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3 Ways Dave & Buster’s Disappointed Investors This Week

Demitrios Kalogeropoulos, The Motley Fool

Dave & Buster's (NASDAQ: PLAY) stock sank in the wake of its first-quarter earnings report on Wednesday. The restaurant and entertainment specialist's headline numbers were fine, with sales rising 10% and earnings per share improving by 9%. However, looking deeper into the results reveals some major challenges to its turnaround plan.

Let's dive right in and get a better look at three ways this latest earnings report fell short.

A father and son playing arcade games.

Image source: Getty Images.

1. Losing share through negative comps

Investors weren't expecting much in the way of sales growth at existing locations. Comparable-store sales were projected to slow down from the prior quarter's 3% jump, which had marked the chain's best result in two years. Still, it was a surprise to see comps fall back into negative territory, even if the drop was minor.

Executives said the decline had something to do with a calendar shift that changed the timing of the Easter holiday. Yet the negative comps also show some weakness in its growth initiatives, especially on the food side of the business. Sales in that department fell 3.3% on top of a large decline in the prior year. Thus, the hints of market share gains the company showed three months ago proved only temporary as Dave & Buster's gave up ground to industry rivals.

2. Labor and operating costs rising

CEO Brian Jenkins and his team had given investors some good reasons to believe that profitability might improve, or at least stabilize, in 2019. The company posted strong enough demand for its exclusive virtual reality (VR) titles last quarter, for example, that it raised prices on the games. Food menu changes seemed primed to help that division become more efficient, too.

Unfortunately, the latest results show that it might be some time before investors see rising profit margins. Food costs this quarter expanded to more than 26% of sales, and the chain paid more for labor and other operating expenses. Overall, operating income fell to $58 million, or 16% of sales, from $59 million, or 18% of sales. Reduced tax expenses helped cushion the blow, but Dave & Buster's still posted a 1-percentage-point drop in net profit margin, down to 11.7% of sales.

3. Lowering the bar for 2019

Heading into the report, investors were looking at a wide range of potential outcomes for 2019. Comps might land anywhere from flat to up 1.5%, executives said in March, which would reverse the prior year's 1.6% drop. Earnings were projected to end up flat or to rise by as much as 10%.

Management this week added clarity around those targets -- but not in a positive way. Dave & Buster's now sees comps ranging from down 1.5% to up by less than 1%. The low end of that range would mark the chain's third straight year of falling comps.

More jarringly, earnings are on track to land between $103 million and $113 million, compared to $117 million last year and $121 million in 2017.

A change in narrative needed

Dave & Buster's is still opening stores at a record pace, and management still sees room to roughly double the restaurant count to around 250 locations. Yet with market share slipping and with operating income set to decline for a third consecutive year, it's clear that the chain isn't in rebound mode today.

The good news is that just a slight improvement in its operating trends would be enough to change that narrative. However, there were no signs of that impending turnaround in the chain's first-quarter report.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Dave & Buster's Entertainment. The Motley Fool has a disclosure policy.