Barnes & Noble's (BKS) CEO Demos Parneros on Q3 2018 Results - Earnings Call Transcript

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About: Barnes & Noble Inc (BKS)
by: SA Transcripts

Barnes & Noble, Inc. (NYSE:BKS) Q3 2018 Results Earnings Conference Call March 1, 2018 10:00 AM ET

Executives

Andy Milevoj - Vice President of Investor Relations

Demos Parneros - Chief Executive Officer, Director

Allen Lindstrom - Chief Financial Officer

Analysts

Mark Rosenkranz - Craig-Hallum Capital Group

Ryan Vaughan - Needham & Company

Operator

Good day and welcome to the Barnes & Noble fiscal 2018 third quarter earnings call. Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Mr. Andy Milevoj. Please go ahead, sir.

Andy Milevoj

Good morning and thanks for joining us on our fiscal 2018 third quarter earnings conference call. With us today are Demos Parneros, Allen Lindstrom and 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 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.

And now, I will turn the call over to Demos.

Demos Parneros

Thanks Andy and good morning everyone. Today, I will provide a brief review of our third quarter results before moving to our long-term strategic turnaround plan, which we expect to provide steady and consistent improvement in fiscal 2019 and beyond.

Entering the holiday period, we were encouraged by the trends that developed during the second quarter and continued into November. Our traffic and conversion trends were improving while book sales were strengthening. Unfortunately, December sales softened primarily due to lower traffic. However, comp store sales improved in January, declining 3.5% for the month. As a result, the third quarter comp sales declined 5.8%, improving 60 basis points as compared to the nine week holiday period.

Our book business continued to outperform the overall comp sales trend, declining 4.1% while double-digit declines in gift, music and DVD categories weighed on the overall performance. This was somewhat offset by growth in toys and games and café businesses.

While our third quarter performance did not meet our expectations, we remain focused on executing initiatives to invest in, evolve and grow our core businesses while at the same time improving profitability by operating more efficiently. Our near-term initiatives are focused on reducing expenses and stabilizing profits to support our long-term goals of growing the business through new stores and expanding our omnichannel capabilities.

To position our business for growth, the foundation of our strategic plan is built on four pillars. One, strengthening the core. Two, improving profitability. Three, accelerating execution. And finally, number four, innovating for the future.

Let me walk you through each of these. Books are a heritage and centerpiece of everything we do. So the first pillar of our strategic plan is to strengthen the core. As we highlighted last quarter, we are reasserting our book leadership by placing a greater emphasis on books while taking a much more pointed view of our non-book products.

We know that customers value Barnes & Noble for our expansive assortment, the expertise of our booksellers and the experience we provide. Our customer value proposition is a distinct competitive advantage for B&N and we are working to further improve our merchandise mix and hence, the overall shopping experience, increase the value of our membership program and improve our omnichannel capabilities.

To enhance the overall shopping experience, we are evaluating each of our customer touch points and engaging more directly with our customers. This includes evolving our labor model to ensure that booksellers are focused on helping customers first and performing tasks second.

Beyond the in-store experience, Barnes & Noble has tremendous multichannel assets to deliver any book anytime anywhere in any format. Over the course of the past year, we have begun to utilize these assets to improve our omnichannel capabilities and better fulfill our customers' needs.

For example, approximately six months ago, we launched our ship from store program, which fulfills bn.com offers from our store inventory. The program increased delivery speed while reducing shipping costs. Furthermore, later on this year, we will launch our buy online, pick-up in store offering for customers. This will replace our current reserve online, pick-up in store program. Through this new offer, our promise to customers is that they can place an online order and pick it up at their local store within one hour.

Barnes & Noble's membership program is a key element to strengthening our core and enhancing the overall value proposition. Over the past six months, we have been testing new offers tied to the program in certain markets and are encouraged by the results. Customers have responded well and we have added over 0.5 million members since the beginning of this fiscal year, bringing our total count to 6.5 million members.

The second pillar is to improve profitability. We need to return to growing profits and are looking at a series of actions to accomplish this goal. We recently launched an aggressive expense management program that will reduce expenses and redeploy dollars towards our growth initiatives. This includes our recent action to transition to a new, more efficient store labor model that provides greater flexibility and better customer service by eliminating tasks and allowing booksellers to focus more on customers. Making this organizational change was difficult but necessary decision. In addition to improving labor efficiency, our team is focused on doing a thorough review of all areas of the business, with a goal of reducing expenses in other areas such as logistics and direct procurement, to name a few. Our plan is to realize additional expense savings in 2019.

The third pillar is to accelerate execution. To accomplish this, we need to be simpler, faster and more decisive. We are removing roadblocks while making better fact-based decisions that are supported by solid analytics. Our team is energized by this.

To support these efforts, we are focused on attracting, retaining and developing top talent throughout the organization. Over this past year, we have attracted new talent to our senior management team and recently have made another key hire to support our strategic plan. In mid-February, Tim Mantel joined the company as Chief Merchant who will be responsible for overseeing all of the company's merchandising initiatives.

I am very proud of the work that our team has done. In my first year on the job, I am thrilled to say that we have added eight new executives to our team. This has allowed us to have an incredible balance between people with deep company history and bookselling experience, combined with the talented retail executives we have added. I feel like we have a fantastic team to lead our transformation.

Lastly, to support our longer term growth, we need to innovate for the future, which is our fourth pillar. Innovations are our greatest growth accelerator and we are putting tremendous effort behind it. We are excited to announce that later this year we will open five new prototype stores that feature a smaller format and new design. This rightsized format will have a new look and merchandise focused on books and other categories that are more reflective of today's business model. We look forward to welcoming customers to these new stores.

So while there's a lot of work to be done, we feel great about our team that we have in place and the plan that we have developed to position the company for long-term growth. To be clear, even when an organization is working with a sense of urgency and clearly defined strategic goals, turnarounds take time. We anticipate a multiyear process to implement the changes that we have outlined in our strategic plan. We look forward to keeping you updated on our progress on our upcoming calls.

Now I will turn it over to Al who will review our financials.

Allen Lindstrom

Good morning. Today, I will provide an overview of our third quarter results, which ended on January 27. Comparisons are to the prior year quarter unless otherwise noted.

Consolidated sales decreased $69 million or 5.3% to $1.2 billion. Retail sales decreased $66 million or 5.1% to $1.2 billion for the quarter. Comparable store sales decreased 5.8% while online sales declined 5.2%. The company's book business declined 4.1%, outperforming the overall comps. Non-book comps declined 7.5% as declines in gift, music and DVD categories accounted for nearly half of the overall comp sales decrease.

Consolidated gross margin decreased $37 million primarily due to the lower sales volume. Rates declined 110 basis points on expense deleverage, increased promotional activity, member discounts and markdowns to clear certain non-returnable inventories.

Total selling and administrative expenses of $273 million include $10.7 million of severance costs resulting from the implementation of our new store labor model. The company estimates this will result in annual cost savings of approximately $40 million. Excluding this charge, SG&A rates were flat with the prior year despite the sales shortfall. Third quarter results include a non-cash goodwill impairment charge of $133.6 million. While the company has initiated a strategic turnaround plan, achievement of its goals requires significant multiyear transformation.

The consolidated third quarter EBITDA loss was $6.6 million. Excluding nonrecurring charges, third quarter EBITDA would have been $137.7 million as compared to EBITDA of $157.8 million in the prior year. NOOK turned its third consecutive profitable quarter on continued cost rationalization.

During the quarter, the company established a valuation allowance of approximately $35 million against certain deferred tax assets. This charge was partially offset by a tax benefit of $26.4 million, following the enactment of the Tax Cuts and Jobs Act legislation. Deferred tax assets and liabilities were remeasured due to the reduction in the corporate tax rate. The consolidated third quarter net loss was $63.5 million or $0.87 a share as compared to net earnings of $70.3 million or $0.96 a share in the prior year.

Turning to the balance sheet. Our company ended the quarter with borrowings of $60 million under our $750 million credit facility. Over the past 12 months, the company has returned $44 million in cash to its shareholders through its Board approved dividend policy. The dividends are reviewed by our Board of Directors on a quarterly basis. Our next Board meeting will be held in mid-March, at which time, the Board will review the upcoming dividend payment.

Capital expenditures were $70 million on a year-to-date basis, slightly less than prior year levels. We now expect full-year capital expenditures of approximately $90 million. During the quarter, the company opened two stores while closing four.

Turning to full year guidance, the company expects comparable store sales to decline in the mid-single digits and consolidated EBITDA to be in the range of $140 million to $160 million, excluding unusual or nonrecurring items.

With the recent actions we have taken, coupled with continued cost reduction initiatives, we are now targeting approximately $50 million of cost savings in fiscal 2018. We expect to achieve additional savings in fiscal 2019 by realizing the full annual benefit of these initiatives, combined with the implementation of new 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 will take our first question from Mark Rosenkranz with Craig-Hallum Capital Group.

Mark Rosenkranz

Hi. Good morning. Thanks for taking my questions.

Demos Parneros

Good morning.

Mark Rosenkranz

Yes. I want to dive in a little bit on the expense improvements that you are looking to get here. Just talk a little bit about maybe the long-term versus short-term on what can we kind of expect to see over the next 12 months? And do you see any other type of improvements beyond just the immediate $40 million in benefit you are going to get here in the next couple of quarters?

Demos Parneros

Sure. Maybe Allen and I can team up on this one. So we have detailed the new labor model, which we are excited about and that really allows us a lot more flexibility in scheduling and really being focused on customers versus a lot of the tasks. So we have eliminated many tasks. We are taking a hard look at every position to make sure that we have the relevant positions for today's model.

And so while that was a tough one, I feel like our team did a great job on that one. Obviously, we are taking a hard look at everything. And as we have said in past calls, everything is on the table and we are pretty much going through the P&L line by line. We gave a few examples like indirect procurement which really touches every part of any expense we take as well as other areas.

Allen Lindstrom

And just to add on to that, some of the areas that Demos talked about earlier, logistics and indirect procurement as well as synergies in our corporate offices where we see efficiencies. And remember, one of the big things we are doing here in reducing or managing expenses tighter is so we can reinvest in our business and start to grow our topline.

Demos Parneros

And Al, actually, one other, sorry, I should have mentioned this earlier, is we are really looking at sort of rightsizing the expenses, more so than cutting away expenses. And we are relooking and reimagining ways to do things. So whether it's how we unload a truck or how we do simple tasks in the store, we are really looking to update and modernize and speed up the way we do things so that we can take expense away and just become more efficient. So that's an ongoing process for us.

Mark Rosenkranz

Okay. Great. That's helpful. Thank you very much. And then just switching gears to the comp improvement you saw in January. I am just wondering if you could give a little more color on maybe the book versus non-book mix? And then maybe some of the traffic trends you have seen following that improvement in January? And what kind of expectations do you have going into the rest of the year here?

Allen Lindstrom

So the comps in January, books were strong in January. They continued to be strong, especially the frontlist. And we still have work to do in adjusting our non-book over-assortment. And that is still something we expect to continue to work on for the balance of this fiscal year, so we can head into next year strong.

Demos Parneros

Yes. And just a couple of thoughts on that. I mean, I am really excited about the partnership that we have with our publisher partners. There's an exciting lineup of books coming out that has been ongoing and we are just working more closely together to really maximize the opportunities. We have talked at really, last call, in more detail about taking a hard look at our assortments in everything but books.

So we are going to be a leader in books clearly and do a fantastic job for customers there. But we just felt like we had too much assortment, but we are very committed to the stationery, gift, toys and games businesses as really they are an important part of our assortment and our value prop to the customer.

So it's an exciting time for us because we are really freshening up and we are starting to build momentum. Obviously, with the new merchant, we are very excited to have him. We have new additions to our marketing team as well, our store design team. So really, it will all work together to put something in front of customers that's much more exciting.

Mark Rosenkranz

Okay. Great. Thanks for taking my questions.

Operator

And we will go next to Ryan Vaughan with Needham & Company.

Ryan Vaughan

My question is around the $140 million to $160 million of EBITDA. If I am doing my math correct, it looks like you are looking for somewhere around $15 million to $35 million in 4Q. Can you just give us a little bit of an EBITDA bridge, how to think about that, even just kind of get to the $140 million here? If last year, it looks like it was kind of a mid-single digit EBITDA number. That's my first question.

Allen Lindstrom

Sure. There's a bit of a bridge on the back on the guidance that you should probably take a look at. And the Q4 results this year include, the projections, I should say, include the action we just took on the store labor model. It also includes additional expense efficiencies that we have already implemented in areas such as indirect procurement and it also includes the improved or expected improved sales trends that we started to see in January and we are expecting for Q4.

Ryan Vaughan

Okay. So just to be clear, it sounded like January was much better than December. Is that holding January into February and subsequent months? Or is it continuing to improve like you saw, December to January, that goes into that guidance?

Allen Lindstrom

Yes. February had some weather obviously. We don't want to blame weather. Usually, it's not something we do here, but it did have weather. So outside of that, our Q4 projections are to continue the improvement.

Ryan Vaughan

Okay. Great. The other question I wanted to ask, going back to a June 2016 presentation, I think it was about 35% of CapEx as maintenance and then the other, maybe it was 60% or 40-60. Can you just talk a little bit about that growth CapEx? Is that translating to EBITDA? Or is this kind of in conjunction with the multiyear that we should expect to see some EBITDA gains from, call it, the $60 million or $50 million, $60 million of cash that you are spending on CapEx?

Allen Lindstrom

It's a good question. We have invested this year in a mix of merchandising initiatives and the normal maintenance that we do in our stores. And as Demos talked about before, we do have new store investments and we try to manage our CapEx prudently and making sure we are investing in the right projects that generate the appropriate returns.

So in this fiscal year, in our CapEx number, you can see we are a little bit lower than what we originally guided. And in addition to the expenses, we are taking a hard look at our maintenance CapEx to make sure we free up cash to be able to invest in those growth initiatives such as new store and merchandising initiatives and other things that we think generate the appropriate returns.

Ryan Vaughan

Great. And last one, just going back to that June presentation of 2016, just I think clearly, you have a fantastic lease flexibility, real estate schedule. As it sits today, I think it was 98% of stores were cash flow positive. Any sort of update there as we kind of fast-forward almost two years?

Allen Lindstrom

Yes. It's still very high. It's probably about 95% now, just given the decline in EBITDA year-over-year. But it's still an extremely high percentage of our store base.

Ryan Vaughan

Thank you very much.

Demos Parneros

Yes. Just to follow-on on that. Thanks for the questions. To follow-on on that, that's something that we are focused on. And with the transition to end of lease, either taking smaller spaces or downsizing where possible, we are very focused on that floor percentage as well. Thanks again.

Ryan Vaughan

Thank you.

Operator

[Operator Instructions]. And we will take our next question from David Lee with Midwest ATC [ph].

Unidentified Analyst

Good morning.

Demos Parneros

Good morning.

Unidentified Analyst

Yes. I have just a quick question. I know you guys, I believe, have five new concept stores with the Barnes & Noble Kitchen. I just didn't know how those locations are doing compared to the profit margins of the stores that don't have the Barnes & Noble Kitchen. And how many stores you plan on adding the Barnes & Noble Kitchen to over the next quarter or next year?

Demos Parneros

Sure. So in the last few months, we opened the final two planned Kitchen stores. So we now have all five up and running. So it's been a great learning experience for us. What's interesting is that they are all different sizes. I think two are pretty close and the other three are just varied sizes and varied restaurant sizes.

We don't have any more planned at the moment. The new stores that I referred to earlier are traditional Barnes & Noble bookstores, which are smaller than our current prototype. So that's the update on new stores planned.

As far as margins of Kitchen stores versus non-Kitchen stores, I will put the restaurant part to the side and say that the book part of the store is in line and consistent with our experience of our normal kind of mix of books. So no significant change there.

Unidentified Analyst

Okay. Thank you. And just two more quick questions. First one, I think you guys mentioned it in last earnings call. Are you guys trying to do any price matching within your competitors? Or are you guys still waiting to determine that?

Demos Parneros

We don't have a price match policy today and we have no plans at this point for price match policy. Obviously, we constantly evaluate competitive pricing and our pricing as part of our course of business, but nothing announced there.

Unidentified Analyst

Okay. Thanks. And last thing, what do you feel like Barnes & Noble as being their biggest hurdle over the next four quarters? And that's it. Thanks.

Demos Parneros

Well, I mean, our challenges have been pretty well documented. We have had consistent traffic shortfall over the past number of quarters. And what our team has been focused on is how do we provide better experience to our customers, taking a hard look at pretty much everything in our business, beginning from our overall value proposition, starting with our merchandise mix, having all the right books at the right time available and we feel like we have done a really great job with that.

Our non-book assortment is something that we have talked a lot about and something that we have been working hard on and making good improvements with. We talked about our member program and how we have added 500,000 new members. So there's incredible loyalty to the Barnes & Noble brand and the experience that our fantastic booksellers provide to customers every day.

Customers love their bookstores and we are working hard to make bookstores not only more comfortable for them, but more inviting, easier to navigate, et cetera. So it's a lot of the list that you might expect.

And then finally, without getting into a long list here, we are really working hard to tie the barnesandnoble.com site to the store. And we have talked a little bit about the exciting shift from store initiative which is now plus six months old and working well and very excited about our buy online, pick-up in store coming soon.

So I think it's relentless focus on our customers, in a way, to really try to build the traffic back up and turn the business around. In the meantime, we are focused on expenses in the short term to help fund our growth. And I think that's a quick summary of our priorities.

Unidentified Analyst

Okay. Good to hear. Thank you very much.

Demos Parneros

Thank you.

Operator

[Operator Instructions]. We will take a follow-up question from Ryan Vaughan with Needham & Company.

Demos Parneros

Good morning.

Ryan Vaughan

Sorry. I was on mute there. Thanks again for taking the question. It's great to have all three of you there to answer these. Just you mentioned the five prototype. Can you give a little bit more specificity around, I think your average box is around 26,000. What ideal? What kind of prototype that you are rolling out in those five concepts?

Demos Parneros

We are very excited about the new concept. Let me break it down into the concept first and the five next. So the new store design is approximately 14,000 square feet. If we find a killer location where the size is 15,000, we can flex up to 15,000. We can go up and down a little bit. But generally, we are building to a 14,000 square foot store.

And this is very exciting for us. We have done a lot of work. We have used the five Kitchen stores, I will call them, to learn because the book part of those stores has really been instructive and helpful to help us understand assortments and signage, way-finding, all of the things that you might look at in store design.

We think these stores have a fresh look. They are very customer focused. They have got our revised, latest thinking for adjacencies, signage, way-finding. We have also rightsized the portion of the store dedicated to each part of the business. So you will see less of a decline in categories and no space in the categories that we intend to eventually optimize out of.

We will have front and center will be our new books and there will be a café as we have today. So a lot of the same, but I would say fresher, cleaner, newer, very up-to-date and really excited about it.

Over the summer, we have a few stores that were relo stores. We are going to plug in this new prototype into those stores. They are slightly bigger than the 14,000, but we didn't want to wait. So we will get those in. And then as we add additional stores, we will plug in the 14,000 square foot prototype into the right size. So it's an iterative process and we intend to continue to learn and adapt as we go, but excited to be launching.

Ryan Vaughan

Yes. Absolutely. And the one thing that, just looking at this on a maintenance basis, I mean, you have, call it, $100 million of free cash flow at your disposal here. And obviously, you are touching on some of these growth initiatives. And you did say in March, you will evaluate the dividend. I mean, how do you think about that? If there is $100 million of available capital as you are going through your turnaround, you have a ton of time here to get the business rightsized and back on a positive trajectory, how do you think about it, Demos or Allen or Andy? Just it would be great to get your thoughts kind of balancing out growth? I mean, I will tell you, I don't think you get rewarded whatsoever for your dividend. It's now almost 15% of your market cap. Just kind of balancing those things out, like investing for the future or even buying back a ton of your stock at the same token? Just would be curious to get your thoughts as we sit here today?

Demos Parneros

Yes. Sure. I mean, we have outlined our 4Q growth strategic initiatives to help us stabilize the business and get back to growth. I would say that we start with relentless focus on customers and really paying attention to what our customers are telling us and I think our team has done a nice job with that.

We have talked about the expense reductions to help stabilize the P&L and also give us more of an opportunity to invest in growth. So I would say that we are moving at a very quick pace but a careful pace. I think we are putting a lot of rigor and analytic view on everything we do.

Our team's talking a lot, we are testing a lot and we, as we have shared with many of the examples, are doing a lot of different things, whether it be the ship from store and some of the omnichannel initiatives to really speak to how customers want to shop today to developing a smaller but I would say, more intimate and more size-appropriate store that allows us to be very competitive and to be able to fulfill end-of-lease opportunity. So it's quite a few things happening at once, but I would say there's a lot of focus and a lot of careful planning.

Ryan Vaughan

Thank you.

Demos Parneros

Thank you.

Operator

And this concludes today's question-and-answer session. Mr. Milevoj, I would like to turn the conference back to you for any additional or closing remarks.

Andy Milevoj

Great. Thank you so much and thank you everyone for joining us on today's call and your interest in Barnes & Noble. Our year-end earnings release will be released on or about June 21. We look forward to speaking to you then. Thank you.

Operator

Thank you. And this does conclude today's call. Thank you for your participation. You may now disconnect.