Barnes & Noble's (BKS) CEO Mike Huseby on Q4 2015 Results - Earnings Call Transcript

Barnes & Noble Inc. (NYSE:BKS) Q4 2015 Results Earnings Conference Call June 25, 2015 10:00 AM ET

Executives

Andy Milevoj - VP, Investor Relations

Mike Huseby - CEO

Allen Lindstrom - CFO

Max Roberts - CEO of College

Analysts

Alex Fuhrman - Craig-Hallum Capital Group

John Tinker - Maxim

Rick Schottenfeld - Schottenfeld Group

Operator

Good day and welcome to this Barnes & Noble Fourth Quarter and Yearend 2015 Earnings 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 Vice President of Investor Relations, Mr. Andy Milevoj. Please go ahead, sir.

Andy Milevoj

Good morning, and welcome to Barnes & Noble's fiscal 2015 yearend earnings conference call. Joining us today are Michael Huseby, CEO of Barnes & Noble, Inc.; Max Roberts, CEO of College; and Allen Lindstrom, CFO; as well as other members of our Senior Management Team.

Before we begin, I would like to remind you that this call is covered by the Safe Harbor disclaimer contained in our press release and 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.

During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties, including those contained in our press release. The company disclaims any obligation to update any forward-looking statements that may be discussed during the call.

At this time, I'll turn it over to Mike Huseby.

Mike Huseby

Thanks, Andy and good morning, everyone.

The company is successfully implementing its strategic and operating initiatives that improve the annual performance of each of our business units as reflected by our 30% consolidated EBITDA increase. Also we ended 2015 with an improved balance sheet, leaving us well positioned to move forward to focus on operating each of our businesses.

Our acquisition of the Microsoft and Pearson interests and of Media, which was the entity that held both the College and NOOK consumer assets was an important positioning step that we took in fiscal 2015. That's enabling us to combine the retail and NOOK business, which both serve a common consumer book market.

By regaining a 100% ownership interest of our College business, we're able to form Barnes & Noble Education and take the steps necessary, which are proceeding at full pace to separate our education business so that it can soon become a separate public company.

The NOOK media transaction combined with the extinguishment of the note related to the College acquisition also contributed to strong balance sheet, given the preferred interest previously held by our former NOOK Media Partners.

Additionally, as part of the separation and as announced in our press release this morning, we expect that I will be named Executive Chairman of Barnes & Noble Education when the pending spin-off becomes effective.

At this time, we will have no further comment on Management or Board matters related to the spin-off. We will provide updates as soon as we can and expected amendments to the S1 filing that we have pending in the registration process.

Now let's review our businesses. At retail we implemented merchandizing initiatives, which drove traffic and sales to our book stores and grew core comparable store sales 0.5% for the year. Barnes & Noble continues to be a destination for customers who want an opportunity to browse and discover the tremendous depth and breadth of our content offered in our stores.

Our merchants have done a masterful job in making books even easier to discover and to buy. Beyond books, our toys and games and gift merchants continue to curate and impressive selection of products that appeal to our customer base as reflected in the growth of these departments, which continue to outperform other categories. Toys and games in particular grew 16% on top of the 12% increase of a year ago.

We're always seeking and finding new opportunities to engage with our customers and reinforce Barnes & Noble as a unique destination. Last summer we launched our Get Pop-Cultured with Barnes & Noble campaign, which celebrated various pop culture icons.

These events occurred over a three-week period and drove traffic to our stores. We're hosting the second annual Get Pop-Cultured campaign this summer and can't wait to see the response to our events including Minions fund that celebrates this summer Minions' movie.

Throwback Thursday, which celebrate the decades from the 50s to the 90s and other events like Fandrill Friday and Vinyl Day celebrating the resurgence of Vinyl records and the broad assortment that Barnes & Noble offers.

As we look out to the fiscal 2016 publishing list, we're very excited about a number of books across all geometries. The literary world is anxiously awaiting the publication of Harper Lee's, Go Set a Watchman. This rediscovered work, which was initially submitted to Ms. Lee's publishers before To Kill a Mockingbird and was assumed to be lost features the same characters from that book some 20 years later.

We're also very excited about another recently discovered manuscript that will delight an entirely new generation of readers, What pet should I get? It's a first original Dr. Seuss' book since 1990 and includes a very -- it's very own full text -- his very own, excuse me, full text and illustrations.

Also E. L. James surprised all of her fans and book sellers too by announcing her new book Grey, which is a follow-up to her 50 Shade series via Instagram, just two and half weeks ahead of its publication date. All of these books present great opportunities to engage with our customers.

We're also hosting special Get Pop-Cultured events next month celebrating the release of Harper Lee's and Dr. Seuss' books. We're thrilled to have E. L. James launch her new book Grey with an exclusive New York book signing at Barnes & Noble that drew a huge crowd.

Additionally, we're focused on connecting with our customers beyond the book store. I am pleased to announce that we're launching our improved BN.com website next week, which has better search capabilities and improved user experience and is expected to increase sales and yield cost savings.

We expect the website to be a valuable resource for customers whether they choose to have their orders shipped to home or made available for in-store pick up.

Turning to NOOK, NOOK's EBITDA loss declined 60% to $86 million as a result of the strategic shifts we've implemented such as our Samsung partnership to produce NOOK co-branded devices and also steps we continue to focus on to both rationalize NOOK's cost structure while also integrating its valuable content offering with our retail business.

The benefits of NOOK's strategic shift from hardware to content focused activities as reflected throughout our financials including improved margins and lower expenses as content becomes a focus of the NOOK sales mix.

Combining NOOK with our retail business will give us all of these benefits and most importantly, the ability to provide Barnes & Noble customers any book, anytime, anywhere, in any format that they choose.

As I mentioned earlier, the acquisition of Microsoft and Pearson's interest in NOOK Media was a significant accomplishment for the company and provided us with several benefits.

First it gave us back ownership and operating control of these assets and the flexibility to combine the NOOK consumer business with retail where there is significant consumer market overlap. Second, this combination provides the opportunity for more efficient and integrated management and operation of the physical and digital book businesses, which should benefit both the top and bottom lines.

With the upcoming launch of our new BN.com eCommerce platform, we can now take advantage of opportunities to streamline and consolidate systems and processes that are common to BN.com and NOOK.

Also the termination of the Microsoft commercial agreement as part of NOOK Media transaction has eliminated our obligations to expand internationally. We are continuing to evaluate our options with respect to our existing international customer base.

While Microsoft did provide funding for that expansion prior to termination of our agreement with them, we jointly concluded that the potential benefits of that agreement did not justify its continuation.

Turning to College; College also had a very successful year with new contract growth increasing at an accelerating rate. In fiscal 2015, College opened 48 new stores under 19 contracts whose estimated first year annual sales are $90 million compared with the opening of 30 stores under 19 contracts with first year annual sales of $52 million year ago.

In addition, as of June 18, 2015, College has been awarded 14 contracts whose estimated first year annual sales are $48 million, which will be opened during fiscal year '16. Total College sales increased 1.4% as compared to a year ago and would have increased 2.3% for the year excluding the comparison to the additional week last year.

In addition to the new store growth, College sales benefited from improving comparable store sales trends, which increased 0.1% for the year. Comparable sales improved on a higher general merchandize sales somewhat offset by the increase in lower price rentals.

As outlined in Barnes & Noble Education’s S1 filings, we believe that there is a long term growth trend in the College business and we're making the appropriate investments to support both the growth in new business and our digital platform.

The investments that we have made in platforms such as faculty and light, our book stores websites and registration integration have enabled College to become a tremendous resource for the schools we serve beyond the book store. We believe our College business is a platform for growth and that separating our education business will substantially enhance its prospects for success.

The vast majority of our faculty use faculty and light. This platform enables faculty members to use our portal to discover textbooks and digital course materials for their courses and form their decisions on information provided and shared by their peers and even seek low cost alternatives or customized options to reduce course material costs for students.

Through registration integration we are tied directly into the school’s education platform, which enables students to acquire the course materials necessary for the class they just registered as soon as they're registered for their class.

And our recent investment in flash notes appeared at peer market place for students to sell and buy student created course-specific study materials and tutorials provides our schools with tools to help improve academic outcomes.

Through these offerings and others, Barnes & Noble College offers a robust suite of technology-enabled solutions for students and faculty that help propel successful student outcomes.

In summary, we're very pleased with the progress that the entire organization has made over the past two years.

It has put us in a position to separate the consumer and higher education businesses. The spin-off of Barnes & Noble Education from Barnes & Noble Inc. will allow each business to independently focus on their own unique growth initiatives. We continue to expect the spin-off to occur by the end of August and it will continue to provide additional information regarding the spin through amended S1 fillings.

With that I’ll turn it over the Al Lindstrom for the financial review.

Allen Lindstrom

Thanks Mike.

This morning we released our fourth quarter and full year results for fiscal 2015. Please note that the fourth quarter and full year ended, May 2, 2015, consisted of 13, 52 weeks respectively as compared to 14 and 53 weeks last year. Comparable sales data exclude the impact of the additional week and are on a comparable week basis. The remaining comparisons to the prior year fiscal fourth quarter and prior full fiscal year unless otherwise noted.

Consolidated sales were $1.2 billion for the quarter and $6.1 billion for the full year. Retail sales decreased 9% to $869 million for the quarter. The inclusion of the 53^rd week contributed $57 million in additional retail sales last year representing the majority of the sales decline.

The remaining drivers of the fourth quarter retail sales declines include lower comparable store sales, store closures and lower online revenues. Retail core comparable store sales which excludes sales of NOOK product decreased 0.5% for the quarter primarily on inclement weather.

On a full-year basis, retail sales declined 4.4% to $4.1 billion from the prior year. Comparable store sales declined 1.9% while core comparable store sales increased 0.5% both in line with company guidance. Sales of NOOK products of retail stores declined primarily on lower device unit volume.

Core product sales benefited from growth of non-book categories and continued stabilization of physical book revenues. The balance of the annual decline was primarily attributable to store closures, the 53^rd week and lower online sales.

Fourth quarter College sales decreased 8.1% to $274 million impacted by the 53^rd week which contributed $15 million in additional college sales last year. Due to the seasonality of the business, college experienced an unfavourable sales shift from the fiscal calendar this quarter. The later shift in fiscal weeks resulted in a sales decrease in addition to the 53 week as the prior year included additional back-to-school rush sales.

On a full-year basis, despite comparisons to the 53^rd week, college sales increased 1.4% to $1.8 billion led by new store growth. Comparable store sales increased 0.1% in line with company guidance as higher general merchandise sales were offset by growth of lower price in textbook rentals.

NOOK sales, which include sales of devices, digital content and accessories were $52 million for the quarter and $264 million for the full year decreasing 40% and 48% respectively.

Device and accessory sales declined primarily on the lower units selling volume while digital content also declined on lower unit sales. Consolidated gross margin rates increased 180 basis points for the quarter and 170 basis points for the full year. Fourth quarter retail margins were essentially flat as a percent of sales as compared to year ago.

On a full-year basis, retail margins increased 70 basis points on higher sales mix, the higher margin core products, lower markdowns, higher vendor allowances and the previously noted warranty reimbursement. These favourable variances were partially offset by higher occupancy costs, expense to leverage on the sales decline and lower vendor settlements.

Fourth quarter college margins increased 270 basis points primarily on a favourable sales mix including previously deferred higher margin textbook rental revenues.

On a full-year basis, college margins were relatively flat as a percent of sales at the benefit from a favourable sales mix of higher margin textbook rentals and general merchandise as well as rate improvements offset by higher occupancy cost on contract renewals and comparisons to a prior year favourable LIFO adjustment of $7.7 million.

Fourth quarter NOOK margins improved primarily on a higher mix of higher margin content sales, lower occupancy cost and higher device related margins. Full-year NOOK margins improved on these drivers as well as previously disclosed benefits earlier in the year.

Consolidated selling and administrative expenses decreased 10 basis points for the fourth quarter well increasing 30 basis points for the full year. The fourth quarter included approximately $2.4 million of separation related costs, bringing the year-to-date total to $11.5 million spread amongst each business segment. Retail expenses increased 170 basis points during the quarter, primarily on sales to leverage, higher professional fees and general timing of expenses.

Full year expenses increased 120 basis points on sales to leverage higher professional fees including separation related costs and the previously noted $7 million charge taken last quarter related to the termination of the company’s pension plan.

College expenses increased a 190 basis points for the quarter and a 140 basis points for the full year on higher investments to support business growth, additional user development and separation related costs.

In addition, fourth quarter expenses de-levered against the sales decline. User expenses including occupancy and S&A costs finished at $26 million for the full year as compared to $22 million last year. In fiscal 2016, we expect user expenses to be approximately $2 million higher than fiscal 2015.

NOOK expenses declined $35 million for the quarter primarily on comparisons to a $28 million prior year impairment charge on the relocation of the Palo Alto facility. NOOK expenses declined $97 million for the full year on cost rationalization, lower sales and comparisons to the prior year impairment charge.

As a result of the factors just discussed, fiscal 2015 consolidated EBITDA increased $76 million or 30% to $327 million. Retail EBITDA of $323 million decreased $32 million from the prior year primarily as a result of the sales decline. College EBITDA of $91 million decreased $23 million from the prior year primarily on increased investments.

Offsetting these declines was a $131 million reduction in NOOK EBITDA losses on cost rationalization efforts, prior year impairment charges, current year benefits previously discussed and improved margins.

The company’s full year effective tax rate was 68.3%, which includes our normal rate of approximately 40% increased by partnership lost allocations, partially offset by a favorable change in valuation allowances.

Consolidated fourth quarter net losses were $19.4 million or $0.37 a share as compared to the prior year net loss of $36.7 million or $0.72 a share. Fiscal 2015 consolidated net earnings were $36.6 million or $0.21 a share as compared to our prior year net loss of $47.3 million or $1.12 a share.

As Mike mentioned earlier, the company improved the strength of its balance sheet during fiscal 2015. We acquired Microsoft and Pearson’s interest in NOOK Media, paid the junior seller note and ended the year with no borrowings under our $1 billion credit facility.

We finished the fiscal year with $74 million of cash, $60 million of which was at College. Cash declined from the third quarter levels primarily due to the seasonality of the business. Consolidated capital expenditures for fiscal 2015 were $143 million as compared to $135 million in the prior year.

In fiscal 2015, we did not open any retail book stores while closing 13 ending the year with 648 retail stores. We expect to close approximately the same amount of retail stores in fiscal 2016 as the prior year.

College opened 48 new stores and closed 24 this year ending with 724 locations. Looking ahead to fiscal 2016, we expect retail comparable store sales to be approximately flat while core comps are expected to increase approximately 1%. College comparable store sales are expected to also increase approximately 1%.

The Company expects to continue to reduce EBITDA losses in the NOOK segment. We expect capital expenditures of approximately $150 million in fiscal 2016, which include approximately $85 million at retail primarily for existing stores approximately $55 million at College largely for new and existing stores and approximately $10 million at NOOK in support of digital initiatives.

With that we will open the call for questions. Operator, please provide the instructions for those interested in asking a question.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to our first question from Alex Fuhrman with Craig-Hallum Capital Group.

Alex Fuhrman

Great, thank you for taking my question and congratulations on a great year. I wanted to ask about the guidance for same-store sales particularly at the retail segment. It sounds like you have a lot of exciting events in the literary world with major book launches coming up over the next couple of months.

So as you think about that 1% comp guidance would it be reasonable to think of perhaps a little bit of a higher comp rate in the first half of the year and then comps kind of in the flat to negative range in the back half of the year or are you thinking about that 1% increase more or less evenly throughout the year?

Allen Lindstrom

I would say that the comps we would expect them to be evenly throughout the year excluding the impact of the big books. So…

Mike Huseby

We’re not going to give guidance by quarter by cycle. It does have inflow Alex, because of these big books, but as we look out over the year as a whole, we’re comfortable with the guidance we provided.

Alex Fuhrman

That’s very helpful. Thank you. And then on the store growth side for college, I think you’d mentioned year-to-date of being about 14 contract signed for openings in 2016 or fiscal '16 rather.

Could there be more than that? I’m just kind of thinking that, that seems like it’s been a little bit slower than the pace the last couple of years. Is that just the number of contract signed to-date or is that what we should be expecting in terms of openings for the year there?

Allen Lindstrom

That’s what we have to date and basically that we feel very comfortable with our projection for the years and we see it consistent with previous.

Mike Huseby

That’s Max Roberts is our CEO of College. And the first question was answered by Al Lindstrom, our CFO.

Alex Fuhrman

Great, well thank you very much for your answers and look forward following up again soon.

Mike Huseby

Thanks Alex.

Operator

[Operator Instructions] We’ll go next to John Tinker with Maxim.

John Tinker

Thank you. Could you just talk a little more about the decline in the NOOK losses? I know that the gross margins now at 77%, compared to 37%. So I assume that’s the attractive content side kicking in.

But what’s your relationship with Samsung now and I know you’ve expanded it, but why do you see them continuing here down?

Mike Huseby

Well, couple of questions that you’re asking, this is Mike, the relationship with Samsung is excellent. As you know John, tablet sales in general for all companies that sell tablets and particularly those that are focused on reading have dropped fairly dramatically in the last year.

Samsung has been a great partner for us to work with and forecasting demand and trying to respond to the change in the shifting market demand between tablets, fablets etcetera. So we continue to work with them to look at other ways to meet demand in those areas where we think consumers really will move to find attractive our software for reading. The NOOK reading experience, which we continue to improve.

So the Samsung, to answer your first question, the Samsung relationship is excellent. They’ve been great partners. The decline in NOOK losses, as you mentioned, we’ve done a pretty good job of holding the margin even with the decline in content sales and as you point out, the NOOK margin is improved and I think Al said this because of the mix away from devices and more towards content.

The losses as we pointed out, we didn’t get into a lot of detail, but combining the NOOK digital operation with the retail group allows for a more common platform for both management of people, which relates to also how do we better integrate the marketing, go-to-market efforts of NOOK physical, NOOK digital rather in the physical book market and also on our BN.com eCommerce efforts.

And also the technology platforms, the technology platforms for NOOK and retail in terms of ERP are different. There's an opportunity to consolidate not just technology platforms, but processes and that means reduction of cost as well -- not just personnel, but in terms of maintenance, hardware, software and maintenance those types of things.

So nobody is giving up just the opposite on trying to improve the content picture in terms of digital content. There is good ideas that both the retail and NOOK Management have to us how we can better work together to push digital content and eventually stabilize that revenue picture for content in the digital -- from digital sources.

But there is substantial opportunity still to reduce losses and net loss I should say and cost at NOOK, but it's not going to happen in a week. It's going to take some time because of the nature of the items that we're working on.

If you look at how fast the losses have dropped, in 2013, the loss approached $500 million and last year's $218 million and now it's $86 million. So I really have to commend our NOOK Management and others at Barnes & Noble that have been associated with that effort. It's been very focused and have done a great job.

John Tinker

Just to follow-up the re-launch of BN.com, are there any sort of one-off expenses attached to that?

Allen Lindstrom

No. It will be depreciated based on the investment that we've made so far once it goes live, but other than that there is no launch expenses with it.

John Tinker

Thanks.

Mike Huseby

Thank you.

Operator

[Operator Instructions] We'll go next to Rick Schottenfeld with the Schottenfeld Group.

Rick Schottenfeld

Hi guys. Just a quick question. You have not yet named a new CEO for retail with Mitch's retirement and is there any risk of that delaying the spin or is that necessarily have to be completed before the spin?

Mike Huseby

Absolutely not. One thing I will say about that as we do have a search and very pleased with the results of that, that search we think it will be successfully completed in the near term.

We're not to be for some reasons that would not hold up the spin, the retail management team is very strong and that's not going to be a factor in the timing of the spin.

Rick Schottenfeld

Okay. Great. Thank you.

Mike Huseby

Thanks Rick.

Operator

And at this time, there are no other questions in queue. I'll turn it back to our presenters for any closing remarks.

Mike Huseby

Great. Thank you for joining us on today's call. Please note that our next schedule call and financial release will be our first quarter earnings call on or about September 9, 2015. Have a good day.

Operator

And that does conclude today's conference call. We appreciate your participation.