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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

N. Richard Nelson - Stephens Inc., Research Division

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

Seth Sigman - Crédit Suisse AG, Research Division

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

James Andrew Chartier - Monness, Crespi, Hardt & Co., Inc., Research Division

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

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

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

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Aaron Goldstein - JP Morgan Chase & Co, Research Division

Cabela's (CAB) Q3 2012 Earnings Call October 25, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen, Welcome to the Cabela's Inc. Third Quarter Fiscal 2012 Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded. I will now turn the call over to Chris Gay, Director, Treasury and Investor Relations. Please go ahead, sir.

Chris Gay

Good morning. I welcome everyone listening today, both on the conference call and by webcast. A replay of today's call will be archived on 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

Thanks, Chris, and good morning, everyone. Our record third quarter financial results validate that our growth strategy is working well, and our new next-generation stores are performing well above our legacy destination store base. For the quarter, we realized strong growth in comp store sales, higher merchandise and operating margins, strong growth in our Cabela's CLUB Visa program and very strong performance from our next-generation stores. This strong performance led to record third quarter earnings and further increases in return on invested capital. We are particularly pleased with the very strong performance we're seeing from our next-generation stores. Several quarters ago, we noted that our next-generation stores at that time were outperforming our legacy stores on a sales per square foot and profit per square foot basis by 30% to 40%. As we continue to open additional next-generation stores, this outperformance has only improved. For the 8 next-generation stores that were open for the entire quarter, sales and profit per square foot are meaningfully better than the 30% to 40% we noted last year. This is extremely encouraging as we continue to accelerate retail store expansion. Additionally, our next-generation stores are performing better than our legacy stores as they enter the comp base. In the quarter, our next-generation stores had comp store sales several hundred basis points higher than our existing store base.

For 2013, we expect to open 6 domestic next-generation stores, one Canadian next-generation store and 2 Outpost stores. Additionally, we will be relocating our existing 45,000 square foot Winnipeg store to a more desirable location and have increased the size to 70,000 square feet. We have announced all our next-generation store locations for 2013. Our scheduled store openings for 2013 represent a 13% growth rate in Retail square footage. Current plans call for opening 2 next generation and one Outpost store in the first quarter, one next generation and the Winnipeg relocation in the second quarter and 4 next-generation stores and one Outpost store in the second half of the year. As a result of the strong new store performance, we are accelerating square footage growth as we plan for 2014.

For 2014, we now expect to open 8 domestic next-generation stores. We have already announced 3 of these sites: Anchorage, Alaska; Bristol, Virginia; and Christiana, Delaware. Four new locations were approved at or prior to this month's board meeting, and we intend to publicly announce the specific locations over the next several months. The final location is still being reviewed and is expected to be approved shortly. In addition to our domestic next-generation stores, we are also pursuing additional opportunities in Canada. Canada is proving to be a great market for Cabela's. Our 3 Canadian stores continue to be some of our best-performing new stores.

For 2014, we are searching for new locations for our next-generation stores. Three weeks ago, we opened our first Outpost store in Union Gap, Washington, which was a huge success, with thousands of people waiting to shop the store on grand opening day. While still early, the results from this store are extremely encouraging. We are particularly pleased that due to the emphasis on softgoods and Cabela's branded products, merchandise margin is several hundred basis points higher than consolidated merchandise gross margin.

Customer feedback has been overwhelmingly positive, and we are already planning enhancements for our future Outpost stores. In addition to strong new store performance, we also realized continued strength in comp store sales, which increased 3.9% in the quarter. The increase in comp store sales was broad based as sales increased in 27 of our 32 comp stores. For the quarter, average ticket increased nearly 5%. Excluding firearms, comp store sales increased 1.6%. For the quarter, merchandise gross margin increased 130 basis points to 37.2%. This is the highest third quarter merchandise margin in more than 8 years. Similar to last quarter, we continued to see significant strength in the firearms and shooting categories, which caused a material mix shift into these lower-margin categories. For the quarter, this adverse mix resulted in roughly a 60 basis point headwind to merchandise margin. Now let me turn to Retail profitability, which is a key initiative in our Retail growth strategy. For the quarter, Retail profitability increased 190 basis points to 18.7%, a new third quarter record. This is the 14th consecutive quarter of Retail profit contribution improvement. Improvements in Retail profitability were due mostly to higher merchandise margin.

Despite the strong results from our next-generation stores, higher gross margin and a 28% increase in earnings per share, results in our Direct segment did not meet our expectations. Our CLUB Visa free-shipping offer generated higher revenue growth, no lift in gross profit dollars, greater order frequency and increases in new cardholder sign-ups. The absence of shipping income from CLUB customers impacted Direct revenue by 300 basis points. Additionally, a less promotional approach to our non-CLUB Visa customers, combined with weaker demand for softgoods and footwear, also negatively impacted Direct revenue growth. As the third quarter progressed, we responded with an increase in advertising spend and have seen improved results as we moved into the fourth quarter. During the quarter, we realized improvements in Internet traffic, and multichannel customers increased 3.9%.

Now let's look at operating expenses. For the quarter, operating expense, as a percent of revenue, increased 110 basis points to 35.6% compared to 34.5% in the year-ago quarter. Deleverage of operating expense is due mostly to higher preopening cost, increased advertising and additional investments in IT. We fully expect to leverage expenses during the fourth quarter and the fiscal year. Now let's look at our Cabela's CLUB Visa program, which had another exceptional quarter. We continued to see strong growth in average active accounts, lower funding costs and improvements in delinquencies and net charge-offs. For the quarter, average active accounts increased 9%. We also realized significant improvements in net charge-offs, which were just 1.71% and are at the lowest levels we'll -- we've seen in 5 years. With the backdrop of low funding cost, strong account growth and favorable delinquencies and charge-offs, we are very confident that the Cabela's CLUB Visa program will continue to have a very good year.

Now looking at guidance. It is clear our strategies are working, and our next-generation stores are achieving superior results. Accordingly, we expect our full year 2012 earnings per share to be at the high end of our previous guidance of $2.63 to $2.68. While our 2013 budget is not yet finalized, we expect 2013 earnings per share to grow at least at a low double-digit rate. As we continue this exciting time of growth and expansion for our company, I want to personally thank each and every Cabela's outfitter for all your hard work, your dedication and effort in cherishing and delighting our customers each and everyday. Now I'll turn the call over to Ralph Castner to review in more detail, among other things, performance of our Cabela's CLUB Visa program.

Ralph W. Castner

Thanks, Tommy. Following up on Tommy's remarks, we're very pleased with the third quarter performance and, in particular, the strong performance of our next-generation stores. For the quarter, GAAP earnings per share increased 28% from $0.47 to $0.60. As a reminder, in the third quarter a year ago, we incurred impairment and restructuring charge of $3.5 million. Excluding these charges, earnings per share in the third quarter of 2011 would've been $0.50. For the quarter, Financial Services revenue increased 20.3% to $85.9 million. The increase in Financial Services revenue was primarily due to higher interest and fee income and lower interest expense. For the quarter, net charge-offs, as a percentage of average credit card loans, improved 52 basis points to 1.71% compared to 2.23% in the third quarter last year. This is our lowest charge-off level in more than 5 years. Additionally, we continue to see improvements in delinquencies. Greater than 30-day delinquencies were just 0.81% as compared to 0.94% a year ago. Greater than 60-day delinquencies were 0.59% as compared to 0.55% a year ago, and greater than 90-day delinquencies were 0.26% as compared to 0.27% a year ago. Now let me highlight the future funding plans of our Cabela's CLUB Visa program. Our next term securitization doesn't mature until January of 2015, and we not -- and we do not expect to complete another term securitization this year. As we look forward to 2013, we expect to complete a term securitization in the first half of next year to fund growth. Additionally, we worked to early renew one of our commercial -- one of our conduit facilities. These facilities, of which we have 3, all have 3-year terms. By early renewing one of the 2 facilities that will mature in 2014, we will have only one of our 3 conduit facilities mature at any one year.

From an inventory standpoint, inventory increased 11% or $69 million year-over-year to $722 million. The increase in inventory is attributable to new stores, as well as preparing for the fall, winter and holiday season. We're maintaining our favorable levels in the firearms and shooting categories, and we've improved Retail in-stock level slightly. Accounts payable increased $121 million year-over-year, which is mostly attributable to the Cabela's CLUB Visa payable through our processer, FDR. This is merely a timing difference related to quarter end. Gift instruments and credit card reward points increased nearly 14% or $26 million year-over-year to $218 million. $20.3 million of the increase was due to additional credit card rewards. The cash flow -- this cash flow is often overlooked benefit as the Cabela's CLUB Visa program pays for the points when earned rather than when redeemed. To the first 9 months of the year, cash flow from operations was $57.6 million, up slightly from the same period a year ago, and capital expenditures were $144.2 million. With our accelerating store growth plans, we expect full year 2012 capital expenditures to be between $175 million and $200 million. With cash flow from operations expected to approach $300 million this year, we expect to fund this growth with internally generated cash. 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 third quarter and the very strong results of our new next-generation stores. With that, operator, let's open the call up for questions.

Question-and-Answer Session

Operator

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

Reed Alan Anderson - Northland Capital Markets, Research Division

First question, Tommy, I just want to kind of follow up on your kind of on the prepared remarks regarding the Direct piece. I mean, you talked about weaker demand for clothing and footwear. I wanted to just be clear though, was that statement or that commentary, is that specific to the Direct channel? Or was that what you were kind of seeing across your business in the third quarter?

Thomas L. Millner

Reed, let me give you some expansive color on that. When we talked on the last call, we indicated to you guys that the favorable trends in the Direct business that we'd seen in Q2 were proceeding into July and the early part of third quarter. Those trends essentially continued in the Direct business and also in the Retail business until the middle of August. And then in the Direct business, to your question, it certainly felt like the consumer slowed down a lot from mid-August through the end of September, and September got worse than the second half of August, particularly in clothing and footwear. From what we're seeing anecdotally around the marketplace, that probably shouldn't be a surprise. What is encouraging is that once we got that shot of cold weather in early October, it felt like either that stimulated the customer or this timeout the customer took in September turned. So we have seen a really nice improvement in trend now in the early parts of the fourth quarter in both businesses. So it was interesting in the Retail business, we didn't -- the clothing and footwear slowed, not as much as it did in the Direct business. And as we've come into Q4, we're seeing comp trends nicely above third quarter trends.

Reed Alan Anderson - Northland Capital Markets, Research Division

Okay, good. And back to that, just one more on the Direct piece then. And there -- was there any change in, I know that you've tweaked the advertising a little bit, in terms of mailing out books or timing or cadence that could have possibly factored into that slowdown that was more pronounced than Direct?

Thomas L. Millner

Yes. As we've consistently said, this is a -- the Direct business has been tough for more than 5 years, and we're managing a lot of levers to try and find that optimal pitch level to get the business back to flat and then, hopefully, to positive. As we approach the third quarter with the great trends coming in, in July and with a large Cabela's CLUB Visa free-shipping offer, now that's 1/3 of our customer base in the Direct business, almost 70% is non-CLUB business, we elected to be a little less promotional. We pulled a number of offers, none of them I would characterized as huge. But our promotional cadence was less with the other side of our business. Then as we got deeper in the quarter and saw the slowing of the business, we did respond with self-mailers and more catalogs and more spend on dot.com to drive traffic. So that was the note that you saw with ad spend being up. So catalog circ was actually up 11% in the quarter, but that came late, and in the face of a pretty tough climate in September, which has turned in October.

Reed Alan Anderson - Northland Capital Markets, Research Division

And just a couple of others. Overall, it seems like you've tested, at least, selective, I don't know if it's just in some mailings or Direct or some stores, too, but a little bit some higher end, higher price point positioning, some branded stuff. I've seen stuff on the Camels. I'm just curious what's your initial read on that is.

Thomas L. Millner

We are really pleased.

Reed Alan Anderson - Northland Capital Markets, Research Division

Okay. And so would -- will we see that expand more at the store level, you think, in the fourth quarter, or is it -- or not?

Thomas L. Millner

Well, our position in the fourth quarter is to be -- the fourth quarter's really big for us, needless to say. So we're gonna take a much more aggressive posture with price. We're going to be more aggressive promotionally to really make sure that we protect this big bulk of business that we've got. So I wouldn't be surprised at all to see -- we had terrific merchandise margins in Q4 of last year. I would expect margins to be nearly at those levels as we get a little more promotional. There's just -- we're coming out of a presidential election. We don't know who's gonna win. And we want to make sure we're positioned aggressively in Q4 and are taking that kind of posture in both businesses.

Reed Alan Anderson - Northland Capital Markets, Research Division

Okay, that makes sense. And then, Tommy, last question. You just -- you gave a little look into the kind of next year in terms of just high-level expectations, in terms of earnings, et cetera. And my question would be, as you look at -- and you've had a terrific year on the margin side, and you just talked about this again. As you look into next year, right now, based on what you know, is it -- do you still see that sort of margin expansion continue into next year? Or is it perhaps a year where you get a little pause there and it's more of kind of balanced between -- and maybe not a lot of expansion?

Thomas L. Millner

Well, we expect expansion always. Will it be at the same rate that we've seen? Probably not. I think it is a year where we balance margin growth a little lower to -- especially as we're working through the balance in the Direct business.

Operator

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

N. Richard Nelson - Stephens Inc., Research Division

Tommy, I'd like to get your latest, like, results on gun sales as it relates to the election. I understand Cabela's has a red plan and a blue plan. I'd like to learn a little bit more about that. What the guidance for next year might assume about guns and ammo?

Thomas L. Millner

Well, that's a really great question, and the crystal ball gets pretty murky when you look at the polls. At least coming in to the fourth quarter, we've taken a pretty aggressive position in inventory commitment to both guns and ammunition. So that's a starting point. Clearly, if the president's reelected, I would expect some surge beyond the current levels, which are really good. And if Governor Romney is elected, Rick, I still think we're gonna see gun growth next year. It probably won't be at the same pace. But 3 weeks ago, the Fish and Wildlife Service released data that validated what we all know, that the shooting sports are actually growing and vibrant. More women, more adults are hunting and more youth participation, and this is a reversal of a 25-year declining trend. So there's still gonna be economic uncertainty next year, regardless of who wins the election. That is clearly stimulating demand. And we've got a lot more people involved in the sports that we cater to. So it's probably a difference of degrees as we sit here today, but we're doing a lot of stuff in our stores to make sure we are the easiest, fastest place to shop for your firearms purchases. We've got the biggest assortment as you know, the most knowledgeable people. So I feel really good about that part of our business. It'll be a matter of degrees, I think.

N. Richard Nelson - Stephens Inc., Research Division

How important are gun sales to the growth that we're seeing in the non-gun categories? You mentioned on firearms categories were up 1.6%. But how much of that is attachment to firearms purchase?

Thomas L. Millner

Obviously, some of it is. But I think what we've seen in years past that we've talked about on prior calls is during these periods of really accelerating gun sales, there is a stealing of share of wallet that our customers have that shifts away from footwear, clothing, a new 4-way parka as -- they have a limit to -- unfortunately, they have a limit to how much of their money we can relieve them of. But there is that shift that happens. So we continue to believe, and I think history validates that if guns settle a little bit, it frees up dollars to be spent in other parts of our store.

N. Richard Nelson - Stephens Inc., Research Division

That makes sense, and potentially, a higher margin of purchases?

Thomas L. Millner

Well, yes. The headwinds in the quarter were 60 basis points because of the acceleration of guns.

N. Richard Nelson - Stephens Inc., Research Division

Okay. The Outpost stores, it sounds like you're very pleased with the performance there. Wondering if you could share the economics and how you think the ROI there might compare to the next-gen stores, which I realized are above the legacy stores.

Thomas L. Millner

Let me give you a little color, and then I'll have Ralph talk about the economics. First of all, there -- a number of folks on the call who made the effort to come to the grand opening, and we really appreciate that. And I think their eyes were opened about how exciting this store was. Couple of takeaways for me, Yakima, Union Gap is a relatively small market community, yet we had huge lines of people waiting at grand opening. I thought the store looked fantastic. The visual presentation of merchandise in the store was as good or better than our big stores. If we had a concern coming into grand opening, it was the concern of does the customer walk in and say, "Oh, this is Cabela's light. This isn't a real Cabela's store." And I can categorically tell you, that did not happen. Those customers walked in the store and, like, our jaws dropped, their jaws dropped. Now what's been encouraging -- and what's 3 weeks or a month of a trend in a new store? There's a whole a lot of the story still to be told. But the concentration of Cabela's branded merchandise in hardgoods and softgoods is unlike anything we've ever tried in one of our legacy stores or our next-generation stores. And we are seeing a really strong lift in margin to no one's surprise. So I'll -- before I turn it over to Ralph, I'll just close with, remember, this is a test. We -- we're going to open 5 of these stores. We're gonna see how they do. But I got to tell you, we are really excited with what we're seeing, especially the customer reaction. Ralph, do you want to talk about the economics?

Ralph W. Castner

Well, yes. Keep in mind, Rick, we were talking about this Outpost store. It was not open at all in the third quarter. So we haven't even, from a financial standpoint, closed the month yet with that store's results in it. Having said that, we modeled that store on a per square foot basis to be consistent with our next-generation stores, and those are the trends we're seeing after 3 or 4 weeks.

N. Richard Nelson - Stephens Inc., Research Division

And then finally, if I can ask you on the cost side of the Direct channel. Do you think there's opportunity there for cost takeout? Or is the plan to reallocate from catalog to Internet and basically maintain the current cost structure?

Thomas L. Millner

Well, it's actually a more complicated answer than that. There is clearly a shift that we are going through from print dollars to paid search, we have an exciting new e-mail provider, so from print to digital dollars. But as we really expand mobile commerce through tablets and PDAs, there's probably some capital investment we're going to have to make that will have some small expense tied to it. But I think the story is really figuring out how to effectively sell softgoods in the printed digital transformation online and making sure that, from a technology standpoint, as consumers move from desktop to tablet, that we've got the most robust way for them to interact with us. And that's the journey.

N. Richard Nelson - Stephens Inc., Research Division

The free shipping offers that you tested in the quarter, are you happy with those? And is that a program that is gonna be expanded in the fourth quarter?

Thomas L. Millner

Yes. It's a -- if you go to cabelas.com, you'll see it's free shipping to all of our Cabela's CLUB Visa customers. We have -- it's an offer, not a permanent benefit, because it's a test. We're learning how this actually impacts our business. And I would say it's -- the reaction is mixed. We did get a lift in sales, albeit with only 1/3 of our customers. Because of the cost of free shipping, there was no lift in gross profit dollars. So lift in sales, no lift in margin dollars. We did see an increase in transactions, as you would expect, and ticket was down on more frequent transactions. And then the absence of shipping income did impact the growth rate by 300 basis points. That's a long way to tell -- long way of telling you we're going to continue to evaluate in the fourth quarter this offer and decide what we do next year based on what we learned.

Operator

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

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

And just to follow up on that last comment. Why do you think the free shipping offer didn't drive more of a lift, enough of a lift, to pay for the offer? Do you think it has anything to do with you're already targeting your best customers versus maybe some more marginal customers? I'm just wondering if you can -- were you surprised that the program sort of, in a way, I guess, didn't pay for itself?

Thomas L. Millner

Well, a little bit. It -- these things are really hard to tell, Matt. The clothing and footwear business just got really soft in the back half of the quarter. And we're not ones to blame it on the weather, but it was -- it -- September was very warm in most of our markets and we're in the middle of fall goods at that point in time. So was it that? Or was it this boom in gun sales that we don't benefit from in the Direct business that really was a drag and didn't let the promotion drive soft good sales? It is interesting. As I mentioned, we have the free shipping promotion in place now and plan for it to be the rest of the fourth quarter. And now that weather's gotten colder, we're seeing a nice improvement in trend rate in the Direct business. So that's why we don't want to jump to conclusions. We'll get through the fourth quarter and then really take a hard look at whether it met our expectations or not, if that makes sense.

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

Yes, it does make sense. And then turning to expenses, they were a little higher than what we were expecting. Is there anything abnormal in there in the quarter? What leaves you confident that we'll see leverage in Q4 given the increase in advertising that you alluded to earlier in the call?

Thomas L. Millner

Well, first, make sure you understood me clear: Our aggressive approach in Q4 is going to be more in pricing than in some massive increase in ad dollars. So being a little more aggressive in pricing will affect merchandise margin, not expense. Having said that, in the expense category in the quarter, roughly 1/3 of the increase in expense was in preopening cost; 1/3 was in advertising, which is really paid search and self-mailing catalogs. And I think just the sheer volume of business that we do in Q4 naturally allows us to leverage our fixed costs a lot better. So I think we're very confident about that. In fact, year-to-date, we have leveraged expenses.

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

Was the outpost -- were preopening costs for the outpost store -- I assume most of that hit in Q3 and maybe was a little higher than normal.

Thomas L. Millner

Yes, with no revenue attached.

Ralph W. Castner

Yes, all of it was.

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

Okay. And then just lastly, your comments on the next-generation stores are really encouraging. I'm wondering if you can comment on the returns on those stores. In your slide deck, I think you've noted that you are looking for a 34% four-wall return, which assumed $450 per foot. How much higher could that four-wall return be? And where do you think the payback on these newer stores trends towards?

Ralph W. Castner

Well, I think the stores, quite frankly, certainly add. The average of the stores is at or slightly above the levels that we shared with you in the slide you're referring to. We've seen some deviation there. One of the upside -- one of the stores in the upside has significantly exceeded those expectations, and a handful, of -- slightly below. But look, we feel really good about our next-generation stores and gain on returns, at least, is good as what we outlined in our Analyst Day which is, I'm sure, the slide you're referring to.

Operator

We will take our next question from Seth Sigman with Crédit Suisse.

Seth Sigman - Crédit Suisse AG, Research Division

So on the Direct business, you did a really good job of explaining all the different moving pieces. But just want to clarify whether you're seeing any changes maybe in the competitive landscape to go down this path? And then how much of it maybe has just been cannibalization from the recent store openings? And then, a follow-up.

Thomas L. Millner

Well, I mean, we just -- that's -- clearly happens but our internal position as a leadership team is, look, that's a reality. We have to grow against that. So look, it's a reality. We've opened -- this year, we've opened 1, 2, 3, 4 -- we've opened a bunch of stores that cannibalized the Direct business probably a couple of million bucks each, but still we got to get the business to close to flat on a consistent basis and then try to get from flat to up.

Seth Sigman - Crédit Suisse AG, Research Division

Okay. And -- but just to clarify, nothing is really changing on the competitive landscape?

Thomas L. Millner

No, no, not at all.

Seth Sigman - Crédit Suisse AG, Research Division

Got it, okay. So shifting gears to the credit card business. You're starting to see an acceleration in account growth. I mean, can you maybe speak to how much of that is being driven by new store openings versus within some of the older stores and then, specifically in those next-generation stores, maybe what you're learning about the penetration, where it can go with the new stores?

Thomas L. Millner

Well, Ralph was here in the 2002-to-2007 time period when we saw pretty good growth, so I'll let Ralph comment on that.

Ralph W. Castner

I think there's no question that the new stores are helpful as we think about credit card growth, but we're also seeing great growth at some of our base stores. But to the point of your question, I think you'll continue to see slight upward pressure on the growth rate as we open more and more stores. And at least on a per-square-foot basis, I don't think we're seeing anything different as it relates to the new stores versus our older ones.

Seth Sigman - Crédit Suisse AG, Research Division

Got it, okay, that's helpful. And then just finally, the comp acceleration that you're seeing early in the fourth quarter, I mean, any additional color on where that's coming from on a category basis?

Thomas L. Millner

Well, it's been pretty broad-based. When you're in the fight everyday, it's hard to tell. It was -- weather certainly broke cold early in October. And I mean, we just saw an immediate impact in our stores in the Northwest through the Rockies, upper Midwest, all the way to the East Coast. We just -- it was just immediate in both businesses. And then the weather broke a little warmer and our trends continued pretty good. So I think we're fairly optimistic about the balance of the quarter. We are promotionally ready to have a good fourth quarter.

Operator

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

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

Just a couple of questions. One is, with relation to the promotional comment on the fourth quarter, are you seeing anything -- you mentioned that you don't see anything competitively different online. Are you seeing anything in the stores, in the environment, land-based competition that might be different that prompt you to be that way?

Thomas L. Millner

No. I -- it's just a bit of caution, David. Coming out of a major presidential election and all of this talk of a fiscal cliff and just broader economic malaise, we want to make sure that the customer that's shopping for hunting, fishing and camping gear comes to Cabela's. And we think that's an appropriate thing to do.

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

And secondly, with the improvement that you've made so far on merchandise margins in the last several years, how much more run way do you have on that line item going forward? Do you feel like that you're discovering further additional ways to improve that merchandise margin? Or are we, say, 2/3 the way there?

Thomas L. Millner

Yes, I think there's -- we still have opportunities perhaps not at the level that we have gained in the last 3 years but deeper penetration of Cabela's-branded merchandise. And if the outpost model is scalable and customers react to more Cabela's-branded merchandise in those stores, that's a lift. Price optimization tools, better collaboration with our vendors, they're just -- it's a continuous improvement process that we think offers opportunity but probably not at the same level that we've seen in the last several years.

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

And I guess my last question, perhaps for Ralph. It seems like the credit business is in really good shape right now from a positioning standpoint. What would happen next year if rates became -- overall, rates became more volatile? Can you talk about any exposure you might have in that regard?

Ralph W. Castner

Well, we -- yes. From sort of a textbook interest rate risk perspective, we think we're actually well hedged to maybe a little bit overhead. So in other words, in a rising rate environment, we can actually make a little bit more money. Now that all presumes, of course, that we can -- look -- and our agreements allow for the automatic increase in rates as rates go up. The question is how the consumer is going to respond to that, particularly if they would move up dramatically. But at least from a textbook standpoint, we're hedged to a little bit over-hedged against a rising interest rate environment.

Operator

We'll take our next question from Jim Chartier with Monness, Crespi, Hardt.

James Andrew Chartier - Monness, Crespi, Hardt & Co., Inc., Research Division

Two questions. The first: It looks like preopening expense is about $10 million this quarter, based on your comments. What did it look like in the first 2 quarters of this year? And then my second question is -- obviously, it sounds like you're going to be -- planned to be as promotional and more promotional, fourth quarter. If sales trend well, what's your ability to dial back on those promotions and willingness to do so?

Thomas L. Millner

Well, we obviously have the flexibility to dial promotions up or back and pricing up or down so we have that kind of flexibility. But just going into the quarter, given the things I've talked about, our posture is going to be a little more aggressive.

Ralph W. Castner

Just to comment on preopening. The $10 million number you quoted is for the 9-month period. For the quarter itself, the third quarter, there are about $4.1 million, up from $1.4 million a year ago. You'll remember, a year ago -- which kind of goes to the expense question that was asked earlier, a year ago, most of our stores were open in the first half of the year, so the preopening costs were relatively low. And we saw a big increase in the third quarter which, interestingly enough, about matches the dollar increase we've seen on a year-to-date basis.

Operator

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

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

A couple of questions for you guys. Catalog SIRC in -- and spend on catalog SIRC for the fourth quarter, was some of that a pull-forward into the third quarter?

Ralph W. Castner

No. I mean, I -- it's hard to measure that, but we expect to be aggressive with respect to direct marketing costs beginning in September into the fourth quarter. So we don't see a -- we don't see any movement downward to the fourth quarter.

Thomas L. Millner

No.

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

Okay. And then maybe building on that, Tommy, can you give us an idea on the nature of some of the promotional activity and the specific intent or strategy behind that in the fourth quarter?

Thomas L. Millner

Jim, a lot of our competitors are listening on the phone. So respectfully, if I don't answer the question, I hope you'll understand.

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

I do, I do. Okay. Clarification question: The next-gen store sales profit per square foot, 30% to 40% better, is that inclusive of the grand opening halo effect? Or is that a...

Thomas L. Millner

No -- well...

Ralph W. Castner

It -- I guess it depends on your point of view. We only looked at the stores that were opened for the full quarter, so it would include -- there was 8 stores -- there were -- 8 next-generation stores were opened for the quarter, 2 of which, Tulalip and Wichita, opened in March and April of this year. So to the extent there was still a grand opening effect from a March store into July or, in the case of Wichita, in April store into July, the benefit of that was included but it's only on 2 of 8 stores.

Thomas L. Millner

And there wasn't much benefit. I mean, the halo is pretty much gone by then.

Ralph W. Castner

Just by the way, Jim, on the impact of the next-generation stores: They performed significantly better than the 30% to 40%, which was the last metric we gave you. They were really good. To that effect, in your note, Jim, I -- in your note I read this morning, there was a -- you were talking about new store productivity and how it was off a little bit second quarter. We had a talk about it offline, but I wonder if the math on that wasn't because we had 2 stores -- the 2 next-generation stores we opened in August were both opened fairly late in the quarter so we didn't get a lot of sales. But I'm telling you, we feel really good about how those new stores are opening, all 8 of them.

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

Okay, that's good to hear. I don't think I used the word awful.

Ralph W. Castner

No, "off," was the...

Thomas L. Millner

Off.

Ralph W. Castner

Not awful.

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

Okay, all right. And then...

Thomas L. Millner

Jim, we do read your stuff.

James Andrew Chartier - Monness, Crespi, Hardt & Co., Inc., Research Division

Yes, I was surprised. That's pretty good, Ralph. Very productive. The -- then given the number of new stores added in the quarter, was the rate in cardholder growth what you thought it would be, Ralph?

Ralph W. Castner

Yes, yes.

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

Where I'm going with is, how do we think about that going forward? I calc-ed out about -- okay, U.S. store growth, maybe 15% unit growth, is about 2/3 of that a good rate for cardholder growth going forward?

Ralph W. Castner

I had expected it maybe to be a little bit higher than that, Jim. I mean, the -- we were up, well, I think it was 12.9% in the quarter on account growth. And I think that will continue to be -- there will be a little slight upward pressure on that but it won't get -- anything north of 15% would seem to be unusually high mainly because, I mean, we do have 40 stores now and some of them are new but it's largely dependent upon how the original 30 continue to perform which, by the way, have performed nicely.

Thomas L. Millner

Jim, one other thing, in the outpost store, in order to maximize the efficiency of labor in our outfitters inside the store, the customer service manager is also the CLUB booth manager. And one question we had was, "How productive would Union Gap be in apps to trans?" And they just did a terrific job. So that was a -- that's a really important validation for us, at least a month into the store, that we were able to consolidate work duties and still get excellent performance in card sign-up.

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

Okay, good to hear. And then last question, one on a clarification. You mentioned 8 new stores in '14. Is that U.S. only and the idea is there could be Canada stores on top of that?

Thomas L. Millner

Yes.

Ralph W. Castner

Yes. Jim, just to -- let me add on to Canada a little bit, talk about -- they -- talk about '14. Jim, you are right that we had -- we talk about 8 U.S. next-generation stores. We expect to also open up to 3 outpost stores and some significant, by that I mean 1 to 3, stores in Canada. And quite frankly, the constraint which -- the Canadian stores are performing unbelievably well. The constraint we really have there at the time and I'm still trying to wrestle with is just how much to push the management team there because going from 3 stores to 6 is a big deal. So...

Thomas L. Millner

After going from 1 to 3.

Ralph W. Castner

1 to 3. So -- but we feel really good about that business.

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

That makes sense. So the outpost stores are incremental to that 8 in '14.

Ralph W. Castner

It is -- that's correct.

Thomas L. Millner

That's correct.

Operator

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

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

Well, it sounds like you stepped up inventory commitment in firearms for Q4. Can you talk about how you position inventory in your other categories, particularly in clothing and footwear? And secondly, do you have significant fall carryover inventory in those 2 categories?

Thomas L. Millner

Some but not meaningful to create a markdown issue down the road. While we've clearly beefed up firearms and ammo inventories, we're also in a really good inventory position in clothing and footwear and also across the chain -- across the inventory categories. We just -- we're planning for a very good Black Friday to Christmas season, and you can't do that without inventory. Plus we have new stores coming online that are driving some inventory increase just from a timing standpoint. I think what's really important to note, though: We are very comfortable with the quality of our inventory levels.

Operator

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

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

First, looking at the credit card account growth. Can you just say how much of that maybe came from the free shipping promotion? And then looking at that, weighting that into the free shipping, does that make that more profitable or breakeven as a promotion?

Ralph W. Castner

Well, there's no question -- one of the things we look at when we talk about the free shipping is new club growth. And there's no question there was an uptick in card accounts both from the Internet and the call centers because of the free shipping offer. We did not promote free shipping, from a CLUB standpoint, very hard in our retail stores. And it's -- I know you know, 80% of our new accounts comes through Retail. So look, it clearly -- the free shipping offer, with respect to CLUB accounts, clearly provided a tailwind for the quarter but it wasn't that significant so...

Thomas L. Millner

Only because we're talking about 1/3 of 40% of our business in Direct, with 80% of card sign-ups coming from Retail.

Ralph W. Castner

I mean, to help you swag it, it's -- in my opinion, it's -- less than 100 basis points on the growth rate was attributable to free shipping, but it was helpful.

Thomas L. Millner

And I think part of what we're going to be analyzing in the fourth quarter is, did the customer that signed up for the card just do it to get that one free shipping offer and they're not going to use their card 3 weeks later or 1 month later or 2 months later? So what was the quality of the sign-up? We pretty much know what that is in Retail. But off a big promotion like this, we don't know if we're getting kind of just a deal-related customer or whether we're actually getting a long-term loyal customer. And that's something we're going to look at.

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

Okay, that helps. And then second, Tommy, you talked a little bit about gun sales kind of eating into your customer's wallet. Can you talk about categories that maybe were hurt a little bit more by somebody that bought a gun and then maybe didn't buy a binoculars? Whatever it may be, which categories maybe were down in the quarter?

Thomas L. Millner

Categories that were down in the quarter, in Direct it was footwear, men's apparel, power sports; in Retail, hunting apparel. And I attribute most of that to the very warm September. And then men's apparel and camping were all softer in the quarter.

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

Do you think weather maybe drove more of that than something about firearms...

Thomas L. Millner

Probably, yes.

Ralph W. Castner

Just -- I'm sorry. Just to add on to it, Mark. One of the interesting things about the comp, and there's been some questions on the comp, but a year ago we had a onetime offer that we pulled out of the base, which is why the comp was down a year ago, that we did not repeat this year. So on -- in Retail, we feel really good about posting up almost a 4% comp in what was a tough retail environment so...

Thomas L. Millner

With margins up 130 basis points.

Ralph W. Castner

Yes. So we felt really good about the comp. But if there was an expectation, it should have been higher because it was against an easy compare. We didn't necessarily view this quarter as an easier compare than any other quarter of the year because the year ago was sort of artificially deflated because of the absence of that promotion.

Thomas L. Millner

And that was the promotion that we affectionately, internally called the devil offer. It was $150 off a $500 purchase, which I think we told you a year ago. What customers did was they go buy a $500 gun that has 25 point margins in it and we give them $150. So we basically paid them to take the gun and that didn't make sense -- or buy big bulk ammo purchases. So we were actually pleased with the 3.9% comp and up 130 basis points in margins.

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

Okay. And I guess we've been looking at, excluding firearms, being up to, what was it, 1.6%? Can you give some...

Thomas L. Millner

Yes.

Ralph W. Castner

Yes.

Operator

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

Anthony C. Lebiedzinski - Sidoti & Company, LLC

I may have missed this, but just wanted to clarify: In your comments about the Direct business improving in the first few weeks of the fourth quarter, do you mean that it's actually -- the revenue is up? Or is it just less of a decline versus the third quarter?

Thomas L. Millner

Yes, it's a trend change from third quarter, so it's down less.

Aaron Goldstein - JP Morgan Chase & Co, Research Division

And also -- and in terms of the charge-off rates, they're the lowest in 5 years. Is this a level where we should think about this as far as the stabilization there? Or do you expect any additional improvement, perhaps?

Ralph W. Castner

Well, I don't think we should expect any additional improvement from these levels. And quite frankly, I wouldn't be surprised, as we move into '13, to see that number sort of freeze up in the -- both this. The only thing that would keep that lower than that is the growth rate does, to some extent, suppress the charge-off just because it takes time for people to charge off. That's the only thing that's going to keep it at these levels. But I -- it's hard for me to imagine it gets much better than where it is today.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And then just a couple of housekeeping questions. Preopening costs for the next-gen stores versus the outpost locations?

Ralph W. Castner

Oh, I -- they're clearly less because they're smaller stores. But I don't know -- we're running -- in the quarter, we ran -- we opened 3 stores and ran $4 million. Now all the 3 opened got limited in the quarter, but so you're running $1 million to $2 million a store and they're slightly less than that for an outpost store.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

And your tax rate has jumped around quarter-to-quarter. What's the expectation for the fourth quarter?

Ralph W. Castner

I would expect something pretty similar well until it -- let me pull up the tax note. But pretty similar to what we had in the third quarter.

Operator

And with no further questions in the queue, I would like to turn the call back over to Tommy Millner for any additional or closing remarks.

Thomas L. Millner

Thank you again for joining us today, and we look forward to talking to you again soon.

Operator

This does conclude today's conference. We thank you for your participation.

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