Barnes & Noble Education, Inc. (BNED) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Adam and I will be your conference operator today. At this time, I'd like to welcome everyone to the Barnes & Noble Education Fiscal 2019 Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Tom Donahue, CFO, you may begin your conference.

Good morning and welcome to our third quarter fiscal 2019 earnings call. Joining us today are Mike Huseby, Chairman and CEO; Barry Brover, EVP Operations; Kanuj Malhotra, President of Digital Students Solutions; Lisa Malat, Chief Operating Officer, Barnes & Noble College; as well as other members of our senior management team. Before we begin, I would remind you that the statements we will make on today's call are covered by the safe harbor disclaimer contained in our press release and public documents. The content of this call are for the property of Barnes & Noble Education, and they're not for rebroadcast or use by any other party without prior written consent of Barnes & Noble Education. During this call, we will be making forward-looking statements with predictions, projections and other statements about future events. These statements are based upon current expectations and assumptions that are subject to risk and uncertainties, including those contained in our press release and public filings with the Securities and Exchange Commission. The Company disclaims any obligation to update any forward-looking statements that may be made or discussed during this call. At this time, I'll turn the call over to Mike Huseby.

Thanks, Tom. Good morning everyone and thanks for joining us today. This quarter, we continue to accelerate our business transformation, advancing our efforts to ship to enhance digital offerings in all of our segments. The acceleration is most evident in our DSS segment where we successfully launched our Bartleby Digital Study subscription products in our BNC and MBS scores. As a reminder, the Bartleby Study subscription is a new direct-to-student product that provides access to step-by-step textbook solutions and experts Q&A. After initial soft launch in August, January-March to start of our first selling season for Bartleby within our store footprint. It was very encouraging start what we project as important driver of long-term growth. In January and February, we proved out our strategy of leveraging our vast store footprint and strong relationships with faculty, administrators and students to introduce new scalable and valuable digital products and services. Each day, we are improving Bartleby's ability to compete by significantly expanding the number of textbook solutions we offer students. We're pleased to report that we surpassed the 1 million of such solutions in January. Because of our unique role at the campus physical or virtual book store, we know which course materials are most widely adopted by faculty and used by students and which subject students are most frequently struggling to master. We're leveraging our deep knowledge of student course material consumption to better inform and manage the cost of our content development. This is the key point of differentiation for us. In addition to saving time and development cost, our unique relationships and insight will allow us to scale Bartleby relatively quickly and efficiently. Bartleby gains more than 50,000 gross subscribers to the Spring Rush period including the month of February. Importantly, the majority of those subscribers were originated by our in-store team members. Our store personnel draw tremendous energy to the introduction of Bartleby and clearly proved that they can sell direct-to-student digital products. As I mentioned, Spring Rush was our first in-store sales for Bartleby. This digital study product is relatively nascent with heavy reliance on promotional sales that we are working hard to convert to satisfy paying customers. We'll continue to test and adjust pricing models and content offerings based on the feedback we've received. Additionally, we've recently signed a content licensing agreement with the major publisher that allows us to further increase Bartleby's content, library and more efficiently acquire subscribers. We expect to continue to scale this offering and anticipate that we will begin to see meaningful financial impacts 12 to 18 months from now. We strongly believe in Bartleby's ability to supplement and complement the academic support already provides to students on campuses today by faculty members and tutoring centers. We expect our direct-to-student offerings add substantial value to our customers, company and our shareholders. Looking ahead, our vision is to further integrate and leverage the strengths of our three business segments. Our DSS offerings can be packaged and priced to provide more value to the campus partners we serve through BNC and MBS. For example, we are exploring different ways to design First Day inclusive access bundles that will not only includes students digital courseware through course fee but also include our proprietary or other sponsored digital learning products. Our institutional partners are increasingly being tasked with increasing affordability and accessibility objectives in order to compete with other universities and a current U.S. robust job market. These all-in inclusive access bundles can provide a truly compelling price value proposition for affordable seamless delivery of dynamic learning tools to students, driving efficiency and improving outcomes for both the student and university. The industry shift from physical to digital has been underway for some time, but this quarter we saw that shift continue to accelerate. Trends such as lower average selling prices and the continued decline of fiscal courseware contributed to somewhat higher than expected declines in revenue and EBITDA for the BNC and MBS segments. Total comp sales at BNC decreased 7.7% primarily attributable to declines in the textbook sales, slightly offset by 1.6% increase in our higher market general merchandize sales. Consistent with prior years, the Spring Rush period extended beyond the quarter due to later school openings and students buying materials later in the semester. So factoring the month of February, comp store sales at BNC decreased 4.9% on a year-to-date basis. Total sales at BNC decreased by 8% due to comp store decline as well as the impact of previously disclosed negative net store closings, representing approximately 4 million in revenue for the quarter. As a result an increased emphasis on our value proposition and improve sales execution, we're starting to see the reversal of revenue declines attributable to competitive losses. We restructured our sales team to ensure broader partners and optimal efficiency and are aggressively targeting more cost to reignite our managed stores growth. We've begun to win new accounts as a result of these efforts and are encouraged by our healthy pipeline for new business. We're also engaged in an expanded dialogue with both current and potential campus partners about our ability to serve them with digital offerings we now have the ability to provide. These are discussions we would not be able to have without the investments in digital platforms and offerings, we have made and are continuing to make. Given the current industry dynamics, we're accelerating our efforts to move a higher percentage of our offerings for digital by continuing to make important investments in people, process and technology including our virtual bookstores, our e-commerce business, OER plus courseware and other institutional offerings such as a new courseware adoption and insights platform for faculty and academic leadership that we will introduce this summer. Our inclusive access offering First Day remains an important initiative for institutional business. We're pleased with a continued adoption and acceptances to this model and saw a 133% increase in First Day sales for the quarter. As a reminder, First Day results and sell-through more than 90% compared to approximately 35% today. We also recently announced expanded relationships with multiple publishers including Oxford, Wiley and Macmillan Learning, which allow us to offer even more content through our First Day platform. As a result, the faculties at colleges and universities who adopt our First Day model have the flexibility to choose content for multiple publishers. In short, by making publishers digital content available through inclusive access programs on BNED campuses nationwide, we are delivering a variety of choice to ensure that faculty can choose the materials that are right for their class while still helping to save students money. At MBS, sales were down approximately 16.2% for the quarter. This decline was higher than we anticipated due to decrease demand for physical books in the wholesale business. MBS wholesale was also impacted by lower publisher rental penetration than expected due to publisher offerings of lower-priced loose-leaf and other options. In time of rental programs in which the publisher retains the titles to the books and we earn a fee on each book rented, results from lower recorded revenue, but will optimize margin and cash flow as MBS never have to take titles of the inventory. While we originally anticipated benefits from this pub rental programs to be recognized in fiscal 2019, we now anticipate the cash flow benefits to be recognized by MBS in fiscal 2020. As publishers have shared both publically and in our discussions with them, a large number of their top physical titles will be available for rental in the fall. MBS remains ready and able to distribute these titles. We continue to transform MBS to an innovative service provider for the industry while we also explore new ways to best utilize MBS's advanced distribution capabilities. Similar to BNC, MBS's direct sales were impacted by closed doors as well as the industry shift from physical to digital, which includes the use of inclusive access models offered directly from publishers. We are currently working to combine important functions, including unifying our BNC and MBS sales force is to go-to-market as a cohesive unit to drive new store sales, which we expect to have a positive impact going forward. While we continue to invest in high value digital growth platforms, we remain focused on managing the BNC and MBS businesses for margin and cash flow as they evolve their products and business models. At the same time, we're making structural changes to reflect our go to market approach for new business to more effectively provide new business sales whether new physical or virtual stores or custom store solutions. We expect to discuss such changes in further detail at year-end. We are actively driving required and very significant change throughout BNED need to adjust the needs to the shipping industry and the changing students. As a management team, we're highly confident in our vision for the future and we'll allocate capital and manage our cost structure to maintain an acceptable level of short-term profitability and strong free cash flow. We're making necessary investments to drive scale digital revenue and related returns for many years. While any digital transformation takes longer than any of us would like or times even have the patience for, we believe that we have a right team and the right plan in place. As an industry leader with longstanding institutional and student relationships, we have the strong grasp on where this market is today where it's heading and the actions we need to take serve our customers both now and in the future. Even though we are pushing tremendous change through our organization, we recognize the need to effect positive change faster to move at what we call digital speed and with measurable and improve results. We're taking all steps possible to achieve that speed and those results. I'll turn it over to Tom for the financial review.

Thank you, Mike. Please note that the third quarter end and on January 26, 2019, consisting of 13 weeks. All comparisons will be to the third quarter fiscal 2018 unless otherwise noted. Total sales for the quarter were $550.3 million, compared with $603.4 million in the prior year. This decrease was $53.1 million or 8.8% was comprised of $39.9 million decrease from the BNC segment, the $22.5 million a decrease from the MBS segment and the $0.3 million decrease in the DSS partially offset by lower elimination is between the BNC and MBS. Comparable store sales at BNC decreased by 7.7% in the quarter as compared to a 6.2% decline in the prior year period. Comparable textbook sales for the quarter decreased by 11.2% as compared to the prior year increase of 7.2%. Textbook sales continue to be impacted by lower average selling prices of course materials, enrollment declines and student purchases from publishers directly and other online providers. General merchandise comparable store sales recorded increased by 1.6% compared with a 2.8% decrease in the prior year, driven by strong growth preservation products, computer and supplier products and the previous and caffeine convenience product sales trends. As Mike mentioned earlier, consistent with prior year Spring Rush period extended beyond the quarter due to later school openings and the continued pattern of students buying course materials later in the semester. Factoring in the month of February, comparable store sales at BMC decreased 4.9% on a year-to-date basis. Net sales for MBS in the third quarter were 116.4 million, compared with 138.9 million in the prior year period, a decrease of 22.5 million or 16.2%. MBS wholesale net sales were 77 million, a decrease of 15.1 million or 6.4%. This decline was higher than anticipated due to decreased demand for physical books in the wholesale business. MBS wholesale was also impacted by lower publisher rental penetration than expected due to publishers offering lower-priced loose-leaf and other options. MBS direct sales were 39.4 million, a decrease of 7.4% or 15.8%. Direct sales were impacted by closed stores as well as the industry shift from physical to digital, which includes the use of inclusive access models offered directly from publishers. DSS sales were 5.2 million in the quarter, compared with 5.5 million in the prior year period. The decrease reflects lower sales at Student Brands with weakness as a StudyMode website partially offset by growth in the sales at other in this website like Bartleby Writing as well as foreign language properties. Going forward, we will forego some near-term monetization for some of our websites in our Student Brands portfolio as we publish both free content and premium content to drive SEO for sustainable long-term growth. The consolidated gross margin rate of 24.2% was down slightly from 24.4% in the prior year period. This is primarily attributable to a shift to lower margin digital products and a higher contract cost related to contract renewals and new store contracts. Selling and administrative expenses in the third quarter decrease slightly compared with the prior year period. The decrease at BNC of 2.1 million or 2.3% was primarily the result of decreases in comp store payroll and operating expenses, a decrease in net new store payroll and operating expenses and a decrease in infrastructure costs including LoudCloud digital operations. MBS expenses decreased by 1.1 million or 8.9%, driven by lower payroll and operating expenses. DSS selling administrative expenses of 3.6 million increased by 1.2 million, primarily due to ongoing costs associated with the development of Bartleby as well as cost related to Student Brands and other digital offerings. Corporate services increased by 0.5 million as a result of higher professional fees primarily related to our digital offerings. Given the revenue trends in BNC and MBS, we're focused on managing costs, realizing we're also relying on our store personnel to market and sell new digital offerings. Our cash balance at the end of quarter was 22 million relatively flat to the prior year. There were 70.1 million in outstanding borrowings compared with 113 million in outstanding borrowings in the prior year period. In fiscal 2019, we expect the average debt to be approximately 145 million with the peak borrowings of approximately 250 million fully recognized and repaid during Fall Rush. And with additional borrowings until the end of the fiscal year, this is similar patterns to fiscal 2018. As an indicator of our strong financial position, on March 1st, we amended and extended our existing credit facility for a five-year term through February 2024. Under the terms of the agreement, we will continue to have an asset back revolving credit facility and an aggregate committed principal amount of 400 million as well as the 100 million incremental first in last out seasonal loan facility. Both facilities have slightly more favorable pricing. CapEx for the third quarter was $8.6 million, compared with $7.7 million in the prior year, the increase from the prior year as a result of investments in digital for BNC and DSS. Currently or BNC store count is 773 have opened one and closed one within the quarter. As of today, we have contracts to open additional five stores in Q4 2019 or and fiscal year 2020 with three additional known closings. The net new stores will result in $12 million in estimated annual sales and bring our total store count to 775 locations. Our MBS direct store count is 680 have an opened six and closed three during fiscal quarter. As of today, MBS has contracts to add 11 additional new stores with two closing again in the Q4, 2019 or in fiscal year 2020. The net new stores are expected to result in $1 million in additional annual sales bringing our total store count to 689 locations. For fiscal year 2019, we expect consolidated sales to be in the range of $2.15 billion to $2.2 billion before intercompany eliminations and consolidated adjusted EBITDA to be approximately $100 million. Capital expenditures are expected to be approximately $60 million increasing over fiscal year 2018, primarily due to the Company's investments in digital content required to develop and offer new DSS products. With that, we will open the call for questions. Operator, please provide instructions for those interested in asking questions.

Thank you. [Operator Instructions] And your first question comes from Greg Pendy. Greg, Your line is open.

Can you just give us a little bit of color on, it sounds like Student Brands, did you lose subscribers I guess during the current quarter? And can you guys give us kind of a rough estimate? You told us Bartleby had 50,000, I guess subscribers. Are you ultimately looking to combine the two offerings of the both Student Brands and Bartleby?

Greg, this is Kanuj. In terms of looking at a bundle, it's premature to say, we're going to optimize the pricing plans that has the best use for students. There are different used cases riding in the study subscriptions. I think for the moment, the initial thought is that they remain separate a la carte subscriptions. In terms of some of the weaknesses at Student Brands, some of that's been purposeful as Tom referred to, in terms of the monetization opportunities. So last year, we had things like a for $2 for two essays to promote increasing new subscriber activity. We eased off of that because that actually exacerbates churn later on. So, we were trying to monetize in a more responsible way where we're publishing a lot more content that ultimately that publishing content ranks through SEO. That takes some time for Google to start indexing it and longer term we think with the acquisition of PaperRater, we see that there's a lot of white space and we envision that that business goes back to growth. Tom, I don't believe you disclosed subscriber numbers. So I won't say anything there in terms of that, but overall in terms of writing, we think that a lot of room for -- there's a lot of white space there for students to have not only the existing product attributes, but things will launch in the future like our Triple Play writing, which has other features like plagiarism detection and revision assistance and other writing aspects.

Okay, but is that being pushed I guess in the store as much as Bartleby is? Or were you kind of focused right now -- it's an impressive ramp 50,000, I assume, some of those weren't paying subscribers on Bartleby. But are you also putting Student Brands, I guess, point-of-sale within the stores?

There's good point. We did -- we actually did give preference to Bartleby as a new product. So whereas in the fall, we had marketed the writing product, but our goal is to really accelerate Bartleby. But we're becoming much more segmented where we can do both, we think there's the opportunity to both. But the used case for writing is different than Bartleby study subscriptions. But there was definitely a preference given to ramping Bartleby given it was launched in production.

Your next question comes from Alex Fuhrman. Alex, your line is open.

Would love to get a better sense of the opportunity or perhaps risk ahead, as some of the publishers you do business with are looking to have their top titles available for rental? And it sounds like Barnes & Noble Education is, I think in your words, ready and willing and able to help fulfill these rentals. Are there other companies that you're going to be competing with for some of that business? And can you just talk about the potential that you may be seen or heard from some of these publishers perhaps going direct to the consumer with digital rentals? Just trying to gauge, if we should think about that as potentially an opportunity for BNED or maybe equally as large of a risk?

Alex, this is Mike. It's both, obviously, maybe not obviously, but it is. In terms of the opportunity and MBS being ready and able, they're also under contract with a couple of the large publishers. We released those press releases early last year, as we talked about this. In the last quarter, we anticipated Pearson and McGraw-Hill and they talked about this in their own earnings calls, really rolling out the pub rental program much more fully last fall. Without getting into the reasons why that didn't happen, as we understand them, they're talking about it publicly now in our discussions with them, they're committed to doing it this coming fall. One of the things about this business is that it's, it becomes into kind of big chunks every year the seasons are the Fall Rush in the Spring Rush. There are other things we sell all year long general merchandise et cetera in our e-commerce business. But as you know, a high proportion of revenues and cash flow is earned in the fall and Spring Rush. So the opportunity is for MBS to be the distributor of choice for those two large publishers and possibly some other publishers are those are the two that are really pushing the pub rental opportunity. They've disclosed they'll have over 700, I think of their top titles available for rental. And it's a good opportunity for MBS because and this is a good opportunity for the publishers. MBS interact with about 3,500 stores, including our stores, pallet stores and independent stores as a wholesaler. And as a service provider, we have our systems in 400 of those stores. So from a publisher's perspective, if they want to rent their top titles, they can deal with MBS and get basically one invoice for all that activity for 3500 stores as opposed to for -- to the publishers who really are able -- aren't set up to do the expense themselves, dealing with individual stores and students to rent books, buy them back et cetera. So, we're very confident that as this rolls out in the fall, this will be a good opportunity for MBS as we described in the past. It's not so much of revenue opportunity because we don't take titles of books, so we don't have gross sales price, but we are in a very healthy cash flow from performing these services. I don't know about risk as it relates to others doing this. There are -- IndiCo was doing this, maybe still is or some of the publishers, but I think we're in a better position to render this service than anybody given MBS's capabilities and I'll just leave with that. In terms of publishers going direct, that's been going on for quite a while. One of the ways we try to protect ourselves from that risk is by having exclusivity provisions in many of our bookstore management agreements, not just for physical product on the campus, but also for any additional product that goes through LMS or Learning Management System of the school. And we've been somewhat successful and enforcing those rights. Having said that, obviously, publishers are pushing digital direct as much as they can in many different ways, and there is a risk, it's also an opportunity for us as it creates more digital products to pull our exclusive access pipeline with our digital products. We do have agreements with all three of the major publishers for either inclusive access for digital distribution in the case of Cengage. So as we said in the speech, everything is going digital, everything is going e-commerce, that's what we're emphasizing. And our big emphasis internally is to go faster and more complete to digital as quickly as we can. Having spent that, we still believe there is a fairly long tail on physical book and we're very well to set up almost uniquely provides those services end to end. So, we're full of risk and opportunities, Alex, as you say, but we're really trying to scale the Company towards digital to take advantage of the opportunity that exist with the increased penetrations even though ASPs are going down.

[Operator Instructions] Your next question comes from Karim Foad from Barclays. Karim your line is open.

This is Karim Foad from Barclays speaking. Just two from me. So, how is the introduction of Cengage Unlimited impacted the business? So that's the first one. And secondly, focusing more textbooks, you've mentioned the Spring Rush season initially in February. Has that been weaker than your expectation leading into it?

Can you clarify the second part of the question on textbooks? Would you mind repeating that, which…

So with the textbook sales with the Spring Rush season, has it been weaker than what your expectation were leading into the rush season?

Yes. I think that we said that. It was textbook sales decline slightly higher than we thought. They were going to in the Spring Rush particularly wholesale. We anticipated that MBS would be able to sale through a higher percentage of returns they received in the fall, for example, the demand would be higher than it was. As a retail level, while we expected slightly higher demand, the 4.9% decrease in comp sales that BNC experience was within our expectations and our guidance. Regarding Cengage Unlimited, they're offering subscriptions through physical and virtual campus stores as well as schools and branded e-commerce sites. We understand and agree with the intent of what they're doing, which is to offer more affordable course materials to drive student success and deal with one of the big main points of the student, which is the saving money. Our role just like any other offering from a publisher is to aggregate and distribute Cengage Unlimited. We don't market it as a preference over any other publisher product. We let the students make that choice or the faculty whoever's making the decision, we share. We have an agreement with them specifically on CU where we share in the margin. So we're very happy to help them and students take advantage of Cengage Unlimited.

[Operator Instructions] And we have no further questions at this time. So, I'll turn the call back over to Tom Donohue for closing remarks.

Thank you, Adam, and thank you for joining today's call. Please note that our next scheduled financial release will be our fiscal 2019 fourth quarter earnings call on about June 25th. Have a great day. Thank you.

And that does conclude today's conference call. You may now disconnect.