Barnes & Noble Education, Inc. — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Quarter ended October 29, 2016; results cover 13 and 26 weeks and are compared with periods ended October 31, 2015. The company operated 771 campus bookstores serving more than 5 million students and faculty. Because the August 2015 spin-off from Barnes & Noble created stand-alone versus consolidated reporting differences, comparability for the 26-week period is affected. Results are also highly seasonal, with most sales and operating profit generated in the second and third fiscal quarters.
Key financial metrics
| Metric | 13 weeks ended October 29, 2016 | Prior comparable period | 26 weeks ended October 29, 2016 | Prior comparable period |
|---|---|---|---|---|
| Total sales | $770.7 million | $755.9 million | $1,009.9 million | $994.8 million |
| Gross profit | $171.5 million | $175.1 million | $218.9 million | $226.7 million |
| Gross margin | 22.3% | 23.2% | 21.7% | 22.8% |
| Operating income | $56.8 million | $59.5 million | $4.0 million | $11.3 million |
| Net income | $29.3 million | $33.4 million | $1.4 million | $6.5 million |
| Diluted EPS | $0.63 | $0.69 | $0.03 | $0.14 |
| Adjusted EBITDA | $70.4 million | $72.7 million | $33.9 million | $37.5 million |
Product sales and other increased 2.0% for the quarter and 1.4% year to date; rental income increased 1.2% and 2.3%, respectively. Selling and administrative expense declined 0.7% for the quarter and 1.0% year to date. The effective tax rate increased to 47.8% from 43.4% for the quarter and to 49.2% from 39.5% year to date, primarily reflecting nondeductible compensation expense.
Comparable-store sales decreased 2.9% for both the quarter and year-to-date period. Textbook sales were the principal weakness, while eTextbook revenue increased. New stores contributed $50.0 million of quarterly sales and $58.5 million year to date; closed stores reduced sales by $10.7 million and $12.5 million, respectively. The company opened 34 stores and closed 14 during the 26 weeks, producing an estimated $88 million of annual net incremental sales.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow was $179.3 million for the 26 weeks, compared with $81.5 million in the prior period, primarily due to working-capital changes and deferred-tax movements.
- Investing cash flow was negative $23.5 million, including $17.5 million of capital expenditures and $0.9 million for the Promoversity acquisition.
- Financing cash flow was negative $7.9 million, principally reflecting share repurchases.
- Cash and cash equivalents were $176.6 million at October 29, 2016, compared with $28.6 million at April 30, 2016 and $88.6 million at October 31, 2015.
- The company had no borrowings under its $400 million five-year asset-backed revolving credit facility at quarter-end. It borrowed and repaid $47.4 million during the 26 weeks and had $4.3 million of letters of credit outstanding.
- Accounts payable were $439.7 million and total current liabilities were $580.5 million at quarter-end. Management stated that operating cash flow, the credit facility and short-term vendor financing should provide adequate resources for foreseeable needs.
- The company repurchased 688,948 shares for approximately $6.7 million under its $50 million authorization; approximately $26.7 million remained available. It also repurchased 116,914 shares for employee tax-withholding obligations.
Material changes and unusual items
- Gross margin declined 90 basis points for the quarter and 110 basis points year to date. Drivers included textbook markdowns and price matching, higher college contract costs, unfavorable product mix and lower rental margin rates.
- The company recorded $1.8 million of restructuring costs year to date related primarily to employee costs following the digital-operations restructuring. Most employee-related restructuring was completed in the first quarter.
- Transaction costs were $0.6 million for the quarter and $2.2 million year to date, primarily related to business development and acquisitions.
- Digital expenses related to Yuzu and LoudCloud declined $3.9 million for the quarter and $7.0 million year to date. Management expects a lower digital cost structure in fiscal 2017 following the restructuring, outsourcing of the Yuzu reading platform and the LoudCloud acquisition.
- In June 2016, the company acquired Promoversity for a preliminary purchase price of $1.4 million to enhance customized e-commerce and collegiate apparel offerings. The acquisition was not material.
- Goodwill was $281.4 million. The most recent impairment test indicated that fair value exceeded carrying value by approximately 9%; no impairment was recorded, but management identified risks if comparable-store sales, store openings or digital projections deteriorate.
- Management corrected an immaterial prior-period balance-sheet classification error that reduced cash and accounts payable by $125.6 million as of October 31, 2015; it did not affect earnings, EPS or debt covenants.
Outlook, commentary and risks
Management continues to target growth through new bookstore accounts, merchandising changes, digital products, acquisitions and partnerships. It expects new store openings to remain an important growth driver and believes outsourcing trends in the campus bookstore market provide additional opportunity. No specific quantitative revenue, earnings or EBITDA guidance was provided in the filing.
Key risks include declining college enrollment or student funding, lower consumer spending, textbook price competition and migration toward lower-priced rental or digital formats, contract non-renewals, store closures, execution of the digital strategy, technology and cybersecurity risks, inventory obsolescence, supply-chain disruption, labor costs, access to capital, debt-covenant compliance, litigation and the challenges of operating independently after the spin-off. The company is subject to ordinary-course litigation. A patent matter involving Barnes & Noble-related digital products remained pending; Barnes & Noble is obligated to indemnify the company under the separation agreement.
Investor verification items
- Confirm the effect of spin-off-related reporting differences when comparing year-to-date results with fiscal 2016.
- Assess whether comparable-store sales and textbook trends improve, particularly at community colleges, and whether new-store growth offsets closed stores.
- Monitor gross-margin pressure from markdowns, price matching, rental economics and higher college contract costs.
- Evaluate whether digital restructuring and acquisitions produce the expected cost savings and revenue growth.
- Review seasonal working-capital requirements, inventory levels, vendor financing and continued access to the revolving credit facility.
- Track nondeductible compensation and the elevated effective tax rate.
- Review goodwill sensitivity, legal developments and the indemnification status of the pending patent litigation.