Business Context and Reporting Period
Barnes & Noble Education, Inc. filed its Form 10-K for the 52 weeks ended April 29, 2017 (Fiscal 2017). The filing is annual rather than a standalone 2016 fourth-quarter filing. Results include Barnes & Noble College (BNC) for the full year and MBS Textbook Exchange (MBS) from its February 27, 2017 acquisition date. Fiscal 2016 ended April 30, 2016.
BNED operates physical and virtual college and K-12 bookstores, textbook wholesale distribution, textbook rental, general merchandise, and digital education services. At year-end, the Company operated 769 BNC physical stores and 712 MBS virtual bookstores, serving more than 6 million students.
Key Financial Metrics
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Total sales | $1,874.4 million | $1,808.0 million | +3.7% |
| Gross profit | $457.4 million | $453.3 million | +0.9% |
| Gross margin | 24.4% | 25.1% | Down 70 basis points |
| Operating income | $13.6 million | $4.6 million | Improved $8.9 million |
| Operating margin | 0.7% | 0.2% | Improved |
| Net income | $5.4 million | $0.1 million | Improved $5.3 million |
| Diluted EPS | $0.11 | Approximately $0.00 | Improved |
| Adjusted EBITDA | $78.3 million | $80.5 million | Down $2.3 million |
| Adjusted Earnings | $12.3 million | $15.5 million | Down $3.1 million |
| Capital expenditures | $34.7 million | $50.8 million | Down $16.1 million |
Product sales and other revenue increased 3.8% to $1,638.9 million, while rental income increased 3.1% to $235.4 million. Gross margin pressure reflected higher contract costs, textbook markdowns and lower rental margin rates.
Cash flow from operating activities was $68.0 million, compared with $83.1 million in Fiscal 2016. Investing cash flow was $(224.4) million, primarily because of the $187.0 million cash acquisition of MBS. Financing cash flow was $147.3 million, principally reflecting increased borrowings.
Cash and cash equivalents were $19.0 million at April 29, 2017; cash, cash equivalents and restricted cash totaled $21.7 million. Total borrowings were $159.6 million, consisting of $59.6 million under the BNED Credit Facility and $100.0 million under the FILO seasonal facility. Total assets were $1.30 billion and total stockholders’ equity was $713.7 million.
Material Changes Versus the Prior Comparable Period
- BNED acquired MBS for total consideration of $187.0 million, including $48.1 million of preliminary goodwill. MBS contributed $34.1 million of sales and a $2.6 million net loss during the post-acquisition period.
- BNC sales increased $37.5 million, including $109.5 million from new stores, partially offset by $50.6 million of lower comparable-store sales and $23.8 million from closed stores.
- BNC comparable-store sales declined 3.0%, primarily because of lower community-college enrollment, purchases directly from publishers and online providers, and weaker retail conditions.
- BNC opened 38 stores and closed 20, ending with 769 stores versus 751 previously. MBS added 80 virtual accounts during Fiscal 2017.
- Gross margin declined to 24.4% from 25.1%, while selling and administrative expense improved to 20.2% of sales from 20.6%.
- Operating results benefited from the absence of Fiscal 2016’s $12.0 million non-cash impairment charge, but Fiscal 2017 included $9.6 million of transaction costs and $1.8 million of restructuring costs.
- Fiscal 2016 restructuring of the Yuzu digital operations was completed in Fiscal 2017.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management did not provide a clear quantitative revenue, earnings or EBITDA outlook in the filing. Management expects growth opportunities from continued bookstore outsourcing, new physical and virtual accounts, digital courseware, predictive analytics, open educational resources, and synergies from MBS. As of June 16, 2017, BNC had signed 23 additional physical-store contracts for Fiscal 2018 with estimated first-year annual sales of $50 million. MBS had signed 46 additional virtual accounts with estimated first-year annual sales of $8 million.
The business is highly seasonal: retail sales and operating profit are concentrated in the second and third quarters, while MBS wholesale activity partly offsets weak retail activity in the first quarter. MBS generally has substantially lower sales and operating profit in the fourth quarter because it is preparing inventory for the fall selling season.
- Key risks include intense competition from Amazon, publishers, digital-content providers, textbook-rental platforms, open educational resources and other bookstore operators.
- Contract renewals are material because many BNC contracts can be cancelled on 90 to 120 days’ notice, and higher contract costs may pressure margins.
- MBS integration, inventory management, supply availability and realization of acquisition synergies remain significant execution risks.
- Students’ price sensitivity, declining enrollment at some community colleges, textbook format changes, piracy, publisher pricing and direct-to-student sales may reduce revenue or margins.
- Cybersecurity, data privacy, technology outages, point-of-sale system performance and third-party cloud-service disruptions could adversely affect operations.
- Goodwill totaled $329.5 million. The latest impairment test showed estimated fair value exceeding carrying value by approximately 5%; weaker comparable-store sales, accelerated store closures or lower digital growth could lead to future impairment.
- Contractual obligations totaled approximately $1.14 billion, including $826.2 million of school-management and lease obligations, $250.0 million of FILO obligations, and $59.6 million of Credit Facility obligations.
- Management stated that it was in compliance with debt covenants and believed operating cash flow, credit availability and vendor financing would fund foreseeable needs. The FILO facility requires annual repayment by July 31 and carries LIBOR plus 3.0% interest.
- The Company reported no material off-balance-sheet arrangements. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting, although MBS was excluded from management’s internal-control assessment for the acquisition year.
- A patent dispute resulted in a $269,832 judgment, plus $12,606 of supplemental damages; Barnes & Noble, Inc. was obligated to indemnify BNED for the matter.
Most Important Facts for Investors to Verify
- Reconcile Fiscal 2017 consolidated performance with the limited two-month contribution from MBS and review MBS’s full-year pro forma results: $2.25 billion of sales and $32.1 million of net income for Fiscal 2017.
- Assess whether BNC’s 3.0% comparable-store sales decline and lower gross margin are temporary or structural.
- Review MBS integration progress, wholesale inventory levels, seasonal borrowing needs and expected procurement synergies.
- Monitor liquidity around the FILO repayment requirement, borrowing availability, covenant thresholds and working-capital seasonality.
- Evaluate the sustainability of earnings excluding transaction and restructuring costs, noting that Adjusted EBITDA declined despite reported net-income improvement.
- Review goodwill and other intangible-asset sensitivity, particularly the small excess of estimated fair value over carrying value.
- Confirm the status of the Unizin agreement announced in May 2017 and whether LoudCloud adoption produces material revenue or profitability.
- Consider the absence of dividends, ongoing share repurchases, contractual commitments, supplier concentration and the continuing competitive shift toward digital and direct distribution.