Barnes & Noble Education, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and first 39 weeks ended January 30, 2016, compared with periods ended January 31, 2015. The company completed its spin-off from Barnes & Noble, Inc. on August 2, 2015 and began independent public-company operations thereafter. Comparability is limited because prior-period results were presented on a stand-alone basis with allocated corporate costs, while post-spin-off results include the company’s consolidated costs and direct charges under transition agreements.
Business context
The company operates college bookstores and provides textbook rental, e-commerce, digital education and learning services in the United States. It operated 748 stores at January 30, 2016, after opening 34 and closing 10 stores during the first 39 weeks. The business is highly seasonal, with the majority of sales and operating profit generated in the second and third fiscal quarters.
Financial performance
| Metric | 13 weeks ended Jan. 30, 2016 | 13 weeks ended Jan. 31, 2015 | 39 weeks ended Jan. 30, 2016 | 39 weeks ended Jan. 31, 2015 |
|---|---|---|---|---|
| Total sales | $518.4 million | $521.6 million | $1,513.3 million | $1,499.0 million |
| Gross profit | $120.6 million | $121.6 million | $347.3 million | $342.4 million |
| Gross margin | 23.3% | 23.3% | 23.0% | 22.8% |
| Operating income (loss) | $(2.4) million | $14.3 million | $8.8 million | $33.3 million |
| Net income (loss) | $(3.6) million | $8.7 million | $2.9 million | $19.4 million |
| Adjusted EBITDA | $22.6 million | $26.9 million | $60.2 million | $70.9 million |
| Basic diluted EPS | $(0.07) | $0.09 | $0.06 | $0.34 |
First-39-week sales increased 1.0%, driven by new stores, but comparable-store sales declined 2.7%. Third-quarter sales declined 0.6% and comparable-store sales declined 4.1%. Lower textbook sales were partly offset by higher general merchandise sales and rental income.
Selling and administrative expenses increased 5.7% for the first 39 weeks to $287.1 million, or 19.0% of sales, from 18.1% of sales. The increase reflected new-store costs, higher comparable-store payroll and benefits, corporate infrastructure costs associated with the separation, and higher Yuzu expenses.
The company recorded a $12.0 million non-cash impairment and other-than-temporary loss, consisting of approximately $9.0 million related to capitalized Yuzu eTextbook content and $3.0 million related to an investment. Excluding the impairment, first-39-week net income was $11.4 million versus $19.4 million in the prior period, and third-quarter net income was $4.9 million versus $8.7 million.
Cash flow, liquidity and capital structure
- Operating cash flow was $125.9 million for the first 39 weeks, compared with $120.5 million in the prior period.
- Capital expenditures were $37.7 million, compared with $35.1 million.
- Cash and cash equivalents were $126.9 million at January 30, 2016, compared with $174.6 million at January 31, 2015 and $59.7 million at May 2, 2015.
- The company had no outstanding borrowings under its new five-year, $400 million asset-backed revolving credit facility, although it borrowed and repaid $60.6 million during the period. Letters of credit outstanding were $3.6 million.
- The facility is secured primarily by inventory and receivables, bears interest initially at LIBOR plus 2.00% or the alternate base rate plus 1.00%, and includes customary covenants and potential cash-control provisions if excess availability falls below specified levels.
- The company repurchased approximately 849,842 shares under its repurchase program during the quarter for approximately $8.7 million, leaving approximately $41.9 million authorized for future repurchases at January 30, 2016. It also repurchased 40,719 shares for employee tax withholding obligations during the first 39 weeks.
Material changes, outlook and risks
- The spin-off increased the company’s responsibility for corporate infrastructure and may result in higher costs than historical allocations from Barnes & Noble. Transition services from Barnes & Noble are scheduled to end no later than two years after the separation unless terminated earlier.
- Management is restructuring its digital operations by outsourcing the Yuzu platform to VitalSource and acquiring LoudCloud Systems to expand digital learning, analytics and learning-management capabilities.
- Management expects digital spending to decline from approximately $26 million in fiscal 2016 to approximately $13 million in fiscal 2017. Planned Yuzu-related severance, retention and facility costs are estimated at $8 million to $10 million during the fourth quarter of fiscal 2016 and first quarter of fiscal 2017.
- The LoudCloud acquisition closed March 4, 2016 and was financed with cash from operations. The MD&A states a purchase price of $17.9 million, while the subsequent-events note contains an apparent unit error stating “$17,900 million”; the filing text should be verified.
- Goodwill of $274.1 million passed the annual impairment test, but fair value exceeded carrying value by only approximately 9%. Future impairment risk depends particularly on comparable-store sales, store closures and digital performance.
- Key risks include textbook and digital-content competition, declining enrollment or student spending, contract renewals and profitability, inventory and supplier risks, dependence on seasonal cash generation, execution of the digital restructuring and acquisition, data security, access to financing, and costs or liabilities associated with the spin-off.
- A material patent litigation matter remains pending. Barnes & Noble is obligated to indemnify the company under the separation agreement. In February 2016, the court upheld infringement and validity for one patent and ordered a new damages trial.
Important facts for investors to verify
- Assess comparability of historical results because prior periods include allocated Barnes & Noble costs and post-spin-off periods include new standalone expenses.
- Verify the timing and execution of the Yuzu-to-VitalSource transition, the $8 million–$10 million restructuring estimate and the projected $13 million annual digital-spend reduction.
- Confirm the LoudCloud purchase price and accounting treatment, including the apparent “$17,900 million” typographical inconsistency.
- Monitor comparable-store sales, textbook demand, community-college enrollment, store contract renewals and the effect of new store openings.
- Review goodwill sensitivity, particularly the limited 9% fair-value cushion and dependence on digital-growth assumptions.
- Track liquidity through peak seasonal working-capital requirements, credit-facility availability and covenant thresholds.
- Review the pending patent damages trial and the scope of Barnes & Noble’s indemnification obligations.