in the non comp stores. There is a natural lever in labor around bonuses. And as you think about our guide, as we guide down, so those bonus goes down in the stores as well if we are if our numbers are coming down. And so that you see that both in our G and A expense that we saved some money in incentive comp year over year because of that in G and A and also in the field. And then we're just having really good experience this year, really every quarter and it was fantastic this quarter on medical claims.
And we keep wondering if that's going to be ongoing, but it has been ongoing in all three quarters this year and it actually expanded some. So labor came out in a really good way for us. On the other store operating expenses, 170 bps of decline. We've been talking about the occupancy thing for a while. We are opening new stores, they have much higher rent really compared to the legacy stores.
Well over half of that 170 bps is in occupancy cost. So and we did invest some money in additional marketing as well. I think I don't know if you mentioned that Steve or not, but we did spend a bit more in marketing in the quarter. I think we had indicated we expected to deleverage marketing about the year on our prior conference call that did occur in the quarter. And we did invest some money in showing the fight, the big fight that we view as sort of an investment spend to kind of build our reputation as a sports viewing venue.
And it did protect the business. To call it an incremental win in terms of profit, I wouldn't say that's the case. I think it's more of a trying to hang on to the sales at home watch event and so we did spend some money on that. But occupancy is a big number, Andy.
Okay. And then looking out, I mean, obviously for 2018, you're implying sort of flat to slightly lower EBITDA margins again with the new store inefficiencies as
sort of
a headwind. Are there any other pushes or pulls we should kind of think of at this early stage even before you're obviously into the year?
You know what, I'm going to hesitate to we're going to stick with what our prepared remarks were on the guide. We'll cover some of the specifics, line items and some of that stuff on our April or fiscal year end call, Andy. But our kind of overall high level guide does imply some potential for margin erosion. And I think I would point heavily towards the new store mix, growing occupancy costs more I mean, we've booked 14 stores this year, 11 25 of those stores out of our 100 are built in the last 2 years and we're just growing more and more of those and that's a structural difference in our cost structure. We don't view it as a long term negative.
It is just what it is. And we still like the returns as we grow. We're going to keep growing. We're going to build some of these little 15 to 20s and some of the smaller MSAs. We're excited about the potential of those.
When we come to the Rogers, we're excited to see what that's going to do. But they're not going to have, as Steve said, the same kind of margins as our legacy stores. We're not going to be doing those kind of margins in those stores.
Okay. Thank you.
Our next question will come from Sharon Zackfia with William Blair.
Hi, good afternoon. I guess a couple of questions. I know you televised and marketed Eat and Play combos during the quarter. So I'm just wondering what you thought the response rate was there? Was it good or in keeping with what you had hoped?
And then as you think about kind of breaking through with consumers with a value message, maybe more specifics on how you do that? And then, as a tangential question, and I understand this is a loaded question, For 2018, are you should we expect a step up in the tax rate to the 36% to 37% that you normally tell us? Or is 30% a good number to plug in for right now?
I thought it was going to be 22%. No.
I knew it was loaded.
Yes. So tax rate, we're guiding 29.5% to 30% for the full year. You should be thinking that that's 36.5% to 37% directionally excluding the impact of the simplification related to share based payment. So we're going to be quoting the numbers with and without in terms of net income because we are getting a significant credit or a shelter in the numbers this year when we honor that. It's a good 600 basis points, 700 basis points.
I really can't predict what next year is going to bring in terms of option exercises out of my control and Steve's control. So I don't want to predict that. We're going to be talking about the numbers pre that so we can look at true comparisons. We don't want to have to roll over the net income numbers, the EPS numbers that have that big credit in it. My God, as it goes down next year, but that meaning tax rate goes up, but it really depends on that option exercise next year.
Yes. Then on the marketing question for what we did with in play combo, We ran it as a test for a couple of weeks. To be honest, we didn't see anything that was meaningful there in terms of an increase in either the penetration or a lift in overall sales. So we're kind of back to the drawing board as it relates to the value promotion that can significantly impact sales. And you can also say that, I mean, we ran even longer in the quarter for all you can eat wings, which is a very serious discount in terms of that combination package.
And again, didn't see a huge uptick in terms of what we saw on the F and B side in particular from a revenue and penetration standpoint. So we will be coming at you with something different in 2018 as it relates to value messaging.
Is there anything, Steve, planned for the holidays around value? Or is it really something where we're going to hear more in 2018?
I think you're going to hear more in 2018. We're not really featuring value between now and over the holidays as a big message. We always have some amount of value with respect to the amusement. We'll have play X number of games free, which is a value message there. But just on the food and beverage side, I don't think you're not going to see a significant value message play there.
Okay. Thank you. Next, we'll take a question from Joshua Long from Piper Jaffray. Great.
Thanks for taking my question.
Wanted to circle back to the smaller format stores and just see if we should be thinking about those as maybe backfilling existing units or an opportunity to go into newer markets that otherwise wouldn't have been able to support some of the larger or the prior store formats?
And the
way we're thinking about it, when we said in the prepared remarks between 20 40 new stores of this size. Those are new markets that we had deemed to be too small for our current small format. So those are completely new markets for us. Now having said that, again, I alluded to this a little bit in my comments that depending on how much volume these stores could do, there's a chance that some of the ones that we had originally thought of as small stores, you might think about doing this way if you got a better return. So again, early to tell, early days, but that's the way we're thinking about it.
These are 20 to 40 completely new markets that we wouldn't have been in with our current small format.
Great. That's helpful. And then as we think about the move into virtual reality, that's something that we've talked about in the past that it maybe wasn't the right time or maybe the technology just hadn't gotten there yet. So how should we be thinking about that as still being able to kind of hit all the buckets for what you're trying to do in terms of turning people over, getting the turns on the game and that kind of bogging down the midway? What's changed there from either a technology or process standpoint where it makes more sense now to kind of start investing in that as a test?
I think that there's a couple of things. 1, we have figured out a multiplayer platform that we can do more than 1 person at the same time. Some of what we experimented with in the past was sort of a single player, either single first person shooter, driver, all of that stuff, that was essentially a single person at a time. And so we've been able to come up with a way to and I don't want to give away too much here because we're not we want to save some for the launch, but it's a multiplayer. At the same time, It's something that we think is a platform that we're going to be able to rotate different content on.
So those are 2 of the things that we think are significant. It will be attended, so there will be a small amount of labor associated with this. And I would think about it as more of an attraction oriented piece, although there will be it will be interactive in the sense of a game, but it's more like a simulator than it is like a redemption kind of game.
That's helpful. And definitely want to keep some of the allure there for the release, but is it should we think of it as an upsell or something that you could still participate in through just the normal Power Card process?
So we've done a little testing on this and we're here to pour, we've made it all an incremental spend, not on the power plant.
Great. Thank you.
Our next question will come from Brian Vaccaro with Raymond James.
Thank you and good evening. I wanted to circle back on your recent comp trends. And you mentioned you're off to the sluggish start, obviously. But we've been hearing that the casual dining industry seems to have stabilized a bit versus a weaker and softer trend in the Q3. I guess I'm curious how you what you think is driving sort of that differential in your recent performance?
Is there one piece of it, special event, something else that might be driving that differential in relative performance that you point out?
I think probably what I didn't say on Jake's question is a mild start to fall and winter is not particularly good for us. And we don't feel like we're getting really a favorable swing so far in terms of the start to our Q4 as it relates to weather. So what might be healthy in casual dining, maybe opposite for us, I think, is what you may find.
Okay. All right. And could you also speak to what you're seeing in terms of your mall versus non mall locations in the recent quarter?
We continue to see some divergence in terms of mall versus non mall in terms of the mall stores underperforming slightly, the non mall stores. But then again, when you flip back to the compares, they have much not much, but they have tougher compares. So if you look at it on a 2 year stack and a 3 year stack, they're sort of in line at this point with 2017 lagging the overall a bit. Okay. That's helpful.
We'd like to see mall traffic be better. It's like we'd like to see casual dining, but to be stronger and not negative comps. It's not necessarily helpful for malls to be struggling. I mean, we are a destination. People do come to visit us, just us.
But there's at least one guy, that's all I have to say, that might have come to the mall and then sees us. So we'd like to see traffic and that's not helpful.
Yes. All right. That's helpful color on that. And last one on the sales front, and I just have one more margin question. But if you look at the new unit performance in the quarter, if you compare the average weekly sales in the non comp units versus, say, the comp base, it looks like that spread widened out quite a bit here in the Q3, at least on RMAT.
Curious if there A, can you confirm that? But B, are there any factors like seasonality, large versus small that could be impacting that relationship, which has been a little tighter over the last few quarters at least to RMF?
The latter. I mean, we've been I think we've been trying to communicate. First of all, we're guiding a large store format to do 11,000,000 steady state lower than our current average, which is upper 11s for the whole system. And we're building smalls that we're targeting to do roughly 7,000,000 steady state sales. And then we're building these stores that are somewhere in between.
That's the reality of what our development cycle has been. Of the 25 non comp stores that we have in our store base, only 10 of them are true largest, 40,000 and up. 7 of them are small and we have 8 of these sort of in betweens that are going to do somewhere in between. So I think that's the piece that's maybe being missed here. And then I would say as you look at kind of our what we've opened to date, I'm talking about the 17 classes, 9 stores have been opened to date.
While we've said most of the stores are going to be skewed large this year, only 4 of those 9 are true largest. Most of the largest are coming here in the Q4 that we just opened. So that mix is impacting the AUVs and it's not a surprise to us. Again, we're focused on ROI and return on investment and but we don't expect AUVs to stay for the whole brand to be constant at the current base, makes comp store AUVs because of the mix.
Okay. That's really helpful color. And the last one for me. If you look at your implied 4th quarter EBITDA guidance, it would seem to imply some pretty meaningful margin contraction. I think again, in this Q3, you had negative comps and you saw a little bit of positive expansion on the EBITDA margin line.
I know we've got preopening, but can you walk through maybe some of the other puts and takes that are embedded in your implied Q4 EBITDA guidance outside of the preopening line? Thank you.
Yes.
If you go to the top end of our guide, you are going to see some margin compression relative to kind of what 40 bps of favorable margins year to date. The big changes are number 1, marketing. We've leveraged marketing year to date. We anticipate that will be a deleveraging item in our Q4. So that's a fairly significant number.
Pre opening cost, we guided that number up by about $2,000,000 So preopening is going to be a drag, increased drag. It is year to date, but it's going to increase in Q4. Again, we view that as a good add, this is an investment and strong pipeline in new stores, but there is an increase related to preopening costs. And I would say the other significant item is probably around the relative to our kind of trend to date is around gross margins. We've been very favorable on the amusement side on a year to date basis.
We are and a lot of that on the heels of this simulation mix shift that we've seen, and we are hesitant to be too aggressive on what we're projecting on the gross margin front. So we are not being as strong on our gross margin projection in Q4. And we do see more inflation on the food commodity side too in Q4. So those are kind of the big items that are causing the separation from what we see year to date versus the Q4 kind of implied margin.
Okay. Thank you. And in the 'eighteen guidance, Brian, just to follow-up, while you're talking about food costs in the 4th quarter, Can you give an early read on food inflation guidance in 'eighteen and also what you expect on wage inflation?
I think we're going to hesitate again to get into all the items
of the
guidance. I would say what's that?
We're going to guide on our Q4.
Yes. We'll guide some of the line item specifics next year when we get on our April call.
All right. Fair enough. Thank you.
And next we'll take a question from Stephen Anderson from Maxim Group.
Yes. Good afternoon. I have a
question about the food and beverage side of the business. Then I'll congrats on the comments, but wanted to ask about some of the local store marketing efforts like some local promotions that maybe run-in some stores but not in others. Is this something that you would seek to pursue in 2018 in certain markets?
I think we'll have tests that go in some markets and not others. And we do allow a certain amount of latitude for our stores to do promotions on a local basis, but I wouldn't say it is a large part of the 2018 strategy. Thank
you. Our next question will come from Andrew Smolzak from BMO Capital Markets.
Hey, thanks for taking the question. I actually have 2 quick things. First, as you're looking at the smaller the new smaller footprint stores and kind of thinking about the mix of square footage, have
you thought about going back
to your existing stores and even some of the larger stores just given where the food and beverage trends have been and you're talking about maybe a more fast casual type of opportunity within those stores. Have you gone back to think about or could this be kind of foreshadowing of thinking about how the footprint could change kind of to retrofit some amusement side or any other changes?
So, yes, we've thought about it. We've discussed it. I think that for the most part, we feel comfortable with the capacity that we have on the amusement side. But that's with today's level of amusement sales, etcetera. I think if you continue to see amusement sales grow, at some point, you may want to take some of the space within the box and reallocate it.
And I think that is the beauty of what we have with a lot of the stores, 35,000 and up, we would have the ability to, number 1, do something like this quick casual. And then some other instances, if we wanted to take a shot at increasing the Midway and seeing what kind of impact that would have, we could. And you would have to make some trade offs in terms of what you think that does the volume in other areas of the business. But you might look at some stores and say, hey, that's worth another that's another thing worth testing, excuse me. But we don't have any plans today to do that.
Okay. Great. That's helpful. And my other question, can you talk about maybe the characteristics of the markets that you're looking at for the smallest footprint stores? And I guess I am just wondering the thought process behind the 20 to 40 number that you put out, how did you come to that number?
Thank you very much.
So, we are really thinking about smaller DMAs or SMAs, SMSAs, that kind of range in size from, call it, the low 200s up to 5 or so average, I think it's somewhere in the 4 range for the size of the adjustable market there. And that was really a smaller market than we thought we could address with our current small format. So that's why we collected those and that's how we collected those. Why didn't we go smaller than that? We look at a number of different factors to try to determine where we thought we could get that $4,000,000 to $4,500,000 of sales.
And we thought that at the 200 level of population, we could probably get that. And some of those have some tourist topspin and some of those sort of things. But at that level, we thought we could get there, and that's really how we selected those stores.
Great. Thank you very much.
Sure.
We have no further questions at this time, and I'd like to turn the call back over to our speakers for any additional or closing remarks.
Really, that's it from our end. Thank you very much for joining the call today. We look forward to reviewing the Q4 results with you in early April.