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Barnes & Noble, Inc. (NYSE:BKS)

F3Q07 Earnings Call

November 20, 2007 10:00 am ET

Executives

Joseph Lombardi - CFO

Steve Riggio - CEO

Analysts

Aaron for Charles Grom – JP Morgan

Bill Armstrong - CL King

Deron Kennedy - Goldman Sachs

Dave Weiner - Deutsche Bank

Operator

Good day and welcome to the Barnes & Noble third quarter2007 earnings results conference call. Today's call is being recorded. At thistime for opening remarks and introductions, I would like to turn the call overto the Chief Financial Officer, Mr. Joseph Lombardi. Please go ahead, sir.

Joseph Lombardi

Good morning and welcome to Barnes & Noble's thirdquarter 2007 conference call. Joining us today are Steve Riggio, MitchellKlipper, Marie Toulantis and other members of the senior management team.

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

This morning before the market opened we released ourresults for the third quarter ended November 3, 2007. Consolidated sales totaled $1.176 billion for the quarter,a 5.7% increase over last year. Sales at Barnes & Noble stores were $1.015billion for the quarter, up 4.5% over a year ago. Comparable store salesincreased 2.6% for the quarter, which was at the high end of guidance for aflat to low single-digit increase.

In the third quarter, we opened 14 Barnes & Noble storesand closed three for a quarter end total store count of 709. We closed two moreB. Dalton stores in the second – I mean, third quarter resulting in a total B.Dalton store count of 92.

Sales at BarnesandNoble.com were $108 million for thequarter, a 14.5% comparable sales increase compared with the prior year period.Third quarter net earnings were $0.07 per share.

The company's results include an after-tax benefit of $6.2million, or $0.09 per share, resulting from a more favorable physical inventoryshortage rate than previously estimated and accrued. Excluding this benefit,third quarter net loss per share was $1.8 million, or $0.03 per share, betterthan guidance for a loss of $0.06 to $0.10 per share.

As a result of the physical inventory benefit, gross marginswere 30.2% or 40 basis points higher then last year. The previously mentionedinventory benefit was $10.3 million on a pre-tax basis. Excluding this benefit,gross margins were 29.3%, or 50 basis points lower then last year. Our guidancefor the year reflected a 90 to 100 basis point reduction in gross margins dueto the rollout of our new membership discount structure a year ago.

Despite the higher sales of discounted bestsellers thisquarter, our gross margins were better than guidance primarily due to twofactors:

  1. Our distribution costs were lower than planned;
  2. Our comp store sales gains enabled us to leverage fixed occupancy costs.

Our selling and administrative expenses were favorable tolast year by 30 basis points as a result of sales leveraging. Operatingearnings were 0.4% for the quarter. After adjusting for the inventory benefit,operating losses as a percent of sales was flat with a year ago at negative0.5%.

At quarter end, the company's balance sheet and financialcondition remain in excellent shape. Inventories increased less then 2%compared with last year with 5% more sales on a year-to-date basis. The companyhas $4.4 million of debt, net of cash on hand. Seasonal borrowings peaked at$38 million in early November.

In the third quarter of 2007, the company acquired 4.9million shares under its share repurchase program for $172.5 million at anaverage price of $35.36. Year-to-date, the company has acquired 6 millionshares for $220 million at an average price of $36.50. The company has $232.4million remaining under its existing share repurchase authorization.

Capital expenditures were $58.2 million for the quarter and$140.3 million year-to-date.

Now for fourth quarter and full year guidance. For thefourth quarter and full year, the company expects comparable store sales atBarnes & Noble stores to increase in the low single-digits. The companypreviously expected full year comparable store sales to range from flat toslightly positive.

Fourth quarter earnings per share is expected to be in therange of $1.67 to $1.86. The company is increasing its full year earningsguidance to be in the range of $1.91 to $2.09, compared with previous guidanceof $1.69 to $1.87.

Guidance has been raised $0.22 per share for three reasons:

  1. The third quarter out performance of $0.14 per share;
  2. The reduced fully diluted share count as a result of third quarter share repurchases, which will benefit the year $0.04 per share;
  3. Improved net earnings from higher projected fourth quarter sales guidance of $0.04 per share.

The weighted average fully diluted share count forecastedfor the fourth quarter is 64.3 million shares and the weighted average fullydiluted share count forecasted for the full year is 67.1 million shares.

In addition, full year capital expenditures are nowforecasted to be about $10 million lower then previously announced. Updatedcapital expenditures guidance for fiscal 2007 is now $190 million to $200million.

Now I would like to turn the discussion over to our ChiefExecutive Officer Steve Riggio.

Steve Riggio

Good morning. We are pleased with our third quarter results,especially in light of the comparatively soft retail environment. Ourcomparable store sales grew 2.6%, and that was on top of a 2% growth in thethird quarter of 2006. Our Internet sales grew 14.5%, compared to slightlynegative sales in the third quarter of 2006.

I think there are three factors we want to point to thatwere behind the numbers. First and most importantly is the effect of media onthe book industry and on the sales of individual titles. Following the enormouspublicity generated by JK Rowling's HarryPotter and the Deathly Hallows, we were frankly prepared for the bookbusiness to return to a relatively quiet period.

While we did believe it would be a good quarter for newreleases, one can never bank on extensive media coverage of writers and theirbooks. It's just a hard thing to predict. We were pleasantly surprised when thethird quarter opened quite strong with the release of Stephanie Meyer's Eclipse, which became the fastest-sellingteen novel in our history. The Stephanie Meyer phenomenon was covered extensivelyin the media and the anticipation for the next August release of the finalvolume in her series actually started building the day that Eclipse went on sale. So that wasterrific news.

Indeed, media coverage of adult books was more extensivethen typical, led by two shows, the CBS news magazine 60 Minutes and Oprah Winfrey.60 Minutes featured stories of AlanGreenspan's The Age of Turbulence,Clarence Thomas' My Grandfather's Son andJoel Osteen's Become a Better You,and Valerie Plame Wilson's Fair Game shotthose books onto the top of our bestseller list. We see the impact immediatelyin our Internet sales and in the days following after these stories run.

The Oprah effect-- which of course, everyone in the industry knows about -- I think was strongerthen typical and it was probably due to the sheer number of books that shementioned on her shows, not just the selections from her Oprah Book Club.

The phenomenal demand for Jessica Seinfeld's Deceptively Delicious Cookbook was apleasant surprise, as was Oprah's support of Elizabeth Gilbert's Eat, Pray, Love; her full hour show on CathyBlack's Basic Black; and her coverageof Michael Roizen's YOU: Staying Young.Of course, her book club selections are still the most powerful and trustedendorsement in the business, even sending classics such as Gabriel García Márquez’s Love in the Time of Cholera to the top of bestseller lists.

In terms of other media, we also saw the growing impact ofshows like Jon Stewart and Stephen Colbert, with the latterproducing one of the major bestsellers of this year, I Am America (And So Can You!).

The second factor, it was a particularly good quarter fornew releases for brand name fiction writers and those included John Grisham,David Baldacci, Patricia Cornwell, James Patterson and the return of KenFollett with his World Without End.

Lastly, the third quarter saw the launch of our new websitewhich impacted Internet sales. Utilizing the latest web technologies, our newsite enables more and better and faster browsing. It features an updated designand we think it makes it feel, more than ever, like a natural home, just as ourbookstores do. We've increased the amount of rich media on the site, includingpodcasts, original video programming, live webcasts and that gives users anopportunity to become more intimate with books and writers. We launched our new site with an extensiveemail towards the end of the quarter and that generated a great deal ofinterest, accolades from our customers and the resulting traffic.

The strength of the new release schedule, the attention ofthe attendant media did enable us to deliver sales at the higher end of ourexpectations and we did that without ramping up promotional coupons ordiscounts. We did about the same amount of activity as in the prior year.

Our member base, Barnes & Noble members who pay a $25annual fee to get extensive discounts in our stores, continued to grow throughthe year as more and more customers see the value in being members.

As we look ahead to the fourth quarter and the holidayseason, on a negative note, I think the writers' strike is certainly not goodnews for the book business, as we are already hearing of cancellations ofwriters that were scheduled to be on some of the major talk shows. Nevertheless,several books by brand name writers with new and forthcoming titles includingSue Grafton, Jim Cramer, Steve Martin and Dean Ornish. There's a very, verystrong lineup of gift books for this year.

As in previous times, we expect a film version of MitchAlbom's For One More Day, which airsI believe on December 9 to be perfectly timed for the holiday season, as thatwill be a great gift book.

Thank you.

Joseph Lombardi

Now we would like to turn it over to questions.

Question-and-AnswerSession

Operator

Your first question comes from Charles Grom – JP Morgan.

Aaron for Charles Grom – JP Morgan

Congratulations on a good quarter. As we head into theholidays, several retailers have called out toys as an underperformingcategory. Are you guys seeing any signs that some of that share might beshifting into the book channel as we head into the fourth quarter?

Steve Riggio

We've had a pretty solid business in the adult gamebusiness, classic board games and the like. That has grown pretty steadily overthe last few years, but we're not particularly in the children's toy businessso we don't see anything there.

Aaron for Charles Grom – JP Morgan

But do you see a shift towards board games or maybeadditional share headed into the channel for children's books, things alongthose lines?

Steve Riggio

I don't think I wouldcorrelate that. I would hope that parents buy books for their kids instead oftoys. Children's book sales have been fairly healthy for some time, but I don'tsee a direct relationship between those. Maybe we'll know in January.

Aaron for Charles Grom – JP Morgan

A question on the competitive front. Qualitatively it seemsthat there may be a little more promotion from one of your competitors in thethird quarter and headed into the fourth quarter then last year. Are you guysseeing any changes?

Steve Riggio

Seeing changes where?

Aaron for Charles Grom – JP Morgan

In the competitive environment?

Steve Riggio

I think it's fairly obvious that the amount of special offersand coupons out there have been ramped up in the marketplace, but we've kept itpretty much to the same as prior year. We are satisfied with our performancebased upon that.

Aaron for Charles Grom – JP Morgan

We shouldn't think about that strategy headed into thefourth quarter as well?

Steve Riggio

No. I mean, we're always looking at it, it is alwayssomething we study but coupons are the kind of thing that you can ramp up veryeasily, but when you turn them off you have pretty ugly comparisons you'refacing in the following year.

We think our strategy is pretty sound. We give everydaydiscounts. We do have promotional coupons going out through the year on top ofit. We think we're in a pretty good place.

Operator

Your next question comes from Bill Armstrong - CL King andAssociates.

Bill Armstrong - CL King

Joe, why is CapEx down $10 million from your previous plan?

Joseph Lombardi

We had some projects, particularly IT projects, that won'tget completed this year and are moving so we're just going to take the numberdown in '07.

Bill Armstrong - CL King

They're not going to becancelled they are just getting pushed out to next year?

Joseph Lombardi

Basically, yes.

Bill Armstrong - CL King

On Q4, it looks like your comps guidance is a little higher.Is that just looking at Q3 trends and extrapolating them out to Q4, or arethere specific titles or other trends that you see that cause you to be moreoptimistic?

Joseph Lombardi

I think our guidance is based upon what we see, what wethink is happening in the trend line.

Bill Armstrong - CL King

Are we seeing maybe the beginning of a turnaround after acouple of years of pretty soft overall industry book sales?

Steve Riggio

I think the bookbusiness, if I had to use a word to describe it would be more like “stable”.It's never really had major declines or actually any unit decline in the pastseveral years. It's low single-digit growth; it's not double-digit growth noris it double-digit decline.

I think that the media effect on the third quarter wasprobably more pronounced then we've seen in a long time. We do hope thewriters' strike gets settled so we can get authors and books back on the talkshows. If that's not settled, I think that may impact the sales of some of the media-sensitivebooks.

Of course, going into the first quarter of next year -- wehaven't seen it yet -- but we would expect that the Presidential election andit's effect on book sales hopefully will be the same as it was the last timearound, which was positive.

Bill Armstrong - CL King

Given that the third quarter was driven at least in part bythe media plugging some titles, if we don't see a repeat of that at that levelin Q4, does that put your comps guidance at risk?

Joseph Lombardi

We're very comfortable with our comp guidance and we'recomping off the slightly negative number last year in the fourth quarter, sothe comparison is easier as well.

Bill Armstrong - CL King

Finally on your Q3 gross margins coming in above plan, it lookslike you were able to leverage some of the fixed components of the cost ofgoods sold line. Was there any movement either in the mix or margins withincategories that helped?

Joseph Lombardi

No, the margins were pretty predictable and on plan. I thinkwhat we're noting when we talk about why margins improved, our markdowns werealso on plan; our membership discounts as well as other promotions we hadplanned so that was not a source of any surprise.

Bill Armstrong - CL King

Should we look for the margin hit from the member discountsto pretty much anniversary by the first quarter of '08?

Joseph Lombardi

I think it's a little early to start talking about '08.We're lapping in this quarter the anniversary of the discounts so I think weneed to see. Obviously because we've grown our membership base, we have a lotmore members and therefore more member discounts. Margin is going to havepressure in the fourth quarter, it is in our plan.

We'll see when we get out of the fourth quarter and start totalk about what we think the impact is then going forward.

Operator

Your next question comes from Deron Kennedy - Goldman Sachs.

Deron Kennedy - Goldman Sachs

Can you explain again the inventory benefit? Describe whatyour typical accrual is and why it differed and what the gross margin operatingearnings were excluding it? I'm sorry if I missed that earlier in the call.

Joseph Lombardi

Sure. The company has been focusing on shrink and shortagecontrol, particularly for a number of years now and I think our effects arestarting to pay off. Our shrinkage rate has been declining and it declined to alevel that we weren't sure was sustainable. We estimated and accrued to ahigher level and as a result, we're truing up our numbers based upon theresults, as the results were more favorable than we thought they'd be.

I think the good news here is that if we sustain theimprovement, this gross margin benefit is permanent albeit obviously spreadmore proportionately throughout the year. So just good news for us and we're prettyhappy overall with the result.

Deron Kennedy - Goldman Sachs

The operating earnings margin excluding the benefit was whatyear to year?

Joseph Lombardi

Operating earnings year to year was flat; as a percent ofsales, a negative 0.5%.

Deron Kennedy - Goldman Sachs

Could you describe the pace of sales during the quarter?

Steve Riggio

Sales were up throughout the whole quarter. There's not amaterial variance from month to month.

Operator

Your next question comes from Dave Weiner - Deutsche Bank.

Dave Weiner - Deutsche Bank

Good morning. Joe, I think you might have just answered thisone but I'll ask it. I think last year on the third quarter call you gave amembership investment or program impact for the next 12 months, an effect of around$40 million. Is that pretty much what you experienced over the last 12 months?Was that in line with plan?

Steve Riggio

Actually in the third quarter call last year we had said thenumber was $30 million and we raised that, I believe, when we did our year endrelease because the membership signups were more then we anticipated -- 240. Webasically have been on plan this year and tracking to what we thought was goingto happen, and so that's been the case.

Dave Weiner - Deutsche Bank

On your consolidation of distribution center space, is thatbenefiting your gross margin on an ongoing basis as well?

Joseph Lombardi

I think certainly we're very pleased with the way thedistribution center is going. It's now handling everything for retail andonline and our goal is to continue to improve there. We're continuing to workon it. I think it's early yet to say it is benefiting gross margin, but wecertainly believe that to be the case on a go forward basis and we are workingtoward that.

Dave Weiner - Deutsche Bank

But currently it's not hurting gross margin?

Joseph Lombardi

No, correct.

Operator

At this time, we have no further questions so I would liketo turn the conference back over to the speakers for any additional or closingremarks.

Joseph Lombardi

Thank you for listening to our third quarter conferencecall. Please note that our next scheduled financial release will be our holidaysales release on or about January 10th. Thank you all.

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Source: Barnes & Noble F3Q07 (Qtr End 11/3/07) Earnings Call Transcript
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