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Cabelas Inc (NYSE:CAB)

Q2 2013 Earnings Call

July 25, 2013 9:00 am ET

Executives

Chris Gay - Director of Treasury & Investor Relations and Treasurer

Thomas L. Millner - Chief Executive Officer, President and Director

Ralph W. Castner - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Reed Alan Anderson - Northland Capital Markets, Research Division

Seth Sigman - Crédit Suisse AG, Research Division

N. Richard Nelson - Stephens Inc., Research Division

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Lee J. Giordano - Imperial Capital, LLC, Research Division

Charles Edward Cerankosky - Northcoast Research

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Sean P. Naughton - Piper Jaffray Companies, Research Division

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Mark E. Smith - Feltl and Company, Inc., Research Division

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Cabela's Incorporated Second Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded. I will now turn conference over to Chris Gay, Director, Treasury and Investor Relations. Please go ahead.

Chris Gay

Good morning, and welcome, everyone, listening today both on the conference call and by webcast. A replay of today's call will be archived in our website at www.cabelas.com.

With me on today's call are Tommy Millner, Cabela's Chief Executive Officer; and Ralph Castner, Cabela's Executive Vice President and Chief Financial Officer.

This conference call will include forward-looking statements. These statements are made on the 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 report on Form 10-K and quarterly reports on Form 10-Q, filed with 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. Additionally, this conference call may include certain non-GAAP financial measures. Please refer to our website to find reconciliations of these non-GAAP financial measures to GAAP.

Now I will turn the call over to Tommy Millner, Cabela's Chief Executive Officer.

Thomas L. Millner

Thank you, Chris, and good morning, everyone. Our record second quarter financial results validate that our omni-channel model is working well, and our next-generation stores continue to generate superior returns on capital.

For the quarter, we realized strong growth in comp store sales, increases in direct revenue, higher merchandise margin, solid account growth in our Cabela's CLUB and exceptional performance from our next-generation stores. For the quarter, our next-generation stores outperformed our legacy stores in both sales per square foot and profit per square foot by more than 40%.

For the second quarter, there were 12 next-generation stores open for the full quarter, compared to just 6 open for the full quarter in the second quarter last year. We are extremely pleased that both sales and profit per square foot at our next-generation stores have remained at these extraordinary levels as we continue to add additional next-generation stores to the base. Further confirmation on the success of our next-generation stores can be seen in how these stores perform upon entering the comp base. As next-generation stores enter the comp base, they continue to outperform. For the quarter, comp store sales of our next-generation stores were roughly 600 basis points above the consolidated comp. These metrics give us significant confidence as we continue to accelerate retail store expansion.

For the quarter, consolidated comp store sales increased 10.5%. The increase in comp store sales was broad based as sales increased in 10 of 13 merchandise subcategories and in all but one of our comp stores. The one store that did not comp was our Dundee, Michigan store, which was closed for 10 days following a small light-fixture fire. Fortunately, no one was hurt. The night staff was on hand, reacted quickly and was able to extinguish the fire before it did major damage. If the store had not been closed, it, too, would have comp-ed positively.

Excluding firearms, comp store sales increased 9%. While much of the comp increase was a result of strength in firearms and shooting, we realized double-digit comp growth in hunting apparel, archery and optics.

During the quarter, we opened a next-generation store in Louisville, Kentucky and relocated our Winnipeg store. Each of these openings exceeded our expectations, drawing thousands of customers at each event. Today, we announced plans to open 3 new U.S. stores in 2014: a next-generation store in Acworth, Georgia, northwest of Atlanta, and 2 Outpost stores, one in Missoula, Montana and the other in Augusta, Georgia. We also announced plans for another Canadian store in Barrie, Ontario, which will also open in 2014. This brings the total to 13 announced stores for 2014 with the possibility of announcing one more Canadian location. These new stores represent 16% to 18% retail square footage growth in 2014. We are very excited with our 2014 new store lineup.

For the quarter, merchandise gross margin increased 30 basis points to 37.7%. Despite the headwind in consolidated merchandise margin related to the sale of firearms and shooting, strengthened high margins softgoods in footwear, combined with fewer sales discount and markdowns more than offset the mixed headwind. Merchandise margin performance in the second quarter is within the range of how we expect to perform in the future.

Now let me turn to retail profitability, which is a key initiative in our retail growth strategy. For the quarter, retail profitability increased 30 basis points to 18.8%. This is the 17th consecutive quarter of retail profit contribution improvement. Improvements in retail profitability were due entirely to higher merchandise margin as we invested in increased advertising, as well as additional store labor to better serve customers.

We are also pleased with the improved performance of our Direct business. For the quarter, Direct revenue increased 13.7%. Improvement in the Direct business was due to the increased traffic to cabelas.com.

As we mentioned last quarter, with the tremendous success of our new advertising campaign, It's in Your Nature, and our strong financial performance, we expected to make additional investments in national brand advertising and direct marketing. For the quarter, we more than doubled national brand advertising compared to the prior year quarter. As we move through the second half of the year, we will continue to evaluate the levels of this additional marketing spend and expect to adjust accordingly as the second half of the year unfolds.

Turning to SG&A. In addition to higher advertising and marketing spend in our Direct segment, we also made investments in our Retail segment. We spent an additional $4.6 million on comp store labor to enhance customer experience and incurred $2.4 million of additional preopening expense, each compared to the prior year quarter. Operating expense in our other segment increased mostly due to additional spending on IT projects, investments in Canada to fund continued growth and higher distribution cost to support strong sales in the quarter. We continue to closely monitor operating expenses and expect to leverage these expenses in both the third and fourth quarters, as well as for the full year.

Recently, we've implemented a net SKU profitability tool powered by Acorn Systems. We're very excited about the visibility this tool will provide by product, below the gross margin line. Acorn Systems is a leading software provider in this area, and we expect this initiative to yield benefits for many years beginning in 2014.

Now let's take a look at our Cabela's CLUB, which had another exceptional quarter. We continued to see strong growth in average active accounts and favorable delinquency and charge-off trends. For the quarter, average active accounts increased 10.7% and charge-offs remained at extremely low levels and were just 1.87% in the quarter.

Now turning to guidance. We are pleased with our strong second quarter results and the investments we've made to ensure the future health of our company. Our retail stores are performing at very high levels and our Direct business is continuing to show improvement. As a result, we are comfortable with current external earnings estimates for the third and fourth quarter of 2013. Our success through the first half of the year is attributable to the superb efforts put forth by our Outfitters. I want to personally thank each and every one of our Outfitters for their hard work, effort and passion in cherishing and delighting our customers each and every day.

Now I'll turn the call over to Ralph Castner to review in more detail, among other things, performance of our Cabela's CLUB.

Ralph W. Castner

Thanks, Tommy. Following up on Tommy's remarks, we're very pleased with our strong second quarter results, including the particularly strong performance from our next-generation stores, improvement in our Direct business and solid performance of our Cabela's CLUB.

For the quarter, earnings per share increased 31.9% to $0.62, as compared to $0.47 in the prior year quarter. Retail revenue increased 25.8% over the same quarter a year ago, led by the exceptional performance of our next-generation and Outpost stores. The strong performance of these new stores strengthens our confidence as we continue our retail expansion. Direct revenue increased 13.7% to $180 million, compared to $158 million in the same quarter a year ago. The growth in the Direct business is a direct benefit of our omni-channel strategies and increased marketing spend.

For the quarter, financial services revenue increased 11.7% to $89 million. The increase in financial services revenue was primarily due to higher interest and fee income, as well as interchange income. Average active credit card accounts increased 10.7% and average balance of credit card loans increased 12.9% during the quarter. Net charge-offs, as a percentage of average credit card loans, remained consistent with the prior year quarter rising a single basis point to 1.87%. Additionally, we continued to see improvements in delinquencies: greater than 30-day delinquencies, which is 0.66%, as compared to 0.73% a year ago; greater than 60-day delinquencies were 0.39%, as compared to 0.43% a year ago; and greater than 90-day delinquencies were 0.20%, as compared to 0.23% a year ago.

For the quarter, we reduced our allowance for loan losses by $2.2 million as we continued to see historically low charge-off rates. Should charge-off and delinquencies remain at these historically low levels, we may realize further reductions in allowance for loan losses in the second half of the year.

For the quarter, financial services interest expense increased 25.6% to $15.9 million, as compared to $12.7 million in the same quarter a year ago. As previously discussed, we made a conscious effort to lengthen our maturities and lock in historically low fixed rates. As a part of this strategy, we completed a 10-year, $327 million term securitization at a rate of 2.7% in February this year, an addition [ph] of nearly $240 million of 10-year CDs. With the recent increases in 10-year interest rates, we do not expect to complete another 10-year fixed-rate term securitization this year. This strategy increased interest expense in our Financial Services business by more than $2 million in the quarter.

Recall that in the fourth quarter of 2012, we recorded a liability of $12.5 million as a result of preliminary court approval of a Visa antitrust settlement. Since that time, a group of plaintiffs have opted out of the proposed settlement. Accordingly, we reevaluated the impact of the 10-basis-point reduction of default interchange income and determined that the estimated liability for the proposed settlement should be reduced by $1.2 million. We recognized $1.2 million as interchange revenue in the quarter. During the quarter, we incurred impairment and restructuring charges of $937,000 related to the closure and relocation of our Winnipeg store.

Now let's look at the tax rate. For the quarter more effective tax plan, as well as a state income tax settlement in the second quarter a year ago, led to a tax rate reduction, which is expected to continue to some extent. As a result, the tax rate in the quarter was 30.5%, compared to 35.9% in the year-ago quarter. With our continued international expansion, we expect the effective tax rate to be between 32.5% and 33.5% for 2013, with similar rates in 2014.

Parent company interest expense for the second quarter was $3.9 million, compared to $6.4 million in the same quarter a year ago. The second quarter a year ago was impacted by additional interest expense from a tax settlement.

As we are accelerating retail square footage, we have seen an increase in capitalized interest associated with new store construction. For the remainder of 2013, we expect interest expense to be between $4 million and $5 million per quarter.

Later this morning, we'll open our fifth new store of the year in Ashwaubenon, Wisconsin, a suburb of Green Bay. For the remainder of the year, we will open 5 more stores. In the third quarter, we'll open next-generation stores in Thornton, Colorado and Lone Tree, Colorado, both suburbs of Denver, and a Canadian store in Regina, Saskatchewan. In the fourth quarter, we plan on opening 2 Outpost stores, one in Waco, Texas and one in Kalispell, Montana. With regard to comp stores, we will have 3 next-generation stores entering the comp base in the third quarter of this year.

Now let's turn to inventory. Inventory increased nearly the same rate as merchandise sales at 20.6% or $119 million year-over-year to $696 million. This increase is a result of 7 store openings since the second quarter a year ago, combined with the inventory planning and allocation for the store openings I previously mentioned. Inventory turns improved to 3.1x on a trailing-4-quarter basis and we're very comfortable with the quality of our inventory.

Accounts payable increased $64 million year-over-year. The increase is mostly attributable to increased inventory purchases as we gear up for 6 store openings in the third and fourth quarters. Additionally, there are increases in unpaid expenses related to retail expansion and construction. For the quarter, cash flow from operations was $60 million and capital expenditures were $70 million, virtually all the cash we have as held in our Financial Services subsidiary.

At quarter end, we have $55 million outstanding in our line of credit. With our accelerating store growth plans, we expect full year 2013 capital expenditures to be between $300 million and $325 million. Cash flow from operations is expected to be between $300 million and $350 million for 2013. We expect to utilize a small amount of external financing in 2014 at the parent company.

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

Thomas L. Millner

Thanks, Ralph. We're very pleased with our record financial results for the second quarter and in particular, the strong performance of our next-generation stores and improvement in our Direct business. We're very excited about our future growth opportunities and making sure we cherish and delight every customer, every day.

With that, operator, let's open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Reed Anderson with Northland Securities.

Reed Alan Anderson - Northland Capital Markets, Research Division

Tommy, just to kind of start off, where you finished up with your remarks on the next-gen stores performing exceptionally well, particularly on a comp basis, will you kind of peel back the layer of the onion there and look at what's driving that? Could you maybe give a little more detail? Is it particular categories? Is it more on the softgoods side? What are you seeing the best performance in those next-gen stores?

Thomas L. Millner

Well, Reed, the simple answer is that the penetration by category in next-gen stores is not different than in legacy stores. So there's nothing going on from a product category standpoint that's driving the improvement. It's just the quality of the presentation. We've got more vertical merchandise presentation and it's just making a big difference. I think what we were very pleased about in the quarter. It's easy to say, well, that the next-gen stores in the comp base, there's one of them and it was 600 basis points better. But when it's a data point of 5 stores, that becomes more of a real meaningful data point that just encourages us even more that we've got the right store format for the future so long as we pick great locations. And we seem to keep doing that.

Reed Alan Anderson - Northland Capital Markets, Research Division

Yes, so that makes sense. In terms of the store openings, you kind of continue to see that number accelerate and that's terrific. I'm curious from an execution standpoint, just anecdotally, it seems like you're getting faster, better at opening stores. By necessity, you kind of have to, but can you speak to the team you've got and your ability to continue to see that hold up what you've got for a pace and even accelerate a little bit?

Thomas L. Millner

Well, I don't see us accelerating a lot more than that 12 to 14 stores a year. That's kind of in our sweet spot. Mike Copeland and his team have got a great manager-in-training program. We've beefed up our preopening teams. We've actually been able to cut a significant amount of time to get the stores open from end of construction to grand opening. And time is money, so that's pretty important. But I think we're in a really good sweet spot in terms of number of stores and our ability to execute. And we just keep getting better with repetition, to no one's surprise.

Ralph W. Castner

Reed, to your question, as we look out into 2014 and further, we've made a conscious decision to sort of limit store growth at, let's see, about 14 stores per year. And we'll be going -- we'll be taking a small step function between '13 and '14 going from about 12 to 14 stores. But it will level off at about 14 stores a year, mainly because we just -- as you know, Cabela's is all about customer experience and we think anything faster than that could jeopardize customer's experience. But we feel really good about a pace of 14 stores for probably 2014 through 2016 or '17.

Reed Alan Anderson - Northland Capital Markets, Research Division

Sounds great. Tommy, from a category standpoint, one you called out was optics and I know that -- it's not a huge category per se, but it's a category I know you've done a lot on the merchandise and product side, really built out some great features in your own branded product. So what I'm -- my question is as you look at that and the success you've had there, thinking that you're coming at that category, though, really offering great quality at a very good price point, is that a category that you have headroom to pricing? Is that something we should think about in that category for you for your brand?

Thomas L. Millner

Well, thanks for the compliment on the product. The merchants have done a great job and our operations folks have done an equally good job in presenting the product on the floor. But the combination of improvements in the Cab Euro line of binocular spotting scopes and sports optics, together with some really great products from our branded vendors, has all kind of come together to create a lot of momentum in the category. And I don't think there's any doubt that we're outperforming the broader market in optics. So I think there's upside in that category, Reed. It's a growing category and we seem to be very good at selling it both on the floor and from an assortment standpoint.

Reed Alan Anderson - Northland Capital Markets, Research Division

Good. And then my last question is, I just got your best of fall '13 book in the mail the other day, and just flipping through here, I mean the presentation, kind of the way you showcased product, I mean, it's just tremendously better, I think, than it was even a year or 2 ago. So like as you think about there -- as I think about that relative to the, now, another great quarter on the Direct business, you think that's a key to why you're doing better there, Tommy? Is that you're just better at merchandising it? Or are there are other drivers, products, et cetera? How do you think about that and the sustainability of going direct like we've seen last couple of quarters?

Thomas L. Millner

Well, I think it's -- we went on this path of omni-channel in our print to digital transformation 18 months ago. And we said it was going to take some time and we were in early innings. I would say we're probably still in the fifth inning. We have definitely gotten better at presentation in catalogs, consistency of presentation across all channels. So our retail flier looks like the splash page of our -- of cabelas.com and the presentation and signage in the store all work together, which is a dramatic change from the past.

And then we're making leaps-and-bounds progress in content on .com in navigation and that's beginning to make a difference. Our Foothills team in Denver is teaching us so much about social media and how to interact with a new generation of consumers that are coming. But I'd still say we're in the fifth inning and I don't want there to be any sense that on the strong 13.7% performance in Q2 in Direct that we're declaring victory. We are not. Our long-term expectations in Direct are still in that up low-single-digit range. Although I got to tell you, we believe our ability to do that. Our confidence is continuing to improve every day that, that's a reality.

And then one last thing, we did spend a little more money in IT. A lot of that was in our digital transformation initiatives and what that means is having a robust mobile platform that mirrors the experience of going to a desktop to buy from us, which is not the case today. That is absolutely on track for fall implementation as is our store to door fulfillment. So that if you see a product online and we have it in a store, we don't tell you no, we actually ship it to you. We are on track there. So lots of good things going, which buoys our confidence a lot. But believe me, we're not declaring victory yet.

Operator

And we'll take our next question from Seth Sigman with Crédit Suisse.

Seth Sigman - Crédit Suisse AG, Research Division

So just a follow-up on that Direct question. Last year, I think you tested a free shipping promotion. If I remember correctly, you lost some shipping revenue. It may have hurt some non-CLUB Visa sales, how do I think about that as you start lapping that in the third quarter this year?

Thomas L. Millner

Well, that's a really good question, Seth. I think the only month that's more challenging is in the month of July. And I'll give you a little color on where we are in July. Retail comps are in the mid-single-digit range, which is slightly above our internal forecast. And then the Direct business is up slightly, which again, is also above our internal plan. This is the -- July is the first month that we lap free shipping from last year and it's frankly the only month we see those kinds of headwinds in Direct.

As we go forward, the $5 Flat-Rate offer has been really good for the business, because it allows us to pulse free-shipping offers around the $5 Flat Rate for CLUB members. So we're going to continue $5 Flat Rate definitely through the end of this year and then we'll look into next year. But we really like what we're seeing. We're getting as many CLUB attachments. There's been no degradation there. So it was a really great change.

Ralph W. Castner

We feel really good, as far as July goes, we feel really good about the Direct business. That we're comping up over what was a very strong month a year ago because of the roll out of free shipping.

Thomas L. Millner

And Seth, we feel really good about the quarter. We're off to a good start and are pretty pleased with where we are 3 weeks in.

Seth Sigman - Crédit Suisse AG, Research Division

Okay, good. And those trends that you mentioned, how do they compare to the end of the second quarter? Basically, how did the quarter shake out in terms of you were running mid-teens early in the quarter, how did May and June shake out and now we know where we are today?

Thomas L. Millner

Retail comps, to no surprise, you saw the mixed data. Retail comps settled late in the second quarter. So we're trending consistent with that, probably to no surprise. And the Direct business deceled only because of the -- this first month of lapping that free-shipping offer.

Seth Sigman - Crédit Suisse AG, Research Division

Got it. And just one more quick one on the SG&A topic. Given those comp trends, I mean how should we think about the ability to leverage expenses given some of the buckets that you mentioned that you're investing in?

Ralph W. Castner

Well, I think we'll leverage it more than we did in the second quarter as we get into third and fourth quarter. We clearly made a lot of investments in the second quarter as we'd signaled. So we will -- in the third and fourth, we will leverage better than we did in the second, but probably not as well as we did in the first just because there's some things we want to continue to improve about our business. And quite frankly, the top line will probably de-accelerate a little bit, particularly as we comp in the fourth quarter the up 12% comp that we had a year ago.

Operator

And we'll take our next question from Rick Nelson with Stephens.

N. Richard Nelson - Stephens Inc., Research Division

Tommy, you provided a comfort with third quarter and fourth quarter on a consensus estimate. I'm curious how you're planning of thinking about the comp in those periods and what you're thinking in terms of the guns and ammo category in the back half of the year?

Thomas L. Millner

Well, Rick, as we look ahead if you go even past Q4 where we got a 12% comp facing us, we got 24% comp in Q1 and then a 10.5% in Q2, it's not going to surprise anybody on the call but it's going to be tough to comp a plus 12% and then a plus 24%.

The gun business, and I'm just going to talk about guns now, not ammo, but the gun business is settling to what I would probably assume to be a new normal, which is elevated above history but not at the fever level that we saw recently. And that's a good thing.

So could comps get a little choppy in Q4, Q1, Q2 of next year? Yes, probably. Well, I think what gives us a whole lot of comfort, if you look at the second quarter, 10 of 13 merchandise subcategories comp-ed up and many of them have nothing to do with guns and ammo. In fact, a category like archery, one could argue, albeit a smaller category always takes a hit when guns and ammo are booming because our customer says "Look, I'm buying a gun. I don't need to buy a bow." Footwear, again, great category in the quarter. So we're able -- we're now able, with the quality of our assortments in our presentations, guns are going to be what guns are going to be. I don't see ammo slowing down a whole lot anytime soon. It could come down a little bit, but it's still stretched pretty tight from a supply standpoint. But guns are going to come back to normal. That's not a surprise and what we're encouraged about is the performance of everything else in our assortment, let alone the spectacular performance in the 5 next-gen stores that came into the comp base.

Ralph W. Castner

Yes, and that's a real reason, and I may have sounded a little pessimistic about comps a few minutes ago, but there's a real reason to be optimistic about comp store sales. As you think about the mix of our new stores, we've got 30, I believe it's 35 stores in the comp base today. Five of those stores are our next-generation stores that are comp-ing 600 basis points better than the average. Well, as you start -- as you start adding over the next 12 months, we're going to roll about 7 new stores into the comp base in addition to the 5 that are there today and if we continue to see that kind of elevated performance of 600 basis points over the average as a whole, that should really be accretive to comps. And in addition to that, we're looking at some new and expanded product categories to introduce into the stores, too, to help with comps too. So there's reasons to be

optimistic even going up against this -- the real elevated gun and ammo levels that we've seen over the last -- of the last few quarters.

N. Richard Nelson - Stephens Inc., Research Division

That color is really helpful. Can you discuss the industry-supply situation in guns and ammo and your own inventory levels. Are you still able to maintain the margins in the gun category?

Thomas L. Millner

Yes, let's break that down, Rick. Ammunition supplies are different by category: .22-caliber ammunition is still very, very, very tight; pistol and revolver ammunition, in some categories, remains tight, although better; and rifle ammunition, particularly .223, is improving, although still at -- not at levels that would replenish our inventories at historic normal levels. So we're still under-inventoried and still under-inventoried against demand every day. And that could improve a little bit in the balance of the year, but I don't see a radical improvement.

Guns. Supply is improving. There's still some handgun categories that are tight. Modern sporting rifles are more easily to get and we would envision in the back half of the year, if you follow our advertising circulars for retail, we pretty much had to stop advertising guns for the most part. We'll be able to pick our cadence back up in the back half of the year and start advertising and promoting guns. So there could be a little bit of downward pressure on gun margins but I don't see the industry going crazy and radically dropping prices across the board. There's not enough supply to make that happen. Does that help?

N. Richard Nelson - Stephens Inc., Research Division

Yes, yes, that's helpful. And a final question, the 3 categories that lagged in the quarter, I'm curious if they're weather related and if that business just gets pushed out from Q2 to Q3?

Thomas L. Millner

Well, it was. The categories were fishing, camping and powersports, so it was all weather-related with the late start of spring. I'll take fishing as an example. It started very slow in April because the lakes up in your part of the world were still frozen, so you couldn't fish. The business did come late in the quarter, although clearly, we comp-ed down very slightly in fishing. But it did come on later in the quarter but I don't think there's going to be a meaningful difference in the third quarter. I think what's more important is our merchants and planners did a great job of making sure our inventory positions were good and clean as the season started to wind down so that we don't have big overhang. It actually turns into an opportunity next year if we see more normal weather patterns in the spring.

Operator

We'll take our next question from Matt Nemer with Wells Fargo.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

So first, I just wanted to talk about the tactical decision that you guys made to invest in advertising and labor during the quarter. Going forward, are you targeting a certain percent of sales? How should we think about that in the back half? And then is there any way to measure the payoff on that in terms of either Net Promoter Scores or the kind of brand awareness from the advertising?

Ralph W. Castner

Well, obviously, we spent a lot of time measuring our advertising. Some is easier to measure than others and some of it we feel helped us get to 13.7% increase in the Direct business in the strong comp performance that we saw. I think as we move forward to the back half of the year, you'll see a little bit less than that. But we just saw, particularly coming out of Q1, what we saw as being a strong business, saw an opportunity to expand our brand nationwide. What's a little -- which went hand-in-hand with making more sense is we're rolling out more retail stores and have more of a national footprint.

Thomas L. Millner

Matt, as you know, it's pretty easy to measure the impact of -- we increased circulation 12.5% in the quarter. We made additional investments in search engine optimization, all of which are things, as you know, are easily measured. Almost by definition, we haven't really ever done any national brand advertising to -- and It's in Your Nature gave us that chance. So by definition, it's hard to say doubling of our brand campaign in the quarter related to 200 basis points on the direct comp because we spent more money on It's In Your Nature. We just thought it was the perfect campaign. We had a great business environment to spend a little bit more money and we did. I think as we look at the back half, a lot of those investments are behind us and we'll probably be a little more judicious and go back to our normal cadence in the back half of the year.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Okay. That's helpful. And then just a couple of housekeeping questions. The first is on the store-to-door launch in the back half. Any sense for how much -- how many orders or how many opt-outs or card cancels there are when you are out of inventory on the site, but you have it in the stores? Is there a way to quantify how many of those orders that you could potentially fulfill?

Thomas L. Millner

Yes, it's a meaningful number and I think the best thing to tell you is let's just wait and see how it rolls out. We're not going to do it in one big bang. So we're not going to do every store on one day. That would be imprudent. But by the time we get to early November, we should have phased in every store to be able to fulfill from. So it'll build slowly through October but what I wanted to convey is we are right on track to implement this and it's going to have a favorable impact.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

And then just lastly, I didn't hear a lot of mention about the Outpost stores. I'm just wondering -- I know that they were -- there aren't that many that are open, but it sounded like the gross margins were tracking above the company average. Can you give any more detail about how you're feeling about the Outpost stores in terms of returns and performance?

Ralph W. Castner

Well, the only reason that you didn't hear much about the Outpost, we've only got 2 open into a 5-store test. But they are similar to our next-generation stores, they're comp-ing much better or they're performing on a per square foot basis much better than our legacy stores. And they're right in line with plans. So we feel good about our Outpost stores. We're, at least, I'm looking forward to the back half of the year when we get 3 more open and have a full 5 store open and just see how they perform collectively. And it, quite frankly, when you have more of them open, it will give us an opportunity to dedicate more resources. Just those stores that have dedicated teams are those stores, which is something we're looking forward to.

Thomas L. Millner

Matt, this could be unrelated to our increase in brand spending and spending more marketing dollars. But something we've been paying very close attention to are the buying patterns and shopping habits of our new-to-file customers in 2013 versus 2012. And quite interestingly, those new-to-file customers that bought a firearm and those new-to-file customers that bought ammunition, and I'm looking those at separate categories, and then those customers new to file who bought sort of everything else, what has been astounding in 2013 is all 3 of those categories of new-to-file customers are coming back more often and buying more than new-to-file customers did in 2012, and it's a significant change not a little change, a significant change. Now can we tie that back to brand advertising or additional marketing programs, probably pretty hard to do but we are converting those new-to-file customers into regular customers better than we did in 2012 and that bodes well for the company long term.

Operator

We'll take our next question from Lee Giordano with Imperial Cap.

Lee J. Giordano - Imperial Capital, LLC, Research Division

Can you talk a little more about the Financial Services business and what you're seeing in interest rate environment and then, I guess, the potential impact from the higher rates that we're seeing recently?

Ralph W. Castner

Yes, well, as everyone knows, particularly the 10-year rate went up pretty significantly about 4 weeks ago and has settled down a little bit. And that's changed our strategy a fair amount. We're still trying to lengthen liabilities but, well I mean, what's interesting to me is we've set, now that we have $500 million of 10-year liabilities, which is about the total, it's out about $550 million, actually, of both 10-year CDs and 10-year term securitizations, we're in an interesting situation where increases in the short-term rate would actually be a significant lift to earnings. And to kind of help quantify that, if LIBOR would move up 50 basis points, we think that would be upside to our earnings of $5 million to $10 million per year. So we've put ourselves in a great position for a rising-rate environment, which it seems to me, at some point is going to happen. I don't know if that's sooner rather than later, but it seems like rates are going to have to go up at some point. So we feel really good about where we sit from an interest rate risk exposure.

Thomas L. Millner

And Lee, as Ralph said in his comments, going long on a 10 year impaired earnings by higher interest expense in the quarter by $2 million, but we just thought that was a great thing to do long term for the company, albeit at a short-term impact.

Operator

We'll take our next question from Chuck Cerankosky with Northcoast Research.

Charles Edward Cerankosky - Northcoast Research

If you're looking at the price versus volume in your sales in the quarter, can you comment on that especially if you look at it with and without guns and ammo?

Thomas L. Millner

I don't have it with or without guns and ammo, but transactions were up 9.9% in the quarter and average ticket was up 0.6%.

Ralph W. Castner

And those numbers are at Retail.

Thomas L. Millner

At Retail.

Ralph W. Castner

That's of the Retail comp, most of it was driven by transactions versus ticket.

Charles Edward Cerankosky - Northcoast Research

Right but no specific comment on inflation as it impacted your sales?

Thomas L. Millner

No. It wasn't meaningful at all.

Charles Edward Cerankosky - Northcoast Research

If you look at your sales mix between Direct and Retail, could you talk about that a little, what moved the margin? And I realized we don't have guns and very little ammo this time around in Direct, but could you comment on that sort of adjusting for guns and ammo?

Thomas L. Millner

Well, we saw a great performance out of high-margin categories like hunting apparel and footwear, which helped us a lot. Just the strong categories in Direct and Retail were basically the same ones. If we start layering in both optics and bows -- and archery in both and the weak categories were, in both Retail and Direct, where the slow start to spring categories of fishing, powersports and camping. So not a material difference between the channels.

Ralph W. Castner

Yes, I mean, not surprisingly this trend we've seen over a number of years is that most of our improvement in merchandise gross margin comes in the Retail side of the business and this quarter was not unusual with respect to that.

Charles Edward Cerankosky - Northcoast Research

So it had more margin improvement than Direct?

Ralph W. Castner

Yes, a matter of fact it had more than all of margin improvement that we saw.

Charles Edward Cerankosky - Northcoast Research

What's driving archery?

Thomas L. Millner

It's just had a great year, Chuck. I wish I could tell you. When Hunger Games, when that movie started, it launched a resurgence of archery together with some really exciting new products. We have a co-branded bow with our partner BowTech that's just been a real successful product. And what's kind of interesting is I was looking yesterday Hunger Games 2, the movie hits the screen on November 22 and it may have another push to help the archery category. And plus, there are a lot of -- the scholastic archery programs in the United States are nothing short of phenomenal. So there is just a lot of interest and a lot of great new product in archery and, look, we have a great assortment and are capitalizing on it.

Charles Edward Cerankosky - Northcoast Research

Looking at The Street guidance range or excuse me, The Street range for earnings this year, it's $335 million to $355 million, I guess this is as of last night, with The Street consensus around $343 million. Can you comment on that relative to your comments around the quarters?

Ralph W. Castner

I'm not sure what I can add to it. We said that we're comfortable with external estimates for both the third and fourth quarter. So -- and if you add them up to what we did in the first half of the year, that gets you in the range that you mentioned. So...

Charles Edward Cerankosky - Northcoast Research

Well, I'm just thinking it's a $0.20 range. Would you be more focused on the middle or high end or what?

Ralph W. Castner

I'm not sure we can comment on the range. We -- our comments in the script are relative to consensus.

Operator

We'll take our next question from David Magee with SunTrust.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

I have a couple of questions. First, given the Direct performance this year and the performance of new stores, does that cause you to rethink the potential impact from cannibalization that you talked about in the past? Or is that relationship going to hold the way you set it up before?

Ralph W. Castner

Obviously, given the importance of ammo to the Direct business, we've seen that business perform really well. We haven't gone back recently and looked at the cannibalization impact. We'll do that as we get all the stores opened in 2013. But I think it's -- our normal expectation, the $2 million to $3 million a store, still seems reasonable as we think about opening up new stores.

Thomas L. Millner

David, what I remain really curious about, I can't wait to get stores open in Anchorage, Alaska and we announced Acworth, Georgia this morning and Augusta. It's going to be really interesting to see what happens to our Direct business in those markets, markets like those where we have no physical presence. I'm really curious to see, does it actually, could it actually lift the Direct business because we're more front of mind? Because you drive by our store every day. You think, "Well, I don't have time to go to the store but I'm going to go online because I saw the name and I know the company." And it's going to be interesting to see how that unfolds.

Ralph W. Castner

Well, particularly in the Southeast, as Tommy mentioned some of them, but now in 2014 we've got 4 stores opening in the Southeast, which are Greenville, South Carolina and Bristol, Virginia, Acworth, Georgia and Augusta, Georgia. That'll give us pretty good visibility to some pretty important markets in the Southeast and could be helpful to the Direct business.

Thomas L. Millner

And that's our lowest performing Direct region is where we don't -- in the Southeast, where we don't have a lot of store visibility.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Second question is the -- on the credit card business, it sounds like, obviously, you're growing the account base very nicely and it sounds like they're engaged. Do you see anything happening different on the competitive front with regard to other players in the loyalty programs, the rewards programs?

Ralph W. Castner

No, not particularly in the loyalty space. We haven't seen anything meaningful going on there. It's a great brand and that's really what attracts people to our card program.

Operator

We'll take our next question from Sean Naughton with Piper Jaffray.

Sean P. Naughton - Piper Jaffray Companies, Research Division

You guys have done a really nice job of improving the merchandise margins. It sounds like you may be a little bit more advertising in the back half on the firearm category, so that could have a little bit of an impact there. But curious, what's your outlook is for just inflation on the costing environment that you're seeing as you source goods for Q3 and Q4 at this point?

Thomas L. Millner

Well, those goods are long ago bought. I think we bought fall softgoods in footwear probably a year ago. But so we're not seeing a lot. I mean, it's just not even an issue. Inflation pressures from the supply side are not a threat to our business or our margins. And we're not seeing a lot of pressure. We're buying now for spring of '14 and looking at fall buys for '14 and not seeing pressures that are anything other than completely manageable.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Okay. That's great. And then, if there was potentially a slowdown in the firearms and ammunition, I mean, could that potentially be a little bit more opportunity then to offset some of that sales slowdown with the better profitability or higher merchandise margins from the rest of the store?

Ralph W. Castner

Well, I think there's a couple of opportunities. The biggest one is obviously mix. For example, in this quarter, margins were hurt 58 basis points by mix. So they would have been much higher had it not been for that. So clearly if guns and ammos slow, there'll be an opportunity that the -- it will not have as much impact on gross profit dollars because of the mix issue. And then combine that with my comments earlier about comp store sales doing well, because of all the new next-generation stores entering the base and the possibility of some new and expanded products, those are all things that we're doing in preparation of a slowdown in guns and ammo.

Thomas L. Millner

And, Sean, to add just a little more color, as we look to the back half of the year, last year margins in Q3 were 37.2%, which was the third highest rate in a quarter going all the way back to Q1 of 2007. So that's a pretty high run rate. I wouldn't expect a lot of upside to that. It gets a little easier in Q4 with margins at 36.2%. So I think probably limited opportunity for expansion in Q3 just because the rate's so darn high, with some opportunity in Q4. But as we get through that, we continue to be committed to continuous improvement in margins. Our price optimization tool will give us some benefit in 2014. Net SKU profitability, the net SKU profitability tool from Acorn we mentioned is an interesting one because it actually doesn't help merchandise gross margin rate because most of the impact is in below-the-line cost. And Ralph used a great example to me yesterday, that there's a cost to get apparel in that's already prepacked, hung versus loose pack that we have to put on a hanger. Little silly stuff like it's activity-based costing. And this tool allows us real visibility into what the total cost of a product is, not just what it cost to buy versus to sell. So it could really impact below-the-line cost in 2014.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Okay. That's really helpful. And then, I guess, just a secondary question here is just on the competitive dynamics out there, you guys have seen great success going to the smaller format, closer in to some larger communities and then, obviously, the Outpost strategy. Looks like some other people are also accelerating some of their growth in these areas. Have you seen anything that has been potentially impacting your business, as people have been coming into the market or closer to you guys? Or just any comments there would be really helpful.

Thomas L. Millner

I think it's very important for everyone to remember that it's easy for us to get fixated on our big box competitors when in fact, a huge preponderance of our industry remains independent dealers. That's really the big competitor for all of the big boxes in or the specialty guys in our business.

Have we seen an impact? No. We overlap with almost everyone of our big-box competitors today and we have for a long period of time. What gives us all the confidence in the world, and Ralph and I have seen every location with our own eyes in each one of the markets that we're going to in '13, '14 and soon to be '15. I can assure you that our '13 stores and our '14 stores and the '15 stores we're looking at, we are in the best locations in those markets. Our balance sheet allowed us to get the best locations and we would submit that the best location in retail, as long as your strategy is good and the community is a viable, is the winning strategy. And we feel absolutely 100% confident we're in the best places in those markets. And what everybody else does, I can't do anything about that nor can Cabela's, but we're in great locations.

Operator

We'll take our next question from Jim Duffy with Stifel.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Couple of questions for you guys. So the Direct revenue progress is encouraging. It's come with some margin compromise, however. Is that to suggest that going forward, you're more comfortable sacrificing rate of margin to drive gross profit on the Direct side?

Ralph W. Castner

Well, there's clearly been some of that and some of it, it's caused by the mix issue. But no, I think it's just as it has been for years, it's just been tougher to grow margins in the Direct business. So I think when you see things like mix impact that business, we're less able to compensate for it on the Direct business than we are at Retail.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Okay, makes sense. And then I'm going to throw this one out too and see what I get. When you buy a gun, of course you need ammo. Have you guys ever done any sort of analysis to look at correlation between gun sales and then ammo demand in the following periods?

Ralph W. Castner

Other than what Tommy discussed earlier about the retention rate of customers, I mean, that's kind of where we're really focus on, is how often they come back. Obviously, part of that purchase is for ammo, but we're interested in selling them an array of products. But ammo is a driver for repeat purchase of these new customers to file.

Thomas L. Millner

What was really interesting, Jim, was this -- the all other customers that we've gotten that are buying unrelated gun and ammo products, they're coming back more frequently and buying more.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Got you. Maybe I missed this. Could you guys talk about -- I know sounds like it was positive, but did you talk about the comp rate for the softgoods categories like footwear and apparel?

Ralph W. Castner

We didn't give you a specific rate but one of the, in retail, one of the strong, well, the strongest softgoods categories were hunting apparel and footwear. It did nicely in the quarter.

Thomas L. Millner

Really nicely.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

And then just a technicality, the powersports, when you talk about that, does that include boats or is boats...

Thomas L. Millner

It does. Yes, it does.

Operator

We'll take our next question from Mark Smith with Feltl and Company.

Mark E. Smith - Feltl and Company, Inc., Research Division

I don't if you guys key in or want to quantify ammo impact on Direct business?

Ralph W. Castner

We discussed last time, Mark, that we weren't going to break out ammo anymore on a specific level. So I guess the answer is no.

Mark E. Smith - Feltl and Company, Inc., Research Division

I think on the last question you said mix, obviously, was a big piece of what pushed the Direct margin down a bit.

Ralph W. Castner

I did. And I mean, ammo was strong in the quarter. I mean, there's no question, it's been strong.

Mark E. Smith - Feltl and Company, Inc., Research Division

Okay, perfect. And then next, can you just talk about, maybe over the last 6 months or even a year, and what we're seeing on Cabela's branded mix really in categories excluding, obviously, hunting -- or I'm sorry, firearm, ammo, powersports, just kind of the trend continuing to see on Cabela's branded gear, especially as we look at some of these Outpost and next-generation stores?

Thomas L. Millner

Yes, I'll be glad to. If you'll think back to 2 analyst meetings ago. I think we're in Phoenix. We really laid out for you guys what our plans were for Cabela's branded products. And it involved getting Cabela's branded products at the better and best categories of our merchandise assortment and out of opening-price-point merchandise. So a deliberate, conscious strategy to improve performance and quality across the board, everywhere from footwear to co-branded bows to optics to camo patterns. Everything we did, we were going to reserve our very best, highest performing products to bear the Cabela's brand name. And we were going to be probably less concerned about what percent of penetration and just -- if we give customers great products, they're going to buy them and just -- we're going to let the chips fall. And, man, the reaction to our spring Cabela's branded merchandise from BOA footwear to our new Guidewear assortments to men's casual and women's, our Bowtech co-branded bow, just terrific. And as we go to the fall, man, we've just got really neat stuff. We have a color changing camo pattern that, it's called Phase technology, so as it gets colder or warmer, the camo pattern actually changes, the fabric changes, the look of the camo. It's just really cool technology. Our Zonz camo is, you can see it online today, revolutionary camo. So we're getting better at just elevating the quality and performance of Cabela's branded products and we think that just bodes very well for the brand long term.

Operator

We'll take our final question from Anthony Lebiedzinski with Sidoti.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Just a couple of questions, please. First, can you just tell us what's driving the improvement in the legacy stores that you highlighted in the press release?

Ralph W. Castner

Well I think, yes, there's -- I tell you, that's mainly driven by people. Just as we've continued to hire more great retail expertise from across the industry, those people are applying learnings to both our Direct -- to both our legacy stores and our new stores and we're seeing real lift to that business.

Thomas L. Millner

And Anthony, we've done a really good job of taking the learnings, adjacencies that we've learned a lot about in next-gen stores of where to put product categories. We've taken those learnings instantly to the legacy stores and, we've mentioned this in prior calls, pulling sunglasses from the back corner of the store and putting them on the front-drive aisle, it just makes a difference. So it's using a lot of the learnings from next-gen stores and Outpost in product presentation in the legacy stores, and I would submit to you, just better products overall. Our customers are reacting to better product in legacy stores and next-gen stores.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Got it, okay. And in the Retail segment you gave us a breakdown of the merchandise categories, kind of the '13 performed well. Can you give us a similar kind of statistic for the Direct business?

Thomas L. Millner

They were not meaningfully different. The 3 categories that were weak in Retail were also relatively weak in Direct, which was fishing, camping and power sports, which was attributable to the weather in the late spring. And the other categories that were good in Direct were optics, footwear, archery and shooting. So not much difference between the 2 channels.

Operator

And with no further questions, I'd like to turn the call back over to management for any additional or closing remarks.

Thomas L. Millner

Well thanks, everybody, for joining us today, and we look forward to talking to you again, soon. Thanks.

Operator

This concludes today's conference. Thank you for your participation.

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Source: Cabelas Inc (CAB) Management Discusses Q2 2013 Results - Earnings Call Transcript
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