Barnes & Noble Education, Inc. (BNED) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Barnes & Noble Education Fiscal 2020 Second Quarter Conference Call.At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator instructions]I would now like to hand the conference call over to Tom Donohue, CFO. Thank you. Please go ahead.

Thank you. Good morning and welcome to our fiscal 2020 second quarter earnings call. Joining us today are Mike Huseby, CEO and Chairman; Barry Brover, EVP of Operations, Kanuj Malhotra, President of Digital Student Solutions, as well as other members of our Senior Management team.Before we begin, I'll 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 -- for the property of Barnes & Noble Education and are 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 risks 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, and thank you all for joining us today. As you saw in this morning's press release today, we announced that BNED's Board of Directors has approved the engagement of a financial advisor to assist with the evaluation of a range of potential strategic opportunities. This review will help position BNED to be able to deliver more immediate benefits for the institutions and students we serve and allow for the exploration of all strategic paths to enhance shareholder value.The higher ed industry we serve has significantly transformed over the past few years, including a rapid shift to Digital, declining enrollments, student retention issues, and an increased focus on affordability. Our strategic initiatives are centered on addressing affordability, access and achievement, and include growing our high-margin DSS business by introducing and scaling bartleby subscriptions, growing our share of course material adoptions through BNC FirstDay and other new digital models, stabilizing and now increasing revenue from new business wins to grow our footprint of managed stores and strengthening and growing our general merchandise business.The operational highlights in today's press release, provide evidence of our progress on each of these priorities. Our strategy is being validated daily by the markets we serve. However, we need to accelerate the execution of our strategy in order to more rapidly deliver value to our customers and to enhance shareholder value. We believe that more aggressively exploring strategic opportunities will help facilitate this acceleration of value creation.The past few years have been a disruptive time in the course materials marketplace as evidenced by trends seen in our own business as well as those disclosed by the large publishers. Course material sales declined 7.7% on a comp basis for the quarter, a slight improvement over the rate of decline in the prior year period. The sales decrease was primarily due to price and volume declines, with approximately 40% of the decline attributable to price declines.We are moving to digital delivery models of course materials as rapidly as the market demands and allows. As we are able to scale digital delivery, we expect our share of courseware delivered to students to increase while fulfillment costs should ultimately decrease dramatically to mitigate lower unit pricing impacts. For example, our FirstDay digital models are now able to very effectively address demands from our campus partners for affordable and accessible courseware, while at the same time substantially improving the total financial contribution to our schools and to BNED.We continue to see increased market adoption with revenues from FirstDay increasing 93% year-over-year. As we saw with certain pilot schools this fall, our new FirstDay complete packages and pricing will result in a true win-win-win for our institutional customers and their students, BNED and the publishing partners who collaborate with us. Students enjoy significant courseware discounts while penetration is approaching 100% of adoptions, provide BNED and our campus partners with substantially improved economics.Tom will give more detail on how strong these improvements are. This past summer, we also announced a new important strategic partnership with VitalSource, which will now power the technology enabling our FirstDay platform. Transitioning our platform to VitalSource's technology allows us to accelerate and optimize FirstDay implementations.This partnership drives substantial efficiencies related to the development and maintenance of our platform technology and will enhance value for our partners by offering new functionality and expanded content offerings. Most importantly, it's a true long-term strategic partnership which allows us to more rapidly and effectively deliver the benefits of FirstDay packages and pricing to our customers. While, digital courseware delivery is increasing, evidence persists that there is still a strong appetite to learn using the physical book. Our annual student pulse survey received responses from more than 100,000 students, 96% of those students told us that they find print textbooks to be a helpful resource. Our ability to service the full supply chain of both digital and physical courseware and to package them together as we did this past fall in our FirstDay complete offerings is the strength that we have that is unmatched by any of our competitors.We are also driving further value for institutions through products and services such as the introduction this fall of our BNC Adoption & Insights Portal or AIP, our new internally developed platform for faculty and academic leadership to submit and monitor course material adoptions. Our AIP has had significant benefits for the pilot schools that have been using the platform to date and has also generated very strong interest with new business opportunities.Our AIP platform has enhanced the value of our service to clients by significantly streamlining the process of course material selections for faculty and providing much needed visibility for academic leadership to support compliance, affordability initiatives, and student success. It also provides data to ensure that adoptions are being submitted and recommended in accordance with the affordability and other objectives of the schools that we serve.In the schools where we've implemented AIP, we both collected more course material submissions and received them earlier in the process. As one example, a four-year public large institution where AIP has been implemented, we've received almost 40% more course material submissions to date, at other institutions, the tool has already helped facilitate a 100% submission rate across all courses. This will translate into the ability to offer students more affordable content and greater selections in our stores, which we expect to drive unit sale increases for these schools starting in the upcoming Spring 2020 term.The value that we provide the institutions is important to focus on as we seek to grow our store footprint, which remains a critical asset in our current and future success. Our access to more than 6 million students and even more through our e-commerce sites is an unmatched sales channel for both our retail and DSS businesses, which is why we are focused on expanding our footprint of managed stores.We have made great strides in winning new business this year, year-to-date with five months still remaining in fiscal year 2020, we have contracts to open approximately $97 million of new business gross sales for 36 million net after store closings. By comparison in fiscal 2019, new business gross sales net after store closings were 12.8 million. Within DSS, we saw the power of our footprint throughout the past two rush periods as we've concentrated on the in-store and online sales of our bartleby suite of services.Fiscal '20 to-date, including the month of November, we gained over 100,000 gross bartleby subscribers representing over 100% growth compared to approximately 50,000 subscribers gain during the spring 2019 term. Considering that, bartleby has been marketed in our footprint for less than a year, we are very encouraged by the continued momentum and a focused effort of our teams to accomplish this important goal.We remain very proud of our differentiation and offer the product more focus on providing how to learn, by merely providing answers or shortcuts to the learning process. With a spring and fall Rush period behind us, we have learned a great deal and plan to move forward with even more efficient sales efforts.Bartleby is quickly becoming a strong suite of products offered at disruptive price points and the results we've achieved with bartleby thus far confirms our commitment to our direct to student strategy. Additionally, we've seen becoming an increasingly important channel of customer acquisition throughout the fall semester, and we expect this channel to be an increasingly significant source of customer acquisition beyond our physical distribution over the coming quarters.In addition to direct student sales with a truly unique opportunity to scale bartleby through institutional offerings, including bundles with our FirstDay offerings. We've added new dedicated talent to the team, and we look forward to providing updates to you on this exciting initiative. We feel confident in our ability to scale bartleby, ensuring we are best serving today's students and providing them with academic support, anytime and anywhere. Within our stores, we've continued to make enhancements this quarter to ensure we're strengthening our general merchandise business and enhancing retail experience. We continue to see the success of our concept shops, which are now at more than 70 campuses nationwide.This includes trend-based concept shops, such as those centered around Game day or graduation, as well as brand based concept shops, such as those featuring Urban Outfitters, live in 10 of our stores or Champion merchandise. Additionally, we continue to make progress developing our NextGen e-commerce platform, which we expect to fully launch in fiscal 2021. Our new e-commerce platform will provide a hyper local personalized shopping experience for all customers and ensure that we provide a best-in-class omnichannel experience for the campus communities we serve. Which should resolve the increased sales for us and our partners.In a short period of time BNED has accomplished a tremendous amount and undergone incredible change, as a service provider that exists at the intersection of students, faculty institutions publishers, it has been critical for us to evolve, to best service industry as our value creation center scale including high margin DSS offerings, increased omnichannel general merchandise sales, and scaling more profitable and more affordable digital courseware packages, we expect their contributions to our operating results to first stabilize and then grow our EBITDA, helping to reverse the trend of recent years as EBITDA has declined with courseware sales trends.We are also managing our cost structure as prudently and efficiently as possible for the sense of urgency. We're very confident in initiatives we have set forth to ensure we can serve the market where it is today, and where it's headed in the future. Now our focus is on moving as quickly as possible to implement and scale these initiatives. We believe that, by providing greater value to our customers through all our offerings we will in turn significantly enhance shareholder value. We've seen the impact of our solutions at each and every campus we serve, and we're helping to drive affordability access and achievement, we are proud to work toward such important missions.We've already made great strides in driving value for both students and institutions and now we are poised to have that translate into our operating results going forward and to translate into enhanced shareholder value. With that I will turn it over Tom for the financial review.

Thank you, Mike. Please note that the second quarter ended on October 26, 2019 and consist of 13 weeks. All comparisons will be in the second quarter of fiscal 2019, unless otherwise noted. Total sales for the quarter were $772.2 million compared with $814.8 million in the prior year. This decrease of $42.5 million or 5.2% was comprised of $42.1 million decrease from the retail segment and $0.6 million decrease from the wholesale segment partially offset by the $0.3 million increase from the DSS segment.Comparable store sales in the retail segment decreased 5.9% for the quarter as compared to a decrease of 5.8% in the prior year period. Comparable course material sales for the quarter decreased 7.7% as compared to a prior year decrease of 8.0%. Course material sales continue to be impacted by lower average selling prices, with approximately 40% of the decrease in the quarter due to lower pricing.Course material sales were also impacted by enrollment declines and student purchases from publishers directly as well as other online providers. As we continue to scale our FirstDay inclusive access programs, we expect the model for our course material sales to change and ultimately stabilize. As we move to digital course material sold through the FirstDay program bookstore marginThis will slightly decrease but we'll sell through -- but the sell-through will increase from approximately 35% to almost 100%. The commissions we pay to the schools will also decrease. We believe these increases in sell-through in volume will help stabilize the course material declines we've experienced in recent years.General merchandise comparable store sales for the quarter were essentially flat decreasing at 0.1% compared with a 1.8% increase in the prior year. Net sales for the wholesale segment were $40.2 million, a decrease of $0.6 million or 1.5% compared with the prior year period. The decrease is primarily due to the decrease in supply and the decrease in customer demand, including our own retail segment.DSS sales were $5.2 million in the quarter, an increase of $0.3 million or 5.7% as compared to the prior year period. The increase is primarily due to the increase in sales of bartleby subscription. As Mike previously stated, as we scale this business, the high margin contributions from DSS will be an important factor in stabilizing and then growing our EBITDA, helping to reverse the trend of recent years of EBITDA declines as it has declined with our courseware sales.The consolidated gross margin for the quarter was 24.3% down from 25.9% in the prior year period. This is primarily attributable to the decreases in the retail segment related to the shift to lower margin digital products and higher markdowns as well as higher costs from our college and university contracts.Selling and administrative expenses in the second quarter decreased by $1.9 million or 1.7% compared to the prior year period. The decrease in the retail segment of $2 million for quarter was primarily the result of decreases in physical store payroll and operating expenses as well as corporate payroll. Partially offset by increases in infrastructure costs, and product development costs. Wholesale expenses decreased in the second quarter by $0.8 million, primarily due to lower payroll expenses and operating expenses. DSS Selling and administrative expenses increased in the quarter by $1.2 million, primarily due to ongoing costs associated with the development of bartleby.Corporate Services in the quarter decreased by $0.3 million as a result of lower compensation-related expenses and lower operating expenses. Our cash balance at the end of the quarter was $24.6 million, an increase of $4.6 million as compared to $20 million in the prior year period. There were no outstanding borrowings in the quarter, the same as the prior year. Our current and projected liquidity remained strong despite declining sales trends in physical course materials and the significant investments we are making inStrategic change initiatives. We continue to expect free cash flow to be in excess of $25 million to help finance these initiatives. In fiscal 2020 we expect the average debt to be approximately $115 million, compared with $143 million in the prior year. Our peak borrowings of approximately $200 million were hit during the summer and fully repaid during the fall rush. We expect additional borrowings until the end of the fiscal year and a similar guidance of fiscal 2019. CapEx for the second quarter was $10.9 million compared with $14.9 million in the prior year.Currently, our retail segment operates 1,436 college University in K-12 school bookstores, comprised of 772 physical bookstores in their e-commerce sites, as well as 664 virtual bookstores. As of today, we have contracts to open an additional 21 stores in fiscal 2020, with four additional loan closings, this will bring our total physical and virtual store count to 1,453 locations, net of closed stores. While our new stores are typically EBITDA positive when we sign the contracts, it typically takes a new store, approximately 18 to 24 months to fully mature to reach a comparative EBITDA margin.For fiscal year 2020, we expect consolidated adjusted EBITDA to be between 85 -- $80 million to $85 million, capital expenditures are expected to be in the range of $40 million to $50 million, and we continue to expect free cash flow to be between $25 million and $35 million. The Company defines free cash flow as adjusted EBITDA less capital expenditures, cash interest, and cash taxes.With that, we will open the call for questions. Operator, please provide instructions for those interested in asking the question.

[Operator instructions] Your first question comes from Ryan MacDonald with Needham. Your line is open.

Yeah, good morning everyone and thanks for taking my questions. I guess just first off, talking -- touching on the strategic review. Can you just maybe talk about sort of what you felt really changed in the business, I guess, when we look out the past three, six months versus today to really, I guess change your viewpoint on sort of pursuing, I guess or at least considering strategic alternatives.

Yeah, hi, Ryan. It's Mike Huseby, I think probably the main thing and I alluded to it in the call that we've put in the various releases, the level of unsolicited inquiries we've had from potential strategic partners, whether they're strategic partners from a commercial sense that would improve our competitive position or financial players I think all of whom see that there is – based on public stock price, there’s a lot of value in the assets that we have given the relationships we have with schools, the contracts, and the terms we operate under as well as how MBS and BNC are starting to work together, and we're putting those two companies together and the upside of DSS, so they see a lot of, a lot of upside in the asset. Obviously the time horizon for that is something we talk about, but that's the main thing I think that changed, and the volume of those inquiries that we are handling in terms of trying to educate potential strategic partners that can help us accelerate our strategy or pursue other strategic paths has increased, and at the board level, our discussion has been well. Because of that, it's probably time to -- for the Board to get some independent advice from a financial advisor on the various opportunities and alternatives that are available as we said in the release. That's probably the main thing that's changed.We haven't changed our strategy, it's the same as it was six months ago as we said, -- what also has changed now, I think is that we actually have things that are done instead of just things we're talking about, we've actually -- we have tools in place like AIP and offerings in place like FirstDay Complete that have been piloted, and we see how they work and how they can contribute to the financials, improved results and improvement of our financial results longer term. These new packages and pricing models, as well as some of the other DSS bartleby starting to scale and instead of sitting here like we were nine months ago talking about all the great things we can do, we've actually done them now, and tested them, and we have -- more interesting things to actually show, specific things to show to potential strategic partners.So I think the financial advisor, to ask your questions is Board decision, and it's based on -- let's put a structure in place to deal with all this. We want management to keep going and doing what it's doing, not be distracted, and since there is so much interest let's see what the best way is to optimize shareholder value and accelerate strategy.

Got it, that's super helpful. Thank you. I guess just switching over into the bartleby business now, great to see you exceed 100,000 subscribers year-to-date. They are obviously -- you're gaining some nice traction in the marketplace. Can you talk about sort of what you're seeing in terms of mix of how you're attracting students to the platform, is it more, would you say it's more heavily weighted towards online channels or are you seeing a benefit or impact from the in-store and the college Bookstore footprint that you build.

Hey, -- Ryan this is Kanuj. The primary acquisition channel still remains the college stores, which is comprised both of our physical store footprint we sold at point of sale in the stores and websites we operate on behalf of our student partner , and the half of our stores and the stores are still the primary -- in-store, the primary source of acquisition. SCO is starting to build as Mike referred to in his speech. That is a longer-term strategy and institutional. The other thing, we haven’t really started to focus on, but right now it's primarily in store.

That's very helpful. And in terms of what you're seeing, I guess obviously it's still very early, and sort of as you're building this business, but maybe you can talk about sort of a combination of Spring semester, and what you're seeing thus far in Fall semester, what are you seeing in terms of sort of usage or average utilization from students with bartleby.

I mean, we're seeing increased usage and time on the platform for the active users, receive increased, people really focusing on the question and answer capabilities. So, as you get into Exam peak periods, we've seen very peak usage in and around mid terms, even now as we're heading into final exam season, you can see the question volumes peak, so the usage is continuing to increase, the content leverage continues to increase, and time on site is increasing. So all leading indications and KPIs related to usage are trending very nicely and frankly ahead of where we would have thought.

Excellent. And then just one more for me. And just, I guess maybe it's more of a broader macro question here. Recently, there was some announced price increases at Cengage. I think in early November, that they were sort of pushing to college bookstores. Can you talk about what sort of impact this could have on the retail business for Barnes & Noble and how this potentially impacts your viewpoint moving forward on the potential merger between Cengage and McGraw-Hill? Thanks.

Yeah, that's a pretty broad question, involves more than Cengage. I think it, Ryan, this is Mike. And I'll let, Barry to chime in on this as well. But the publishers, and their pricing has been kind of all over the place. There's a lot of competition from different providers that they and we haven't experienced in the past and I think they tried a lot of different things, and I think that this is another example of something else.Ryan, I think that, you know I don't want to comment on the proposed merger that's under regulatory review between Cengage and McGraw-Hill, we're relatively agnostic when it comes to the publishers. Our job really is we are an extension of the schools that we serve, which they hire us to go out and procure the content. So, we're an agent of the school, we operateContract. So that's an important thing to understand and when things come out in the press, like they did today, where and others are taking positions on the merger because they're citing some of the practices that's engaged and others are engaging on pricing, I mean those can be looked at in a number of different ways, but ultimately the prices can't -- the prices can go down and maintain ala carte pricing forever. So that's why, FirstDay inclusive access makes so much sense, is that by bundling -- and by bundling curriculum into an inclusive access solution the penetrations go up, not just for us but for the publishing partners that we work with. And the schools who share net revenue and the beautiful thing is that the students end up getting substantial discounts, say 30% discounts on average, on what we've seen thus far.And, so it works for everybody so for a publisher, whether it's Cengage or someone else, let's say the bookstore, set's the price, that's really not the case. We don't set the price, the price is set by the publisher, we share and -- we share the margin and that how -- but at some point in time, something if they're going to meet the objectives of affordability from the schools, which we're very focused on, we think the best solution is to try to collaborate with the publishers.As we're doing in many cases and as our clients are demanding, which is really the important point is that this is what our customers want, our customers are under all kinds of financial pressures of their own and they are under pressures to deliver affordability and better curriculum and what we're hearing and we interact with our customers, our schools at the highest levels, including faculty, but also with the administration, the profiles, etcetera, because they want these kinds of packages that gives students substantial discounts and they don't want to have to deal with all the different pricing schemes that various publishers are trying to throw at this students and the faculty and in many cases confusing them.So it's our challenge to work with the publishers, during this changing kind of transformative environment to make sure they understand what our customers want and that we're representing our customers and that in our footprint of managed stores the best thing for them to do is to listen to the customer and work with us.

Your next question comes from Greg Pendy with Sidoti. Your line is open.

Hi guys, thanks for taking my questions. Can you share with us any color, just where community colleges are at within the portfolio just assuming they are probably taking a bigger portion. The brunt of the enrollment declines and probably have a lower merchandise mix. Any color there, on how that's doing versus the tip course , say four-year colleges.

Yeah. Greg, community colleges, continue to be. This is Barry Brover, continue to be in the low 20% of our total portfolio. You know -- we actually seen, well more than two down in many of our community colleges, we've seen improvements in the trends, on -- has we've been able to implement significant FirstDay programs that have really made a difference as far as increasing our market share and growing our course materials business.

I think, Mike said it well. I mean, our number one priority is Focus is developing more affordable solutions for cost materials , working with the publishers and with our schools. We've made some tremendous progress this year with the growth of our FirstDay, program and the introduction of our FirstDay complete, in meetings with our clients and our customers, we realize that their, number one priority. We believe we have the tools, the systems and the people and wherewithal to be able to respond to that. And ultimately that will drive increased volume. As Tom, talked to relative to the future of course materials. Okay, great.

Greg, just. Sorry this is Tom. Just, the Community college represent usually around 25% of the total revenue. It's probably closer to 20% or 21% now.

Okay. And I guess just bigger picture, they're been early adopters and some of your offerings. Correct? With the terms of. Okay, got it. And then just, I guess just moving on to, just one more, just on the textbook solutions, when you said it peaked at 100,000. Any color on maybe writing solutions offerings where that's -- where the subscriptions are on that. Or is that included in the 100,000.

No, it's not included in 100,000 just to be clear the 100,000 is our gross acquisition, so it's not of any current activity. So, we haven't disclosed sort of the gross subscriber activity for the overall writings business. We also, just to be clear the routing solutions business, the assays business, we bought with student brands as one, but we also, this semester soft launched, part of the writing and we had very good reviews, but an aggressive marketing push of action we expected in the spring, but we haven't disclosed that number, Greg.

[Operator instructions] Your next question comes from Alex Fuhrman with Craig-Hallum Capital. Your line is open.

Hi. Thanks for taking my question. I wanted to ask about some of the partnerships that you've launched recently, Urban Outfitters, AT&T, champion. Can you talk about how some of those partnerships are going, what the potential might be to scale those up to more locations and then just thinking about your portfolio of college bookstores here, how many of those locations are candidates to have that type of partnership do you think.

Hi Alex, it's Barry Brover. I will take a shot at it, those programs are very exciting for us. The concept shops, which are champion as well as just graduation and other stream type merchandise has done a great job of bringing back excitement through visual merchandising into our floors increasing foot traffic and giving us great reviews from our clients and our customers, as well as our vendor partners.Urban Outfitters was a great opportunity, it's sitting in 10 stores today again great excitement, great media, great for us traffic in the store, certainly you would imagine that, that is -- resonates very well in a large state or private school, probably not the most relevant in the community college, but we may have other program, so we continue to look to expand our network of vendors and suppliers that want to showcase their product to the 18 to 24 year old both in-store and online, and are very excited about the impact it's having through our business and how it's transforming the whole retail experience in our stores.

Yeah, thanks. To answer the question. h the question directly. This is Mike, I mean, the each -- as Barry saying he answered it very completely, I think, but each store is different, each school is different and there -- as you are saying and implying some larger stores lend themselves to the real estate that's available, et cetera lend themselves to partnerships that you don't necessarily, as Barry said have another other stores.But that's the point, as we try to treat each partnership differently in terms of selling very clear targets with them and expectations in KPIs as about so the expectations I think has been met in every case this year, of all the things that we tried, we said on the speech that, stores are about 70 stores. So that -- that's a pretty good representation…

Distribution. So we can gather the data and see whether or not we want to expand that into more stores at a different level. So for example, smaller, smaller footprint that type of thing. But, yeah.

And just taking on to that. Alex, what we're also piloting, is a more streamlined version for our community college, that has a different customer base. So more of a concept and presentation style that's more aligned with a community college customer, and over time as course materials, the physical footprint required decreases with more things going digitally.

It certainly opens up the opportunities to the space for us to be able to bring in more concepts, more products and really make this a retail destination spot for the community.

There are no further questions queued up at this time. I'll turn the call back over to Tom Donohue.

Thank you and thank you for joining today's call. Please note that our next scheduled release will be our fiscal 2020 third quarter earnings call, on or about March 3, 2020. Thank you. Have a good day.

This concludes today's conference call. You may now disconnect.