Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Barnes & Noble (NYSE:BKS)

Q4 2005 Earnings Conference Call

March 16, 2006, 11:00 AM

Executives

Joseph Lombardi, Chief Financial Officer

Steve Riggio, Chief Executive Officer

Analysts

Mark Rowen, Prudential

David Sheek, Stifel Nicholas

Matthew Kessler, Goldman Sachs

David McGee, SunTrust Roberts and Company

Joseph Lombardi, Chief Financial Officer

Thank you. Good morning and welcome to Barnes & Noble’s 4th Quarter and 2005 Fiscal Year-End Conference Call. Joining us today are Steve Riggio, Mitchell Klipper, Marie Toulantis, Alan Kahn, 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 and Noble.

This morning before the market opened, we released our results for the 4th quarter and full year ended January 28, 2006. Consolidated sales for Barnes & Noble increased 5% to $5.1 billion dollars for the full year. Sales at Barnes & Noble stores are up 6% to $4.4 billion. Comparable store sales increased 2.9% for the full year, at the high end of guidance for an increase in the 2-3% range. Comparable store sales in the 4th Quarter increased 3.3%. On January 5, we reported that our comparable store sales for the nine-week holiday sales period through December 31 were 2.3%; our full 4th quarter comparable store sales improved to 3.3% as a result of strong January sales.

In the 4th quarter, we opened two Barnes & Noble stores and closed four for a quarter end total store count of 681. For the full year we opened 27 stores and closed 12 for a net Barnes & Noble store count increase of 15. We are especially pleased to report that our Maderay, Louisiana store which was damaged during Hurricane Katrina re-opened on Tuesday this week. Sales at B. Dalton which now account for less than 3% of sales were down 20% for the year due to store closings. Comparable store sales at B. Dalton increased .9% for the year and increased 3.8% for the 4th quarter.

For the full year, store closing costs reduced earnings about $0.06 per share and is incorporated in the reported results. We have closed 23 more B. Dalton stores the Quarter, resulting in a total B. Dalton store count of 118. A total of 36 B. Dalton stores were closed during 2005.

Sales at barnesandnoble.com increased 5% this year to nearly $440 million dollars. Gross profit margins improved 30 basis points this year on top of last year's 50 basis point increase. We continue to maintain our focus on the basic blocking and tacking of retail supply chain management. Specifically decreasing reliance on book wholesalers, increasing purchases to our distribution network, creating promotions which drive top and bottom line growth, increasing sales of Sterling products in our stores and online, and leveraging our fixed occupancy costs due to the comparable store sales gains. Best-seller markdowns were a bit of a negative this year largely due to the six Harry Potter books, but that was somewhat offset by reduced sales of lower margin music, where we posted our first full year of negative comps down about 7%.

Our selling and administrative expense rate was 60 basis points higher, representing the sales this year. This increase primarily relates to three expenses recorded during the year; first, a 2nd quarter $6.9 million pre-tax charge related to legal expenses; second, a $12.7 million dollar pre-tax charge of $7.5 million net of tax, related to the impairment of terms to our assets; and finally, $3.6 million related to stock compensation costs associated with restricted stock. For the 4th quarter excluding the asset impairment charge, our selling and administrative expense rate was 20 basis points lower than last year due to leverage. Net earnings from continuing operations increased 19% for the year to nearly $147 million, excluding the impact from the non-cash impairment charge, net earnings increased 25% year-over-year. Earnings per share for the year were $2.03 at the high end of our previously affirmed guidance range and a 21% increase over last year. 4th quarter earnings per share were a $1.76 also at the high end of guidance, excluding the non-cash asset impairment charge. 2005 earnings per share were $2.14 representing a 27% increase over 2004.

On the balance sheet front, inventories remain in excellent shape. We continue to maintain our focus on working capital management and supply chain improvements. Our total company inventory is up about 3% on the 5% sales increase. Inventory turnover improved to 2.4 four-times in each of the last three years. We have improved our turn rate at about 1/10 per year while maintaining our leadership position with the largest selection of books available and on hand for immediate delivery. As reported in our press release, our operating free cash flow for the year was a record $362 million. The company had its second year in a row of working capital improvement added about $115 million dollars to cash flows. Gross capital expenditures for 2005 were $187 million, slightly lower than guidance of $190 million.

We began the year with $536 million dollars in cash at the end of the year after pre-paying in full the $245 million dollar term loan, acquiring $7.7 million v-cash shares for $283 million dollars under our share re-purchase program and also paying $20 million dollars in dividends we are left with $373 million dollars in cash and no debt. In the 1st quarter of 2006, the company acquired an additional 1.6 million shares for $68 million dollars under a share re-purchase program at an average price of $42.56.

And now for guidance for 2006. Our sales guidance for the 1st quarter and full year is for a low single digit comparable store sales increase. The company will adopt Statement of Financial Accounting Standards No. 123 (NYSE:R) in the 1st Quarter of 2006 and begin expensing stock options. As a result we have provided earnings per share guidance with and without charges associated with stock compensation expense. We did have these expenses in 2005 but only for expenses associated with restricted stock which amounted to $0.03 per share. The company expects earnings per share for the 1st Quarter between $0.10 and $0.14 based upon a diluted share count of 70.3 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 $0.14 and $0.18 against last year’s $0.13. For the Full-Year, the company expects earnings to be in the range of $2.20 to $2.30 per share based upon a diluted share count of 71 million. Our full year results include a $0.15 impact related to stock compensation expenses. Excluding this impact, the company is forecasting a 2006 full year earnings per share range of $2.35 to $2.45 against $2.06 last year which represents a 14-19% increase.

I noted in our release and our guidance for 2005 that we would incur additional charges associated with the conversion plans for our new distribution terms. We guided that we expected costs for 2005 of $0.08 per share and it came in slightly higher at $0.09 per share solely due to the reduced share count related to the share re-purchase program. We are forecasting and guiding another $0.09 for 2006 in line with our previous comments and which is included in guidance. The conversion and all related charges are expected to be completed by the end 2006. We are also forecasting operating free cash flow of about $200 million dollars next year and gross capital expenditures of between $190-200 million. We expect to open 30-40 stores this year and close 15-20. At this point, I’d like to turn the discussion over to our Chief Executive Officer, Steve Riggio.

Steve Riggio, Chief Executive Officer

Good morning, we entered the 4th quarter well aware that no blockbuster book titles were going to emerge. Instead it was a season characterized by a solid list of new releases across many categories. Top non-fiction titles included Doris Kearns Goodwin’s Team of Rivals, Jimmy Carter’s Our Endangered Values, John Grogan’s Delightful Marley and Me, and Thomas Freidman’s The World is Flat. It was a season marked by a number of great gift books with the stand out being Silver Spoon, “The Bible of Italian Cooking”. While no single fiction title approached the prior year’s success of Mitch Albom’s The Five People You Meet in Heaven, books by well-known brand name writer’s such as James Patterson, Anne Rice, David Galbachi, and Nicholas Sparks performed well. The key to take away here is that 2005 was the second year in a row that we did not have any adults where our covered category of major blockbuster book. Someone said that there are slow industry growth dynamics behind the book business. We submit that the circumstances behind our performance underscored the stability of the industry and the resilience of our industry and of course the soundness of our strategy which emphasizes that selection of backless titles.

Sales growth for children’s books were strong throughout the year and that growth continued into the 4th quarter. This segment of our business is growing across the board. Baby and toddler business is being fueled by the post-9/11 baby boom, picture book sales are healthy and the teen market is growing at a target pace. Who says kids don’t read any more due to competition from internet and video games. While sales of music, as Joe said, were under last year, I will add that our channel checks indicate that we outperform the industry and we attribute that to our focus on the adult music consumer. We believe the soundness of our multi-channel strategy becomes clearer every year as our customers increasing refer and browse website before making a visit to our stores, and an increasing body of market research validate this belief. According to the most recent study by I Prospect Jupiter done in February, 2006, listen to these numbers, 47% of respondents who researched the product online then bought the product offline. Merchant websites edged out search engines as the destination of choice when conducting product research. We further submit that investors should recognize the tremendous advertising power of the impressions generated by the traffic to our website. If we were to go into the web advertising marketplace and secure an equal number of impressions from deals from search engines, portals, and the like, the value of an equal amount of exposure would be in the 10s upon 10s of millions of dollars.

Barnesandnoble.com not only serves as our direct to home delivery service but it’s a broadcast channel in advertising medium for our brand and we firmly believe that our website is a key factor behind the buoyancy and behind the consistency of our comparable store sales. As Joe mentioned, we opened 27 new stores for the year which included several that we classify as upgrades; the movement of an existing store to a larger and superior location in the immediate vicinity. We find that these stores provide the single greatest return on our investments of anything we do. It’s because we know the community, we’ve got a well trained staff of booksellers, and a solid sales base of empirical data on local sales trends. The other major element of capital expenditures for 2005 was the completion of our new distribution center. This state of the art facility is a great leap forward for us and it will enable us to handle fulfillment for our stores and internet customers in a much more efficient manner and give us more capacity.

Looking at the balance of the 1st quarter, we have a flurry of new releases coming later this month and after April. During the week of March 23, Game of Shadows the new book about Barry Bonds and his steroid sentence handbook goes on sale. Dan Brown’s The Da Vinci Code that’s currently our best selling hardcover fiction book three years after publication, but the trade paperback in mass market editions at lower prices of course will be on sale March 28 and of course the movie is coming up in May. Two new cookbooks by mega best selling celebrity chefs, Rachel Ray and Giaga DiLorenta is due in April which we expect to do very well and in late April we will see the publication of at least two books on the Lost Gospel of Judus and there’s quite a bit of media going to be surrounding that.

In summary we think 2005 was a great year for the company, it was also the first full year that we operated it as a simpler company following the spin-off of gamestop and the acquisition of barnesandnoble.com earlier. This simplicity enables our own organization to be more focused as well as providing greater clarity in our financial statements for our investors. We expect 2006 to be another year of growth with 30-40 new stores and further strengthening of our multi-channel strategy. Thank you.

Joseph Lombardi

At this point we would like to turn the call over for questions.

Question-and-Answer Session

Operator

Our first question is coming from Mark Rowen, from Prudential

Mark Rowen

Thanks, good morning, and congratulations on a nice quarter. Joe, I have a couple of questions; the first, when I look at your growth rate that you are biding for 2006 and you adjust for stock options you are saying 14-19% growth in EPS and then when you adjust for some of the other one time charges it is even higher in the 20s some percent range and what I am trying to understand is you guys have low single digit comps, which means you probably don’t get a lot of leverage, you know you are probably like mid-single digit square footage growth, I am trying to understand where all the leverage is coming from to get to that kind of growth is that all share buy backs and on the share count did you say $71 million was your estimate for full year 2006?

Joseph Lombardi

Yes

Mark Rowen

And with all the share buy backs that you are doing and your share count was lower at the end of this year, how is that possible?

Joseph Lombardi

We do not anticipate further share re-purchasing in our guidance and we also anticipate a reasonable level of our stock option exercises by our employees which we expect that is factored into our guidance. So our guidance today reflects what we believe the numbers will be we are not assuming any share re-purchasing in the future and as far as the earnings goes, obviously the growth is for low-single digit sales comps and the earnings growth associated with that and also we have an upside obviously on the interest line with the cash flow story here as well as reduced appreciation as many of the stores that we have are fully cycled through some of their investments and obviously margin is picking up as well.

Mark Rowen

So would you expect your operating margin to grow at that same level as what you are guiding EPS to grow?

Joseph Lombardi

Operating margin probably will go up a little bit less than EPS.

Mark Rowen

So where, I mean other than the depreciation is less where is all of the leverage coming from if your comps are only going to be low-single digits?

Joseph Lombardi

We generally say we comp at leverage of 2% so low-single digits from 1-3. That’s where we think we are at.

Mark Rowen

And are you expecting significant increases then or in gross margin or a significant decrease in SG&A expense compared to last year?

Joseph Lombardi

I think we should cycle against SG&A fine, there should be a tick of improvement there and I think on terms of margins we are certainly looking to keep adding ticks to the ticks we’ve already added and it’s all down the line that will improve the profitability.

Mark Rowen

Second question, you had a nice increase in gross margin year-over-year in the 4th quarter about 40 basis points and how much of that is related to self publishing and if not can you give us an update on what’s going on with the self-publishing initiative?

Joseph Lombardi

I think our gross margins is a sum of so many things that elements to add those types of improvement, we certainly don’t have to make what piece of that is just throwing publishing or self-publishing. But, we are very happy with what we’ve done with the self-publish product and Sterling in particular had a terrific 4th quarter in our stores and we continue to push.

Steve Riggio

It’s a pretty broad based publishing company we are not hit oriented. We publish about 4,000 titles with close to 600-700 new ones a year so there are not stand outs there it is just constant execution and better representation of those books in our stores and now that we have the, owned the company for three years we are learning a lot more about how to better execute on that front.

Mark Rowen

Can you give us an update on percentage of book store sales that are self-published now?

Joseph Lombardi

No, we are not going to do that any more, but it’s doing fine according to our plan goals.

Operator

Our next question will come from David Sheek, Stifel Nicholas

David Sheek

Hi good morning. Two questions; if you could take us through the multi-years (inaudible) now that we are moving through the (inaudible) process on just re-update us I guess on both the Sterling initiative, I know you said your not going to give up the quarter-by-quarter update, but just talk about the five-year goal what do you expect to see out of that move and then also the distribution facilities that would be the first thing. Secondly, Steve, you talked about children’s and some of the other categories that did well during the year, can you talk a little more specifically about what accelerated from the last sales update that we had as we must of seen the sale pro-ration the end of January.

Steve Riggio

Regarding the distribution center, it is a larger and obviously more state-of-the-art facility which will enable us to handle more capacity, turn around books a lot faster to our stores, increase our fill rates to our stores and our internet customers. As you may know, we exist in a very fragmented industry we deal with probably 10,000 different vendors so this is a great leap forward to us and we don’t expect in any one single year there to be significant gains in any expenses or margins but it is just something that we need to do because of the unique circumstances of our vendor base.

Regarding Sterling, it is a broad based general trade book publisher and we are not investing in intellectual properties that have a lot of high risk associated with them. We are very pleased with the development of the titles we are leaders in many categories including crafts, how-to woodworking, astrology, puzzles and games, and wines and spirits and in most of those categories we are the number one publisher. So it is good for us to own. The primary reason we bought it was to increase our sales and increase our margins by having more exciting books priced right and of course because we own the company the margins flow through to us. I think that is about it.

Joseph Lombardi

Does that cover you David?

David Sheek

Yes, I mean if you could talk broadly about what that might do to margins over again I am not trying to think of any Quarter or even a year but over say five years where might we see it?

Steve Riggio

Well let’s look at the company’s margins. As you recall, when we introduced our member program over four year ago we took a fairly substantial margin hit. The margin pressures associated with the launch of such a program were very, very significant in the first couple of year, but as you’ve seen through the years, our margins have come back and it’s grown in each successive year. We do not point to any one element that is driving those margin increases it’s a little bit about our purchasing more directly from publishers; it’s a little bit of publishing. In the retail business it’s shrink, it is management of inventories, and that’s the story on margin, it is little bits of very, very solid execution. We don’t want to commit to any number going out over the five years these numbers are 10ths of percentages and but we are very focused on them and I think you can see in the results over the last two years that we are pretty good a delivering them.

David Sheek

So when we look back at your history and we see where it would be, I don’t mean to put words in your mouth, but if it is ok so that’s a way to think about where you might be thinking over a long-term margins could end up. Where they’ve been prior to similar to what you just talked about.

Joseph Lombardi

Yes, I think Steve’s commentary about 10ths is how we think of it.

David Sheek

So then the second question was if you could talk more specifically about the difference between pre-holiday and then January, was it gift cards and how did that float your work?

Steve Riggio

The January season has I guess in the last three or four years become more solid for us in terms of the weeks immediately after Christmas. Part of that is due to very good merchandising on our part obviously the gift card phenomenon has fueled some of that, that may tend to take off over time but that is probably the two reasons why we are seeing more buoyancy in January.

The publishers have jumped on this fitness thing more so every year too. Interesting we did not see a major book emerge this year as we did see in prior years such as the South Beach Diet, but it was quite a bit of what we call New Year, New You Publishing and we did a great with that in the stores and on our website.

Operator

Next from Goldman Sachs we’ll hear from Matthew Kessler.

Matthew Kessler

Thanks a lot good morning. I’ve got a couple of questions most of them revolve around financial issues. First of all, just to clarify on your guidance I have a slightly different take; I guess you guided x-options to 14-19% growth is that correct?

Joseph Lombardi

That’s correct.

Matthew Kessler

And that included, if you will, charges in the year ago numbers that if you command us back it would look like to me at least that the growth your guiding to is somewhat lower than 14-19% if you use that somewhat higher base.

Joseph Lombardi

Depending on what you add back, yes that is true.

Matthew Kessler

If you add back the financing cost, legal settlement, and then the asset impairment charges. The second question I have, Joe, if you could just touch on the asset impairment charges kind of give us a sense of where they came from and whether you had or plan to have similar charges in prior or future periods.

Joseph Lombardi

I guess I would say we are required to review the cash flow generated by our stores comparing it to the carrying value of the store’s assets every year in addition with the accounting change last year it is no longer classified (inaudible) allowances against Cap X. The test for the store cash flow coverage is more difficult than it’s ever been. The charge we took relates to some B. Dalton stores and a handful of Barnes & Noble stores and it’s an appropriate charge. You can expect a charge of this size always absolutely not but there is always little charges. Our P&L has store closing costs every year in the 5-6% range and that is just in our numbers.

Matthew Kessler

So this is in addition to that?

Joseph Lombardi

Yes.

Matthew Kessler

And my final question, just as I try to get kind of granular with your sales numbers you give us very specific number kind of to the $100,000 level for B. Dalton as well as essentially for the internet business the number for bn.com or rather for Barnes & Noble is sort of rounded and as we look at the components of your sales I would imagine that the Sterling number is sort of in addition to that, do you have a precise a little more precise number for the Barnes & Noble’s stores?

Joseph Lombardi

Yes, $4 billion and 357.

Matthew Kessler

And for the Quarter please?

Joseph Lombardi

$1 billion 438.

Matthew Kessler

And the remainder is kind of Sterling and related?

Joseph Lombardi

And calendar club.

Operator

Our next question will come from David McGee, SunTrust Roberts and Company

David McGee

Hi good morning, good Quarter. A couple of questions, one your total assets impairment charges is that, so I understand, is that on the $0.10 this year versus $0.05-0.06 last year?

Joseph Lombardi

No, it’s $0.09 this year versus $0.00.

David McGee

And when you do the closing up of the stores to be closed in the quarter are those results for those stores included in the overall numbers?

Steve Riggio

Yes.

David McGee

So the 4th Quarter does include those stores.

Steve Riggio

Yes, always does.

David McGee

And then the account table in terms of inventories the distributors to cash flow in the last couple of years, can you or do you us behind that and do you see a further upside of that metric?

Joseph Lombardi

I certainly wouldn’t guide you to further upside, I think some of this has to do with timing and buying things more timely and kind of managing the supply chain as tightly and as well as we can it really is just a part of the day-to-day management of inventory buying.

David McGee

Would your new (inaudible) help in that regard?

Joseph Lombardi

Certainly.

Operator

And at this time there appears to be no further questions in the queue. I’d like to turn the call back over to the speaker.

Joseph Lombardi

Thank you for listening to our 2005 year-end conference call, please note that our next scheduled financial release will be our 1st quarter release on or about May 18. Thank you.

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Barnes & Noble Q4 2005 Earnings Conference Call Transcript (BKS)
This Transcript
All Transcripts