We thought they beat on revenues but we’ll take the margin beat



BYI delivered another solid quarter on the back of better than expected margins.  While revenues missed our estimate, they were in-line with consensus and strong gross margins pushed EPS above even our Street high estimate of 79 cents.  The market clearly liked what they saw, as the stock rallied another 2% after hours on top of being up 6% intraday.  At $49, the stock trades at 15x FY2014 earnings and throws off a 10% FCF yield, not bad in our opinion, especially given the price tag that SGMS was willing to pay for WMS, which we believe is an inferior business.  We have long thought BYI’s system business was way undervalued by investors.  With more predictable revenues and consistent growth, valuation of this segment should command its due premium.


So what did we like in the quarter?

  • Gaming equipment margins:  Excluding the 200bps benefit from a customer’s election to reduce costs, margins were still north of 50%
    • Even taking into account the higher mix of conversion kit sales in “other product sale revenues,” margins on box sales were still a little north of 50%.  Given that BYI isn’t introducing a new cabinet any time soon and their content remains solid, this should be sustainable.
    • Conversion kits are a big opportunity for BYI.  The vast majority of BYI’s sales comprise of Alpha 2 cabinets.  Currently, BYI’s makes a very small amount of revenues on conversion sales. However, we see no reason why this shouldn’t be a nice area of growth for them for the next few years.  As a point of reference, WMS sold $48MM of conversion kits in FY12 and $31MM in FY11.  FY14 should see strong growth in conversion kit demand which carries over 90% margins. 
  • Systems margins and growing maintenance revenue
    • Maintenance revenues of $23MM and growing.  Need we say more?  As BYI develops more content and continues to deploy more DMs and iVIEWs, the revenue earned per unit per day hooked up to their system should continue to grow.  Needless to say, the continued addition of units hooked up to BYI’s systems also grows this pie.  In our opinion, this is the highest quality and stickiest revenue stream at the company and deserves the highest multiple.  It’s much harder for a casino to replace a system than to replace a slot machine.  Once you have a system, you are going to pay maintenance fees to make sure you get continued updates and the latest products since the incremental cost is nominal. 
    • Margins on systems have averaged 74.4% over the last 10 quarters.  Between the high margins and the visibility on this business, what’s not to like?     

What wasn’t so hot?

  • It looks like replacements in the December quarter were likely softer than we anticipated for the market as a whole.  We now think that YoY replacements, excluding Canada, may have been flat to slightly down for the full calendar year of 2012.  With the trends we’re seeing in the regional markets right now, that doesn’t leave us feeling very encouraged on our 2013 outlook.
  • International segment continues to struggles with no real light at the end of the tunnel.  We expect this 800ish run rate to continue through year end.
  • Gaming operations saw some deceleration and was a little more seasonal than we thought
    • Roughly 50% of BYI’s gaming operation units pay variable fees and approximately 60% of their revenues are comprised from variable fees games
    • Seasonality, Sandy, and weak regional results weighed on the December quarter
    • The March quarter will be better seasonally but we don’t expect much growth in the WAP install base until the June Q

Stand On Your Hands

This note was originally published at 8am on January 18, 2013 for Hedgeye subscribers.

 “When torrential water tosses boulders, it is because of its momentum”

-Sun Tzu


To invert is to change from one position, direction, or course to the opposite position, direction, or course.   Within the context of yoga, the art of inversion includes using breathing and your core mussels to control the mind and the body; inversion allows for efficient brain stimulation.


Blockages of blood flow to the brain can sometimes result in cognitive difficulties or, in extreme cases, serious health issues.  Performing daily inversions combats this by forcibly flushing old blood out of the brain and replacing it with freshly oxygenated, nutrient rich blood coming directly from the heart.  Performing the ritual of Adho Mukha Vrksasana has been empowering and beneficial for me.  The state of relaxation that follows can lead to gratifying periods of reflection. 


Listening to restaurant companies present at the ICR XChange conference is another ritual than can lead to soul searching.  “What am I doing?” “Does this matter?” “Did he really just say that customers love getting a free bucket of peanuts?” 


After many years of attending the ICR XChange conference, I decided not to attend this year.  As part of a new approach in 2013, I am trying to do things differently.  Being a restaurant analyst that is not at the ICR conference is analogous to performing an inversion; in part, it represents the avoidance of group-think that can lead to poor investment ideas.


The truth is, the #OldWall process is broken and, other than secret one-on-one meetings with management, which I have no desire to attend, little-to-no incremental insight is available from listening to restaurant company executives at ICR this week.  The ICR Exchange Conference is as #OldWallSt as it gets.  All 21 sponsors of the 15th Annual ICR XChange are the biggest investment banks on Wall Street.  Before each presentation, an industry analyst takes the podium to say a few kind words about the presenting company and its future prospects.  There are countless intelligent people to learn from at the event but, at its core, it represents the inherent conflict of interest that typifies the traditional sell-side research model from Wall Street. 


Listening from afar, I am realizing that I have made the correct decision.  Listening to endless generic presentations, getting to Chipotle’s “break out” table 30 minutes early just to get a seat, knowing in advance that commentary will be uniformly bullish whatever the underlying reality, becomes a meaningless exercise eventually.  After yesterday’s preannounced EPS miss from Chipotle, anyone could have written the script for today’s conference: “Everything is fine, we are still changing the industry, and our growth opportunity is still as great as ever.  This EPS miss was merely a blip”.  The bar scene in Miami definitely had a Wall Street influence last night.  A lot of conviction can be gathered on an idea while having a few drinks.


The “read through” and “takeaway” from a company meeting at ICR is often meaningless.  We are getting passed a lot of notes from the sell-side stating that “our meeting with management gives us confidence” in our buy rating.  If you ever receive a note from ICR saying that management meetings have bolstered confidence in a short thesis, call me collect.


That’s the problem with the #OldWall, it is very difficult to speak one’s mind about a company.  As an analyst, your incentives should line up with your clients’: produce effective research on the value of the securities in question and assist those paying clients in making their stock selections.   Unfortunately, the incentives of an analyst are too often in conflict with the clients.  Getting paid and retained is what matters; if clients happen to do well, that’s a happy coincidence.  Ask yourself how your sources, and their firms, get paid.


Coming out of events like ICR, the momentum in certain stocks can build and get a lot of people paid in the short run.  If there is one stock in the restaurant space that has embodied momentum over the past few years, it has been Chipotle. Today, management hinted at raising prices in 2H 2013 to absorb food inflation.  Yesterday, the stock reacted very favorably to that news, we think, in error.  The following is a checklist of questions that we think investors need to become comfortable with before getting behind this move in CMG:

  • If they decide to take price, do they have pricing power?
  • How much sensitivity is there?
  • Is new unit volume growth coming back?

On December 12th, we wrote that the CMG bottoming process was likely to take several quarters and that we would be more constructive on the stock at $250.  We know that over the past number of years, new unit AUV growth has led the inflection points in revenue growth, which has sequentially decelerated over the last two reported quarters.  Until new unit AUV growth bottoms, we expect top line growth to remain sluggish. 


The ICR XChange posed an opportunity for management to hint at taking price and, as usual, the congregation was more than willing in their acceptance of the myth.  Chipotle has to operate, like everyone else, in the real world.   CPI for Food Away from Home has rolled over and, with the share-of-stomach battle in casual dining heating up, there could be limited upside from here.  We see significant risk to Chipotle’s traffic, which sequentially decelerated from 3Q to 4Q, even with price coming off the menu, if price is raised meaningfully.


Standing on my hands, over 1,000 miles from Miami, those are the points that I think matter for Chipotle’s shares going forward.   The stock ripping yesterday was predictable but we would caution against chasing it unless you can get comfortable with our checklist above.  


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the S&P500 are now $1644-1691, $109.28-110.83, $3.61-3.71, $79.19-79.98, $1.32-1.34, $88.51-90.27 (oversold), 1.84-1.93%, and 1466-1484, respectively.


Function in disaster; finish in style,


Howard Penney


Stand On Your Hands - hp1


Stand On Your Hands - hp2

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.

Pre-Earnings Call: Look Into Europe

Takeaway: Join us Monday for a pre-Qtr call to review European retail pre-earnings. Tickers include GPS, ANF, KORS, RL, URBN, DECK, GES, TIF, TJX.

Pre-Earnings Call: Look Into Europe - Retail europedial

We’d like to invite Hedgeye clients to participate in a call we are hosting on Monday February 4th to explore the state of retail in Europe in advance of 4Q retail earnings. We’ll be co-hosting the call with Stacey Widlitz of SW Advisors where she will give us her view on incremental changes we’re seeing with different brands in Europe, including promotional cadence vs. last year, and general selling trends overall.  When we hosted a similar call with Stacey last quarter, her insights proved correct on GES, GPS and ANF. We’ll revisit those names, as well as the following on Monday…



PVH (Hilfiger)








local competition-Debenhams, John Lewis, Next, BHS, House of Fraser

fast fashion (Zara, H&A, Topshop)


We encourage you to send any questions in advance to , and we’ll be sure to both ask (anonymously) and answer for you on the call. Stacey will also be available for Hedgeye clients after the call to discuss trends in more detail.


We hope you can join us.




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: BYI reported a solid quarter which exceeded Street expectations across almost all business lines.  Margins on equipment sales were particularly impressive even without the one time 200bps customer benefit.  Guidance was also better. 




  • BETTER:  NA replacement units were up YoY for the 7th consecutive quarter.  BYI thinks they had 20%ish ship share in F2Q 2013 - much higher than F2Q 2012's share of 16%.
  • PREVIOUSLY:  “Our North America replacement units sales were up year-over-year reflecting what we believe is a refocus by operators in investing in their casino floors and an increase in ship-share resulting from our improved content.”


  • SAME:  Cash connection had 1,360 units (up 144 units from last Q).  BYI reported 87% growth in the installed base of WAP games. 
  • PREVIOUSLY:  “Cash Connection, which ended the quarter with 1,216 units, up 591 units from last quarter. Our ending WAP-installed base increased by 26% over the June quarter and 94% versus last year.”


  • SAME:  Bally's Cloud-based Mobile platform has grown to more than 6 million users.   
  • PREVIOUSLY: “Bally Mobile continues its strong momentum and has now grown to approximately 6 million users. Thanks to the measurable ROI, these mobile applications are generating for our customers, we are seeing significant growth, both in new customer acquisitions, which has grown by more than 50% year-over-year, and in the delivery of new features for existing customers.”


  • SAME:  BYI shipped 399 Illinois VGT units in F2Q 2013. All of BYI placements in IL have been for-sale so far
  • PREVIOUSLY:  “We shipped 175 VGT units to Illinois during this quarter and have signed deals for over 4,000 VGT units in this market. We expect the entire rollout to take about two years to complete. As the distribution channel has consolidated, we now expect a higher mix of these missions to be outright sales rather than on lease.”


  • WORSE:  International game sales once again came in below expectations at 787 units.
  • PREVIOUSLY: “International game sales units during the quarter were at 743 units, below our expectations, due to various market conditions and product approval timeline delays. Game sales in international regions remain an important growth opportunity for us. We have multiple product development initiatives currently underway focused on these markets.”


  • BETTER:  Systems revenue increased QoQ as guided by IGT. Gross margins were better than expected. Part of the guidance raise was attributed to better visibility on the systems front.  We continue to believe this segment is undervalued by investors.
  • PREVIOUSLY: “The systems implementations in Canada and Africa are progressing well and we are gearing up for the significant implementations there during the coming months. This combined with growing opportunities for iVIEW DM lead us to be quite bullish on systems for many quarters to come. We expect our systems business to strengthen from this recently completed September quarter due to some of the visibility and some larger installs and also the September quarter can be seasonally slow for customers wanting to put a new system in during some peak season.”


  • BETTER:  operating margins rose to 24% vs 20% in the prior year period. SG&A  declined to 28% of total revenues from 29% last year.
  • PREVIOUSLY:  “We have the belief that our overall operating margin can continue to increase as we leverage revenue growth and margin against what should be a lower percent of SG&A against revenue over time. So, over the mid-term or so, we would hope to be able to get a couple more points in operating leverage”

BYI F2Q13 REPORT CARD - byi244

FNP: Focus

Takeaway: Getting closer to a sale of Juicy? Regardless of the decision, we think the team has focus. Only good can come from that.

Reuters just noted that FNP is exploring alternatives, including a sale, of Juicy Coture. It says that the company has been having discussions, but has not yet made a decision.


This is completely in-line with our thesis on the company, that Juicy has gotten to a point where disposing the asset and paying off debt will allow FNP to focus on its crown jewel – Kate Spade – which is one of the fastest-growing assets in retail. At the same time, it will have Lucky Brand to continue its role as the annuity in the portfolio to help fund Kate’s growth prospects.


It’s easy to get hung up on internalizing near-term growth and margin performance – a hundred million in revenue here or there, or margins plus or minus a point or two. That seems like a lot in a given reporting period.


But with Kate, the company is en route to adding another $1bn+ in revenue and doubling margins. Will COH or KORS double margins? Not when they’re sitting at 31% and 20%, respectively. In fact, we’d argue that COH and KORS margins will converge closer to 25% over the next 2-3 years.  Kate should get close as well from its current margin rate of around 12% (fully loaded).


Kate is doing it right. The company has been investing capital consistently back into building the operating platform to aggressively gain share. Some of that base investment tapers off as the company moves into adolescence. Our point is that in looking at what the company is capable of, think big. This is not about a few points of comp here or there.


We know that we sound like a broken record with our bull call on FNP. But quite frankly, it is a great story worthy of being a bull.


The company is hosting an analyst meeting for Kate Spade in 1Q where the growth opportunity should be more apparent to the investment community.


As for Juicy, we’re often asked “is it really worth anything?”, our answer is ‘definitely’. Think of all the times people chalked up certain consumer brands as being dead. It happened at FNP, actually, when the company owned Mexx – which was a far bigger dog than Juicy. We hate to pick a multiple out of the air in valuing assets, but does 0.5x sales sound in the ‘fair’ category? Sure, it's consistent with past transactions in retail. We wouldn’t be shocked by more. That suggests about $250mm, which could repay 65% of FNP’s debt.


(If the table below is tough to read, let us know and we'll send the file).  


FNP: Focus  - 1 31 2013 8 03 53 PM

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.