Good day, everyone, and welcome to the Barnes & Noble Education Second Quarter 2016 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Thomas Donohue. Please go ahead. .

Thank you. Good morning, and welcome to Barnes & Noble Education's Fiscal 2016 Second Quarter Earnings Call. Joining us today are Max Roberts, CEO; Patrick Maloney, President of Barnes & Noble College; and Barry Brover, CFO, as well as other members of the senior management team..

Before we begin, I would remind you that this call is covered by the safe harbor disclaimer contained in our press release and public documents and is the property of Barnes & Noble Education. It 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 Max Roberts. .

Thanks, Tom, and good morning, everyone. The company has successfully completed our first fall rush as a stand-alone independent company.

Since we begin trading as a separate public company on August 3, we continue to execute our core strategies where our primary business focus is to increase market share by winning new accounts, increase sales at our existing bookstores, grow our digital learning platform and pursue strategic opportunities through acquisitions and partnerships..

We are pleased with our top line and overall performance in the second quarter despite the lower enrollment in community colleges, which adversely affected our comparable sales. Our sales increased by 0.6% for the quarter and 1.8% year-to-date. This increase was driven by our new store growth, which is an integral part of our strategy.

We are executing well..

We continue to win new contracts, expand our footprint and increase our market share along with a number of students and faculties we serve throughout the United States. We opened 7 new stores in the quarter, while not closing any, bringing our total store count to 743. These 7 new stores represent approximately $7 million of estimated annual sales..

In addition, we have signed contracts for another 10 new stores with estimated annual sales of $13 million, and we expect these stores to open later this year. Thus far, total estimated annual sales for new stores in fiscal 2016 exceeded $64 million..

Our business model is dynamic with a compelling suite of products and services to support our campus partners and help drive student success, and we continue to look at opportunities to enhance our offerings.

Our deep integration with our schools and our powerful omni-channel commerce platform delivers a great experience for the 5 million students and faculty that we serve..

We create social and academic hubs that are the center of campus life. This fall rush alone, we executed close to 1,000 events in stores and where -- that were localized and highly relevant to each individual campus.

This dynamic service model has rewarded us with new business wins, the retention of existing contracts and a deeper connection with the students and faculty on the campuses we serve..

And as previously reported publicly by certain major publishers, enrollments in community colleges have decreased year-over-year. We have experienced the same trend for our comparable store community colleges, seeing enrollments decrease in the mid-single digits year-over-year.

And as a result, our comparable store sales for these community colleges decreased by approximately 7%..

first is localized employment markets improving; second, shifts in skill requirements for jobs, specifically in manufacturing, healthcare and technology; third, funding from state, local and federal governments; and finally, reduction in federal aid funding as a result of performance requirements implemented a few years ago.

The enforcement of these performance requirements has resulted in some enrollment decreases..

Historically, community colleges have been very aggressive in responding to falling enrollments by changing course offerings and admissions. Also, state governments are very sensitive to voter sentiment on education funding and tend to react quickly to the legislative process..

Enrollments at community colleges also tend to be more fluid as when compared to other types of schools and course offerings and can be created quickly as demand changes.

The enrollment makeup of community colleges is not dependent on physical infrastructure for student life, which is typically associated with 4-year institutions and faculty are generally adjunct and can be flexed quickly.

We are already seeing our partners implementing strategies to improve retention and enrollment in geographic areas where enrollments were lost to increased employment and manufacturing. As we have seen in the past, we believe enrollments will rebound..

A very important strategy of our business is the management of the portfolio composition of our schools. We continue to maintain a balanced portfolio of colleges and universities with 24% of our sales from community colleges, 39% from state schools, 17% from private schools and 18% from our super stores with the balance being specialty stores..

Comparable store sales excluding community colleges for the quarter decreased 1.3% and 0.2% year-to-date. Enrollments for this part of the portfolio were essentially flat for the rush period. .

In the second quarter, general merchandise sales increased $2.2 million or 1.3% on a comparable sales basis. Emblematic apparel and gifts continue to show strong sales increases. Customers continue to respond enthusiastically to our broad selection of brands such as Nike, Under Armour, Adidas and Champion.

During the fall rush period, our sales mix is more dependent upon school and computer supplies. This category was also adversely impacted by enrollments at community colleges, which negatively affected total general merchandise sales..

The second generation of Yuzu was available for our students this fall. Our digital capabilities play an important role to our future growth and opportunities for 2 reasons. First, it is a key solution for prospective colleges and universities that seek to provide their faculty and students a richer and more dynamic educational content.

Yuzu has been an important part of our success in winning new contracts. Second, Yuzu and FacultyEnlight put us in a position to be a leading provider of digital course materials to faculty and students as the marketplace accelerates in the delivery of digital content..

Our e-commerce channels continue to be strong once again growing at 14% overall and 31% for our general merchandise business year-over-year. For the fall rush, nearly 32% of our textbook sales were driven through the web with 75% of our students choosing to pick up in the store. .

Our mobile strategies are continuing to drive engagement and sales. Customers are responding enthusiastically to our mobile app with over 260,000 customers downloading the app, driving a 70% activation rate, more than double the retail industry average.

Customers can check the status of their orders, download promotions and discounts and shop right within the app..

The strength of our relationships with our customers and the seamless online channels drove our Cyber Monday sales, which occurred during Q3 to a record high, up approximately 35% as compared to last year..

As we wrap up our first quarter as a stand-alone independent company, we would like to thank all of our employees, especially our store managers and booksellers who take care of our customers and campus partners every day. We look forward to our students returning to campus in early January for the spring rush..

Again, our overall top line year-to-date performance is positive, we remain focused on our growth strategies as outlined in the S-1, and we are confident of our future growth..

With that, I'd like to wish everyone a very happy and safe holiday and turn it over to Barry for the financial review. .

Thank you, Max. This morning, we released our second quarter results for fiscal 2016. Please note that the second quarter ended on October 31, 2015, and consisted of 13 weeks.

The results of operations for the 26 weeks ended November 1, 2014, and the 13 weeks ended August 1, 2015, reflected in our consolidated financial statements are presented on a stand-alone basis since we were still part of Barnes & Noble, Inc. until August 1, 2015..

The results of operations for the 13 weeks ended October 31, 2015, reflected in our consolidated financial statements are presented on a consolidated basis, as we became a separate public company. Please note all comparisons will be to the second quarter of fiscal 2015 unless otherwise noted..

Total sales for the quarter were $755.9 million compared with $751.7 million from the prior year. The second quarter includes our fall back-to-school or rush sales and is our largest quarter.

This sales increase of $4.2 million or 0.6% was driven by sales from net new stores, which contributed an additional $30.4 million in sales for the quarter and were partially offset by our comp store sales decline of $22.6 million.

As Max discussed, our comparable store decline of 3% for the quarter and 1.9% year-to-date was primarily driven by the decrease in enrollments in 2-year community college..

Products sales increased during the quarter, driven by the net new stores and continued growth in general merchandise sales, partially offset by the decline in textbooks. For the quarter, our general merchandise sales in comparable stores increased over the prior period by $2.2 million or 1.3%.

While our emblematic apparel sales continue the strong increases, the back-to-school or rush quarter includes a larger percentage of school and computer supplies, which were impacted by the decrease in enrollments..

Our rental income declined for the quarter by $0.9 million or 1.3%. The rental income was impacted by an increase in our rental deferral of $3.1 million as of the end of the quarter. Excluding the impact of the rental deferral, rental income increased by $2.2 million or 1.9%..

Gross margins were $175.1 million, an increase of $1.6 million or 0.9%. The margin rate was 23.2%, a 10 basis point improvement for the quarter. The margin rate increase was primarily driven by improved textbook margins for both used textbooks sold and rented as a result of our improved inventory management strategies.

A favorable sales mix of selling more general merchandise and used rentals, both of which generate higher margins, partially offset by higher occupancy costs associated with contract renewals..

Selling and administrative expenses increased $6.9 million or 7.2% to $102.4 million, 90 basis points as a percentage of sales.

The increase was primarily due to higher store payroll and operating expenses, primarily in new stores, corporate payroll and expenses for technology and support programs, continued investments in Yuzu and approximately $1 million of incremental expenses related to separation and being a stand-alone public company..

Yuzu expenses, including occupancy and selling and administrative expenses, were $6.8 million for the quarter as compared to $6.1 million in the prior year. This brings the total Yuzu spend on year-to-date basis to $13.5 million, a $1.3 million increase over the prior year.

At this point in the development cycle of Yuzu and with 6 months completed in the fiscal year, we expect Yuzu expenses for fiscal year 2016 to be flat with the prior year and not up $2 million, as previously stated..

Our EBITDA was $72.7 million for the quarter, a decrease of $5.2 million compared to the prior year, primarily due to the reduced earnings on lower comp sales, increased expenses previously discussed, partially offset by the earnings contribution from our new stores. .

The effective tax rate for the second quarter was 43.4% compared with 43.5% in the prior year. The reduction in our effective tax rate is largely driven by a lower-projected income tax liability, resulting from changes in state tax laws and tax rates..

Second quarter net income was $33.4 million or $0.69 per diluted share compared to net income of $37 million or $0.95 per diluted share in the prior year..

The current year's fiscal quarter has 48.6 million shares outstanding while the prior year had 37.5 million shares outstanding. The current period reflects the dilution of the previously disclosed Series J preferred shares converted at Barnes & Noble, Inc. in July 2015 prior to the spin..

The balance sheet continues to be strong with no debt outstanding at the end of the quarter and $214 million of cash. The decrease in cash as compared with the prior year is the result of intercompany funding that occurred with our former parent from November 14 through the date of the spin. .

As previously disclosed, the company entered into a 5-year $400 million ABL credit facility with a group of lenders on August 3, 2015. And this facility replaces the credit facility that the company had access to as part of Barnes & Noble, Inc.

During the quarter in early August, the company borrowed and repaid $8.7 million under the facility and remained out of the facility through the end of the quarter..

Merchandise inventories increased by $90.5 million as compared to the prior year. This increase was the result of higher textbook inventories and inventory associated with new stores.

The company delayed the textbook returns to publishers in order to maximize sales through the quarter and into the third quarter as we have seen students purchasing course-related materials later in the semester. The textbook returns were completed in the third quarter. .

Our accounts payable increased by $44 million from $431 million to $475 million, along with the increase in inventory..

In our stockholders equity section, you will see the reclassification of the parent company investment. Our capital expenditures for the second quarter were $12.8 million compared with $15.3 million in the prior year, and on a year-to-date basis were $24.5 million compared with $24.6 million last year..

Currently, our store count is 743, having opened 7 new stores while not closing any in the quarter. We will be opening an additional 10 stores based upon the new contracts signed to date..

We expect comparable store sales to be in a range from flat to down 2% and Yuzu spend to be approximately flat to last year, a decrease of $2 million from the prior outlook. In addition, capital expenditures will be approximately $50 million for the fiscal year.

We expect for fiscal year 2016 incremental stand-alone costs associated with the spin and being an independent publicly-traded company to be approximately $3 million to $5 million on top of the expenses included in the carve-out financials previously presented in the S-1 for fiscal 2015.

This includes approximately $2 million in additional stock compensation expenses..

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

[Operator Instructions] Our first question is from Alex Fuhrman from Craig-Hallum Capital Group. .

I wanted to ask a little bit more about the lower comp store sales guidance for the year.

It sounds like if I'm interpreting this correctly, that's the largest difference between this and your prior guidance is lower than expected community college enrollments, but it also sounds like your 4-year college comps were down a little bit here in the quarter.

I mean, is that decline you saw in the 4-year colleges consistent with what you were expecting for the full year considering how strong the first quarter is or is there maybe something that's negatively impacting the trend of the 4-year schools as well?.

We -- Alex, this is Max. We do not break out the guidance between community colleges when we planned it and the other schools we saw the enrollments decreasing in community colleges.

And we look at the overall trend, which reflects the decrease in the community colleges, and also what we saw in the first 2 quarters year-to-date, and we came up with an overall guidance. .

Okay. And then it sounds like great news about winning some new contracts here during the quarter. And it sounds like there haven't been any closure so far in the year. When you say that there's going to be 38 openings this fiscal year, I assume that's a gross number.

How many closures would you expect to offset that in the balance of the year? And then however you look at it whether it's in terms of number of units or the volume of new business won, is this kind of a run rate that you would think is reasonable to shoot for in 2016 and '17 as well?.

I'll let Barry talk a little about the closures that we -- but at the end of the day, our growth is very top line based. At the end of the day, we have seen a strong pipeline, we called out in the S-1. It's key to our strategy.

And the reason for the top line growth is to position us to have a larger customer base, to expand our offerings and services and also to position it for mergers and acquisitions and have a larger customer base.

Traditionally, the accounts that we have lost have been schools as we did last year that we voluntarily closed because of the operation and we have a number that we don't disclose necessarily as to what we budgeted for contingency of losing schools but it is minor and would not adversely affect the top line. .

And just to add to that Alex, this is Barry, in the first quarter, we did close 9 stores, which, as Max alluded to, were typically smaller stores that were satellite stores that were unprofitable, were smaller stores that were part of a bigger contract.

We did not close any stores in the second quarter and there are no known closings expected for Q3 at this point in time. .

Our service model and the way we approach each school on a decentralized local basis with very strong relationships and events that we have on campus, we feel that our retention rate will continue as it always has in the past and generally, we have no expectations of closures with our existing accounts. .

That's great.

And then lastly, if we could just talk kind of broadly about Yuzu, was there anything specific or intentional about taking the spending down by a couple million from your prior guidance? Or is that perhaps just related to the timing of some spending you're going to have there as you get close to the end of the year? It sounds like obviously Yuzu has been very important in the sales process when approaching new business.

Is there anything really to speak of yet in terms of explicit Yuzu revenues at this point? Or is that really the biggest value of the asset to you is how you're using it to pitch new business?.

It's kind of all in. We -- Yuzu has been very important on the front side, it's acquiring new accounts, along with FacultyEnlight, which is also a digital product that we work directly with publishers on.

And we see that since version 2 was released, we want to flex our spending between the different products and rationalize the expense structure based on what we see coming down the pipe for enhancements.

And we feel comfortable that we're going to have a flat spend this year and when we originally looked at some development that we got behind us at this point in time. .

[Operator Instructions] And it appears there are no further questions today. Mr. Donohue, I'll turn the conference back over to you. .

Okay, thank you. And thank you for joining us on today's call. Please note that our next scheduled financial release will be our fiscal 2016 third quarter earnings which will be on or about March 8, 2016, and thank you for joining us today. .

And that does conclude our conference today. Thank you all for your participation..