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Cabela's Inc. (NYSE:CAB)

Q2 2008 Earnings Call Transcript

July 31, 2008 4:30 pm ET

Executives

Chris Gay – Treasurer, IR Manager

Dennis Highby – President and CEO

Ralph Castner – VP and CFO

Pat Snyder – SVP of Merchandising, Marketing, and Retail Operations

Analysts

Jim Duffy – Thomas Weisel

Mitch Kaiser – Piper Jaffray

David Cumberland – Robert Baird

Chris Svezia – Susquehanna Financial Group

Paul Lejuez – Credit Suisse

Bob Simonson – William Blair

Derek Leckow – Barrington Research

Zack Shafran – Waddell & Reed

Rick Nelson – Stephens

David Penler [ph] – Western Research [ph]

Operator

Good afternoon, ladies and gentlemen. We'd like to welcome you to today's Cabela's Incorporated second quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session and instructions will be provided at that time. (Operator instructions) And now at this time, for opening remarks, I'd like to turn the conference over to Mr. Chris Gay, Treasurer and Investor Relations Manager. Please go ahead.

Chris Gay

Good afternoon. I welcome everyone listening today both on the conference call and by webcast. This afternoon we issued our second quarter fiscal 2008 earnings press release. If you have not yet seen it, it is available in the Investor Relations section of our Web site at www.cabelas.com. In addition, a replay of today's call will be archived on our Web site.

Leading our call today will be Dennis Highby, our President and Chief Executive Officer. Dennis will provide a high level review of our second quarter results and update everyone on our profit improvement initiatives. Also joining us this afternoon is Ralph Castner, our Vice President and Chief Financial Officer. Ralph will review our second quarter financial results in more detail. Additionally, Pat Snyder, Senior Vice President of Merchandising, Marketing and Retail Operations and Brian Linneman, Senior Vice President of Global Supply Chain Operations will be available during the question-and-answer portion of the call.

Before we get started, let me read the safe harbor language. This conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are usually identified by words such as "expect," "anticipate," "project," "intend," "plan," "believe," and "confident." Forward-looking statements are based on our current assumptions and expectations and are subject to risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements.

We encourage you to review the risks identified in our filings with the SEC including the information set forth in the risk factors section of the company's Form 10-K for the fiscal year ended December 29, 2007 and Form 10-Q for the fiscal quarter ended March 29, 2008.

Now, let me provide a summary of our second quarter results. Consolidated revenues increased 16.6% to $526 million. For the quarter, retail revenue increased 37.1%, driven mostly by new stores. For the quarter, comparable store sales declined 1.6%. This is much improved from the first quarter. For the quarter, direct revenue increased 1.5% due to continued strength in internet sales. For the quarter, financial services revenue declined 6.7% due to higher net charge-offs.

For the quarter, operating income was $14.9 million compared to $20.3 million in the year ago quarter. The decline in operating income is due mostly to higher net charge-offs at our financial services business and lower merchandise gross margins. And diluted earnings per share for the quarter were $0.11.

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

Dennis Highby

Thanks, Chris. As we enter the second half of 2008 we remain focused on our business and our initiatives to improve retail profitability. Let me start by reviewing the performance of our three main operating segments.

First, I'd like to review our retail business which is our largest and fastest growing segment. Comp store sales improved significantly in the second quarter compared to the first quarter. For the quarter comp store sales were down 1.6% compared to down 8.4% in the first quarter. The improvement is due to increased advertising and the performance of this advertising. The contingency lowered traffic levels offset by higher averaged ticket. For the quarter, average ticket under comp store base increased nearly 3%.

With the current consumer environment and higher fuel prices, we have received questions regarding traffic levels and drive times to our stores. We have spent time analyzing retail store drive times and I'd like to share just a couple of points with you. Customers continue to drive significant distances to visit our stores. For the 10 stores in the comp base in 2006, the average drive time to those stores was 1 hour and 45 minutes. These same stores now have an average drive time of 1 hour and 30 minutes in the first half of 2008.

Additionally, for those same stores, 43% of the sales in the first half of 2008 came from customers within a 1 hour drive time of the store. Recently, we have built stores closer to metropolitan areas. For the more recent stores, nearly 65% of the sales came from customers within a 1 hour drive of the store.

Another key point is that our customers continue to want to shop at Cabela's. Our market research is showing that customers are shopping less with our competition and sticking with us during the tough economic time.

Next is our direct business. We continue to test new specialty catalogs and catalog sizes to optimize both growth and profitability in our direct business. For the second quarter revenue in our direct business grew 1.5%. For the quarter we introduced 5 new catalog titles and increased catalog circulation and pages mailed.

We were able to increase catalog circulation and pages mailed while maintaining direct marketing costs at 14% of direct revenue. We continue to closely monitor catalog productivity with a goal of maintaining direct marketing costs.

One of the key indicators of a healthy direct company is the growth of its customer file. Through the first half of 2008 acquisition of customers is ahead of 2007 and shows that we are still growing our customer base. For the first half of 2008, retention of current customers and orders per customer are tracking ahead of 2007 levels.

Improvement in customer acquisition and retention are being offset by a slight decline in average transaction size. Our financial services business while strong is not immune to the current economic climate. For the quarter revenue declined 6.7% compared to the prior year. Revenue growth was adversely impacted by higher charge-offs in the quarter.

We continue to monitor delinquencies and charge-offs closely. For the quarter net charge-offs were 2.76% compared to 2.53% in the first quarter. In the second quarter, a year ago, charge offs were 1.65%. We are taking proactive steps to manage charge-offs. Maintaining extremely high credit standards is ultimately the best defense against losses from higher charge-off levels associated with difficult economic environments.

Now, turning to consolidated operating income, for the quarter, consolidated operating income was $14.9 million compared to $20.3 million, a year ago quarter. The decline in consolidated operating income is due to higher charge-offs at our financial services subsidiary and lower merchandise gross margins.

Now, let me review the progress we are making in our four initiatives to improve profitability. For everyone's benefit, the four initiatives are

First, improving retail store productivity, second, enhancing our merchandise planning and retail merchandising, third, improving inventory levels, and finally, executing more effectively our retail advertising strategy.

With regard to store operations, we continue to make improvements in retail store productivity. For the quarter, sales per labor hour in our comp store base increased 4.7%. We achieved this increase in operating performance at our retail division despite a 1.6% decrease in comp store sales. Improvements in labor productivity have been driven by improvements in several areas including more streamlined flow of goods to our retail stores, higher average ticket and better managing staffing levels at our stores.

We have also made progress in the area of merchandise planning and retail merchandising. We continue to flex seasonal assortments in our stores, improve visual merchandising and improve the timing of our seasonal merchandise rolls.

Now, looking at inventory, for the quarter inventory increased 20%. We continue to be encouraged by the trend in inventory growth. Recall that in the fourth quarter of 2007, inventory increased 26% and in the first quarter of 2008, inventory rose 23%. On a comp store basis, inventory per square foot was reduced nearly 7% to $60 per square foot.

Looking at our inventory to be received, we feel very good about our inventory levels and expect to show significant improvement in the second half of the year. For the quarter, retail advertising lift increased significantly from the prior year. We are continuing to analyze our media spin on a market by market basis to more effectively spend advertising dollars where they will produce the highest returns.

Our marketing group leverages our extensive customer database to make better informed decisions towards optimizing our marketing investment. In light of the current economic environment and our expectations for a difficult second half of the year, we are also reviewing other opportunities to reduce costs to improve operating margins.

Let me now update you on our new store opening plans. Our store in Scarborough, Maine opened May 15th and we have been very pleased with the result of this location. Our store in Rapid City, South Dakota is expected to open next week. This will be our first next generation store and we are very excited about its grand opening. For 2009, we expect to open two stores.

We continuously review our operation for ways to improve return on investor capital. We believe that we can generate $200 to $250 million of capital from internal sources through the sale of excess land around the existing locations and economic development bonds. We will be converting these items to cash over the next three years.

Our current preference for use of any such proceeds is to reinvest in our company. We're continually reviewing economic conditions and may consider various alternatives for reinvesting our capital.

While we're encouraged by the improving sales trends in our direct and retail business, we recognize that we still have work to do to expand margins and further drive profitability. We expect the sales environment to remain difficult in the back half of the year, but our entire team is energized and focused.

I'd like to again express how proud I am of our employees and how they continue to step up to meet the challenges of a tough consumer climate. I sincerely thank them for their ongoing dedication to this company.

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

Ralph Castner

Thanks, Dennis. During the quarter, consolidated revenue increased 16.6% to $526 million compared to $451.2 million in the second quarter of 2007. Direct revenue for the quarter increased 1.5% to $207 million compared to $203.9 million in the same quarter a year ago. We are pleased with the improved performance of our direct business in the second quarter.

Recall that effective January 1st we began collecting sales tax on direct orders in the 16 states where we have a store. Some analysts have inquired whether this has had an adverse impact on sales. As far as we know, it's never been established there's a direct correlation between the collection of sales tax and sales volumes. We do know that in these states, the performance of our direct business is generally consistent with overall direct revenue growth.

Retail revenue for the quarter increased 37.1% to $273.6 million versus $199.6 million in the same period last year. The increase is due to our new store openings including our most recent opening in Scarborough, Maine in mid May.

Comparable store sales declined 1.6% in the quarter. Comparable store sales continue to be impacted by the challenging macro economic environment. Relative to the first quarter, improvements in comparable store sales were driven by increased advertising and significant improvements in the performance of our retail advertising.

Now, looking at the financial services segment, which encompasses our largest loyalty rewards program. For the quarter, revenue decreased 6.7% to $38.3 million versus $41 million in the second quarter of last year. As Dennis mentioned earlier, the decrease in revenue is due to higher charge-offs. We measure the performance of our financial services segment on a non-GAAP basis. A reconciliation of these measurements to GAAP was provided in our earnings release.

In the second quarter average managed credit card loans increased 25.3% and average active accounts increased 16.6% compared to the same quarter a year ago. Through the first half of 2008, roughly 25% of new accounts came through our direct channel while 75% came through retail. Of the retail accounts, roughly one-third came from our new stores and two-thirds came from our existing stores. For the quarter, average account balance increased 7.5% compared to the prior year quarter.

Now, turning to consolidated gross profit. Gross profit for the quarter increased 9.7% to $209.6 million versus $191.1 million in the year ago quarter. Consolidated gross margin was 39.8% in the quarter compared to 42.4% in the same quarter a year ago. Our merchandise gross margins were 34.5% in the second quarter of 2008 versus 35.9% in the same quarter last year. The decrease in merchandise gross margin is primarily attributable to greater mark downs, particularly in our direct segment.

As Dennis mentioned earlier, one of our initiatives is to improve our inventory levels and inventory turns. We are now being more aggressive at managing inventory levels in season which we believe will ultimately improve our bottom line results. To that extent we're making a more concentrated effort to begin mark downs earlier in the season.

Now, let's look at operating income. Consolidated operating income for the quarter decreased 26.7% to $14.9 million versus $20.3 million in the same quarter last year. On a consolidated basis, operating margins decreased 170 basis points to 2.8% from 4.5% in the same quarter of last year. The decrease is mostly due to higher charge-offs in our financial services business and lower merchandise gross margins.

Operating margins in our direct segment decreased 400 basis points to 12.7% versus 16.7% in the same quarter a year ago. Results here were adversely impacted by lower gross margins and to a lesser extent, reduced marketing fees paid to the direct segment from our financial services segment.

Direct marketing costs were 14% of direct revenue in both this quarter and the year ago quarter. Operating margins in our retail segment decreased 290 basis points to 8.2% as compared to 11.1% in the same quarter a year ago. The decrease in retail operating margins is primarily attributable to higher advertising expense, lower marketing fees and account bounties paid to the retail segment from the financial services segment and higher depreciation expense.

Operating margins in our financial services business were 29.3% as compared to 21.5% in the same quarter of last year. The increase in operating margin is primarily attributable to lower marketing fees paid to the merchandising segments and lower advertising expense in this segment.

With regard to the performance of our credit card portfolio, at the end of the second quarter, accounts more than 30 days delinquent were just 1.08% as compared to 1.1% in the first quarter of 2008 and 0.86% in the year ago quarter. For the quarter net charge-offs were 2.76% as compared to 2.53% in the first quarter of 2008 and 1.65% in the year ago quarter.

Corporate overhead and other expenses increased just 2% in the quarter. Corporate overhead and other expenses as a percent of total revenue declined 130 basis points to 9.7% of sales from 11% of sales in the year ago quarter. Leverage of these expenses came mostly from a decline in incentive compensation, lower depreciation and increased leverage of salary and wages. Depreciation in our corporate overhead segment decreased roughly $1 million, primarily due to a $1.9 million adjustment related to extending the lives of certain technology assets.

Moving onto the effective tax rate, for the second quarter we initiated a restructuring of our legal entities which will result in a lower – in a reduction in our effective tax rate. In the second quarter we realized a disproportionate amount of this benefit. This tax benefit, combined with a relatively low amount of absolute net income resulted in an unusual tax rate for the quarter.

For the second quarter, our effective tax rate was 17.8% as compared to 37.4% in the year ago quarter. We now expect our effective tax rate for the full year of 2008 to be roughly 35.8% as compared to 36.9% in 2007.

Moving onto earnings, for the quarter, net income was $7.3 million as compared to $11.3 million in the second quarter of last year. Diluted earnings per share were $0.11 in the second quarter compared to $0.17 in the same period last year.

Turning now to cash flow metrics, for the quarter we incurred capital expenditures totaling $41.8 million. Additionally, we raised roughly $3.5 million of cash due to the modernization of the economic development bonds related to our Mitchell, South Dakota store. These bonds were called at par and there was no income statement impact to the modernization of these bonds. For 2008, we expect capital expenditures, including purchases of economic development bonds to be in the $100 million to $125 million range.

Now, with regard to annual guidance, we continue to gain traction with regard to our four initiatives to drive real profitability and the year-to-date results reflect this progress. We continue to be confident in our ability to generate mid-teens revenue growth and mid-single digit earnings per share growth for 2008.

While we expect a challenging sales environment for the remainder of the year, most of our growth in profits will be in the third and fourth quarters. We expect profit growth to be driven by lower pre-opening costs and benefits from our profit improvement initiatives.

Our guidance incorporates the following assumptions for the full year. Given the difficult retail environment we now expect same store sales for the full year to be down 5% to 7% as compared to our prior guidance of down 2% to 3%. Through the first six months of the year, direct revenue growth has been a positive 0.4%. For the full year we expect direct revenue growth to be flat to slightly down.

Given recent portfolio trends, we now expect bad debt levels to be roughly 2.7% to 2.9% for the year as compared to our prior guidance of roughly 2.6%. We continue to expect to see pressure in our merchandise gross margins throughout the remainder of the year.

Finally, as we continue to gain traction with our initiatives to improve retail profitability, we expect to see continued leverage of SG&A expenses and improvement in the performance of our retail stores.

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

Dennis Highby

Thanks, Ralph. Our 2008 outlook reflects a continuing tough consumer environment. The guidance we have provided for the full year is realistic and based on the economic environment continuing through the remainder of the year. Our guidance is not predicated on an improving economy for the second half of the year.

We continue to make improvements with regard to our initiatives and to improve retail profitability. We believe that our profitable, multi-channel selling platform, strong brand and superior customer service are a competitive advantage unmatched by anyone in our industry. We remain committed to further leveraging our powerful position in the marketplace and are focused on the significant opportunities to drive efficiencies and increase shareholder value.

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

Question-and-Answer Session

Operator

(Operator instructions) Let's take our first question from Jim Duffy with Thomas Weisel.

Jim Duffy – Thomas Weisel

First, nice job on the comps in what's a difficult environment. Can you guys speak a little bit about what you're doing differently from an advertising standpoint? I know you talked about that a little bit last quarter, but if there is any more findings of some of the programs that have really been working well, and you're putting maybe more wood behind that arrow?

Dennis Highby

Jim, this is Dennis. I think one thing that we've spent a lot of time doing is looking at the customer base that we have – I'm sure Pat might want to add something to this, but we're just doing a better job, getting ads to the consumer that are going to spend money. The other thing we're doing is actually improving the productivity of the ads are just better merchandising. Pat, I don't know if you want to add anything to that?

Pat Snyder

No, I think that pretty well sums it up. We're very pleased with the product selection we've made, and can see that it's lifting the sales in our retail stores. As we measure that, we look at what it costs for $1 worth versus advertising versus how much we left in sales, and we've seen a significant improvement in that area. And the second part is really analyzing our customers and how do we deliver that media to them to make it more cost efficient and more effective.

Jim Duffy – Thomas Weisel

Okay. Very helpful. And then I didn't hear you guys mention particular categories within the stores that were, were some stronger than others I'm sure. Seems like it would have been a tough quarter for fishing.

Dennis Highby

Some of the slower categories as you know marine was tough. Fishing was slow. Hunting, clothing isn't a big category in the spring, but it was slower than normal. Some of the items that were strong. Some categories just in general, hunting equipment continues to be strong. Camping is a great category. Believe it or not, boats by themselves had some strength, and clothing in general was pretty good in that quarter.

Jim Duffy – Thomas Weisel

Okay. And then Ralph, Dennis spoke to $200 million to $250 million in opportunity capital that you think you can free up over the next two to three years, can you provide a little bit more detail about the components of that?

Ralph Castner

Well, yes, there's probably several components to it. I mean, the first of which is land sales around our existing stores that we've talked about. We have two locations where we've paid for the land, and have put those stores on hold. There is probably some opportunity to do something there. We talked about economic development bonds. And a fourth initiative we have not talked a lot about is, in certain of our stores we've looked where we're not fully utilizing all the parking lots and all the lands around the store. We're looking at maybe selling some out lots in some of our retail locations. And actually, we did have one small sale this quarter, but out of lot of a location in Wheeling, West Virginia. We think there is still a lot of upside there.

Jim Duffy – Thomas Weisel

Okay. And then question for you. You mentioned $60 a square foot at retail. How do you calculate what's retail inventory versus what's allocated to the direct business?

Ralph Castner

When we tell you that stat and you can't calculate it because you don't have enough data, but that's just the inventory within the four walls of the store. It doesn't include any of the DC inventory.

Jim Duffy – Thomas Weisel

Okay.

Ralph Castner

And we use that more as internal metric. I don't know that it is apples and apples to other retailers because obviously they'd have some amount of inventory in their DC's.

Jim Duffy – Thomas Weisel

Yes. Because just looking at where your sales for square foot that would imply some pretty impressive turns.

Ralph Castner

Yes.

Jim Duffy – Thomas Weisel

Okay. Thanks very much. I'll probably follow up with some questions afterwards.

Ralph Castner

Okay.

Dennis Highby

Thank you.

Operator

Next in our queue, we have from Piper Jaffray, Mitch Kaiser.

Mitch Kaiser – Piper Jaffray

Thanks, guys. Good afternoon. It was a nice quarter. I'm just curious, in the past you've talked about marketing fees allocated from the financial services to the direct and retail segments, could you give us those, Ralph?

Ralph Castner

Yes. We haven't – I don't – we have not disclosed the absolute number of them. I can help share with you what the change in those was. In the retail business there was a decrease in those marketing fees of 1.3 million. In the direct business the decrease was 2.7 million. And that was obviously a function of the bad debt to the bank, Mitch.

Mitch Kaiser – Piper Jaffray

Okay. Okay. So that helps explain some of the swing on the profitability, particularly, relative to last quarter, because last quarter you were actually up on the retail business on operating margin with a negative eight comp, and obviously the comp's much better but your margins were down, right?

Ralph Castner

Yes. I think – I really think, Mitch, that some of the bank marketing fees and actually masking a lot of our improvement at retail. We have made some real progress there at retail and unfortunately you don't see it in the margin because of some of the activity that's going in the financial services segment.

Mitch Kaiser – Piper Jaffray

Okay. Okay. And on the 250 million you talked about that supporting growth, could you talk about how you're going to balance growth versus potentially paying down debt?

Ralph Castner

Yes. I mean, we want to invest capital in a way that will maximize the return to our shareholders. There is obviously a lot of options there. You mentioned one which is paying down debt, obviously, the share repurchases is a choice and continuing to roll out retail stores is a choice, and we want to deploy capital in a way that maximizes the return to our shareholders.

Mitch Kaiser – Piper Jaffray

Okay. Okay. But, is it possible that we would see a re-acceleration of stores then next year potentially? I know I think you've got two in the pipeline at this point?

Dennis Highby

We have two stores announced for '09. I mean, there is a chance that we might do something there, but I'd count on two right now.

Mitch Kaiser – Piper Jaffray

Okay. And then thanks for the color on the guidance, that's helpful. You mentioned merchandise margins being tough for the back half of the year, but, if I remember right you had a very good comp in the third quarter last year, but at the expense of margins. Would you actually expect margin to be down in the third quarter against easier compare or no?

Dennis Highby

I don't know if we're going to comment on what margins are going to be in the third quarter, but we continue to see customers liking to buy merchandise that's a good value. There could be pressure on margins in the merchandise margins in the third quarter.

Mitch Kaiser – Piper Jaffray

Okay. Okay. And then lastly, you will be up against much easier compares from a pre-opening standpoint in the third quarter, correct?

Ralph Castner

That's true, Mitch.

Mitch Kaiser – Piper Jaffray

Okay. Thanks, guys. Good luck.

Dennis Highby

Thank you.

Operator

Next in our queue we have David Cumberland with Robert Baird.

David Cumberland – Robert Baird

Thank you. Ralph, can you give the 60 plus and 90 plus day delinquency numbers?

Ralph Castner

Yes, I can as well, and on the call I gave the 30 plus which is 1.08. The 60 plus is 0.66 and the 90 day is 0.33. Do you want me to repeat what they were last quarter or do you have that?

David Cumberland – Robert Baird

I do have that. So, is the increased charge-off guidance related to something you've been seeing in the 60 or 90 day delinquency numbers?

Ralph Castner

No. It's more. We are actually really pleased with the delinquency numbers because we see that as sort of a stabilization of our portfolio. I think the only reason that we have refined our bad debt guidance is just the increase we continue to see over the year ago period. But, as you know, at the start of the year we gave guidance that we expected our charge-offs to be at 2.6% and we're just seeing slight upward pressure on that, that we wanted to update you about.

David Cumberland – Robert Baird

And then on the depreciation within corporate overhead. You mentioned an adjustment related to extending lives of assets. And did I hear right that, that benefit Q2 by $1.9 million?

Ralph Castner

You heard me correctly.

David Cumberland – Robert Baird

And would future quarters have a similar benefit?

Ralph Castner

The benefit will decrease over time. I would say in the third quarter there'd be probably a benefit of roughly the same amount, but then as you go throughout the year the amount of that benefit would decrease.

David Cumberland – Robert Baird

Thanks. And then my last question. On the direct marketing costs, those were called out as being the same percentage despite an increase in catalogs and pages or circulation and pages. How are you able to achieve similar level with those increases?

Dennis Highby

You know, Pat might want to add something to it. But it's a combination of just the number of pages, the number of catalogs, the number of new titles. I mean, we did have five new titles this year, and we dropped a couple titles, but it's – I mean, those guys in our direct marketing department, I mean, they're pros they've been doing it for a long time, I mean, their goal is to make sure that they keep marketing costs in line.

David Cumberland – Robert Baird

Great. Thank you.

Dennis Highby

Thank you.

Operator

We'll move on now to Chris Svezia with Susquehanna Financial Group.

Chris Svezia – Susquehanna Financial Group

Good afternoon, gentlemen. I guess a couple questions. I guess Ralph, maybe for you first. I was wondering if you can maybe help us out with how we should be looking at the net managed financial services as a percentage of the overall outstanding balance, if you can help us out at all with that. I mean it came at it looks like 7.6% for the quarter. Any thoughts about how that might look as we move towards the back half of the year? That would certainly be helpful.

Ralph Castner

Well, I think the only color I can give you is to point to the last page of our press release where we break out the components of that. I mean, I can comment on each one. I mean, we're seeing interest income going down just with the overall level of interest rates. Interchange income continues to stay about that 4% number as with other fee income continuing to stay about 1.5%. We're seeing interest rates go down not as much as what – we're seeing interest expense go down, not as much as interest income is going down. And there is really two reasons for that. The first one is we're seeing increased spreads in the securitization market which we are counting on. The second is that at these low rate levels, we're making a conscious decision to try to lock in more fixed rate debt which is at the end of the day slightly more expensive. So, we are seeing some pressure in spreads. And the rest of which is the bad debt expense which is what we've already talked about. So, I don't know how much more color to give you than that, Chris.

Chris Svezia – Susquehanna Financial Group

Okay. That's helpful. Anything maybe you can add on the new, I guess as you continue to add on new holders that you're seeing both at the store level and on the direct level. Can you maybe just comment in terms of what you're seeing in terms of the quality of those new applicants? Any color on FICO scores or anything like that might be helpful too.

Ralph Castner

I'm not sure I can give you much color on FICO scores. You know, no, I don't know that I can add much of FICO scores. We have not seen significant movement in our average FICO scores. I did have some comments in the prepared script to talk about where the mix of our accounts are coming from. And the intent there was to point out just how productive from a credit card standpoint some of our locations are. It's just amazing how they keep churning out accounts, and we continue to have a nice quarter with respect to both growth in accounts and growth in average balance. And the power of having now over 1 million cardholders out there in the marketplace is tremendous, and it's a competitive advantage that we don't think very many of our competitors have.

Chris Svezia – Susquehanna Financial Group

Sure. Okay. That's helpful. And then I guess can you maybe, Ralph, just break out on the long-term debt that 800 million that's on the press release? Can you just maybe break out what's the long term less current maturity fee?

Ralph Castner

I can. You'll have to give me just a second to turn to that. Very little of it, there's only about $28 million of that. Let me get to declassified balance sheet so I make sure I get it right. Because – the short answer to your question is $26,701,000 is classified as current.

Chris Svezia – Susquehanna Financial Group

Right.

Ralph Castner

Our revolver is not classified as current because it does not have a pay down. About 200 off to find it quickly. $220 million of that. The total debt is $633,511,000, $26 million of it is current. $220,940,000 is our revolver, which we expect to have paid down by the end of the year. And then the rest of it is debt with normal maturity levels that are some time in the distant future.

Chris Svezia – Susquehanna Financial Group

Okay. That's helpful. And I guess the last question I have is just, I guess, Dennis for you. As you look at the stores that you opened up in the second half, third and fourth quarters of last year, any color on how those are performing relative to your plan? And kind of what you're seeing out there in terms of level of productivity of those stores?

Dennis Highby

You know, I don't think there is any change from the last time we talked about it. We're not going to get into store by store performance. One thing I would like to say though lot of these stores are very, very productive stores, and we're very excited about them. On some of the stores that we called underperforming stores on the last call, we took action by sending teams to couple of these stores, really getting in the heads of management what customers are seeing, and really paying attention to what advertising we were doing in the store. What, how effective it was. Do we need to change? I mean, there is in some cases maybe 30 different things that we needed to work on to improve. Just some things like we thought they had the right assortments. Customers told we didn't have quite the right assortments. We had – we talked before about having some regional mixes that weren't quite right. We've been fixing them. The big one was just the whole backroom productivity. We finally seems like we've got that behind us where the merchandise coming from a distribution center flows very freely into the store, doesn't get clogged up in the backroom, and we've seen improvements on these stores.

Chris Svezia – Susquehanna Financial Group

Okay. That's good to hear. Thank you very much, gentlemen. I appreciate it. Good luck.

Ralph Castner

Thank you.

Operator

Next in our queue is Paul Lejuez with Credit Suisse.

Paul Lejuez – Credit Suisse

Hey, thanks, guys. Can you just talk about where the retail merchandise margins were? I think you mentioned that direct was down, but what was merchandise margin at retail?

Ralph Castner

Yes. There was not a significant change at retail. We've been using our – I don't know if one of you guys, Pat, probably want to comment. But we've been using our direct channel, particularly with the internet because we believe that's one of the more profitable ways to move inventory, and we've been taking some of our inventory through there, but we've not seen a significant change in the gross profit at retail.

Paul Lejuez – Credit Suisse

Okay. And then on the other line, on the bank detail, there was a negative impact of 2.3 million. What was that? And can you also tell us when the next securitization is planned?

Ralph Castner

Yes. I can do both those, Paul. As you and I have talked before, the impact of the securitization accounting is isolated in that other line, and at the same – and that – because of the increase in bad debts, those assumptions changed which caused a decrease in that line item. So, a year ago, we had in the quarter, we had a net profit of $1.6 million as a result of securitization accounting, and in this quarter we had a loss of $2.2 million.

Paul Lejuez – Credit Suisse

And the next securitization?

Ralph Castner

Oh, I'm sorry. We have one well, there is a securitization which we had term securitizations we expect to close in August of this year. Once that securitization is closed, we will not need to do anymore transactions for the rest of the year. We do have a commercial paper conduit which comes due in October which we expect to renew, but we don't need to renew that securitization conduit to get through year-end.

Paul Lejuez – Credit Suisse

Okay. And then can you just tell us, remind us about the pre-opening costs in the third quarter of last year? And what do you expect them to be this year? How much of a benefit?

Ralph Castner

I'm not sure I've got that benefit isolated. I believe it's broken out in the Q and you'll see it there. If I can find it here quickly I'll share it with you, Paul.

Paul Lejuez – Credit Suisse

Okay. And then you did give the change in the marketing fees. You know, that – if you look at that net revenue line as a percent of the average managed credit card loans, at what level would that have to be where there are no marketing fees that get transferred over from the bank to the retail or direct segments?

Ralph Castner

I'm sorry; I didn't understand your question, Paul. Say it again, please.

Paul Lejuez – Credit Suisse

So you said – the amount that got transferred over, the marketing fees that got paid from the bank to direct and retail went down, correct?

Ralph Castner

Yes.

Paul Lejuez – Credit Suisse

At what level would that have to be at that percentage? If you look at the net managed financial services revenue as a percent of average managed credit card loans, at what level does that have to get down to before there is no marketing fee that would get transferred over?

Ralph Castner

That's a tricky way to ask me what the total amount of marketing fees are which I already said I'm not going to answer, sorry.

Paul Lejuez – Credit Suisse

Okay. And then just last, just looking over the past several years at the third quarter, and obviously you've been adding stores throughout the year, but earnings are down seemingly every year in the third quarter. And I'm just wondering; should we expect the same thing this year? Can you maybe help understand what is it about the third quarter that earnings keep going down? And are you more dependent this year on the fourth quarter as you have been in years past?

Ralph Castner

We've talked a lot, Paul, about how when this – as this becomes a more retail centric business because you've got all the fixed costs, either occupancy costs or interest costs that are straight lined throughout the year, this business is going to become more and more fourth quarter. However, in the third quarter, a year ago, we had a lot of pre-opening costs and we expect to be somewhat helpful as we lap the third quarter a year ago. But absent that, we would expect a lot of pressure on the first half of the year including the third quarter. You know, quite frankly, we're pretty pleased with where we've been through the first six months of the year specifically given the increase in charge-offs we've seen at the bank.

Paul Lejuez – Credit Suisse

Did you say that you do expect pressure on the third quarter of this year?

Ralph Castner

No. What I told you is normally I would expect pressure on the third quarter this year, but we have the benefit this year of lapping the pre-opening costs that we would have had in the third quarter a year ago, so that will give us somewhat of a tailwind.

Paul Lejuez – Credit Suisse

Got you. Thanks.

Ralph Castner

Normally, yes. (inaudible) the pre-opening costs I would. I think we talked at the start of the year that we expected $10 million for the full year of benefit from pre-opening costs.

Paul Lejuez – Credit Suisse

Got you. Thank you and good luck.

Dennis Highby

Thank you.

Operator

Next up we have Bob Simonson with William Blair.

Bob Simonson – William Blair

Good afternoon. Ralph, could you just kind of quickly run through what it was that the explanation with the change in tax rate?

Ralph Castner

Yes. And actually that merits some conversation, only because it points out to what an opportunity we have for the remainder of this year, and into next year. We did a legal entity reorganization in the second quarter which will allow us to – that really has (inaudible) benefits. One of which is lower the state part of our effective tax rate. And what happened with that is a lot of those benefits – well, the other thing it did is it freed up, we had some net operating losses in certain states we wouldn't have been able to use until we consolidate legal entities. With the consolidation of legal entities, we are able to take advantage of some of those net operating losses this year, which allowed us to lower the effective tax rate. But we expect a reduction in the effective tax rate going forward as a result of this legal entity reorganization. Hello!

Dennis Highby

Bob, are you still there?

Operator

Actually, he has disconnected. Let's move onto our next question from Derek Leckow, Barrington Research.

Derek Leckow – Barrington Research

Yes. Hi. Thank you. Good afternoon. Let me just follow-up on that question then on the tax rate. What was the amount of the NOLs in the quarter?

Ralph Castner

That we're able to use?

Derek Leckow – Barrington Research

Yes.

Ralph Castner

Somewhere around $900,000.

Derek Leckow – Barrington Research

Okay. And then going forward you said 35.8% for the effective rate for the year?

Ralph Castner

I did.

Derek Leckow – Barrington Research

And then what – do you think it's going down again in '09 or–?

Ralph Castner

We've got – yes, I think it could continue to go down slightly. There is two things really affecting the effective tax rate as we go forward that I just want to comment on. As we open retail stores in more states, we will continue to pay state income tax on our direct business in those states which will put some upward pressure on that. Now with only two states – with only two stores open next year that won't be a huge deal. But this legal entity reorganization should put downward pressure on our tax rate, and I expect the net impact of that to be downward pressure, yes.

Derek Leckow – Barrington Research

Okay. And then just I want to get some insight in the customer behavior here in the quarter. I mean, you had a couple of major events. You had the tax rebates out there. You had a positive Supreme Court decision on individual gun ownership rights. I wonder if you can talk to any of those items and what they might have benefited you in the quarter.

Dennis Highby

I think the tax stimulus obviously had improvement in our business. It's hard to measure how much really was. You know, looking in – you know, for the election this fall, it'll be interesting to see what happen to firearm sales. But firearms have been very strong in anticipation of the Supreme Court ruling. So I don't know – Pat, do you have any color to add on that?

Pat Snyder

Well, I think if you look at the first six months of the year, our hunting categories were some of our strongest and that includes firearms and ammunition, and we really expect it to keep growing through the last six months of the year also.

Derek Leckow – Barrington Research

Can you give us how much the hunting tools category was up? Is that in the – it's in that category, I assume, right?

Pat Snyder

As a percent we don't give that information out.

Derek Leckow – Barrington Research

Okay. But it's up versus last year and it continues to be…

Pat Snyder

Yes.

Derek Leckow – Barrington Research

– your expectation it will be up for?

Pat Snyder

Yes. It's one of our stronger categories through the first six months of the year.

Derek Leckow – Barrington Research

And then can you talk to the categories where you have a large penetration of your Cabela's branded products? How are those categories performing right now?

Pat Snyder

It's primarily in our soft goods category and clothing and footwear. Clothing for the second quarter actually picked up a little bit. And we saw it as one of our stronger categories. So, I mean, we continue to see growth there. We're expanding into the hard goods categories with quite a bit more Cabela's labeled product and again, those are primarily the hunting and fishing categories. So, we're doing well with that product in our hunting categories.

Derek Leckow – Barrington Research

Okay. Just to clarify. The soft goods category was up over last year or up from the first quarter?

Pat Snyder

Up over last year.

Derek Leckow – Barrington Research

Okay. Great. Thanks a lot.

Dennis Highby

Thank you.

Operator

Our next question comes from Waddell & Reed's, Zack Shafran.

Zack Shafran – Waddell & Reed

Good afternoon. Two questions, actually. One, when you talked about the gross margin, can you expand upon any issues that you've seen as far as sourcing costs and transportation costs? And then secondly, I'm wondering in the four initiatives if you guys have made any changes to the actual number of SKUs at any of the stores?

Dennis Highby

You know, Pat might want to talk about the number of SKUs. We're doing out best to make sure we have the right SKUs. Merchandise, that we're importing obviously is going up. Freight is going up. But we're doing our best to pass those costs directly onto our consumer. I don't know, Pat do you want to add to that?

Pat Snyder

Yes. To comment on the SKU count in our stores, it's remained fairly consistent year-over-year. I think we're just doing a much better job of making sure we have the right quantities of the right merchandise in the stores.

Zack Shafran – Waddell & Reed

Very good. Thank you.

Pat Snyder

Thank you.

Operator

Let's return to taking a question from Bob Simonson.

Bob Simonson – William Blair

Let honest. The comps were down 8.4 and then down 1.6 in the second quarter. What does that number show for the first half?

Dennis Highby

I believe it's…..

Pat Snyder

4.9%.

Ralph Castner

4.9% I believe.

Pat Snyder

Down 4.9%.

Bob Simonson – William Blair

So your estimate of down in a range of 5 to 7 means it gets a little tougher in the second half, which is kind of what you said?

Dennis Highby

Right.

Bob Simonson – William Blair

And is this more an issue since retail is growing in its importance in the fourth quarter that it's more a retail store, Christmas issue or?

Dennis Highby

I think it – Bob, it's just us trying to be realistic that we are in a tough consumer environment right now, we'd love to have them higher than that. We're going to do our best to improve from that projection, but I think we're just guiding to 5 to 7 down.

Bob Simonson – William Blair

Okay.

Ralph Castner

If I can add to the Dennis, I mean, our best comp in quarter last year was the third quarter. And I think just looking into that, realizing we were down 4.9% on a year to-date basis, and just trying to plan for we think it's a realistic back half of the year is where we set the numbers at those levels.

Dennis Highby

And I think the third quarter last year was up 4.5%, 5%, some like that.

Bob Simonson – William Blair

Right. Ralph, could you remind me what line item do you put the depreciation through?

Ralph Castner

SG&A.

Bob Simonson – William Blair

Okay. And then little discussion on the private label, I mean, somebody asked about transportation, but in the private label is that still expanding? Are you finding it harder to get the same prices from some of the vendors in the overseas markets?

Dennis Highby

I think Pat would like to comment on that. Go ahead, Pat.

Pat Snyder

You know what we see is price increases coming through in almost all of our products today, regardless if it's soft goods or hard goods categories, and we're just doing our best to try and consolidate vendors, consolidate raw materials to make it a better buy for our customers.

Bob Simonson – William Blair

When youif you look at the private label overall, is there a pressure in there from vendor price increases to lower that? Or did you just say you're offsetting it by maintaining the mark on?

Pat Snyder

We'll maintain the mark on it. In the expansion of Cabela's brand product, we continue to expand our hard goods categories. Soft goods is probably already in roughly the 70% to 75% Cabela's brand product.

Bob Simonson – William Blair

Okay. Very good. That was the ones I had left over. Thank you very much.

Dennis Highby

Thank you.

Operator

And next up in our queue Jim Duffy, Thomas Weisel.

Jim Duffy – Thomas Weisel

Yes, thanks. So just looking at that other line item and hearing what you said earlier about opportunities to sell kind of out lots and so forth, in modeling this, should we be perhaps getting more aggressive with growth in that other line item? I recognize it's lumpy, but...

Ralph Castner

You know, I think those will be spread out over such a period of time that I don't know that I would model a significant change in any one quarter. We see this as a two to three year kind of process. And I think what it just goes to Jim is sort of a sustainability of those items.

Jim Duffy – Thomas Weisel

Okay. How much was the sale this quarter?

Ralph Castner

I believe we sold $3 million to $4 million worth of land, and had a gain of somewhere between around 2 million.

Jim Duffy – Thomas Weisel

Okay. Thanks very much.

Ralph Castner

By the way, Jim, I was just to add on to that, we had the same amount of gain in the same quarter a year ago.

Jim Duffy – Thomas Weisel

Okay

Dennis Highby

Thank you.

Operator

(Operator instructions) Our next question now comes from Rick Nelson with Stephens.

Rick Nelson – Stephens

Thank you. Ralph, last year, you opened 7 of the 8 stores in the third and fourth quarters, but the bulk of that 10 million in annual pre-opening expense that you referred to earlier, would that be falling in the third quarter of last year?

Ralph Castner

Yes. A significant amount of it was in the third quarter. And you'll see that – I was trying to pull the Q out here. We have not enjoyed a significant improvement in pre-opening costs in the first half of the year, most that yet to come.

Rick Nelson – Stephens

Got you. So the third quarter would be the easiest compare from a pre-opening standpoint?

Ralph Castner

Yes.

Rick Nelson – Stephens

And Dennis, can you talk about the cadence of the business? During the quarter many retailers are talking about the business becoming more difficult later in the quarter, was that the case at Cabela's as well?

Dennis Highby

You know I think it's been a difficult first six months of the year. But I think you sit back and look at all the tools that we have. With our internet we're able to react to some things with our customers. Our direct business is still strong, and I think we're very fortunate. We have new retail stores out there. But as far as the cadence of the business, it's still a business that people love what we sell. We think we still have the best customer service, and we're just looking forward to a great fall. I mean, Christmas is still going to be there. The dear seasons are still going to be there, and we're looking forward to see what happens this fall. But we're optimistic.

Pat Snyder

If I can add to that….

Rick Nelson – Stephens

(inaudible) catalog operation, are you seeing meaningful regional differences in the sales coming out of those areas?

Dennis Highby

That's a good question. I'm sure Pat would want to add on. One thing, seems like we've seen some strength in our direct business where they raise corn. There's any correlation between some of the high grain prices that might be coming in this fall, but lot of the states around the coast are little bit softer. Texas has been a good state for us. Pat, do you have any other color on that?

Pat Snyder

Yes. The softness we see are really it's a state that you would realize they were as California, Arizona and Florida. The strength, we continue to see it through the Midwest. Iowa is a very strong state for us. New York is a strong state for us.

Ralph Castner

Rick, you were talking about the business during the first half of the year. When I kind of step back and look at this, last year our net income for the first half of the year was 18.4 million, and through the first half of this year it's been 17.2 million. I think at the start of the year if you would have told me those were the results in a six month period when bad debts increased by $12 million, I think I'd tell you we'd be really pleased and I think we are pleased.

Rick Nelson – Stephens

And the charge-offs in the quarter, what sort of strategies do you have to reign that in? Do you hire more collectors? Or I mean –

Ralph Castner

There is a whole business with respect to that, that Joe Friebe and his team at the bank are going through. I mean and it's little subtle things you do. For example, we've stopped giving automatic credit line increases. Now if you want a credit line increase you have to call in and ask for one. There's things that you can do that, manage that exposure on the front-end. The best way to deal with is on the front-end. Yes. I mean, you have to hire the right amount of collectors to collect (inaudible) accounts, but quite frankly, by the time you get to that point, that's the wrong place to manage it.

Rick Nelson – Stephens

Great. Thank you.

Dennis Highby

Thank you.

Operator

We'll take our final question from David Penler [ph] with Western Research [ph].

David Penler – Western Research

Hi, guys. Are you planning anything different for the holidays this season? Or is it going to be similar to the initiatives that you used last year?

Dennis Highby

This is Dennis. I'm sure Pat might want to add something. But we have a lot of levers to pull. We have the internet; we can drive business there. We have a solid plan for our catalogs this fall. I don't know, Pat, if you want to add anything?

Pat Snyder

Yes. It's a good question. We're constantly reviewing our programs from a year ago and the catalogs are a great example. We'll go in and maybe adjust a mailing or improve the product selection or change the assortment in the catalogs, and so we're doing quite a bit actually to try and improve sales and drive more business in the Christmas season.

David Penler – Western Research

Okay. Thanks, guys.

Dennis Highby

Thank you.

Operator

Mr. Gay, I'll turn the conference back over to you for additional or closing remarks.

Dennis Highby

Just like to thank everybody for joining us today. We look forward to talking to you again soon. Thank you.

Operator

That concludes today's conference call. Thank you for your participation. Have a good day.

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Source: Cabela's Inc. Q2 2008 Earnings Call Transcript
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