Barnes & Noble Education, Inc. — Fiscal 2017 First-Quarter Form 10-Q
Reporting period: 13 weeks ended July 30, 2016. The comparable period ended August 1, 2015 was presented on a stand-alone basis before the August 2, 2015 spin-off from Barnes & Noble, Inc.; the current period is consolidated. Results are highly seasonal and are not indicative of the full fiscal year.
Business Context
The Company operates college bookstores and related e-commerce and digital education services. It operated 770 stores at quarter-end, serving more than 5 million students and faculty. During the quarter, it opened 33 stores and closed 14, with estimated annual net incremental sales of $86 million. The Company acquired Promoversity for $1.5 million to support customized e-commerce and collegiate apparel sales.
Key Financial Metrics
| Metric | Q1 Fiscal 2017 | Q1 Fiscal 2016 | Change |
|---|---|---|---|
| Total sales | $239.2 million | $239.0 million | Up 0.1% |
| Product sales and other | $217.7 million | $218.7 million | Down 0.4% |
| Rental income | $21.5 million | $20.3 million | Up 6.1% |
| Gross profit | $47.4 million | $51.5 million | Down 8.0% |
| Gross margin | 19.8% | 21.6% | Down 180 basis points |
| Operating loss | $(52.8) million | $(48.2) million | Worsened by $4.5 million |
| Net loss | $(27.9) million | $(26.9) million | Worsened by $1.0 million |
| Basic and diluted loss per share | $(0.60) | $(0.65) | Improved by $0.05 |
| Adjusted EBITDA | $(36.5) million | $(35.1) million | Worsened by $1.4 million |
| Adjusted earnings | $(25.9) million | $(26.9) million | Improved by $1.0 million |
Comparable store sales declined 2.8%, including a 6.8% decrease in textbook revenue, partly offset by a 1.6% increase in general merchandise sales. Selling and administrative expense declined 1.4% to $85.5 million, primarily due to lower digital expenses and comparable-store operating costs, partly offset by new-store costs and $1.5 million of transaction costs.
Cash Flow, Liquidity and Debt
- Operating cash flow was an outflow of $25.2 million, compared with an inflow of $9.6 million in the prior-year period.
- Investing cash flow was an outflow of $12.8 million, including $6.2 million of capital expenditures and $1.0 million for the Promoversity acquisition.
- Financing cash flow was an inflow of $18.4 million, including net credit-facility borrowings of $25.0 million, offset partly by $6.6 million of share repurchases.
- Cash and cash equivalents ended the quarter at $8.9 million, compared with $28.6 million at April 30, 2016.
- Credit Facility borrowings were $25.0 million under a $400 million five-year asset-backed revolving facility; $3.6 million of letters of credit were outstanding.
- The Company stated that operating cash flow, available revolver capacity and short-term vendor financing should provide adequate resources for foreseeable needs, but future financing access depends on capital-market and economic conditions.
Material Changes Versus the Prior Comparable Period
- Sales were essentially flat, as new-store growth offset lower comparable-store and textbook sales.
- Gross margin contracted because of lower used-textbook margins, increased college contract costs, lower rental margins and unfavorable rental mix.
- Operating results included $1.8 million of restructuring costs related primarily to digital-operation employee matters and $1.5 million of transaction costs.
- Digital expenses declined by $3.1 million following the Yuzu restructuring and related cost reductions.
- Interest expense increased to $0.7 million from essentially zero because of borrowings under the new credit facility.
- The Company repurchased 676,048 shares for $6.6 million at an average price of $10.03 per share; approximately $26.8 million remained available under the $50 million authorization.
- Inventory increased seasonally to $724.3 million from $312.7 million at April 30, 2016, while accounts payable increased to $560.2 million from $152.2 million.
Outlook, Commentary, Risks and Unusual Items
Management expects new store openings to remain an important growth driver and intends to pursue additional outsourced bookstore contracts. The Company expects a lower digital cost structure in Fiscal 2017 following the Yuzu restructuring, outsourcing of the Yuzu reading platform and acquisition of LoudCloud. No specific revenue, earnings or EBITDA guidance was provided in the filing.
- The business is highly seasonal, with most sales and operating profit generated in the second and third fiscal quarters.
- Key risks include declining enrollment or student funding, competitive pricing, lower textbook demand, contract non-renewals, store closures, excessive or obsolete inventory, labor and supply-chain disruptions, technology and cybersecurity risks, and the ability to achieve expected digital cost savings and growth.
- Goodwill was $281.3 million. The most recent impairment test showed approximately 9% excess fair value over carrying value; future declines in comparable sales, accelerated store closures or weaker digital performance could create impairment risk.
- The Company recorded a 47.8% effective tax benefit rate on its pretax loss, but expects higher nondeductible compensation expense in the current fiscal year.
- A patent dispute involving Adrea LLC remained pending. Barnes & Noble, Inc. is obligated to indemnify the Company under the separation agreement. A damages retrial concerning one patent was held in June and July 2016; post-trial briefing was pending at the filing date.
- The Company stated that no material changes occurred in its previously disclosed risk factors and that its disclosure controls were effective.
Important Facts for Investors to Verify
- Whether second- and third-quarter seasonal sales and cash generation offset the first-quarter operating and cash losses.
- Whether comparable-store sales and textbook margins stabilize after the 2.8% comparable-sales decline and margin contraction.
- The pace and profitability of the 33 newly opened stores and the sustainability of the stated $86 million annual incremental-sales estimate.
- Whether digital restructuring and LoudCloud integration deliver the expected lower cost structure and improved profitability.
- Liquidity under the asset-backed facility, including borrowing-base availability, covenant compliance and seasonal working-capital requirements.
- Inventory levels, markdown exposure and the ability to convert seasonal inventory into cash.
- Progress and potential financial exposure from the Adrea patent litigation and the related Barnes & Noble indemnification.
- The effect of future accounting adoption, including leases and revenue recognition, on reported results and balance-sheet obligations.