Barnes & Noble (BKS) Q2 2018 Earnings Conference Call Transcript

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Barnes & Noble (NYSE: BKS)
Q2 2018 Earnings Conference Call
Nov. 30, 2017 10:00 a.m. ET

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Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, please stand by we're about to begin. Good day, and welcome to this Barnes and Noble Fiscal 2018 Second quarter 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.

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Andy Milevoj -- Vice President, Investor Relations

Good morning, and thanks for joining us on our fiscal 2018 second quarter earnings conference call. With us today are 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. And now I'll turn the call over to Demos.

Demos Parneros -- Chief Executive Officer

Thanks, Andy, and good morning, everyone. Today, I'll provide an overview of our second quarter results and discuss some encouraging trends and initiatives that we expect to benefit us in the back half of the year. Our second quarter EBITDA lost $25 million, primarily driven by our 6.3% comp store sales decline and higher clearance, which I'll discuss in just a moment. Approximately half of the comp sales decline was due to comparisons to the Harry Potter release a year ago.

And as we look at the different components of our business, we continue to be encouraged by the improving sales trends in our book business. However, sales trends in non-book categories, especially in gift, continued to weigh on our comp sales trends. To improve our performance in our gift and toys and games businesses, we began to reduce our over-assortment of slower moving, nonreturnable merchandise. This decision is part of our broader strategy to grow sales and become more productive by featuring a narrower product assortment with higher turnover.

Going forward, we will place a greater emphasis on books while further narrowing our non-book assortment. Another area where we see opportunity is cafe. Historically, cafe sales have followed the overall traffic trends in our stores. During the quarter, we began testing bounce back offers on our receipts, directing customers who made purchases to the cafe for a discounted coffee or a buy one get one offer.

As a result of this initiative, for the first time in over a year, our cafe comps were slightly positive in the last month of the quarter. While traffic remains an issue, we are doubling down on our efforts to improve in-store conversion. Through customer research, we discovered that customers come to Barnes & Noble not only to browse and discover but also to interact with our booksellers. This is a big takeaway for our store managers from a recent conference.

We encourage our booksellers to be more proactive with customers and actively engage with them. As a result, we saw immediate improvements in our conversion rate following the conference, with the year-over-year conversion improving 2.7% for the quarter. We also believe this has contributed to the 1.5% increase in comp book sales during the back half of the quarter. Additionally, we're encouraged by some of the tests that are currently under way in our test and learn pipeline.

We are seeing positive traction in our membership tests that are focused on pricing and benefits. This has led to accelerating growth in both new member enrollments and renewals, and we now have over 6.4 million members. Additionally, members in our test stores are lifting sales in both book and non-book categories. Also, as it relates to testing, this month, we opened two new concept stores, one in Plano, Texas; and the other in Ashburn, Virginia.

These stores are part of our ongoing effort to test new concept stores. The Plano store, in particular, is one of our new smaller format, 10,000 square foot prototypes, being tested in the company. We are still learning from all these new stores and -- that we've opened across the country, and we are excited about the knowledge that we're gaining. We also have a strong lineup -- title lineup this fall that began in Q2 and will continue into the holiday season.

It includes Tom Hanks' Uncommon Type, John Grisham's The Rooster Bar, Dan Brown's Origin, Walter Isaacson's Leonardo da Vinci and surprise drop-in title, Darker by EL James. To complement this lineup, we'll also feature exclusive editions of best-selling titles this holiday season, including The Art of Harry Potter, which includes rare and unpublished works of art and is only available at Barnes & Noble; Shea Serrano's Basketball (and Other Things); David Baldacci's End Game; and James Patterson's People vs. Alex Cross, among other titles. We'll also feature authors in our popular Signed Editions program, which provide for unique one-of-a-kind gift.

To help customers find the perfect gift for everyone on their list, we are launching our 12 Days of Inspiration marketing campaign tomorrow. This in-store and online campaign features 12 days of special offers. Additionally, for our online customers, we unveiled a new suite of smart tools to help customers find meaningful gifts online rooted in the bookstore experience of browsing, discovery and bookseller knowledge. Our book draft tool enables customers to discover new titles based on the titles they already like.

Our smart gift tool allows customers to send gifts without worrying if it's exactly right because it provides the recipient with the ability to exchange for similarly priced gift of their choice. And for the digital customers -- digital book customers, we introduced our new NOOK GlowLight 3 device. Beyond these top-line opportunities, we remain laser-focused on cost reduction initiatives that are centered on realizing efficiencies and simplification. As Al will discuss further in just a moment, we expect to reduce costs by $40 million this fiscal year.

This process is under way and has been embraced by our team. As we look to the balance of the year, we are encouraged by the positive trends that have developed during the second quarter and are leading into the holiday season. This provides us with the confidence that we will achieve our EBITDA guidance of $180 million for the year. In addition, we've launched our strategic turnaround plan and expect steady and consistent improvement in the coming quarters.

Now I'll turn it over to Al, who will review the financials.

Allen Lindstrom -- Chief Financial Officer

Administrative expenses of $254 million slightly declined during the quarter. Retail expenses increased $4.2 million, delivering as a percent of sales on the lower sales volume. Store payroll increased as a percent of sales on sales deleverage and higher wages. The current year also includes increased consulting fees to support strategic initiatives, higher employee benefit costs on medical claims and higher eCommerce advertising expenses.

These increases were partially offset by prior year severance charges. NOOK reduced expenses by $5.1 million on continued cost rationalization efforts. The second quarter consolidated EBITDA loss was $25 million as compared to EBITDA of $0.7 million in the prior year. NOOK turned its second consecutive profitable quarter despite lower sales on continued cost rationalization.

The consolidated second-quarter net loss was $30.1 million or $0.41 a share as compared to a loss of $20.4 million or $0.29 a share in the prior year. Turning to the balance sheet and cash flows. The company ended the quarter with $243 million of borrowings, which is reflective of the seasonal working capital requirements of the business. Bank debt is expected to peak at approximately $285 million during the third quarter, flat with last year, under our $750 million asset-backed revolving credit facility.

Over the past 12 months, the company has returned $47 million of its cash to its shareholders and $162 million over the past 2.5 years through its dividend and share repurchase programs. Capital expenditures were $29 million for the quarter, consistent with prior year levels. During the quarter, we did not open or close any stores. Turning to guidance.

We expect full year comps to decline in the low single digits, which is largely dependent on the results from the upcoming holiday season. As Demos discussed earlier, comp sales trends improved post Harry, and we are cycling against last year's headwinds. We expect flat comps for the second half of the fiscal year. We expect favorable book trends to continue and are taking actions to improve sales of our non-book categories.

Our fiscal 2018 consolidated EBITDA forecast is approximately $180 million as we expect to mitigate the sales decline through expense management. Through the first half of the year, our internal EBITDA targets are on plan. In addition, the forecast includes improvements in our eCommerce and NOOK businesses. NOOK EBITDA is now expected to break even for the full fiscal year.

We are targeting over $40 million of cost reductions in fiscal '18. These reductions will come from rightsizing our cost structure, increasing productivity, streamlining operations and eliminating nonproductive spend. Areas of focus include store labor efficiency, indirect procurement, inventory management, supply chain costs, back-office operation and digital synergies. Our forecast does not include potential one-time charges, which may result from our strategic initiatives.

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

Questions and Answers:

Operator

Yes, sir. Thank you. Ladies and gentlemen, if you wish to ask a question, of please signal by pressing *1 on your telephone keypad. Please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, *1 places you in the queue. We'll first go to Alex Fuhrman with Craig Hallum Capital Group.

Alex Fuhrman -- Craig-Hallum -- Analyst

Great. Thank you for taking my question. You know, wanted to dig a little bit more into the forecast for flat same-store sales in the back half of the year. Obviously, it seems like the decline here in the second quarter that you just reported was pretty consistent with what we've seen for the last six quarters in a row.

So it seems like this is a pretty dramatic inflection positive to get up to flat. Can you give us a little bit more color specifically on what you've seen so far in the quarter? Obviously, Thanksgiving weekend is a really important period for retailers and for Barnes & Noble. Can you give us a more quantitative sense of how your business did in November and Thanksgiving weekend?

Demos Parneros -- Chief Executive Officer

Sure. Let me start by just reinforcing the sort of in the quarter trends. Al mentioned that last month of the quarter was the best one, the first was the worst and we sort of climbed out of the hole, obviously not enough given the numbers that we've just shared. But we are pleased, albeit not where we want to be yet, with the trend, not only over the last month but really over the last 10 weeks period.

So things that we are seeing that give us some encouragement here are improvement in the core book business. So what we're calling our trade and children's core business is fundamentally sound and has shown good improvement over the past few months, and we're seeing that come through November and hope to see that through the holiday season. So that's the first. Second, we did comp over the biggest title of the year.

That obviously had a big impact on the quarter, but as the quarter progressed, the impact diminished. And we were at least able to predict how sales would come through, and we feel good that we've performed as we expected, again, albeit not enough. We understood the trend, and it came through as we expected. So the big impact in the quarter for us was, I would say, a fairly aggressive decision to clear through a lot of unproductive inventory that simply wasn't selling and wasn't turning and was -- is just overall unproductive, really taking up space in stores and our DCs.

So tough call to make, but we made the decision to clear through a lot of that. Obviously, that hurts sales. It hurts margin. It hurts expenses.

But we feel like it's the right long-term move to make to set us up for success in the holiday season and then, of course, beyond that. As we look ahead, we've got a lot of initiatives in place. We've talked a little bit about our test and learn pipeline. And while we're not ready for prime time yet, I feel our team's done a very good job at loading up the pipeline with a lot of good ideas.

We mentioned a couple of the wins. Some of the membership acquisition ones, I think, are very good. And some of the new store takeaways are, I would say, very good features for us to consider into our future store build-outs and designs, and ideally, rolling backward into the chain. We're not quite ready to go with that yet, but we're seeing a lot of encouraging signs and we're really happy with the 2 stores that we just opened this past month.

Hopefully, that gives a little bit more color to your question.

Alex Fuhrman -- Craig-Hallum -- Analyst

Yes, I appreciate that. That definitely does give a little bit more color. I guess what I'm getting at is just trying to understand, was the month of November positive for Barnes & Noble in terms of same-store sales? Or is there a little bit of hope and expectation that the sequential improvement you saw in October and November is then going to continue to get better in December and January and that's how you get to a flat comp?

Okay. That's helpful. And then just moving on to the cost cuts, the $40 million, can you tell us specifically what exactly does that $40 million mean? Is that specifically a -- kind of a number for Retail segment SG&A? Just how should we be thinking about that $40 million and kind of where that goes in terms of the financial accounting and just in terms of how we get your guidance?

Allen Lindstrom -- Chief Financial Officer

That's -- Alex, it's Al. That's the full year year-over-year number, including -- it's for the total business. It doesn't -- it's not reflective of future year run rate benefits from any reductions we make this year, so it would just be a partial year benefit if we made the adjustment this year. So it's really just the full year consolidated impact that we're forecasting for that number.

Getting back to the previous point, I just want to make one more point on the comps for the second half of the year. Remember, we're comping against a minus 9% for the holiday period. And if you look at Q2, we were down 6% on a minus 3% from the year before as well.

Demos Parneros -- Chief Executive Officer

And Al, if I can just add on to your other point to the expense question. The way that we're looking at the expense initiative here is -- our team's really focused on this. I think they've done a nice job of coming together to understand what needs to happen here. The business has fundamentally changed over the last couple of years.

And our old operating model just simply isn't working as well. And so we're taking a hard look at this. So as an example, we have a new store labor operating model that was developed by our store's team. So this is not a top-down, beat it down kind of initiative.

This is something that was built by the team that actually is responsible for delivering this result, and that fairly yielded good savings. We talked about the inventory a little bit with the clearance. That has caused a lot of unnecessary costs, not only at the DC logistics costs but also within store labor, not to mention opportunity costs of selling more. So there's a couple -- the indirect piece, as Al mentioned, is one that we just simply haven't spent much time with.

So those are just three, four examples of the plan, and we feel like we've got a good path to get there.

Alex Fuhrman -- Craig-Hallum -- Analyst

Thank you very much.

Demos Parneros -- Chief Executive Officer

Thank you.

Operator

The next question comes from David Schick with Consumer Edge Research.

Dave Novak -- Consumer Edge -- Analyst

Good morning, this is Dave Novak for Dave Schick. Our question is on price. Can you talk about how you feel broadly about your pricing in stores and online relative to the competition? And we've seen retailers in other industries start to move toward price matching over the last few months. Is this something that you would consider?

Demos Parneros -- Chief Executive Officer

Sure. Thanks for your question. We spend a lot of time thinking about price, but really, we spend more time thinking about our overall value proposition and who we are and what our customers are looking for. So we're not -- our strategy is not to fight on price every day, though we understand the importance of price.

So I would say that -- we work backward with your question. Our online price is fairly consistent and, I'd say, very, very competitive with our online competition. There might be a slight difference here and there, but for the most part, we think it's minor. With respect to our stores, we don't have pricing that is the same as our online pricing, although many of the items are the same.

For new release books, new titles are very, very competitively priced. If you are one of our 6.4 million members, you get an additional 10% off that. Our members love the program, and they see the value in the program as we see strength in our member sales versus our nonmember sales. There's also quite a bit of promotion that goes on throughout the year.

Certainly, this is one of those times of the year where customers are actually able to apply additional discounts on top of the everyday discount structure that we have. And then lastly, with your question on matching, we don't have a match program at the moment. I will say that that is one of the tests that's in slate right now, and that's been in place for a couple of months. We expect to wrap that up over the next two months and then we can make a call on that one.

Dave Novak -- Consumer Edge -- Analyst

Great. That's helpful, thanks.

Operator

The next question comes from Greg Pendy with Sidoti.

Greg Pendy -- Sidoti -- Analyst

Hey, guys, thanks for taking my question. I just wanted to dig into the comments you made around gift and toys. And how should we be thinking about that if you do sort of pare back in those categories to focus a little bit more on books just from a margin perspective? And then in addition, how does that play into -- with the opportunities you have on the leases, about 20% rolling off every year, is that something you might be testing more stores in a smaller footprint if there's an opportunity with pretty much a much heavier focus on books?

Demos Parneros -- Chief Executive Officer

Sure. That's a great question, one that we've asked ourselves, actually, quite a bit. It's on a couple of the important issues that we're wrestling. But let me start backward.

So the first thing I'll say to the last part of your question is yes, we are definitely interested in smaller stores. Irrespective of the mix of product inside the store, we believe that our store base today is too big at roughly 26,000 square feet per store, and we believe that the future store format will be much smaller than that. In fact, we're designing multiple sizes of stores, more to come on that. Actually, one last thing on that before we move to the question about assortment, is one of the great things about the 5 test stores that we've opened, 3 that have been opened now for, I don't know, between 6 and almost 12 months and then the 2 brand new ones that have just opened, is that they all represent a little bit of a different look and feel from a bookstore size and then, of course, look and feel.

They all have the consistent look and feel, which is our new look that we're thrilled with and more importantly, customers love and are giving us that feedback. But we actually have store sizes ranging from roughly 5,000 square feet all the way up to 20,000 square feet. And so that gives us a really good opportunity to study space productivity options within the assortment of each of the key categories, where we have to make trade-offs. Clearly, we're going to prioritize books first, and then as space permits, we'll go into our gift and educational toys and games category.

So as leases roll, you're exactly right, it's about 120 plus or minus a little bit per year. Our real estate team and our store's team is squarely focused on making the best decisions for the long-term and really taking a hard look at the performance and productivity of each of the stores. If a store is an underperformer, we won't hesitate closing it. Our goal, as we stated at the last meeting, is to be net positive in stores starting next year.

So our preference is to relocate or downsize if that's possible and then give customers a brand-new store that's exciting and different and reflects our newest thinking. Hopefully, we can strike the perfect success formula with one of our five. But based on what we've run so far, my feeling is that it will be a combination of the things that we've learned from those stores plus our existing stores. So we actually view the renewal process of the 120 per store as a key advantage for us.

It really puts us in a good position to be selective. And we're starting to study -- we've begun already, actually, studying the network impact within the overall portfolio for each of the markets that come up for renewal. And then lastly, as it relates to the decision on focusing more on books, it's simply who we are. I mean, that's our heritage.

That's what customers expect from us. If in doubt, we go and listen to our customers. We've been listening very carefully to our customers for many, many years. We've done recent research that reinforces and validates that.

And we want to be the best at selling books. Our publishers are right there with us. They've been great partners. Our booksellers share their feedback with us, and we know it's the right decision.

With respect to space for gifts and -- educational toys and games and gift, we actually have plenty of room in the stores. We just have to do a better job with our selection of products, and we have to stay focused to who we are and what the brand represents to our customers. So we feel that we got a little bit off track and we felt like it was the right thing to address that, and that's why we cleaned up and are in the process of cleaning up a lot of that inventory. So we still will be in those businesses, we'll just be in a better and more focused way.

Greg Pendy -- Sidoti -- Analyst

That's really helpful. Thanks a lot.

Demos Parneros -- Chief Executive Officer

Thank you.

Operator

And once again, as a reminder, it is *1 to be placed into the queue. At this time, we next move to Neil Tena with Eos Capital

Neil Tana -- Eos Capital -- Analyst

Just following up on a previous question on the lease rolling. Do you think that as you kind of downsize and things like that, that part of the conversation would be to kind of potentially like work to reduce rents and things like that and other trade-offs in terms of how you kind of think about your real estate portfolio?

Demos Parneros -- Chief Executive Officer

Sure, Neil, forgive me, we're getting a lot of static, so just bear with us.

Andy Milevoj -- Vice President, Investor Relations

And Neil, it's Andy. Would you just mind putting your line on mute while we respond due to the static? Thank you.

Demos Parneros -- Chief Executive Officer

Okay. Hopefully, you can hear us. We can now -- we actually have a clear line now. So -- and I apologize.

I think I've got the question. But with respect to the leases, our approach with the leases is to be much more ahead of the game. So if our leases do in a year or two from now, we're starting to think about that. But we've actually started to think about that already.

So our team basically is taking a 3-year look at this. And so we're looking at the next 120 times three years. So that's about 350 stores in play that we're looking at right now. We look at them both individually one by one and [indiscernible] and also the impact they have on the portfolio within the market they live in.

And we'll make the best decision for the company. We'll use capital the best way possible, deploy a lot of our brainpower and analytical rigor to do the right thing. Our goal is to get smaller. We want to have smaller stores that are more efficient, that require less inventory but actually have better in-stock and better discovery for customers.

So we want to have actually a better store even though it's a smaller store from a square footage standpoint. And as it relates to the rent, I think you asked about can we get -- obviously, we'll be paying less rent because we're going to be taking, on average, I would say, 40% to 50%, sometimes even more percent less square footage. So it's not quite cut the footage in half, get half the rent, it really depends on the individual location. Obviously, the more we can save, the better.

But we're also looking at ways to be efficient in our store designs and be much more modular and flexible so that we can make changes in a fairly affordable way. So I hope that catches all the parts of your question.

Neil Tana -- Eos Capital -- Analyst

Yes. Thank you. Sorry about the static.

Operator

We'll take our next question from Randy Baron with Pinnacle Associates.

Randy Baron -- Pinnacle Associates -- Analyst

Hi, good morning. I have two questions on the financial statements and then just a broader administrative one. On the balance sheet, debt was a little higher than we had modeled at $240-some-odd million. I understand that's seasonal, but I'm just curious if you could walk me through kind of why debt was $50 million higher than last year and what kind of management's leverage targets going forward.

That's the first question.

Allen Lindstrom -- Chief Financial Officer

So the reason debt is a little bit up over last year is, obviously, our earnings are down a little bit. We've returned cash to shareholders via dividends over the past fiscal year, and you're also going to have, especially at the end of the second quarter, a timing of impacts to your purchases, your payments, and your returns. We feel that our AP ratio was a little bit lower than last year, so that actually has an impact as well. In my comments, I did note that our debt peak -- we expect it to peak this year at $285 million in the third quarter, which is flat with the prior year, so there is a little timing in there as well.

Randy Baron -- Pinnacle Associates -- Analyst

Okay. And then long-term leverage targets, is that something you can talk about?

Allen Lindstrom -- Chief Financial Officer

Yes, we typically don't guide to long-term leverage targets. We are just going to manage the business as we see appropriate using our revolving credit facility and seasonality of the business reflective in the quarter.

Randy Baron -- Pinnacle Associates -- Analyst

Okay. And then just turning to the P&L. First half, $40 million loss in EBITDA. You need $195 million or $200 million to hit guidance.

But you mentioned that's going to be excluding one-time charges from strategic initiatives. I'm just curious, generally speaking, what those initiatives could be and what the magnitude of them, ballpark, could be.

Allen Lindstrom -- Chief Financial Officer

We haven't identified those charges because we would have disclosed -- and had we identified those already, we're just calling those out should we have to take any actions to hit our numbers. We're going to do what we think is right for the long-term business in terms of reducing expenses. So if there are investments we need to make in order to save and manage our expenses more judiciously, we're going to do it.

Randy Baron -- Pinnacle Associates -- Analyst

Okay. That's great. And then lastly, understanding that it's only been two weeks, I'm just curious what the status is of the dialogue with Sandell. Has there been any follow-up from either party since the press releases? Thank you.

Demos Parneros -- Chief Executive Officer

There's really not much to say on it. I mean, we have made a statement as a result of their proposal. And at this point, don't really have much else to say.

Randy Baron -- Pinnacle Associates -- Analyst

Okay. But I'm just curious if there's been any -- so there's no comment that there's been any follow-up at all from either party.

Demos Parneros -- Chief Executive Officer

Correct.

Randy Baron -- Pinnacle Associates -- Analyst

Okay. Thanks.

Demos Parneros -- Chief Executive Officer

Thanks, Randy.

Operator

It appears there are no further questions in queue. At this time, I'd like to turn the conference back over to management for closing remarks.

Andy Milevoj -- Vice President, Investor Relations

Great. Thank you, everyone, for joining us on today's call and for your interest in Barnes & Noble. Our third quarter earnings release will be released on or about March 1. We hope everyone has a good day and a great holiday season.

Thank you.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. We thank you for your participation. You may now disconnect.

Duration: 35 minutes

Call Participants:

Andy Milevoj -- Vice President, Investor Relations

Demos Parneros -- Chief Executive Officer

Allen Lindstrom -- Chief Financial Officer

Alex Fuhrman -- Craig-Hallum -- Analyst

Dave Novak -- Consumer Edge -- Analyst

Greg Pendy -- Sidoti -- Analyst

Neil Pana -- Eos Capital -- Analyst

Randy Baron -- Pinnacle Associates -- Analyst

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