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Barnes & Noble, Inc. (NYSE:BKS)

F2Q08 Earnings Call

August 21, 2008 10:00 am ET

Executives

Joseph J. Lombardi – Chief Financial Officer

Stephen Riggio – Vice Chairman of the Board and Chief Executive Officer

Analysts

Aaron Stein – JP Morgan

William Armstrong – C.L. King & Associates, Inc.

David Schick – Stifel Nicolaus & Company, Inc.

Operator

Welcome to the Barnes & Noble second quarter 2008 earnings conference call. (Operator Instructions) At this time for opening remarks and introductions I’d like to turn the call over to Chief Financial Officer, Joseph Lombardi.

Joseph J. Lombardi

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 second quarter ended August 2, 2008. It is important to note that our results for the quarter were impacted by the comparison against last year’s record breaking sales of Harry Potter and The Deathly Hallows. Last year in the second quarter we had a 4.4% comparable store sales increase a 17.9% comparable increase online and a total sales increase of 7.6%. This year consolidated sales totaled $1,224,000,000 for the quarter, a 1.6% decrease over last year’s 7.6% increase. Sales at Barnes & Noble stores were $1,090,000,000 for the quarter, down 1.6% over a year ago. Comparable store sales have declined 4.7% for the quarter which was in line with guidance which called for a decrease in the low to mid single digits. Excluding the impact from the Harry Potter book, comparable store sales decreased 1.5%.

In the second quarter we opened 10 Barnes & Noble stores and closed four and at quarter end total store count of 703. We closed 10 more B. Dalton stores in the quarter resulting in a total B. Dalton store count of 73. Sales at BarnesAndNoble.com were $99.8 million for the quarter a 3.6% comparable sales increase on top of last year’s 17.9% increase. Excluding the sales impact of Harry Potter last year, online sales increased 13.9% for the quarter.

Gross margins improved 150 basis points this quarter. Last year’s gross margins included sales of the highly discounted Harry Potter book. In addition, we had a benefit in the second quarter from our physical inventory shortage results which were more favorable than we previously estimated and accrued. In fact, our shortage results this year were the lowest in our company’s history. As a result, the company had an after tax benefit of $0.12 per share this quarter or a 90 basis improvement on the gross margin line.

Typically in a quarter where comparable store sales decline gross margins are pressured as we are unable to leverage occupancy costs. However, even though we had 4.7% comparable store sales decline, we were able to offset much of the planned deleveraging for two primary reasons: one, greater throughput and usage of our distribution centers; and two, reduced markdowns as a percentage of sales. Greater volume from our DCs enables us to lower our distribution costs per unit and purchase books at higher margins. In addition, as a result of certain changes to our promotional strategies, our markdowns have declined year-over-year on an apples-to-apples basis without the Harry Potter discount last year.

Selling and administrative expenses increased 40 basis points this year as a result of the negative comparable store sales. In absolute dollars, selling and administrative expenses declined year-over-year due to tight expense controls as we manage through current sales trends. The company reported net income per share of $0.27 for the quarter. Excluding the $0.12 benefit from the inventory shortage, the company reported earnings per share of $0.15 higher than the company’s guidance of $0.08 to $0.13 per share.

At quarter end the company’s balance sheet and financial condition remain in excellent shape. Inventories declined 1.9% this quarter in line with the 1.5% comparable stores decline excluding Harry Potter. The company has borrowings of $119 million at quarter end or $93 million net of cash largely as a result of the share repurchase activity in the first quarter.

Now, I’d like to talk about third quarter and full year guidance. Due to our sales being at the lower end of guidance in the second quarter as well as the overall retail sales environment, the company is lowering its full year comparable stores sales guidance from slightly negative to a decline in the low single digits. Additionally, for the third quarter, the company expects comparable stores sales to decrease in the low single digits against last year’s 2.6% increase. Although the full year sales forecast has been lowered, the company is reiterating previous earnings per share guidance to be in the range of $1.70 to $1.90. Despite the challenging retail sales climate, the company continues to expect full year results in line with previously issued guidance as a result of the margin benefits already realized and our continuing focused on controlling expenses and improving gross margins.

Full year earnings per share is based on a reduced fully diluted share count of 57.8 million shares. The third quarter net loss per share is expected to be in a range of $0.10 to $0.15 per share based upon a basic share count of 54.3 million. The company is also lowering guidance for full year capital expenditures to $210 to $220 million or $10 million less than previous guidance as certain projects have been cancelled or deferred. In terms of new stores, we are still forecasting 30 to 35 openings this year and 15 to 20 closings. Due to the reduced availability of desirable retail locations going forward we currently expect only 20 to 25 new stores opening in 2009.

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

Stephen Riggio

We’re very pleased that our second quarter results exceed both our expectations as well as last year’s performance. As Joe mentioned, strong expense controls and margin improvements were the principal elements that controlled the results. I’ll just speak briefly about each. First, one would expect some deleveraging, if not significant deleveraging with a 4.7% comp sales decline. Instead, we continue to manage the business extremely well in the trenches, in the midst of what is a very soft retail environment. Of course, this may provide some optimism for the future if sales rebound from recent trends. We’re managing the business well and of course, like all retailers we hope sales rebound.

The gross margin story is a very good one. It indeed benefited from a one-time gain and due to the lower sales of deep discounted books last year, namely Harry Potter and from continued efficiencies in the supply chain. But, I will note that the gains were also from a pull back of promotional discounting and couponing. While we do send emails out frequently, the degree of the discounting and the couponing has been declining. We found that everyday discounts offered by our member program, are strong enough incentives to keep the customers coming back in to our stores and to our website.

In fact, the closer examination of sales will reveal that even in this soft retail environment across America, the book business is stubbornly holding up. If we normalized our sales without the impact of Harry Potter and its add on sales last year, throw in the double digit decline we’re still experiencing in the music business, the rest of our business was relatively flat so as we’ve said for many years, the book business is a relatively stable business.

Our Internet sales were clearly a bright spot in the quarter with a 13.9% growth excluding the effect of Harry Potter. I will note that this is the seventh straight quarter of growth for our Internet business with double digit growth in 2007 and for the first half of 2008. Traffic to the site is up, conversions are up and we continue to enhance the site from usability as well as a content perspective. We’ve also begun to expand our content offerings to include products offered only online enabling us to leverage the eCommerce infrastructure we have built. If you look at all of the business that we transact in our stores and online, and you exclude the effect of Harry Potter, and the music business, our comp sales are actually up a freckle about .6% overall. So, all in all we’re very pleased with the results of the quarter.

The business is relatively stable is what I’d like to say. We look forward to getting through the second half of the year. We know it’s still a challenging retail environment but we believe we’re managing the business well and as Joe said, we’re managing our inventories very well. With that, we would like to turn this over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Aaron Stein – JP Morgan.

Aaron Stein – JP Morgan

I just want to make sure I understand your full year EPS guidance. The $1.70 to $1.90 does that include the $0.12 of shrink benefit in this past quarter?

Joseph J. Lombardi

Yes.

Aaron Stein – JP Morgan

Then I guess the other piece would just be the upside to the beat. So I guess it makes sense because you’re taking your sales guidance down but you’re really taking down your back half view by about $0.17? Am I reading that right?

Joseph J. Lombardi

If you look at it, we’ve taken our sales guidance down for the back half of the year. We’ve over achieved in the front half of the year but we view, obviously, a lot of the work that was done to improve the shortage results in the company is a positive and if we can keep that rate up, that’s permanent. So, we just happen to book it all at once, normally it would be spread over four quarters.

Aaron Stein – JP Morgan

In terms of the comp trend, could you give us a little more detail on maybe how the comp trended through the quarter? Then maybe specifically, with the Olympics what you’re seeing in trends today?

Joseph J. Lombardi

The comp trend for the quarter was relatively even throughout the quarter if you exclude the Harry Potter week. There was no particular pluses or minus. The Olympics were predicted to be obviously a comp store impact for us and we planned that so we’re – the business is soft. We had a comp of -4.7 and a -1.5 of that Harry and it was pretty much throughout the quarter.

Aaron Stein – JP Morgan

Then just a final question, we noticed that on your member discount there were a few best sellers that were highlighted at 50% off which is about 10% increase from your usual 40% off rate. Is that something that you guys are looking at in terms of tweaking that program? Or, is that just a pilot.

Stephen Riggio

Our member program is seven years old and we continue to experiment with a variety of different offers of different discounts at every level. So, is it typical of what we’ve been testing? Yes and we will continue to test. But, the message is that overall the amount of discounts that we give over and above the everyday discounts has been declining because we feel that we don’t need to do that. Customers are coming back by the virtue of the fact that they’re members.

Operator

Our next question comes from William Armstrong – C.L. King & Associates, Inc.

William Armstrong – C.L. King & Associates, Inc.

A couple of questions, you’re going to reduce store openings did I hear to about 20 to 25 next year?

Joseph J. Lombardi

Yes.

William Armstrong – C.L. King & Associates, Inc.

I thought you were seeing more and better real estate opportunities with the soft retail market and soft real estate market? I thought the landlords were offering better deals and more of them?

Stephen Riggio

It is true that landlords are offering better deals for many existing centers. As you can imagine we’re a very, very desirable tenant. We continue to be very selective about going in to existing centers or renovated centers but in terms of new development, the principal reason for the pull back is that many developments are being cancelled. So, the developer is not able to finance many new projects and that’s the principle result so we can’t go somewhere where there is no center. Some of those centers involved most of those decisions were ones we pulled out of where the developer pulled the plug.

William Armstrong – C.L. King & Associates, Inc.

On the shrink benefit, what was the dollar amount that was in the cost of goods sold?

Joseph J. Lombardi

It’s about $11 million pre tax.

William Armstrong – C.L. King & Associates, Inc.

Music continues, that’s down double digits. Are you seeing any developments going forward there either to my point of stabilization or perhaps on the other side, even getting worse?

Joseph J. Lombardi

I would say that the music business is declining, it’s continued declining, it’s declining double digits and we are planning and managing the business with that as the tread line.

William Armstrong – C.L. King & Associates, Inc.

Any progress in reducing the square footage devoted to music in your stores?

Stephen Riggio

Absolutely. We’ve expanded our DVD selection and that business is still holding up nicely.

William Armstrong – C.L. King & Associates, Inc.

Finally, Joe could you just repeat the average share count that you’re talking about for Q3 and for the full year please?

Joseph J. Lombardi

Absolutely. The share count for the full year is on a fully diluted basis, 57.8 million shares and the third quarter net loss which is a basic share count is 54.3 million.

Operator

Our next question comes from David Schick – Stifel Nicolaus & Company, Inc.

David Schick – Stifel Nicolaus & Company, Inc.

Could you guys just talk a little bit, I know you’ve talked in the past about experimenting, or being opened minded to technology whether it’s in the store or the changes you make to the website, or potentially eBooks and we’ve talked over the years about. Could you just bring us up to speed about what you’re thinking now that your online competitors had a product out for a number of months and just where you’re thinking about that whole marketplace and what you hear from publishers, etc., you’re point of view on those?

Stephen Riggio

I believe one analyst has put out a forecast on that, probably the first person who has done a survey of the industry to forecast what eBook sales might be based upon some assumptions that he’s made. We began selling digital magazines earlier this year on the website. We’re very encouraged by what we’re seeing there and like with all new strategic developments of any type, we will announce it on the day that we launch but we can’t really make any further comments on anything that we will be doing or might be doing, it’s just so highly strategic.

David Schick – Stifel Nicolaus & Company, Inc.

It sounds as if you’re still working on that at least at the level which you’ve said you pursue these things in the past, at least at that level, is it fair to say that?

Stephen Riggio

Yes, of course. There’s the indication that we began selling digital magazines and the fact that we’re very pleased with what we’re seeing there points to a small slice of the arena. We do not believe that eBooks is the total universe of digital products that will be sold in the marketplace. It is a subset of a much larger arena of digital content in many ways. So, we’re looking at the entire arena.

Operator

At this time we have no additional questions.

Joseph J. Lombardi

Thank you for listening to our second quarter conference call. Please note that our next scheduled financial release will be our third quarter earnings on or about November 20. Thank you.

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Source: Barnes & Noble, Inc. F2Q08 (Qtr End 08/02/08) Earnings Call Transcript
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