Earnings Call Transcript - BNED Q2 2020

Operator, Operator

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

Tom Donohue, CFO

Thank you. Good morning and welcome to our fiscal 2020 second quarter earnings call. Joining us today are Mike Huseby, CEO and Chairman; Barry Brover, EVP of Operations; Kanuj Malhotra, President of Digital Student Solutions; as well as other members of our Senior Management team. Before we begin, I'll remind you that the statements we will make on today's call are covered by the Safe Harbor disclaimer contained in our press release and public documents. The content of this call is the property of Barnes & Noble Education and is not for rebroadcast or use by any other party without prior written consent of Barnes & Noble Education. During this call, we will be making forward-looking statements with predictions, projections, and other statements about future events. These statements are based upon current expectations and assumptions that are subject to risks and uncertainties, including those contained in our press release and public filings with the Securities and Exchange Commission. The Company disclaims any obligation to update any forward-looking statements that may be made or discussed during this call. At this time, I'll turn the call over to Mike Huseby.

Mike Huseby, CEO

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

Tom Donohue, CFO

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

Operator, Operator

Your first question comes from Ryan MacDonald with Needham. Your line is open.

Ryan MacDonald, Analyst

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

Mike Huseby, CEO

Yeah, hi, Ryan. It's Mike Huseby. I think probably the main thing, and I alluded to it in the call, is the level of unsolicited inquiries we've had from potential strategic partners, whether they're strategic partners from a commercial sense that would improve our competitive position or financial players. I think all of whom see that there is based on public stock price, there’s a lot of value in the assets that we have given the relationships we have with schools, the contracts, and the terms we operate under, as well as how MBS and BNC are starting to work together, and we're putting those two companies together and the upside of DSS. So they see a lot of upside in the asset. Obviously, the time horizon for that is something we talk about, but that's the main thing that changed. We haven't altered our strategy; it remains the same as it was six months ago. What has changed, however, is that we now have completed projects rather than just discussions. We have successfully executed and tested them, and we have more compelling items to present to potential strategic partners. Regarding the financial advisor, that will be decided by the Board, and it's based on establishing a structure to manage everything effectively. We want management to continue its current focus without distractions, and given the high level of interest, we aim to determine the best approach to enhance shareholder value and accelerate our strategy.

Ryan MacDonald, Analyst

Thank you for that information. It's great to hear that you've surpassed 100,000 subscribers this year. Clearly, you're making significant progress in the market. Can you discuss how you're attracting students to the platform? Is the focus primarily on online channels, or do you see advantages from your presence in physical stores and college bookstores?

Kanuj Malhotra, President of Digital Student Solutions

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

Ryan MacDonald, Analyst

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

Kanuj Malhotra, President of Digital Student Solutions

I mean, we're seeing increased usage and time on the platform for the active users. We've seen very peak usage in and around midterms, even now as we're heading into final exam season. You can see the question volumes peak, so the usage is continuing to increase, the content leverage continues to increase, and time on site is increasing. All leading indications and KPIs related to usage are trending very nicely and frankly ahead of where we would have thought.

Ryan MacDonald, Analyst

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

Mike Huseby, CEO

Yeah, that's a pretty broad question and involves more than Cengage. I think, Ryan, this is Mike. The publishers and their pricing has been kind of all over the place. There's a lot of competition from different providers that they and we haven't experienced in the past and I think they tried a lot of different things, and I think that this is another example of something else. I don't want to comment on the proposed merger that's under regulatory review between Cengage and McGraw-Hill; we're relatively agnostic when it comes to the publishers. Our job really is we are an extension of the schools that we serve, which they hire us to go out and procure the content. So, we're an agent of the school. That is an important thing to understand, and when things come out in the press, like they did today, where others are taking positions on the merger because they're citing some of the practices that they've engaged in and others are engaging on pricing, I mean, those can be looked at in a number of different ways, but ultimately the prices can't go down and maintain a la carte pricing forever. FirstDay's inclusive access approach is effective because it bundles curriculum into a cohesive solution, which increases penetration not only for us but also for our publishing partners. Schools receive a share of the net revenue, and students benefit from significant discounts, averaging around 30%, based on our observations. This model benefits everyone involved. Publishers, whether it's Cengage or another, have their prices set by bookstores; we don't determine the pricing ourselves. Instead, we share the margin as part of the arrangement. However, to achieve the schools' affordability goals, something will need to change. What we're hearing in our interactions with the customers, our schools at the highest levels, including faculty, but also with the administration, is that they want these kinds of packages that give students substantial discounts, and they don't want to deal with all the different pricing schemes that various publishers are trying to throw at students and faculty, which in many cases can confuse them. Therefore, it's our challenge to work with the publishers during this changing transformative environment to ensure they understand what our customers want and that we're representing our customers.

Operator, Operator

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

Greg Pendy, Analyst

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

Mike Huseby, CEO

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

Barry Brover, EVP of Operations

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

Tom Donohue, CFO

Greg, just sorry. This is Tom. Just the community colleges represent usually around 25% of the total revenue; it's probably closer to 20% or 21% now.

Greg Pendy, Analyst

Okay. And I guess just bigger picture, they've been early adopters of some of your offerings.

Tom Donohue, CFO

Correct.

Greg Pendy, Analyst

Okay, understood. Regarding the textbook solutions, when you mentioned it reached 100,000, could you provide more details on the writing solution offerings and whether subscriptions are included in that figure?

Tom Donohue, CFO

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

Operator, Operator

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

Alex Fuhrman, Analyst

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

Barry Brover, EVP of Operations

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

Mike Huseby, CEO

To answer the question, Alex, I mean, each store is different, each school is different. As Barry is saying, he answered it very completely, but some larger stores lend themselves to the real estate that's available and therefore lend themselves to partnerships that you don't necessarily, as Barry said, have in other stores. But that's the point; as we try to treat each partnership differently in terms of selling very clear targets with them and expectations in KPIs as about so the expectations have been met in every case this year of all the things that we tried.

Tom Donohue, CFO

So that’s a pretty good representation. We can gather the data and see whether or not we want to expand that into more stores at a different level. Smaller footprint or that type of thing. But, yeah.

Alex Fuhrman, Analyst

And just taking on to that, what we're also piloting is a more streamlined version for our community college that has a different customer base. So more of a concept and presentation style that's more aligned with a community college customer, and over time, as course materials' physical footprint required decreases with more things going digitally, it certainly opens up the opportunities for us to bring in more concepts, more products, and really make this a retail destination spot for the community.

Operator, Operator

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

Tom Donohue, CFO

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

Operator, Operator

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