Good day, welcome to the Dave & 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, thank you all for joining us. On the call today are Steve King, Chief Executive Officer, 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 & 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 daveandbusters.com under the investor relations section. 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 should review the 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. I'll turn the call over to Steve.
Thank you, Jay, good afternoon, everyone. We appreciate your participation in our quarterly conference call. Today I'll review our third quarter performance, highlight our key strategic priorities, update you on our strong new store pipeline and significant white space opportunity. Brian will walk you through the key financial highlights, 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 four 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, 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 yet, I'll talk about that a little more later.
Second, we're committed to reigniting the momentum in our F&B segment by improving product alignment and speed of service. Third, we're taking steps to remove friction in the guest experience. Fourth, 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 third quarter had its challenges, including weather and difficult comparisons, our team pulled through remarkably well, and 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 Hurricane Maria on Puerto Rico, where we had the store scheduled to open during the quarter, revenue would have been up double digits.
Q3 comps were down 1.3%, which 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 of the year of 5.9%, including amusement comp of 10.4%. This year's Q3 same-store sales performance on a two-year and a three-year stack base, which 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 fourth quarter.
Our non-comp and new store performance remains impressive. Of the 101 stores we operated during the third quarter, 25 were non-comp or 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 of Games lineup this year was comprised of highly recognized and marketable content, including "Spider-Man," "Aliens," "Despicable Me," "Space Invaders," and the world's largest "Pac-Man," among others. We ran our All You Can Eat Wings promotion for the first six 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 incidence 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 one 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. To reflect the impact of the three storms during the quarter, including the delayed Puerto Rico opening, a still soft overall environment, and additional investments in pre-opening for new stores, we're lowering our guidance slightly. Brian will elaborate on these changes and provide a more detailed financial update in his prepared remarks. Brian?
Steve, good afternoon, everyone. 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've been up low double digits. We were able to maintain EBITDA margins despite a slight decline in comparable store sales. Here are some of the other highlights for the third quarter. Total revenues in the quarter increased 9.3% to $250 million. That's up from $228.7 million in the prior year due to strong contributions from newer stores. Revenues from our 76 comparable stores fell 1.3% to $196.4 million, while revenues from our 25 non-comp stores, including one that opened during the quarter, increased to $52.4 million. That's up from $29.5 million 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 million on total revenue. Please note 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 million in sales for the quarter and $4.5 million 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 third quarter, amusement and other represented 56.9% of total revenues, reflecting a 120-basis point increase from the prior year period, continuing a long-term trend and reflecting the primary focus of our promotional strategy.
Breaking down the 1.3% decrease in comp sales, our walk-in sales fell 0.9%, essentially in line with Knapp-Track, while our special events business was down 4.8%. 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% and 4.1% respectively. To put this in perspective, in Q3 this year, we lapped our strongest comp from last year of 5.9%, and as Steve mentioned, we lapped over 10% comp in our amusements category. During the third quarter, 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 $44.6 million in the third quarter, and as a percentage of sales improved 60 basis points, reflecting a slight decline in F&B margins, improved amusement margins, and higher amusement sales mix.
Food and beverage cost 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 inflation 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 win merchandise. Total store operating expenses, which includes operating payroll and benefits and other store operating expenses, were $140.7 million, 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 cost 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. 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. 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 $64.6 million for the quarter, reflecting growth of 8.5% compared to $59.6 million last year. As a percentage of sales, this was a decrease of 20 basis points year-over-year to 25.9%.
G&A expenses were $13.4 million, essentially flat versus prior year, as increased headcounts 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&A expenses were 50 basis points lower year-over-year with a leverage on overall sales growth. Pre-opening costs increased to $5.6 million. That's up from $4.6 million 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% to $45.6 million. Our margins were flat, while adjusted EBITDA grew 12.1% to $54.1 million. Net interest expense for the quarter increased to $2.2 million. That's up from $1.6 million 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 third quarter of last year. The decrease in the effective rate reflected a favorable seven and a half percentage point impact from the adoption of the new accounting standard related to share-based payment transactions, which reduced our income tax provision by $1.3 million 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 $12.1 million or $0.29 per share on a diluted share base of 42.3 million shares. This compared to net income of $10.8 million or $0.25 per share in the third quarter of last year on a diluted share base of 43.3 million 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 million of outstanding debt on our credit facility, resulting in low leverage of just over one times.
With our recent refinancing, which expanded our borrowing capacity by over $300 million, 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 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 2.1 million shares of our common stock for $123.4 million. This brings our inception to date total repurchases to 2.6 million shares for $152.2 million, with $147 million 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 two critical points.
First, our full year guidance now includes an estimated unfavorable impact from hurricanes Harvey, Irma, and Maria of $5.5 million on sales and $2 million on EBITDA, and excludes any potential recoveries from business interruption insurance. Second, this guidance now includes an additional $2 million in pre-opening 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 million to $272 million, which at the midpoint of the range is down $3 million from our prior guidance. However, in light of the impact of the hurricanes and our higher investment in pre-opening 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 $1.148 billion to $1.152 billion, compared to our prior guidance of $1.16 billion to $1.17 billion, reflecting the impact of hurricanes, including 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% and 2%. This reflects the impact of hurricanes in the third quarter and a slower than expected start to the fourth quarter. 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 million-$112 million based on an effective tax rate of 29.5%-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 42.6 million 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 million-$200 million.
That's up from prior guidance of $182 million-$192 million, 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 less week in 2018 compared to our 53-week year in 2017. This unfavorably impacts revenue and EBITDA by approximately $20 million and $4 million respectively. Next, we are very excited to have a strong new store pipeline. We plan to open and add 14-15 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 two of the exciting new smaller format stores at 15,000-20,000 sq ft. 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 third quarter, we opened one new store in Pineville, North Carolina. In the fourth quarter so far, we've opened four stores, including one in Brandon, Florida, located just east of Tampa, Woodbridge, New Jersey, and just yesterday, two stores, one in Auburn, which is near Seattle, Washington, and one 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 eight stores in new markets for Dave & Buster's, six 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 eight that are approximately 40,000 sq ft, two that are in between 30,000 and 40,000 sq ft, with the remaining four stores being the 30,000 sq ft or less, our 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 and 2019. I'll expand a bit on our four 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 2018, 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 titles that incorporate VR experience tied to well-known properties in 2018. Turning now to our F&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 adults, 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 & 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 smartphone that can improve table turns 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 F&B strategy and realizing the payoff will likely take some time, but this is clearly a focus for us. The third 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, wait lists 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. The fourth 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 first 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 U.S. and Canada alone. By the end of fiscal 2017, we'll have 106 stores operating across 36 states, Puerto Rico, and Canada.
That's right at half of our addressable market, excluding 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 were not included in our original plan of 211. This store format, at 15,000-20,000 sq ft, will be smaller than our typical, what we currently call small, which ranges from 25,000-30,000 sq ft. Preliminarily, we see the potential for 20-40 such locations over the long term. We anticipate AUVs of $4 million-$5 million. Store-level EBITDA margins around 25%. Cash investment, excluding TI, of less than $5 million, 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 first 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 that ensures continued solid execution. We're confident that we have the strong and dedicated team needed to execute our vision. 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 four strategic priorities include accelerating 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. At this point, operator, would you turn the lines open for Q&A?
Certainly. Ladies and gentlemen, if you'd like to ask a question at this time, please press star one on your telephone keypad. If you're on a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. We ask that you please limit yourself to one question and one follow-up. If you would like to ask further questions, you may press star one to enter the queue again. Once again, that's star one for any questions at this time. 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 fourth quarter, the implied guidance of same-store sales. Looks like it's a 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 narrowed down in the fourth quarter. Then also just the comments about a kind of slow start to the quarter and just kind of any help on what you can attribute that to.
Well, Jake, I think you have it right. Our guide for the fourth quarter implies sort of slightly positive to low single-digit decline. It's driven by a slow start, a kickoff to the quarter. We ended Q3 with storms and some of that stuff. It was a bit softer. We have brought our guidance down. As we look at it, our business, if you date back three years, 2014 to 2016, we are a comp grower of 20% magnitude over that period of time. Casual dining is down 0.5%. That's three years straight of very strong collective performance, outperformance to now averaging about 7% a year in comp over those three years. We have some pretty tough compares. We have some big weeks to go. Our sales bookings are right now recovering and solid.
These are some of the biggest weeks that we have coming up here around the holidays. We're trying to give ourselves some range of performance in that guide.
Okay. When I think about the holidays, I know you get a Saturday back for Christmas and also for New Year's. How material impact should that be in thinking about Halloween? That seemed to be about 150 basis points good guy last year. Maybe help us out there. I know there's the Super Bowl as well, kind of trailing into the last day of the quarter. 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. That's a positive impact that's in front of us coming up here in December and early January. I don't want to specify a specific number on that.
Okay. 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, and 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 draw traffic. Why the shift now towards a smaller box?
Well, let me answer your first question first, which was, what's different about this time compared to last time? 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. We had special event space in there. We had a dining room. We had everything that you had in a traditional size store, it was just everything was smaller. What that manifested itself in is the midway or the arcade was about 5,500 square feet. In this new format that we're doing, we're going to have an arcade that's 10,000 square feet, which is essentially the same size as what we have in our current smalls.
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&B Sports. We will have some dining oriented towards the arcade like we have in most of our stores. We're really going to focus on D&B Sports attached to a 10,000 sq ft midway. We just think it's going to be a much better and more effective way for us to try to tackle those smaller markets. In terms 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. We want to see what kind of returns 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, can you just highlight what you see as the mobile order and pay opportunity and how quickly you guys think you can execute upon that, if there's something to help you build that food and beverage business?
I think we see it as a two-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, is pretty low. We're testing that just to make sure that we understand that. We think the bigger short-term opportunity is really pay at the table. 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. One of the things we're particularly excited about is because of the size of our space that the ability for the guest to alert somebody that they're 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. We're excited about what that technology can do in the short term. Then, I think in the longer term, our vision would be there are a number of things that could be enabled by a smartphone, including kind of activating the games.
Really, it's a question 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. 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? 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 of competition and cannibalization. We often have both happening at the same time in the same market. There's a little gray to the estimate. We spend a lot of time trying to analyze it, but we're hesitant to just start quoting a scientific number on this. The reality is-
Okay, thank you
that it's a significant headwind for us. To give you some perspective, I think might help, if you dial back from Q3 2016 through Q3 2017, you've heard us talk about Topgolf and 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 two competitors or ourselves. That's a significant number of stores where either Topgolf Main Event or D&B has opened. 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.
Topgolf is still growing hard, and there is more money being invested in the dining and entertainment space, not just those two guys. I think part of it is we keep showing our 50% year-one returns, and it attracts money. I think there are more competitors coming into 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. We think most of these folks have lower ROIs. That doesn't mean it's not going to attract capital. We don't think it's going to go away. We feel like we have the team to respond.
We're going to feel the competition, I think, for some time.
I apologize. Just a quick follow-up on that. You said a third of the system theoretically or roughly has been impacted over the trailing four-quarter period. Sounds like you expect it to be a similar level moving forward, if we were to take this back a year or two, would this have been a quarter of the system impacted by either cannibalization or encroachment?
Shoot. I have those numbers somewhere. We started talking about this last year, really Topgolf and Main Event really started to expand their store growth, I would say it was back half of 2015.
Okay.
This was not on our radar. We've been tracking the competition, it was not a meaningful topic in the 2012, 2013 kind of years, even 2014. Right now, I think Steve mentioned it in his remarks, next year, we're going to skew slightly towards existing markets than our store base for next year. Slight, which is a little bit different this year. There's a little more cannibalization headwind moving into next year, if you look at our remarks. 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. You actually got labor leverage with negative comps and all the disruption, but 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. We've been working hard, and our COO, Margo Manning, her and the operations team did really a fantastic job dialing in hourly labor in the quarter. We actually were favorable year-over-year on our hourly line. That hadn't been the case in any quarter really as much this year.
The 4.4-
Especially with the comp decline. Fantastic work, and as I mentioned in my remarks, guest satisfaction, guest pulse went up, and we improved. 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 does bonus. Bonus goes down in the stores as well if our numbers are coming down. You see that both in our G&A expense, that we saved some money in incentive comp year-over-year because of that in G&A and also in the field. We're just having really good experience this year, really every quarter, and it was fantastic this quarter on medical claims.
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. 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. We did invest some money in additional marketing as well. 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 a year on our prior conference call. That did occur in the quarter.
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. 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. It's an at-home watch event, so we did spend some money on that. Occupancy is a big number, Andy, in that number.
Okay. Looking out, 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 gonna hesitate. 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 our fiscal year-end call, Andy. 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. We built 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. We still like the returns as we grow. We're going to keep growing.
We're going to build some of these little 15-20s in 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. They're not going to have, Steve, 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 & Play combos during the quarter. I'm just wondering what you thought the response rate was there. Was it good or in keeping with what you had hoped? As you think about kind of breaking through with consumers with a value message, maybe more specifics on how you do that. As a tangential question, and I understand this is a loaded question, for 2018, should we expect a step up in the tax rate to the 36%-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 a loaded question.
I can get the tax. Steve will do the tax thing first. Yeah. Tax rate, we're guiding 29.5%-30% for the full year. You should be thinking that that's 36.5%-37% directionally, excluding the impact of the simplification related to share-based payment.
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 on our guide. It's a good 600, 700 basis points. I really can't predict what next year is going to bring in terms of option exercises. It's out of my control and Steve's control. 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 gut is it goes down next year, meaning tax rate goes up, it really depends on as I said, option exercise next year. Yeah.
On the marketing question for what we did with Eat & Play Combo, we ran it as a test for a couple 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. We're kind of back to the drawing board as it relates to a value promotion that can significantly impact sales. You could also say that, 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. Again, didn't see a huge uptick in terms of what we saw on the F&B side, in particular, from a revenue and penetration standpoint. We will be coming at you with something different in 2018 as it relates to value messaging.
Is there anything, Steve, though, 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, 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. Thank you for taking my question. I 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 format.
The way we're thinking about it, when we said in the prepared remarks between 20 and 40 new stores of this size, those are new markets that we had deemed to be too small for our current small format. Those are completely new markets for us. 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, we might think about doing this way if you got a better return. 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. 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. 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 net-net kind of bogging down the midway. What's changed there from either a technology or a 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. One, we have figured out a multiplayer platform that we can do more than one person at the same time. Some of what we experimented with in the past was sort of a single player, either first-person shooter or driver, all the rest of that was essentially a single person at a time. We've been able to come up with a way to, and I won't give away too much here because 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. Those are two of the things that we think are significant. It will be attended, so there will be a small amount of labor associated with this.
I would think about it as more of an attraction-oriented piece, although 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, definitely want to keep some of the allure there for the release. Should we think of it as an upsell or something that you could still participate in through just the normal Power Card process?
We've done a little testing on this, and herein before, we've made it all an incremental spend, not on the Power Card.
Great. Thank you.
Sure.
Our next question will come from Brian Vaccaro with Raymond James.
Thank you and good evening. 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 third quarter. I guess I'm curious 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. What might be helping casual dining may be opposite for us, I think is what you may find.
Okay. All right. 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. Again, when you flip back to the compares, they have not much, but they have tougher compares. If you look at it in a two-year stack and a three-year stack, they're sort of in line at this point with 2017.
Lagging the overall a bit.
Okay. That's helpful.
We like to see mall traffic be better.
Yeah.
Just like we like to see casual dining to be stronger and not negative comps. Yeah, it's not necessarily helpful for malls to be struggling. We are a destination. People do come to visit us, just us, but there's at least one guy, as I like to say, that might have come to the mall and then sees us. We like to see traffic, and it's not helping.
Yes. All right. That's a helpful color on that. 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 third quarter, at least on our math. Curious if, 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 our math?
The latter. I think we've been trying to communicate that, first of all, we're guiding a large store format to do $11 million steady state lower than our current average, which is upper $11 million for the whole system. We're building smalls that we're targeting to do roughly $7 million steady state sales. 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 large, it's 40,000 and up. Seven of them are small, and we have eight of these sort of in-betweens that are going to do somewhere in between. I think that's the piece that's maybe being missed here. I would say, as you look at what we've opened to date, I'm talking about the 17 class.
Nine stores have been opened to date. While we've said most of the stores are going to be skewed large this year, only four of those nine are true larges. Most of the larges are coming here in the fourth quarter that we just opened. That mix is impacting their AUVs, and it's not a surprise to us. Again, we're focused on ROIs and return on investment, but we don't expect AUVs to stay for the whole brand to be constant at the current base comp store AUVs because of the mix.
Okay. That's really helpful color. The last one for me, if you look at your implied fourth quarter EBITDA guidance, it would seem to imply some pretty meaningful margin contraction. In this third quarter, you had negative comps, and you saw a little bit of positive expansion on the EBITDA margin line. I know we've got pre-opening, but can you walk through maybe some of the other puts and takes that are embedded in your implied fourth quarter EBITDA guidance outside of the pre-opening line? Thank you.
Yeah. If you go to the top end of our guide, you are going to see some margin compression relative to kind of, what, 40 basis points of favorable margins year to date. The big changes are, number 1, marketing. We've leveraged marketing year to date. We anticipate that that will be a de-leveraging item in our fourth quarter. That's a fairly significant number. Pre-opening cost, we guided that number up by about $2 million. Pre-opening is going to be an increased drag. It is year to date, but it's going to increase in Q4. Again, we view that as a good/bad. This is an investment and a strong pipeline of new stores, but there is an increase related to pre-opening costs. I would say the other significant item is probably 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. A lot of that on the heels of this simulation mix shift that we've seen, we are hesitant to be too aggressive on what we're projecting on the gross margin front. We are not being as strong on our gross margin projection in Q4. We do see more inflation on the food commodity side, too, in Q4. Those are kind of the big items that are causing the separation from what we see year to date versus the Q4 implied margin.
Okay. Thank you. In the 2018 guidance, Brian, just to follow up while you were talking about food costs in the fourth quarter, can you give an early read on food inflation guidance in 2018 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 guess I would say. What's that?
We're going to guide on our first fourth quarter.
Yeah. We'll guide some of the line item specifics next year when we get on our April call.
All right. Fair enough. Thank you.
Next, we'll take a question from Stephen Anderson from Maxim Group.
Yes, sir. Good afternoon. I have a question about the food and beverage side of the business. I don't know if you addressed this on the comments, but I wanted to ask about some of the local store marketing efforts, like some local promotions that may be 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. 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 Strelzik from BMO Capital Markets.
Hey, thanks for taking the question. I actually have two quick things. First, as you're looking at 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 bev 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 of those stores, maybe to enhance the amusement side or any other changes?
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, et cetera. 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. 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.
In 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 to volumes in other areas of the business. You might look at some stores and say, "Hey, that's another thing worth testing." Excuse me. We don't have any plans today to do that.
Okay, great. That's helpful. My other question, can you talk about maybe the characteristics of the markets that you're looking at for the smallest footprint stores? I guess I'm just wondering the thought process behind the 20-40 number that you put out. How did you come to that number? Thank you very much.
We're really thinking about smaller DMAs or SMAs, SMSAs that kind of range in size from call it the low 200s up to five or so. Average, I think, is somewhere in the four range, for the size of the adjustable market there. That was really a smaller market than we thought we could address with our current small format. That's why we collected those, and that's how we collected those. Why didn't we go smaller than that? We looked at a number of different factors to try to determine where we thought we could get that $4 million-$4.5 million of sales. We thought that at the 200 level of population, we could probably get that. Some of those have some tourist top spin and some of those sort of things.
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. 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 fourth quarter results with you in early April.
That does conclude our conference for today. Thank you for your participation.