Barnes & Noble Inc. (NYSE:BKS) Q3 2017 Earnings Conference Call March 2, 2017 10:00 AM ET
Leonard Riggio - Chairman, Chief Executive Officer
Allen Lindstrom - Chief Financial Officer
Andy Milevoj - Vice President, Investor Relations
Alex Fuhrman - Craig Hallum
David Schick - CER
Michael Schechter - TowerView
Greg Pendy - Sidoti
Good day and welcome to the Barnes & Noble Third Quarter 2017 Earnings conference call. Today’s conference is being recorded. At this time for opening remarks and introductions, I’d like to turn the call over to the Vice President of Investor Relations, Mr. Andy Milevoj. Please go ahead, sir.
Good morning and thank you for joining us on our fiscal 2017 third quarter earnings conference call. With us today are Len Riggio, Demos Parneros, Allen Lindstrom, and other members of our senior management team.
Before we begin, I’d 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 issue 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 this call.
Now I’ll turn the call over to Allen.
Good morning. Today I’ll provide an overview of our third quarter financial results. Comparisons are to the prior year quarter unless otherwise noted.
Third quarter sales decreased $113 million or 8% to $1.3 billion due in large part to lower comparable store sales. Comps decreased 8.3% for the quarter due primarily to lower traffic and comparisons to coloring books and artist supplies. Similar to other retailers, the company continues to experience challenging traffic trends and remains focused on opportunities to improve sales. Online sales increased 2.2% for the quarter while Nook sales decreased 26%.
During the quarter, consolidated gross margins decreased $55 million primarily due to the lower sales volume. From a rate perspective, retail margins declined 130 basis points on higher markdowns resulting from the holiday sale shortfall and de-leverage on fixed occupancy expenses. During the third quarter, the company cut its SG&A expenses by $44 million, reducing its SG&A rate by 140 basis points.
Nook continued to make progress on its cost rationalization efforts, cutting third quarter expenses by $11 million or 40% as compared to a year ago. On a year-to-date basis, Nook has cut expenses by nearly $40 million from last year’s levels.
Retail expenses declined $32 million primarily on lower TV advertising, reduced ecommerce expenses, and lower variable costs commensurate with the sales decline. From a rate perspective, third quarter retail expenses declined 80 basis points as these savings were partially offset by expense deleverage. On a consolidated basis, we’ve reduced expenses by $84 million so far this year and believe there are additional opportunities to reduce costs going forward.
Third quarter EBITDA decreased $11 million as compared to the prior year as the sales decline was partially mitigated through these expense reductions. Consolidated third quarter net earnings were $70.3 million or $0.96 a share as compared to net earnings from continuing operations of $80.3 million or $1.04 per share in the prior year. The effective tax rate for the quarter was 44%, resulting from the filing of tax returns this quarter. This rate includes certain adjustments for the finalization of the college separation.
Turning to the balance sheet, the company ended the quarter with borrowings of $18.2 million under its $750 million credit facility. Inventories remain well controlled despite the sales shortfall. During the quarter, the company returned $14.4 million in cash to its shareholders, including $10.9 million in dividends and $3.5 million through share repurchases. During the quarter, the company completed its $50 million stock repurchase program authorized in October 2016. Since July 2015, the company has returned $129 million in cash to its shareholders through share repurchases and dividends. Capital expenditures were $74 million on a year-to-date basis, relatively consistent with prior year levels.
Now let’s turn to our fiscal 2017 outlook. Despite post-holiday sales improvements, trends softened in late January and into the fourth quarter. As a result, the company now expects full-year fiscal ’17 comps to decline approximately 7%. Given our third quarter results and lower fourth quarter outlook, we now expect consolidated EBITDA in a range of $180 million to $190 million, excluding charges.
Now I’ll turn the call over to Len.
Hey, thank you, Al. I’d like to spend a few minutes this morning talking about sales. In the past several days and weeks, there has been a lot of coverage in the press about the decline in retail. Some basically think they see retail going away. I don’t. However, for the past eight or 10 years, I’ve predicted and we are witnessing a major shift in the way retail works and the type of stores that need to be opened, and the shifting demographics of retail and the shift in traffic patterns. So I’m not alone in concerns about the retail world, and we certainly are not alone as a retailer as we experience what has been happening of late.
Let me talk to some long-term trends. In the first place, we all know the effect of ecommerce since its start about 20 years ago. This is a long-term effect that affects retailers, continues to affect us, but the effect of ecommerce and the major bite ecommerce has taken has abated somewhat. So I don’t think that what we’re experiencing today is any shift or any major event which leads sales to go down. It’s part of a long-term trend that we’ve long experienced.
In the first place, obviously ecommerce affects sales at Barnes & Noble to the extent that we lose sales to our huge ecommerce competitor, but I’d like to suggest that this is not a zero sum game. It’s very clear that people visit our stores, and in visiting our stores we become a showroom which in effect creates online sales. At the same time, a visit to a website, either ours or others, has the effect of stimulating store traffic. Someone could be doing a search and a book pops up, the book could pop up at another ecommerce retailer or us, and the customer’s reaction would be, I’d like to go to the store and take a look at it. So ecommerce also helps our store sales. Now, whether it’s more negative or positive is something that needs to be considered, but it’s not a zero sum game.
Now, we also have to look at the drop in retail traffic, and our sales are suffering because of traffic declines, some due to the fact that people are not coming to us, but we think more due to the fact that there are less cars in the lot, there are less pedestrians walking by, our retail co-tenants have had sales declines and traffic declines, so that where years ago one retailer’s traffic would--or traffic increases would be the benefit of the others, what we are experiencing today is that the decline of one increases the decline or causes the decline in others.
Now in our particular case, there is a long-term effect of the so-called digital revolution. Had we made a prediction of where retail book selling was going four years ago, it was pretty clear that if the sale of devices and the sale of ebooks continued to escalate as it was, there would be no future in retail book selling. We also know that that increase in sale of digital products has abated and possibly, very possibly might be abating. We know this by our numbers and we know it anecdotally as we speak to people, many, many customers who have come back to books because they prefer reading books and also owning books, as opposed to owning just a dot on their site.
There are demographic shifts that we can talk about, and the retail analysts who are on this call are aware of those. We have shifts from the suburbs back to main street back to the inner cities. The population is shifting. Retailers like us are aware of it, we’re adjusting our store models, we’re adjusting our location selections and even our offerings on the basis of those demographic shifts. There are some good long-term components in our mix here, and that is the strength in children’s reading. We continue to have good performance in our juvies. Kids are reading, parents are buying books for kids. There’s still a buoyant teen reading market, and senior citizens continue to be strong in terms of our traffic count and their book purchases.
Now, I’d like to talk to something that’s in the air, and I have to first preface this by saying I’m not looking to and we are not looking to make any excuses here for our decline in sales. Nevertheless, we have to identify what the causes are before we take action. About eight or nine months ago, I was the first, we were the first retailers to talk about the effect of the election, this particular unprecedented election cycle and post-election goings-on. There is a profound effect of media on book sales. Many, many books get their start in the media, the newspapers and on television. There are precedents for this throughout the course of our history, when the media becomes preoccupied over a sustained period.
The book authors and the book subjects stop appearing on the evening news programs, certainly the commentator programs, great shows like CBS Sunday Morning, and even one of the biggest drivers of book sales, which is the morning news shows, the morning entertainment shows. All the talk now is about politics, and books have been starved of any presence there. We see cookbooks and health books and fashion and dieting - so, so many books become explosive as a result of their exposure on TV and in the newspapers. That has all but dried up.
Now in addition to that, there has been a measurable effect of this election that we noticed some time ago, and I’ve charted this over a long period of time. I was one to think that this would go away after the election, and it did just a little bit and our sales started to look like they were righting themselves and it seemed like people were going back to their normal lives. Then we had the inauguration and it started again, and even more fiercely than we had experienced before. So what we’re looking at, and I’m sure other retailers are though I haven’t seen much reporting on it, what we’re looking at is a major difference between our sales in the daytime and our sales at night. The conclusion that we could come to and we believe is the case is that people are spending their time at night watching--there’s no question that the viewership of Fox News and CNN and MSNBC’s of the world is way, way up again, subscription to the Times, as you know, way, way up. People are all engaged in this new government and all of the controversies that come with this and the war between the parties.
We all know about this, but in terms of our numbers, there’s almost a 4% to 5% difference between our night time comps and our day time comps, and I submit that it’s due to the fact that people are spending time at home--you know, rushing home, eating takeout food at home, and they’re watching the various events. So when we isolate some of those events, obviously like the debates, debates in the past would get 20 million viewers. Debates today get 90 million viewers, certainly in this cycle, so people are home watching the debates, and for all of these kind of news hits that we get, major announcements by the president, all these controversies that come up, our sales are suffering in the evening hours.
Also of interest is our sales are suffering in the weekdays as compared to the weekends, so our weekday sales are also 3% to 4% different than they are on the weekends. These factors have been measured by us; the question is, can we do anything about it, and I guess the attendant question is, how long will it last? I would assume at some point here, Americans go back to living their lives, that this ongoing no-end debate either will finally subside. I was wrong, however, in expecting that the debate would subside soon after the November election - it didn’t, and I thought it would subside five days after the inauguration. It has not. I expect us to be coming out of this slump, as it were, but I can’t predict the day or the month, the week or the month that this would happen.
So I just wanted to make sure that people were aware, I believe other retailers have talked about this, were aware of this effect on our sales. Again, I’m not submitting this as an excuse, but the question of what to do about the lack of traffic in the parking lot, the lack of traffic in the stores, there’s no easy answer to it. Remember that advertising is costly and the short-term effects of advertising never pay for themselves.
The last thing I want to talk about is expenses. As Al said, there are opportunities in expenses in the future; however, we are going after areas of expenses that we think we have major opportunities, but we’re not going to cut store service. That would be a disaster for us and is completely unacceptable, so we’re trying to do so by reducing the tasks in the stores, by being smarter managers, but we’re not going to take our important sales people off the floor. We’re going to win in the long range here and prosper in the long range by giving the service to which customers have long expected.
So with that, I’ll turn it over to any questions you may have.
We’ll take our first question from Alex Fuhrman of Craig Hallum Capital Group. Please go ahead.
Great, thank you very much for taking my question, and appreciate the thoughts on the industry here. I guess my biggest question here would revolve around your capital allocation. It seems that even with the results getting a little bit softer this year, you were still able to buy back some stock during the quarter. Now with things perhaps taking another leg down or staying weak in terms of traffic, do you still feel confident in your ability to fund your $0.60 annual dividend going forward, and is there any thought at the board level towards authorizing a new share repurchase here, beyond the one that you just maxed out?
Yes, I mean, that’s a perfect question. We have a board meeting next week--sorry, the week after next, and this will be a major subject of the board meeting. I can’t say what the outcome will be, but we’ve been--obviously we have a budget for next year to be approved, and when we do a next-year budget, we usually add five year, or four years forward to that, so the board would be looking at our plans this year and into the future, and we’ll make that determination at that time.
Okay, that’s helpful, thank you. Then just thinking about how traffic is largely out of any individual retailers’ hands here and there could be a number of scenarios going forward, in view of some of the opportunities to cut costs and some of the improvements you’ve seen in Nook, what would you see as kind of an ongoing EBITDA run rate? Do you feel that EBITDA could kind of remain stable over the next few years in that 180 to 190 range if you were to continue to see, let’s say, low to mid-single digit declines in comp store sales?
I mean, there’s no question that we have to keep the EBITDA at that level and hope to improve it. Without question, we can’t have the company--the EBITDA decline, because what’s the future in that? So we’ve got to--you know, right now the thing that is actionable to us is expense reduction, and again smart expense reduction, but that will only last so long. Maybe we’ve got another two years of having expense reductions. I don’t know that we can get to the $80 million again, but we’ll have expense reductions but then you kind of run out of gas there. Our future is going to be determined by reversing the negative sales, and you know about--I guess Al could give you a better number, but it was--our sales were running at 3% to 4% negative trend line for years, even worse with the digital revolution, and then we started to creep up to the kind of minus-1% and we thought okay, this is it, we’re going to break into the positive and once that line starts pointing in the upward direction, the future will be secure.
We’re not there. We have to make it with increased sales. As you know, we’ve tried other products in the stores, we’ve had some significant success with educational toys and games and other products. At the same time, we have the decline in movies, in DVDs and CDs, so we’ve tried other product and we are continuing to experiment with various types of boutiques and lines of merchandise that we put in the stores as an attempt to both increase sales and traffic. But we’re not there yet. We have to get there.
So the answer is yes, we--our goal is absolutely, absolutely to stay in the 180 to 200 range, and we have to beat that number if there’s going to be a future for Barnes & Noble.
Great, that’s really helpful. Thank you very much.
Our next question comes from David Schick from CER. Please go ahead.
Hi, good morning, and thanks for taking my question and all the details. It sort of feeds off that last question, but how do you think about the balance of trying new things, you know, some of the more--the bigger jumps and how you want to evolve the business at a time when there’s so little visibility for the externalities that you talked about?
Well you know, you have to keep trying. You can’t go to sleep here, obviously. This thing has our attention, the attention of our merchants and operating people really big time. Some opportunities come to us because of the failing of some retailers. Some retailers are dropping much faster than us, so some of the things that they sell are things that we could sell or we’re in fact selling, so it’s possible for us to pick up big market share from that. But the question is--I mean, we have not found the magic bullet, so to speak. We haven’t found that one category that we can get into and have a rapidly ascending line of sales increases to offset the areas of our business that are in decline.
So we’re looking for it. Our new stores, which I hope you’ve taken a look and seen what we’re trying to do, offer some fresh approaches to merchandising, a completely fresh approach to design and presentation, and we’ve done--we’re in the process of doing, I mean, almost a dizzying amount of tests at this point, trying both product and approach. But I haven’t found--we have not found that one thing that we can put in the store and say, okay, here it is - it’s a boutique of XYZ, and this boutique would have a profound effect on our sales. We’re not there yet.
How about on the real estate side? In times past when retail is under pressure, the real estate community realizes that the bookstore is vital to the traffic health. I know traffic is a little different right now, but how are you conversations going on the real estate side of the equation?
Yes, I mean, there is no question that opportunities abound in real estate. There’s no question that the developers, the major developers have been very adept at changing--well, you know they’re changing the composition of their malls, they’re changing the location of their malls, and they have many, many locations available. I spoke to the major developers eight years ago and they didn’t agree with what I saw, but I assure you they agree now with what at least I saw, and others probably did. So yes, there are vacancies that we never thought were possible in some of the major malls, what we used to call fortresses. There are many more vacancies available in the, let’s say--we’d grade them A-plus supermalls, and then A malls and B, and so on, but there are opportunities all over the place as retail is being challenged.
We’re fortunate to have a strong balance sheet here, but we have to couple the strong balance sheet with an EBITDA, with profits that give the developers assurances that we have staying power. So that’s one of the major reasons why we have to deliver on the bottom line, because we want to have the strength with which to leverage our importance, as you suggested, to mall traffic by taking spaces that are better than the ones we now have.
Very helpful, thank you.
As a reminder, it is star, one if you’d like to ask a question. We’ll take our next question from Michael Schechter of TowerView. Please go ahead.
Good afternoon. Len, it’s been, I guess, six months since you postponed your retirement to come back, and we were just wondering where things stood in the CEO search and the process; and two, if you could give us an update on the new stores and how they're functioning.
The last one is easy - the new stores are doing very, very well, and they’re showing promise beyond that which they’re doing, so we’re learning from them. We are on the eve of having--from the test that we put out there, I’m going to call this phase testing a prototype, to having a prototype that we think will carry well into the future, so we’re pretty pleased with that. Obviously we have the--you know, we’ll have the task if we’re sure what we see is working, we’ll have the task of opening more stores and actually changing--relocating stores perhaps within the same market, so what we may be doing is closing one and opening one in the same marketplace, which we know how to do and has long been our practice.
Regarding the CEO, what can I tell you? I’m happy I’m doing what I’m doing. I’ve worked harder for the past six or nine months than in the past 20 years. I have been the chairman of several companies for many years, and now I’m all-in with Barnes & Noble. We have--regarding our search, we have a spectacular new Chief Operating Officer in Demos Parneros. He’s intelligent, he is vastly experienced in retail, he’s run more than 3,000 stores for Staples. He’s a lifetime retailer, he’s very smart, he’s taken to this job, he’s all-in. He certainly is a top candidate for the CEO position. The board will be considering and I’ll be considering where we go with the search.
I have to say that I’m still committed to the company no matter what, so that when we do put in a CEO, I will stay at least for some period, remain at least for some period as the chairman.
We’ll take our next question from Greg Pendy from Sidoti. Please go ahead.
Hey guys, thanks a lot for taking my call. I guess just one real quick question. When we talked earlier about reinvigorating sales on that front, can you just talk about the quarter specifically? I know it was very helpful you mentioned gross margins were impacted by markdowns. You also mentioned you’ve seen sort of a slowdown in coloring book and artist supplies, so just wondering how much mix might have impacted that gross margin, how we should think about that going forward, given that you captured some pretty hot categories in the past that might be seeing a slowdown. Thanks a lot.
Al and Mary?
Yes, the markdowns affected the margins for the quarter, as we called out. It was really to move merchandise following the holiday sales shortfall. The coloring book products were at higher margins than the prior year, so that does affect your mix a bit, and you also have the pressures of the comps and what it does, because we put our occupancy up in the margin section, so you’re also fighting that.
But other than that, there wasn’t any seismic shifts in our product lines that would have caused any product mix. Obviously the less devices you sell, those are at lower margins, that does help your mix as well.
Okay, thanks a lot. That’s helpful.
There appear to be no more questions at this time. I’d like to turn it back to Andy for any additional or closing remarks.
Great, thank you, Operator, and thank you everyone for joining us on today’s call and for your interest in Barnes & Noble. Our year-end release will be released on or about June 22. Have a good day everyone.
This does conclude today’s presentation. Thank you for your participation, you may disconnect.
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