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Here is some follow up to our earlier IGT note


  • Earnings
    • We think the low end of the range is likely, so $0.31-0.32 vs. guidance of $0.31-0.37
    • Management continues to defend the quality of the quarter with no acknowledgement that it was one of their worst in a long time.  They are adamant they will hit their annual guidance.
  • Stock buyback  
    • We still don’t have a good explanation on the terrible timing other than that it took a while for the Board to approve and perhaps the quarter’s results were not obvious at that point
      • The buyback was a Board decision and they only meet 4-6x a year so the timing was a bit disconnected with the quarter.  They still view the stock as an attractive value in the long term. 
      • We still think they needed the accretion.
  • North American product sales
    • Since IGT only has 2 buckets in product sales, used units fall into the box sale bucket and that’s where they have always been.  However, typically there are only 100-200 used unit sales per quarter vs the 1,000 used units recognized this quarter. 
    • The used units were old participation products that IGT had in its inventory so the ASP was low, but since they were already either entirely or mostly depreciated, the margin was high
    • The 500 deferrals in NA were primarily related to IGT’s Baton Rouge shipment.  Only 1/3 of their 400+ units were recognized in the quarter.
  • International product sales
    • The 500 deferral units were related to Peru and Argentina
      • In Peru, IGT has a new distributor that they have starting shipping to last quarter but haven’t been able to recognize the units yet
      • In Argentina, the new import restrictions put in place by the government in February 2012 have caused considerable delays for IGT’s products to clear customs.  There is currently a WTO suit against Argentina’s import-substitution policy and other restrictive measures put in place.
    • IGT still expects double-digit international shipment growth for the year
      • In 2011, they recognized 14,700 units.  YTD, they have recognized 10,300 units.  This implies F4Q recognition of at least 5,870 units.  Needless to say we are very skeptical.
      • Growth to come from APAC and Latin America
      • Expectation of recognizing the 900 units that have been deferred over these last 2 quarters should help
  • IGT expects to ship 3,000 units to Canada next quarter
    • If they do, 2012 shipments will represent 44% of their current awards from Quebec (7,200) and Atlantic Lottery (1,612)
    • There are still 3 other provinces to award replacements
  • North American non-box sales did not include recognition of the Revel system
    • IGT hopes to recognize revenues from Revel in FQ4


Favorable tax adjustments make for tough comparisons at Blue Chip


  • For the last several quarters, BYD’s Midwest/South segment EBITDA was boosted by a property tax reversal stemming from a change in the assessed value of Blue Chip
  • BYD included the tax benefit in its adjusted EBITDA but wasn’t explicit about its inclusion in the earnings release - of course until now when lapping it made for a tough comparison
  • In their Q2 2011 release and conference call, they attributed the strong margins to good cost controls



CRI: 2Q Report Card


Conclusion: Strength in Carters' wholesale drove the beat this quarter – and we’ll give them that, but that alone isn’t enough to support a stock with such lofty expectations. Importantly, with little delineation and differentiation of product by channel, stronger wholesale performance is actually competing against CRI’s own retail. In fact, this has been reflected by the decline in new store productivity. With Carter’s retail accounting for nearly 2/3 of 2H revenue growth and ~50% of CRI’s top-line in F13, the company is increasingly reliant on increasing the volume of less productive stores. It should come as no surprise then that store growth has continued to increase over each of the past two years at +14% and +17% in F11 and F12 respectively up from +10% in F10. This is simply not sustainable. Assuming CRI maintains this rate of growth, it would hit its ~600 store opportunity threshold by F14 – then what? We think it will have blown up it's wholesale business long before then -- there's your risk. 

Lastly, the timing of management choosing to go dark on AUR disclosure for “competitive reasons” headed into 2H just smells bad. With product cost pressures now turning to a tailwind down -10% in 2H, the company will have to continue to post solid gross margin results for EPS to meet or exceed current guidance. The opacity in AUR disclosure does little to increase confidence in that regard.

All in, we’re reducing our 2H EPS numbers by $0.05 to $1.45 primarily reflecting higher SG&A spend (e-commerce and marketing) offsetting stronger trends at wholesale. At the time of writing this note, consensus was at $1.84 for 2H and $2.67 in F12 and $3.38 in F13. We’re at $2.40 and $2.95 respectively. If our estimates prove correct, this name has another 25-40% downside from these levels.


CRI: 2Q Report Card - CRI S


Accountability and Outlook: Here’s a look at CRI’s variance between guidance and actual, as well as the outlook for 2H vs. expectations:


CRI: 2Q Report Card - CRI Table


Highlights from the Call:

Comp trends:

  • +1% in each of the brands
  • Carters:
    • April: -3.4%
    • May +2.2%
    • June +3.9%
  • Oshkosh:
    • April: -1.9%
    • May: +6.
    • June: Roughly flat
  • Expect a 2 point shift into Q1 primarily due to Easter shift and unseasonably warm temperatures
  • Current comp trends tracking to plan
  • Not seeing a traffic problem and of the 33 remodels to date, see sales upside due to traffic

AUR Trends:

  • Pulling back on disclosure for competitive reasons
  • "But we continue to make good progress on pricing"

Carter's Wholesale:

  • No customers have seen any major issues with their business resulting in any shifts in demand
  • 4 out of top 5 customers had growth in excess of 10% in 1H
  • Continue to receive positive feedback
  • Have moved Christmas up and could potential see goods in stores within a month
  • Outlook for the business is good

2H Guidance:

  • Didn’t feel the need to increase guidance every 3 months, but have a good growth plan in sales and earnings for the year 
  • First half was far better than envisioned
  • 2Q is the least significant quarter of the year with 2/3 of profitability in the remainder of the year
  • Contniued decline in off price sales will impact 2H wholesale results


  • Second full year of doing business online
  • 1mm square foot DC just north of Atlanta
  • Product is flowing in- wont be shipping out until later this year
  • Margin benefit will be significant- pay a healthy premium to third party provider
  • Carters e-commerce would reach near a 10% operating margin

Direct Sourcing:

  • Previously worked with Li and Fung as a sourcing agent
  • Goal is to be complete over a 5 yr timeframe
  • Canada currently does direct sourcing and the margins are higher
  • Have hired a very talented team over the past 5 years to head up the intiaitive

Product cost outlook:

  • Outlook is good and continues to be good
  • Fall cost for both brands are down about 10% after being up 20% last fall
  • Still not back to normalized levels from 2 years ago
  • Seeing visibility in spring 2013 which could be down 10%
  • Level of clearance sales is down meaningfully which is benefitting margins
  • Off price sales might be half of what they were last year

SG&A Outlook:

  • Directionally, SG&A will rise as a percentage of sales
  • As the business evolves the GM will improve but SG&A as a % of sales will increase
  • Largely driven by Canadian ops, DTC, e-commerce, etc.

Channel Acquisition:

  • Establishing a sourcing team in Hong Kong to support international partners
  • Opening a third party logistics center in Hong Kong
  • Now product will go from Asia to Hong Kong without going to Georgia first
  • Earning impact is immaterial


  • Girls product offering is working which had been the weaker component over the years
  • Gender split is 50/50 for OshKosh; girls is currently running at a slightly higher percentage with girls outperforming

Gross Margin:

  • Majority of upside was driven by Carter's business
  • Child of mine has been a  good margin performer
  • Started to ship fall product and costs are down about 10%
  • Inventory position is dramatically better than a year ago
  • Will continue to see a mix shift benefit
  • At wholesale, customers are focused on maintaining strong pricing via product offering, brand presentation and ease of shopping

Canadian Comps:

  • Cobranded comps +5%, nameplate comps -12%
  • Experienced a significant pull forward in demand into Q1
  • Overall first half was down about 1.5% due largely to outerwear and warmer weather


  • Planning for pricing to be flattish in 2H
  • Spring 2013 pricing will be similar to Spring 2012 pricing

14% pretax margin goal:

  • Current business is much different relative to 2010
  • Expect it will take 4 or 5 years to get back there


  • OshKosh bookings ex off price down slightly


  • Down slightly in the quarter
  • But the quality was more significant
  • Conversion is up at record highs

OshKosh Mall initiative:

  • Looking for the best real estate- not avoiding malls where product is already being sold



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MCD: What’s In A Dollar (Menu)?

McDonald’s is shifting around its menu in an attempt to wean customers on to its Extra Value Menu. At first glance, a shift in menu pricing may not seem like a huge deal for a company the size of McDonald’s. But the move could leave investors hungry for returns as inflation costs and a general disdain for higher prices being passed on to consumers hit the stock price.


McDonald’s (MCD) reported its second quarter earnings this week, noting that earnings had declined 4.5% due to FX risk, namely a stronger US dollar. The company produced a profit of $1.35 billion, or $1.32 per share, compared with a profit of $1.41 billion at $1.35 a share during the same time last year. This was a disappointment for investors to say the least.


So as we look at what lies ahead for MCD in Q3, there’s a very important shift occurring that we believe could negatively impact earnings down the road. That shift is the pricing structure of the menu at McDonald’s. Like many other fast food restaurants, McDonald’s has had a “Dollar Menu” for some time now. Consumers are used to it being there and can get behind something that costs a buck. In this era of inflation and higher commodity prices, however, it remains unprofitable to operate the Dollar Menu.



MCD: What’s In A Dollar (Menu)? - CPI home away from home



In an effort to compromise, MCD went and created the “Extra Value Menu,” which includes the following : 20-piece chicken McNuggets, double cheeseburgers, chicken snack wraps, Angus snack wraps, medium iced coffees and snack-sized McFlurries, plus up to four regional options.


This falls in line with the overall change in pricing structure of the McDonald’s menu, which now consists of four different tiers (combos are excluded): Premium: $4.50-$5.50+ / Core: $3.50-$4.50 / Extra Value Menu : $1.20-$3.50+ / Dollar Menu .

In summary, McDonald’s has taken more costly items like burgers and soft drinks off the Dollar Menu and shifted them to the new Extra Value Menu, replacing them with cookies and ice cream. Believe it or not, there’s a lot of risk in taking away cheap burgers and fries from customers, as Hedgeye Managing Director of Restaurants Howard Penney explained in a note from earlier this year:


We see this as a big risk for MCD.  If customer preference is to have the drink and fries as part of the dollar menu then there is a risk that this change negatively impacts customer satisfaction.  The company told us that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet.  Still, ordering the $1 items individually is being taken off the table.”


Americans are still reeling from the effects of inflation and are opting for items on the cheaper menus instead of the $6-8 combo meals on the core menu. That puts a squeeze on McDonald’s profits and is a factor that cannot be ignored come this fall.  With the company taking price in the U.S. of 3% versus last year, in line with the BLS’s Food Away from Home CPI measure and below Food at Home CPI, customers may be less impressed by McDonald’s value proposition that in years past.


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




  • BETTER:  WYN produced a 2 cent beat over prior guidance and continued to deliver on their promise of returning cash to shareholders




  • LITTLE WORSE:  Excluding the impact of currency, the quarter was flat YoY on a SS basis.  Rentals transaction volume was down though but constant currency increases in price per transaction were better due to mix.
  • PREVIOUSLY:  “We continue to see a stable environment for our rental businesses over in Europe. We've said that that's what we expected. When we entered the year, we said that's what we saw through the first quarter after the first quarter call, and now with April and May in the books, we'll see the exact same thing." 


  • BETTER:  2Q VPG was 6% higher, ahead of FY2012 guidance of +3.5%.  Management says it’s likely that VPG will come in close to the top-end of the 2-5% guidance range for 2012.  Business is still on pace to add 27k new owners in 2012.
    • “We had expected kind of a mid-single digit VPG growth and we ended up with a, I think, 11% VPG growth for the first quarter. We're not suggesting that that's the pace that we're going to remain at going forward.”
    • We expect VPG growth to moderate somewhat throughout the year as we lap the rollout of the credit prescreening program. Consistent with last year, we expect to add 27,000 new owners in 2012.


  • SAME:  Management still expects to spend about $125MM developing timeshare for the foreseeable future
    • I don't see us going back, ever going back to the model we had before where we were building at a pace of $600 million of build a year in order to fuel the kind of growth that that business was on. Right now, we're spending $125 million a year to finish the development of inventory that we already have on our balance sheet. And that's a pace that we'll be at for the next eight to 10 years. And then after that we may go more heavily on this WAAM model and not even have that much development in the future


  • SAME:  WYN repurchased 3.8MM shares for $190MM in 3Q and continues to see value in their stock at current levels
    • We continue to believe that share repurchase offers a compelling return, and with the $750 million increase as of market close yesterday, we have $940 million available in our share repurchase program


  • SAME:  We've made significant progress over the past two years with one of our key Apollo initiatives, brand.com.  Revenue in room nights across the brand portfolio are up approximately 20% from this channel year-to-date in part due to improved content and Web functionality.
    • Wyndham Hotel Group continues to make progress in executing its Apollo initiatives, which is a series of technology projects focused on improving our value proposition to franchisees. Our franchisees will be able to measure our results by the number of direct room nights we deliver to overall bookings, primarily through online strategy. Our goal is to capture the maximum amount of online traffic and then convert these online visitors to stay-in guest. Remember that the launch of our new hotel brand websites and improved content were the first step in our Apollo plan to drive more room nights through our online direct distribution channels. Preliminary results have exceeded our expectations with brand booking increases averaging over 10%


  • SAME:  They launched the 2 planned initiatives on schedule; namely consolidation of their 23 ResortQuest rental sites into an single platform under the Wyndham Vacation Rentals brand umbrella and an integrated reservation platform for the UK cottage and parts brands.
  • PREVIOUSLY: In the second quarter, we expect to launch two significant initiatives. First, in North America, we will consolidate 23 Rental websites into a single improved site. Second, in Europe, we will integrate the inventory and reservation platform of our UK cottages, parts and lodges brands into a common property management system, a change the will enable further yield management and operational efficiencies


  • SAME:  Completed another successful launch of RCI.com with improved click to chat functionality.  Expect online transactions to improve exchange margins by 225bps from where they were in 1Q 2008 when they started initiatives.  In 2Q, 41% of transactions were booked online compared to just 13% when they started the project.
  • PREVIOUSLY: The strength of RCI's technology continues to pay off with online transaction penetration growing to over 40%, up more than 400 basis points from last year.

CAT - Backlog Declines & Backlogs Drives the Stock


CAT: Backlog Decline Implies Weak Orders


  • Despite the move up in CAT today, which we view as short covering driven, weak backlog trends support recent underperformance in the shares.
  • Backlogs declined for first time since 3Q 2009, as the company drew down backlogs in todays “beat.” 
  • As shown below, months of backlog are highly correlated with CAT’s relative performance.
  • Implied orders (estimated as change in backlogs plus revenue) declined 3.0% y-o-y after posting 12.2% growth y-o-y in 1Q2012.  That is a significant deceleration.
  • Something has to give: orders will need to rebound, production will have to be cut, or backlogs will be drawn down.  The current macro data does not suggest a near-term order rebound to us.
  • CAT has been one of the primary beneficiaries of what we view as unsustainably high levels of resource capital investment.  Slowing activity in China is a risk to mining capital spending.
  • Though CAT has an excellent competitive position and a strong franchise, we believe that the shares are overvalued from a cyclically adjusted perspective. 
  • While the months of backlog is still relatively high, historically that has presented an exit opportunity. 


CAT - Backlog Declines & Backlogs Drives the Stock - cat vs months backlog



Orders vs. Revenue:  Implied orders rates now trail revenue, as indicated by backlog declines.



CAT - Backlog Declines & Backlogs Drives the Stock - change in backlogs



BA is not CAT:  For those noting a slight decline in years backlog at Boeing Commercial Aerospace this quarter, that metric is negatively correlated with relative performance.  A change in a 5 month backlog has more relevance than a change in a 7 year backlog.  Though we are well into the commercial aerospace cycle, we think Boeing still has room to run.



CAT - Backlog Declines & Backlogs Drives the Stock - ba rel vs backlogs


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