Missed due to international shipments and the black box that is systems. We'll have more commentary in an upcoming post. 



"Delays in certain decisions and the unfavorable timing of some go-lives related to our systems resulted in lower than normal quarterly systems revenues; however, we continue to see strong growth opportunities in systems. We are well positioned to capitalize on our innovation in new products and our investments in new jurisdictions in 2011."

- Richard M. Haddrill, the Company's Chief Executive Officer



  • "During  fiscal 2011 We have already purchased 826,000 shares of common stock for $27 million, $22 million of which was in our first quarter"
  • Sold 2,823 gaming devices at an ASP of $15,685
    • Units missed expectations "driven by fewer new openings and expansions during the period and a continued sluggish North America replacement cycle."
    • International shipments were 823 or 29% of total
    • ASP increased primarily due to mix
    • "Gross margin increased to 49 percent from 48 percent last year, primarily due to improved manufacturing efficiencies and improved material costs related to production of our ALPHA Elite(R) cabinets, including our popular V32 cabinet, and lower royalty expense."
  • Gaming operations was the sole bright spot in this earnings release with revenues of $79MM. Driven by better premium placements. Cash Spin had over 1,200 units installed.
  • Systems missed big due to timing of go-lives. Margins were good at 73% though due to a high mix of products sold and maintenance revenues which reached $15.9MM
  • FY2011 Business Update:
    • Lowered EPS guidance to $2.05 -$2.30 (took down high end by 10 cents)
    • Assumes no Illinois sales due to delays
    • "The Company continues to expect that its Diluted EPS from continuing operations in the second half of fiscal 2011 will exceed the first half."
    • This guidance considers a continued challenging North American replacement market, as well as the assumption that the Company will begin to see meaningful revenue from the Italy VLT market in the second half of fiscal 2011, although the timing in this market is subject to change due to potential delays resulting from regulatory and other unforeseen issues.
    • "Reiterated fiscal 2011 guidance for systems revenues of $220 million to $235 million, but updated the systems maintenance revenues component to $63 million to $65 million."


  • Expect that 2H earnings will be at least 60% of total EPS for FY2011
  • Game sales:
    • ASP's benefited from sales of certain custom games
    • 2,000 to NA: 1,763 were replacement sales
    • 230 units were shipped to Maryland but were on participation so they weren't included in the game sale units
  • Gaming operations:
    • Driven by the continued placement of premium gaming like Cash Spin and Digital Tower Series
    • Haven't released Cash Spin internationally yet
  • Systems:
    • Systems revenue will be back half weighted in 2011
    • Seeing increased interest in iView DM due to their new applications
    • Customers have been taking longer to make purchasing decisions
  • Leverage ratio continues to remain way under 1x
  • Expect increased ship share starting in calendar 2011
  • Games in Maryland are earnings 150% of floor average - New Alpha Pro-Series. With iDeck, think that their games will do even better.
  • Have received approval for iDeck and have recently started shipping Pro-Series cabinets with iDeck installed
  • Expect placing games in Italy in 1H calendar 2011
  • Also expect to start selling into New South Wales early in calendar 2011
  • Given the delays in IL, they are now not expecting to ship any games to that market in FY2011
  • Don't expect to see any meaningful pick up for replacement spending in calendar 2010 but are cautiously optimistic that spending will increase in calendar 2011
  • Systems is focused on the development of systems applications that will enhance customer revenues
    • USpin Bonus
    • Bally Command Center
  • Expect to see a real benefit to game sales as they launch Alpha 2 games on their new cabinet this month


  • What percentage of their systems guidance is in signed orders?
    • Had expected a weak systems quarter in Q1. Risk is that 2-5MM can slip from Q to Q.. which is what happened this quarter - one order got delayed.
    • Second quarter will be better than first but not as good as 3rd & 4th quarter
  • Patent suit by WMS?
    • They were surprised by this since the product was first released 2 years ago
    • Feel like there is no financial risk to them 
  • Unit sales / Maryland?
    • If MD units were for sale vs. participation, they would have earned 2 more cents
  • Can't quantify the IRS benefit yet - but it's not included in guidance
  • Cabinets are Pro Series - 20% of the cabinets shipped in the quarter.  There were no Alpha 2 titles ready, but the Alpha 2 processor is available
  • More cautious on Alabama, more optimistic on Acqueduct
  • Did they ship games to Cosmo?
    • Shipped just under 50% of their units; rest will ship this quarter
  • International sales?
    • No new openings in Asia
    • Mexico wasn't as active as it was in the past
  • Gross margins impact of Alpha 2 rollout going forward?
    • 20% of domestic were new pro-series cabinet - did have some impact
    • Doesn't see margins going more than 50-100bps below current levels
  • Acqueduct isn't included in their FY2011 scenario - can open as early as April and as late as June. Even if it opens in April, the revenue contribution won't be material since it's participation
  • Internet gaming, how does BYI think about it?
    • View it as an extension of their systems business
    • An opportunity for them to license content and enhance customer's marketing capabilities to customers online
  • Canadian RFP process?
    • Expect a decision on the systems RFP within the next 60-120 days
  • Why did rental and daily fee games decrease?
    • Some rental games came out but premium games increased
    • Some of the rental games were converted to purchase games (V32's)
  • The go-live that slipped will be in the December quarter- that was the difference in the expected earnings but still below where analysts were
  • The more recent positive vibes from customers are on games mostly but should carry over into systems... just a modest pickup though in mood
  • Gross margin decline for game operations - typically 70-74% range - just depends on jackpots related to WAP games

SKX: Laughter in Beaverton

We’ll see what they have to say on the conference call. But here’s an excerpt from our 10/12 report (Toning Footwear – A Year Later, What’s Next?) showing how the company’s expectations for Toning sales were simply too high. The primary reason? People buy in units, not in dollars. With every other brand coming out with Toners at price points less than half of where SKX is selling, only bad things can come.


There’s a lot of laughter in Beaverton right now.  


“In looking at Skechers’ share of the industry in 2010 and gradual deterioration thereof, we assume the brand will account for ~45% of the domestic market in 2011 compared to ~60% in 2010. With price deterioration, cost inflation, and margin degradation, we estimate that incremental  Shape-up margins will come in closer to 20% in 2011 from 25%-30% EBIT in 2010. The combination of share loss and compressed incremental margin is likely to reduce 2011 EBIT dollars by $40-$75mm. That’s on an base of what we estimate to be ~$170-$200mm of Shape-Ups related EBIT in 2010.  In order to simply keep EBIT dollars flat, we’d have to assume that either: 1) Skechers maintains 60% share of the category, or 2) the domestic toning industry would have to grow 50%-75% in 2011 to $1.7-$2.0Bn. For many reasons, this simply will not happen. This has yet to be reflected in consensus estimates assuming mid-to-high single digit EBIT and earning declines in 2011 – we’re shaking out down 30%.”


SKX: Laughter in Beaverton - SKX Toning EBIT 10 27 10


SKX: Laughter in Beaverton - SKX S 10 10



Isolated Curiosities

This note was originally published at 8am this morning, October 27, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Clouds are not spheres, mountains are not cones, coastlines are not circles, and bark is not smooth, nor does lightning travel in a straight line.”

-Benoît Mandelbrot


To say Benoît Mandelbrot lived a great life would be an understatement.  The recently deceased Sterling Professor of Mathematial Sciences at Yale University had the opportunity to follow and study his passion his entire life and, as a result, his contributions to the field of mathematics were vast.


Most interesting to our Hedgeyes was Mandelbrot’s work on fractals, which underscore many of our own market models.   In fact, Mandelbrot actually coined the term fractal in his consummate work, The Fracatal Geometry of Nature.  He also did what many academics actually have a hard time doing, he extended his academic studies into the more practical areas. According to our friends at Wikipedia:


“Although Mandelbrot coined the term fractal, some of the mathematical objects he presented in The Fractal Geometry of Nature had been described by other mathematicians. Before Mandelbrot, they had been regarded as isolated curiosities with unnatural and non-intuitive properties. Mandelbrot brought these objects together for the first time and turned them into essential tools for the long-stalled effort to extend the scope of science to non-smooth objects in the real world. He highlighted their common properties, such as self-similarity (linear, non-linear, or statistical), scale invariance, and a (usually) non-integer Hausdorff dimension.”


Mandelobrot passed away at the age of 84 years after more than 60 years of pursuing his passion.  He was one of the most celebrated mathematicians of the last 50 years and won innumerable awards for his work, including:  the Wolf Prize for Physics in 1993, the Lewis Fry Richardson Prize of the European Geophysical Society in 2000, the Japan Prize in 2003, and the Einstein Lectureship of the American Mathematical Society in 2006.  Most interestingly of his awards was perhaps that fact that he has an asteroid named after him:  27,500 Mandelbrot.


As it relates to financial markets, his primary contribution was determining that price changes in “financial markets did not follow a Gaussian distribution, but rather Lévy stable distributions having theoretically infinite variance.”  In addition to his study of financial markets, he also had an idiosyncratic character that was near and dear to our hearts. So much so in fact, that he actually gave himself his own middle initial, “B”, which actually did not stand for anything.


So in memory of Professor Mandelbrot and chaos theorists everywhere (especially our Harvard friend at a well known money management firm in Canada), we are going to focus on only 3 important global macro events this morning as it relates to managing risk, which are as follows:


1.  The Election – As many of our subscribers know elections are near and dear to our hearts and the upcoming midterm election is one we’ve been very focused on. (If you would like to trial our research and to see some of proprietary election analysis, please email  In fact, we are on record saying that we are more bullish for Republican chances than our friend Karl Rove.   For us, though, it is not about politics, but is simply math.  As the math stands now, and excluding races that are “too close to call”, the Republicans will win 233 seats in the house (a majority) and will win 45 seats in the Senate.  We believe that turnout could be the wildcard and slide many of the “too close to calls” to the Republicans as many poll internals show a highly motivated Republican base.  The primary implication of this is that the Republicans will likely implement immediate budget cuts, which, according to reports this morning, could be as much as $100BN as soon as January.  While in the short term a decline in government spending may hurt GDP, in the longer term deficit reductions will put the U.S. economy on a more stable path of growth.


2.  Greek Deficits – If you don’t think that government numbers can be wrong or revised lower, well now you know.  Greek deficits this morning were revised higher to 15% of GDP as, shockingly, tax revenues were worse than expected.  As we’ve been saying for months, sovereign debt issues in Europe will rear their ugly heads again and obviously Greece is at the forefront of that again this morning.  We’ve highlighted this point of Interconnected Global Risk in the Chart of the Day below, which highlights that credit default swaps in Europe are making higher lows. As these CDS spreads increase, we are likely to see equity markets act inversely to those spreads widening.


3.  U.S. Dollar – The U.S. dollar is appreciating this morning (not a sentence we have been used to typing over the last few months) on the back of Wall Street Journal reports that while Quantitative Guessing will likely be implemented on some level, it won’t be the “shock and awe” type that many proponents of Krugman Kryptonite were hoping would be implemented.  It seems Chairman Bernanke may actually be listening to some of his colleagues at the Fed like Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, who said Monday that more expansive monetary policy was a "bargain with the devil."  Indeed.  The most immediate term impact of a stronger dollar is likely a correction in those commodities that are priced in dollars.


Just like Mandelbrot, many of the fine folks at Hedgeye have left higher paying jobs to pursue their passion. This passion is the art and process of producing objective and real-time investment research, which we believe is Hedgeye’s core competency.  We aren’t always right and we aren’t always popular, but we passionately believe in what we do and we thank you for your support. 


Yours in risk management,


Daryl G. Jones

Managing Director


Isolated Curiosities - brots


Marriott Mgmt Commentary + Q&A



Kevin Kimball: Executive VP, Global Business Finance

  • Base Fees estimated to growth to $770MM under the 7% revpar case
    • $90-95MM coming from new units
    • $635MM -$710 coming from existing (560-563MM in 2010)
  • Franchise fees estimated to growth to $590MM (base case)
    • $80-85MM coming from new rooms
  • Incentive fees were $145MM in 2007 vs. $43MM in 2009
    • In 2007, House Margins were $52/room vs. only $30/room in 2009 on RevPOR of $206 and $168, respectively
    • Under the base case (7%): RevPOR  = $207 with Net House profit margins increasing to $51MM; in which case, total incentive fees would increase to $110MM
    • When owners invest more money in the hotel (renovations/ etc) hurdle is increased
    • Newly owned hotels take 2-3% to earn and owners priority
  • In 2010, only 5% of their NA limited service hotels are expected to pay owner’s priority
    • Because they are in large portfolios where results are pooled before paying an owner’s priority
    • More supply coming online
    • Required capex investments by owners
    • Expect that in base case scenario 21% of their limited service hotels will pay fees
  • International incentive fees:      
    • 57% paying in 2010 (58% in 09, 61% in 2007)
    • Expect by 2013 – 64% will pay under base case
  • So worldwide incentive fees:
    • 25% paying in 2010 (flat to 2009)
    • 43% expected to pay by 2013 (base)
  • NA incentive fees:
    • $65MM in 2010
    • By 2013, those same hotel earnings in 2010 are expected to generate $90-150MM in fees and additional hotels that aren’t currently paying are expected to contribute $15-65MM of fees
  • Total International  incentive fees of $110MM in 2010 are expected to grow to $180-225MM by 2013
    • 135-160MM from hotels currently paying fees
    • $5-15MM from hotel not yet paying fees but open
    • $40-50MM from hotels opening from 2010-2013
  • Total worldwide incentive fees of $173-177MM in 2010 are expected to grow to $285-440MM by 2013
    • $225-310MM from hotels currently paying fees
    • $20-80MM from hotel not yet paying fees but open
    • $40-50MM from hotels opening from 2010-2013
  • 2013E split of incentive fees base $345MM:
    • NA FS: 36%
    • NA LS: 7%
    • International: 57%
  • In North America in 2010:
    • 10% are recording incentive fees
    • Of the hotels that aren’t
      • 5% need < 10% increase in House Profit margins
      • 3% need < 20% increase HPM
      • 10% need < 30% increase in HPM
      • 70% need > 30% increase in HPM to earn fees
  • In North America by 2013 (base case):
    • 29% are recording Incentive fees
    • Of the hotels that aren’t
      • 15% need < 10% increase in House Profit margins
      • 9% need < 20% increase HPM
      • 7% need < 30% increase in HPM
      • 38% need > 30% increase in HPM to earn fees
  • Owned, leased, corporate housing revenues and other expected to increase at a 1-6% CAGR from $1,025 in 2010E to $1070-$1205MM in 2013
    • Net of expense growth expected to go from $90MM to $145-$230MM
  • Owned and Lease only (almost all leased):
    • $820MM in 2010 of revenues and loss of $15MM in 2010 (over $750MM from leased which lost $20MM)
    • Expected to grow revenues to $840-$975MM by 2013 and net of expenses: $15-$100MM
  • Branding fees, corporate housing and other:
    • $205MM of revenues ($75MM or so of branding fees) in 2010 and $105MM net of expenses
    • By 2013 expect $230MM of revenues and $130MM of net of expenses around $85-90MM from branding fees
  • G&A: 16-18% of revenues or $765MM in 2013

Carolyn Handlon: EVP & Global treasurer

  • Adjusted EBITDA of $1.54-$1.94BN by 2013
  • Total debt of $4.5BN by 2013 under base case (~700MM of timeshare related)
  • Think that they can do a bank deal around 4%
  • Other balance sheet highlights 2013:
    • Contract acquisition costs: $990MM
    • Equity & Cost investments: $285MM
    • Notes receivable: $1,775
    • Sr Mezz/other non securitized: $760MM
    • Loans to timeshare owners: $150MM
    • Loans timeshare owners securitized: $865MM
  • FCF from 2011-2013 of $1.6-$2.1BN:
    • $3.6-4.1BN of cash from ops
    • $300-700MM from capital recycling
    • Investment spending: 2.3-2.7BN

Carl Berquist: CFO

  • Use of FCF:
    • Management and franchise contract growth
    • Select real estate development/property acquisitions
    • Strategic opportunities in key markets
    • Other ROI enhancing investments
    • Maintain IG rating
    • Return cash to shareholders
  • Investment spending – how they will spend $2.3-2.7BN?
    • New units: 73%
      • Mezz, key money, sliver equity
    • Refreshing/repositioning hotels: 5%
      • Loan programs for franchisees to help owners renovate properties
    • Systems/ Corporate: 11%
      • Technology investments
      • Backoffice investments
    • Existing units: 11%
      • Room expansions
      • Repositioning owned and leased hotels
      • Purchasing 2-3 hotels/year
  • How will they invest?
    • 55% will be in capex
    • 25% note advancements
    • 17% contract acquisition costs
    • 3% in equity and cost method investments
  • How did they invest in 2006-2008?
    • 60% was in capex
    • 6% note advancements
    • 11% contract acquisition costs
    • 2% in equity and cost method investments
    • 21% in timeshare
  • They expect timeshare to be cash flow generative – no net investment: from $625-675MM of FCF
  • Cash flow:
    • FCF of 1.6-2.1BN
    • They will issue common stock & other (stock comp) : $500-900MM
    • Net debt issuance: $1.2-2.3BN
    • Gives them: $3.3-5.3BN for stock buybacks
    • Which means that they can reduce their share count from 378 to 349-320 by 2013
  • Expect to generate a return on invested capital of 21-28% and EPS growth CAGR of 20-36%
    • and think that there is upside from even better REVPAR or the incremental tentative 22,000 rooms that they can potentially add to their system


  • Assume that at the midpoint of the share buyback accounts for $0.05 of the buyback
  • Assume 2.5-3% GDP growth for their 7% RevPAR forecast (+/- 2% for low end and high end of their forecast for GDP)
  • $500-900MM is their stock compensation plan
  • Timeshare is not going to consume any capital above the cash that they generate from sales
  • The share counts post buyback were weighted for 2013
  • Don’t know why they add back the cost of their timeshare financing to calculate their cash flow

Austerity’s Bite in Spain

We’ve written a lot of research over recent weeks and months regarding the impact of austerity measures across Europe. Turning to Spain, we continue to identify three main fundamental drivers that should drag down growth prospects over the intermediate to longer term: 1.) one of the highest rates of unemployment across Europe-27, 2.) continued real-estate depreciation and supply overhang, and 3.) eroding consumer confidence and spending alongside austerity’s consumer squeeze. 


As a reminder, Spain’s €15 billion austerity package includes:

  • 5% average pay cut for all civil servants and a 15% cut on ministers’ salaries
  • €6 billion reduction in public works projects

Spain’s PM Jose Zapatero gained some credibility at home in sacking two wasteful ministries for housing and equality earlier this month, yet the government is still running against the lofty goal of cutting the deficit from 11.2% in 2009 to 6% in 2011, and to 3% by the end of 2013.


Notwithstanding this lofty deficit reduction plan, austerity’s squeeze on wages and jobs should further erode consumer confidence and spending, which is already depressed given the country’s 20.5% unemployment rate and uncertain growth direction following the bust in the country’s real-estate bubble.   


While we applaud countries that are working to reform years of fiscal imbalances for longer term health, we expect Spanish growth to feel “pain” from Austerity’s Bite.   


Matthew Hedrick



Austerity’s Bite in Spain - sp1


Austerity’s Bite in Spain - sp2


Conclusion: Margins improved during the quarter, but sales continue to lag the industry.  We will have to wait and see what happens at Chili’s, but management appears to be doing all of the right things and given its upcoming initiatives and quarterly sales comparisons, there is visibility of a turnaround in top-line come fiscal 3Q11.


My original thesis around wanting to own this name has not changed; the company is working to fix its business model, which will result in significant margin expansion.  What has changed is the timing around when sales growth will start to materialize, and following the company’s fiscal 4Q10 earnings, I said we were possibly 9 months away from seeing a real turn in the fundamentals.  I think that timing continues to hold true as comps should begin to improve come fiscal 3Q11 when the company is no longer lapping last year’s “3 Courses for $20” promotion.



Margin growth already started to materialize during the first quarter with restaurant-level margins improving nearly 190 bps and EBIT margins up about 240 bps.  Improved cost of sales was the primary driver of margin growth in the quarter, down about 200 bps YOY as a percentage of sales.  Management attributed the decline in cost of sales to its more profitable value offerings (2 for $20 this year versus 3 for $20 last year), menu pricing and lower YOY commodity costs, which drove 70 bps of the 200 bp decline. 


The company guided to a similar level of COGS as a percentage of sales for the balance of the year, which would imply a nearly 200 bp full-year decline.  During the second quarter, this YOY benefit should continue to be driven by favorable commodity costs, which are 90% contracted.  Going forward, the company expects food costs to put increased pressure on margins as a result of higher beef costs (only 52% contracted on food costs in 2H11).  These increased food costs, however, should be offset by improvements in the company’s inventory control and actual versus theoretical costs as the company expects to fully implement its POS and back-of-the-house technology in 3Q11.

First quarter margins were also supported by the company’s team service initiative, which was already in place during the quarter.  Labor costs were relatively flat YOY as a percentage of sales as result of sales deleverage and increased manager bonuses, which offset the labor costs savings associated with team service.  Management expects the P&L to continue to benefit from team service savings, in addition to sales leverage in the back half of the year; though the company will continue to invest in manager bonuses if sales trends continue to improve YOY.


The company has already completed five kitchen retrofits domestically and two internationally, which have resulted in increased speed and consistency of food with better labor utilization.  For reference, the completed kitchen retrofits are expected to drive 300 bps of the 500 bp margin increase.  The test results have been so successful that the company has decided to accelerate the rollout of its changes to the prep process.  These changes are expected to optimize the labor component of prep and maximize food prep yield, which will benefit both the labor and COGS expense lines once fully implemented in January (beginning of fiscal 3Q11). 


The company expects to begin the rollout of its reimage program during the fourth quarter as long as test results prove favorable.  The priority of the reimages will be to further drive sales and will follow the implementation of team service, POS and the total kitchen transformation.



Brinker is fixing its business model and transforming its cost structure at Chili’s while working to improve its guest experience and yet, the stock is trading down over 7.0% today.  The company needs to see a turn in sales performance at Chili’s before investors will be convinced that the stated initiatives are working.  Margins are improving already, but in this environment, investors need to see solid top-line trends and unlike most of its casual dining peers that have reported before it, Brinker reported a comp miss relative to street expectations.  And, trends at Chili’s continue to lag the casual dining industry.


Same-store sales at Chili’s declined 5.0% relative to the street’s -4.1% estimate.  That being said, trends improved nearly 130 bps on a two-year average basis from the prior quarter and got better sequentially throughout the quarter.  Adjusting for the one week calendar shift that resulted from the fact that fiscal 2010 was a 53-week year relative to 52 weeks in fiscal 2011, blended comparable sales were -5.8% in July, -5.2% in August and -0.8% in September.  This compares to -8.8% in July of last year, -3.1% in August 2009 and -5.4% in September 2009, which implies a 420 bp acceleration in two-year average trends from July to September.  It is important to remember that the company first introduced its “3 Courses for $20” at Chili's in mid-July of last year after starting out the month with a double-digit decline in comps, continued the promotion into August and then was off of it in September.  To that end, the company saw its best comp growth during September when it was no longer lapping “3C”. 


Chili’s ran its “3C” promotion for six weeks in fiscal 1Q10 and about 10 weeks in fiscal 2Q10 (I included the chart of Chili’s comp performance from 4Q09 through 1Q11 as a reference of the concept’s comparisons for the remainder of the year).   With Chili’s continuing to lap last year’s strong promotional calendar during fiscal 2Q11, trends should remain sluggish, but like we saw in September, trends should see an uptick come 3Q11 when the company is lapping more comparable promotional offerings.  Trends should also improve as guest service continues to improve once the increased speed and consistency initiatives (resulting from the improved prep process) are fully implemented in January.




Howard Penney

Managing Director

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