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BKS > SEC Filings for BKS > Form 10-Q on 5-Sep-2013All Recent SEC Filings

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Form 10-Q for BARNES & NOBLE INC


5-Sep-2013

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

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), cash received from the Pearson plc (Pearson) strategic investment in NOOK Media and short-term vendor financing.

The Company's cash and cash equivalents were $80.0 million as of July 27, 2013, compared with $20.2 million as of July 28, 2012.

On July 27, 2013, the Company had borrowings of $7.5 million against its $1.0 billion credit facility compared to $302.8 million in the prior year period. This decline is attributable to cash flows generated by the Retail and College segments, offsetting NOOK segment losses, as well as funds received from strategic investments in NOOK Media. The Company had $33.9 million of outstanding letters of credit as of July 27, 2013 compared with $35.1 million as of July 28, 2012.

The Company has arrangements with third-party manufacturers to produce its NOOK® products. These manufacturers procure and assemble unfinished parts and components from third-party suppliers based on forecasts provided by the Company. Given production lead times, commitments are generally made far in advance of finished product delivery. The prior year holiday sales shortfall resulted in higher than anticipated levels of unfinished goods. As a result, the Company is in negotiations with certain vendors for purchase commitments totaling approximately $46.7 million. Based on current negotiations and product development plans, the Company has recorded a provision of $5.3 million for commitments which it estimates as the most likely outcome. Future charges may be required based on the final result of these negotiations as well as changes in forecasted sales or strategic direction.

Merchandise inventories decreased $199.7 million, or 10.3%, to $1.748 billion as of July 27, 2013, compared with $1.947 billion as of July 28, 2012. This decrease included lower trade book inventory at B&N Retail as a result of improved inventory management and lower forecasted sales and lower textbook inventories at B&N College as a result of improved inventory management. NOOK inventories also decreased due to lower net realizable value and lower units on hand. Receivables, net decreased $2.7 million or 1.8% to $150.8 million as of July 27, 2013, compared to $153.5 million as of July 28, 2012. Prepaid expenses and other current assets increased $99.7 million, or 51.8%, to $292.0 million as of July 27, 2013, compared to $192.3 million as of July 28, 2012. This increase was primarily due to higher short-term deferred taxes. Accounts Payable decreased $92.7 million, or 7.2%, to $1.196 billion as of July 27, 2013, compared to $1.289 billion as of July 28, 2012. Accounts payable was 68% and 66% of merchandise inventory as of July 27, 2013 and July 28, 2012, respectively. Accrued liabilities decreased $28.5 million, or 5.3%, to $511.6 million as of July 27, 2013, compared to $540.1 million as of July 28, 2012. Gift card liabilities of the B&N Retail segment increased $16.2 million, or 5.2%, to $329.0 million as of July 27, 2013, compared to $312.9 million as of July 28, 2012 as gift card issuances exceeded redemptions over the past twelve months. Other long-term liabilities increased $78.4 million, or 21.8%, to $437.7 million as of July 27, 2013, compared to $359.4 million as of July 28, 2012. This increase is primarily due to the Microsoft Commercial Agreement financing transaction and tax reserves partially offset by a reduction in deferred rent and the junior seller note.

The Company's investing activities consist principally of capital expenditures for the maintenance of existing stores, new store construction, digital initiatives and enhancements to systems and the website. The Company plans to launch its new eCommerce website next year. The new website is expected to enhance its search, provide faster shipping and yield cost savings. The Company believes that the new website will allow it to


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be more competitive in the marketplace and continue to be a valuable resource for its customers, whether they would like to buy books shipped to their homes or picked up in the stores. Capital expenditures totaled $28.3 million and $26.5 million during the 13 weeks ended July 27, 2013 and July 28, 2012, respectively.

On April 27, 2012, the Company entered into an investment agreement among the Company, Morrison and Microsoft pursuant to which the Company would form 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, 300,000 convertible preferred membership interests in NOOK Media for an aggregate purchase price of $300.0 million. On October 4, 2012, NOOK Media was formed and the Company sold to Morrison 300,000 convertible preferred membership interests in NOOK Media for an aggregate purchase price of $300.0 million. The convertible preferred membership interests have a liquidation preference equal to Microsoft's original investment. Concurrently with its entry into this agreement, the Company has also entered into a commercial agreement with Microsoft, whereby, among other things, NOOK Media has developed and distributed a Windows 8 application for e-reading and digital content purchases, and has entered into an intellectual property license and settlement agreement with Microsoft and Microsoft Licensing GP. As part of the commercial agreement, for each of the first three years since the launch of the application for Windows 8, NOOK Media received and expects to continue to receive advance payments of $60.0 million per year from Microsoft. These advance payments are subject to deferral under certain circumstances. The Company previously disclosed that it expected to be selling content in 10 international markets by June 30, 2013. While substantial progress has been made towards meeting the target expansion requirement, the Company now expects expansion into these 10 markets to be accomplished by the end of fiscal 2014. This delay may entitle Microsoft to defer a portion of advance payments until the target expansion requirement is met. Microsoft has paid and is obligated to continue to pay to NOOK Media $25.0 million each year for the first five years of the term for purposes of assisting NOOK Media in acquiring local digital reading content and technology development in the performance of NOOK Media's obligations under the commercial agreement. Under the terms of this transaction, NOOK Media was debt-free at inception, except for trade accounts payable and other working capital requirements. Under the limited liability company agreement of NOOK Media, no distributions may be made by NOOK Media without Morrison's approval.

On December 21, 2012, NOOK Media entered into an agreement with a subsidiary of Pearson to make a strategic investment in NOOK Media. That transaction closed on January 22, 2013, and Pearson invested approximately $89.5 million of cash in NOOK Media at a post-money valuation of approximately $1.789 billion in exchange for convertible preferred membership interests representing a 5% equity stake in NOOK Media. Following the closing of the transaction, the Company owns approximately 78.2% of NOOK Media and Microsoft, which holds convertible preferred membership interests, owns approximately 16.8%. The convertible preferred membership interests have a liquidation preference equal to the original investment. In addition, NOOK Media granted warrants to Pearson to purchase up to an additional 5% of NOOK Media under certain conditions at a pre-money valuation of NOOK Media of approximately $1.789 billion.

At closing, NOOK Media and Pearson entered into a commercial agreement with respect to distributing Pearson content in connection with this strategic investment.

On August 18, 2011, the Company entered into an investment agreement between the Company and 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, based on the initial conversion rate. The initial conversion rate reflects an initial conversion price of $17.00 and is


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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.

On September 30, 2009, in connection with the closing of the acquisition of B&N College (the Acquisition), the Company issued the sellers (i) a senior subordinated note (the Senior Seller Note) in the principal amount of $100.0 million, with interest of 8% per annum payable on the unpaid principal amount, which was paid on December 15, 2010 in accordance to its scheduled date, and
(ii) a junior subordinated note (the Junior Seller Note) in the principal amount of $150.0 million, payable in full on the fifth anniversary of the closing of the Acquisition, with interest of 10% per annum payable on the unpaid principal amount. Pursuant to a settlement agreed to on June 13, 2012, the sellers have agreed to waive their right to receive $22.8 million in principal amount (and interest on such principal amount) of the Junior Seller Note.

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) $50.0 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, dispose of 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 April 27, 2012, the Company entered into an amendment to the 2011 Amended Credit Agreement in order to permit the transactions contemplated by the investment agreement among the Company, Morrison and Microsoft and to make certain other changes to the Company's 2011 Amended Credit Agreement in connection therewith. On December 21, 2012, the Company entered into an amendment to the 2011 Amended Credit Agreement to permit the transactions contemplated by the investment agreement between NOOK Media and a subsidiary of Pearson and make certain other changes to the Company's 2011 Amended Credit Agreement in connection therewith. On April 26, 2013, the Company entered into a letter amendment to the 2011 Amended Credit Agreement in order to amend the definition of Consolidated EBITDA contained therein to exclude the impact of inventory charges in the fiscal quarter ended January 26, 2013 from the calculation of Consolidated EBITDA.

On June 24, 2013, the Company entered into an amendment to the 2011 Amended Credit Agreement in order to amend the restricted payments covenant contained therein. The 2011 Amended Credit Agreement, as amended and modified to date, is hereinafter referred to as the 2013 Amended Credit Facility.


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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's three operating segments are: 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 and rent textbooks for the upcoming semesters. Revenues from textbook rentals, which primarily occur at the beginning of the semester, are 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 expanding digital market, increased online competition and the economic downturn. However, the Company has benefited from reduced physical bookstore competition in the marketplace, the successful execution of new merchandising strategies, its ability to acquire new college contracts and by expanding its offering to college students. Additionally, the Company has leveraged its unique assets, iconic brands and reach to become a leader in the distribution of digital content.

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 benefited 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 Toys & Games business as a result of the successful execution of new merchandising strategies. The Company is making further investments in its retail business this fiscal year and plans to launch a new eCommerce platform, which it believes will allow it to be more competitive in the marketplace.

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. The Company is making further investments in its college business, including investments to enhance offerings of digital products. The Company believes higher education provides a long-term growth opportunity.


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NOOK represents the Company's digital business, including devices, digital content and accessories. Over the past four years, the Company entered the e-book market, launched its NOOK® brand of eReading products, and has introduced several NOOK® black-and-white and color devices, 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. In addition to NOOK® devices, the Company makes it easy for customers to enjoy any book, anytime, anywhere with its free line of NOOK® Reading Apps™. Customers can use Barnes & Noble's eReading software to access and read books from their personal Barnes & Noble digital library on many 3rd party devices including Windows 8 PCs and tablets, iPads™, iPhones®, and Android™ tablets and smartphones. 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.

The Company sells digital content in the U.K. directly through its NOOK devices and its nook.co.uk website. The Company plans to continue to expand into additional international markets and believes that its partnership with Microsoft will help foster that expansion. The Company previously disclosed that it expected to be in 10 international markets by June 30, 2013. While substantial progress has been made towards meeting the target expansion requirement, the Company now expects expansion into these 10 markets to be accomplished by the end of fiscal 2014. Additionally, the Company believes that its newly formed partnership with Pearson will accelerate customer access to digital content by pairing Pearson's leading expertise in online learning with NOOK's expertise in reading technology, online commerce and customer service.

The Company has made significant investments building the valuable NOOK® digital retailing platform, which has resulted in millions of digital customers buying content from Barnes & Noble. While the Company experienced disappointing NOOK® device sales over the most recent holiday selling season, the Company's digital strategy is to offer customers any digital book or magazine, any time, on any device. The Company remains committed to having a premier digital bookstore and is focused on selling content to its existing customers as well as exploring new markets. Additionally, the Company remains committed to its NOOK device business. The Company intends to continue to design and develop innovative NOOK black-and-white and color devices, and believes that by offering high-quality reading devices at lower costs, it can drive device sales, and ultimately content sales. The Company will also focus on the sale of its existing device inventory and intends to continue to provide the resources necessary for quality customer service and support of those devices as well as devices in use by NOOK's existing customer base.

The Company believes its footprint of more than 1,300 stores will continue to be a major competitive asset in capturing digital content share. 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 net number of retail stores. B&N College expects to increase its college store base.

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, cash received from the


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Pearson strategic investment in 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 key strategic initiatives.

Results of Operations

13 weeks ended July 27, 2013 compared with the 13 weeks ended July 28, 2012

Sales

The following table summarizes the Company's sales for the 13 weeks ended July 27, 2013 and July 28, 2012:

                                                  13 weeks ended
                              July 27,                        July 28,
      Dollars in thousands      2013          % Total           2012          % Total
      B&N Retail             $ 1,008,202          75.9 %     $ 1,119,387          77.0 %
      B&N College                226,022          17.0 %         220,718          15.2 %
      NOOK                       153,138          11.5 %         191,975          13.2 %
      Elimination                (57,860 )        (4.4 )%        (78,573 )        (5.4 )%

      Total Sales            $ 1,329,502         100.0 %     $ 1,453,507         100.0 %

During the 13 weeks ended July 27, 2013, the Company's sales decreased $124.0 million, or 8.5%, to $1.330 billion from $1.454 billion during the 13 weeks ended July 28, 2012. The increase or (decrease) by segment is as follows:

• B&N Retail sales for the 13 weeks ended July 27, 2013 decreased $111.2 million, or 9.9%, to $1.01 billion from $1.12 billion during the same period a year ago, and accounted for 75.9% of total Company sales. The decrease was attributable to a 9.1% decrease in comparable store sales, which decreased sales by $87.5 million and lower online sales, which declined by $7.9 million. Closed store sales decreased sales by $19.4 million, partially offset by new stores that increased sales by $1.0 million. Comparable store sales were adversely impacted by lower NOOK unit volume. Core comparable store sales, which exclude sales of NOOK products, decreased 7.2% as compared to the prior year. Core comparable sales were impacted by comparisons to the strong sales of the Fifty Shades and Hunger Games trilogies in the prior year. Excluding these trilogies, core comparable sales decreased 2.9% during the quarter. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc.

• B&N College sales increased $5.3 million, or 2.4%, to $226.0 million during the 13 weeks ended July 27, 2013 from $220.7 million during the 13 weeks ended July 28, 2012. The increase was attributable to new store openings over the past year which increased sales by $9.9 million, partially offset by closed stores which decreased sales by $2.4 million. Comparable store sales decreased 1.2% or $2.8 million, primarily driven by lower textbook sales during the summer sessions, partially offset by higher general merchandise sales.

• NOOK sales decreased $38.8 million, or 20.2%, to $153.1 million during the 13 weeks ended July 27, 2013 from $192.0 million during the 13 weeks ended July 28, 2012. Device and accessories sales decreased $25.4 million or 23.1%, to $84.5 million during the 13 weeks ended July 27, 2013 on lower unit volume. Digital content sales decreased $12.9 million or 15.8% to $68.6 million during the 13 weeks ended July 27, 2013. The digital content decrease was due to lower device unit selling volumes and the comparisons to the Fifty Shades and Hunger Games trilogies in the prior year. Excluding the impact of these two trilogies, digital content sales decreased 6.9% during the quarter.


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• The elimination represents sales from NOOK to B&N Retail and B&N College on a sell through basis. The decrease versus the prior year was due to the lower device sales volume at B&N Retail.

During the 13 weeks ended July 27, 2013, B&N Retail had one store opening and two closings, and B&N College had 15 openings and 9 closings.

Cost of Sales and Occupancy



                                                        13 weeks ended
                                     July 27,        % of          July 28,         % of
 Dollars in thousands                  2013          Sales           2012           Sales
 B&N Retail                          $ 707,476         70.2 %     $   780,734         69.7 %
 B&N College                           175,773         77.8 %         169,675         76.9 %
 NOOK                                  135,912         88.8 %         165,866         86.4 %
 Elimination                           (57,860 )      (37.8 )%        (78,573 )      (40.9 )%

 Total Cost of Sales and Occupancy   $ 961,301         72.3 %     $ 1,037,702         71.4 %

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 July 27, 2013, cost of sales and occupancy decreased $76.4 million, or 7.4%, to $961.3 million from $1.038 billion during the 13 weeks ended July 28, 2012. Cost of sales and occupancy increased as a percentage of sales to 72.3% from 71.4% during the same period one year ago. The increase or (decrease) by segment is as follows:

• B&N Retail cost of sales and occupancy increased as a percentage of sales to 70.2% from 69.7% during the same period one year ago. This increase was attributable to occupancy deleverage against the sales decline and comparisons to the strong Fifty Shades trilogy margins in the prior year partially offset by higher mix of higher margin Core products in the current year.

• B&N College cost of sales and occupancy increased as a percentage of sales to 77.8% from 76.9% during the same period one year ago due to higher occupancy costs as a result of contract renewals.

• NOOK cost of sales and occupancy increased as a percentage of sales to 88.8% from 86.4% during the same period one year ago. This increase was attributable to heavier device promotions, increased royalty costs and sales mix.

Gross Margin



                                                   13 weeks ended
                                   July 27,       % of       July 28,       % of
            Dollars in thousands     2013        Sales         2012        Sales
            B&N Retail             $ 300,726       29.8 %    $ 338,653       30.3 %
            B&N College               50,249       22.2 %       51,043       23.1 %
            NOOK                      17,226       18.1 %       26,109       23.0 %

            Total Gross Margin     $ 368,201       27.7 %    $ 415,805       28.6 %

. . .

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