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Cabela’s Inc. (NYSE:CAB)

Q4 2008 Earnings Call

February 19, 2009 4:30 p.m. ET

Executives

Chris Gay – Treasurer and IR Manager

Dennis Highby – President and CEO

Ralph W. Castner – VP and CFO

Patrick A. Snyder – SVP of Merchandising, Marketing and Retail Operations

Brian J. Linneman – SVP of Global Supply Chain and Operations

Analysts

Rick Nelson – Stephens Incorporated

Reed Anderson – D. A. Davidson

Mitch Kaiser – Piper Jaffray

Paul Lejuez – Credit Suisse

Reed Anderson – D. A. Davidson

Jim Duffy – Thomas Weisel Partners

David Cumberland – Robert Baird

Bob Simonson – William Blair

Operator

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Cabela's Incorporated fourth quarter and fiscal 2008 year’s end earnings conference call. (Operator instructions).

I will now like turn the conference over to Mr. Chris Gay, Treasurer and Investor Relations Manager. Please go ahead sir.

Chris Gay

Thanks, good afternoon. I welcome everyone listening today both on the conference call and by web cast. A replay of today’s call will be archived on our website at www.cabelas.com. Leading our call today will be Dennis Highby, our President and Chief Executive Officer. Also joining us this afternoon is Ralph Castner, our Vice President and Chief Financial Officer; Pat Snyder, Senior Vice President of Merchandising, Marketing and Retail Operations and Brian Linneman, Senior Vice President of Global Supply Chain Operations.

This conference call will include forward-looking statements. Statements are made on a basis of our views and assumptions as of this time and are not guarantees of future performance. Actual events or results may differ materially from those statements. For information about certain factors that could cause such differences, investors should consult our annual reports on Form 10-K and quarterly reports on Form 10-Q filed at the Securities and Exchange Commission and available on our website including the information set forth under the captions “Risk Factors” and special note regarding forward-looking statements. Now let me provide a summary of our fourth quarter results.

Consolidated revenues for the quarter were $879.4 million as compared to $889.5 million in the year ago quarter. For the quarter, retail revenue increased 6.9% to $429.5 million. For the quarter, comparable store sales increased 2.2%. For the quarter, direct revenue was $410.4 million compared to $446.9 million in the year ago quarter. For the quarter, financial services revenue increased 0.7% to $38.1 million, and diluted earnings per share for the quarter was $0.74.

Fourth quarter results benefitted by $8.7 million from a change in accounting for breakage of gift instruments, this was partially offset by $5.8 million of charges related to severance cost, goodwill and other asset impairments and a pre-payment penalty associated with our pre-payment of $26 million of debt.

Now I'll turn the call over to Dennis Highby, our President and Chief Executive Officer.

Dennis Highby

Thanks Chris. Our fourth quarter results demonstrate the power of our profitable multi-channeled model. The strength of Cabela’s brand and our ability to capture market share in a considerable traction we’re realizing and our efforts to reduce cost and carefully manage inventory levels. During the quarter our merchandise strategy was to take market share, increase inventory turns, and improve cash flow. The strategy put a particular focus on firearms and related accessories, which resulted in a 2.2% increase in same store sales for the quarter. Ralph will provide a comprehensive review of our fourth quarter results shortly; however we’re very pleased with our ability to guide positive accounts to our sales, tightly controlled inventory levels, generate record cash flow from operations, reduced debt levels and further streamline our retail operations during the quarter.

I’ll now highlight some of the many accomplishments we had during the year, which provide a strong foundation for future growth.

First was our focus on tightly managing inventory levels. Inventory levels decreased 15% or $90 million to $518 million at the end of 2008 as compared to $608 million at the end of 2007. We believe this improvement is sustainable and there continues to be opportunity to inventory levels in 2009.

Second, cash flow from operations improved significantly in 2008. During the year on a consolidated basis we generated cash flow from operations of $155 million as compared to $32 million in 2007. We believe this is a sustainable level of cash flow from operations well into the future.

Because of our exceedingly strong cash flows, we prepaid $26 million of outstanding debt at the end of the fourth quarter. This debt repayment along with a lower outstanding balance in our revolving line of credit, allowed us to exit 2008 with less debt than we had a year ago. After this debt repayment, our lease adjusted debt to total capital is 32%. This gives us one of the strongest balance sheet in the retail industry, making us much better prepared to weather this economy storm than most of our competitors.

Third, visits to our internet website increased 32% in 2008 and our website was once again the most visited e-commerce website in the sporting goods industry. For 2008 Cabela’s had more than twice the traffic of our next closest competitor. In fact of America’s largest retail websites, Cabela’s ranks in the Top 40 in annual sales regardless of the industry. For 2008, internet revenue increased 8.2%.

Fourth, we have several improvements in our retail operations including high leverage ticket in our customer base, improved customer service levels across our entire store base and improve labor as a percent of sales.

Fifth, we realized significant improvements in distribution efficiencies. Distribution cost as a percent of merchandise revenue improved 40 basis points in 2008 as compared to 2007. Automated receiving of inbound units improved 66% of units from 41% of units last year. Improvement in distribution cost have been driven by benefits, we continue to realize from our warehouse management system as well as improved vendor compliance and improved merchandise planning.

Finally, World’s Foremost Bank continue to add new cardholders. In 2008, the average number of active accounts increased 15.5% to 1.14 million average active accounts. The Cabela’s Club Visa Loyalty Program provides us a significant strategic advantage over our competitors. We will continue to add new Cabela’s Club members to gain market share from our competition.

These are just some of our numerous accomplishments during this challenging year. In reviewing the merchandise categories that contributed to revenue growth during the year, most were in our hunting category. For the fourth quarter and the year, we realized significant growth in hunting equipment, which is consistent with our experience during the last recession.

The extremely strong performance of hunting equipment helped drive our positive accounts for the quarter. The strength we realized in this category provides a glimpse of the power of our strong brand and broad product offering. We believed our financial stability and great vendor relationships provide us with a significant advantage over our competitors and obtaining enough inventories in these strong performing categories.

Now let me review the progress for making our initiatives to improve profitability. We continue to make improvements in retail store operations. For the year average ticket in our customer base increased nearly 2%. Additionally, labor as a percent of retail revenue improved 70 basis points for the year. Improvements on labor productivity have been driven by improvements in several areas including more streamlined (inaudible) to our retail stores and better managing staffing levels of our stores.

In 2008, we reduced the non-selling labor at our retail stores by 20%. We’ve been able to leverage payroll expenses while improving customer service levels. Our online customer shopper service scores surveys scores, which we call Voice of the Customer, improved nearly 270 basis points during the year and we’re pleased to report Cabela’s ranks number 11 for Overall Best Customer Service in the National Retail Federation 2008 Customer Service Survey.

We continue to improve our merchandise planning and retail merchandising, our open to buy process continues to gain traction and helps significantly improved inventory levels in 2008. We continue to flex these new assortments in our stores, improved our visual merchandising and signage, and improved the timing of our seasonal merchandise selection. In fact, given the improvements in merchandise planning, the transition to our spring assortment will be one of the cleanest in company history.

For the quarter, retail advertising glitz continues to increase from prior year. The improvements in retail advertising have been driven by more precise targeting of our retail fliers, a higher proportion of direct mail distribution, increased products density and more efficient broadcast buys.

Let me now update you on our new store opening plans. For 2009, we now expect to open one store. This will be a store in Billings, Montana, which is expected to open the second quarter of 2009. The store will be one of our next generation store formats. We now expect our store in East Rutherford, New Jersey to open in spring of 2010.

Looking forward to 2009, we will continue to build in the many successes related to our initiatives to improve profitability. There is still significant opportunity to drive additional efficiencies to improve profitability, generate cash and improve return on invested capital. I’d like to highlight several of these areas for you.

We’re in the process of rolling out several initiatives that we believe we have a positive impact on overall contribution of our retail stores. These initiatives include: Focusing on our core merchandise assortment, reducing labor as a percent of sales, improved flow of products to our stores, and providing enhanced training of customer service.

We will continue to improve our merchandise planning, retail merchandising and inventory levels. 2000 initiatives including SKU rationalization, focus on a set of core SKUs to drive higher fill-rates, more refunds, and higher margins; improving our retail space allocation, further refining our open-to-buy process, reducing unplanned inventory levels and improving our in-season mark-down strategy. We’re also focused on driving improved results in our direct business.

Internet initiatives for 2009 include: Improving our dominant on-line marketing programs for sustained customer retention and acquisition, focused internet merchandise to our core merchandise assortment, and expanding our international brand awareness. Cabela’s catalogues drive traffic to both our internet sites and retail stores.

With respect to our catalogs, our focus will be on leveraging catalog cost through improved contact strategies, maintaining contact frequency and optimizing the cost of space of every catalog. We will continue to rebind our customer marketing campaigns by delivering a more concise offer based upon our customer’s buying behaviors.

Now I turn the call over to Ralph Castner to review our financials in more detail.

Ralph W. Castner

Thank you Dennis. We’re pleased with our ability to continue to capture market share and drive meaningful improvements in both inventory levels and cash from operations for the quarter and the year. During the quarter, consolidated revenue was $879.4 million compared to $889.5 million in the fourth quarter of 2007. Direct revenue for the quarter was $410.4 million compared to $446.9 million in the same quarter a year ago. While we added five new titles in the quarter, direct marketing cost declined 10.2% as we continue to refine our customer contract strategy via the catalog by delivering the more concise offering for our customer base.

Retail revenue for the quarter increased 6.9% to $429.5 million versus $401.8 million in the same period of last year driven by 2.2% increase in comparable sales for the quarter. While this yearly, we’re seeing the same trends continue in 2009 and we expect the same store sales to be positive in the first quarter of 2009.

Now looking at the financial services segment, which encompasses our largest Loyalty Reward Program; In the fourth quarter, average managed credit loans increased, 18.9%, and average active accounts increased 12.3% to 1.2 million loyal customers. For the quarter the average account balance increased 5.9% compared to the prior year quarter. For the quarter revenue was $38.1 million versus $37.8 million in the fourth quarter of last year. For the quarter, charge-offs increased to 2.91% to 3.53% sequentially. Due to the deteriorating environment, we’re planning charge-offs for 2009 to be between 4.5% and 4.6%.

We recently implemented a risk based pricing strategy. This strategy will allow us to lower interest rates paid by our most credit billed (ph) customers, an increase to rates paid by our much credit billed (ph) customers. This will increase total interest income and combined with other pricing changes will substantially offset any expected increase in bad debts as well as higher interest cost.

At the same time, we changed our index rate for pricing our portfolio from prime rate to LIBOR. With this new index our assets and liabilities will be priced using the same index, which will reduce interest rate risk associated with changes between the prime rate and LIBOR. We measured the performance for our financial services segment on non-GAAP basis, a reconciliation of these measurements to GAAP is provided in our earnings release.

Now, I turn you to consolidated gross profit. Gross profit for the quarter was $345.5 million versus $371.8 million the year ago quarter. Consolidated gross margin was 39.3% in the quarter compared to 41.8% in the same quarter a year ago. Our merchandise gross margin was 36.5% in the fourth quarter of 2008 versus 39% in the same quarter of last year. Gross margins were negatively impacted by greater mark-downs and a shift in sales from higher margins soft goods to lower margins hard goods, roughly 40% of the gross margin deterioration of the quarter in attributable to this mixed shift. As we moved to 2009, we’re very focused on our varying merchandise gross margins. We expect to drive margin improvement mostly in our soft good category, with less liquidation and an improved marked-out strategy.

Also, in 2008, we experienced margin pressure in certain hard good categories due to increased commodity prices. In 2009, we expect lower commodity prices or the flexibility to pass price increases on to our customers.

Now, looking on operating income; Consolidated operating income for the quarter was $84.3 million as compared to $94.1 million in the same quarter last year. On a consolidated basis, operating margins were 9.6% as compared to 10.6% in the fourth quarter of last year. The decrease is mostly due to the lower merchandise gross margins.

Operating margins in our direct sales was 16.5% versus 18.5% in the same quarter a year ago. Results here were adversely impacted by lower gross margin, which was slightly offset by improvements in direct marketing cost and higher marketing fees paid by financial services segment to the direct segment.

Direct marketing cost was 14.7% of direct revenue in the fourth quarter of 2008 as compared to 15% of direct revenue in the year ago quarter. Operating margins in our retail segment were 14.5% as compared to 15.3% in the same quarter a year ago. Improvement in salary wages and advertising expense helped offset the declining gross margins in our retail segment.

Corporate overhead and other expenses decreased 6.9% in the quarter. Corporate overhead and other expenses as a percent to total revenue declined 40 basis points to 6.7% to sales from 7.1% of sales in the year ago quarter. Improvement to these expenses mostly came from lowering salary wages, a decline in set of compensation and a lowered appreciation.

Moving now to earnings; for the fourth, net income was $49.4 million as compared to $56.2 million in the fourth quarter of last year. Diluted earnings per share was $0.74 fourth quarter compared to $0.80 in the same period last year. The fourth quarter results included an $8.7 million revenue benefit due to a change in our estimate for gift instrument breakage, which was partially offset by $5.8 million of charges related to severance cost, goodwill and other asset impairments and a penalty for the optional pre-payment of debt.

Turning now to cash flow metrics, in 2008 we generated a record cash flow from operations; Cash generated by operations for 2008 was $155 million as compared to $32 million in 2007. For the full year we incurred capital expenditures totaling to $110 million. For 2009 we expect capital expenditures including purchases of economic development bond to be in the $40 million to $50 million range. During the fourth quarter we pre-paid $26 million of debt. The pre-payment penalty on this note was $775,000. We do not have another material debt payment due until 2012.

In anticipation of possible regulatory changes, Cabela’s contributed $25 million of capital in the World’s Foremost Bank during the fourth quarter of 2008. WFBs tier one capital ratio was 28.1%, which is nearly three times the 10% level which is required to be considered well-capitalized by the regulators. Given these two events, we ended the year with $20 million outstanding in our revolving line of credit.

Given the significant dislocation of securitization market, we made the decision to fund more portfolio to lower cost (inaudible) with deposit. At the end of the year, we reported $86 million of short and long term tiered deposits to fund credit card receivables.

As of the end of the ear, WFB reported $2 billion of cash. We have a $250 million terms securitization which matures in March of 2009. We intend to use our cash on hand to retire this securitization when it comes due.

WFB also has $850 million of commercial paper conduits with a one year maturity used to fund credit card receivables. These conduits mature at first time during 2009. We expect to either renew conduits or replace them with CDs. In January of 2009, we raised an additional $65 million of CDs to supplement our commercial paper conduits. Today we learned at Moody’s Investor services has downgraded the rating on 21 classes of term securitization issued by the Cabela’s credit card master note trust. This is only one of three rating agencies that rate our term securitizations. They have no impact on any of our commercial paper conduits. World’s Foremost Bank continues to have many liquidity options available including access to CD market, renewing our existing commercial paper conduits and access in terms securitization market without a rate to Moody’s.

Now with regard to annual guidance; despite the current macro-economic environment, we expect consolidated revenue to decline only slightly as compared with 2008. Also for fiscal 2009, we expect earnings per share to be roughly equal to 2008 levels. This guidance reflects our view of the challenging retail environment continuing throughout 2009 and incorporates the following assumptions:

We expect customer sales and direct revenue growth full year to decline in a low single digit rate. Given the recent portfolio trends, we expect bad debt levels to be 4.5% to 4.6% for the full year of 2009. This compares to the 2.95% experience for the full year of 2008. We expect profits in the first half of the year to be slightly less that the prior year with increasing profitability in the second half of the year.

Now let me turn the call back over to Dennis for some closing comments.

Dennis Highby

Thanks Ralph. In 2008, we made significant progress managing our inventory levels, improving cash flow from operations, increasing our market share, improving our internal operations. We expect 2009 to continue to be a tough retail environment and as such we’re focused on managing factors within our control. Throughout 2009, we will continue to focus on improving retail profitability, improving merchandise margins, controlling cost, carefully managing inventory levels, maximizing cash flow, and strengthening our balance sheet.

We are confident that our profitable multi-channel selling platform, strong brand and superior customer service are our competitive advantage unmatched by any one in our industry that will service well for many years to come.

With that operator let’s open the call for questions.

Question-and-Answer Session

Operator

Thank you. Today’s question and answer session will be conducted electronically. (Operator’s instructions).

And will take our first question from Paul Lejuez with Credit Suisse.

Paul Lejuez – Credit Suisse

Hey, thanks Chris. Just a pair of question, you made a comment about the $155 million of cash flow from operations and I think you said that that was a sustainable level, but wasn’t nearly a $100 million of that generated just from reduction in inventories?

Ralph W. Castner

Paul, this is Ralph. It was, but flipside of that yields more of this when you get the K (ph). Basically, the way to get to the sustainable level is net income with $76 million and add back $64 million of DNAs (ph) so that gives you to roughly a $140 billion. You’re correct in that inventory was down. You know $90 million some, but accounts payable was also down at $83 million. So that roughly offsets the benefit we got from the inventory reduction. So we believed it’s sustainable and not dependent upon future reduction in inventory to achieve those kinds of levels.

Paul Lejuez – Credit Suisse

And then the expenses came in well below what I was looking for. How should we think about expense dollars going forward? Can we expect to see on the retail direct side of SG&A – that dollars are down in the mid to high single digit range – like we saw this quarter?

Ralph W. Castner

Well, I think, obviously, that's going to be a function of revenue. But I think we would hope for them to be down slightly more than whatever the delta in revenue is.

Paul Lejuez – Credit Suisse

Okay. So you're talking you expect leverage then in your SG&A?

Ralph W. Castner

Yes.

Operator

And we’ll take our next question comes from Rick Nelson from Stephens Incorporated.

Rick Nelson – Stephens Incorporated

Can you talk about the hunting category, I guess firearms category, what that contributed to the count in the quarter?

Dennis Highby

I'm sure Pat's going to want to add on to that, but we're excited that we have the merchandise that people want in this type of environment right now. We saw strength in ammunition firearms, reloading was big, archery is strong and just a lot of the accessories that go along with the shooting industry, and it continues to be strong in the first quarter.

Do you want to add anything, Pat?

Patrick A. Snyder

Oh, I think you pretty well covered it.

Dennis Highby

Okay.

Rick Nelson – Stephens Incorporated

And how sustainable do you think that growth is?

Dennis Highby

I think that's a great question. I don't think anybody knows but we're very encouraged in the first six weeks of this year that our consumers – or the consumers are coming to Cabela's to get this merchandise.

And again, Cabela's, through the years has been famous for carrying a wide selection of this type of merchandise. They know that if anybody is going to get it from a vendor, we're going to get it and it's going to be priced right. So as far as how long it's sustainable, it's up to the consumer.

Rick Nelson – Stephens Incorporated

You reported 2.2% same-store growth this quarter. You indicate the first quarter is also tracking in positive territory, yet your guidance it calls for a low single-digit account decline. What, I guess, goes into that type of target?

Dennis Highby

Well, I think it's prudent in this environment to forecast that retail is going to have a tough year, but we are forecasting counts for the year to be down. But we're encouraged so far beginning of the year. We'll see how the year plays out.

Rick Nelson – Stephens Incorporated

Can you talk about traffic and ticket in the quarter?

Dennis Highby

I think Pat will probably want to add something to that, but in general, traffic was flat, up very slightly, and I believe the average ticket increased 2%, 3% for the quarter, so.

Rick Nelson– Stephens Incorporated

Do you think lower gas prices are helping with store traffic? I know traffic was down in the third quarter yet up in the fourth.

Dennis Highby

I think anytime you have the benefit of gasoline going less than half of what it was in the summer, I think it’s impossible to measure. But I'm sure it was one of the contributing factors that just made our consumer feel better during the fall hunting seasons and gave them the confidence to get out in the field and use the products that we sell.

Rick Nelson – Stephens Incorporated

And inventory levels, you made good progress there. Are they any targets that you'd like to throw out in terms of where you want to be with inventory at the end of 2009?

Dennis Highby

I don't think we have any specific target but we talked before how our planning department with the new open-to-buy process. It's really showing strong results.

I don't know if – Brian, you want to add anything, but we actually think that we're planning on turns to improve on inventory throughout 2009.

Brian J. Linneman

Yes, Rick, the only thing I'd add to it would be just we're looking at a modest turn improvement throughout 2009. It won't be as significant as it was in 2008.

Operator

And we’ll take our next question comes from Mitch Kaiser with Piper Jaffray.

Mitch Kaiser – Piper Jaffray

Ralph, on the thinking behind the second half being stronger than the first half, could you just kind of take us through the basic thinking behind that?

Ralph W. Castner

Well, I think – and by the way, that comment was strictly related to earnings. We just put in a lot of cost cut initiatives and business improvement initiatives this year that we think will – that we'll really start to see more of an attraction of in the back half of the year.

Pat Snyder might want to add something to that part to that, but I think from the P&L standpoint, we expect the back half to be slightly better than the first half.

Mitch Kaiser – Piper Jaffray

Okay. Pat, can you tell us some of those things that you're doing then?

Patrick A. Snyder

Yes. If you look at some of the initiatives we have in place, especially in the retail stores, we're starting to see labor as a percent of sales improve. And that's coming primarily from our labor management tool. We're just doing a better job of managing our staffing.

Operational efficiencies are another area that we've been working hard on and we measure that by the amount of non-filling labor that we have in our store and our ability to reduce that. So we can sit and continue to see this non-filling labor go down and we just think we'll continue to see the improvements from the initiatives that we have in retail.

Mitch Kaiser – Piper Jaffray

Okay, sounds good. In terms of the direct business, did you talk about the sales decline there? Is it just more people going in the stores and with gas prices being down? Or how would you categorize that in the fourth quarter? Or is it mixed that gun sales were so strong and I would assume that more of that's in the retail chain other than direct?

Dennis Highby

I think we did see a shift from our direct business, just a slight shift, where people are going to our stores. But again, we're excited that we still have the industry leading Web site. We have the whole direct business four times – four or five times larger than our biggest competitor.

Pat, I don't know if you want to add something to that.

Patrick A. Snyder

I would consider our catalog still our primary marketing tool and we use it to push traffic onto the Internet or into the retail stores. But with the growth that we saw in the retail stores on the ammunition and firearms side, I think it was part of the reason the catalog was down. We think a lot of that traffic or some of that – a portion of that traffic went into the stores to purchase that merchandise.

Mitch Kaiser – Piper Jaffray

Okay, sounds good. Thanks guys and good luck.

Operator

Your next question comes from Reed Anderson from D. A. Davidson.

Reed Anderson – D. A. Davidson

I just was looking for a little more commentary on the skew reduction issue that you talked about. I don't know if that would be Pat or Dennis, but just thought on if that's – there's big categories that are getting significantly reduced or if it's just kind of across the board a little bit less inventory. Just more color behind that initiative, please.

Dennis Highby

I think I'll have Brian handle that one. Brian?

Brian J. Linneman

Yes. What we're really doing is clearly looking at the products that drive the majority of our business in. Pat's merchants, along with the merchandise planners, are going category by category and we're clearly looking to get rid of any products or skews that aren't contributing significant sales gross profit dollars to our business.

So it's an analysis that we'll take on this year and there'll be further improvements in spring of 2010.

Reed Anderson – D. A. Davidson

But it sounds like it's touching on really all areas at this point, pretty much.

Brian J. Linneman

That's correct.

Reed Anderson – D. A. Davidson

On the inventory, could you just – what was inventory down per foot? I haven't had a chance to do the math, but you could probably give me a pretty close number.

Brian J. Linneman

Inventory per square foot for the year was off about 9.1%.

Ralph W. Castner

And just when you try to do the math, you know that you can't tie to that number because Brian's just looking at the inventory that's within the store.

Reed Anderson – D. A. Davidson

Exactly, that's what I was hoping you'd give me, so that's very helpful. Thank you. And would you expect to see that number – on a personal basis where we are today, would that number even come down a little bit in '09, or do you think that when you said stable, did you mean that the per store is about where you want it a year from now?

Brian J. Linneman

We're in the range of where we want to be in the stores. We clearly took it down in 2008, but I think it's going to – we're pretty comfortable where we've got it now and hope to maintain that measure there.

Reed Anderson – D. A. Davidson

Okay. And then shifting gears a little bit, curious, obviously hunting, and particularly firearms, do very well for you. I know in the – particularly on the long gun side of that business, there's been a fair amount of vendor-driven promotions, rebates, whatever. Curious if you felt that that was very helpful to you or if you just think that it's the underlying demand that really helped you in the fourth quarter?

Dennis Highby

Yes, I think it's just the underlying demand. Any time a vendor has a promotion it doesn't hurt anything, but the consumer's out there looking for hunting products right now and we're excited about it.

Reed Anderson – D. A. Davidson

Okay. Let's see, a question on the CD piece. Switching gears again, the financial services – when we see that on your balance sheet, now. Does that just show up to your regular income statement or does that actually still show up in the financial services business? Can you just clarify where we see that from a cost and an earnings standpoint?

Dennis Highby

Well, it shows up in the financial statement as I’m sure you know under the financial services segment. As I’m sure you know, we pay a marketing fee to the direct and retail business of everything over a 2% ROA, so there could be some affect on those business. I’m not sure I know what your question is.

Reed Anderson – D.A. Davidson

So I guess what I’m getting at is when we see the net revenue line reported for financial services and inside of that, above that line is an interest cost.

Dennis Highby

Yes, that’s interest income minus interest expense, yes.

Reed Anderson – D.A. Davidson

And the portion attributable to the CD business is buried in side of that. Is that correct?

Dennis Highby

That’s correct.

Reed Anderson – D.A. Davidson

I just wanted to make sure that that wasn’t going to have a big bump on your other interest expense. That’s buried inside of financial services, okay. And as you sit here today Ralph, what is a reasonable balance for CDs as a proportion of your funding for your side? I think it’s just $480 million now. What might that look like a year from now do you think?

Ralph W. Castner

It could be

Reed Anderson – D.A. Davidson

What would be a range, perhaps?

Ralph W. Castner

Well, I think the real answer is it depends on what happens to a whole bunch of external factors. We don’t have any other term securitizations that mature in 2009, so the only thing we might do is continue to raise CDs just as sort of a precautionary measure.

We have the $850 million of conduits come due. We expect to renew those. We may put some of those on the balance sheet through CDs just to mitigate any risk of those not renewing. I would clearly expect it to be higher than it was at the end of ’08 and probably hundreds of millions of dollars higher.

Reed Anderson – D.A. Davidson

Okay. So if you think about your number of cards or balance or whatever, you’re going to find essentially most of it with CDs. Now tell me will that keep your ability to grow that piece of your business a little bit lower or do you still think you’ll grow it kind of at a, I don’t know, mid single-digit rate, high single-digit rate sort of thing?

Ralph W. Castner

Right now, our thinking is the funding limitations won’t have any impact on our ability to grow accounts. We believe – and Reed you and I have talked about this off-line – we believe that our loyalty club program is a key strategic advantage and particularly in these times where we’re not growing stores, we think it’s very important to build out loyalty with our customers and this is a great way to do it.

Reed Anderson – D.A. Davidson

So that’s helpful. You don’t expect it has any limiting factor at this point – that’s good. Lastly, I was just curious – you’ve got one quasi-competitor at least in your space that’s sort of undergoing a merger, or there’s some change going on there. There’s a little disruption in the marketplace. I’m just curious if you’re seeing any benefit from that or the reverse in any of your stores attributable to just to the competitive environment.

Dennis Highby

You know we’ve always had competitors. Some get stronger. Some get weaker and I don’t know if we’ve seen any material shift from the competitors. If there was some it’s probably very, very small.

Operator

We’ll take our next question from Jim Duffy with Thomas Weisel & Partners

Jim Duffy – Thomas Weisel Partners

So, one thing I’m wondering there, are you able to quantify the impact that might have had on the comp having less inventory in the stores?

Dennis Highby

You know I think it definitely had an impact on your field percent in our direct business as we entered the critical Christmas season. It was not as high as we wanted and a lot of that transpired over into the retail stores.

Again, that’s hard to measure because the consumer has that when they’re in the store they do have different choices compared to when they’re really just buying online or buying from the catalogs, but I’m sure it didn’t help anything.

Brian J. Linneman

Okay. In terms of operating with lower inventories in the stores, is it just improvement in flow that you feel allows you to do so? Are you better able to chase inventory from vendors in this type of environment?

Dennis Highby

No, I think some of the inventory that is not in the stores anymore – Brian might want to add to this – but I mean some of the inventory that is not in the stores today is inventory that wasn’t needed in those stores. It had very, very low demand from the consumer, so we’re just doing a better job planning what inventory really drives our business and I think we’re doing a great job on it right now.

Jim Duffy – Thomas Weisel Partners

So Brian, you’re comfortable with the current level of inventory in the stores and think that you can come positive despite the fact the inventories – we’ll just say 10% or so?

Brian J. Linneman

Yeah, I would just add on to Dennis’ comments that I think we’re flowing goods to stores in a much more efficient manner. We’re also doing a much better job pre-season in the merchandise planning process which allows us to react in-season to clear goods much cleaner. As Dennis mentioned in the script. We’re entering our spring seasonal changeover and it’s the cleanest we’ve been in the company’s history.

Jim Duffy – Thomas Weisel Partners

That’s good. Now, have you been able to capitalize on a lot of opportunistic buys that have helped you on the merchandise margin maybe to offset some of the mix dynamic?

Dennis Highby

You know I think Pat might want to add to this, but we’re always looking to offer great values to our customers. I don’t think there was anything that was different this last quarter from the quarter before. Pat do you have anything to add to that?

Patrick A. Snyder

Well you know we’re always looking for special buys and I believe the vendors have really tightened up on their inventory positions, so when available we certainly take advantage of them, but I think they’re starting to tighten up a little bit.

Jim Duffy – Thomas Weisel Partners

That’s helpful. Ralph would the increase in bad debt expense that you’re planning for the year, can you kind of quantify the expected offsets you’re expecting between interest income and the fee income on the financial services side of things?

Ralph W. Castner

No, I’m not sure I can give you much help other than we would expect way more of it to come from interest income than from fee income.

Jim Duffy – Thomas Weisel Partners

Okay. Well then, the (inaudible) is helpful. Final question here, on the firearms did the lift there begin in the third quarter?

Dennis Highby

Jim we’ve seen strength in hunting, especially firearms and ammunition accessories all through the year but we just ended up with a very strong. Here in those categories we continue to see our customers wanting to buy that type of product. So, again, we’re very excited about our business coming into this first six weeks of the year.

Jim Duffy – Thomas Weisel Partners

Did you quantify the impact of the comps in the fourth quarter from stronger firearm and ammunition sales?

Dennis Highby

I don’t know if we did or not. Excluding, I guess you want to take out the related firearms stuff. I think comps maybe would have been down 1%.

Jim Duffy – Thomas Weisel Partners

Okay. Going into the first quarter, is the inventory still available in that category to continue to capitalize on the demand?

Dennis Highby

We have great relationships with our vendors. We’re famous for paying our bills on time and I think it’s maybe hard for people to understand that Cabelas has always been very, very strong in these categories – much stronger than our competition and our customers know that if the inventory is available from the vendors, Cabelas will have it first.

Operator

(Operator instructions). We will take a follow up question from Paul Lejuez with Credit Suisse.

Paul Lejuez – Credit Suisse

You guys mentioned that comps are running positive in the first quarter. Can you share with us what’s happening on the direct side of the business in the sense that it seemed to be kind of the offset to the positive comps in the fourth quarter.

Dennis Highby

I don’t know if I want to get into too much, but again we’re seeing strength in these categories that are really driving our business and we have a solid plan for our direct business this year. We’re going to be very frugal on making sure that we contact the customers with the right amount of hits with catalogs and right promotions through our Internet and we’re budgeting it to be down slightly, but we’ll wait to see what happens in these times during the year.

Again, we have the merchandise, we have best selection, and our customers know us, so we’ll see how it turns out.

Brian J. Linneman

Paul, the only thing I’ll add to that is it’s performing better than it did in the fourth quarter.

Paul Lejuez – Credit Suisse

It’s still negative.

Brian J. Linneman

I didn’t say that. You said that.

Paul Lejuez – Credit Suisse

Okay. On the gross margin, if you exclude that gift card breakage, it was down over 300 basis points, which is I think one of your worse gross margin quarters that we’ve seen, so how do we think about that going forward? I mean are we looking for several hundred basis points gross margin declines, and I’m talking merch. margin only.

Dennis Highby

Go ahead, Ralph.

Ralph W. Castner

I’m sorry, go ahead Pat.

Dennis Highby

Credit card breakage and I’ll pick up the rest.

Ralph W. Castner

I’m sorry. I guess I do understand the question Paul.

Paul Lejuez – Credit Suisse

Now if you include gift card breakage, gross margins because that’s you’re adding sales with no cost of goods, right?

Ralph W. Castner

That’s right, yes.

Paul Lejuez – Credit Suisse

So your gross margin would have been something like 35% to 20%, which is down over 300 basis points. So if that’s the normal run rate, how do we think about that? Do we think about that as a normal run rate, or is down 100 to 200 basis points maybe going forward. I just want to understand what’s factored into guidance for ’09.

Dennis Highby

I think Pat will talk to margins but Paul, we're focused on, as a company, doing the best we can in these times to improve margins from 2008. We have a lot of things that I think Pat would like to share with you.

Patrick A. Snyder

Sure, just to start off with, Paul, when we entered the fourth quarter, it was very obvious the consumer was very price-driven; and that was really part of our strategy to discount product and have promotions to maximize our sales.

But you have to also remember, we liquidated roughly $90 million worth of inventory, and a portion of that came in the fourth quarter. So we obviously had margin decline because of that. As you look into '09, we really think we can go back in and recapture some of this margin specifically in the soft goods categories. This was the area where we liquidated the most merchandise.

We're going to be much more selective in discounting product going forward and we're going to improve our markdown strategy. And then we think with both of those areas, we can start to increase our margins again. And we do expect to see pressure from the shift in product mix where we see the hard goods being a higher percentage of our sales. But we expect to see positive margins for the second half of the year.

Paul Lejuez – Credit Suisse

And Ralph, can you give a sense of what the marketing fee was that the bank paid to retail and direct for the year?

Ralph W. Castner

No, I'll just tell you, there wasn't. I won't share with you the absolute number; it was actually down for the year as compared to a year ago, as you probably imagine.

Paul Lejuez – Credit Suisse

And I'm just wondering what happens to the credit card portfolio now that you're going through CDs. Do you actually hold the receivables on your balance sheet?

Ralph W. Castner

Well, we didn't as of the end of the year; you can see that on the balance sheet. At the end of the year, what happened is we'd raised a bunch of CDs, $400 million of CDs and $400 million in cash, and we expect to use that cash to pay down the term securitization. Yes, to add to your point, at that point, those receivables would come on balance sheet.

Paul Lejuez – Credit Suisse

Since you're using CDs, what happens to the Tier I capital ratio when you use CDs? Does that matter?

Ralph W. Castner

Yes, it matters a lot. There's a greater requirement. At a very high level, the requirement is you have to have 10% capital for everything that's on balance sheet, and it's a much lower percentage from everything that's off balance sheet.

So part of the reason why I told you right now our Tier I capital's at 28% and we put in $25 million in '08 – that was clearly done in anticipation of A – either bringing receivables on balance sheet; or B, legislative changes of regulatory rules around capital. We just to make sure we've got plenty of capital in the bank.

Paul Lejuez – Credit Suisse

What do you figure that Tier I ratio goes to?

Ralph W. Castner

By when?

Paul Lejuez – Credit Suisse

End of year.

Ralph W. Castner

It all depends many will stay on balance sheet. It'll be about ten, for sure – way above ten.

Operator

And we'll take our final question today from Derek Leckow with Barrington Research.

Derek Leckow – Barrington Research

I just have a quick clarification here on these two one-time items. Is this about a $0.04 net benefit to the bottom line, is that about right?

Ralph W. Castner

No, I think it was about $0.03. It was eight, seven and five, eight (ph) is my recollection.

Derek Leckow – Barrington Research

Okay. So when you talk about your guidance, then we're talking about a number that's more off of that number. Or are you talking about guidance off of the number that's reported?

Ralph W. Castner

No, I was talking off of the reported number.

Derek Leckow – Barrington Research

Okay, that clarifies that. And then on the direct business, are we expecting that to be down, that sort of single-digit rate for the year, as well, or does that have a different profile in terms of growth next year as compared to the retail business?

Dennis Highby

Anything can happen in this environment, but we have a strong direct business. We just are planning it to be down a little bit this year.

Derek Leckow – Barrington Research

And as far as the cost associated with that segment, should we kind of assume the same level of circulation and so forth so that we come up with roughly the same operating margin for that business?

Dennis Highby

Pat might want to add something, but I think in general, our circulation's going to be similar to what it is, but we're going to do a better job maybe reducing the number of pages. Pat, do you have anything to add to that?

Patrick A. Snyder

Sure, we're constantly analyzing our mailings and determine how many books to mail, how many pages we need in the catalogs. And we'll adjust [inaudible 0:04:58] course of the year based on what we see our business coming in at. So if our business is down, we'll start to play with that a little bit.

Derek Leckow – Barrington Research

Is your feeling, though, that the 14.7% operating margin for that business is sustainable?

Patrick A. Snyder

Yes.

Operator

And it appears that there are no further questions at this time. Mr. Gay, I'd like to turn the conference back over to you for any additional or closing remarks.

Chris Gay

I'd just like to thank everybody for joining us today. We look forward to talking to you again soon. Thank you.

Operator

And that concludes today's conference call. Thank you for your attendance and have a wonderful day.

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Source: Cabela’s Inc., Q4 2008 Earnings Call Transcript
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