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Barnes & Noble, Inc. (BKS)

Q1 2006 Earnings Conference Call

May 18, 2006, 11:00 a.m. EST

Executives:

Joseph Lombardi, Chief Financial Officer, Barnes & Noble, Inc.

Steve Riggio, Chief Executive Officer and Vice Chairman, Barnes & Noble, Inc.

Marie Toulantis, Chief Executive Officer, Barnes & Noble.com

Analysts:

Mark Rowen, Prudential Securities

Cory McCallum, SunTrust Robinson Humphrey

David Weiner, Deutsche Bank

Matthew Fassler, Goldman Sachs

Danielle Fox, Merrill Lynch

David Schick, Stifel Nicolaus & Company, Inc.

Operator

Good day, everyone, and welcome to this Barnes & Noble First Quarter 2006 Earnings Results Conference Call. Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the Chief Financial Officer, Mr. Joseph Lombardi. Please go ahead, sir.

Joseph Lombardi, Chief Financial Officer

Good morning and welcome to Barnes & Noble's first quarter 2006 conference call. Joining us today are Steve Riggio, Mitchell Klipper, Marie Toulantis and other members of the senior management team.

Before I begin, I would like to remind you that this call is covered by the Safe Harbor disclosure contained in our public documents, and is the property of Barnes & Noble. It is not for rebroadcast or use by any other party without the prior written consent of Barnes & Noble.

This morning before the market opened, we released our results for the first quarter, ended April 29, 2006. Consolidated sales for Barnes & Noble increased 2% to $1.1 billion for the quarter. Sales at Barnes & Noble stores were up 2% to $981 million. Comparable store sales decreased 0.3% for the quarter, below guidance which called for a low single-digit increase. Our comparable store sales were fairly consistent throughout the quarter with the exception of the last two weeks of April, at which point they trended lower, resulting in slightly negative comps for the full quarter.

In the first quarter, we opened eight Barnes & Noble stores and closed five, for a quarter-end total store count of 684. Comparable store sales at B. Dalton decreased 1.8% for the quarter, and now represent only about 2% of sales. We have closed five more B. Dalton stores this quarter, resulting in a total B. Dalton store count of 113. Sales at Barnes & Noble.com were $91 million, flat with a year ago.

Our selling and administrative expense rate was 100 basis points higher as a percentage of sales this year. 40 basis points of this increase relates to this quarter's adoption of FAS 123(R) and the related expense associated with stock compensation costs. The remaining 60 basis point increase is a result of sales deleveraging. This unfavorable SG&A rate was completely offset by a 60 basis point margin increase.

Steve is going to comment further on our sales and margin trends in a few minutes. Our conversion and transition plan for the new distribution center continues on plan. Redundant costs included in our results for the transition were $0.03 per share, as expected. We still expect costs of $0.09 per share for the year related to the conversion/transition plan, broken down by $0.03, $0.02 and $0.01 for the next three quarters.

Earnings per share for the quarter were $0.14, at the high end of our guidance range, excluding stock compensation expense, earnings per share increased 31% versus the year-ago period.

In the first quarter of 2006, the Company acquired 2.2 million shares for $93 million under its share repurchase program, at an average price of $43.25. The Company has $78 million remaining under the current program.

And now for guidance for the second quarter. Our sales guidance for the second quarter is for a low single-digit comparable store sales decrease, as we cycle against last year's 4.3% comparable store sales increase, which included Harry Potter. The Company expects earnings per share for the second quarter between $0.22 and $0.26, based upon a diluted share count of 70 million shares. This includes a $0.04 per share projected charge for stock compensation costs. Without those costs, on an equivalent basis with last year, we are forecasting earnings per share between $0.26 and $0.30.

When comparing earnings per share this year to last year, it is important to remember last year we had two charges in our second quarter, which amounted to $0.07 per share, one for debt redemption costs and the other for legal costs. If you exclude such charges last year, earnings per share were $0.25. Our guidance for the second quarter, therefore, excluding stock compensation costs, is for earnings per share growth to increase between 4% and 20%. Full-year guidance for sales and earnings per share remain unchanged. At this point, I would like to turn the discussion over to our CEO, Steve Riggio.

Stephen Riggio, Chief Executive Officer, Vice-Chairman

Good morning. The first quarter sales reflected a relatively non-eventful new release schedule, especially in terms of hardcover new releases. A few brand name authors did have new books, including Stephen King, James Patterson and Mary Higgins Clark, but they sold as expected. There was, however, a noticeable absence of the type of books that garner major media attention -- no diet or health books that broke out from the pack, no major new work of fiction that generated significant word-of-mouth momentum. While books on world events and the current political scene are selling well, again, no one book emerged to dominate the bestseller list. In the area of religion, The Jesus Papers, The Gospel of Judas, What Jesus Meant and Misquoting Jesus continued to address our customers’ interest in spirituality and inspirational stories. But there was no one book that approached the sales of last year's first quarter sales of The Purpose-Driven Life by Rick Warren.

Instead, the standout new releases for the quarter were paperbacks. The paperback editions of Dan Browne's The Da Vinci Code sold well, especially the lower-priced mass-market edition. The Covenant with Black America by Tavis Smiley sold out its entire first printing in just a few days, and has remained on our bestseller list since publication in February. The release of Rachel Ray's Express Lane Meals continued her unbroken string of winners. Within the puzzle areas, Sudoku books continued to sell extremely well. But across the entire store, our backlist paperback sales were solid, as consumers have come to depend on us for a vast selection of titles.

Gross margin for the quarter was better than planned, and that is a result of our sales mix shift into higher margin products. Sales of deep-discounted bestsellers represented a smaller percentage of our sales, as did lower-margin music CDs. Conversely, sales of backlist paperbacks and children's books, which are not deep-discounted, represent a higher percentage of our sales. And in addition, our margin continues to benefit due to lower purchases from book wholesalers.

We opened eight new stores this quarter, all great stores, including locations in Fairbanks, Alaska; Jonesboro, Arkansas; Montclair, California; and Southlake, Texas. We continue to find many new exciting opportunities. We were also very, very pleased to reopen our location in Metairie, Louisiana, which was closed since Hurricane Katrina.

I will talk a little bit about the second quarter. Right now, our best-selling book appears to be The Great Deluge by Douglas Brinkley, selling extremely well. Other titles include Mayflower by Nathaniel Philbrick; Lies at the Altar by Robin Smith, due to the plug on Oprah; Burnt Toast by Teri Hatcher; and Crime Beat by Michael Connelly.

Looking ahead to the rest of the second quarter, lots of new books from brand-name authors: Patricia Cornwell, Janet Evanovich, Laurell Hamilton, John Updike, Ann Coulter, Nora Roberts, Johanna Lindsey, Harry Goodkin (phonetic), Robert Parker, Danielle Steel. James Patterson fans will be delighted to know there will be two books out this quarter, and our pick for Father's Day is Tim Russert's Wisdom of Our Fathers. Thank you. At this point, we would like to turn it over to questions.

Question-and-Answer Session

Operator

Thank you. Operator Instructions We will begin with Mark Rowen with Prudential Securities.

Q - Mark Rowen

Thanks good morning, Steve and Joe. The comp that came in lower than expected -- you said it was the last couple of weeks, was it primarily traffic and I'm assuming, and not ticket, and do you think that that is -- are you seeing something going on just sort of in general in the economy, do you think that’s causing that lower comp?

A - Joseph Lombardi

The comp decrease in late April was all traffic. And we are disappointed with those couple of weeks. May has been a little bit better than that April trend, certainly, particularly the Mother's Day business. So, at this point, we're just comfortable kind of with the guidance that we are giving for Q2 and, obviously, given the Harry Potter comparison as well.

Q - Mark Rowen

Well, and did you see anything related to gas prices with a relationship to the drop-off in traffic? Can you correlate that, or is that kind of hard to do?

A - Steve Riggio

I think that's kind of hard to do. I think, though, that most of the media I have been reading and hearing lately is that there was a slowdown in April. And it affected retailers in general, not sort of our segment or us in particular.

Q - Mark Rowen

Okay. And May is looking a little bit better than the back half of April was?

A - Joseph Lombardi

Yeah. The last two weeks of April were very difficult, but we are comfortable guiding the way we have guided at this point.

Q - Mark Rowen

Okay and then, so the gross margins improvement, that was primarily mix shift, where you just didn't sell a lot of the lower-margin stuff from a year ago, and you sold more higher-margin stuff? Is that what I heard Steve say?

A - Steve Riggio

That is correct.

Q - Mark Rowen

Okay, all right, and then on Barnes & Noble.com, what's going on there? It looks like, from what I can tell, you have been doing a little bit more advertising in search, places like Google and maybe Yahoo, but it doesn't look like it's driving the business there. Marie, could you maybe just kind of give us a little detail on what's going on there?

A - Marie Toulantis

Well, you might be, I don't know, noticing more advertising. We certainly have not stepped it up. In fact, the prices for paid search, non-brand keyword continues to go up and be very competitive. So, I think that we are being very careful and evaluating very carefully our expenditure on things like that, because there's no point driving unprofitable sales. So, I don't know what you are referring to when you see an increase in advertising in those areas.

Q - Mark Rowen

Well, I guess I noticed that you started doing some local advertising on Google, which I think is new.

A - Marie Toulantis

You mean on Google Maps?

Q - Mark Rowen

Yeah, right.

A - Marie Toulantis

Yeah, that is just in a beta, that is not driving anything.

Q - Mark Rowen

All right, and then, on the keyword Search, so is -- because costs continue to go up, ROIs are going down on that, is that becoming a less attractive vehicle for you to acquire customers?

A - Marie Toulantis

Yeah.

Q - Mark Rowen

And are you thinking about shifting dollars to other mediums going forward?

A - Marie Toulantis

We are always looking at that Mark, because we can certainly buy sales if we wanted to, and we could have a big increase in the top line. But that's not how we choose to run the business. And we carefully evaluate all the ways of acquiring new customers and getting sales, including all the obvious ways to do it via the Internet. So, we look at everything, and we are constantly shifting and evaluating. But we are not in the business of acquiring sales that are unprofitable sales or at very high cost of acquisition.

Q - Mark Rowen

Great, is the cost that is going up on buying those viewers -- is that being driven primarily by the large book retailers who are your competitors or a lot of smaller players?

A - Marie Toulantis

I think it's pretty much across the board. I mean you read that everywhere, that it's not just in our industry but everywhere this is becoming extremely competitive. And I think obviously there will be a shakeout down the road, because people can't continue to pay such an effective cost of advertising, in terms of looking at an ROI. But for the moment, it seems to be somewhat irrational. So, again, our policy has always been not to play in that arena. So yes, you'll see us doing some. But we are always going to be evaluating it, and spending our dollars the best way we can to generate a return.

Q - Mark Rowen

Okay great. Joe, just a quick housekeeping question. Depreciation expense has come down pretty significantly, depreciation and amortization, over the last couple of quarters. What is driving that?

A - Joseph Lombardi

Largely cycling through the store, depreciation expense from the large openings in mid-'90s. That is just going to be a continuing phenomenon that will continue.

Q - Mark Rowen

Okay great, thanks very much.

Operator

Moving on, we will now go to David Magee with SunTrust Robinson Humphrey.

Q - Cory McCallum

Good morning. This is Cory McCallum (phonetic) here for David Magee this morning. I was wondering if you could give us an outlook for visibility, title visibility in the second half?

A - Steve Riggio

Actually, we will be getting a good picture of that at the booksellers’ convention this weekend. I don't have a list handy with me. We know a little bit about it. It's too early to comment on it. We do know that Mitch Albom has a book that will be coming out. And Jim Cramer will have another book coming out. But I think on the next call, we will give you a more thorough update on what it looks like.

Q - Cory McCallum

Okay and if you could, discuss a little bit about, if you could, next quarter's inventory and how that is going to be shifted there?

A - Joseph Lombardi

Do you say next quarter's inventory?

Q - Cory McCallum

Yeah, I mean inventory turns were down here, inventory per store was up. And I just wondered if that was an ongoing trend or something that will be rectified going forward?

A - Steve Riggio

You know when I look at inventory turns over the past -- the rolling 12 months, we are up a freckle, about 2.42 against 2.36. So, I mean, at any moment in time it could be slightly off. But inventory levels are fine. Remember, the vast majority of our inventory is returnable, so the sales dip at the end of April obviously makes the turn a little light at the end of the quarter. But I mean it's not something that we're concerned about. We are certainly managing to it.

Q - Cory McCallum

Okay thank you.

Operator

Our next question comes from Dave Weiner with Deutsche Bank.

Q - David Weiner

Great, good morning. Thanks for taking my call. Two quick questions, the first, when I look at my model here, it looks like the other category for the segment sales went up pretty dramatically this quarter, over 30%. First of all, could you just verify that that is true? And second of all, is that mostly driven by Sterling?

A - Steve Riggio

The sales are mostly driven by Sterling. And the other segment is up as well, and that largely would be the reason.

Q - David Weiner

So can you comment at all, I mean, to what degree that contributed to your gross margin?

A - Steve Riggio

It certainly helped. But Sterling is a relatively small piece of the business, so it didn't contribute that much to the consolidated amount. And, gains in public books were terrific, which are profitable both for us and for them.

Q - David Weiner

Great -- okay great. And then secondly, just coming back to the Internet business, so I guess I'm trying to understand a little bit about what programs or what catalysts you have in place to try to drive sales? Like what specifically are you doing to try to drive sales?

A - Marie Toulantis

Well, we are doing a number of things. I didn't want to imply before that we don't do any Internet advertising, because you will see us on thousands of affiliated websites and the typical sort of affiliated programs that we have had for years. What I was saying is that we're going to be very careful about how we spend the advertising dollars so as not to overspend just to drive, solely to drive the top line. So, you will see us continue to do a number of initiatives with regard to direct mail, direct e-mail to our customers through our member programs, where customers can receive a 10% discount in our stores and online, communicating with that customer base as well as a number of other initiatives.

Q - David Weiner

And just on there one last question, on Borders' new loyalty card, can you comment at all how that might have affected the business, your business this year, this quarter?

A - Steve Riggio

We have not seen any difference in the performance of those stores that compete directly with the Borders and those which do not compete directly with the Borders.

Q - David Weiner

Okay. So strategically you're not taking a different bent at all, even at certain store levels?

A - Steve Riggio

No.

Q - David Weiner

No. Okay great thanks for your time.

Operator

Our next question comes from Matthew Fassler with Goldman Sachs.

Q - Matthew Fassler

Thanks a lot. Good morning. I would like to ask two questions. The first relates to SG&A. It sounds like the sales slowdown late in the quarter against some fixed costs, and perhaps you are just in payroll plan, led to a little bit of deleverage. Can you talk about your flexibility in the event that the sales environment remains choppy, to rein in SG&A, whether you've baked that into the rest of your guidance for the year, if that's sort of a safety net, if you will, in case, the sales to remain soft?

A - Steve Riggio

I mean, we manage our -- the most important things to manage with the variability of sales is the payroll, and we manage that every day, every week. And obviously, our store managers are responsible for flexing their payroll according to the sales trends. That being said, you can flex a number of things such as payroll, which is a large number, and the fixed costs are really what deleverages at that point. And you do the best you can.

Q - Matthew Fassler

And was that -- since it sounds like sales slowed down rather suddenly and sort of towards the end of the quarter, way past your planning process, was this an instance where it probably was tough to rein that in? Or would you say that those processes kicked-in and what we see sort of included the effect of some slimming down in those last couple of weeks?

A - Steve Riggio

I would say, I would rather say we're managing our payroll every week, regardless of sort of one or two week phenomena. And certainly, in the difficult sales weeks, it is harder to meet your sales per hour goal. But we continue to manage it, that's just everyday business.

Q - Matthew Fassler

Got you. And then secondly, just in terms of timing, you obviously have a year round business, you're not an Easter business, but there was a change in the calendar that impacted a lot of retailers. Just as you think about the timing of the business, do you think that Easter had anything to do with it at all? Or was that just not part of the consideration here?

A - Steve Riggio

We don't think so. We certainly planned for the Easter flip and knew it was coming. And what we're discussing in late April is a post-Easter sort of (multiple speakers) anyway.

Q - Matthew Fassler

Understood. Thank you very much.

Operator

Our next question comes from Danielle Fox with Merrill Lynch.

Q - Danielle Fox

I think, I have two quick questions. First, I was wondering if you could talk a little bit more about the comp trend by product category. I think you mentioned in the past that music has been weak. I know it's not a very large percentage of sales, but I mean were book comps positive but music a drag? What happened among the different product categories?

A - Steve Riggio

We generally don't like to break the store down into a whole bunch of comps by subject, department, etc. But your point is taken. The music, the business is negative.

Q - Danielle Fox

Okay. And then, I guess, just the DC costs that you highlighted in the quarter, I think you said that there were $0.03 of redundancy costs. When we're thinking about ‘07, should we be thinking about those costs going away, or some of the savings beginning to offset the incremental costs?

A - Joseph Lombardi

You should be thinking about those costs going away.

Q - Danielle Fox

Okay. Thanks very much.

Operator

Operator Instructions. We will now go to David Schick with Stifel Nicolaus.

Q - David Schick

Hi, good morning. I guess, related to a couple of questions that have been asked. Was there anything by category that changed, I guess music or otherwise, gifts, etc. that changed more dramatically in that late April period?

A - Steve Riggio

No, it was a traffic issue.

Q - David Schick

So, everything was together. Okay. Secondly, could you talk a little bit about the MasterCard and just the very early stages here?

A - Steve Riggio

Yeah, we launched this new Member MasterCard a few weeks ago, and we believe the additional value proposition for the members enhances what is a good bookselling offer for our members. We think it's just -- it's a nice plus for them. It's very early on.

Q - David Schick

So it's too early to talk about whether it's meeting expectations for signups?

A - Steve Riggio

It was just launched a few weeks ago.

Q - David Schick

Great. Okay. And then lastly, I don't know whether it's just near us in the stores, but the Collector's Library, the Barnes & Noble Collector's Library seems pretty prominently displayed and well displayed in the store. Could you talk about the Barnes & Noble imprint stuff and how it's doing in the stores? Is there any difference there in what you're showing the customer and how that's showing up at the register?

A - Steve Riggio

Well, because we own a publishing company and have been publishing books under our own name for probably the better part of 15, 20 years gives us the opportunity to do promotions on a cyclical or, in some cases, permanent basis, semi permanent basis. If we have got a good line of books that sell well, we will keep it in highly visible storefront space until it kind of falls off. It gives us the opportunity often to off-price them to our customers. But there's nothing that we've done recently that’s any different or signifies a change in direction. We think our classics series is very well done, and our customers have embraced them. And that's about it.

Q - David Schick

So, there was nothing incremental there to drive growth during the quarter?

A - Steve Riggio

No, no, no. That's all.

Q - David Schick

Okay. Great thank you.

Operator

At this time, there are no questions. I would like to turn the conference back over to you, Mr. Lombardi for any additional or closing remarks.

Joseph Lombardi, Chief Financial Officer

Thank you again for listening to our first quarter 2006 conference call. Please note that our next scheduled financial release will be our second quarter release, on or about August 17th. Thank you.

Operator

This concludes today's presentation. Thank you for your participation, and have a wonderful day.

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