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“WMS’ fiscal third quarter results reflect lower-than-expected global new unit demand, unit shipments expected to be fulfilled in the March quarter not shipping until early April, and delays in the commercialization of certain new products. We’ve already begun to implement the appropriate solutions to address the root causes for the fulfillment issues and we are revising our processes for regulatory submissions to try to shorten the time frames from-concept-to-launch for our advanced technology-based new products."

- Brian R. Gamache, Chairman and Chief Executive Officer




  • “Despite the continued impact of customers’ constrained capital budgets, our strategic direction remains laser focused. We made progress on several fronts in the third quarter including further increases in sales of new units into international markets, a year-over-year increase in average selling prices and progress towards lowering the cost structure and improving the profit margin for our popular Bluebird xD™ units. We also successfully introduced several new games for our participation business that are improving the average revenue per day performance of our installed base."
  • Product sales:
    • New  units sold: 6,058
      • New units to NA: 3,720 (replacements: 3,000)
      • International: 2,338
      • "Growth in Mexico and Australia, and modest growth in Asia and Latin America more than offset lower shipments to Europe. Mechanical reel products were 21% of global new unit shipments in the March 2011 quarter"
    • ASP: $16,492
      • ASPs "rose 3%... , primarily reflecting a product sales mix that benefited from Bluebird2 and Bluebird xD premium-featured units representing 92% of total global new unit sales in the March 2011 quarter, compared to 89% in the March 2010 quarter and 96% in the December 2010 quarter. The average selling price was essentially flat on a quarterly sequential basis, representing a slightly more favorable mix of premium products offset by a greater portion of international shipments of original, lower-priced Bluebird cabinets in the March 2011 quarter."
    • Used machine sales: 2,500 (vs. 2,200 in March 2010)
    • Hardware & conversion kit sales: 2,200 (vs. 3,000 in March 2010)
      • "Other product sales revenues rose ... 12%... driven by higher revenues from low-margin used gaming machines sales, while revenues from higher-margin hardware and game conversion kit sales declined modestly year over year."
    • GM: 48.6%
      • "Reflecting the impact from the introduction this year of the Bluebird xD cabinet, more low-margin used gaming machine revenues and a declining margin achieved on the sale of such units, lower new unit sales revenue, added costs associated with customer changes to existing orders and new orders received late in the quarter, and lower revenues from high-margin conversion kit sales."
      • "Additional cost structure reductions and supply chain improvements are expected to drive higher Bluebird xD and overall product sales gross margins in the June 2011 quarter."
  • Game ops:
    • Install Base (End of period): 10,002 (average: 10,021)
      • Coin in: 3,829
      • % net win:  3,107
      • Daily lease: 3,066
      • "Installed base ... reflects a greater-than-anticipated number of conversions of existing games to newly launched participation games, which reduced the opportunity to grow the installed base. In the March 2011 quarter, WMS launched the new video THE PRICE IS RIGHT- The Ultimate Show, YAHTZEE and Attack from Mars/Revenge from Mars games, and continued the rollout of THE GODFATHER and THE WIZARD OF OZ™- THE GREAT AND POWERFUL OZ games that launched in the December 2010 quarter."
    • Average win per day: $76.14
      • Sequential 2% increase "reflecting the successful introduction of new participation games and historical seasonal influences"
    • "Other gaming operations revenues increased modestly, reflecting revenues from the start-up of the Company’s UK-based online gaming site, partially offset by a decline in royalty income as a result of WMS’ direct entry into markets previously addressed through content licenses to third parties"
    • GM: 60.7%


  • Fulfillment issues: The $8MM delay in fulfillment was due to orders received in the quarter after the cut off date as well as changes to orders late in the quarter. 
  • Believe that customers do not have the increased confidence to increase their budgets to spend on slots
  • Growth in used machine sales continues to depress their margins. 50% of these sales were WMS games. Sales of used gaming machines reduced their margins by 180 bps in the quarter.
  • Deployed 700 new units to their install base, however, most of these games replaced their existing install base games rather than grow the base, but did contribute growth in daily win per day.
  • Invested $30MM in stock repurchases
  • Collection rates remain high and default rates were 1/2 of 1%. Only 2.3% of total receivables were aged more than 90 days - more favorable than their competitors
  • Will provide more color on their F2012 on their next call
  • Portal apps were delayed from original guidance of October to April
  • Adoption of enhanced technologies can experience an extended adoption period - and so they expect the same for portal applications. Plan to maintain pricing flexibility with their earlier adopters.
  • During the last 90 days they have launched multiple games in their G+ Deluxe series - which are amongst their best performing games
  • 400,000 unique log ins have been created to date in Players Life
    • vs 250,000 on their last call 
  • Will continue to opportunistically repurchase WMS shares
  • Began marketing efforts for their UK online site


  • Sense of NA ship share?
    • 26-28% range in the quarter but wallet share was more like 30% given their higher ASP. Expect to get back to 30% ship share with their new product launches. Assume high 20s-30ish% ship share in their FY2012 guidance
      • Based on IGT's and Konami's NA units, we estimate that WMS's ship share was closer to 20%- however this is a preliminary #
  • Haven't bought any more stock since April since they have been in a quiet period
  • Pricing didn't enter into their issues in F3Q
  • Their 2012 guidance includes no new markets aside from some Italy units
  • Not giving up on their 30% operating margin goal - they just need more volume
  • Have 107k BB1's out in the field today
  • xD was just over 20% this quarter and it is still at a bit of a lower margin than the BB2 product although they closed the gap a lot. Expect to reach parity in FQ1.
  • Italy - made their initial submissions and hoping for field trial in June, which once completed will allow them to begin sales
  • R&D- they are just below the 15% mark of revenues. They are trying to manage expenses with their revenues.
  • D&A looked a little higher because they have been investing more in their install base to BB2 from BB1. So D&A will continue to be at that higher level going forward.
  • Felt that they were punished for keeping their game ops games out there too long which is why many of the new games are just replacing old games in their base. Expect a nice uptick in win per day over the next two quarters as well as some uptick in their install base.
  • Have an industry leading delivery time of just 2 weeks - which is part of the reason that they had some issues this quarter - which lead to them taking orders too late in the quarter
  • Expect growth to come from game operations, higher ship share penetration - especially internationally, and new business like portal applications and UK casino
  • Is the deployment of the Italy units contingent on a successful trial? - Yes
  • 700 new NA units include shipments to a Ocean Downs, Grand Falls, and a variety of expansions in Canada and the US
  • 25% of their game operations install base is BB2 or xD and plan to change out the rest over the next few years
  • Did not recognize Galaxy Macau in the quarter
  • Had an obsolescence plan for BB1's out there for the next few quarter. Other than that no new marketing initiatives.
  • Great and Power Oz - is doing very well for them - #s close to the original peaks they reached
  • Doesn't believe that their pricing had anything to do with what happened in the quarter

Skinning Growth’s Cat

"There's more than one way to skin a cat.”

-Mark Twain, A Connecticut Yankee, 1889


Conclusion: Though earnings season is off to a fairly healthy start, we urge substantial caution to anyone buying equities right now in hopes economic growth will rebound enough to reach the $96.92 target consensus has forecasted for 2011 S&P 500 EPS. Aided by an ailing consumer, our call for slowing US GDP growth looks firmer by the day.


Current Virtual Portfolio Positions: Growth Slows (Short: SPY, XLI, NKE, and SAM; Long: FLAT) as Inflation Accelerates (Short: ELD; Long: FXC, FXB, SU, PBR, Gold, Crude Oil, and the Chinese Yuan).


At the beginning of the year, the delta between Hedgeye estimates for the slope of domestic growth and inflation and consensus’ overly bullish forecasts for GDP and CPI were as wide as they’ve been since early 2008. Nearly four months into the year, that spread has narrowed quite substantially as the sell side has begun to capitulate on both fronts in the last several weeks.


While normally we’d look to fade sell side capitulation (i.e. get longer of risk assets), careful analysis of their collective behavior reveals that they haven’t really “capitulated” at all. In fact, the Bloomberg Consensus Real GDP Forecast has increased on a YTD basis for each of the four quarters of 2011. That’s remarkable, considering the peak-to-trough decline of the 1Q11E estimate of (-90bps)! Interestingly enough, the 4Q11E estimate has been ratcheted up alongside the 1Q11E estimate’s last leg down. Sell side forecasts for all-time high S&P 500 earnings have to be achieved somehow…


Skinning Growth’s Cat - 1


As Daryl Jones penned in a note yesterday titled: “Consensus Meets The Hedgeye: Q1 GDP Estimates In Freefall”, our conviction in the simple theme we introdued six months ago remains unshaken. That message remains: Growth Slows as Inflation Accelerates.


At the start of the year, the biggest risk to our bearish bias for US GDP growth was, in fact, improvement in employment statistics – which was to be expected, given the confluence of their traditionally lagging nature and 4Q10’s robust growth figures. As such, we’ve seen the Unemployment Rate tick down in recent months alongside recent strength in Nonfarm and Private Payrolls growth. The go-forward outlook is certainly less bullish, however, with Rolling Initial Jobless Claims now trending sideways for the eighth week in a row.


Skinning Growth’s Cat - 2


It doesn’t come as a conceptual surprise to us that employers aren’t opening up their coffers and taking on additional labor expenses as The Bernank’s Inflation continues to make higher highs in the form of some of the most expedited rallies we’ve seen across commodity markets in many years. Simply put, as input prices increase, producers are forced into pulling various operating levers to protect profit margins – an effect compounded by the certain companies’ public status (gotta meet the street’s earnings estimates somehow…).


The net result of their collective choices has been to slow hiring plans and limit wage growth; the latter is doubly affected by the former as a slack labor market limits the bargaining power of current employees for wage increases. Average Hourly Earnings growth has slowed to a +1.7% YoY growth rate in the last two months from +1.9% YoY in January.


On the hiring side, we’ve seen a similar slowdown. NFIB’s Small Business Plans To Hire Index slowed to 2 in March from 5 in February; on a 3-month moving average basis, the index slowed to 3.3 vs. 4.7 in the prior month. The ISM data points to a similar slowdown in hiring plans. Using a weighted average of the Employment subcomponents within the Manufacturing (30%) and Non-Manufacturing (70%) Reports on Business Surveys, we’ve created an index that accurately tracks Private Payrolls growth on a concurrent basis. It’s interesting to note that this index just backed off its all-time high of 58.3 in February ’11 to 56.5 in March. While, in theory, the index could continue to make higher all-time highs from here, we know that ISM readings above 60 are typically not sustained – especially when they are 1.6 standard deviations above the long run average. Thus, reversion to the mean seems likely for this series, just as slowing jobs and wage growth seems likely for the US economy.


Skinning Growth’s Cat - 3


Skinning Growth’s Cat - 4


So why is US economic growth slowing? Well, aside from Housing Headwinds, a potential currency crisis, burgeoning sovereign debt, and depressed consumer confidence stemming from natural hazards and geopolitical risk (alongside the centrally-planned fear mongering associated with crisis ZIRP), the most tangible thing we can all agree on is accelerating inflation. Whether you agree with our thesis that the uptick in inflation that continues to be reported on a global basis is a function of Burning the Buck is beside the point. Both market prices and government statistics are pointing to higher prices for global consumers.


Skinning Growth’s Cat - 5


Skinning Growth’s Cat - 6


What does that mean to consensus’ “resilient” US consumer? It means that the consumer will increasingly fill the pinch of higher prices and depressed wage growth. While members of the Keynesian Kingdom will continue to tell you that there’s no inflation if wages aren’t appreciating, we market practitioners realize the glaring lack of common sense associated with this academic fallacy. As such, we’ve taken the liberty to create alternative measures of inflation for a more useful gauge of consumer prices.


Along these lines, we’ve introduced our original Hedgeye Inflation Index last year, which simply attempts to measure the spread between what consumers buy and they earn. Since we’ve introduced the project back in early 2010, we’ve made a few additions to make it more robust, given the natural limitations associated with using the CRB Index as a proxy for consumer prices. As such, we are now equipped with the following measures of inflation:


Hedgeye Inflation Index (Original): YoY % change in CRB Index less the YoY % change in Average Hourly Earnings. We use the CRB Index as a proxy for prices here because its daily price quotation allows for a real-time, up-to-the-minute gauge of inflation.


Skinning Growth’s Cat - 7


Hedgeye Inflation CPI Index: YoY % change in Headline CPI less the YoY % change in Average Hourly Earnings. We use Headline CPI here because of its encompassing nature, particularly relative to the market prices of commodities. While the series has been repeatedly adjusted throughout history to limit COLA expenses for the federal government, we cannot deny its appeal as a broad-based, official statistic.


Skinning Growth’s Cat - 8


Hedgeye Inflation Chinese Import Prices Index: YoY % change in Chinese Import Prices less the YoY % change in Average Hourly Earnings. While the series may appear out-of-place to the naked eye, careful analysis of the products the US imports from China lend credence to this selection (ranked in order of largest to smallest): electrical machinery and equipment; power generation equipment; apparel; toys, games, and sports equipment; furniture; footwear; plastics; iron and steel; leather and travel goods; and optics and medical equipment.


Skinning Growth’s Cat - 9


Hedgeye Inflation Expectations Index: University of Michigan 1Y ahead Inflation Expectations Index less the YoY % change in Average Hourly Earnings. This derivative is designed specifically to capture the consumer’s own expectations of the spread between his income and expenses. It’s worth pointing out that the +2.9% spread (or +290bps) is the highest ever reading in this data series (starting in March ’07). The consumer knows he’s getting squeezed on the P&L.


Skinning Growth’s Cat - 10


No matter how you skin this cat, the net result is that inflation is up and to the right.


What does this all mean for consumption growth (~70% of the US economy)? Net-net, it means that the consumer has less discretionary income to spend after nondiscretionary purchases are made. As such, we’ve seen a measured slowdown in discretionary spending over the last few months as The Bernank’s Inflation started to show up measurably at the pump. We’ve taken the liberty to create an index to track consumer discretionary spending trends. Interestingly enough, growth in the Hedgeye Consumer Discretionary Spending Index has inflected in a fairly meaningful way, slowing to +1.3% YoY in February vs. its cyclical peak of +5.2% YoY in December ’10. As we receive more up-to-date data points in the coming weeks, it’s important to keep in mind that growth decelerating to below +1% YoY has proceeded the last two recessions.


Skinning Growth’s Cat - 11


All told, we maintain our bearish outlook for the slope of US growth over the intermediate-term TREND, largely due to the Consumption Cannonball, which looks to gain steam in the coming months. We underestimated the consumer’s resiliency in 4Q10 when we introduced this thesis. We don’t anticipate we’ll be making the same mistake of being too early this time around.


Darius Dale


What Happens in Egypt, Does not Stay in Egypt


Conclusion: Watching the Egyptian elections in August will be an early leading indicator on whether or not the Middle Eastern regimes can peacefully transition.


Position: Long oil via the eft OIL


Since the onset of civil unrest in the Middle East, beginning with the Jasmine Revolution in Tunisia, our consistent view has been that the Jasmine Revolution will spread throughout the region.  Over the course of the last three months, this has played out in spades.  In the longer term, the geopolitical outcome of the mass civil unrest in the Middle East remains largely unknown.


Look no further than Egypt for a prime example of this uncertainty. While the people of Egypt, broadly speaking, were elated when long term President Hosni Mubarak stepped down on February 11th, the future of Egypt continues to remain cloudy. Egypt remains incredibly relevant due to its place as an important American ally in the region and its role in global commerce as the home of the Suez Canal. 


In many ways, Egypt will be a real litmus test for the Middle East.  With 85 million people, it is the largest country in the region and geographically it is very central.   Furthermore, Egypt does not have any major tribal or sectarian issues, like many sovereign states in the Middle East, so it should have the best chance at a peaceful and democratic transition.  Not dissimilar to Egypt’s role in the late 1970s when it was the first Arab nation to officially recognize Israel via the 1979 Egypt-Israel Peace Treaty, Egypt’s leadership may usher in a new era in the Middle East.


Currently, Egypt is being led by the Egyptian military, who assumed control after President Mubarak stepped down from office.  In theory, this is a positive for the West as the United States is a major funding source for the Egyptian military to the tune of $1BN+ per year by some estimates.  That said, following the August elections in Egypt, the Egyptian military will no longer be in control.


The key perceived risk with the August election is that the Muslim Brotherhood will gain control of Egypt.  While the most recent public comments from The Muslim Brotherhood (on their website ikhwanweb.com) were related to Syria, they clearly emphasized the group’s position towards Israel and the United States.  The key excerpt from the release is as follows:


“The Brotherhood treasures Syria's good position as a pillar of resistance, embracing Palestinian rights for liberating the land, supporting the armed resistance, embracing the stances of Palestinian faction leaders, and Palestinian and Lebanese legitimate rights while being against the Zionist-American Greater Middle East project.”


This is clearly not the most encouraging comment as it relates to peaceful co-existence with Israel.


In the 2005 parliamentary elections in Egypt, which were marred with fraud, the Muslim Brotherhood won 20% of the seats and was the largest opposition bloc to President Mubarak.  While the Muslim Brotherhood doesn’t represent the largest percentage of the Egyptian population, more than 90% of the population is Muslim and on some level identifies with this group.  Further, the Muslim Brotherhood is the most organized political entity, which will be a key advantage in the upcoming August elections.  Secretary of State Clinton highlighted this risk this weekend in The New Yorker when she commented on a recent meeting in Egypt:


“I looked at these twenty young people around the table, and they were complaining about how the elections are going to be held, and the Muslim Brotherhood and the Islamists are so well organized, and the remnants of the old National Democratic Party are so well organized. I said, ‘So, well, are you organizing? Do you have an umbrella group that is going to represent the youth of Egypt? Do you have a political agenda?’ And they all looked up and said no. It made my heart sink.’”


As noted, in many ways Egypt remains both a key to future stability in the region and, via its upcoming elections, a crystal ball into the future.  Beyond Egypt, whose outlook remains precarious, the rest of MENA has an even less stable intermediate term political outlook.  We’ve summarized some of the key recent events below.


Libya – Reports from the weekend have suggested marginal progress by the Libyan rebels as Gadhafi’s forces have withdrawn from the port city of Misrata.  This was supported by the first U.S. Predator drone strikes, some of which occurred on Colonel Gaddafi’s personal compound.  Despite these events, one thing is clear, the NATO intervention, which began in late March, has been largely ineffective due to its limited engagement and unclear goals.  Absent a larger role from NATO, which would likely be led by the United States, it seems unlikely that Gaddafi will be ousted anytime soon and a deadlock is likely to remain the status quo well into the summer.


Syria - Over the weekend, the Syrian army forcefully repressed protestors and “shot their way” into the southern city of Daraa to crack down on anti-government protestors. These military activities were continuing this morning.  Further, security forces encircled certain Damascus suburbs this weekend, including Douma and Madaamiya.  In response, the White House issued the fifth in a series of statements, with the first on March 24th, that denounced Syria’s actions.  So far, the denouncements have had little effect as the government continues to take more aggressive actions against popular unrest.


Bahrain – Saudi troops have rolled into Bahrain to settle street demonstrations.  Conversely, Iran has encouraged the protestors in Bahrain.  The derivative impact of this has been calls from the Kuwaiti parliament for the Gulf Cooperation Council to liberate certain indigenous groups from Iran, which has led to an acceleration of tensions between Iran and other Arab states.


On March 23rd we gave a presentation of our outlook for crude oil and used the following quote from Tom Friedman:


“One thing I can tell you about Egypt: it is not Las Vegas. What happens in Egypt does not stay in Egypt.”


This point continues to hold true, especially as the August elections loom in the land of the pharaohs.


Daryl G. Jones

Managing Director

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Some tidbits that weren’t evident from the earnings release and conference call.


  • North American shipment breakdown:
    • The Gun Lake units shipped in the December quarter but were recognized this quarter (650 units)
    • Woodbine Racino in Canada (~235 units)
    • Ocean Downs (300 units)
    • IGT shipped approximately 340 units to Grand Falls in Iowa but the units won’t be recognized until FQ3
  • International shipment details:
    • Asia: 100
    • Australia: 1,000
    • Europe: 500
    • UK: 1,100
    • S. Africa: 200
    • Latin America: 1,800
  • ASP impact of the sale of leased units
    • Patti Hart misspoke on the call; there were just under 500 leased 8960 platform units that were sold in the quarter – not 1,500
    • We estimate that the impact of the discounted units on ASPs was around $245/unit
    • The units were sold from a number of locations
  • SG&A increase
    • Staffing up in the interactive group - $3MM incremental
    • Latin America - $1MM incremental commissions and salaries
    • $1.7MM restructuring charge
    • $3.6MM bad debt expense – which is elevated from the $1.5-2MM
    • High 80s, low 90s or around the same level as this quarter is a good SG&A proxy for the next 2 quarters 
  • D&A
    • Was a little low this quarter but should trend back up a bit
    • $17-18MM per Q is a good run rate
  • New NA shipments will be down in the back half of FY11; especially in 4Q
  • For International, 21-22k for the year is still a good estimate - Galaxy Macau was not in this quarter's #s but will be for next quarter

European Risk By the Charts

Position in Europe: Long British Pound (FXB)


As we noted in the European Risk Monitor yesterday, Europe’s sovereign debt issues continue to drag and perpetuate headline risk, however the EUR against most major currencies and most European equity indices continue to shake off these threats under the belief that the heavy hand of the EU and IMF will extend to any and every country that needs financial relief.  If we add continued hawkish comments on inflation from the ECB and weak USD policy to this mix, we think these are the main catalyst driving the strength in the EUR-USD. Keith’s models suggest the EUR-USD has immediate term support at $1.44 and resistance at $1.46, so we’re currently at an overbought level.


Risk in Greece and Portugal are the main focal points at the moment. Regarding Greece, discussions surround a potential restructuring of government debt, which we think is a foregone conclusion given the expedient rise in government yields and therefore the severe headwinds in store for future debt issuance and interest payments (see chart of 10YR Greek yields and the other PIIGS below).


European Risk By the Charts - m1


As always, Greece’s fiscal imbalances are glaring and expanding. Debt as a % of GDP is expected to ramp to 159% in 2012, and PM Papandreou and Co. plan to reduce the country’s deficit from a high of 15.4% of GDP in 2009 to 3% by 2014. We’re of the camp that they’ll come up short.


A bailout of Portugal also lingers, with an estimated agreement to the tune of 50-80 Billion EUR set for mid-May. As we present in the chart below, catalysts for this deadline include getting ahead of a hefty payment of government debt (principal and interest) in June (~ 7.1 Billion EUR) and elections for the next government in June.  


European Risk By the Charts - m2


Not unlike in the US, aggregate public debt levels are increasing across Europe, despite such standouts as the UK that is actively tightening spending and enhancing revenue. Today, Eurozone debt as a % of GDP was released for 2010 at 85.1% versus 79.3% in 2009. We pulled the data back in the chart below. We think we could see a significant slope to the year-over-year change of outstanding debt over the next 3-5 years as the periphery struggles to reduce years of fiscal imbalances.


European Risk By the Charts - m3


Matthew Hedrick


Higher Highs? SP500 Levels, Refreshed



If you didn’t know The Bernank is whispering dovishly in these FOMC meetings right now, now you know...


We’ve been making this call for the last 2 weeks, but it’s worth repeating - he will remain Indefinitely Dovish through June. US Dollar crash helmets on. The Inflation trade up into the right. Central planners, unite!


I didn’t and won’t say this will end well, but I will say that higher-intermediate-term highs in the SP500 (on a close above 1343) are going to be bullish for the very immediate-term TRADE (into the actual Fed decision and press conference – yes, press conference tomorrow, Euro style). That’s why I have cut back the gross short exposure in the Hedgeye Portfolio to 9 shorts this morning (14 LONGS, 9 SHORTS).


For the first time since mid-February I am registering what I’ve called the danger zone for US stocks (1) – as in danger that the market pins that price on the donkey, and falls, hard...


Interestingly, but maybe not surprisingly, given that a there is a career risk management exercise at work in the institutional performance chasing game associated with higher-highs, I am registering less than a 2.5 standard deviation overbought zone that’s above my prior 1 zone up at 1.


So, I’ll wait and watch for 1 Short Selling Opportunity prices (those will still be lower-long-term highs). If I don’t get them, I don’t mind. Patience in the face of a US government sponsored Currency Crash (like Q2 of 2008) is required.




Keith R. McCullough
Chief Executive Officer


Higher Highs? SP500 Levels, Refreshed - 10

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