Congress Holds Court

“If we get jammed up, we're holding court on the street.”

-Jimmy Coughlin, “The Town” (2010)


Just when I thought the biggest tail risk to whatever remains of our free-market lives (Congress) couldn’t find lower-lows, the Republicans redefined the ridiculous yesterday.


In a must read section of a Bloomberg News article by Julie Hirschfeld Davis this morning, Republican Congressman Kevin McCarthy of California gets YouTubed for playing a clip from “The Town” to inspire the Republican troops at their party headquarters yesterday.


I don’t think Julie could have made up this scene if she tried. To put this movie in context (in case you haven’t seen it, it’s an outstanding movie directed in 2010 by Ben Affleck with a 4.5 star rating on Netflix), this is a Boston bank robber movie where the aforementioned character that I quoted (“Jim”, played by Jeremy Renner) is as emotionally unglued as the VIX.


Back to the Global Macro Grind


The VIX (the Volatility Index) is up +15.6% in a straight line this week as Congress Holds Court, watches gangster movies, and does their best to implode the US Dollar (down another -0.9% yesterday, taking its cumulative losses to -2.2% in the last 7 trading days).


This is not only a national embarrassment for the country, but a professional embarrassment for each and every one of these morons who don’t realize that the entire world is watching them – real-time.


Did I call them morons? Sorry, I meant Market Morons. Not all of them, some of them, couldn’t tell you what a EUR/USD currency trade in swap means or where to execute it. All the while the entire world’s globally interconnected risk trades off of their unawareness. Nice.


Domestically, this analytical incompetence isn’t lost on people. Actually, it isn’t Internationally either. In terms of scoring the Fiat Fools globally, consider the following polls:

  1. USA – Congress hits new low in yesterday’s Rasmussen reading; only 6% of Americans think Congress is doing a good job
  2. JAPAN – Japanese PM Naoto Kan’s approval rating hit a fresh new low yesterday of 17.1% (that’s lower than Obama’s!)
  3. ITALY – Embattled hot-tubing Prime Minister, Silvio Berlusconi’s approval ratings are dropping 1000 basis points a month

What do all of these countries and their said/sad leadership have in common? Print LOTS OF MONEY!


Yeah baby, print it – and if you get jammed up with a 17 year-old while swimming naked or swilling with some Republicans in de Club, just bust out some fear-mongering and hold court on the manic media’s streets. They need content.


If you didn’t know this is all ending the way that gravity predicted it would, now you know. Thank God for that.


What to do with your hard earned money?


I’ve actually taken this gong show as an opportunity to get invested. Yesterday, on weakness, I bought the US Dollar (UUP) and Indian Equities (INP), taking my Cash position in the Hedgeye Asset Allocation Model down to its 2nd lowest level of the year (37%).


This doesn’t make me a raging bull. This simply makes me a buyer on red and a seller on green. As we outlined in our Q3 Macro Themes call a few weeks ago, as the Fiat Fools of our world play “Policy Pong” with our markets, we should stop getting frustrated by it – and just trade it. Be a “Risk Ranger” (another Q3 Theme) and trade risk around the range.


Yes, buy-and-hold fans, trading is a required exercise in modern day risk management. Doesn’t that make me a “short-termist” when our longest of long-term views have been what has really led us to being right on 2011 Growth Slowing As Inflation Accelerates? The Fiat Fools and their policies do 2 very specific things to your economies and markets:


1.       They shorten economic cycles

2.       They amplify market volatility


And on that note about volatility, I’ll end this morning’s missive where I began – with a preview of the next episode of “The Town’s” Debt Ceiling from our squirrely friend Jimmy, who so seemingly inspired Republican Congressman McCarthy yesterday: “Secrets with this one.”


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $98.06-100.81, and 1, respectively. Buy low. Sell high.


Best of luck out there today and enjoy the show,



Keith R. McCullough
Chief Executive Officer 


Congress Holds Court - Chart of the Day


Congress Holds Court - Virtual Portfolio


We were convinced from our analysis of KONA that the company was going to perform well through 2011 and viewed the stock favorably as a result.  Over the past month KONA has been the best performing casual dining name over the past month (up 23.4%) and is now up 62% year-to-date. 


Early in the quarter, there were some serious questions raised about the future following former CEO Mark Buehler's resignation.  As we wrote on June 9th, the departure of the CEO was not related to weakness in the business and the 2Q financial performance confirmed our thesis. 


KONA 2Q EPS came in at $0.08 or $0.11 ex-special charges.  Same-restaurant sales came in at +9.1%, implying two-year average trends 180 basis points above those in 1Q11.  Management also provided some conservative sales guidance for the upcoming quarter.  Guidance is for 6% same-restaurant sales in the third quarter, including 3% price.  This comp guidance, implies two-year average trends of 3%.  This would be a sequential slowdown from the two-year average trend in 2Q but it would likely bolster investor confidence in the company’s ability to continue to grow share.  The 3Q trends suggest that the company will post positive SSS for seven straight quarters. Currently KONA is running about 2.2% in pricing; the company took about 150 basis points in June to help offset higher commodity costs.


Restaurant level margins also increased year-over-year during 2Q11to 17.2% versus to 16.3% last year. On a sequential basis, restaurant operating profit improved 320 basis points over 1Q11.


We continue to like the KONA story.








Howard Penney

Managing Director


Rory Green



BWLD reported earnings after the close and EPS came in below expectations at $0.58 versus $0.60.  Comps, however, blew away consensus with company comps gaining 5.9% year-over-year versus consensus +3.6%.  Franchise comps, too exceeded expectations at +2.7% versus +1.6%. 


Below are our Top Ten Takeaways from the quarter:

  1. The same-restaurant sales trends are a huge positive for BWLD.  Despite the earnings miss, which is impacting the after-hour trading, people are coming through the door and the resolution of the NFL lockout dispute is another positive for the second half of the year besides the obvious appeal consumers have for the brand.
  2. Strong comps are likely to continue, in our view, as the football season gets underway and the company increases its media presence in the third and fourth quarter.  The company gave the to-date 3Q number as 4.9% which, if it were the reported 3Q comp, would imply a further 90 basis point acceleration in two-year average trends from the 2Q number. 
  3. The company is not taking price, aside from a nominal 10 or 20 basis point increase with the new menu in September, in the near future.  Thanks to benign chicken wing prices, the company can afford to let price roll off the menu.
  4. Chicken wing costs, the most important commodity for BWLD, continue to be favorable in the third quarter.  For the first two months of the third quarter, wing costs are averaging around $1.14 per pound versus $1.42 during the third quarter of 2010. 
  5. Operating margin came in lower than expected largely due to higher preopening expense and G&A expense.  Some of the increase in G&A was due to higher recruiting and training costs for restaurants opening in the new West Coast market.  This is because the new markets do not have the training centers and number of existing personnel required to train new hires.  Preopening expenses are also up as unit growth continues at a fast pace.
  6. Restaurant operating margin, a more pure assessment of restaurant performance in our view, increased year-over-year.  Food, operating, and occupancy costs were favorable while labor costs were up slightly year-over-year as higher labor costs were incurred in new markets.
  7. The company’s earnings power is strong.  Despite EPS coming in below expectations, largely because of increased G&A and preopening expense, net earnings growth in the first six months of 2011 was over 29%.  The company has raised its expected annual net earnings goal for the year from 18% to “more than 20%” as a result of the strong performance.
  8. New unit growth is set to continue to contribute to returns but will also keep G&A and preopening expenses elevated.  The cost of training people in new markets where there is a lack of training centers is higher than training people in new markets.  In the second half of the year management is guiding to 29 company store openings, 37 franchisee openings and 3 in Canada.   As long as new unit volumes remain strong, we believe that the cost of growth is worth the price for shareholders. Management calls the expenses, “investments in our future”.
  9. As the company is opening new stores and expanding into new markets, it is also closing older, lower volume locations.  We believe that this is positive for the company in the intermediate-to-long tem despite the immediate term increase in costs associated with the closures.
  10. Continued innovation in the product and sports-related promotions are likely going to support traffic going forward into 2H11.  The lack of a significant price increase, when other restaurant chains are likely going to have to raise prices somewhat, could also help as customers continue to seek value.






Howard Penney

Managing Director


Rory Green


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%


2Q results were further confirmation that Domino’s continues to lead the Pizza category.  Below is a quick recap and our most important takeaways from the call.


Domino’s Pizza reported very strong 2Q results and is trading sharply higher today, as it should be.  EPS of $0.40 cents beat expectations of $0.36 with solid margin improvements on the labor and occupancy lines, offset by higher food costs (cheese and meats).  Domestic Company-owned same-store sales grew 5.3% in the second quarter versus a difficult +8.3% compare from 2Q10.  This implies a sequential acceleration in two-year average trends of 60 basis points.  Consensus was looking for +3.2%.  International same-store sales grew 7.4% versus expectations of 6.1%. 


Top Ten Takeaways from the 2Q11 earnings call:

  1. DPZ continues to take share, printing industry-leading same-store sales numbers.  This quarter was particularly impressive in that domestic company-owned same-store sales increased on a one- and two-year basis.  Management said that this was driven more by increased customer loyalty and improved retention than new customers.
  2. The company is innovating to stay ahead of the competition on the top-line by continuing to support its revenue line with investment in innovation, such as the new iPhone App, and promotions. 
  3. The company’s stance on pricing remains cautious; a new promotion was launched yesterday which offers a large pizza with two toppings for $5.99.  Where the company may take pricing, is in coupons.
  4. DPZ raised its commodity basket inflation forecast for 2011 to 4.5%-6% from 3%-5%. 
  5. The price of cheese remains the greatest variable.  2Q brought average per block prices of $1.68 for DPZ, far in excess of what it had expected after the 1Q earnings call.   Management has a contract for cheese that eliminates one third of the volatility of the spot price.  In the back half of the year, management sees cheese prices “easing off” and finishing below $2 before the end of the year.  We would not be so sure; while a cheddar cheese recall did impact prices, demand has kept prices elevated – as management alluded to – and we think the decline in prices could be more gradual than management is implying.
  6. The company is locked on chicken, locked on wheat into next year, locked on cheese but only eliminating one third of volatility, has some conversion agreements on meat but there is also exposure there.
  7. The company’s international markets are a big strength with comps in the high-single digits and the company has now had 17.5 years of positive same-store sales comps in international markets.  The company is growing at a very fast pace in international markets, emboldened by the strong performance across a broad base of markets, and will see some increase in G&A associated with supporting the infrastructure required to support this growth. Mexico, which had been lagging over the past 18-24 months, has now picked up.
  8. Overall, the pizza category is not “strong” but Domino’s is taking share from regional pizza players but the company doesn’t see any interaction between its pizza and the frozen pizza category.
  9. Third quarter comps will likely not be as strong as the company laps a more difficult 3Q comparison that was boosted by advertising.
  10. The company’s share repurchase authorization has been increased to $200 million by the board of directors.  In the second quarter, the company retired approximately 1.75 million shares of common stock for a cost of $41.4 million at an average price of $23.71 per share.



DPZ: LEADING THE PACK - dpz quadrant


DPZ: LEADING THE PACK - dpz cheese


DPZ: LEADING THE PACK - cheese 726



Howard Penney

Managing Director


Rory Green




Beat and raise should drive the stock higher



"Our third quarter results further demonstrate the positive momentum generated by our new games, platforms and internal process improvements. We are expanding our business in new and existing markets around the world in a capital-efficient manner driven by our customer-first philosophy. The investments we are making today are expected to position the company to deliver continued revenue and earnings growth."

- Patti Hart, CEO of IGT




  • Adjusted EPS of $0.26  excluding a $0.04 discrete tax benefit and revenue of $489MM
  • Gaming operations revenue of $267MM and average revenue per unit per day of $55.55 up $1.47 YoY "on performance improvements in our MegaJackpots brands globally, and down $0.83 from the immediately preceding quarter due to a higher mix of lower-yielding international units."
    • 62% gross margins "impacted positively by improved game performance and lower jackpot expenses."
    • "IGT's gaming operations installed base totaled 53,300 units, an increase of 800 units from the immediately preceding quarter primarily due to additions in international lease operations."
  • Product sales revenue of $222MM
    • 8,900 unit sales, up 7% YoY "primarily due to increases in domestic replacement and Latin America sales and down 2% sequentially, primarily due to fewer new openings domestically"
    • "Domestic average selling prices increased 2% compared to last year's third quarter due to a higher percentage of new cabinets, specifically, the Universal Slant and G23 MLD products.  International average selling prices increased 16% compared to last year's third quarter primarily due to favorable geographical and product mix, particularly in Europe and Australia, and favorable foreign exchange rates."
    • 56% gross margins: "The increase in gross margin was driven by increased higher-margin international machine sales."
  • SGA "flat compared to last year's third quarter, as lower bad debt provisions offset higher variable compensation expenses."
  • Cash: $401MM; Debt: $1.65BN
  • "During the quarter, the Company repurchased 1.5 million shares of common stock at an average price of $16.25 per share for a total cost of $25 million."
  • "During the quarter, the company closed on the previously announced tender offer to acquire Entraction Holding AB"
  • Barcrest sale is expected to close in F4Q11
  • Outlook: $0.89 to $0.93
    • "This range excludes the favorable impact of $0.08 per share from certain items detailed in the supplemental reconciliation at the end of this release."



  • Operating margin was their best in over 3 years.  Their business now has the potential to deliver steady growth and returns.
  • Entraction acquisition is an example of their plan to responsibly grow their business.  Expect nice growth in their interactive division.
  • Coin-in per machine per day was up 13% in their WAP units, but international mix of more leased machines negatively impacted yields.
  • International product sales - favorable shifts in product mix and FX rates (Barcrest and Japan were lower priced units and are now excluded)
  • $185MM of operating cash flow was generated in the quarter
  • Gaming operations: Over 1,000 Center Stage units installed, which are performing well.
  • Shipping universal slant with large portfolio of games. Improving their game development process.
  • International continues to break records - achieved their highest ASPs. Early returns on their 6 Asian games are encouraging.
  • Interactive grew revenues 20% YoY.  Significant increase in total wagers and average bet.
  • Hosted systems user conference in June - demonstrated new applications on their SbX system which they expect to continue to roll out over the next year.  They had significant international wins this quarter.
  • Released Hot Roll Series with their first on-screen interactive bonus.
  • Universal Slant Top box has been well received. Already received orders for 2,300 units. They can swap out titles in an hour on these machines. Advanced design of this machine reduces its manufacturing time by as much as 50%.
  • Reduced time to bring games from idea to market by 33%



  • The low hanging fruit has been picked; now it's really pruning and that takes more arms and legs and that's why they have added Eric Berg to their team
  • How are they thinking about the i-gaming opportunity? They are very bullish on the idea of convergence of content. Their igaming strategy is an 100% international strategy.
  • Product gross sales margins - where could they go when units improve?  59% GM that they enjoyed this quarter was a product of mix and cost reductions.  Mix will move around Q to Q. Mix will determine if they can get to 60+% margins.
  • SbX PNL potential? They believe that customer adoption is increasing.
  • What kind of market share do they expect in new markets? 50%+ is viewed as a successful allocation.
  • Trends in their domestic install base? Stabilization in their WAP segment where they have suffered a lot of degradation. Return to more normal seasonal trends. Some of that is due to better games and some is due to a more stable / healthy consumer. This was their second consecutive quarter where their WAP business saw improvements across install base, yields and coin in.
  • Did they sell any of their games ops games this quarter? Their sale of gaming ops games has been very selective for mature games or ones that weren't easily upgradable. There were maybe a few hundred sales in the quarter of games that were at the end of their life cycle.
  • How much of the price increase was due to FX? Regional mix, product line mix was 50% and FX was the other 50%
  • Center Stage - they are still deploying the hardware (backlog) and are also layering on conversions
  • How  many Universal Slant shipments this quarter? Not a huge number this quarter - most of the 2300 is in their backlog.  Interest is really high. They have not yet put forth a real effort on creating a poker refresh.
  • MLD was just south of 50% of their shipments this quarter
  • When will their interactive division revenue become material?
    • Will likely not get to 10% of their business. But it's not unrealistic that by 2013/2014 the business could become material enough to break out.
  • 82% of their gaming operations units were variable. The mix is pretty consistent across domestic and international units.
  • Growth rate on international gaming operations going forward are better than what they are in the US given the relative maturity of their business. Internationally, they have almost 13,000 units internationally. They should be able to continue to grow their international unit install base (albeit the international units have lower yields). They are focused on Asia and Latin American more so than Europe and Australia.