For almost two years, the restaurant industry has been facing significant headwinds. Declining traffic and rising food prices that management teams are reluctant to pass on to their clientele have made it difficult for investors in the field.

For a long time, Dave & Buster's (NASDAQ:PLAY) was able to buck the trend, showing comparable-store sales (comps) growth in the face of declines among its peers. In this week's second-quarter earnings release, we see that the company has indeed continued to grow its comps. But that growth is slowing, and is expected to continue slowing for the rest of the year.

People eating at Dave & Buster's

Image source: Dave & Buster's

Dave & Buster's: The raw numbers

Before we dive into the details of the most recent quarter, here's how the company performed on the headline numbers.

Metric

Q2 2016

Q2 2017

Year-Over-Year Growth

Revenue

$244 million

$281 million

15%

EPS

$0.50

$0.71

42%

Free cash flow*

$37 million

$58 million

57%

Data source: SEC filings. *Free cash flow presented on trailing-26-week basis.

Obviously, there's some serious leverage the company is enjoying, as earnings growth almost tripled revenue growth.

On this front, there were two main levers: gross margins for the company's amusement category -- all those games you play before and after your food arrives -- expanded 97 basis points, to an astounding 88.9%. The second lever was the fact that the company's income tax rate was cut in half thanks to an accounting change.

The former lends itself to long-term strength that investors should get excited about. The latter, however, is a one-off benefit that doesn't indicate enduring leverage. Indeed, if this year's tax rate had been the same as it was last year, earnings would have come in at just $0.59 per share, showing more modest growth of 18%.

The outlook is what's spooking investors

That sober analysis is the backdrop for the other announcement that management made: Comps estimates were revised down for the rest of the year, to a midpoint of 1.5%. Previously, management saw comps coming in at a midpoint of 2.5%. To put the trends in perspective, here's the company's recent comps history.


Chart source: Infogram.

Speaking as to why things will continue to slow down, CEO Steve King offered three reasons:

One, a casual dining environment that seems to have been progressively worse over the course of the summer... 

[Two], the competitive openings ... [were] modestly higher than we expected.

And then, I think the unknown here is ... the impact related to Hurricane Harvey which we were shut down for a full week, and we're back open but not at full strength.. 

Those are all factors to keep an eye on moving forward, with competition perhaps being the most dangerous. While the weakness in the industry is not new, and there's little management can do to mitigate the weather, the encroachment of competition will test the moat around Dave & Buster's -- providing high-margin entertainment for the whole family, while eating. This it has had all to itself. Investors seemed disappointed with the report, with shares down 9.7% at 11:30 a.m. on Wednesday.

What else happened?

Dave & Buster's is headquartered in Dallas and has roughly 100 locations in North America.

  • During the just-reported quarter, the company opened four new stores.
  • For the full year, management upped its guidance for new store openings from 12 to 14. By year's end, there are expected to be 106 stores. The company's long-term goal is 211 stores in the United States and Canada.
  • During the just-reported quarter, 1 million shares were repurchased for $67.2 million. Overall, diluted share count was down 1% from the same time last year.

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