Liquidity and Capital Resources

The primary sources of Barnes & Noble, Inc.'s (Barnes & Noble or the Company) cash are net cash flows from operating activities, funds available under its senior credit facility, cash received and committed in the formation of NOOK Media, LLC (NOOK Media) and short-term vendor financing.

The Company's cash and cash equivalents were $471.0 million as of October 27, 2012, compared with $23.6 million as of October 29, 2011. This increase is due to the formation of NOOK Media as discussed below.

Merchandise inventories decreased $40.5 million, or 2.2%, to $1.796 billion as of October 27, 2012, compared with $1.837 billion as of October 29, 2011. This decrease was primarily due to timing of product receipts. Receivables, net decreased $16.1 million or 6.7% to $224.5 million as of October 27, 2012, compared to $240.6 million as of October 29, 2011. This decrease is due to mix of channel partners and increased collection efforts. Prepaid expenses and other current assets increased $43.0 million or 23.8% to $223.3 million as of October 27, 2012, compared to $180.4 million as of October 29, 2011. This increase was primarily due to higher textbook rental inventory on the growth in this business and higher short-term deferred taxes. Accounts Payable decreased $13.6 million or 0.9% to $1.448 billion as of October 27, 2012, compared to $1.462 billion as of October 29, 2011. Accounts payable was 81% and 80% of merchandise inventory as of October 27, 2012 and October 29, 2011, respectively. Accrued liabilities increased $34.1 million or 7.8% to $471.0 million as of October 27, 2012, compared to $436.9 million as of October 29, 2011. This increase was primarily due to several factors, including deferred income (textbook rentals and member program), compensation and general timing of expenses. Gift card liabilities increased $9.9 million or 3.5% to $297.2 million as of October 27, 2012, compared to $287.3 million as of October 29, 2011 due to additional business.

The Company's investing activities consist principally of capital expenditures for new store construction, the maintenance of existing stores, digital initiatives and enhancements to systems and the website. Capital expenditures totaled $67.0 million and $75.5 million during the 26 weeks ended October 27, 2012 and October 29, 2011, respectively.

On April 27, 2012, the Company entered into an amendment (the 2012 Amended Credit Facility) to its existing agreement with Bank of America, N.A. entered into on April 29, 2011, as administrative agent, collateral agent and swing line lender, and other lenders in order to permit the transactions contemplated by the investment agreement among the Company, Morrison Investment Holdings, Inc. (Morrison), and Microsoft Corporation (Microsoft) and to make certain other changes to the Company's 2011 Amended Credit Agreement in connection therewith.

On April 29, 2011, the Company entered into an amended and restated credit agreement (the 2011 Amended Credit Agreement) with Bank of America, N.A., as administrative agent, collateral agent and swing line lender, and other lenders, which amended and restated the credit agreement (the 2009 Credit Agreement) entered into on September 30, 2009 with Bank of America, N.A., as administrative agent, collateral agent and swing line lender, and other lenders. Under the 2011 Amended Credit Agreement, Lenders are providing up to $1.0 billion in aggregate commitments under a five-year asset-backed revolving credit facility (the 2011 Amended Credit Facility), which is secured by eligible inventory with the ability to include eligible real estate and accounts receivable and related assets. Borrowings under the 2011 Amended Credit Agreement are limited to a specified percentage of eligible inventories with the ability to include eligible real estate, accounts receivable and accrued interest, at the election of the Company, at Base Rate or LIBO Rate, plus, in each case, an Applicable Margin (each term as defined in the 2011 Amended Credit Agreement). In addition, the Company has the option to request an increase in commitments under the 2011 Amended Credit Agreement by up to $300.0 million, subject to certain restrictions.

The 2011 Amended Credit Agreement requires Availability (as defined in the 2011 Amended Credit Agreement) to be greater than the greater of (i) 10% of the Loan Cap (as defined in the 2011 Amended Credit Agreement) and (ii) $50 million. In addition, the 2011 Amended Credit Agreement contains covenants that limit, among other things, the Company's ability to incur indebtedness, create liens, make investments, make restricted payments, merge or acquire assets, and contains default provisions that are typical for this type of financing, among other things. Proceeds from the 2011 Amended Credit Agreement are used for general corporate purposes, including seasonal working capital needs.

On October 27, 2012, the Company had borrowings of $338.4 million against its $1.0 billion credit facility compared to $274.9 million in the prior year period. The Company had $34.6 million of outstanding letters of credit under the 2012 Amended Credit Facility as of October 27, 2012 compared with $31.0 million as of October 29, 2011.

On April 27, 2012, the Company entered into an investment agreement among the Company, Morrison and Microsoft pursuant to which the Company would form a Delaware limited liability company (NOOK Media), and transfer to NOOK Media the Company's digital device, digital content and college bookstore businesses and NOOK Media would sell to Morrison, and Morrison would purchase, 300 million convertible preferred membership interests in NOOK Media for an aggregate purchase price of $300.0 million. Concurrently with its entry into this agreement, the Company has also entered into a commercial agreement with Microsoft, pursuant to which, among other things, NOOK Media would develop and distribute a Windows 8 application for e-reading and digital content purchases, and an intellectual property license and settlement agreement with Microsoft and Microsoft Licensing GP.

On October 4, 2012, NOOK Media was formed and it has received the $300.0 million Microsoft investment. Under the terms of this transaction, NOOK Media was debt-free at inception, except for trade accounts payable and other working capital requirements. At closing, B&N Retail assumed the outstanding bank borrowings of the Company. Under the limited liability company agreement of NOOK Media, no distributions may be made by NOOK Media without Morrison's approval.

In November 2012, the Company received $21.3 million from Microsoft related to the first installment on the guaranteed advance payments to NOOK Media and the payment related to assisting NOOK Media in acquiring local digital reading content and technology development.

On August 18, 2011, the Company entered into an investment agreement between the Company and Liberty GIC, Inc. (Liberty) pursuant to which the Company issued and sold to Liberty, and Liberty purchased, 204,000 shares of the Company's Series J Preferred Stock, par value $0.001 per share (Preferred Stock), for an aggregate purchase price of $204.0 million in a private placement exempt from the registration requirements of the 1933 Act. The shares of Preferred Stock will be convertible, at the option of the holders, into shares of Common Stock representing 16.6% of the Common Stock outstanding as of August 29, 2011, (after giving pro forma effect to the issuance of the Preferred Stock), based on the initial conversion rate. The initial conversion rate reflects an initial conversion price of $17.00 and is subject to adjustment in certain circumstances. The initial dividend rate for the Preferred Stock is equal to 7.75% per annum of the initial liquidation preference of the Preferred Stock to be paid quarterly and subject to adjustment in certain circumstances. The entry into the investment agreement and the issuance and sale of the Preferred Stock was approved by the Company's Board of Directors following a recommendation made by a Special Committee of the Board of Directors. The terms, rights, obligations and preferences of the Preferred Stock are set forth in a Certificate of Designations of the Company, which was filed with the Secretary of State of the State of Delaware on August 18, 2011.

Based upon the Company's current operating levels, management believes cash and cash equivalents on hand, net cash flows from operating activities, cash received and committed in the formation of NOOK Media, short-term vendor financing and the capacity under the Amended Credit Facility will be sufficient to meet the Company's normal working capital and debt service requirements for at least the next twelve months. The Company regularly evaluates its capital structure and conditions in the financing markets to ensure it maintains adequate flexibility to successfully execute its business plan.

Segments

The Company identifies its operating segments based on the way the business is managed (focusing on the financial information distributed) and the manner in which the chief operating decision maker interacts with other members of management. The Company has three operating segments: B&N Retail, B&N College and NOOK.

Seasonality

The B&N Retail business, like that of many retailers, is seasonal, with the major portion of sales and operating profit realized during its third fiscal quarter, which includes the holiday selling season.

The B&N College business is highly seasonal, with the major portion of sales and operating profit realized during the second and third fiscal quarters, when college students generally purchase textbooks for the upcoming semesters. Textbook rentals, which primarily occur at the beginning of the semester, are being recognized over the rental period.

The NOOK business, like that of many technology companies, is impacted by the launch of new products and the promotional efforts to support those new products, as well as the traditional retail holiday selling seasonality.

Business Overview

The Company's financial performance has been significantly impacted in recent years by a number of factors, including the economic downturn, increased online competition and the expanding digital market. However, recently the Company has benefited from reduced physical bookstore competition in the marketplace, as well as the successful execution of new merchandising strategies.

The Company derives the majority of its sales and net income from its B&N Retail and B&N College stores.

B&N Retail comparable store sales trends have improved as one of B&N Retail's largest competitors in the sale of physical books, Borders Group, Inc. (Borders), completed liquidating all of its stores under Chapter 11 of the Bankruptcy Code in early fiscal 2012. While the Company expects declining physical book trends to continue industry-wide as consumer spending shifts further online and toward digital products, it expects to be the beneficiary of further market consolidation as other non-book retailers reduce their presence in the book category. Additionally, the Company continues to experience positive trends in its Juvenile, Gift and Toys & Games businesses as a result of the successful execution of new merchandising strategies. Other categories such as Café also improved as a result of increased store traffic.

The Company has leveraged its unique assets, iconic brands and reach to become a leader in the distribution of digital content. In 2009, the Company entered the eBook market and the popularity of its eBook site continues to grow. Since then, the Company launched its NOOK® brand of eReading products, which provide a fun, easy-to-use and immersive digital reading experience. With NOOK®, customers gain access to the expansive NOOK Store™ of more than three million digital books, plus periodicals, comics, apps, movies and TV shows, and the ability to enjoy content across a wide array of popular devices through free NOOK Reading Apps™ and NOOK Video apps.

Over the past several years, the Company has introduced leading devices in the tablet and eReader categories. In April 2012, the Company introduced NOOK Simple Touch™ with GlowLightTM, the world's first E Ink device with patent-pending lighting technology that lets you read in the dark. In September 2012, the Company introduced NOOK® HD, the lightest and highest-resolution 7-Inch HD tablet, and NOOK ® HD+, the world's lightest full HD tablet.

In addition to NOOK® devices, the Company makes it easy for customers to enjoy any book, anytime, anywhere with its free line of NOOK® software specific application, which has won the Webby People's Voice Award. Customers can use Barnes & Noble's eReading software to access and read books from their personal Barnes & Noble digital library on devices including Windows 8 PCs and tablets, iPad™, iPhone®, Android™ smartphones and tablets, PC and Mac®. The Lifetime Library™ helps ensure that Barnes & Noble customers will always be able to access their digital libraries on NOOK ® products and software-enabled devices and BN.com. The Company also offers NOOK Newsstand™, which provides an extensive selection of digital newspapers and magazines, available in both subscription and single copy format, NOOK Kids™, a collection of digital picture and chapter books for children, NOOK Study™, an innovative study platform and software solution for higher education, and NOOK Video™, which offers an extensive and diverse digital collection of standard and high-definition movies and TV shows available for streaming and download.

In the Fall of 2012, the Company began selling NOOK® devices internationally, through its website and partnerships with leading retailers, as well as digital content in the U.K. The Company plans to continue to expand into additional international markets and believes that its newly formed partnership with Microsoft will help foster that expansion.

As digital and electronic sales become a larger part of its business, the Company believes its footprint of more than 1,300 stores will continue to be a major competitive asset. The Company will continue to integrate its traditional retail, trade book and college bookstores businesses with its electronic and Internet offerings, using retail stores in attractive geographic markets to promote and sell digital devices and content. Customers can see, feel and experiment with the NOOK® in the Company's stores.

Although the stores will be just a part of the offering, they will remain a key driver of sales and cash flow as the Company expands its multi-channel relationships with its customers. While the Company plans to open a few retail stores in new geographic markets, the Company expects to reduce the total number of retail stores.

B&N College provides direct access to a large and well-educated demographic group, enabling the Company to build relationships with students throughout their college years and beyond. The Company also expects to be the beneficiary of market consolidation as more and more schools outsource their bookstore management. The Company is in a unique market position to benefit from this trend given its full suite of services: bookstore management, textbook rental and digital delivery.

Although the Company believes cash on hand, cash flows from operating activities, funds available from its senior credit facility, cash received and committed in the formation of NOOK Media and short-term vendor financing provide the Company with adequate liquidity and capital resources for seasonal working capital requirements, the Company may raise additional capital to support the growth of its digital businesses.

Results of Operations

13 and 26 weeks ended October 27, 2012 compared with the 13 and 26 weeks ended October 29, 2011

Sales

The following table summarizes the Company's sales for the 13 and 26 weeks ended
October 27, 2012 and October 29, 2011:



                                             13 weeks ended                                                    26 weeks ended
                       October 27,                      October 29,                      October 27,                      October 29,
Dollars in thousands       2012          % Total            2011          % Total            2012          % Total            2011          % Total
B&N Retail             $    996,028          52.9 %     $  1,025,802          54.2 %     $  2,115,415          63.4 %     $  2,123,054          64.1 %
B&N College                 773,007          41.0 %          769,650          40.7 %          993,725          29.8 %          990,144          29.9 %
NOOK                        160,347           8.5 %          151,847           8.0 %          352,322          10.6 %          343,259          10.4 %
Elimination                 (44,850 )        (2.4 )%         (55,338 )        (2.9 )%        (123,423 )        (3.7 )%        (146,092 )        (4.4 )%

Total Sales            $  1,884,532         100.0 %     $  1,891,961         100.0 %     $  3,338,039         100.0 %     $  3,310,365         100.0 %

During the 13 weeks ended October 27, 2012, the Company's sales decreased $7.4 million, or 0.4%, to $1.88 billion from $1.89 billion during the 13 weeks ended October 29, 2011. The increase or (decrease) by segment is as follows:

• B&N Retail sales for the 13 weeks ended October 27, 2012 decreased $29.8 million, or 2.9%, to $996.0 million from $1.03 billion during the same period a year ago, and accounted for 52.9% of total Company sales. The decrease was attributable to closed stores, which reduced sales by $14.5 million, and lower online sales, which declined by $16.7 million. Comparable store sales were flat versus the prior year. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc.

• B&N College sales increased $3.4 million, or 0.4%, to $773.0 million during the 13 weeks ended October 27, 2012 from $769.7 million during the 13 weeks ended October 29, 2011. The increase was attributable to new B&N College stores which increased sales by $35.0 million, offset by lower comparable store sales and closed stores that reduced sales by $24.8 million and $6.4 million, respectively. Sales were impacted by the continued growth of textbook rentals, which have a lower price than new or used textbooks, and a portion of rental sales are deferred over the rental period. On a comparable basis, which reflects the retail selling price when rented, sales declined 0.5% versus the prior year.

• NOOK sales increased $8.5 million, or 5.6%, to $160.3 million during the 13 weeks ended October 27, 2012 from $151.8 million during the 13 weeks ended October 29, 2011. The increase was attributable to higher digital content sales, offset by lower device sales. Digital content sales are defined to include digital eBooks, digital newsstand and the apps business. Device sales declined due primarily to lower average selling prices.

• The elimination represents sales from NOOK to B&N Retail and B&N College on a sell through basis.

During the 13 weeks ended October 27, 2012, B&N Retail had no store openings or closings, and B&N College had 11 openings and four closings.

During the 26 weeks ended October 27, 2012, the Company's sales increased $27.7 million, or 0.8%, to $3.34 billion from $3.31 billion during the 26 weeks ended October 29, 2011. The increase or (decrease) by segment is as follows:

• B&N Retail sales for the 26 weeks ended October 27, 2012 decreased $7.6 million, or 0.4%, to $2.11 billion from $2.12 billion during the same period a year ago, and accounted for 63.4% of total Company sales. The decrease was primarily attributable to closed stores that reduced sales by $30.6 million and lower online sales of $25.7 million, offset by an increase in comparable sales of 2.4%, which increased sales by $42.7 million. The comparable sales increase was driven by higher physical book sales in the first quarter due to the Borders liquidations and stronger titles. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc.

• B&N College sales increased $3.6 million, or 0.4%, to $993.7 million during the 26 weeks ended October 27, 2012 from $990.1 million during the 26 weeks ended October 29, 2011. The increase was attributable to new B&N College stores which increased sales by $42.3 million, offset by comparable store sales and closed stores that reduced sales by $28.7 million and $9.4 million, respectively. Sales were impacted by the continued growth of textbook rentals, which have a lower price than new or used textbooks, and a portion of rental sales are deferred over the rental period. On a comparable basis, which reflects the retail selling price when rented, sales declined 0.8% versus the prior year.

• NOOK sales increased $9.1 million, or 2.6%, to $352.3 million during the 26 weeks ended October 27, 2012 from $343.3 million during the 26 weeks ended October 29, 2011. The increase was attributable to higher digital content sales, offset by lower device and accessory sales. Digital content sales are defined to include digital eBooks, digital newsstand and the apps business. Device sales declined due primarily to lower average selling prices.

• The elimination represents sales from NOOK to B&N Retail and B&N College on a sell through basis.

During the 26 weeks ended October 27, 2012, B&N Retail had no store openings and two store closings, and B&N College had 36 openings and nine closings.

Cost of Sales and Occupancy



                                          13 weeks ended                                            26 weeks ended
                       October 27,       % of       October 29,       % of       October 27,       % of       October 29,       % of
Dollars in thousands       2012         Sales           2011         Sales           2012         Sales           2011         Sales
B&N Retail             $    702,667       70.5 %    $    735,312       71.7 %    $  1,485,316       70.2 %    $  1,522,115       71.7 %
B&N College                 604,786       78.2 %         601,959       78.2 %         774,462       77.9 %         771,281       77.9 %
NOOK                         96,581       83.6 %          83,026       86.0 %         183,875       80.3 %         157,747       80.0 %

Total Cost of Sales
and Occupancy          $  1,404,034       74.5 %    $  1,420,297       75.1 %    $  2,443,653       73.2 %    $  2,451,143       74.0 %

The Company's cost of sales and occupancy includes costs such as merchandise costs, distribution center costs (including payroll, freight, supplies, depreciation and other operating expenses), rental expense, management service agreement costs with schools, common area maintenance and real estate taxes, partially offset by landlord tenant allowances amortized over the life of the lease.

During the 13 weeks ended October 27, 2012, cost of sales and occupancy decreased $16.3 million, or 1.1%, to $1.40 billion from $1.42 billion during the 13 weeks ended October 29, 2011. Cost of sales and occupancy decreased as a percentage of sales to 74.5% from 75.1% during the same period one year ago. The increase or (decrease) by segment is as follows:

• B&N Retail cost of sales and occupancy decreased as a percentage of sales to 70.5% from 71.7% during the same period one year ago. This decrease was primarily attributable to a higher mix of higher margin core products and increased vendor allowances.

• B&N College cost of sales and occupancy remained flat as a percentage of sales at 78.2% as compared to the same period one year ago.

• NOOK cost of sales and occupancy decreased as a percentage of sales to 83.6% from 86.0% during the same period one year ago. This decrease was primarily due to a higher mix of higher margin content sales, partially offset by lower device margins on lower average selling prices and higher occupancy costs on increased office space in Palo Alto, CA.

During the 26 weeks ended October 27, 2012, cost of sales and occupancy decreased $7.5 million, or 0.3%, to $2.44 billion from $2.45 billion during the 26 weeks ended October 29, 2011. Cost of sales and occupancy decreased as a percentage of sales to 73.2% from 74.0% during the same period one year ago. The increase or (decrease) by segment is as follows:

• B&N Retail cost of sales and occupancy decreased as a percentage of sales to 70.2% from 71.7% during the same period one year ago. This decrease was primarily attributable to a higher mix of higher margin core products, and increased vendor allowances.

• B&N College cost of sales and occupancy remained flat as a percentage of sales at 77.9% as compared to the same period one year ago.

• NOOK cost of sales and occupancy remained relatively flat as a percentage of sales at 80.3% versus 80.0% during the same period one year ago. This decrease was primarily due to a higher mix of higher margin content sales, partially offset by lower device margins on lower average selling prices and higher occupancy costs on increased office space in Palo Alto, CA.

Gross Margin



                                           13 weeks ended                                              26 weeks ended
                        October 27,       % of        October 29,       % of        October 27,       % of        October 29,       % of
Dollars in thousands       2012          Sales           2011          Sales           2012          Sales           2011          Sales
B&N Retail             $     293,362       29.5 %    $     290,490       28.3 %    $     630,099       29.8 %    $     600,939       28.3 %
B&N College                  168,221       21.8 %          167,691       21.8 %          219,263       22.1 %          218,863       22.1 %
NOOK                          18,915       16.4 %           13,483       14.0 %           45,024       19.7 %           39,420       20.0 %

Total Gross Margin     $     480,498       25.5 %    $     471,664       24.9 %    $     894,386       26.8 %    $     859,222       26.0 %

The Company's consolidated gross margin increased $8.8 million, or 1.9%, to $480.5 million during the 13 weeks ended October 27, 2012 from $471.7 million during the 13 weeks ended October 29, 2011. This increase was due to the matters discussed above.

The Company's consolidated gross margin increased $35.2 million, or 4.1%, to $894.4 million during the 26 weeks ended October 27, 2012 from $859.2 million during the 26 weeks ended October 29, 2011. This increase was due to the matters discussed above.

Selling and Administrative Expenses



                                                                13 weeks ended                                              26 weeks ended
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