Earnings Call Transcript - BNED Q2 2022

Operator, Operator

Hello, everyone, and welcome to the Barnes & Noble Education Fiscal 2022 Second Quarter Earnings Conference Call. My name is Bethany, and I'll be your co-operator today. I would now like to hand the call over to your host, Andy Milevoj, Vice President of Investor Relations. Andy, please go ahead.

Andy Milevoj, Vice President of Investor Relations

Good morning, and welcome to our fiscal 2022 second quarter earnings call. Joining us today are Mike Huseby, CEO and Chairman; Tom Donohue, CFO; Jonathan Shar, Executive Vice President, BNED Retail; David Henderson, President of MBS; and David Nenke, President of DSS. Before we begin the call, I'd like to remind you that the statements we make on today's call are covered by the safe harbor disclaimer contained in our press release and public documents. The 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 and Chairman

Thanks, Andy, and thank you all for joining us this morning. We were thrilled to welcome students back to campus this fall. Our second quarter results reflected their eagerness to return to an on-campus, in-person learning environment with a significantly increased resumption of on-campus events and sporting activities. This was further corroborated by an NRF report issued this summer that indicated that college students and their families had planned to spend an average of $1,200 on college or university items, 30% more than a year ago as students prepare to transition back to an in-person learning experience. The top three categories included electronics, storm furnishings, and clothing. While many institutions implemented policies to return students to an on-campus learning experience, the volume of students, alumni, and tourists is not yet back to pre-pandemic levels. The operating environment continues to present a number of different challenges, including undergraduate enrollment declines of approximately 3% according to the National Student Clearinghouse Research Center, fewer international students than pre-COVID levels, and many community colleges continuing to offer virtual classes. In addition to enrollment declines, we are also experiencing challenges with escalating freight costs, labor shortages, and supply chain issues. While we expect these conditions to persist through fiscal '22, we're hopeful that they will begin to mitigate as we move into the next fiscal year. Despite these challenges, our organization has proved resilient in providing best-in-class service to our campus partners and their students. The growth of our First Day offerings helps to mitigate the macro pressures on our course materials business, and through our general merchandise partnership with Fanatics and Lids, we were better positioned to address the global supply chain issues facing many retailers. As you look ahead, our entire organization is excited by our company's momentum as we continue to execute on strategic initiatives that further distinguish our competitive offerings, which, as a whole, cannot be replicated in the marketplace. Our innovative academic solutions offerings, unparalleled merchandise assortment, new best-in-class omnichannel customer experience, and strategic investments provide an unparalleled customer value proposition for the institutions and the customers that we serve, all of which we expect to accelerate our growth. The benefits of our inclusive access course material models are resonating with institutions across the country and delivering greater student access and better student outcomes. We are seeing tremendous demand for our First Day Complete equitable access program as schools have demonstrated the positive impact the solution has on improving student outcomes and reducing stress at the beginning of each academic term. Additionally, First Day Complete eliminates barriers to course material access, allowing students to engage with the course content from day one and achieve greater academic success. Equally important, the program also supports our school partners’ missions of improving student academic achievement, persistence, and retention. It's not surprising that based on these benefits, we experienced significant growth in the 2021 fall term when First Day Complete was offered through 65 campus bookstores, up from just 12 campus bookstores the prior year, representing approximately 295,000 total undergraduate student enrollment, up from 43,000 students the prior fall, and an almost 7x year-over-year increase. With this growth, the program was available across a broad spectrum of schools from small private colleges to large public universities and multicampus community college systems. Year-over-year revenue for both our First Day models increased 80%. For the 2022 spring term, we have 10 additional stores that have signed up for First Day Complete, representing undergraduate enrollment of over 86,000 students. First Day Complete is disrupting the traditional course material delivery model in collaboration with leading institutions across the country. By delivering all course materials via one convenient service, First Day Complete ensures that students have access to all their learning materials across all of their courses before the first day of class. This allows them to engage with course content from day one to support their academic success. Also, First Day Complete offers full academic freedom for faculty, allowing them to select the best course materials for the term from BNED's expansive relationship with more than 6,000 publishers, creating a one-stop simplified experience. Data shows that course materials are still an optional purchase for many students, even though it's been well documented that students who have their course materials before the start of class performed better academically. First Day Complete helps to remove barriers and provide the same fundamental level of access across an entire institution for all students. Our survey showed that students who utilized the program felt that they had better experiences, were better prepared for the academic term, and ultimately achieved better academic results, confirming BNED's equitable access program is making a positive impact on student success. First Day Complete is also proving to be a competitive advantage for the schools that have adopted it, which we believe will further help to accelerate the adoption by additional schools. Some BNED partner institutions have started to report that they have seen enrollment growth, which they, at least in part, attribute to the ability to market the benefits of First Day Complete to prospective students. Turning now to our general merchandise business. With the resumption of on-campus events and sporting activities, we experienced 78% gross comparable sales growth during the second quarter. Our partnership with Fanatics and Lids offers an unparalleled merchandise assortment and a best-in-class omnichannel customer experience for logo and emblematic products, allowing us to offer our schools a totally reimagined retail experience. This partnership expands the breadth and quality of our offerings in-store and online, including newer, more exciting brands such as Vineyard Vines, Lululemon, and johnnie-O that are highly relevant for our student, parent, and alumni demographic. Both partners are leaders in their space, which provides us with buying power and a partnership that schools will benefit from. We have already seen the impact on winning new business and are excited to see what this year will bring as the strategic partnership will ultimately benefit the students and schools that we serve. Specific to Fanatics, we will benefit from their powerful e-commerce systems and data insights to grow market share and add new customers. These sites are truly best-in-class mobile-first experiences that leverage the Fanatics platform to provide an incredible user experience. We continued to transition additional school e-commerce websites to the new Fanatics experience, and through November, we now have over 540 sites live on the Fanatics platform. Turning to our DSS business, our Bartleby suite of solutions continues to exhibit its rapid growth. DSS revenue grew 39% to $8.3 million, with product revenue growing approximately 70% year-over-year. Pharma B generated 120,000 new growth subscribers during the quarter, representing a 33% year-over-year growth. We introduced Bartleby Plus during the quarter, which combined Bartleby Learn with Bartleby Write to provide a dynamic study bundle to help students tackle their assignments 24/7. This comprehensive offering includes over 5 million step-by-step textbook and homework solutions, a math solver with detailed solutions, expert Q&A in 30 subjects, essay templates that help students outline their papers with an interactive guide, plagiarism detection, and a citation generator, amongst other tools. Bartleby products and services are designed to improve student success and outcomes, offering pathways for learning that fit the schedules and demand of today's students. We believe our bundle provides tremendous value to help improve student outcomes. In conclusion, while there continue to be various challenges operating our business in this COVID-affected environment, we remain focused on executing our strategic growth initiatives, which is already helping to mitigate the impact of such near-term challenges. Most importantly, we believe these initiatives position us well for longer-term sustainable growth. With that, I will turn it over to Tom for the financial review.

Thomas Donohue, CFO

Thanks, Mike. Please note that the second quarter of fiscal 2022, consisting of 13 weeks ended on October 30, 2021. All comparisons will be to the second quarter of fiscal 2021, unless otherwise noted. As Mike highlighted earlier, while we are not back to pre-pandemic levels, the second quarter, which is historically the highest sales period for the company, benefited from many students returning to in-person classes and greater attendance at campus events and sporting activities as compared to the year-ago period when schools supplemented in-person classes with hybrid and remote learning models, coupled with a significant reduction in events and sporting activities. Total sales for the quarter were $627 million compared to $595.5 million in the prior year. This increase of $31.5 million or 5.3% was comprised of a $32.4 million increase from the retail segment, a $14.7 million decrease from the wholesale segment, and a $2.3 million increase from the DSS segment. Retail gross comparable store sales increased 13.2% during the quarter. Gross comparable textbook sales were essentially flat as the broader industry headwinds were mitigated by the rapid growth of our First Day offerings. BNED's First Day Complete and First Day by course offerings increased revenue by 80% to $96 million during the quarter as compared to $53.4 million in the prior year period. Gross comparable general merchandise sales increased 78.3% as compared to a 52% decline a year ago. Our general merchandise business benefited from the return of many students to the campus and the reopening of most of our campus stores, the majority of which were closed in the year-ago period due to COVID. As a reminder, per our agreement with Fanatics and Lids, logo and emblematic product sales are now accounted for under the agency accounting method, in which BNED receives 1% of sales for the logo and emblematic sales online and in-store. Each sales channel in-store and online has its own commission rate, which will change as the relationship matures. Our comparable sales reflect the actual retail selling price or tender received for the products sold under the agency model, rather than solely the commission received, whereas GAAP sales on our P&L reflect the commission we've received. Net sales for the wholesale segment decreased $14.7 million or 40.5% to $21.7 million, primarily due to COVID-19-related supply constraints resulting from the lack of on-campus textbook buyback opportunities during the prior fiscal year and lower customer demand, which was partially offset by lower returns and allowances. Additionally, during the prior year period, the wholesale CSS model fulfilled direct-to-student course material orders for retail campus bookstores that were not fully operational due to COVID-19 campus store closures, whereas those sales shifted back to the campus bookstores in the current period. DSS sales grew $2.3 million or 39.2% to $8.3 million, benefiting from an increase in subscription sales. The consolidated gross margin rate for the quarter was 23.2% compared to 19.4% in the prior year period. This was primarily due to the favorable sales mix of higher-margin general merchandise products, lower contract costs on renewals and new contracts, coupled with lower inventory reserves and lower markdowns. Our selling and administrative expenses increased by $15.9 million or 17.3% compared with the prior year period as we reopened most stores and brought employees back to serve the increase in on-campus students as compared to the prior year period when we furloughed many employees in response to our COVID-related temporary store closures. At the end of the quarter, our cash balance was $11 million with outstanding borrowings of $183.3 million as compared to borrowings of $99.5 million in the prior year period. This increase is mostly due to the timing of receivables associated with the significant growth of our First Day offerings. Schools generally remit payments for students enrolled in the courses after their student drop/add dates. Our current liquidity position remains strong. CapEx for the quarter was $9.9 million, essentially in line with the prior year period. Currently, our retail segment operates 1,445 college, university, and K-12 school bookstores, comprised of 794 physical bookstores and their e-commerce sites, as well as 651 virtual bookstores. With that, we will open the call for questions.

Operator, Operator

The first question comes from Alex Fuhrman at Craig-Hallum Capital Group.

Alex Fuhrman, Analyst

I wanted to ask about the First Day Complete offering. It looks like it added a good amount of revenue for the quarter. Can you talk about how it performed operationally given everything that's going on with the supply chain and in terms of profitability and how it contributed to the overall EBITDA for the quarter? Would you say that it met your expectations here in the first big semester with a critical mass of students?

Michael Huseby, CEO and Chairman

Thank you for your question, Alex. This has been a key focus for us, and we are still in the process of analyzing the results from the fall semester and the cash flows associated with First Day Complete. We're very pleased with its performance and the operational execution. Jon Shar will provide more details shortly. Overall, the implementation went smoothly, aided by a significant portion of digital courseware in our larger First Day Complete programs this year, making fulfillment easier compared to institutions that had a higher mix of physical books. In terms of financial impact, several factors influence the complete contribution to our finances, including enrollments, the conversion of enrollments, and the unit pricing for semester hours. Our expectations vary depending on the time of year. When we set our budget for fiscal year '22 in the spring, we weren't aware of the enrollment declines, particularly in community colleges. The conversion rates matched our expectations, while average pricing has been slightly lower due to the mix of full-time and part-time students in the current environment, leading to fewer credit hours than anticipated. Overall, we are very satisfied with the performance of First Day Complete and First Day, and Jon will elaborate further.

Jonathan Shar, Executive Vice President, BNED Retail

Thank you, Mike. Building on that, the team performed exceptionally well in implementing First Day Complete across the 65 campus stores during the fall term. We achieved full coverage of the book lists for those schools. The transition to digital and the availability of digital content greatly facilitated this execution. Overall, the execution at scale was impressive and gives us strong confidence in our ability to continue expanding the program. Regarding our expectations for the model and the program's benefits, it aligned well with what we anticipated. Additionally, the implementation occurs on a local campus-by-campus basis, which means that the costs and pricing per credit hour are unique to each campus, determined by their average enrollment and specific course book lists. We did observe a decrease in prices, which was driven by the reduction in content costs and our schools' intent to lower these costs, benefiting our operating expenses. The model has been highly effective. As mentioned in the script, we've added 10 more campus stores and approximately 86,000 undergraduates for spring, a term when we typically would not expect to see significant additions to campus stores and enrollment. Most campuses usually make these decisions at the start of the academic year when tuition and fees are planned months ahead. We are very excited about the future of First Day Complete and its potential impact on our campus partners, student outcomes, and our business.

Alex Fuhrman, Analyst

That's really helpful...

Michael Huseby, CEO and Chairman

One additional point to mention is that we are currently scaling this initiative. This is our first semester where we have achieved significant scale with First Day Complete. We have learned many lessons about how different schools are marketing this program, including what is effective and what is less effective, which has led to some instances of lower conversion rates or perhaps higher opt-out rates than we would typically expect. Some schools have achieved a 100% participation rate, while others are lower, resulting in an average that is below 100%. However, we have gained valuable insights, and I believe this will enhance conversion rates and results as we move forward, starting in the spring.

Alex Fuhrman, Analyst

Great. That's really helpful. And I did want to follow up on the 10 additional schools that are signed up for the spring semester. That was certainly unexpected given that schools don't typically tend to shake things up like that in the middle of the academic year. Can you talk a little bit about the sales pipeline? I mean, I would have to think it's pretty strong given that you have 10 schools joining the program midyear. Is it too early to get a sense of how many strong leads you have heading into the fall semester next year?

Michael Huseby, CEO and Chairman

Specific guides. Yes. Go ahead, Jon.

Jonathan Shar, Executive Vice President, BNED Retail

Yes, we're optimistic. The addition of 10 stores and an enrollment boost of 86,000 is a very encouraging indicator. Our optimism stems from the positive impact the program is having on student outcomes, as well as the benefits in retention and persistence that our institutions are demonstrating. Additionally, as Mike mentioned, some institutions are experiencing enrollment growth due to their effective marketing of this program. Therefore, based on this, our pipeline looks very strong, and I'm genuinely excited about the opportunities ahead, especially considering the data from the institutions that have implemented the program with us.

Operator, Operator

The next question comes from Ryan MacDonald at Needham.

Ryan MacDonald, Analyst

Congratulations on a successful quarter. It's encouraging to see the advancements in your partnership with Fanatics and Lids, especially regarding the additional sites being launched. I'm interested in understanding what kind of increase you are experiencing in general merchandise sales as those sites go live. Also, how do you feel about the opportunities for general merchandise as more sites roll out leading into the spring semester?

Michael Huseby, CEO and Chairman

Thank you, Ryan. That's an important question. For the upcoming fall rush, we had nearly 15 schools fully operational on the Fanatics e-commerce system. As you are aware, we transitioned the management of the stores for emblematic logo items to Lids and Fanatics through the FLC partnership we established in April. They worked diligently over the summer to stock inventory in stores as we anticipated a rebound in demand. The e-commerce results from those 15 stores showed significant growth. When we compare this to 2020, we see a notable difference, especially since 2020 had limited campus and store openings, leading to higher e-commerce activity. So, when we look at both 2020 and 2019, we've observed substantial improvement in our metrics. It’s also worth mentioning that the 540 sites we reference are now part of the Fanatics experience. This means that when students navigate our e-commerce system and choose apparel or emblematic items, they are redirected to the Fanatics system, which is customized to represent each school's brand in a more local and personalized way. This transition has occurred for over 500 schools in just the past six weeks. We're optimistic about the upcoming results from Black Friday, which we'll share in our third quarter report, as well as Cyber Monday, for which we’re still awaiting data from Fanatics. However, early indications from the increased number of schools offering the Fanatics experience are encouraging. I invite you or anyone interested to explore the sites to see the wide variety of offerings and user-friendly interfaces, which truly reflect best-in-class e-commerce websites. We are excited about what lies ahead this spring semester and during the holiday season, particularly in the e-commerce space with so many schools now operational.

Ryan MacDonald, Analyst

Yes. It's a really good point on the e-commerce side when you think about the holiday season and the potential that opens up here. As my second question, I really wanted to ask about Bartleby. It's great to see the continued strength in the growth rate there and that the gross subs numbers continue to climb. Just curious to see what you're seeing in terms of student usage and adoption there as we've progressed through the semester? Because obviously, as we saw Chegg put up some weak numbers and had talked about maybe some changing student usage patterns there. Just trying to understand if that's something that's more industry-wide or how Barnes & Noble's performance comparatively looks for Bartleby?

Michael Huseby, CEO and Chairman

Yes, I think David Nenke can address that for us.

David Nenke, President of DSS

We have observed that students are returning and adapting to a combination of on-campus and virtual learning environments. Our service is designed to enhance their educational experience, regardless of their chosen learning method. We're pleased to report that we are witnessing strong engagement, with our customers consistently utilizing our services. In fact, most of our key metrics for paid subscribers have shown a year-on-year increase in terms of usage and engagement. This positive trend indicates that we are effectively developing services that support our customers' learning journeys. While I won't comment on broader industry trends, our focus remains on delivering the best possible service to our clients. Overall, we are encouraged by the positive responses we are receiving for our products.

Operator, Operator

The next question comes from Rory Wallace at Outerbridge Capital.

Rory Donald Wallace, Analyst

I was curious on First Day Complete. With the new signings, which seem like a quite high average enrollment for the spring term, is this a situation where the First Day revenues could actually grow sequentially in the January quarter? And just following on some of the comments that Mike made around optimizing the marketing strategy behind the programs. Is this something where the schools are being receptive to kind of this co-marketing feedback in terms of how to optimize the program structure to really drive enrollments or conversions?

Michael Huseby, CEO and Chairman

Yes, Rory, this is Mike, and I'll let Jon join in. Regarding your question about marketing and co-marketing, each school has its own approach, with some being more cautious and others very aggressive. Some have promoted First Day Complete as if the books are free, and as Jon mentioned, those schools have increased enrollments and attracted attention from neighboring schools that are now interested in what they're doing. Some schools are overly cautious during the sales process because many people are involved in the decision to adopt the First Day Complete inclusive access model. Consequently, they sometimes downplay marketing and the option to opt out, rather than focusing on the benefits that have emerged in certain cases. Our discussions with schools during the sales of First Day Complete made it clear they recognize the benefits, but realization of those benefits is contingent upon them being more positive in their marketing rather than cautious. These insights I mentioned relate to marketing learnings, and schools we have worked with are beginning to adjust. I'll let Jon add more specific insights if he'd like.

Jonathan Shar, Executive Vice President, BNED Retail

Yes, building on the effective execution by our store teams and support for institutions adopting First Day Complete, we have strong confidence in our ability to deliver results and enhance student outcomes, creating a seamless experience for students and transforming the delivery of course materials. We've engaged in productive discussions on how to collaborate and improve the marketing and positioning of the program within these institutions. We believe there is significant opportunity to increase student participation in the program, which would drive further sales growth at these institutions. Many students are experiencing this for the first time, especially in schools that just began participating this semester. As students recognize the benefits of having their course materials ready before classes start, we anticipate growing acceptance and understanding of these advantages, which also reflects in our survey results. With schools eager to collaborate on marketing and students growing more enthusiastic, we expect to see increased participation and growth, encouraging more schools to join as they observe the positive outcomes experienced by their peers.

Michael Huseby, CEO and Chairman

Rory, regarding your question about incremental January revenue growth, we are not providing specific guidance on future performance. However, it is reasonable to expect that growth will occur given the increase in student enrollments under the First Day Complete program.

Rory Donald Wallace, Analyst

I appreciate that. And I guess following on the question around the fall '23 pipeline. Do you have enough sort of sales and operational capacity to try to target similar or even higher levels of enrollment growth for First Day Complete in fall of 2023? I understand just a lot of running parts with the environment right now.

Michael Huseby, CEO and Chairman

Yes, we do have a pipeline and a very detailed sales process. We won't go into specifics, but we have a strong pipeline for fall of '23. Some of the schools adopting First Day Complete in the spring semester are moving ahead, but most of the schools we are in discussions with or have commitments from are prepared for fall of '23. Some schools are moving earlier, but they are unable to make that change quickly due to previously published rates and tuition for fiscal year '22 for the spring semester.

Rory Donald Wallace, Analyst

Great. Tom, I have a couple of questions for you regarding cash flow for First Day Complete. I understand that you're generating more receivables and adjusting your collection cadence. Do you expect to reduce these by the end of this fiscal year, or are you anticipating a structurally higher level of receivables and days sales outstanding moving forward? Additionally, I'd like your thoughts on incremental margin performance. It's a challenging supply environment, but it appears you're benefiting from your higher-margin initiatives. How do you feel about margin performance in the upcoming quarters?

Thomas Donohue, CFO

Thank you, Rory. Historically, our working capital cycle involved bringing in products, selling them to students, receiving cash, and then paying our vendors. However, with the introduction of First Day and First Day Complete products, we're often purchasing items before receiving payment from the schools. This has resulted in higher receivables. We're learning from this situation and actively working on improvements as the semester progresses. The key date to note for billing and reconciliation with the schools is the census date, which triggers the process student by student. Consequently, the higher receivables on our balance sheet reflect the rapid growth of these programs, which is a positive development. We expect a lot of this to stabilize by the end of the fiscal year as we move through the spring term. Regarding margin performance, it's influenced by the mix of products students are purchasing. While we haven’t returned to pre-pandemic levels, bringing students back on campus is driving up sales in other areas such as supplies, café items, and branded merchandise, which should gradually enhance our margins. Although we're not yet at pre-pandemic levels, progress is being made in the right direction.

Michael Huseby, CEO and Chairman

It depends how we'll be pulling. This is Michael Huseby. In the general merchandise area, given the supply chain issues, we did sell through some of the older inventory that was transferred to the rest of the stores as many as possible, also available online in SEO. We've seen good take-up and good usage from our customers on that product. We're very excited about the full range of features being available to customers, et cetera. So that will be one of our key priorities going forward as we kind of look at providing a full suite of services to our customers and how they use it and how they engage with their products. So for the back half of the year, we'll continue to work on features and some of those things that part of the process is going to be one of the key initiatives for us and really getting that in the hands of students so they can use the full range of the product. So that was, I think, one of the things that we were excited about going into, and it exceeded our expectations for the fall rush period.

Operator, Operator

We don't seem to have any further questions. I will now turn the call back over to Andy for his closing remarks.

Andy Milevoj, Vice President of Investor Relations

Great. Thanks, Bethany, and thank you all for joining us on today's call and your continued interest in BNED. Please note our next scheduled financial release will be our fiscal '22 third quarter earnings in early March. We hope everybody has a great holiday season. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for joining. You may now disconnect your lines.