Barnes & Noble Education, Inc. — Fiscal 2020 Second Quarter 10-Q
Business context and reporting period
BNED operates college, university, and K-12 physical and virtual bookstores, a textbook wholesale business, and direct-to-student digital education services. The filing covers the 13 and 26 weeks ended October 26, 2019, compared with the periods ended October 27, 2018. The company operated 1,436 stores at quarter-end, including 772 physical and 664 virtual stores, and served more than 6 million students. Results are highly seasonal, with retail sales generally concentrated in the second and third fiscal quarters.
Beginning in the fourth quarter of fiscal 2019, BNED realigned its reportable segments into Retail, Wholesale, and Digital Student Solutions (DSS), with shared costs reported in Corporate Services.
Financial performance and liquidity
| Metric | 13 weeks ended Oct. 26, 2019 | 13 weeks ended Oct. 27, 2018 | 26 weeks ended Oct. 26, 2019 | 26 weeks ended Oct. 27, 2018 |
|---|---|---|---|---|
| Total sales | $772.2 million | $814.8 million | $1,091.9 million | $1,152.3 million |
| Gross profit | $187.0 million | $210.8 million | $258.6 million | $277.4 million |
| Gross margin | 24.2% | 25.9% | 23.7% | 24.1% |
| Operating income | $56.4 million | $78.5 million | $12.6 million | $29.4 million |
| Net income | $35.9 million | $59.7 million | $3.8 million | $21.1 million |
| Diluted EPS | $0.74 | $1.25 | $0.08 | $0.44 |
| Adjusted EBITDA | $74.5 million | $95.5 million | $49.4 million | $63.1 million |
For the quarter, product sales and other revenue declined 5.0% and rental income declined 8.4%. Selling and administrative expense decreased 1.7%, but cost of sales increased to 75.8% of sales from 74.1%, resulting in lower gross and operating margins. The effective tax rate rose to 34.7% from 22.1%. For the six-month period, the effective tax rate was 56.3% versus 12.4% in the prior year.
Operating cash flow was $161.4 million for the 26 weeks, down from $236.6 million. Investing cash flow used $16.1 million, including $19.3 million of capital expenditures. Financing cash flow used $134.8 million, reflecting $150.0 million of borrowings and $283.5 million of repayments. Cash, cash equivalents, and restricted cash totaled $25.4 million at October 26, 2019, including cash and cash equivalents of $24.6 million.
BNED had no outstanding borrowings under its $400 million asset-based revolving credit facility or its $100 million incremental FILO facility at quarter-end. Letters of credit totaled $4.8 million. The company stated that operating cash flow, available credit facilities, and vendor financing should provide adequate resources for the foreseeable future.
Current assets were $749.2 million and current liabilities were $692.6 million. The balance sheet included $289.7 million of operating lease right-of-use assets and $287.3 million of operating lease liabilities. Future minimum fixed lease payments totaled $324.1 million before $36.8 million of imputed interest.
Material changes versus the prior comparable period
- Total sales declined 5.2% for both the quarter and six-month period.
- Retail sales decreased 5.4% for the quarter and 5.1% for the six-month period. Comparable Retail sales declined 5.9% and 5.1%, respectively, driven primarily by lower course-material sales, increased purchases from publishers and online providers, lower enrollment at two-year community colleges, and a shift toward lower-cost digital offerings.
- Retail rental income decreased 8.4% for the quarter and 9.1% year to date, primarily because of increased digital offerings and lower rental activity.
- Wholesale sales decreased 1.5% for the quarter and 14.0% year to date, reflecting shifts from physical textbooks to digital products, lower textbook supply, and lower customer demand.
- DSS sales increased 5.7% for the quarter and were flat year to date. Higher bartleby subscription sales were offset by lower Student Brands sales.
- Gross margin fell 170 basis points for the quarter and 40 basis points year to date. Management cited lower product margin rates, higher markdowns, unfavorable Wholesale mix, and higher contract-related costs.
- Adjusted EBITDA declined 22.0% for the quarter and 21.6% year to date. DSS profitability was pressured by investment in the bartleby student success hub and amortization of newly developed content.
- BNED recorded $1.6 million of second-quarter and $3.0 million of year-to-date restructuring and other charges, primarily professional fees, severance, process-improvement costs, and shareholder activist-related activities. It also recorded a $0.4 million non-cash impairment loss year to date.
- BNED adopted ASC 842 lease accounting on April 28, 2019, adding substantial operating lease assets and liabilities to the balance sheet without restating prior periods.
Guidance, outlook, commentary, and risks
The filing does not provide clear numerical full-year revenue, earnings, or EBITDA guidance. Management expects to expand digital solutions, increase inclusive-access adoption, win new accounts, and pursue acquisitions and partnerships. First Day inclusive-access revenue increased 93% in the first half of fiscal 2020, and BNED announced a VitalSource technology agreement to support the platform.
Management believes future operating cash flow and borrowing availability will fund foreseeable operating and financing needs, but notes that future requirements depend on inventory levels, new store openings, acquisitions, economic conditions, and market access. Approximately $32.8 million of long-term tax payable related to the LIFO reserve was recorded; management expects some additional amount could become payable within 12 months but cannot reasonably estimate the amount.
Key risks include declining or changing college enrollment, price-sensitive customers, competition from publishers and online and digital providers, declining physical textbook demand, used-textbook supply constraints, publisher consignment and rental programs, store contract losses or closures, execution risk in digital initiatives, technology and cybersecurity risks, labor and shipping costs, litigation, tax matters, and access to credit markets. Ordinary-course legal proceedings were not expected to have a material adverse effect, although outcomes remain uncertain.
Most important facts for investors to verify
- Whether the decline in comparable course-material sales and rental revenue stabilizes as digital and inclusive-access offerings grow.
- Whether the First Day platform's reported 93% revenue growth translates into sustainable profitability and offsets lower-margin digital mix.
- The effect of gross-margin compression, Wholesale inventory markdowns, and DSS investment on future Adjusted EBITDA.
- Cash generation during the remaining seasonal cycle and continued availability under the credit and FILO facilities.
- The timing and amount of additional LIFO-related tax payments and the company's ability to fund them without increasing borrowings.
- Future operating lease obligations, store openings and closures, contract renewals, and the effect of the Retail segment realignment.
- The comparability of non-GAAP Adjusted Earnings and Adjusted EBITDA, including excluded content amortization, restructuring, impairment, and other unusual items.