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BKS > SEC Filings for BKS > Form 10-Q on 5-Mar-2014All Recent SEC Filings

Show all filings for BARNES & NOBLE INC

Form 10-Q for BARNES & NOBLE INC


5-Mar-2014

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 credit facility, cash received and committed in connection with the formation of NOOK Media LLC (NOOK Media) and related commercial agreements, cash received from the Pearson plc (Pearson) strategic investment in NOOK Media and short-term vendor financing.

The Company is party to an amended and restated credit facility with Bank of America, N.A., as administrative agent, collateral agent and swing line lender, and other lenders, dated as of April 29, 2011 (as amended and modified to date, the Credit Facility), consisting of up to $1 billion in aggregate commitments under a five-year asset-backed revolving credit facility expiring on April 29, 2016, which is secured by eligible inventory and accounts receivable with the ability to include eligible real estate and related assets. Borrowings under the Credit Facility are limited to a specified percentage of eligible inventories and 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 Credit Facility). In addition, the Company has the option to request an increase in commitments under the Credit Facility by up to $300 million, subject to certain restrictions.

The Credit Facility requires Availability (as defined in the Credit Facility) to be greater than the greater of (i) 10% of the Loan Cap (as defined in the Credit Facility) and (ii) $50 million. In addition, the Credit Facility 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 Credit Facility are used for general corporate purposes, including seasonal working capital needs.

The Company's cash and cash equivalents were $489.6 million as of January 25, 2014, compared with $213.6 million as of January 26, 2013. The increase in cash of $275.9 million is attributable to the proceeds from the Microsoft Commercial Agreement, B&N Retail and B&N College profits and improvements in working capital, including the sell through of existing NOOK inventory, partially offset by NOOK losses. On January 25, 2014 and January 26, 2013, the Company had no borrowings under its $1.0 billion credit facility. During the 39 weeks ended January 25, 2014, the Company had gross borrowings of $734 million and gross repayments of $811 million under its credit facility netting to a $77 million reduction in its credit facility. The Company had $34.4 million of outstanding letters of credit as of January 25, 2014 compared with $34.6 million as of January 26, 2013.

Merchandise inventories decreased $343.1 million, or 19.2%, to $1.442 billion as of January 25, 2014, compared with $1.785 billion as of January 26, 2013. This decrease is primarily due to lower NOOK and B&N Retail inventories. NOOK inventories decreased due to the sell through of devices, while Retail declined on lower sales volume. Receivables, net decreased $99.4 million, or 25.1%, to $296.8 million as of January 25, 2014, compared to $396.2 million as of January 26, 2013. This decrease was primarily due to lower channel partner business. Prepaid expenses and other current assets increased $20.2 million, or 17.4%, to $136.1 million as of January 25, 2014, compared to $115.9 million as of January 26, 2013. This increase was primarily driven by an increase in textbook rental inventory on increased rental business. Short-term deferred taxes increased $44.2 million, or 35.2%, to $170.0 million as of January 25, 2014, compared to $125.8 million as of January 26, 2013. This increase is primarily due to reclassifications, timing differences and a valuation allowance. Accounts payable decreased $121.2 million, or 9.7%, to $1.136 billion as of January 25, 2014, compared to $1.257 billion as of January 26, 2013. Accounts payable was 79% and 70% of merchandise inventory as of January 25, 2014


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and January 26, 2013, respectively. Accounts payable was reduced by $9.1 million and $4.0 million as of January 25, 2014 and January 26, 2013, respectively, due to vendor settlements. Accrued liabilities increased $12.4 million, or 2.0%, to $629.1 million as of January 25, 2014, compared to $616.7 million as of January 26, 2013. Accrued liabilities include deferred income, accrued taxes, compensation, occupancy related, legal and other miscellaneous accruals. Gift card liabilities increased $5.5 million, or 1.4%, to $392.2 million as of January 25, 2014, compared to $386.7 million as of January 26, 2013 as gift card issuances exceeded redemptions and breakage over the past twelve months. The Company estimates the portion of the gift card liability for which the likelihood of redemption is remote based upon the Company's historical redemption patterns. Additional breakage may be required if gift card redemptions continue to run lower than historical patterns. The Junior Seller Note of $127.3 million relates to the acquisition of B&N College and is due September 2014. Other long-term liabilities decreased $89.7 million, or 21.3%, to $331.3 million as of January 25, 2014, compared to $421.0 million as of January 26, 2013. This decrease was due to the reclassification of the Junior Seller Note to short-term, lower tax reserves and deferred rent partially offset by proceeds received from the Microsoft Commercial Agreement.

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. Based on current purchase commitments and product development plans, the Company records a provision for purchase commitments. Future charges may be required based on changes in forecasted sales or strategic direction.

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 this year. The new website is expected to enhance its search capabilities, enable faster shipping and yield cost savings. The Company believes that the new website will allow it to be more competitive in the marketplace and continue to be a valuable resource for its customers, whether they would like their purchased products shipped to their homes or made available for pick up in the stores. Capital expenditures totaled $96.2 million and $111.1 million during the 39 weeks ended January 25, 2014 and January 26, 2013, respectively.

On April 27, 2012, the Company entered into an investment agreement between 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 eReading 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 the Company has launched the NOOK app for Windows 8.1 in 32 countries and 21 languages, the Company has not met the content thresholds in all the markets as per the requirements under the commercial agreement. The Company is actively acquiring content internationally and expects to be in compliance with the requirement by the end of the fiscal year. 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


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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 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.

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 and related commercial agreements, cash received from the Pearson strategic investment in NOOK Media, short-term vendor financing and the capacity under the 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.

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. The net short-term payable of $127.3 million is due September 30, 2014 and has been reclassified to a short-term liability accordingly.


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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 offerings 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


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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.

NOOK represents the Company's digital business, including devices, digital content and accessories. Over the past four years, the Company entered the eBook 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 third 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 the Company has launched the NOOK app for Windows 8.1 in 32 countries and 21 languages, the Company has not met the content thresholds in all the markets as per the requirements under the commercial agreement. The Company is actively acquiring content internationally and expects to be in compliance with the requirement by the end of the fiscal year. Additionally, the Company believes that its 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. 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 delivering world-class reading experiences to its customers through its reading centric e-Ink and color reading devices. As the Company seeks to reduce costs and device exposure, it is actively engaged in discussions with several world-class hardware partners related to device development as well as content package and distribution. The Company 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.


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Although the Company believes cash on hand, cash flows from operating activities, funds available from its Credit Facility, cash received and committed in the formation of NOOK Media, cash received from the 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 and 39 weeks ended January 25, 2014 compared with the 13 and 39 weeks ended January 26, 2013.

Sales

The following table summarizes the Company's sales for the 13 and 39 weeks ended
January 25, 2014 and January 26, 2013:



                                             13 weeks ended                                                    39 weeks ended
                       January 25,                      January 26,                      January 25,                      January 26,
Dollars in thousands       2014          % Total            2013          % Total            2014          % Total            2013          % Total
B&N Retail             $  1,410,308          70.7 %     $  1,505,151          67.7 %     $  3,339,533          66.0 %     $  3,620,566          65.1 %
B&N College                 486,221          24.4 %          517,228          23.3 %        1,449,776          28.7 %        1,510,953          27.2 %
NOOK                        156,866           7.9 %          315,965          14.2 %          418,736           8.3 %          668,287          12.0 %
Elimination                 (57,605 )        (2.9 )%        (114,399 )        (5.1 )%        (148,594 )        (2.9 )%        (237,822 )        (4.3 )%

Total Sales            $  1,995,790         100.0 %     $  2,223,945         100.0 %     $  5,059,451         100.0 %     $  5,561,984         100.0 %

During the 13 weeks ended January 25, 2014, the Company's sales decreased $228.2 million, or 10.3%, to $1.996 billion from $2.224 billion during the 13 weeks ended January 26, 2013. The decrease by segment is as follows:

• B&N Retail sales for the 13 weeks ended January 25, 2014 decreased $94.8 million, or 6.3%, to $1.410 billion from $1.505 billion during the same period a year ago, and accounted for 70.7% of total Company sales. The decrease was attributable to a 4.9% decrease in comparable store sales, which decreased sales by $62.8 million, lower online sales, which declined by $8.1 million and closed stores, which decreased sales by $27.2 million. These decreases were partially offset by new stores that increased sales by $6.6 million. The comparable store sales decline was primarily due to lower sales of NOOK® products. Core comparable store sales, which exclude sales of NOOK® products, decreased 0.5% as compared to the prior year. Core comparable sales improved versus the first half of the year due to a stronger line-up of bestselling titles, an advertising campaign and strong increases in the Toys and Games, Juvenile and Gift categories. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc.

• B&N College sales decreased $31.0 million, or 6.0%, to $486.2 million during the 13 weeks ended January 25, 2014 from $517.2 million during the 13 weeks ended January 26, 2013. This decrease was due primarily to a comparable store sales decline of 4.0% or $35.8 million due to lower textbook sales and higher mix of lower priced used textbook rentals, partially offset by higher general merchandise sales. Sales were also impacted by the continued growth of textbook rentals where a portion of the rental sale is deferred over the rental period. This increase in the deferral from last year, lowered sales by $5.7 million for the 13 weeks ended January 25, 2014. The decrease was also attributable to closed stores, which decreased sales by $5.7 million. These decreases were partially offset by new store openings over the past year which increased sales by $16.4 million.


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• NOOK sales decreased $159.1 million, or 50.4%, to $156.9 million during the 13 weeks ended January 25, 2014 from $316.0 million during the 13 weeks ended January 26, 2013. Device and accessories sales decreased $138.5 million, or 58.2%, to $99.6 million during the 13 weeks ended January 25, 2014 on lower unit sales volume and lower average selling prices. Two new tablet products were launched last year versus one new e-ink product this year, as the Company sold through most of its existing device inventories at reduced prices. Digital content sales decreased $20.6 million, or 26.5%, to $57.2 million during the 13 weeks ended January 25, 2014 on lower unit sales due primarily to lower device sales volumes. The prior year also included $21.2 million of incremental channel partner returns and $15.4 million of promotional allowances.

• 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 January 25, 2014, B&N Retail had no store openings and 10 closings, and B&N College had three openings and two closings.

During the 39 weeks ended January 25, 2014, the Company's sales decreased $502.5 million, or 9.0%, to $5.059 billion from $5.562 billion during the 39 weeks ended January 26, 2013. The decrease by segment is as follows:

• B&N Retail sales for the 39 weeks ended January 25, 2014 decreased $281.0 million, or 7.8%, to $3.340 billion from $3.621 billion during the same period a year ago, and accounted for 66.0% of total Company sales. The decrease was attributable to a 6.2% decrease in comparable store sales, which decreased sales by $191.2 million and lower online sales, which declined by $27.3 million. Closed stores decreased sales by $65.2 million, partially offset by new stores that increased sales by $14.4 million. The comparable store sales decline was primarily due to lower sales of NOOK® products. Core comparable store sales, which exclude sales of NOOK® products, decreased 3.5% as compared to the prior year. Core comparable sales were impacted by lower physical book sales, offset by stronger sales in the Toys and Games and Gift categories. 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 1.7% during the 39 weeks ended January 25, 2014. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc.

• B&N College sales decreased $61.2 million, or 4.0%, to $1.450 billion during the 39 weeks ended January 25, 2014 from $1.511 billion during the . . .

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