Dave & Buster's (NASDAQ:PLAY) key competitive strength is its ability to bring many types of entertainment under one roof. The chain mixes features of an amusement park with those of a traditional restaurant and a sports bar.

Management says this "eat, drink, play and watch" experience sets Dave & Buster's apart in a crowded market since no other national competitor combines these entertainment elements in the same way.

Yet executives are revisiting their bigger-picture approach right now, in the wake of a surprisingly weak fourth quarter that pushed sales growth into negative territory for the first time since Dave & Buster's went public, in 2014.

A woman and a girl high-fiving at an arcade.

Image source: Getty Images.

Sales and profits

Overall revenue improved by 13% to reach $305 million this quarter. However, that gain was entirely due to the addition of 14 stores to its footprint, plus the benefit from an extra week of sales in fiscal 2017 compared to the previous fiscal year.

Sales at existing locations dove by 5.9%, which was even worse than the warning management issued in early January. Back then, executives said they were surprised by low customer traffic in what's normally a seasonally strong period for the chain. But those discouraging trends accelerated through late January, and so comparable-stores sales fell at a sharper rate than the 5% dip management had predicted. The decline sent comps down 0.9% for the full year, compared to a 3.3% increase in 2016.

Profitability took a hit, too, with operating margin falling by nearly 3 percentage points to 13.9% of sales. Excluding benefits from the recent tax law change, that translated into adjusted earnings of $83 million, or 27% of sales, compared to $75 million, or 28% of sales, a year ago.

Store additions

On the bright side, Dave & Buster's made progress toward its plan to roughly double its store footprint over the coming years. The company added five locations during the quarter, including its first in Puerto Rico. For the year, its base rose to 106 from 92 stores.

Management believes that this success is critical to its long-term goals. "Our primary growth vehicle and the biggest driver of value," CEO Steve King said in a press release, "continues to be opening stores that offer excellent returns in the face of a more competitive environment."

Dave & Buster's is targeting a similar growth rate in 2018, with 14 or 15 new locations, constituting what King called a strong pipeline. However, executives said they were disappointed with the customer traffic results and are "working diligently to rebuild momentum by evolving the brand."

A key part of that evolution will mean shifting to smaller-format locations that reduce dining space while keeping the core elements of the "eat, drink, play and watch" approach. The move should open up smaller metropolitan areas and get the company closer to its goal of eventually passing 220 locations. "We remain confident in our long-term prospects," King explained.

Outlook for 2018

The near term will test investors' patience, though. Dave & Buster's 2018 outlook predicts a second straight year of declining comps as adjusted earnings fall to between $255 million and $275 million from $303 million in 2017. A climbing store base should push revenue to over $1.2 billion from $1.14 billion, but shareholders aren't likely to celebrate that increase unless it also includes evidence of rebounding customer traffic at existing Dave & Buster's locations.

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