Do I smell a converts deal and/or equity deal?


Yesterday, MGM announced that it entered into the 7th amendment to its credit agreement.  We wouldn't be surprised if MGM were to issue converts and/or equity on the back of a strong quarter and bullish conference call.


This most recent amendment allows MGM to issue new debt as long as that debt doesn't have seniority over the bank debt or debt that is being refinanced with the issuance proceeds and extends MGM's maturities.  It also allows for an equities issuance that doesn't result in a change in control.  The only give back from MGM is to permanently reduce the bank debt commitment upon any issuances that aren't going towards reducing existing maturing bonds. Below is a summary of Amendment #7.

  • Allow MGM to incur an additional $1BN of debt, provided that the debt is unsecured and covenants are no more restrictive than those contained in MGM's current "Qualified Unsecured Debt"
  • Other than the first $250MM, 50% of the proceeds from any issuance are required to pay down "Qualified Unsecured Debt", specifically proceeds will go towards permanently reducing MGM's term loan and revolving credit facility on a pro-rata basis
  • MGM may also issue "Refinancing Indebtedness" so long as the Refinancing Indebtedness:
    • Has a maturity that dates six months post the maturity of the Credit Agreement and is longer dated than the debt it is meant to take out
    • Is not senior to the Refinanced Indebtedness
    • Amount is not more than 125% of the Refinanced Indebtedness
    • Covenants are no more restrictive than those contained in the company's existing senior secured indentures
  • Company may issue additional equity so long as such issuance does not result in a change of control
    • Other than the first $500MM, MGM must apply 50% of the net proceeds from any issuance towards the permanent reduction of MGM's term loan and revolving credit facility on a pro-rata basis

WRC: Getting By

In-line Q for a company that ‘everyone knows will beat’ is never good – especially when the driver was outsized SG&A reduction. We’re negatively predisposed here, but there’s no catalyst on the downside near-term. We’ll be patient.


Judging by the massive run up in Warnaco’s shares into the close on Tuesday afternoon, one might have thought this was about to be a blowout to the upside.  After all, it wouldn’t e the first time for WRC –which artfully manages expectations.  Yes, Warnaco managed to print an inline quarter, but it did so with a massive 17% y/y decline in SG&A.   As a result, in an environment where expectations are high, inventories are tight, and even the junkiest of companies are beating – this is hardly an impressive result from WRC. 


So what’s next? After going through our model and recognizing management’s guidance of $2.70-$2.80 for the year, we are shaking out at $2.77.  If there’s upside it’s likely to be driven by a massive swing in F/X, which goes from being a 4% drag in revenues in 3Q to a 6.1% benefit in 4Q.  Overall, we remain negatively biased on this one as it is our belief that that the company has been starving itself of investment spend (in the brands) while predominantly focusing on its higher margin, non-US retail expansion (CK stores are still carrying 20% four wall margins).  We can’t argue that this strategy should and will continue to work in the near-term as the company maintains a 20+% square footage growth rate for CK retail expansion (even though backing into new store productivity gets us to abysmal incremental profit metrics).  Over the longer the run, we worry about what will happen when the rate of growth slows and mix-driven margin expansion reverses.  Admittedly, being short WRC as F/X turns into a substantial tailwind, inventories are cleaner than they have been in a year, and same-store sales are showing signs of acceleration, doesn’t make a ton of sense to us.   We’re still skeptical, but realize the factors line up for what is a classic case of “getting by”.


3Q Results

Overall topline came in slightly below our forecast, driven by weaker than expected intimate apparel revenues.  Offsetting this was weakness was a slightly improved retail segment comp, which increased by 2% in the quarter.  Same store sales now appear to have bottomed, after a substantial deceleration over the past year.  In fact, management pointed out that comps for October were up 10%, reflecting a major rebound across both Europe and Asia.  For those of us primarily focused on domestic trends, the interesting takeaway here is that both “weather” and easy comparisons were key drivers of recent strength no matter what region across the globe.


WRC: Getting By - 11 4 2009 9 16 22 PM


For the first time since 2Q08, Warnaco’s sales/inventory spread turned positive, with revenues down 5% and inventories tightly managed, down 11%.  Despite this favorable dynamic, gross margins were still down 260 bps year over year (clearance wasn’t a major theme on the call but it may have played some part here).  The negative impact of foreign exchange, promotional activity and a slight mix shift to lower margin products were to blame.  Offsetting the margin decline was a massive 550bps reduction in SG&A as a percentage of sales.  The decline in expenses of 17% y/y was the largest quarterly decrease we’ve seen since the company announced its plans to eliminate $70 million in annual costs in 2009.  Aside from cost savings initiatives, F/X was a substantial y/y benefit, as last year’s 3Q included $15mm of F/X related expense that reversed this year.  All told, the quarter was inline at $0.75 per share.



WRC: Getting By - 11 4 2009 9 16 57 PM


Eric Levine

Director, Retail Vertical

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FL/FINL/HIBB: Timing is Everything

The trend in higher priced sneakers remains abysmal. 4Q is gonna be tough. But the setup into 2010 is something else entirely.



When sifting through sales results tomorrow, you should keep an eye on any anecdotes around athletic footwear – and specifically, why consumers are avoiding the category on the margin in the midst of an otherwise solid overall retail comp trajectory. Is it because of the strong boot cycle (ie dollars shift to dept stores)? Nah… Not much overlap as it relates to customer/purchase intent. My sense is that it remains the downshift we’re seeing. I’m not referring to a simple shift to lower price point product within like-for-like retailers, but rather the complete downshift into different channels – most notably the Family Channel (one of the reasons why we’ve liked PSS so much).


Maybe Mickey Newsome said it best on Hibbett’s Q2 09 Call: “Our most difficult business was footwear, off mid to high teens with all genders off. I really don’t remember [a quarter] being down this low.  We have gone through some down cycles in footwear but not to the extent that this one is.”


Allow me to inject my opinion… This is a space that is almost entirely product-driven. If the consumer is trading down, it is because there is no reason for them to pay up for something pricey. There are some unique products in the market right now – like Nike’s Lunar Glide. But aside from that, there’s not a whole lot. Something to consider is that come Spring/Summer I think Nike’s pipeline will open up (i.e. things that will be ordered over the next few months and show up at retail six months later), and this is the same time that UA’s new footwear org under new leadership will start humming. 


While that’s good for the whole industry, the particularly levered play is FL, FINL, and to a lesser extent HIBB.  Timing is key, as we still have an ugly quarter ahead. We particularly like FL, as all of this will coincide with the start of Hicks’ (new CEO) plan to turn around this perennial dog.


FL/FINL/HIBB: Timing is Everything - 11 4 2009 8 37 59 PM


FL/FINL/HIBB: Timing is Everything - 11 4 2009 8 38 40 PM

SBUX – Continues to make progress

Starbucks is scheduled to report fiscal fourth quarter earnings after the close tomorrow.  The reported comparable sales number, primarily in the U.S., and any initial fiscal 2010 comp guidance will matter most relative to investor sentiment.


My $0.22 per share estimate is a penny higher than the street and is above the company’s $0.19-$0.20 per share guided range. 


Continued momentum from 3Q09:


Like last quarter, I am expecting continued sequential improvement in SBUX’s comparable sales growth.  My estimates assume a 3% decline in same-store sales growth in the U.S. (from -5% in 3Q09) and a -1% number in the company’s International segment (from -2%).  These assumptions imply that 2-year average growth remains even with last quarter, which could be conservative given the level of momentum in sales growth throughout the third quarter.


I would expect this sequentially better -3% results in the U.S. to be driven largely by continued improvement in traffic trends as check will continue to be pressured somewhat by the company’s recent focus on value offerings, such as its beverage and food pairings and discounts offered through its Starbucks loyalty card programs.


Margins should continue to look better on a YOY basis; though U.S. margins will most likely decline somewhat on a sequential basis from 3Q09’s reported 13.4% number.  This should not come as a surprise, however, as management set expectations lower for the fourth quarter, citing “normal seasonal variances in [its] U.S. business.”  Margin improvement will be driven largely by continued commodity cost favorability in the U.S. and the additional $180 million of costs savings that are expected to be implemented in the quarter. 


Looking at dairy costs, there has been some concerns out there over the recent increase in milk prices, which will no doubt have an impact on the business on a go forward basis, but milk prices on average were down 45% YOY during SBUX’s fiscal Q4 (even more than the average 41% decline during its fiscal 3Q09).  In October and November, some of this YOY favorability has diminished with prices down only about 20%.  But, this is more of a concern for the company come Q1. 


Starbucks recently addressed this concern in a press release after the Wall Street Journal published an article titled “Pricier Milk Could Curdle Profit Growth at Starbucks”, stating, “The Wall Street Journal article of October 11 omits an important aspect of Starbucks dairy cost management.  Approximately six month ago, Starbucks initiated a program to mitigate the price uncertainty of a portion of Starbucks future purchases of dairy products.”  I find it surprising that Starbucks even responded to this article, but I think it further highlights the fact that the company does not think the rising dairy prices pose a significant, immediate risk to earnings.  Management had stated on its 3Q earnings call that it expected dairy prices to be neutral to somewhat unfavorable to earnings on a YOY basis in fiscal 2010.  I am interested to learn more about this dairy cost management program because I don’t recall the company ever hedging its milk exposure in the past. 


Cost savings will play a major role in the quarter as the expected $180 million represents the peak in initiated savings year-to-date ($75M in Q1, $120M in Q2 and $175M in Q3).  That being said, the fourth quarter is also the last quarter before the company begins to lap these initiatives on a YOY basis.


Negative currency translation attributed to the 11% decline in International revenues in the third quarter as a result of the stronger U.S. dollar compared to the British Pound and the Canadian dollar.  In the fourth quarter, this trend continued but to a much lesser degree on a YOY basis.  Based on current exchange rates, this currency impact will likely turn positive in Q1.


Management already provided some fiscal 2010 guidance when it reported 3Q09 results.  Specifically, SBUX said it expects 13%-18% EPS growth (including the 53rd week), assuming 150-200 bps of margin improvement in the U.S. and 200-250 bps of margin growth from its international segment.  The company did not provide any comp guidance or unit growth targets, except to say that it expects to grow store counts year-over-year, driven primarily by international growth and some growth in the U.S.


I think any number better than -1% for U.S. comparable sales guidance would be both positive and reasonable.


Though not relevant to Q4 results, I would like to hear what management has to say about:


1.  the recently launched VIA product.  For reference, Starbucks put out a press release on October 12 stating that after only 2 weeks of national availability of Starbucks VIA, early indicators showed that the product was exceeding expectations. 


2.  how much it is planning to spend behind the brand (management already said it intends to spend significantly higher marketing dollars than any typical quarter to support the launch in Q1). 


3.  its recently announced plan to combine its two Starbucks Card programs in an effort to increase customer frequency.


4.  future plans for free cash flow usage.  As I have said before, I would like to see the company use its increased level of free cash flow in 2010 to establish a dividend.  I would also expect the company to begin to buy back stock again in 2010.



SBUX – Continues to make progress - sbux4q09

Bernanke Panders, Again!

Three minutes prior to the FOMC release, the Buck was Burning to the tune of -0.76%, down to $75.81. That’s -15% lower than where the price of what was once the world’s reserve currency was in March. Three minutes after the release, the US Dollar didn’t really budge.


The Fed made NO changes to the statement other than a token shift in the agency debt plan. The plan on rates is to keep pandering to the fear-mongering politics the moment, keeping rates “exceptionally low” for an “extended period” of time. Citizens of America who hope to save at a real rate of return, shame on you. Go back to your day jobs, if you still have one.


Although the marked-to-market facts have changed (GDP, stocks, credit, gold, oil, etc…), unfortunately Mr. Bernanke’s plan has not. He is being who they hired him to be. A conflicted and compromised head of the US Federal Reserve who is crushing the credibility of the currency, in search of short term political gain.



Keith R. McCullough
Chief Executive Officer


Bernanke Panders, Again!  - BernGeith

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