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Barnes & Noble Education Q3 Earnings Conference Call: Full Transcript

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Operator:

Good day and welcome to Barnes & Noble Education's Third Quarter 2016 Earning Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over Mr. Thomas Donohue. Please go ahead, sir.

Thomas Donohue: Vice President Treasurer and Investor Relations

Thank you and good morning, and welcome to our third quarter earnings call. Joining us today are Max Roberts, CEO; Patrick Maloney, President of Barnes & Noble College; Barry Brover, CFO; and Kanuj Malhotra, Chief Operating Officer of Digital Education, as well as other members of our Senior Management Team.
Before we begin, I'd remind you that this call is covered by the Safe Harbor disclaimer contained in our press release and public documents and is the property of Barnes & Noble Education. It is not for rebroadcast or used by any other party without prior written consent of Barnes & Noble Education. During this call, we will be making forward-looking statements with predictions, projections and other statements about future events. These statements are based upon current expectations and assumptions that are subject to risks and uncertainties, including those contained in our press release and public filings with the Securities and Exchange Commission. The company disclaims any obligation to update any forward-looking statements that may be made or discussed during this call.
At the time, I'll turn the call over to Max Roberts.

Max Roberts: Chief Executive Officer:

Good morning. As we disclosed, sales for the third quarter decreased 0.6% and were 1% higher for the year-to-date. Our third quarter ended January 30, 2016, and includes the results of a partial spring rush. We continue to see shifts in the spending patterns of college students. Based on what we saw in February, students delay the purchasing of the course materials extending the rush period to later in the semester. The spring rush sales above text books and general merchandise extended past the end of the quarter.
We have seen strongest results in February as compared to the same time last year. Our comparable sales for the quarter declined 4.1%. However, we improved sales for the first three weeks of February. For this year and last year, the comparable sales for the quarter declined by 2.9%. This is a slight improvement from our second quarter comps.
Declining enrollments in community colleges have contributed to the reduced sales in both the second and third quarters. As previously stated, approximately 25% of our sales come from the community colleges. Comparable store sales, excluding community colleges and factoring in the three additional weeks of February, decreased 1.2% for the period and 0.5% year-to-date or $6.2 million below last year. Enrollment for schools excluding community colleges are essentially flat for the spring less period.
As we look at first for the quarter by merchandised category, our textbook sales declined 5.4% on a comparable basis primarily due to the later rush period and decreased enrollments in community colleges. Aggressive online market place pricing, digital direct courseware sales, content along with students' reluctance to purchase textbooks is providing some headwinds for course material sale. In order to combat these headwinds, we are successfully piloted our textbook price matching program on multiple campuses this fall and again during this spring rush. The results are positive and the program will be extended in a measured manner next fall.
On campuses where we priced matched our textbook sales and margin increased while stores that did not have the price matching program, experienced sales decreases. While we believe sales and rental of the printed textbook has a long tail, our investment in faculty which is now being used by over 225,000 faculty for the adoption of publisher platform digital content either for an individual student or on a class subscription basis along with our investment in LoudCloud will provide us the necessary platform and tools to effectively compete with digital courseware, OER content, and services sales.
In the third quarter, our comparable general merchandise sales increased by 0.5% and we're also impacted by the later rush shopping and lower enrollments in community colleges. We've seen strong sales at general merchandise in February. Emblematic clothing and gifts continue to show growth and were partially offset by technology product sales which also decreased because of lower enrollment and a lack of product innovation.
We will continue to expand our product assortment to be better aligned with the expectations of students and offer new products and innovation in our merchandize assortment.
Overall, higher education is under tremendous pressures to increase student recruitment, retention success and outcomes. These pressures are forcing colleges and universities to transform their social and academic experiences. This transformation is more than just replacing paper with digital textbooks. Schools need expect and require complete solutions that will empower their students and faculty and drive success in and outside the classroom. We are in a unique position to help them this transformation by providing integrated solutions with physical digital products to the faculty, students and the schools we serve.
Consistent with our strategy, e-textbooks will remain a part of our offering along with new, used and rentals of physical textbooks. We will continue to deliver best-in-class digital learning tools and services.
To results we've taken actions to improve the quality and reduced the cost of our digital platform. These actions include a complete restructuring of our user operations, the acquisition of a foundational digital assets, and entry into a key strategic digital reading partnership with. Our new capabilities will allow us to present a new suite of solutions that has been demanded by our current education customers, and in the long return position us to enter near new markets by providing digital courseware and service solutions to the fore profit in KP12 sectors.
Again, this transformation will put Barnes & Noble Education in a unique position to deliver what student and faculties and the schools we serve are asking for.
In addition the closing of Yuzu's California and Washington facilities, we acquired substantially all the assets of LoudCloud for $17.9 million from cash on hand. LoudCloud, Inc. is a diversified educational technology company that provides customized learning platforms and services to institutions across higher education, KP12 and the core profit markets. LoudCloud will provide a foundational asset for digital product development and also accelerate the development of our advanced learning platform. This acquisition provides us immediate access to advanced technology and a data analytics platform. The software is cloud based, software-as-a-service offering, and is easily configured and is scalable.
LoudCloud has founded by Manoj Kutty along with a talented team of technologists. LoudCloud has a compelling suite of products including a multi learning system management development, development, and e-reading and analytics to support competency based education aimed at developing improved student outcomes and retention. LoudCloud has an established revenue stream and a low cost expense structure. Our immediate priority will to be to use the LoudCloud platform to deliver content and solutions to our and their existing clients. LoudCloud uses its software to capture and analyze key behavioral and performance metrics from students enabling educators to monitor and improve outcome ultimately improving students and institutional success.
Second, to cost effectively need the e-textbook demand, we are outsourcing our Yuzu operational platform rather than continuing to invest and maintain a self developed e-textbook platform. In February 2016, we entered into a strategic commercial partnership with VitalSource Technologies, a part of the Ingram Content Group. The transmission uses digital reading from our platform to the VitalSource platform. This partnership ensures our students will continue to have an excellent digital reading experience and access to a digital catalog of up to 1 million titles. Moreover, it allows us to lower our expense structure by significantly reducing the payroll, operating, and administrative costs, associated with developing enhancing and maintaining our digital reading platform yet still offering our students, faculty and partners a strong digital product with a great user experience. VitalSource is a global leader in building, enhancing, and developing e-reading content. We expect the transition to VitalSource to be completed by June 30th.
These two decisive and positive actions will allow us to impact revenue and compete in digital content and services. We'll have a strong portfolio of turnkey solutions such as course designs, courseware, content, assessment, and analytics, all of which are directly tied to student outcomes. These initiatives will expose us to new markets and a new customer base. Given the strength of our existing relationships with over 500 schools, 250,000 faculty, and more than 5 million students across more than 748 campuses, these actions will allow us to move quickly and efficiently to scale our business in this very fragmented market.
As a result of these initiatives we will be operating in a much lower cost structure resulting in a relatively rapid pay back of the LoudCloud investment. These two transactions will reduce our existing direct digital expenses in 2017 by more than half of the $26 million spent in 2016 resulting in a $30 million expense savings. These expected fiscal 2017 expenses of $30 million includes all direct digital expense associated VitalSource, LoudCloud operations, and key personnel involved in digital education. The cost of severance, retention and other restructuring cost such as sub leasing facilities related to our Yuzu operations including the closing of our California and Washington offices would be approximately $8 million to $10 million and will be incurred during the fourth quarter of fiscal 2016 and the first quarter of fiscal 2017.
Additionally we are recognizing a non-cash impairment charge of $12 million in this quarter. The $12 million charge is the complete write-off of certain capitalized costs associated with publisher content incurred and paid in fiscal year 2014 and fiscal year 2015 for the Yuzu digital platform and a write-off of our flash notes investments made prior to the separation. Barry will discuss in detail the financial impact of these transactions.
Also during the third quarter, the Board approved a stock repurchase program on December 14, 2015. During this quarter, we repurchased approximately 907,000 shares of stock for approximately $8.7 million.
With respect to our core book store business, we have signed during this year's marketing season new accounts with sales representing $77 million of new business. During the fourth quarter, we are seeing many schools finalizing their RFP process and preparing for a transition before the fall 2016 semester. The current pipeline for new business remains strong as colleges and universities continue to look for ways to manage the complexity of the course material landscape and drive revenue to their schools.

Operationally we continue to deliver the highest level of service to our students, faculties and schools. The company has executed two importance strategic initiatives that will help us enter new markets and increase our customer base while at the same time significantly lowering our cost structure. We have experienced comparable stores decreases in both rush periods this fiscal year. We're not happy with these results and we have plans nearing the remainder of 2016 and into 2017 to improve our sales results.
Our key strategies to improve sales trends are; improve the experience of selling publisher hosted content in our stores and on our website to gain a greater share of this growing market, grow a digital sales and margin from the sale of digital content and services through our LoudCloud platform, expand our price matching program to more campuses in order to strengthen our competitive position in the market place, improve our competitive response by accelerating our online market place programs, and finally, continue to align our general merchandise assortment to meet the changing needs of our customers.
Moreover, in light of our results, we are extremely focused on expense management. As Barry will detail in a few minutes, we've made progress in the third quarter of 2016 and will continue to drive efficiencies at the individual store level as well as our corporate office as we look to tailor our expense structure to respond to our revenue outlook.

With that, I'd like to turn it over to Barry for the financial review.

Barry Brover: Chief Financial Officer:

Thank you, Max. This morning we released our third quarter results for fiscal 2016. Please note that the third quarter ended on January 30, 2016, and consisted of 13 weeks, the results of operations for the 39 weeks ended January 31, 2015 and the 13 weeks ended August 1, 2015 reflected in our consolidated financial statements are presented on a standalone basis since we were still part of Barnes Noble Inc. until August 1, 2015. The results of operations for the 26 weeks ended January 30, 2016 reflected in our consolidated financial statements are presented on a consolidated basis as we became a separate public company. Please note all comparisons will be to the third quarter of fiscal 2015 unless otherwise noted.
Total sales for the quarter was $518.4 million compared with $521.6 million from the prior year period. The third quarter includes our Spring, back-to-School or Rush sales and is our second largest quarter. This sales decrease of $3.2 million or 0.6% was driven by our comp store sales decline of $22.1 million partially offset by our net new business which generated incremental sales of $18.4 million. As Max discussed, our comparable store sales declined 4.1% for the quarter and 2.7% year-to-date. The spring rush extended beyond the close of our fiscal third quarter and continued for an additional three weeks into February where we had strong sale of textbooks and general merchandize.
Factoring in these three weeks that contributed to the spring rush, brings the comp sales decline for the period to 2.9% and 2.3% fiscal year-to-date. Textbook revenue declined $21.4 million in comparable stores, primarily due to lower new and used textbook sales driven by the decrease in enrollments into community colleges as well as the factors that Max discussed.
For the quarter our general merchandize sales in comparable stores increased over the prior period by $0.6 million or 0.5%. Including new stores, our general merchandise sales for the quarter were $125 million and $416 million fiscal year-to-date and continued to be an increasing percentage of our overall sales. Our rental income for the quarter was $61.3 million, increasing by $0.8 million or 1.3% primarily due to new store openings. Rental income continues to be a very important part of our value proposition to our students and contributes high margins that continued to increase. We continue to maintain our strong list of over 77% of course required titles available for rent at competitive pricing with a large percentage of our rentals being used, which generates our highest margin.
Gross margin was $120.6 million, a decrease of $1 million or 0.8% due to the lower sales. The margin rate was 23.3% flat with the prior year. The improved textbook margins for both used textbooks sold and rented along with a favorable sales mix of selling more higher margin general merchandise, were offset by higher occupancy costs associated with contract renewals and new store contracts.
Selling and administrative expenses increased $3.3 million or 3.5% to $98 million. The increase was due to higher store payroll and operating expenses in net new stores of $2.1 million, higher payroll and operating expenses in comparable stores of $0.9 million, including $0.5 million in higher employee benefits mostly from medicals claims. In addition, we incurred $0.5 million in legal expenses related to the recently completed digital transactions. Selling and administrative expenses increased by 70 basis points in the third quarter which is less than the 90 basis increase in the second quarter. The increase in basis points in the third quarter is impacted by the spring rush sales extending beyond the quarter, the lower comp sales and the expense increases previously discussed. The company has increased its focus on expenses and saw a 20 basis point improvement in the third quarter. As we look to right sides of selling and administrative expenses.
User expenses including occupancy and selling and administrative expenses was $6.9 million for the quarter as compared to $7 million in the prior year period. This brings the total user spend on a year-to-date basis to $20.4 million, a $1.2 million increase over the prior year. As Max discussed earlier, as a result of the strategic digital transaction, we expect the annualized digital expenses of $26 million in fiscal 2016 to reduce the $13 million in fiscal 2017 resulting in $13 million in forecasted expense savings.
During the third quarter the company recorded an impairment charge of $12 million, $9 million specifically relates to the complete write-off of all of the capitalized costs related to publisher content incurred and paid in fiscal 2014 and 2015 for the Yuzu e-textbook platform and $3 million relates to the complete write-off of our investment in flash notes. As we transition to an outsource model with our e-textbook reader through VitalSource and significantly lower our cost structure, we will incur additional restructuring charges in the range of $8 million to $10 million in the fourth quarter of fiscal 2016 and the first quarter of fiscal 2017 which includes approximately $4 million of non-cash items.
The restructuring cost includes severance, retention costs to ensure a smooth transition, expected costs as we close the offices in Mountain View, California and Redmond, Washington along with the write-off of any lease hold improvements. These expenses are incremental to the previously guided Yuzu digital spend projection for fiscal 2016 of $26 million. During the first quarter of fiscal of 2017 as we complete the final transition to the VitalSource platform, we expect to incur an additional $1 million to $2 million of transitional expenses primarily related to payroll and consulting.
Our adjusted EBITDA adjusting for the $12 million non-cash charge was $22.6 million for the quarter, a decrease of $4.3 million compared to the prior year due primarily to the reduced earnings on lower comp sales, the increased expenses previously discussed, partially offset by the earnings contribution of our net new source.
The effective tax rate for the fiscal third quarter was minus 14.4% compared with 39.6% in the prior year and reflects the impact of federal and state income taxes on income from operations impacted by the effect of certain non-deductible expenses including certain impairment charges noted earlier.
Third quarter net loss was $3.6 million or $0.07 per diluted share compared to net income of $8.7 million or $0.09 per diluted share in the prior year period. Excluding the impairment loss of $12 million or a $8.5 million after tax, net income was $4.9 million compared to net income of $8.7 million in the prior period.
The current year's fiscal quarter has 48.1 million diluted share outstanding, while the prior year has 39 million diluted shares. The current period reflects the dilution of the previously disclosed Series J preferred shares converted at Barnes & Noble Inc. in July of 2015 prior to the spent, partially offset by the share repurchase program that was approved by the Board of Directors on December 14, 2015. Under the share repurchase program, the company repurchased 906,732 shares in the third quarter for approximately $8.7 million.
The balance sheet continues to be strong with no debt outstanding and $127 million of cash at the end of the quarter. The decrease in cash as compared with the prior year, is the result of inter-company funding that occurred with our former parent from January of 2015 through the date of the spend. On a rolling full quarter basis, our average cash balance was over $104 million and our average working capital was over $228 million.
Fiscal year-to-date, cash flow from operations increased by over $5 million as compared to the prior year period due to continued improvements in working capital including deferred taxes. During the quarter specifically in December, the company borrowed and repaid $52 million under the facility and remained out of the facility through the end of the quarter.
Merchandize inventories increased by $80 million as compared to the prior year, $73 million of the increase is in textbook inventories which was impacted by the later rush period. After to spring selling season is complete and before our yearend, the unsold returnable new and used inventory will be returned to the publishers or distributors. Accounts payable increased by $60 million from $492 million to $508 million along with the increase in inventory. Capital expenditure for the third quarter were $13.1 million compared with $10.5 million in the prior year period and on a year-to-date basis, was $37.7 million compared with $35.1 million last year.
Currently our store count is 748 having opened six new stores while closing one in the quarter. We expect to open an additional seven stores in the fourth quarter while closing one additional store. This would bring the full year store openings to 41 and closures to 11, representing $68 million of sales from new business while $5 million of sales from closed stores. Seven of the stores closed were satellite store locations that we elected to close where we continue to operate the main contract. Each of these satellite stores had annual sales below $500,000 and were not profitable.
For fiscal year 2016, we expect comparable store sales to decrease by 2% which is within the range previously provided and expenses related to digital and Yuzu to be approximately $26 million flat to last year and to incur restructuring costs of $8 million to $10 million between the fourth quarter of 2016 and the third quarter of 2017. In addition, capital expenditures will be approximately $50 million for the fiscal year.
With that, we will open the call for questions. Operator, please provide the instructions for those interested in asking a question.

Question & Answer

Operator:

[Operator Instructions] We'll take our first question from Alex Fuhrman with Craig Hallum Capital Group.

Alex Fuhrman: Craig Hallum Capital Group:

Great. Thanks for taking my question. First question I'd like to ask is more about the decision to outsource some of the digital platform that you've been building with Yuzu. I guess you know, would love to get a sense of what exactly functionality you might be losing by outsourcing and maybe if you could walk us through a little bit of the history of what exactly you guys were building with the $26 million here and what your though had been six months, 12 months ago versus what's changed now and do you still feel that Yuzu and faculty and light is a really strong recruiting and sales area for you guys to really be winning new business with new schools?

Max Roberts:

Good morning, Alex, this is Max. Thank you for the question. If you go back, the Yuzu platform was conceived and built under the study under the group and as part of it and at that time both publishers, ourselves, we felt that the e-textbook platform would be the significant e-learning tool and used by students and faculty. As that decision was made, we started developing we had to start in order to build an entire facility, the software technology from the ground up for a e-textbook platform. We also build an architecture that we thought would be expandable into a learning platform. Those were the costs that we had on a run rate of the $26 million. We soon with a sense of urgency evaluated after we separated that the e-textbook market did not materialize to the expectations that we had in the publishers and we quickly started looking at other alternatives.
The vision was always to have a learning platform along with the e-textbook platform. So therefore, we saw an opportunity to bifurcate the two products. We had the opportunity to acquire learning platform LoudCloud and then outsource to VitalSource to transfer the e-textbook. They also served as an e-textbook platform for a number of other companies and we felt that that was the most efficient use of capital and in the acquisition of LoudCloud we have a learning platform that's both classroom dashboards, LMS, different analytic tracking, competency based education. That was the vision we always had to evolve Yuzu into and as a result, by bifurcating we have a very efficient provider of e-textbooks only and then we have a learning platform that is off shored in the development and also the ability to use its marketing staff to grow the digital services and learning platform business.

Alex Fuhrman:

Great. That's helpful and then I would like to ask a little bit about the price match that you talked about on the conference call and forgive me if you gave some of these numbers on the call and I missed it but can you tell us how many schools you tested the price matching and then how many schools do you think there's an opportunity to roll that out to looking out into the next year and was there any sort of a discernible margin hit in those schools where you did the price match and I am just being curious if the lift you saw there was really driven by more aggressive pricing or may be just more of a marketing message around it just by telling students we have as lower price as anywhere else did that just drove more traffic into your stores?

Max Roberts:

Yeah, it's a great question and as we said, we will roll it out in a measured basis and making sure that what we saw in the schools early on continue the same trends. And I'll turn it over to Patrick, our President who actually managed the process and managed this field.

Patrick Maloney: Executive Vice President and Chief Operating Officer:

Thanks Max. We actually are right now with 97 campuses across the United States with the price matching program. Our units were up on these campuses and the margin dollars associated with those units were also up in net margin dollars. So we'll be looking to expand this. We can't commit to how many campuses we're going to expand to for the fall but it will be significant.

Alex Fuhrman:

Great. That's really helpful. Thank you guys.

Operator:

[Operator Instructions] It appears there are no further questions at this time. So I'll turn it back over to our host for any additional or closing remarks.

Max Roberts:

Thank you. And thank you for joining today's call. Please note our next scheduled financial release will be our fiscal 2016 fourth quarter earnings call on or about June 28. Thank you all and have a good day.

Operator:

Thank you for your participation. This does conclude today's call.

 

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