Barnes & Noble Education, Inc. — Fiscal 2018 Third-Quarter 10-Q Summary
Business context and reporting period
The filing covers the 13 and 39 weeks ended January 27, 2018, compared with the periods ended January 28, 2017. BNED operates physical and virtual bookstores, textbook wholesale and rental businesses, and digital education services through Barnes & Noble College (BNC) and MBS. The 2018 periods include MBS, acquired February 27, 2017, and Student Brands, acquired August 3, 2017; the comparable 2017 periods exclude both acquisitions.
As of January 27, 2018, BNED operated 782 BNC physical campus bookstores and 698 MBS Direct virtual bookstores, serving more than 6 million students. Results are highly seasonal, with the second and third quarters generally representing the strongest retail activity.
Financial results and key metrics
| Metric | 13 weeks ended Jan. 27, 2018 | 13 weeks ended Jan. 28, 2017 | 39 weeks ended Jan. 27, 2018 | 39 weeks ended Jan. 28, 2017 |
|---|---|---|---|---|
| Total sales | $603.4 million | $521.6 million | $1,846.0 million | $1,531.5 million |
| Gross profit | $146.5 million | $115.9 million | $427.8 million | $334.9 million |
| Gross margin | 24.3% | 22.2% | 23.2% | 21.9% |
| Operating income (loss) | $(295.6) million | $5.2 million | $(267.9) million | $9.2 million |
| Net income (loss) | $(283.2) million | $3.8 million | $(269.6) million | $5.1 million |
| Diluted EPS | $(6.04) | $0.08 | $(5.77) | $0.11 |
| Adjusted Earnings | $19.6 million | $4.0 million | $39.8 million | $7.8 million |
| Adjusted EBITDA | $34.6 million | $18.8 million | $104.5 million | $52.7 million |
Sales increased 15.7% in the quarter and 20.5% year to date, primarily because of the MBS and Student Brands acquisitions. BNC comparable-store sales declined 6.2% in the quarter and 4.7% year to date. Rental income declined 3.1% in the quarter and 3.8% year to date.
The reported operating loss includes a $313.1 million non-cash goodwill impairment charge related to BNC. Excluding the impairment and transaction costs, operating income was $17.6 million, or 2.9% of sales, in the quarter. For the 39-week period, excluding goodwill impairment, MBS inventory fair-value amortization, restructuring and other charges, and transaction costs, operating loss was $55.8 million, or 3.0% of sales.
Adjusted EBITDA was $104.5 million for the 39-week period, comprising $54.3 million from BNC, $56.0 million from MBS and $(5.8) million of eliminations. Adjusted EBITDA is a non-GAAP measure and should not be viewed as a substitute for GAAP results.
Cash flow, liquidity and capital structure
- Operating cash flow was $141.4 million for the 39 weeks, compared with $145.0 million in the prior-year period.
- Investing cash flow was $(89.8) million, including $30.1 million of capital expenditures and approximately $57.4 million of cash used for the Student Brands acquisition.
- Financing cash flow was $(48.2) million. BNED borrowed $481.6 million and repaid $528.2 million under its credit agreement.
- Cash, cash equivalents and restricted cash totaled $25.1 million at January 27, 2018; cash and cash equivalents alone totaled $22.4 million.
- Total borrowings were $113.0 million, all under the asset-backed credit facility. The credit agreement provides maximum availability of up to $500 million, including the $100 million FILO seasonal facility, subject to applicable conditions and borrowing-base limitations. Letters of credit outstanding totaled $4.8 million.
- Current assets were $954.0 million versus current liabilities of $741.2 million. Stockholders’ equity declined to $448.7 million from $713.7 million at April 29, 2017, primarily because of the year-to-date net loss.
- BNED states that operating cash flow, credit availability and short-term vendor financing are expected to provide adequate resources for foreseeable operating and financing needs, but access to financing depends on economic and capital-market conditions.
Material changes versus the prior comparable period
- MBS and Student Brands materially expanded reported sales and expenses, limiting direct comparability with 2017.
- BNC comparable sales weakened because of lower community-college enrollment, lower publisher prices, greater purchases from publishers and online providers, increased use of lower-cost and digital formats, and broader retail weakness.
- Gross margin improved by 210 basis points to 24.3% for the quarter and by 130 basis points to 23.2% year to date, helped by improved rental margins, lower markdowns and Student Brands subscription revenue.
- Selling and administrative expenses increased 15.3% in the quarter and 15.7% year to date, primarily reflecting MBS operating costs and incremental costs from new stores and Student Brands.
- Net interest expense increased to $3.0 million for the quarter and $7.8 million year to date, primarily because of higher borrowings associated with the acquisitions and the FILO facility.
- BNC goodwill was fully impaired in the third quarter. Remaining goodwill at January 27, 2018 was $49.3 million for MBS and zero for BNC.
- BNED recorded $5.4 million of restructuring and other charges year to date, including approximately $5.4 million related to the CEO transition. The company also recorded $3.3 million of non-cash MBS inventory fair-value amortization and $1.9 million of transaction costs.
- The company did not repurchase shares under its public repurchase program during the 39-week period; approximately $26.7 million remained available. It repurchased 259,348 shares for employee tax-withholding obligations.
Guidance, outlook, commentary and risks
The filing does not provide specific quantitative revenue, earnings or EBITDA guidance. Management expects growth from new bookstore accounts, digital and courseware offerings, inclusive-access programs, acquisitions and partnerships. BNED announced expanded relationships with McGraw-Hill Education and Pearson for digital and rental content, and cited partnerships with The Princeton Review, Unizin and educational institutions as strategic initiatives.
Management expects outsourcing of bookstore operations and demand for affordable digital and rental materials to support long-term opportunities. However, lower textbook prices, declining comparable sales, enrollment pressure, competition from publishers and online providers, and shifts from purchases to rentals remain significant challenges.
- The $313.1 million goodwill impairment reflects a decline in BNC’s estimated fair value, influenced in part by BNED’s stock-price and market-capitalization decline. Future changes in forecasts, discount rates or operating performance could result in additional impairments.
- Approximately $54.4 million of long-term tax liabilities relates to the LIFO reserve. About $13.8 million became currently payable, and additional amounts may become payable within the next 12 months; the timing and amount are uncertain.
- The Tax Cuts and Jobs Act produced a provisional $21.1 million reduction in deferred and long-term tax liabilities. The accounting remained subject to change during the measurement period.
- Key risks include enrollment and funding declines, contract non-renewals, pricing and format changes by publishers, inventory and supply-chain constraints, acquisition integration, digital investment execution, cybersecurity and data privacy, indebtedness and covenant compliance, liquidity and capital-market access, tax matters and litigation.
- Management reported effective disclosure controls. It noted that MBS integration could require changes to internal controls, although no material adverse change was identified.
Most important facts for investors to verify
- Whether BNC comparable-store sales and enrollment trends stabilize after the reported 4.7% year-to-date decline.
- Whether MBS and Student Brands deliver the expected operating contribution and acquisition synergies.
- Whether adjusted profitability translates into sustainable GAAP operating income and positive earnings after acquisition-related and non-cash adjustments.
- The company’s borrowing-base availability, debt covenants, interest costs and liquidity through the seasonally weaker fourth quarter.
- The timing and amount of LIFO-related tax payments and any further effects of tax-law implementation.
- Whether BNC’s goodwill impairment signals further deterioration in forecasts or risk of additional asset impairments.
- Adoption impacts from the upcoming revenue-recognition and lease-accounting standards.
- Progress of inclusive-access, digital courseware, rental and publisher partnerships, including their effect on revenue mix and margins.