Barnes & Noble Education, Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Quarter ended October 28, 2017, covering 13 and 26 weeks. Results include MBS Textbook Exchange from its February 27, 2017 acquisition and Student Brands from its August 3, 2017 acquisition; prior-year comparables exclude both businesses. The company operates BNC and MBS segments and serves more than 6 million students through 1,483 physical and virtual bookstores.
Financial performance and position
| Metric | 13 weeks ended October 28, 2017 | 13 weeks ended October 29, 2016 | 26 weeks ended October 28, 2017 | 26 weeks ended October 29, 2016 |
|---|---|---|---|---|
| Total sales | $886.9 million | $770.7 million | $1,242.6 million | $1,009.9 million |
| Sales growth | 15.1% | — | 23.0% | — |
| Gross profit | $216.6 million | $171.5 million | $281.3 million | $218.9 million |
| Gross margin | 24.4% | 22.3% | 22.6% | 21.7% |
| Operating income | $83.3 million | $56.8 million | $27.7 million | $4.0 million |
| Operating margin | 9.4% | 7.4% | 2.2% | 0.4% |
| Net income | $48.4 million | $29.3 million | $13.6 million | $1.4 million |
| Diluted EPS | $1.03 | $0.63 | $0.29 | $0.03 |
| Adjusted EBITDA | $102.4 million | $70.4 million | $70.0 million | $33.9 million |
For the 26-week period, BNC reported sales of $1,011.8 million and operating loss of $1.1 million, while MBS contributed $274.7 million of sales and $28.7 million of operating income. Consolidated results include $43.8 million of intercompany sales eliminations.
- Cash flow: Operating activities generated $199.6 million in the 26 weeks, compared with $179.3 million in the prior year. Investing activities used $81.7 million, including $22.4 million of capital expenditures and $58.3 million for acquisitions. Financing activities used $119.4 million.
- Liquidity: Cash and cash equivalents were $17.5 million at October 28, 2017, compared with $19.0 million at April 29, 2017 and $176.6 million at October 29, 2016. Cash, cash equivalents and restricted cash totaled $20.2 million at period-end.
- Debt: Outstanding borrowings were $41.8 million, all under the $400 million asset-backed Credit Facility; the separate $100 million FILO seasonal facility had no borrowings. Letters of credit totaled $4.8 million. The company states that operating cash flow, credit availability and vendor financing should fund foreseeable needs, subject to market access and other conditions.
- Balance sheet: Total assets were $1.53 billion, including $515.6 million of merchandise inventory, $78.1 million of textbook rental inventory, $362.4 million of goodwill and $229.5 million of intangible assets. Stockholders’ equity was $729.8 million.
Material changes versus the prior comparable period
- Reported sales increased primarily because of the MBS and Student Brands acquisitions. BNC comparable-store sales declined 3.9% for the 26 weeks and 4.4% for the quarter.
- BNC comparable sales were pressured by lower course-material prices, increased digital and lower-cost options, lower community-college enrollment, purchases directly from publishers and other online providers, and broader retail weakness.
- Rental income declined 4.2% for the 26 weeks and 5.1% for the quarter, although rental gross margins improved.
- Gross margin expanded 210 basis points for the quarter and 90 basis points for the 26 weeks, helped by MBS contribution, Student Brands subscription revenue, improved rental margins and lower contract-related costs.
- Operating results include $3.3 million of non-cash MBS inventory fair-value amortization for the 26 weeks, $5.4 million of restructuring and other charges, and $1.8 million of transaction costs.
- Net interest expense increased to $4.9 million from $1.3 million for the 26 weeks, primarily because of acquisition-related borrowings and the FILO facility.
- BNC opened 24 stores and closed 16 during the 26 weeks, ending with 777 stores. MBS Direct opened 14 stores and ended with 706 virtual stores.
Acquisitions, outlook, risks and unusual items
- Student Brands was acquired for cash consideration of approximately $62.0 million, including cash acquired. Preliminary allocation included $28.3 million of intangible assets and $31.8 million of goodwill.
- MBS was acquired for total consideration of $187.9 million. The acquisition added virtual bookstore and wholesale operations and resulted in $49.3 million of goodwill and $21.6 million of identified intangible assets.
- Management expects growth from new bookstore accounts, expanded digital and courseware offerings, acquisitions and partnerships, and continued outsourcing by educational institutions. No quantitative earnings or revenue guidance is provided in the filing text.
- The business is highly seasonal; results for the first 26 weeks are not indicative of the full fiscal year. Retail sales are generally strongest in the second and third quarters, while MBS has significantly lower operating profit or operating loss in the fourth quarter.
- Management identifies risks from declining enrollment, consumer price sensitivity, publisher pricing and format changes, competition from publishers and online providers, textbook supply constraints, contract renewals, digital investment execution, acquisition integration, technology and cybersecurity issues, indebtedness and access to capital.
- Other long-term liabilities include $77.1 million related to tax payable associated with the LIFO reserve. A portion could become payable within the next 12 months, but the amount cannot be reasonably projected because it depends on inventory levels and the consumer price index.
- The CEO transition resulted in approximately $5.4 million of severance and transition-related charges. No goodwill impairment was recognized, although the excess fair value over carrying value at the annual test was approximately 5%, leaving sensitivity to weaker comparable sales, store closures or underperformance of digital projections.
- Disclosure controls were reported effective. Management noted that integration of MBS may require changes to internal controls. Ordinary-course legal matters are not expected to be material; the described patent litigation judgment was paid, with only a costs issue remaining.
Most important facts for investors to verify
- Separate the reported growth attributable to MBS and Student Brands from underlying BNC performance, particularly the 3.9% comparable-store sales decline for the 26 weeks.
- Review acquisition integration, purchase-price allocations, goodwill and intangible-asset assumptions, including the limited 5% goodwill valuation cushion.
- Reconcile reported earnings with Adjusted Earnings and Adjusted EBITDA, including the $5.4 million executive-transition charge, $3.3 million MBS inventory valuation amortization and transaction costs.
- Assess seasonal liquidity after the October selling cycle, including inventory levels, vendor financing, credit-facility availability and the potentially payable $77.1 million LIFO-related tax liability.
- Monitor debt, interest expense, credit covenants and the company’s ability to fund acquisitions, capital expenditures and working capital.
- Evaluate whether digital, subscription and courseware investments can offset textbook price pressure, lower enrollment and competition from publishers and online providers.