Indigo Books & Music Inc.

Good morning, and thank you for joining us to review Indigo’s fiscal 2022 third quarter results. My name is Craig Loudon, and I’m the Chief Financial Officer.

Joining us from Indigo today is the Chief Executive Officer, Heather Reisman. Regarding the materials for this conference call, we issued the press release yesterday.

It can be found at indigo.ca and on SEDAR. The conference call will be recorded and archived in the Investor Relations section of the Indigo website.

A playback of the call will also be available by telephone until 11:59 PM Eastern Time on February 18, 2022. This conference call may contain forward-looking statements.

And to the extent that it does, we refer you to our cautionary statement regarding forward-looking statements in the press release and the MD&A related to this quarter. I would now like to turn the call over to Heather Reisman.

Good morning, everyone, and thank you for joining us. Our strong sales performance with our print and general merchandise businesses, both in growth mode, delivered another quarter of revenues that exceeded both last year and pre-pandemic levels.

Specifically, sales were $430.7 million. This represents a $65.3 million or 17.9% increase over last year and a $47 million or 12.2% increase over fiscal 2020.

Growth in our core print business is being driven by a renewed interest in reading and the popularity of reading on social media. This latter phenomena, which is still gaining in strength, has been strengthening the Indigo brand with a key demographic.

On the general merchandise side, our lifestyle and kids businesses, both delivered strong results, further insulating our overall business from being dependent on the existence of any one blockbuster book to make our season. This sales growth was delivered despite an endlessly disruptive set of pandemic conditions.

The Omicron variant upended the recovery in retail, which had begun earlier in the fall. It brought another round of severe capacity restrictions in key markets, which blunted the incredible momentum we experienced in the first two months of the quarter.

Most significantly, it impacted us in the critical days leading up to and including December 24 when our stores are typically chockablock and customers are concerned with ensuring product is in hand for Christmas morning. While Craig will provide a detailed financial perspective, we are pleased to deliver an adjusted EBITDA of $52 million, despite heightened freight and logistic costs and minimal external COVID-19 support.

These results are a testament to our meaningfully curated product assortment and strengthened operating model, which included greater sell-through of full-price goods and, of course, the dedicated efforts of our exceptional teams. We are energized by the strength of our business and look forward to moving past this pandemic when we can fully realize our growth potential.

I will now pass it over to Craig.

Thank you, Heather. The results we are discussing are for the 13 weeks ended January 1, 2022.

Comparative figures reference the 13 weeks ended December 26, 2020. We generated revenue of $430.7 million, an increase of $65.3 million, or 17.9% from the third quarter last year.

The company experienced growth across its print and general merchandise businesses. As Heather discussed, the print business benefited from a resurgence in reading.

The company’s position as Canada’s leading bookseller, combined with the effective mitigation of distribution delays experienced by the publishing industry, resulted in its ability to capitalize on the elevated demand, notably introducing the Indigo brand to a younger demographic. The company’s proprietary brands and strategic inventory buys meaningfully contributed to the growth of the general merchandise business.

As a result of social distancing and government mandated capacity constraints in stores, we believe that comparable sales are not currently meaningful to evaluate performance. Instead, we focused on total revenue as discussed as well as omni-channel fulfillment trends.

The retail channel, which is inclusive of orders fulfilled through omni-channel store pickup increased by $67.7 million, or 29.4% to $298.1 million for the 13-week period ended January 1, 2022. Retail revenue growth was driven by high conversion and full-price sell-through, while pandemic conditions softened and the company’s retail network performed stronger than in the same period last year.

The emergence of the Omicron variant dampened the network’s full recovery. Online channel revenue decreased by $3.5 million, or 2.8% to $122.0 million for the 13-week period ended January 1, 2022.

The slight moderation in demand reflects the rebound of retail, as discussed. The online channel sustained sales levels at 86.3% above pre-COVID fiscal 2020 and continues to be central to the company’s growth trajectory.

Cost of sales increased by $34.5 million to $252.4 million for the 13-week period ended January 1, 2022. Excluding the impact of online shipping costs, cost of sales increased by $32.4 million to $229.8 million for the period.

As a percentage of total revenue, this represents a decrease to 53.4% compared to 54.0%. While this was driven by the retail channel rebound, which typically has a higher margin profile, the strength of the company’s product assortment and a tighter promotional cadence delivered improvements in its merchandise margin.

Notably, these improvements more than offset the adverse impacts of higher inbound freight costs triggered by global supply chain constraints. To provide further context in the quarter, pressures from the global supply chain cost of general merchandise business approximately 300 basis points in margin rate.

Online shipping costs increased by $2.1 million to $22.6 million for the 13-week period ended January 1, 2022, largely due to increased fuel costs and additional shipping costs incurred in response to the severe flooding experienced in British Columbia during the period. Overall, operating, selling, administration costs increased by $16.3 million to $127.1 million for the period.

Operating costs were offset by external COVID-19 support of $1.2 million, markedly lower than the $12.9 million the company was eligible for and recognized in that occupancy abatement and government rent and payroll subsidies in the prior year. Operating costs also increased on the return of higher sales volumes in the retail channel.

Adjusted EBITDA improved by $14.2 million to $52.0 million for the 13-week period ended January 1, 2022. Higher adjusted EBITDA was driven by strong sales and merchandise margin performance and achievement against lower external COVID-19 labor support and the corresponding increase in retail operating expenses.

The company recognized net earnings of $45.1 million for the 13-week period ended January 1, 2022, or $1.62 net earnings per common share, compared to net earnings of $30.7 million, or $1.11 net earnings per common share for the same period last year, an improvement of $14.4 million. With no outstanding debt and cash of $189.9 million, the company is well positioned to see through the remaining COVID-19 uncertainty and the execution of a post-pandemic growth strategy.

At this point, we would like to open the call for any questions.

Hi. Thank you.

Yeah, just a couple of questions. I was wondering, can you tell us how many days in the quarter were impacted by COVID lockdowns?

Sure. I mean, I can give you the dates.

This is Craig. David, it varied by geography.

But in Alberta, we were down to only 33% capacity from October 26 onward. In Quebec, we were down to like 30% capacity from December 16.

And then on Ontario 50% capacity from December 17. Now we’ll say in Ontario, even be, I would say, a week before the restrictions went in place, you could see consumer behavior changed drastically.

So I think the measures were announced, but didn’t go into place for a week. So even a week before they went into place, traffic dropped considerably.

Okay. And do you guys, I mean, you must have some idea what that cost you in terms of revenue?

Could you comment about that?

Yeah.

Go ahead. Go ahead, Craig.

Yeah, I mean, we – earlier in that quarter, David, we were exceeding our expectations. So – but in terms of what were expectations in retail, we had hoped to achieve probably at least another $30 million in that channel in the quarter.

But – so it’s a little bit of a guessing game, but if that gives you any sense.

Okay. And that’s helpful.

You realized it has two impacts – it has three impacts. And I think Craig’s point is valuable that based on the momentum in October and November, had that momentum continued, it would have been at least, I think, Craig, you’d say at least, what you’re saying.

But I agree with you in any case. But I just think it’s important to point out that it has a couple of different impact, not just retail sales.

But when you push to online, you just have to ramp up all the delivery costs, which Craig notes in the – in his comments earlier in the call. And then the other factor is in the last week, the last 10 days, in particular, in the last week, when online can no longer pick up, then you have the more significant impact.

Yeah, okay.

So it’s sales and cost.

Right. There’s a few dynamics?

Yeah, yeah.

Okay. And then just looking at the online revenue, I saw it was down – it’s expected to be down because the prior year was benefiting from COVID and all the lockdowns there.

I mean, I’m just trying to get a handle on what online revenue looks like going forward, assuming everything opens back up, and you kind of get back to normal. Any help there would be help us on?

Yeah, I think you should keep in mind that our view and I think most people’s view is that the pandemic has fundamentally changed people’s behavior. So I think it’s fair to say we are optimistic.

Our online is doing extraordinarily well. And we are optimistic that retail will grow.

We’re optimistic or feeling that retail will come back – start to come back more and more to pre-pandemic levels. But the online channel will continue to be very strong, and we picked up a lot of new to online.

Over the course of these two years, we picked up a lot of new to online shoppers. So new to us, and maybe new to online in total.

So we’re feeling positive about the opportunity in online, and it’s running way over pre-pandemic levels way over.

Right. And what’s giving, Heather, confidence in that – certainly, David, in the summer and the early fall when…

Exactly

…things were more wide open and people were more on mobile. We didn’t see retail in line with the pre-pandemic levels, but online still holding up.

So, we’ve seen that demonstrated now. Does that, I mean, consumers changed a little bit in the next two years?

I mean, no one has a crystal ball, but that’s why we have confidence.

Okay. And, Craig, you talked about heightened freight and logistics costs.

I mean, do you expect these off anytime soon? Or, as we all know, the inflationary pressures and supply side chain problems and stuff are just going to be the way it is for a little while?

Well, it will be this way for a little while. The question is what is a little while.

We’re not seeing them back off yet. In fact, I would say they’re at the highest level they’ve been in the pandemic.

I mean, ocean containers that used to cost $2,000 to North America running $25,000 right now. So – but over time, that’s got to adjust.

Egregious rates, like that brings – bring on capacity. So it will adjust over time.

I think you probably noticed in our materials that, that did cost us $6.9 million in the quarter. So, we expect that to equalize somewhat over time, but not immediately.

Okay. And assuming the world gets back to normal, everything’s open up at 100%.

You guys have done a pretty good job at reducing your cost structure. Do you think you can hold it here?

Or there’s going to be more investments again in the cost structure, just trying to assess what the ultimate possibility is to the business when things totally open up?

Yeah, I think I can go first, Heather. The – we can definitely hold it, David.

I think the what is encouraging is, we see a future with both channels firing on all cylinders. Pre-pandemic, we had a very strong retail network, and we believe we’ll get back there.

But our online business was a little smaller. So, frankly, when it wasn’t Black Friday, the rest of the year, there were a lot of fixed costs that weren’t necessarily well leveraged, I think now with the scale in the online channel and we see even further growth there that as a percent of sales over time those operating costs should come down.

Certainly hold and we believe there’s opportunity to come down a little further, not in dollar terms, but as a percent of sales.

Okay. And then I was just looking back at your results and say, in the last five years or so, and you hit a high watermark in the quarter ending December 2017 about $63 million to $64 million of EBITDA.

And I’m just wondering, do you think you can hit that high watermark or even surpass it? Now just I mean, assuming we get back to normal and everything will be at 100%, do you need to hit that level again?

Yes. We think we’re going to hit that now.

I don’t want to set your expectations that it’s going to happen this year. Because when we look at, the traffic is still following a pattern of what I’ve reduced due to Omicron, that has not come back yet.

So I think we’re probably going to be starting next year, still a bit behind in that sense. We don’t see the freight problem equalizing yet.

And so I think we’re still going to have some headwinds here, but we definitely see getting back to those levels of EBITDA. Yes, the question is just on timing.

And again, I didn’t think this time last year, we’d still be sitting here talking about COVID. So really, we need both channels firing on all cylinders and to be out of this before that happens.

Yeah. Okay.

And so then just thinking about post-COVID era, you’re going to make some investments in the business. Would they be retail-driven, online-drive and a combination, maybe you can just give us an idea of what you’re thinking longer-term?

So, we have a couple of things on the plan. We’re definitely going to continue to invest in digital because we see it as a huge opportunity.

We have some further plans for our stores. But we have a quite a thoughtful way of approaching that based on learnings from the last couple of years.

So we will make the appropriate capital investments. We have a very thoughtful plan on them, and we’re feeling pretty positive about the return on capital plan for the next couple of years.

But as you’re talking about an investment in retail, you’re not going to do anything like what you did a couple of years ago?

No, no, we don’t have to – on two counts. We don’t have to.

And secondly, we remain a really desired brand by retailers and we’re being encouraged to – into places we want to stay. We’re not only being encouraged to stay, but we’re being offered renovation funds that we require for the most part.

Okay, that’s fine. Okay, that’s it for me.

Thank you.

Okay. Thanks, David.

You’ve always been. Anybody else?

Okay.

Thank you. Thank you for your time and attention today.

We appreciate you calling in and look forward to reconnecting on a quarterly basis. Our fourth quarter results will be announced on or around June 3.

Thank you again for your support and have a great day.

Thank you. Bye-bye.