Earnings Call Transcript - BNED Q3 2023

Operator, Operator

Good afternoon. Thank you for attending today’s Barnes & Noble Education Fiscal 2023 Third Quarter Earnings Conference Call. My name is Hannah, and I will be your moderator for today’s call. All lines will be muted during the presentation portion of the call, with an opportunity for questions-and-answers at the end. I would now like to pass the conference over to our host, Hunter Blankenbaker, Vice President of Investor Relations. Please go ahead.

Hunter Blankenbaker, Vice President of Investor Relations

Good morning, and welcome to our fiscal 2023 third quarter earnings call. Joining us today are Mike Huseby, CEO; Tom Donohue, CFO; Jonathan Shar, Executive Vice President, BNED Retail and President Barnes & Noble College; and David Henderson, President of MBS. Before we begin the call, I’d like to remind you that statements we make on today’s call are covered by the Safe Harbor disclaimer contained in our press release and public documents. Contents of this call are 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 make 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. And now, I’ll turn the call over to Mike Huseby.

Michael Huseby, CEO

Thanks, Hunter, and good morning, everyone. Thank you for joining us today. I want to start today’s call by thanking our BNED team members. When I consider our journey over the last three years, the operating environment has been anything but predictable or easy. While we are certainly seeing some green shoots, we are still well below pre-pandemic enrollment levels. Nonetheless, our teams have adapted and responded with resolve and innovation to an array of challenges and actions we have taken to meet them, including a significant reduction to our headcount in December. Despite the uncertain macro environment and specific challenges we address, our team continues to rise to the occasion every single day to deliver for the students, educators, and institutions we serve. I am both grateful and proud of our people and their tremendous efforts. Through their efforts, we continue to innovate and adapt our unique platform to the rapidly changing higher education market. As we discussed with you last quarter, we did not see the expected improvements in the operating environment in the fall rush period and recognized the need to take swift and decisive actions. We began undertaking a broad set of measures to manage our cost structure and improve our execution. While some of the strategic initiatives we are implementing will take time and results won’t be linear, we're taking the appropriate actions to deliver consistent and profitable long-term growth. Our third quarter results reflect the early benefits of these actions. We delivered consolidated top-line growth of 11%, expanded our gross margins, and significantly grew adjusted EBITDA on a year-over-year basis. First Day Complete revenue grew 76%, and we’ve made meaningful progress in the discussions with our institutional partners to accelerate market adoption of the FDC model. Before providing more detail on those discussions, let’s review our high-level financial results. Total Retail segment revenue increased 12.4% to $421.2 million fueled by strong First Day Complete, first day by course, and general merchandise sales. The traditional a la carte course material model continued to decline, albeit at a much slower rate than we saw in the fall ’22 rush. Special recognition goes to our in-store teams that continue to explore ways to improve execution to drive sales. This includes providing better in-store support, partnering on collecting more adoptions, enhanced content sourcing through MBS and significant system enhancements to receive and fulfill orders faster. Results on a same-store basis were encouraging. Total retail gross comparable-store sales increased 5.9%. Course material same-store sales grew 7.4% driven by the continued momentum of our First Day Complete offering. General merchandise same-store sales increased 2.3% aided by strong performance in logo general merchandise and cafe and convenience. Third quarter retail EBITDA was $6.2 million, a $21.6 million year-over-year increase. As we announced last quarter, we are taking decisive and aggressive actions to significantly adjust staffing and related costs based on the trends we experienced in the fall rush. This quarter, we saw the initial and partial quarterly positive impact of these cost savings initiatives, which we began implementing in December. We continue to focus on reducing costs and operating more efficiently. DSS revenues decreased 4.5% to $9 million as we shifted our priorities to optimize return on our existing assets with a much more rigorous approach to profitability. The team has executed quickly and well on our initiatives to optimize our marketing spend, drive improved conversion rates, and lower content development costs while investing in the continued optimization of our SEO capabilities. Within our U.S. Bartleby operations, after several months of declining traffic and lower gross subscribers, January subscriber growth was positive. As well-publicized recently, the learning market is evolving at a rapid pace. Within DSS, we are focused on building differentiated capabilities leveraging our years of AI experience. We continue to use AI to enrich and curate content to provide contextually relevant results to learners, to optimize the teaching path for our subject matter experts, and to do demand analysis at scale. For example, we are using OpenAI’s API to help our experts answer questions faster and at a lower cost. In addition, we’re harnessing the power of large language models including GPT-3 to create tools that will guide a student through their own writing experience and teach them to be better writers. We strongly believe that the future of AI in higher education is to support a student’s learning journey, but never to substitute for it. Moving on to wholesale, revenue increased 5.2% during the quarter after more than two years of decline. During the quarter, we saw an easing of supply constraints and more textbook purchasing opportunities, enabling us to fill increasing demand at BNC and other bookstores. Additionally, we believe the recent consolidation in the wholesale textbook market provides a larger opportunity for MBS to meet the continued demand for physical courseware materials and further highlights the unique competitive differentiation that MBS’ wholesale capabilities provide to BNED. Now, let’s take a deeper look at First Day Complete, our number one strategic priority. In December, we kicked off a journey to accelerate the transition of the schools we serve to our subscription-like FDC model. While we are still relatively early in this process, I’d like to provide some color on our conversations. The FDC strategy and overall communication plan has created urgency and prioritized discussions on campuses across our footprint. We are in active dialogues with hundreds of institutional partners regarding First Day Complete and we’re encouraged by the progress we’re making. We plan to provide more specificity on our expected fall 2023 First Day Complete enrollment growth in connection with our year-end earnings release in June. Some schools where we require a fall of 2023 FDC launch have committed to FDC but have asked us to defer its adoption until the fall of 2024, primarily due to their internal process and governance constraints. In cases where we can run a store at an acceptable profitability level, we’re working with these schools to provide a bridge year to make the transition in fall 2024. As expected, certain schools chose not to make the transition to FDC with us. We’re taking a disciplined approach to protect the integrity of the FDC conversion strategy and accordingly we are winding down our relationships with these schools that have a different vision for their institution. In fiscal 2024, our total store count is expected to be lower than today, but our store platform will be more profitable and better positioned for future growth. Our commitment to growing profitability is the key to strengthening our ability to serve our students and institutions in a manner that they deserve and expect. We remain confident in our ability to successfully accelerate the scaling of our FDC model and the long-term growth and sustainable financial benefits of the equitable access model. In summary, after the initial round of conversations with schools, we are confident that accelerating the shift to FDC is the right move for all parties. The assets, achievement, mental health, and affordability benefits to students are clear. The economic benefits that institutions receive are compelling, and much more predictable higher-margin revenue growth is a critical part of the BNED successful path forward with our institutional partners, whose success and ours are truly shared. In closing, our third quarter provides evidence that we’re moving in the right direction and regaining positive momentum. We are highly focused on improving our operational and financial performance as we continue to put the most significant of our environmental operating challenges of the last several years in our rearview mirror. We will also have headwinds such as the broader issues facing our businesses today that we need to diligently manage. However, as we finish fiscal 2023 and look ahead to fiscal 2024, we are in a much-improved position than we were the last three years. I am confident that the actions we’re taking along with the progress we have made put us on the right trajectory to achieve more predictable and sustainable growth and profitability. I’m excited about the road in front of us as we continue to build a stronger, more resilient, and more profitable business model and company, aimed at unlocking long-term value for our shareholders. Now I’ll turn the call over to Tom to discuss the quarter in more detail.

Thomas Donohue, CFO

Thanks, Mike. Please note that the third quarter of fiscal 2023 consisting of 13 weeks ended on January 28, 2023. All comparisons will be to the third quarter of fiscal 2022 unless otherwise noted. Total consolidated sales for the quarter were $447.1 million, an 11% increase. The retail and wholesale segment sales increased 12.4% and 5.2% respectively, while the DSS segment sales decreased by 4.5%. Retail gross comparable-store sales increased 5.9% during the quarter. Gross comparable course material sales were up 7.4% driven by the rapid growth of our first-day offerings. BNC's inclusive and equitable access programs increased revenue by 59% to $121 million during the quarter as compared to $76.1 million in the prior year period. Within this, FDC revenues increased 76% to $67 million. Gross comparable general merchandise sales increased 2.3%. General merchandise sales benefited from strength in logo and emblematic sales as well as cafe and convenience. Net sales for the wholesale segment increased 5.2% to $38.9 million. The increase was primarily due to a slight easing of supply constraints, which improved our ability to meet customer demand. The increase was offset by higher returns in allowances as well as the continued shift from physical textbooks to digital products. DSS sales of $9 million decreased by $0.4 million or 4.5%. As Mike discussed, the DSS team has taken a more rigorous approach to profitable growth and cash generation. As a result of the operating model changes we made in December, DSS reached cash flow breakeven in January. We expect to maintain this discipline and continue to achieve free cash flow breakeven in fiscal 2024. Third quarter consolidated gross profit was $104.2 million, an increase of 19.8%. Consolidated gross margin rate was 23.3% compared to 21.6% in the prior year period. This was primarily due to higher retail gross margins, which benefited from an increase in higher margin FDC and general merchandise sales. Consolidated selling and administrative expenses were down $2 million. Consolidated selling and administrative expenses as a percentage of revenue decreased to 22.3% from 25.2% in the prior year. The decrease is due to lower payroll and compensation expense for long-term incentive awards as well as a partial quarter benefit from the actions to optimize our cost structure and streamline our operations that we announced in December. Since initiating the cost-reduction activities in December, we achieved approximately $7 million to $8 million of run rate savings in the third quarter compared to our prior plan, which assumed a return to a more normal, higher volume operating environment. We continue to expect $30 million to $35 million in annualized run rate savings once fully implemented, which includes $10 million to $15 million in FY 2023. We recorded a restructuring charge of $6 million, primarily related to severance and other termination benefits; $1.5 million of the charge was in retail, $0.9 million was in wholesale, $1.8 million was in the DSS segment, and $1.7 million was in corporate services. During the quarter, we evaluated our store-level long-lived assets in the retail segment for impairment. As a result of this impairment testing, we recognized a $6 million noncash charge. Moving onto the balance sheet, our cash balance was $11.1 million at the end of the quarter with outstanding borrowings of $285.6 million as compared to borrowings of $200.4 million in the prior year period. Receivables increased to $277.5 million, a $27.3 million increase from the prior year. This increase is mostly due to the timing of receivables associated with the significant growth of our first day offerings, as schools generally remit payment for students enrolled in first day courses after the student drop date. As a result, the third fiscal quarter, which has been a source of cash, has shifted to the fourth quarter. As noted in our press release, we worked with our existing bank group to amend and extend our existing asset-backed facility and term loan. The ABL maturity was extended through August of 2024, and the term loan was extended through December of 2024. CapEx for the quarter was $6.3 million, a $5.8 million decrease from the prior period. This decrease was due to reduced store build-out and product and system development. At the end of the quarter, our retail segment operated 1,388 college, university, and K-12 school bookstores comprised of 785 physical bookstores and their e-commerce sites as well as 603 virtual bookstores. As we continue to execute on our FDC strategy and simplify our cost structure to create a more efficient operating model, our total store count is expected to be lower than today. But our store platform will be more profitable and better positioned for future growth. Moving to guidance, given our results to-date and our expectations for the fourth quarter, we continue to expect FY 2023 adjusted EBITDA of $20 million to $30 million.

Operator, Operator

Certainly. The first question is from the line of Ryan MacDonald with Needham. You may proceed.

Ryan MacDonald, Analyst

Hey, Mike and Tom. Thanks for taking my questions and congrats on a nice quarter here. Great to see all the progress that's being made. And I wanted to start on First Day Complete. In the investor presentation, a lot of great detail in terms of the number of potential students and sort of the market opportunity there. As you think about sort of the strategy for accelerating the adoption in the cohorts, can you talk about sort of how quickly you think you can move each of the cohorts to First Day Complete? And then if we think about that 4 million students that you’ve mentioned in the presentation that's sort of the potential opportunity, how much of that do you expect to be able to retain as you kind of make this transition?

Jonathan Shar, Executive Vice President, BNED Retail and President Barnes & Noble College

Hey, Ryan. It’s Jonathan Shar. Thanks for the question. And we’re really excited about the progress we’re making on First Day Complete, the growth we’ve had to date, and then all of the conversations we’re having post the launch of our acceleration strategy. I think from just highlighting where we’re at and where we’re going broadly, we’re having substantive conversations with like hundreds of institutions on First Day Complete, and it’s really exciting to see the alignment on how the model can really enhance student outcomes and support their key objectives of driving greater affordability, convenience, and access for their students. So we’re excited about that. It’s really, as we announced, a multi-year journey. I think our focus is on driving the majority of our institutions to that model for the fall term of ’24, or fiscal ’25, and we’re confident we’re making great progress against that and the cohort strategy has been really effective. So we’re excited about that and excited about where we’re going. We’ve seen many of the institutions that we're marching towards and focused on a fall ’23 launch, really excited about the model, really happy with the service and support and product assortment that we’re providing for their campus and campus community. But as Mike mentioned, some have asked for a bridge to be able to get through the consensus building and the governance that’s required and approvals that are required to move to this subscription-like model or course material acquisition and distribution. And we’ve been able to do that and move over via a bridge to something that’s profitable for running the store at an acceptable level of profitability, which is a great sort of sign of partnership and then allows us to work with those schools to implement the model for the following semester. So making really good progress on all of that and continuing to have great conversations every day with our institutions and prospective institutions about the model.

Michael Huseby, CEO

Yeah, Ryan. It’s Mike. I want to add one thing to your question about the illustrative slide in the investor presentation where we used 4 million. The footnote explains why we chose that figure. It’s an approximate area, and we realized when we launched the strategy requiring many schools to switch to First Day Complete more quickly that the a la carte model wasn’t effective for them or for us, so we anticipated losing some schools. However, as I mentioned in my comments, this positions us to develop a platform of schools that will be more profitable, regardless of whether it has more or fewer students. We expect the platform to decline from its current level but plan to rebuild it on a different foundation. The bridge year that Jon described shows that we are being cautious. If some schools need an extra year to transition and can maintain a highly profitable relationship by, for instance, not paying any commission or management fee, we’re open to that since each discussion is unique. We’re collaborating with the schools and considering their individual preferences. So, while I can’t provide a specific number regarding how many of the 4 million will be present in the fall of ’23 or ’24, I am very confident that we will be a more sustainably profitable company with this strategy.

Ryan MacDonald, Analyst

That’s super helpful color. I appreciate it. And then as we think about, I guess, the pathway to getting, in terms of the transition process, what sort of timeline are we looking at for the full transition to be reflected? I know you talked about getting schools that are interested giving them up until say fall of 2024, which is in your fiscal ’25. So there’s a bit of a runway on that. But in terms of the schools that are unwilling, how quickly do you think that those come out of the model as we start to think about over the next 12 to 24 months?

Michael Huseby, CEO

Yes. I think that there are some that are already coming out of the model that we’ve notified, exercised a communication with, as we have the right to under our contracts. So some have already moved in anticipation of going to a different solution in fall of ’23. Many went under proposal this past year and we’re still involved as part of the conversation that Jon’s talking about, are in that proposal stage.

Jonathan Shar, Executive Vice President, BNED Retail and President Barnes & Noble College

Yeah, and Ryan, it’s Jonathan. Not all of our stores are intended for FDC, and that is not the main topic of discussion. Many stores in our portfolio are performing very well, achieving a high sell-through on course materials and generating significant general merchandise sales. As we highlighted, our general merchandise, logo products, café, and convenience items have all contributed to this growth. So, it's important to note that not every school in our portfolio is part of the conversion to FDC, but it does include the majority of our institutions.

Michael Huseby, CEO

And then new businesses, we have new business that’s coming into the company, who are using an FDC model from day one. So some of that’s happened in the spring. University of Memphis was an example of that. They are a new client that we picked up, and they started with us from day one using First Day Complete. And that’s our objective. Our real objective is to get as many schools using this model because it’s the best model for students, it’s the best model for the schools, and it’s the best model for us and the publishers. And using a model that allows you to sustain the level of service that you want, and gives students that improvement in access and outcomes is really what we should be all about. That’s our mission. And the fact that it benefits us financially really just manifests that it’s the right thing for us to be doing.

Ryan MacDonald, Analyst

That's very helpful clarification. I appreciate that. Maybe one more from me, just shifting to the DSS segment, it’s interesting to hear that you talk about how you’re sort of integrating and utilizing the ChatGPT and starting to try to like weave that into the offering. I’m curious, as you think about the Bartleby business and then the broader DSS business, we’ve obviously seen a pretty wide adoption usage amongst students of ChatGPT. Curious what you’re seeing from a competitive perspective there or if that’s driving any pressure as students sort of only using GPT versus the Bartleby study tool or other study tools? What are you seeing sort of in that segment of the business? Thanks.

Michael Huseby, CEO

It's clear that OpenAI and ChatGPT-3 are dominating media discussions, and our competitors, including Bartleby and Student Brands, are actively exploring their applications. Student Brands has been integrating OpenAI features into their products for a while now. DSS is also quickly adapting to incorporate ChatGPT and other large language models, which enhances speed and efficiency while lowering costs. Our subject matter experts are entering questions for Bartleby subscribers and we saw positive subscriber growth for Bartleby in January. Last year, we focused on profitability and efficiency, refining our pricing and value proposition. We will soon share news about new products aimed at helping faculty leverage OpenAI, including plagiarism detection tools currently being developed by Student Brands. Although AI has existed for some time, ChatGPT's rapid rise with 100 million users in just two months is likely to impact website traffic across various competitors. We believe our value proposition stands out from the typical OpenAI and ChatGPT offerings, and we see significant potential in utilizing this technology in our future endeavors.

Ryan MacDonald, Analyst

Excellent. Thanks for the color. I’ll hop back into queue.

Michael Huseby, CEO

Thanks, Ryan.

Operator, Operator

Thank you, Mr. MacDonald. The next question comes from the line of Alex Fuhrman with Craig-Hallum. You may proceed.

Alex Fuhrman, Analyst

Hey guys, thanks for taking my question. As you kind of move to this all First Day Complete model, can you give us a sense of, at this point, how many schools have said they’re definitely not going in that direction? And as you kind of move through this transition, is there an opportunity to maintain perhaps a scaled-down relationship with some of these schools, whether that means opening a virtual bookstore or selling general merchandise, or is it really more, you’re just going to be walking away from some of these less profitable relationships and really focusing on the best ones?

Michael Huseby, CEO

Hey, Alex, this is Mike. I think we’ll answer the question more specifically in June, when we have a real tally of what the efforts are in terms of how many schools we’re going to have for fall of ’23 on First Day Complete, perhaps those and the store count, so to speak, and those that didn’t go that way that have a different vision, etc. So I don’t think we’re going to get into that today because it’s really in process. We’re not trying to be evasive on that. It’s true that there are so many conversations that are in process still that have to be resolved. And in terms of your other question, second part of your question, yes, there are different ways to skin the cat so to speak to achieve profitability. Quite frankly, many of the stores we try to manage our business on a portfolio basis. Many of the stores that we were requiring consider going to FDC in fall of ’23 very strongly requiring it or we exited the relationship are probably not those stores where it’s going to make sense for us to try to carve out some kind of other partial relationship in hopes of making them profitable. It’s possible. But as Jon said, there are some that are going through a bridge here, which is a different story, where they’re going to agree to go First Day Complete in fall of ’24. And then in the bridge year will go to some kind of an economic change that will allow us to service that and be profitable. But I don’t think, there is some possibility of some could go to virtual only, but most of these are going to be model shifts. They may not be in fall ’23, but they will be in fall of ’24 or will be exiting.

Jonathan Shar, Executive Vice President, BNED Retail and President Barnes & Noble College

Yeah, we are out further, it’s Jonathan and I think the positives, the positive outcome of the acceleration of the conversations and hundreds of conversations we’ve had is that there’s not a lot of marketplace resistance in terms of the value proposition of equitable access in First Day Complete. There seems to be pretty universal alignment on that. It’s just about the prioritization from a campus perspective, and that’s what we’re trying to help those campuses do is drive urgency and drive prioritization to be able to implement the new model. And so I’m really encouraged about the alignment impact we can make on student outcomes and supporting, providing a more affordable solution for students and institutions. It is an important topic on all campuses. So it’s really about partnering with our institutions, helping guide that discussion, moving them to a solution that ultimately is going to have a really significant impact, whether that’s a much more convenient model that supports greater student well-being, affordability, or just access to materials and having materials on day one that’s driving improved academic success in an institution. So I think it’s really about partnership, driving people, supporting the process and getting to an end goal where there’s mutual alignment on the value proposition and ability to shift this model.

Alex Fuhrman, Analyst

Okay. That’s really helpful. Thank you. And then if I could just ask one more, it looks like if you just kind of strip out what you’ve reported and what you’re guiding to, you’re looking for adjusted EBITDA in Q4 to be more than it has in Q3, which typically, not always but for the most part over the last 5, 10 years that has not been the case. So are we still kind of in this post-COVID reopening period where your typical seasonality maybe doesn’t apply or can we maybe interpret that to mean that maybe some of your efforts to enhance profitability are working and should carry forward into next year?

Michael Huseby, CEO

Yeah, Alex. It’s Mike. A couple of things, first off, the FDC program has scaled quite a bit year-over-year, and some of that revenue does fall into the fourth quarter, the way that it sells and the way it gets earned and booked. The other part of it is, as you said, the cost management measures we disclosed, the in-year benefit we estimate to be something like $10 million to $15 million, which was $7 million to $8 million this quarter. So that’s kicking in for a full quarter for the first time in the fourth quarter. And we’re continuing to take measures beyond what we did in December that will help to impact the fourth quarter as well. And so, Tom, you might want to comment.

Thomas Donohue, CFO

Yeah, no Mike, that’s right. And Alex, I think given where we are in a year, we still feel confident we’re within the range, but we might be towards the lower end of it.

Operator, Operator

Thank you, Mr. Fuhrman. There are no additional questions waiting at this time. So I will pass the call back to Hunter Blankenbaker for any further remarks.

Hunter Blankenbaker, Vice President of Investor Relations

Okay. Great. Thanks, Hannah, and thanks everyone for joining us today. And certainly for your continued interest in BNED. As a reminder, our fourth quarter earnings will be in late June. And thanks again for joining today.