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




  • SLIGHTLY BETTER:  Although EPS was in-line, the BYI release was more positive than expected, particularly after the WMS and IGT debacles.  BYI placed more new participation games than expected.  Buying back as much stock as the did was also a plus.



  • IN-LINE:  Reported FQ4 of $0.78 and FY 2012 EPS of $2.45 (although better than the whisper)
  • PREVIOUSLY:  FY 2012 EPS: $2.37-$2.45 ($0.72-$0.80 in F4Q)



  • IN-LINE:  F4Q R&D was 10% of revenues (vs 11% of revenues YoY), while SG&A was 26% of revenues, (vs 28% of revenues YoY). A relief after the cost inflation seen at IGT & WMS
  • PREVIOUSLY:  "Our R&D and SG&A to grow at a somewhat lower percent of revenues, although we continue to invest aggressively in R&D."


  • BETTER:  purchased $73 million (1.6 million shares) of common stock in F4Q and purchased an additional $33 million (745k shares) of stock post June 30.  The company has ~$58MM available under its board-authorized share repurchase plan.
  • PREVIOUSLY:  "We still have approximately $57 million remaining under our board authorized share repurchase plan and would expect to increase this amount in the coming months if necessary."





  • SAME:  BYI reiterated shipping their Atlantic lottery units in F2Q13
  • PREVIOUSLY:  "We were awarded a little over 1,500 games…We would expect to start selling those units in the second quarter of our fiscal 2013, probably take about three to five quarters to fill that order out. Within the class three machines in Canada, there's probably a good 60,000 to 65,000, we routinely replace those games. We're about a 20% player in class three there, but VLT is definitely a new initiative for us."


  • SAME:  F4Q game equipment margins was in-line QoQ.  Guidance commentary on game equipment margins reaching 48-49% within the next 2-3 quarters remain unchanged.
  • PREVIOUSLY:  "Based on anticipated mix for our fourth quarter, which we expect will include multiple Ohio properties, we anticipate our Game Sales gross margin will decline slightly over the third quarter. However, we still expect our Game Equipment margins will approach 48% to 49% within the next few quarters, due to continued reductions in material costs on each of the Pro Series cabinets."


  • SAME:  BYI expects to begin shipments to the Illinois VLT market in FQ2 2013, pending final approval of locations
  • PREVIOUSLY:  "We've had good discussions with customers there, have signed several contracts and feel our products are well positioned for the market, which should result in us winning a fair share. We expect to begin initial VLT shipments in Illinois during the second half of calendar 2012, with the mix of sale versus lease to be determined by the contract terms, which are in various stages of negotiations now."





  • SAME:  F4Q systems margins came in at 74%
  • PREVIOUSLY:  "We currently anticipate that fourth quarter Systems margin will return to the higher end of our historical range of 70% to 75% based on mix.”





  • SAME:  Strong performance by both Grease and Michael Jackson.  BYI continues to believe they will do well.  Cannibalization remains low due to low WAP exposure and unique product offering. 
  • PREVIOUSLY: "We just released Grease in March, and it's doing very well in the marketplace better than our expectations.  We've seen very little cannibalization. Michael Jackson is in beta test performing very well mechanically, and we think it's going to perform well when we launch it here in the next week."


  • BETTER:   WAP increased base increased by 500 units (+31% QoQ and +72% YoY) including Grease & MJ placements; this exceeded mgmt expectations.  BYI continues to think that 750 placements for each of these games is acheivable.  They have a couple of follow on games and changes to extend the life of the games.
  • PREVIOUSLY: "Our guesstimate is that it would be reasonable to get in the neighborhood of 750 each of these two games [Michael Jackson/Grease] placed over the first six to nine months from launch; and we would expect very low cannibalization of our existing WAP games because we have so few WAP games."


Finally a solid quarter and guidance in a sea of disappointments



“Our fourth quarter and fiscal 2012 results validate our leadership position in gaming technology innovation. This innovation leadership and visibility into further growth opportunities for all of our businesses for fiscal 2013 and beyond is tremendously encouraging.”


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



  • 19% NA ship-share
  • iVIEW DM went live in 8 additional locations this quarter. Now have a solid base of 1,050 games running across all major manufacturers and pipeline continues to grow.
  • Anticipate an improvement in their FY13 operating margin as gaming sale margins should increase
  • Recorded a $10MM charge recorded to settle certain outstanding legal matters
  • 4,143 units to NA (1,323 new and expansion units and 2,820 replacements)
  • Still expect to get to 48-49% game sales margins due to continuous cost reductions 
  • Repurchased 1.6MM shares of stock in the quarter
  • In July several of their Elite Bonusing Suite of products went live across iVIEW and iView DMs at South Point in LV.  Since the launch, South Point saw an improvement in food traffic, carded play and player card enrollment.
  • They were the first company to get an interactive gaming supply license in the US
  • BYI's cloud-based mobile product continues to move forward at good speed.  Have 58 gaming and non-gaming sites currently using their mobile products with ~60 applications running.  Expect their content generating revenue on various portals in regulated international markets some time in the near future.
  • First U.S. based play for free poker site at Golden Nugget using their backend B2B i-gaming platform went live this quarter. 
  • They completed testing in Italy and are currently operating in several locations.  Expect to have 1,000 VLTs in Italy by the end of FY13.
  • Making progress in their shipments to Australia and completed their first systems installation there 
  • Expect to begin initial shipments to IL in F2Q pending approval of more locations
  • Making good progress on international systems implementations 


  • Legal $10MM accrual:  For several matters (more than 1, less than 6)
  • Michael Jackson/ Grease:  Think that the games have the potential to have 750 units each. Cannabalization is still low because they don't have much in terms of WAP. They also don't see any impact from consumer weakness yet.  Their gaming operations margin this quarter was impacted by a bit by higher jackpot expense.
    • Average win per day is meeting their expectations.  In each of the quarters this year, they have been above $100/day on WAP and were below that last year.
  • Range for FY2013 depends on success of future WAP releases, ability to hit their margins and meet sales expectations with Pro-Series. There are a lot of new markets opening as well. 
    • How much and how fast of IL will roll out; how much will be for sale vs. participation
    • Italy rollout and win per day performance
  • WAP:  there hasn't been any new competitor pressure 
  • 745,000 shares were repurchased for $33MM post June 30th
  • Grease:  Out since March.  They have a couple of follow on games and changes to extend the life of the games.
  • Their WAP strategy doesn't stop with just MJ & Grease
  • Their iDeck is considered a value proposition; don't need to switch out the button panel.  Same thing with the Curve- customers don't need to change out the reels.
  • They are focused on the categories of gaming operations. They are not focusing on WAP at the expense of Premium.
  • Very comfortable with their leverage ratio given their 50% recurring revenue base.  They have been very focused on execution of their strategies. So a lot of the execution risk is behind them now, and therefore some accretive / strategic acquisitions in addition to using their FCF on making buybacks.  They usually buy back $15-20/MM per quarter. They assume that they will buy back between $60-80MM of stock in FY13.
  • Their DM sales were up several times what they were last year.  Expect that DM sales will keep increasing YoY.
  • In Italy, their prospects are modest given their product delays
  • Their first system went live in Australia and just went live in New Zealand a few months ago.  South Africa is moving along.
  • Canada VLTs do come at a lower ASP- but the margin is good.  IL will also come at a lower ASP.
  • Their i-gaming strategy is to go in with their customers.  They launched their free play poker site for Golden Nugget.
  • They have 58 mobile sites up and running.  They believe that mobile can be more profitable than i-gaming in the near term. 



  • FY2013 guidance for Diluted EPS of $2.95 to $3.30. 
    • "This guidance anticipates continued year-over-year growth in each of game sales, gaming operations, and system revenues. The Company currently anticipates an increase in the placement of its premium games, particularly WAP, an increase in the number of gaming devices sold with continued margin improvements on game sales, and continued growth in its systems business. This guidance assumes an effective tax rate between 38 percent and 39 percent"
  • BYI reported $246MM of revenue and EPS $0.78, a little ahead of consensus estimates
  • In 4Q BYI purchased $73MM of stock and another $33MM since June 30, 2012. In FY 2012. BYI repurchased $155MM of stock at an average price of $40.06.  $58MM is available under their buyback plan as of today
  • Gaming Equipment: 
    • New gaming devices: 5,322; ASP: $17,182 (increase due to higher mix of Pro Series cabinets sold)
    • International shipments: 1,170
    • Gross margin increased to 46%.... primarily due to mix and cost reductions on certain models of the Pro Series line of cabinets
  • Gaming operations:
    • “Increased the Cash Connection wide-area progressive (“WAP”) installed base by almost 500 units in the fourth quarter including additional installations of Grease and the recently launched Michael Jackson"
    • 72% gross margin
  • Systems: 
    • $20MM of maintenance revenue
    • 74% gross margin, due to change in mix.  "Hardware sales were 29%  of systems revenues, and software and service sales were 35%, as compared to 42% for hardware and 29% for software and services" in 4Q11
  • "SG&A increased $2 million primarily due to an increase in payroll to support key new markets."


CONCLUSION: Inclusive of China’s July GROWTH and INFLATION DATA, we reiterate our intermediate-term view of the Chinese economy, which remains: A) we do not expect a meaningful inflection point in Chinese economic growth and B) we do not anticipate a meaningful acceleration in fiscal stimulus, state-directed lending or deregulation in the property market. If anything, we could potentially see increased tightening in the latter if speculative activity is detected in the July/August property price data and/or the State Council’s regional surveys. Lastly, we reiterate our bearish long-term thesis on the Chinese yuan and Dim Sum bond market – a position supported by the latest data points.


Overnight China reported incrementally-dovish July GROWTH and INFLATION data – which, of course, paved the way for aggressive media coverage demanding that the PBOC cut interest rates or RRRs. Those speculative demands were no doubt emboldened by the Chinese stocks’ intraday rally from trading flat-to-down to close up +61bps on the day. The close of 2,174.1 on the Shanghai Composite Index puts it at 5 ten-thousandths of a percent higher than our immediate-term TRADE of resistance.


While we don’t expect to see a sustained follow-through, we are waiting and watching for confirmation; our fundamental case on China (as laid out above) will not change absent a meaningful shift in the data or a quantitative breakout above our TREND line as indicated in the chart below:




Below, we neatly parse the July data into the following three buckets for you:



  • JUL Industrial Production: +9.2% YoY from +9.5%
  • JUL Retail Sales: +13.1% YoY from +13.7%
  • JUL YTD Urban Fixed Assets Investment: flat at +20.4% YoY
    • YTD FAI – Real Estate Development: +15.4% YoY from +16.6%
    • YTD FAI – Construction: +19.6% YoY from +20.6%
  • JUL YTD Source of Funds for Fixed Assets Investment – Foreign Direct Investment: flat at -11.1% YoY
  • Key Takeaways: Chinese economic growth continues to slow across sectors and the continued weakness in retail sales indicates that the government isn’t “rebalancing” the Chinese economy (w/ respect to their current 5yr plan) as quickly as some might have hoped. Beyond that, we flag the -11.1% YoY rate of decline in foreign CapEx as a sign that international corporations remain particularly sour on the Chinese growth story and we continue to see longer-term negative implications here for China’s currency and cross-border capital flows. The recent occurrence of China’s sovereign Dim Sum bond yields normalizing with mainland rates is in support of our thesis, which we outline at the conclusion of this note. 



Spot prices for Rebar and Hot Rolled Sheet steel continue in free-fall, as economic growth expectations remain muted in what is arguably China’s most important domestic commodity market from a economic growth perspective (Fixed Capital Formation = 46.2% of GDP).





  • JUL CPI: +1.8% YoY from +2.2%; slowest rate since JAN ‘10
    • While falling pig prices shaved -71bps off of the YoY headline figure, the food category overall contributed +78bps to the headline figure on a net basis.
  • JUL PPI: -2.9% YoY from -2.1%;s lowest rate since OCT ‘09
  • Key Takeaways: Despite rates of headline inflation falling to new multi-year lows, Chinese interest rate markets continue to price in incrementally less easing out of the PBOC, as indicated in the chart below. We interpret this as a sign that those closest to the source are taking the PBOC’s recent hawkish warning on 2H inflation at face value. 




  • JUL YTD Source of Funds for Fixed Assets Investment – State Budget: +30.5% YoY from +26.7%
  • JUL YTD Source of Funds for Fixed Assets Investment – Domestic Loans: +6.7% YoY from 5.8%
  • Key Takeaways: Consistent with the recent pledged increases in railroad investment and low-income housing development, the State Council continues to “fine tune” its economic policy with respect to “stabilizing growth” by increasing sovereign expenditures on investment. It’s important to note, however, that stabilizing ≠ stimulating. As it relates to a state-directed lending spree, growth in domestic loans earmarked for Fixed Assets Investment accelerated to +6.7% on a YTD, which remains far, far below the +20-40% YoY clips recorded during the 2009-10 lending spree. Mid-single digit growth rates is hardly stimulatory in comparison and is consistent with Chinese policymakers’ decreased willingness to stimulate. In fact, recent statements suggest that they appear keen to avoid the recent mistakes of overinvestment and capital misallocation – both of which contributed to the current property bubble – during this growth slowdown. 




If you haven’t yet had the chance, we encourage you to check out our recent work on China – particularly our thoughts on the outlook for Chinese policy over the intermediate term. Importantly, we are increasingly of the view that aggressive expectations for Chinese stimulus and the associated rebound in Chinese economic growth are being priced into “risk assets” broadly and that Chinese policymakers are likely to disappoint those expectations. For more details please review the following notes: 

  • FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKETS (APR 16): Given the asymmetry of both the pricing setup and fundamental outlook, secular yuan weakness and a bearish re-pricing of the Dim Sum bond market are two long-term TAIL risks we are flagging to you at the current juncture.
  • CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 23): While Deflating the Inflation remains a bullish catalyst for the Chinese economy, the lag between this event and the turn in both the reported growth data and growth expectations may have just increased. As such, we are of the view that waiting and watching for clarity is the best strategy in the immediate term for China.
    • As an aside, China’s Shanghai Composite Index remains in a Bearish Formation and is down -8% since we put out this initial bearish piece on the Chinese economy in this latest cycle. That is far and away the largest decline throughout the region over that duration and is vastly underperforming the regional median gain of +6.7% (same duration).
  • CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD (JUN 7): We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.
  • CHINESE GROWTH: STICKING TO THE CENTRAL PLAN (JUL 13): We maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
  • PONDERING CHINESE GROWTH PART II (JUL 17): Contrary to consensus speculation, we are of the view that Chinese policymakers are likely not readying a stimulus package to be announced and administered over the intermediate term that would be substantial enough to meaningfully inflect the slope of Chinese economic growth. As such, it would be prudent to fade any incremental Chinese stimulus rallies for the time being.  

Best of luck out there,


Darius Dale

Senior Analyst

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FTK: Under Pressure (On Margins)

For months we have been bearish on Flotek Industries (FTK). The case we’ve made is that large oilfield services (OFS) players have seen their revenue come under pressure from lower energy prices. When cost cutting measures come into play, chemical suppliers like Flotek will be the first to undergo price renegotiations, which in turn hits their margins.


Flotek reported its second quarter results today. It missed on the top line ($78MM vs. $81MM estimate) but beat on headline EPS ($0.25 vs. $0.22 consensus).  That headline number is noisy, skewed mostly by a change in the fair value of warrant liability. Operating income (does not include unusual items) was a big miss, which was largely ignored this morning.  Operating income came in at $15.6MM vs. $17.3MM expected.



FTK: Under Pressure (On Margins)  - FTK metricsmatter



Yet after reporting second quarter results, Flotek enjoyed a +15% pop in their stock. We were not short FTK in the Hedgeye Virtual Portfolio but after this pop, we will look to short again when price and timing line up accordingly. Hedgeye Energy Analyst Kevin Kaiser outlines his two-fold bearish thesis on FTK below:


1.            Top line growth is slowing faster-than-expected as drilling activity slows onshore North America;

2.            Gross margins would contract sequentially as pricing power slips and input costs remain sticky in the Company’s Chemical and Drilling business lines.


We were spot on for the first point, but the second point we missed. Apparently the Street is willing to take the company’s word on guidance for gross margins despite our case with regard to pressure on large OFS players like Haliburton (HAL) and Baker Hughes (BHI). We think that margin guidance + the high short interest (18%) is why the stock is so strong this morning.


In essence, this quarter is being spun very well by market participants. On our quantitative model, FTK has broken out above our TREND line of $10.82, so we will wait and watch here.

CRI: Turning Point

Conclusion: The strategic implications of this CRI deal with JCP are spot-on with what we think is a very underappreciated risk in retail. It may give CRI a near-term revenue lift due to channel-fill, but it is ill-equipped to manage undifferentiated product across channels with polarized price points. This will ultimately be its undoing.


We’ve been waiting for this announcement that Carter’s is opening a shop inside JC Penney. It makes perfect sense, actually, in the context of the store that JCP is trying to build. But while these ‘partnerships’ seem equal, the reality is that they’re not, and this one favors JCP by a country mile. Ultimately, we think that this will be CRI’s swan song.

Consider the following…


1)      JCP has a bidding process for all its shops. CRI no doubt went up against Gerber, Disney, Circo, Zutano (highest unit count on Amazon) and others for this business. It is definitely a sales/margin trade off. Note that VFC’s Lee recently lost out to Levi’s in JCP as it did not chase price. Good long term for VFC. Bad short term. CRI is the opposite.


2)      CRI’s challenge is that it puts similar product into every channel of distribution. Look inside Wal-Mart, Target, Macy’s, Amazon, and Kohl’s. They all have product that is remarkably similar. That’s fine when a brand is small, but as it grows up, it gets very dangerous.


3)      Oh and by the way, the same product is in Carter’s own stores, and on its web site, and it’s almost always 40-50% off.


4)      Look at what happened when Liz Claiborne launched Liz & Co inside none other than JC Penney 6 years back. The product looked very similar to what was selling at Macy’s, but at a lower price. It didn’t take Macy’s too long to cut Liz. The market’s reaction was not pretty – the stock went from $43 to $2.


5)      How does Carter’s in-store promotional strategy synch with Johnson’s ‘Every Day Low Price’ strategy? So if a product is $14.99 list in a Carter’s store, it will be knocked down to $8.99 on day 1. On average, the whole lot will clear at about $6.00. If Johnson holds true to his Plan, then he’s going out with an initial price in the $6 range. How will Macy’s feel about that when they’re selling the same thing down the hall for $10? Wal-Mart at $9?   


6)      CRI is setting up this deal with its largest customer’s top competitor – KSS. Let’s think of how that discussion went for the CRI sales rep to Kohl’s. “Hey…Just want to let you know that we’re starting a program with JC Penney to do exclusive shops with product that is at least as good as what we’re selling to you, but will be listed at a 30% discount. You cool with that? Good. Nice knowing you.”


7)      CRI does not need to disclose how big Kohl’s is as a customer, because the reality is that as a percent of aggregate sales no one is within a stone’s throw of 10%. But that’s bc CRI’s own retail business accounts for about 55% of sales versus only 29% for Carter’s wholesale. But that’s comparing apples and oranges. We need to either gross up wholesale, or take down retail for an even comparison. Either way, looking at EBIT is a fair comparison. In the regard, both Carters US brand wholesale and retail each account for about 45-47% of EBIT. International accounts for the rest, more than making up for Osh Kosh, which is perennially in the red. KSS might only account for 3-4% of CRI’s total sales, but it is closer to 6-7% of profits.


8)      This is not just about KSS. There are going to be so many moving parts across retail in 2H. Heck, there already are. That will intensify. The dominoes that fall in footwear, housewears, underwear, fragrances, etc…will cause reverberations that are impossible to predict. For example, JC Penney’s Tourneu shop could take share from Macy’s on the margin at ridiculously low prices. Macy’s might not strike back in the jewelry category, but rather in its terms or pricing with Outerwear vendors like Columbia, Underwear like Hanesbrands, or moderate ends of the portfolio of apparel/footwear from companies like Jones Group. The cross-currents here will be fierce, and we have yet to gain conviction that anyone is really prepared for it.


Growth has come from Playwear. That’s less defendable than the core baby biz (i.e. Competes w/Old Navy)

CRI: Turning Point - category


Can’t look at the wholesale/retail split by revenue, as it grossly understates the importance of the wholesale business.

CRI: Turning Point - revebit


Company-Operated retail stores and mass retailers have grown in importance

CRI: Turning Point - channel


We’ve always believed that slot volume is the ultimate indicator of a Vegas recovery


  • Our predictive model has been proven effective in projecting monthly slot volume on the Strip as indicated by the high correlation between the red and blue lines
  • MGM is as close to a Strip pure play as there is and its stock has closely tracked changes in slot volumes on the Strip
  • We’re not optimistic about slot trends over the near term and maintain that Vegas may be in a secular slot decline due to poor demographics and an aging core slot customer base



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