We thought that the quarter was strong ex-EMEA which was clearly a significant disappointment given -1% comps for that division versus 2.3% consensus.  The two-year average trend for Starbucks' comps declining in all geographies corroborates Keith's recent view that growth is slowing. Given that the stock was up 34% YTD versus the S&P 500 up 11% when the number hit the tape, the sell-off was merited in our view.  Management is, in our view, trying to manage investor expectations for the remainder of the year, raising FY12 guidance but failing to lift it in line with the Street's expectations.


*         Europe is a problem and the company's actions - sending Michelle Glass to London - indicate that they are taking all steps possible to turn things around. It will not happen overnight and the macro environment will likely remain a headwind for some time given deep recession in U.K. referenced by management.

*         Looking into FY13 and the company's position of strength in single serve, its new concepts and beverage lines, and the strong returns being generated by capital investment, there is plenty of fodder to construct a compelling bull case

*         Commodity costs turning from a headwind to a tailwind in FY13 should be a meaningful benefit, particularly in CPG where in 2QFY12, commodity pressure accounted for 620bps of 740bps total margin

UGG: Does The Punishment Fit The Crime?


There’s a lot wrong with DECK right now, but we don’t think it’s terminal.  Revenues were weak and they missed. Bad news. We get it. We’re not trying to gloss over the issues. But 24% of the float is short, and it still is giving up $650mm in market cap today – or about a quarter of equity value and 32% of Enterprise Value? Seems pretty steep.


The question with UGG (over 90% of cash flow) is always ‘is the brand dead?’ And yes, this is always the (seasonally weak) time of year people ask it. No doubt, with inventories up an average of 100% over the past 2 quarters, there’s clearly more weight to the question today than in past years. But consider the following…

1)      Do these stories ALWAYS have to be binary? Why do people view them as either the greatest thing since Nike, or dead in the reincarnation of Heely’s? Can there be something in between where good brands can exist for a long time? Yes. Especially those that have already proven that they can successfully grow beyond US borders.

2)      As it relates to inventory, we need to account for about an incremental $100mmm yy.

  1. $10mm for new stores. Keep in mind that inventory will naturally accelerate as UGG grows its consumer direct model.
  2. $20mm to grow its new European business. Inventories will be heavier up front.
  3. $10mm in cold weather product that has been sold for delivery in later quarters.
  4. $40mm in higher sheepskin costs. UGG is likely to recoup at least some of this in pricing.
  5. $20mm in spring inventory – supporting new product rollouts (i.e. some of which are using alternative materials).  

3)      Let’s put this in perspective. In looking at retailers for the better part of 15-years, if there’s one thing I’ve learned is to rarely beleive a management team’s reasons as to why they have too much inventory.  It’s an easy (and unverifiable) spot to make excuses. But as it relates to leftover inventory from this (aberrational) winter, as well as higher product costs – I am willing to give them a pass right there on over half of the inventory growth.

4)      They’re 95% done with pre-orders – especially strong in men’s and kids (ie less dependent on the sheepskin-laden classic) and are introducing more alternative fabrics without (reportedly) shifting away from identity.

5)      When all is said and done, let’s say that you squarely believe that the UGG brand IS on a decline. We’d challenge you to talk to any wholesaler, and find someone tell you that they’re comfortable not placing reorders on UGGs for this fall and winter. If the brand is still in demand, and a wholesale buyer does not have the goods, then they’re probably out there looking for a job.


We’re coming out at $4.85, $6.05 and $7.10 for 2012, ’13, and ’14, respectively. With $6.80 in cash on hand, we’re looking at 9.4x, 7.5x and 6.4x earnings over those durations. Valuation is by no means a catalyst. But sentiment is low (24% of the short is float), seasonality is out of favor, and you have to wait to fall in order to get a reacceleration in the business. But keep in mind that the ‘there’s no catalyst for 2-3 quarters’ argument is the top bear case I hear. From a risk management perspective, we’ll rarely be early on a name like this. But for someone that wants to stomach near-term noise and look out a year, this looks like a good risk/reward. Sometimes, herd mentality that there is no catalyst is, in itself, a catalyst.


Brian P. McGough
Managing Director


UGG: Does The Punishment Fit The Crime? - DECK snagit



(F12 Outlook post Q4)

Full-Year 2012 Outlook

  • Based upon current visibility, the Company expects full year revenues to increase approximately 15% over 2011 levels. (now +14%)
  • The Company expects full year diluted earnings per share to be approximately flat with 2011 levels (now down 9%-10%) due primarily to the increase in sheepskin costs in 2012 compared to 2011, which the Company projects to adversely impact profitability by approximately $1.40 per diluted share. This guidance assumes a gross profit margin decline of 200 basis points (now -250bps) from 2011 levels due to an increase in costs of goods sold, partially offset by selective price increases, an increased contribution from retail sales, and the addition of the Sanuk brand for the full year. This guidance also assumes SG&A as a percentage of sales of approximately 29%.
  • Fiscal 2012 guidance assumes approximately $13 million, or $0.23 per diluted share, associated with the amortization and accretion expenses related to the Sanuk acquisition.
  • Fiscal 2012 guidance also assumes that the Company’s effective tax rate will be approximately 31%. 
    • UGG up +10% (was 11%)
    • Teva +low-to-mid single-digit (was +10%)
    • Other down -15%
    • Sanuk still expected to be ~$90mm


  • Sanuk continues to outperform - strong sell-in of the spring line equally strong in March/April
    • Brand making progress building distro with retailers incl JWN, Zappos, Journeys, & DDS
  • UGG spring styles were up meaningfully yy
  • Cold-weather boot sales the big offset
  • Sheepskin up 40% in 2012 yy, but coming down from highs
  • Spring styles up 20% in domestic wholesale channel
  • Fall close to closing pre-book, pleased with level of commitment from domestic wholesale
  • Open to buy dollar pool has contracted, but based on conversations with retailers, mgmt believes UGG maintaining share
  • Consumers will see new fall collection as early as June/July (new sneakers, casuals and boots)
  • Closing some accounts that can't display full offering, increased net independent door counts in 2011
  •  Int'l sales of UGG in Europe lower than expected - UK DECK's biggest int'l mkt
  • Still ramping marketing spend in Europe to build awareness and expand product line
  • Goal to develop slippers, cold weather, casuals, men's and kids like in the U.S.
  • Benelux (2nd biggest mkt) had very good Q1 - difference to UK is more mature distributor partners that can offer broader assortment
  •  Asia UGG business grew at a fairly rapid pace in Q1 - wholesale cont. to rebound in Japan vs. tsumani yy
  • Have recently taken minority interest in JV to capitalize on China opportunity
  • Total store comps flat vs. Domestic comp up HSD in Q1 offset by down Int'l comps
    • US regional comps:  Northeast hit hardest
  • e-commerce down -7.5%: Teva up strong offset by HSD decline in UGG
  • Teva posted strong domestic wholesale growth + dom. e-com. Offset by Int'l down
    • Closed-toe product up 38%
    • Due to over-inventoried position at retail, not seeing orders in near-term impacting fall demand = taking down projections for the year.



"UGG Brand's primary selling season at retail typically doesn't get underway until later in the year, hitting peak velocity in November and December."



  • Will not know what 2013 prices look like until they lock in prices for fall '13 line in October
  • Skeepskin is a by-product of the meat industry
  • Sourced primarily from Australia with some from the UK and US
  • Decline in herd sizes driving up price
  • Drought in Australia also a factor
  • Fx also a headwind
  • Are seeing prices starting to decline
  • Believe other companies have shifted to other materials (out of the market)
  • Published price of skins not only factor in DECK's cost:
    • Use higher grade skins
    • Tanneries in China another factor that carry additional costs
  • Trying to offset this to some extent with non-sheepskin product


GM: -403bps

  • ~300bps due to higher product costs
  • ~200bps due to markdowns, closeouts, discounts and DTC mix
  • Offset in part by Sanuk and increased pricing
  • Increased closeouts attributable to discontinued Spring/Fall styles
  • Teva and Other brands and UGG closeouts cause for results below expectations (~-200bps)
  • Sanuk brand margins came in ahead of expectations


SG&A: +36% ($35mm)

  • +$8.7 related to Sanuk acquisition
  • +$4.7mm in marketing (UGG men's and classic campaigns)
  • Addition of 19 new stores LTM


Store Growth:

  • Expect to have 70 at year end vs 46 now
  • 27 stores in comp (18 in US, 4 in UK, 4 in China, 1 in Japan)
    • Of 19 non-comp stores many in Asia and are 1/3 smaller with lower sales/store
    • In addition to infrastructure investments behind store rollouts, this is why store productivity appears to be declinnings
    • Sales/sq.ft. comparable in Asia
  • Additions: 24 store opening left in 2012; 4 in U.S. and 10 each in Eur and Asia



  • Up +95% yy to $209mm due to:
  • Primarily fall UGG product ($90mm), product costs, and addition of Sanuk brand ($12mm)
  • Of $90mm increase in UGG inventory:
    • $65mm fall inventory ($50mm in classics and slippers) have orders for this at full price
    • $10mm in cold weather product that has been sold for delivery in later quarters
  • Can also look at by:
    • $40mm in inventory product cost increases
    • $20mm in European inv to support direct business
    • $20mm spring inventory
    • $10mm new store inventory


  • Cash position $228.6mm




  • Lower projections for Int'l wholesale and Teva domestic sales
  • Total revs now +14% (was +15%)
    • UGG up +10% (was 11%)
    • Teva +low-to-mid single-digit (was +10%)
    • Other down -15%
    • Sanuk still expected to be ~$90mm


  • GM: -250bps (was -200bps) - lower int'l sales and increasing Q1 closeouts
  • SG&A: ~30% of sales (was 29%)
  • Tax rate: ~31%
  • CapEx: ~$80mm (was ~$90mm) - $32mm to new HQs, $26mm new stores, $10mm IT & maintenance, $4mm retail operating systems, $8mm corp infrastructure



  • Revs +8% - added pressure from European business
  • GM: ~43%
  • SG&A 63% as % of sales
  • EPS: -$0.60





UGG Inventory Levels:

  • Most inventory on-hand has been committed for fall - mostly classic product no fashion element


Biggest Changes since last Qtr:

  • Seasonality, weather has profoundly impacted how retailers are buying cold weather product - from one extreme to the other
  • Kid's and men's has done very well, really seasonal product weakness


Gross Margins:

  • Closeout impact fairly equally split between Teva & Other brands and UGGs
  • Channel mix also impacted margin


Order Book:

  • ~95% done with prebook
  • Especially strong in men's and kids - less dependence on traditional classic
  • Have done a good job mitigating sheepskin impact with alternate designs - shifting to more fashion
    • Has allowed DECK to offer lower price points, retailers receptive
  • RED FLAG: no longer offering Fall/Winter backlog (was up +15% last qtr), now just reporting full-year due to addition of Sanuk
  • ASPs up slightly in order book


International Business Outlook:

  • "Feel really strong where we're headed with our retail business and where that's going to end up for the year"
  • Int'l expectations have come down from up over 20% and 33% of sales - now more like +15% (Domestic expectations up)
  • China is all direct, no wholesale.
  • Seeing improvement in Japanese business
  • Have good visibility now with most of European orders pre-booked. Reduced expectations to a level believe achievable.


Spring Product:

  • Typical split between carryover product vs. spring product roughly 40/60 (ballpark)
  • Spring up close to +20%



  • More growth expected in Q4 than Q3
  • European distributor disruptions lowering expectations in Q3


Cost of Skins:

  • Not fully locked in for 2013 yet, waiting for killing season in Q3



  • ~60% of business in 1H
  • Expect good growth in Sanuk in Q2





In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.

OVERALL:  SLIGHTLY BETTER - Adding back the write-off, BYI reported $0.69 cents vs. the Street at $0.67. Gaming ops were the bright spot in the quarter with game sales and systems more or less in-line.  


Here is the report card evaluating actual results against management's previous assertions.  

    • SLIGHTLY BETTER:  Increased the low end of FY 2012 guidance by 12 cents to $2.37-2.45.
    • SLIGHTLY BETTER:  BYI's margins increased 3% YoY and QoQ - which we would categorize as a little better than slight sequential improvement.  On the flip side, next quarter's margin will slip slightly QoQ. The goal achieving of 48-49% in the next few quarters remained unchanged.
    • SAME:  Progress in Australia remained sluggish, but their QoQ shipments did increase.
    • SLIGHTLY WORSE:  While BYI finally has the finish line of approvals within their sight line, the delay in approval will cost them some VLT placements as their concessionaire partners grow tired of waiting.    
    • SLIGHTLY BETTER:  "GREASE" reached an install base of 127 units (currently 170 units in the field), with better than expected initial performance.  Though early, cannibalization impact was relatively low.  Also, "Michael Jackson" deployment is ahead of schedule.  BYI continues to believe that 700-800 games in the field for each title remains achievable.
    • SAME:  Systems outlook remains rosy with a solid backlog.
    • SAME:  Moving along exactly as planned. Will recognize go-live revenues in FQ4 2012.  BYI is already recognizing some service revenues

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Invisible Gorillas

“Miracles happen everyday, change your perception of what a miracle is and you'll see them all around you.”

-Jon Bon Jovi


The Invisible Gorilla was an experiment performed by Professors Christopher Chabris and Daniel Simons at Harvard University in 2004.  In the experiment, candidates were asked to watch a short video of six people, three in white shirts and three in black shirts, pass a basketball around and count the passes. At a point in the video, a gorilla wanders into the action, faces the camera and pounds its chest.  In total, the gorilla is on screen for almost 9 seconds.


In theory, a gorilla wandering into the middle of an otherwise normal scene sounds like an event that would be relatively easy to notice.  The results, on the other hand, suggest otherwise.  Professors Chabris and Simons found that almost 50% of the people that watched the video did not notice the gorilla.  In fact, it was as if the gorilla was completely invisible. 


There are two key takeaways from the experiment.  First, we miss a great deal of what happens around us.  Second, we actually do not even realize that we miss things.  As stock market operators, we obviously pride ourselves in attention to detail and acute analytical skills.  The fact remains that both your and my skills of perception are just not as strong as we believe them to be.


As I think about this experiment, the scariest thing to me is the idea of overconfidence.  I would imagine that most of you believe that if you were to watch the video, you would see the gorilla.  The reality, though, is that only 50% would see it.  You may believe you have great skills of perception, but the facts suggest otherwise.  But, if you know just that, then you have a leg up on the competition.


I will give you an example of a hidden gorilla in the investing world.  Apple recently reported earnings and while Hedgeye currently doesn’t have a technology analyst, we had a healthy debate in our morning meeting on the stock.  On one side there were the bears who basically opined that Apple was a product cycle company and was only as good as its next product, that margins on its hardware sales inevitably had to revert to the mean, and, basically, that Apple couldn’t justify its valuation longer term.


On the other side of the debate was the Hidden Gorilla argument.  In effect, the proponents of Apple in our morning meeting argued that it is somewhat irrelevant to argue about price points on Apple hardware products or fret over the number of iPhones that were sold in the quarter because Apple is actually a software company.  Specifically, via its iTunes online store Apple has become the go-to marketplace for all critical digital content on the internet (from movies to music to books to TV shows to games).  In that business, Apple keeps 30% of the revenue and the publisher keeps 70% of the revenue, but unlike other ecommerce businesses, like say Amazon, Apple has no physical infrastructure costs so the business in theory generates very high and sustainable returns on capital.


Yesterday, Jeff Gundlach gave a really interesting presentation on his general view of the global economy.  He had one slide that discussed Apple and made a comparison between Google’s rapid rise and decline with the conjecture that as Apple effectively “becomes the market” it may have a similar path in the future.   Gundlach may be right on Apple, or in fact he may be missing the Invisible Gorilla, which is that Apple is a much better long term business than its valuation suggests. 


In the Chart of the Day today (yes it incorporates a picture of a gorilla), we compare the overall unemployment rate in the United States versus the unemployment rate for those aged 16 – 24.  In the U.S., the unemployment rate is currently 8.2% and the unemployment rate for the youngest demographic is double that at 16.4%.  This is perhaps the hidden gorilla in the U.S. economy, which is that the youngest demographic is massively underemployed.


In Europe, the unemployed ratio of the youngest demographic versus the average is even more extreme.  Spain exemplifies this more than any major European economy.  This morning Spanish unemployment ticked up to 24.4%.  Youth unemployment in Spain also ticked up, to a staggering 52.0%.  Trust me when I say this: a generation of unemployed is not a positive leading indicator for the outlook of any nation or region.


So, not surprisingly given the employment data the Spanish 10-year yield is back up testing the 6% line this morning. The only real positive indicator I have found as of late is that the perpetual contra indicator Standard & Poor’s cut Spain’s credit rating for the second time this year from A to BBB+ “citing struggling banks and deficit concerns”. Of course, it does beg the question . . . why was Spain rated A to being with?  But, who knows, perhaps the Invisible Gorilla in Europe is that rating agencies will get this one right . . .


While we are on the topic of European sovereign debt, Italy held a debt auction overnight.  In fact, Italy sold €5.95 billion of BTPs with 4-10 years maturity versus a maximum target of €6.25 billion. The 10-year average yield was 5.84% versus 5.24% prior and the bid-to-cover was 1.48 versus 1.65 prior.  Not even the Invisible Gorillas were buying at this auction.


Before winding this note down, I wanted to flag a call out from my colleague Darius Dale in a research note on Japan yesterday.  He wrote:


“As it stands now, Ozawa, who remains one of the most influential members of the ruling Democratic Party of Japan (w/ influence over up to a third of the party by some estimates), opposes the DPJ’s VAT hike bill. His exoneration means he is now free to stir the pot and rally support to defeat the bill from within. Further, his platform centers on expansionary fiscal policy, which, in addition to wanting a shot at regaining full control of the Diet via a snap election, is preventing the LDP from coming to the table to negotiate with the DPJ on its VAT hike proposal.”


Ichiro Ozawa has gone from being the Invisible Gorilla to being the 1,000 pound gorilla in the room, which according to Darius increases the risk that the VAT tax may not get passed and Japanese debt gets downgraded.


Perhaps the miracle that Jon Bon Jovi speaks of in the quote at the start is that we will get out of this global sovereign debt mess unscathed, or, at the very least, that it won’t end all that poorly.  Personally, I remain skeptical.


Keep your eyes out for invisible gorillas,


Daryl G. Jones

Director of Research


Invisible Gorillas - Chart of the Day


Invisible Gorillas - Virtual Portfolio

Unproductive Works

This note was originally published at 8am on April 13, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.”

-John Stuart Mill


John Stuart Mill was arguably the most influential philosopher of the nineteenth century and his writings are still widely studied.  Mill is probably best known for “On Liberty”, which discusses the limits of power that can be justly exercised by society over the individual.  Underscoring his views on liberty are the harm principle and the idea that the individual should have the right to act as she wants as long as those actions do not harm others.  To Mill, protecting and defending individual rights in the face of a potentially tyrannical majority are critical.


One way a majority can negatively influence the rights of the minority is through capital allocation by the government.  We often cite the long run historical work of Reinhart and Rogoff that highlights when government debt-as-a-percentage of GDP reaches 90%, or more, economic growth slows.  Certainly governments play a critical role in providing certain services that are critical and broadly benefit society, but, at a point, government works become unproductive.


With all that is happening in the world, I’m sure many of you missed the U.S. budget numbers for March.  As I said on twitter ( @HedgeyeDJ ), they were, in one word, ugly.  The federal government received $171 billion in revenue and spent $369 billion for a total budget deficit of -$198 billion, or 5.5% year-over-year monthly growth in the deficit. This is the largest March budget deficit of any nation, ever. 


Almost exactly a year ago, in a note titled “The Case of the Missing Stimulus”, I wrote:


“Interestingly, if we look at government spending in the 2008 – 2010 period we can actually see the impact of the stimulus act on government ledgers. In fact, according to the U.S. federal government spent $2.98 trillion in 2008 and $3.59 trillion in 2010. So, the net increase over this period was just over $600 billion, which roughly equates to the spending portion of The Stimulus.”


My point in that note was that while there was a one-time step up in government spending, there has not been a step down as the stimulus plan has been anniversaried.  A year later the same story holds. 


The Chart of the Day today highlights government outlays by month going back ten years.  The conclusion is that the “one-time” increasing in government spending for the stimulus plan has led to a seemingly permanent increase in government spending.  Given the anemic growth we’ve seen in the U.S. over the last 18 months, it is pretty clear this spending fits the category of Unproductive Works.


At 11 am eastern today we will be holding our quarterly theme call. (Please email if you are qualified subscriber and do not currently have the dial in information.)  The quarterly theme call is our summary of what we think will matter in the coming quarter from a global macro perspective and the best way to play the themes via asset allocation.  The themes for this quarter are as follows:

  • The Last War: Fed Fighting - We take a historical look at U.S. Federal Reserve policy to contextualize the impact of Ben Bernanke's Policy to Inflate, Extend & Pretend rock-bottom interest rates, and Burn the Buck on the broader economy and financial markets from Main Street to Wall Street.
  • Bernanke Bubbles - A highlight of the top ten leverage price bubble charts perpetuated and encouraged by The Bernank's policy stance.
  • Obvious Asymmetric Risks - In a macro environment of slow global growth and historically low interest rates we present asymmetric risks to capitalize on over the intermediate term. Low equity market volatility is but one signal of what's ahead for investors.

Underlying much of the discussion today, will be our view that global growth is slowing.  On that note, and despite rumors to the contrary, Chinese GDP growth came in at 8.1%.  This was well short of the estimate of 8.4% growth and dramatically below the “whisper” number of 9.0% that was floated yesterday.  This is the 5thconsecutive decline and the slowest growth rate in three years.  As our Asian Analyst Darius Dale would likely tell you, the actual number shouldn’t surprise anyone as the Chinese have already told us they are going to slow growth.


In other global macro news, European sovereign debt issues are once again front and center.  Yesterday, I wrote a note on Spain and the impact of further decline in real estate prices on Spanish growth (if you didn’t read the note and want a copy, ping  Spanish 5-year CDS are wider again this morning at 492 basis points.  Meanwhile, Spanish equities are down another -2% taking their return in the year-to-date to -14%.  As if that wasn’t bad enough, Spanish CPI was also up +0.7% for the month.  (Not so great for the 23% of Spaniards that are unemployed.)


If you are looking for a positive catalyst today, Chairman Bernanke speaks at 1 pm today in New York.  Even if he doesn’t hint at it, no doubts rumors of QE 3, 4, 5, and 6 will be spreading faster than Chinese growth ahead of his speech.


As you head into the weekend and start contemplating the upcoming Presidential election, I’ll leave you with a quote from a guy that knows a thing or two about U.S government, former President George Washington, who said:


“Government is not reason; it is not eloquent; it is force. Like fire, it is a dangerous servant and a fearful master.”




The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1617-1675, $118.89-122.64, $78.74-79.66, $79.83-83.02, $1.31-1.33, and 1354-1392, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Unproductive Works - Chart of the Day


Unproductive Works - Virtual Portfolio

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.