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Barnes & Noble, Inc. (NYSE:BKS)

F2Q09 Earnings Call

August 20, 2009 10:00 am ET

Executives

Joseph J. Lombardi - Chief Financial Officer

Stephen Riggio - Vice Chairman of the Board, Chief Executive Officer

Analysts

Aaron Stein - J.P. Morgan

Mitchell S. Klipper - Chief Operating Officer

Bill Armstrong - C.L. King & Associates

Allen Rifkin - Banc of America

Operator

Good day. Welcome to this Barnes & Noble second quarter 2009 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 J. Lombardi

Good morning and welcome to Barnes & Noble's second quarter 2009 earnings conference call. Joining us today are Steve Riggio, Mitchell Klipper, William Lynch, 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 press release and public documents. Actual results may differ from any projections contained herein. This call is the property of Barnes & Noble. It is not for rebroadcast or use by any other party without the written prior consent of Barnes & Noble.

This morning before the market opened we released our results for the second quarter ended August 1, 2009. Consolidated sales totaled $1.156 billion for the quarter, a 5% decline from last year. Sales at Barnes & Noble stores were $1.032 billion for the quarter, also a decline of 5% from last year. Comparable store sales declined 6.9% for the quarter, which was within guidance of a 5% to 7% decrease.

Store traffic was down throughout the quarter and was the main driver in our comparable store sales performance. Our average ticket declined slightly.

Sales at Barnesandnoble.com were $102 million for the quarter, a 2% increase over last year.

Gross margin was better than expected this quarter and the good news is that gross margin gains were across the board. First, reduced distribution costs, particularly in freight and payroll, largely due to significantly lower levels of returns and lower freight rates; second, continued physical inventory shortage rates at last year’s record low levels. We were concerned that there might be an unfavorable blip upward in shrink as a percentage of sales, given the sales declines but that did not occur.

Third, a favorable product mix -- lower sales of low margin music and higher sales of higher margin products from the bargain and gift departments.

And fourth, reduced markdowns as a percentage of sales. We are continuing to hone our promotions to maximize our bang for the buck. Further, bestsellers were lower this year as last year included strong sales from a few titles -- Stephanie Meyers The Host, Barbara Walters Audition, and Randy Pausch’s The Last Lecture.

Selling and administrative expenses as a percentage of sales increased 40 basis points this quarter but declined $11.1 million in absolute dollars. This year’s expense includes a $6.75 million or $4 million after tax benefit from an insurance settlement. Excluding the settlements, selling and administrative expenses increased 100 basis points during the quarter as a result of the negative comparable store sales. However, in absolute dollars, selling and administrative expenses declined $4.4 million due to planned cost reductions.

Pre-opening expenses were $1.5 million lower this quarter due to fewer store openings. One store opened this quarter compared to 10 a year ago.

The company reported net earnings from continuing operations of $12.3 million, or $0.21 per share for the quarter. Excluding the benefit from the insurance settlement, which was $0.07 per share, second quarter net earnings were $0.14 per share compared to a guidance of $0.05 to $0.15.

At quarter end, the company’s balance sheet and financial condition remain in excellent shape. Inventories are down $108 million, or 8% from a year ago. The company had $158 million in cash and no borrowings at quarter end or throughout the quarter. Last year at this time the company had $97 million of net borrowings. This represents a $255 million improvement in the company’s net cash position year over year at the end of the second quarter.

Now I would like to comment on third quarter and full year outlook. For the third quarter, the company expects comparable store sales to decrease 1% to 3%. This sales guidance is better than trend due to easing comparisons, as compared to the prior year period. The company continues to expect full year comparable store sales to decline 3% to 5%. Additionally, the fall lineup looks fairly strong, with Dan Brown’s The Lost Symbol being the big third quarter title.

Last week the company announced it had signed a definitive agreement to acquire Barnes & Noble College booksellers. We noted that we expect the acquisition will close on or about October 1st, at which point we plan to update earnings per share guidance for the balance of the year.

I would like to take this opportunity to provide a few additional metrics on the college business related to sales and EBITDA growth rates, as well as new contract acquisition rates.

From the core bookstore business we are acquiring, the five-year historical adjusted EBITDA for college was 12%. However, that number is skewed by fiscal 2005 results, which were unusually strong. Excluding that year, the four-year compounded annual adjusted EBITDA growth rate is 6%. The growth rate for the past two years has been between 4% and 5% each year and 4% to 5% is the expected level of compounded annual growth you should be thinking about over the next five years and which is consistent with the accretion discussed on August 10th.

As we said, purchase accounting is yet to be completed and we expect to provide guidance on or about October 1st.

In the meantime, I can at least update you on new business at college. Last week on the call I noted that college targets for annual growth rate of new business to be a net $45 million. In general, that is $60 million of targeted new business offset by $15 million in contracts not renewed. The average annual gross new business recorded for the last five years was $64 million, ranging from $43 million to the $86 million achieved last year. For the current year, college management has already signed new contracts forecasted to add $56 million in annualized new business to the company.

At this point, I would like to turn the discussion over to our CEO, Steve Riggio.

Stephen Riggio

Good morning. We are very pleased with our performance during the second quarter. Sales were on plan, margins were ahead of plan, and expenses and inventories were extremely well-managed. While all retailers in America continue to struggle with declines in traffic, our comparable store sales have been consistently in the middle of the pack, if not a bit better.

The affordable nature of the products we sell, our growing member base, and the effectiveness of our multi-channel marketing programs have enabled us to more than hold on to our market share.

Sales at barnesandnoble.com were up 2% to last year. The good news is also that traffic to the site is growing, customer satisfaction levels are higher than ever. The most important development of the quarter, however, was the launch of our e-bookstore on July 20th. Our strategy to offer customers an e-books made easy digital store has been a big hit with our customers. We believe that the installed base of tens of millions of PCs, Macs, iPhones, BlackBerries, and Smartphones represents a sizable and ready-to-service market of customers, and our e-reader application is getting wide adoption on all platforms.

Further, we had the two -- top two most downloaded apps in the iTunes store. Right out of the box, our e-reader app, which continues to be the number one book app and the Barnes & Noble bookstore app, which enables customers to browse, search, and snap photos of covers and to buy -- covers of products and to buy them with ease.

In the coming months, we plan to expand our selection of ebooks and expect to be offering well over 1 million titles by the end of the year. This will include every available copyrighted title from major pubs, mid-sized publishers, small presses, university publishers, et cetera, as well as massive online libraries of public domain, titles such as the one currently provided to us by Google.

We will expand our offering to include newspapers and magazines and blogs and in total, we expect that the number of titles we offer in digital format is going to be significantly greater than what we are currently offering in physical format. In effect, the main point here is that it will enable us to sell so many more titles, hundreds of thousands, eventually millions more than we currently offer our customers, and that is certainly one part of the upside from the digital platform that we have built. Thank you.

Joseph J. Lombardi

Operator, now we’d like to turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question today from Aaron Stein with J.P. Morgan.

Aaron Stein - J.P. Morgan

Good morning. Thank you. Joe, I was hoping you could talk a little bit about the components of GPM in the quarter. I know that you broke down a few different buckets. I am curious if you could think about the 100 basis point increase and the magnitude in each bucket.

Joseph J. Lombardi

Of selling and administrative expenses?

Aaron Stein - J.P. Morgan

No, CPM, gross margin.

Joseph J. Lombardi

Gross margin was up 10 basis points year over year, and I would say -- the most significant pieces of that were reduced distribution costs, physical [inaudible] shortage, and the promotional rate of markdowns. We had some benefit as well from a product mix.

I mean, I think what was exciting for us for the quarter is the margin kind of was good across the board. We were selling higher profit items, it was costing us less to get the stuff in the stores and we promoted I think effectively for what we thought we were trying to do and lastly, the stores are controlling their inventory very, very well given the sales decline. So from an operational point of view and a supply chain management point of view, we think we did a pretty good job this quarter.

Aaron Stein - J.P. Morgan

Sorry, I had backed out the $11.3 million benefit from last year from shrink, just seeing that was more one-time, which is catch-up. Is that the way to think about?

Joseph J. Lombardi

Yeah, except that a portion of that certainly less than half is -- it would be a benefit this year as well. We did have a benefit for inventories in the current quarter -- just not -- last year’s number was huge.

Aaron Stein - J.P. Morgan

And then I noticed that you guys have done a good job renegotiating leases as you go. Can you just sort of quantify what impact that had [inaudible]?

Joseph J. Lombardi

We haven’t really broken that out but I think importantly for the quarter, I think going forward -- let me have Mitch comment on that.

Mitchell S. Klipper

For next year, we have 87 leases that are at the end of their primary term, all of which have either been negotiated or under negotiation and I can tell you that almost every one of them are coming in extremely favorable to the company and right behind those 87 leases, we have 124 coming due in the following year and our landlords are very, very anxious to make sure that we will be staying in these centers to keep the occupancy up there, so everything we see and we’ve negotiated is extremely positive on the renewal front, so we are pretty excited about the opportunities that lie ahead on the occupancy line in the foreseeable future.

Joseph J. Lombardi

And for the quarter itself this quarter, occupancy actually, because of the comparable store sales decline, delevered 40 basis points, so actually the benefits are kind of buried in the problem with the sales decline overall.

Aaron Stein - J.P. Morgan

Okay, and then just Mitch, just a quick follow-up on that, is it fair to assume that when you renegotiate, it’s that you are taking a step down and not just staying flat?

Mitchell S. Klipper

Exactly.

Aaron Stein - J.P. Morgan

Okay, perfect. And then just a final question, Joe -- could you just walk us through how the comp trended through the quarter?

Joseph J. Lombardi

It was pretty consistent overall. I mean, the last couple of days was very tough because of the Stephanie Meyer release last year but basically traffic was slow throughout the quarter and when we looked at our comp rates compared to the retailers who reported monthly numbers, we didn’t really see much of a change. Perhaps June for us was a little bit better than the average retailer versus where we stood versus them but not significantly.

Aaron Stein - J.P. Morgan

Okay. Thank you very much.

Operator

Next we’ll hear from Bill Armstrong with C.L. King & Associates.

Bill Armstrong - C.L. King & Associates

Good morning. I did have just a couple of questions on the college bookstore, just getting -- trying to understand the business model a little bit more. The employees that are in the stores, those are employees of the company, is that correct?

Joseph J. Lombardi

That’s correct.

Bill Armstrong - C.L. King & Associates

Okay. What is the average contract term as far as the time period?

Joseph J. Lombardi

The average contract term is about five years.

Bill Armstrong - C.L. King & Associates

Okay, and do the bookstores, do you guys pay rent or how does that actually work?

Joseph J. Lombardi

We actually -- you know, have contracts and we pay basically a percentage of sales and with some fixed minimum guarantees on some of the contracts.

Bill Armstrong - C.L. King & Associates

If a student bought a book, a text book digitally, would that be through the college bookstore or does that bypass the bookstore?

Joseph J. Lombardi

Today that is not through the college bookstore.

Bill Armstrong - C.L. King & Associates

Not through the bookstore -- okay, thank you.

Operator

(Operator Instructions) We’ll take our next question from Allen Rifkin with Banc of America.

Allen Rifkin - Banc of America

Yes, thank you. A couple of questions, if I may -- I was curious if you could maybe provide some color on the vendor reaction post your announcement of the college acquisition and the 30% to 35% accretion that you folks spoke to when you announced the acquisition, could you maybe provide a little bit more color on what type of buying synergies that takes into account? And then I have a follow-up, please.

Joseph J. Lombardi

Sure. The reaction -- every single university that college does business with was communicated with the day we made the announcement, so we’ve certainly had all those communications, both from a corporate level and the college management team itself, as well as their individual regional managers who manage their stores, so all of that communication happened and went well, from what the college management has told us.

And the second question was related to the accretion level -- the accretion level assumes what the EBITDA run-rate was, assumes a higher interest costs for the company because of the new financing to do the facility and it does not include synergies, which is as we discussed on our call last week, is not really what the transaction has. We will certainly look for synergies but we didn’t base the information on, nor the accretion analysis on a whole lot of synergy.

Allen Rifkin - Banc of America

Did not, okay. And then I missed in your prepared remarks what you said -- you said the growth was 12% but excluding -- over five years, but excluding what, forgive me, was -- did it drop to 6% over four years?

Joseph J. Lombardi

We disclosed the five-year sales growth last week so we want to just give you the five-year EBITDA growth. That is 12% but it is a little misleading because the first year of that five-year period, 2005, was an unusually strong growth year so we backed that out, told you that the four years was 6% and the last two, each of which was between four and five.

Allen Rifkin - Banc of America

Right, and then you said going forward, we should expect it should also be four to five. After declining a little bit from four years to two years, what is behind your belief that you can now hold the line on the growth rate?

Joseph J. Lombardi

I think one of the key things for you to think about is one of the amount of schools that are yet not operated by college bookstore operators. 65% of the market is still operated by the institutions themselves and historically college management has -- had better success in down markets as the universities are looking to offload that responsibility and cost of running that bookstore on to professional operators who can manage the store more profitably and with more experience.

So generally speaking, we think the new business contracts are a real opportunity and there’s about 2,000 institutions in the country still yet managing their own bookstores.

Allen Rifkin - Banc of America

Okay, well, thank you.

Operator

We have no further questions. I will turn the conference over to Joseph Lombardi for additional closing remarks.

Joseph J. Lombardi

Sure. Thank you for listening to the second quarter conference call. Please note that our next scheduled financial release will be our third quarter earnings release on or about November 19th. We also anticipate issuing a release upon closing the transaction to acquire Barnes & Noble College booksellers on or about October 1st. Thank you.

Operator

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

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