TMCnet News

BARNES & NOBLE INC - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations
[September 09, 2014]

BARNES & NOBLE INC - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Liquidity and Capital Resources The primary sources of Barnes & Noble, Inc.'s (Barnes & Noble or the Company) cash are net cash flows from operating activities, funds available under its credit facility, cash received and committed to NOOK Media LLC (NOOK Media) and short-term vendor financing.



The Company is party to an amended and restated credit facility with Bank of America, N.A., as administrative agent, collateral agent and swing line lender, and other lenders, dated as of April 29, 2011 (as amended and modified to date, the Credit Facility), consisting of up to $1.0 billion in aggregate commitments under a five-year asset-backed revolving credit facility expiring on April 29, 2016, which is secured by eligible inventory and accounts receivable with the ability to include eligible real estate and related assets.

Borrowings under the Credit Facility are limited to a specified percentage of eligible inventories and accounts receivable and accrued interest, at the election of the Company, at Base Rate or LIBO Rate, plus, in each case, an Applicable Margin (each term as defined in the Credit Facility). In addition, the Company has the option to request an increase in commitments under the Credit Facility by up to $300.0 million, subject to certain restrictions.


The Credit Facility requires Availability (as defined in the Credit Facility) to be greater than the greater of (i) 10.0% of the Loan Cap (as defined in the Credit Facility) and (ii) $50.0 million. In addition, the Credit Facility contains covenants that limit, among other things, the Company's ability to incur indebtedness, create liens, make investments, make restricted payments, merge or acquire assets, and contains default provisions that are typical for this type of financing, among other things. Proceeds from the Credit Facility are used for general corporate purposes, including seasonal working capital needs.

The Company's cash and cash equivalents were $180.2 million as of August 2, 2014, compared with $80.0 million as of July 27, 2013. The increase in cash and cash equivalents of $100.2 million versus the prior year period is primarily attributable to cash flow generated from operating activities over the past twelve months, including the sell through of existing NOOK inventories.

Net cash flows used in operating activities for the 13 weeks ended August 2, 2014 was $139.0 million, as compared to net cash flows provided by operating activities of $2.8 million for the 13 weeks ended July 27, 2013. The unfavorable year over year comparison was primarily attributable to changes in working capital. The prior year included the benefit of the sell through of existing NOOK inventories. The current year includes higher end of month merchandise and landlord check clearings, as a result of the later shift in the fiscal calendar.

On August 2, 2014, the Company had no borrowings under its $1.0 billion credit facility, compared to $7.5 million in the prior year period. The Company had $62.8 million of outstanding letters of credit as of August 2, 2014 compared with $33.9 million as of July 27, 2013.

31 -------------------------------------------------------------------------------- Additional year-over-year balance sheet changes include the following: • Receivables, net decreased $30.5 million, or 20.2%, to $120.3 million as of August 2, 2014, compared to $150.8 million as of July 27, 2013. This decrease was primarily due to lower channel partner business.

• Merchandise inventories decreased $64.2 million, or 3.7%, to $1.684 billion as of August 2, 2014, compared to $1.748 billion as of July 27, 2013. NOOK inventories decreased due to the sell through of existing devices, while Retail declined on the lower sales volume. B&N College inventories increased on new store growth, the timing of back-to-school rush and higher used textbooks driven by increased business in its rental program.

• Prepaid expenses and other current assets decreased $2.9 million, or 3.6%, to $79.2 million as of August 2, 2014, compared to $82.1 million as of July 27, 2013.

• Short-term deferred taxes decreased $68.3 million, or 32.5%, to $141.6 million as of August 2, 2014, compared to $209.9 million as of July 27, 2013. This decrease is primarily due to reclassifications, timing differences, and a valuation allowance.

• Property and equipment, net decreased $83.9 million, or 14.9%, to $478.5 million as of August 2, 2014, compared to $562.4 million as of July 27, 2013 as depreciation outpaced capital expenditures. The Company also recorded $28.4 million of asset impairment charges in the fourth quarter of fiscal 2014 related to the Palo Alto relocation.

• Intangible assets, net decreased $19.2 million, or 3.5%, to $524.4 million as of August 2, 2014, compared to $543.6 million as of July 27, 2013 on additional amortization.

• Other noncurrent assets decreased $7.5 million, or 13.6%, to $47.7 million as of August 2, 2014, compared to $55.2 million as of July 27, 2013 primarily due to amortization of deferred financing costs.

• Accounts payable decreased $95.0 million, or 8.0%, to $1.101 billion as of August 2, 2014, compared to $1.196 billion as of July 27, 2013. Accounts payable were 65.4% and 68.4% of merchandise inventory as of August 2, 2014 and July 27, 2013, respectively.

• Accrued liabilities decreased $109.4 million, or 21.4%, to $402.2 million as of August 2, 2014, compared to $511.6 million as of July 27, 2013.

Accrued liabilities include deferred income, accrued taxes, compensation, occupancy related, legal and other selling and administrative miscellaneous accruals.

• Gift card liabilities increased $9.5 million, or 2.9%, to $338.6 million as of August 2, 2014, compared to $329.0 million as of July 27, 2013 as gift card issuances exceeded redemptions and breakage over the past twelve months. The Company estimates the portion of the gift card liability for which the likelihood of redemption is remote based upon the Company's historical redemption patterns. Additional breakage may be required if gift card redemptions continue to run lower than historical patterns.

32 -------------------------------------------------------------------------------- • The Junior Seller Note of $127.3 million relates to the acquisition of B&N College and is due September 30, 2014.

• Long-term deferred taxes decreased $26.2 million, or 10.6%, to $220.2 million as of August 2, 2014, compared to $246.3 million as of July 27, 2013. This decrease was primarily due to lower depreciation and a pension liability adjustment due to plan termination, partially offset by valuation allowances.

• Other long-term liabilities decreased $71.0 million, or 16.2%, to $366.8 million as of August 2, 2014, compared to $437.7 million as of July 27, 2013. This decrease was due to the reclassification of the Junior Seller Note to short-term and lower deferred rent, partially offset by proceeds received from the Microsoft commercial agreement.

The Company has arrangements with third-party manufacturers to produce its NOOK®products. These manufacturers procure and assemble unfinished parts and components from third-party suppliers based on forecasts provided by the Company. Given production lead times, commitments are generally made far in advance of finished product delivery. Based on current purchase commitments and product development plans, the Company records a provision for purchase commitments. Future charges may be required based on changes in forecasted sales or strategic direction.

The Company's investing activities consist principally of capital expenditures for the maintenance of existing stores, new store construction, digital initiatives and enhancements to systems and the website. The Company plans to launch its new eCommerce website this fiscal year. The new website is expected to enhance its search capabilities, enable faster shipping and yield cost savings. The Company believes that the new website will allow it to be more competitive in the marketplace and continue to be a valuable resource for its customers, whether they would like their purchased products shipped to their homes or made available for pick up in the stores. Capital expenditures totaled $33.1 million and $28.3 million during the 13 weeks ended August 2, 2014 and July 27, 2013, respectively.

The Company provided credits to eligible customers resulting from the settlements reached with certain publishers in antitrust lawsuits filed by various State Attorney Generals and private class plaintiffs regarding the price of digital books. The Company's customers were entitled to $44.2 million in total credits as a result of the settlement, which is funded by these publishers. If a customer's credit is not used to make a purchase within one year, the entire credit will expire. The Company recorded estimated redemptions of $33.6 million as a receivable from these publishers and a liability to its customers in March 2014. The Company's customers had activated $27.7 million in credits thus far as of August 2, 2014.

On April 27, 2012, the Company entered into an investment agreement between the Company, Morrison Investment Holdings, Inc. (Morrison) and Microsoft Corporation (Microsoft) pursuant to which the Company would form a Delaware limited liability company (NOOK Media), and transfer to NOOK Media the Company's digital device, digital content and college bookstore businesses and NOOK Media would sell to Morrison, and Morrison would purchase, 300,000 convertible preferred membership interests in NOOK Media (Series A Preferred) for an aggregate purchase price of $300.0 million. On October 4, 2012, NOOK Media was formed and the Company sold to Morrison 300,000 convertible preferred membership interests in NOOK Media for an aggregate purchase price of $300.0 million. The convertible preferred membership interests have a liquidation preference equal to Microsoft's original investment. Concurrently with its entry into this agreement, the Company has also entered into a commercial agreement with Microsoft (the Commercial Agreement), whereby, 33 -------------------------------------------------------------------------------- among other things, NOOK Media has developed and distributed a Windows 8 application for eReading and digital content purchases, and has entered into an intellectual property license and settlement agreement with Microsoft and Microsoft Licensing GP. As part of the Commercial Agreement, for each of the first three years since the launch of the application for Windows 8, NOOK Media received and will continue to receive advance payments of $60.0 million per year from Microsoft. These advance payments are subject to deferral under certain circumstances. Microsoft has paid and is obligated to continue to pay to NOOK Media $25.0 million each year for the first five years of the term for purposes of assisting NOOK Media in acquiring local digital reading content and technology development in the performance of NOOK Media's obligations under the Commercial Agreement. Under the terms of this transaction, NOOK Media was debt-free at inception, except for trade accounts payable and other working capital requirements. Under the limited liability company agreement of NOOK Media, no distributions may be made by NOOK Media without Morrison's approval.

On March 10, 2014, the Company entered into an amendment (Amendment) to the existing Commercial Agreement. Pursuant to the Amendment, NOOK Media and Microsoft agreed to co-branding within the Microsoft Consumer Reader for reading content delivered by NOOK Media. The Amendment also provided that subject to certain conditions NOOK Media would be permitted to discontinue distributing the NOOK Windows app and will cooperate in good faith with Microsoft to transition users to the Microsoft Consumer Reader. Microsoft and NOOK Media also agreed to updated revenue sharing to address this possibility. The Amendment also permits NOOK Media to cease efforts with respect to a Windows phone app.

On December 21, 2012, NOOK Media entered into an agreement with a subsidiary of Pearson plc (Pearson) to make a strategic investment in NOOK Media. That transaction closed on January 22, 2013, and Pearson invested approximately $89.5 million of cash in NOOK Media at a post-money valuation of approximately $1.789 billion in exchange for convertible preferred membership interests representing a 5% equity stake in NOOK Media. Following the closing of the transaction, the Company owns approximately 78.2% of NOOK Media and Microsoft, which holds convertible preferred membership interests, owns approximately 16.8%. The convertible preferred membership interests have a liquidation preference equal to the original investment. In addition, NOOK Media granted warrants to Pearson to purchase up to an additional 5% of NOOK Media under certain conditions at a pre-money valuation of NOOK Media of approximately $1.789 billion.

At closing, NOOK Media and Pearson entered into a commercial agreement with respect to distributing Pearson content in connection with this strategic investment. On December 27, 2013, NOOK Media entered into an amendment to the commercial agreement that extends the term of the agreement and the timing of the measurement period to meet certain revenue share milestones.

On June 4, 2014, barnesandnoble.com llc (NOOK Media Sub), a wholly owned subsidiary of NOOK Media and a subsidiary of Barnes & Noble, entered into a commercial agreement (Agreement) with Samsung Electronics America, Inc.

(Samsung) relating to tablets.

Pursuant to the Agreement, NOOK Media Sub, after good faith consultations with Samsung and subject to Samsung's agreement, will select Samsung tablet devices under development to be customized and co-branded by NOOK Media Sub. Such devices will be produced by Samsung. The co-branded NOOK tablet devices may be sold by NOOK Media Sub through Barnes & Noble retail stores, www.barnesandnoble.com, www.nook.com and other Barnes & Noble and NOOK Media websites. NOOK Media Sub and Samsung have agreed to develop co-branded Samsung Galaxy Tab 4 NOOK tablets as the initial co-branded devices pursuant to the Agreement.

34 -------------------------------------------------------------------------------- NOOK Media Sub has agreed to a minimum purchase commitment of 1,000,000 devices during the first twelve months after the launch of the initial co-branded NOOK devices; provided that if NOOK Media Sub does not meet certain sales thresholds of the initial co-branded NOOK devices by December 31, 2014, then the twelve month period referred to above shall be extended to fifteen months.

NOOK Media Sub and Samsung have agreed to coordinate customer service for the co-branded NOOK devices and have both agreed to a license of intellectual property to promote and market the devices. Additionally, Samsung has agreed to fund a marketing fund for the co-branded NOOK devices at the initial launch and for the duration of the Agreement.

The Agreement has a two year term, with certain termination rights, including termination (i) by NOOK Media Sub for a Samsung material default; (ii) by Samsung for a NOOK Media Sub material default; (iii) by NOOK Media Sub if Samsung fails to meet its shipping and delivery obligations in any material respect on a timely basis; and (iv) by either party upon insolvency or bankruptcy of the other party.

On August 18, 2011, the Company entered into an investment agreement between the Company and Liberty GIC, Inc. (Liberty) pursuant to which the Company issued and sold to Liberty, and Liberty purchased, 204,000 shares of the Company's Series J Preferred Stock, par value $0.001 per share (Preferred Stock), for an aggregate purchase price of $204.0 million in a private placement exempt from the registration requirements of the 1933 Act. The shares of Preferred Stock will be convertible, at the option of the holders, into shares of Common Stock representing 16.6% of the Common Stock outstanding as of August 29, 2011 (after giving pro forma effect to the issuance of the Preferred Stock) based on the initial conversion rate. The initial conversion rate reflects an initial conversion price of $17.00 and is subject to adjustment in certain circumstances. The initial dividend rate for the Preferred Stock is equal to 7.75% per annum of the initial liquidation preference of the Preferred Stock to be paid quarterly and subject to adjustment in certain circumstances.

On April 8, 2014, Liberty sold the majority of its shares to qualified institutional buyers in reliance on Rule 144A under the Securities Act and has retained an approximate 10 percent stake of its initial investment. As a result, Liberty no longer has the right to elect two preferred stock directors to the Company's Board. Additionally, the consent rights and pre-emptive rights to which Liberty was previously entitled ceased to apply.

On September 30, 2009, in connection with the closing of the acquisition of B&N College (the Acquisition), the Company issued the sellers (i) a senior subordinated note (the Senior Seller Note) in the principal amount of $100.0 million, with interest of 8% per annum payable on the unpaid principal amount, which was paid on December 15, 2010 in accordance to its scheduled date, and (ii) a junior subordinated note (the Junior Seller Note) in the principal amount of $150.0 million, payable in full on the fifth anniversary of the closing of the Acquisition, with interest of 10% per annum payable on the unpaid principal amount. Pursuant to a settlement agreed to on June 13, 2012, the sellers have agreed to waive their right to receive $22.8 million in principal amount (and interest on such principal amount) of the Junior Seller Note. The net short-term payable of $127.3 million is due September 30, 2014 and has been reclassified to a short-term liability accordingly.

Based upon the Company's current operating levels and capital expenditures for fiscal 2015, management believes cash and cash equivalents on hand, funds available under its credit facility, cash received and committed to NOOK Media and short-term vendor financing will be sufficient to meet the Company's 35 -------------------------------------------------------------------------------- normal working capital and debt service requirements for at least the next twelve months. The Company regularly evaluates its capital structure and conditions in the financing markets to ensure it maintains adequate flexibility to successfully execute its business plan.

Segments The Company identifies its operating segments based on the way the business is managed (focusing on the financial information distributed) and the manner in which the chief operating decision maker interacts with other members of management. The Company's three operating segments are: B&N Retail, B&N College and NOOK.

Seasonality The B&N Retail business, like that of many retailers, is seasonal, with the major portion of sales and operating profit realized during its third fiscal quarter, which includes the holiday selling season.

The B&N College business is highly seasonal, with the major portion of sales and operating profit realized during the second and third fiscal quarters, when college students generally purchase and rent textbooks for the upcoming semesters. Revenues from textbook rentals, which primarily occur at the beginning of the semester, are recognized over the rental period.

The NOOK business, like that of many technology companies, is impacted by the launch of new products and the promotional efforts to support those new products, as well as the traditional retail holiday selling seasonality.

Business Overview The Company's financial performance has been significantly impacted in recent years by a number of factors, including the expanding digital market, increased online competition and the economic downturn. However, the Company has benefited from reduced physical bookstore competition in the marketplace, the successful execution of new merchandising strategies, its ability to acquire new college contracts and by expanding its offerings to college students. Additionally, the Company has leveraged its unique assets, iconic brands and reach to become a leader in the distribution of digital content.

The Company derives the majority of its sales and net income from its B&N Retail and B&N College stores.

B&N Retail has experienced declining sales trends due to secular industry challenges, including the growth of the digital book market and online shopping, declining sales of NOOK devices and fewer stores. While the Company expects comparable bookstore sales to continue to decline, it has recently benefitted from improving book industry trends, including a moderation of the growth of the digital book market, as well as successful merchandising initiatives that increased store traffic and sales and drove positive trends in its Toys & Games and Gift businesses. Additionally, the Company continues to expect to benefit from further market consolidation as non-book retailers reduce their presence in the book category. The Company is making further investments in its retail business this fiscal year and plans to launch a new eCommerce platform after the holiday selling season, which it believes will allow it to be more competitive in the marketplace.

36 -------------------------------------------------------------------------------- B&N College provides direct access to a large and well-educated demographic group, enabling the Company to build relationships with students throughout their college years and beyond. The Company also expects to be the beneficiary of market consolidation as more and more schools outsource their bookstore management. The Company is in a unique market position to benefit from this trend given its full suite of services: bookstore management, textbook rental and digital delivery. The Company is making further investments in its college business, including the recent launch of YuzuTM, its digital education platform that provides access to a wide range of rich, engaging content, including digital textbooks and select consumer titles applicable to the higher education market. The Company believes higher education provides a long-term growth opportunity.

NOOK represents the Company's digital business, which includes the Company's eBookstore, digital newsstand and sales of NOOK® devices and accessories. The underlying strategy of the NOOK business is to offer customers any digital book, newspaper or magazine, anytime, on any device. The Company remains committed to delivering to customers the best digital bookstore experience, while rationalizing its existing cost structure. As part of this commitment, the Company entered into a partnership on June 4, 2014, to develop co-branded Samsung Galaxy Tab 4 NOOK tablets that feature the award-winning Barnes & Noble digital reading experience. The co-branded devices combined popular Samsung Galaxy Tab 4 hardware with customized NOOK software to give customers powerful, full-featured tablets that are designed for reading, with easy access to Barnes & Noble's expansive digital collection of more than three million books, leading magazines and newspapers. The companies introduced the Samsung Galaxy Tab 4 NOOK in a 7-inch version in the U.S. in August 2014. The Company also intends to continue to develop and offer the best black-and-white eReaders on the market, backed by quality customer service and technology support for those devices. The Company will continue to sell its existing device inventory through as it segues into new products. At the same time, it will leverage all Barnes & Noble retail, digital and partnership assets, as well as existing NOOK customer relationships. The Company intends to continue to provide the resources necessary for quality customer service and support sales of new devices and those in use by NOOK's existing customer base.

On June 5, 2014, the Company entered into an Assignment of Lease for its 208,000 square foot Palo Alto, California campus. Employees were relocated to new state-of-the-art facilities totaling 88,000 square feet. NOOK employees moved to a new facility in Santa Clara, California, while Barnes & Noble College's digital education employees relocated to a facility in Mountain View, California.

The Company sells digital content in the U.K. directly through its NOOK devices and its nook.co.uk website. The Company plans to continue to expand into additional international markets and believes that its partnership with Microsoft will help foster that expansion. Additionally, the Company believes that its partnership with Pearson will accelerate customer access to digital content by pairing Pearson's leading expertise in online learning with NOOK's expertise in reading technology, online commerce and customer service.

The Company believes its footprint of more than 1,300 stores will continue to be a major competitive asset in capturing digital content share. The Company will continue to complement its traditional retail, trade book and college bookstores businesses with its electronic and Internet offerings, using retail stores in attractive geographic markets to promote and sell digital devices and content.

Customers can see, feel and experiment with NOOK® products in the Company's stores.

Although the stores will be just a part of the offering, they will remain a key driver of sales and cash flow as the Company expands its multi-channel relationships with its customers. While the Company may open a few retail stores in new geographic markets, the Company expects to reduce the total net number of retail stores. B&N College expects to increase its college store base.

37 -------------------------------------------------------------------------------- Although the Company believes cash on hand, cash flows from operating activities, funds available from its Credit Facility, cash received and committed to NOOK Media and short-term vendor financing provide the Company with adequate liquidity and capital resources for seasonal working capital requirements, the Company may raise additional capital to support key strategic initiatives.

Update on NOOK Media Separation The Company continues to make progress on the separation of its Barnes & Noble Retail and NOOK Media businesses. In an effort to optimize the structure of the separation, the Company has been exploring various options and is in discussions (i) with its NOOK Media partners to potentially restructure existing agreements; and (ii) with potential third party partners. Such discussions could affect the structure and timing of the separation.

While we continue to take the steps necessary to separate these businesses by the end of the first quarter of next calendar year, there can be no assurances regarding the timing of the proposed separation or that such separation will be completed.

Results of Operations 13 weeks ended August 2, 2014 compared with the 13 weeks ended July 27, 2013.

Sales The following table summarizes the Company's sales for the 13 weeks ended August 2, 2014 and July 27, 2013: 13 weeks ended August 2, July 27, Dollars in thousands 2014 % Total 2013 % Total B&N Retail $ 954,807 77.2 % $ 1,008,202 75.9 % B&N College 226,094 18.3 % 226,022 17.0 % NOOK 70,027 5.7 % 153,138 11.5 % Elimination (14,481 ) (1.2 )% (57,860 ) (4.4 )% Total Sales $ 1,236,447 100.0 % $ 1,329,502 100.0 % During the 13 weeks ended August 2, 2014, the Company's sales decreased $93.1 million, or 7.0%, to $1.236 billion from $1.330 billion during the 13 weeks ended July 27, 2013. The change by segment is as follows: • B&N Retail sales for the 13 weeks ended August 2, 2014 decreased $53.4 million, or 5.3%, to $954.8 million from $1.008 billion during the same period a year ago, and accounted for 77.2% of total Company sales. The decrease was primarily attributable to a 5.1% decrease in comparable store sales, which decreased sales by $37.9 million, lower online sales which declined by $10.0 million, partially offset by a $7.3 million reimbursement resulting from favorable claims experience with a warranty service provider during the 13 weeks ended August 2, 2014. Closed stores sales decreased by $17.0 million, slightly offset by new stores that increased sales by $3.8 million. Core comparable store sales, which exclude sales of NOOK® products, decreased 0.4% on lower book sales. Sales of NOOK® products at B&N Retail stores declined primarily on lower device unit volume, and to a lesser extent on lower average selling prices. B&N Retail also includes third-party sales of Sterling Publishing Co., Inc, which increased $1.1 million, or 4.9%, versus the prior year.

• B&N College sales increased $0.1 million to $226.1 million during the 13 weeks ended August 2, 2014 from $226.0 million during the 13 weeks ended July 27, 2013. Comparable store sales decreased 2.0% due primarily to timing of the start of the back-to-school rush season. While comparable store sales percentages are adjusted for the impact of textbook rentals, sales dollars were also negatively impacted by the continued growth of textbook rentals, which have a lower price than 38 -------------------------------------------------------------------------------- new or used textbooks and a portion of the rental sale is deferred over the rental period. The increase in the deferral from last year lowered sales by $1.8 million for the 13 weeks ended August 2, 2014. New store openings over the past year increased sales by $4.8 million, offset by closed stores, which decreased sales by $3.2 million. Due to the seasonality of the business, B&N College experienced a favorable sales shift from the fiscal calendar this quarter, created by last year's 53rd week.

• NOOK sales decreased $83.1 million, or 54.3%, to $70.0 million during the 13 weeks ended August 2, 2014 from $153.1 million during the 13 weeks ended July 27, 2013. Device and accessories sales decreased $66.5 million, or 78.6%, to $18.1 million during the 13 weeks ended August 2, 2014 primarily on lower device unit volume. Digital content sales decreased $16.6 million, or 24.2%, to $52.0 million during the 13 weeks ended August 2, 2014 primarily on lower device unit volume.

• The elimination represents sales from NOOK to B&N Retail and B&N College on a sell through basis. The decrease versus the prior year was due to the lower device sales volume at B&N Retail.

During the 13 weeks ended August 2, 2014, B&N Retail had no store openings and three closings, and B&N College had 22 openings and 17 closings.

Cost of Sales and Occupancy 13 weeks ended August 2, % of July 27, % of Dollars in thousands 2014 Sales 2013 Sales B&N Retail $ 660,165 69.1 % $ 707,476 70.2 % B&N College 178,656 79.0 % 175,773 77.8 % NOOK 29,415 42.0 % 135,912 88.8 % Elimination (14,481 ) (20.7 )% (57,860 ) (37.8 )% Total Cost of Sales and Occupancy $ 853,755 69.0 % $ 961,301 72.3 % The Company's cost of sales and occupancy includes costs such as merchandise costs, distribution center costs (including payroll, freight, supplies, depreciation and other operating expenses), rental expense, management service agreement costs with schools, common area maintenance and real estate taxes, partially offset by landlord tenant allowances amortized over the life of the lease.

During the 13 weeks ended August 2, 2014, cost of sales and occupancy decreased $107.5 million, or 11.2%, to $853.8 million from $961.3 million during the 13 weeks ended July 27, 2013. Cost of sales and occupancy decreased as a percentage of sales to 69.0% from 72.3% during the same period one year ago. The change by segment is as follows: • B&N Retail cost of sales and occupancy decreased as a percentage of sales to 69.1% from 70.2% during the same period one year ago. This decrease was attributable to a higher mix of higher margin core products (which exclude NOOK® products), increased vendor allowances and a $7.3 million reimbursement resulting from favorable claims experience with a warranty service provider during the 13 weeks ended August 2, 2014, partially offset by expense deleverage against the sales decline.

• B&N College cost of sales and occupancy increased as a percentage of sales to 79.0% from 77.8% during the same period one year ago due to increased occupancy costs and higher markdowns during a low volume sales period, partially offset by a favorable sales mix of higher margin textbook rentals and general merchandise.

39 -------------------------------------------------------------------------------- • NOOK cost of sales and occupancy decreased as a percentage of sales to 42.0% from 88.8% during the same period one year ago. This decrease includes a benefit from the previously disclosed adjustment of lease accounting items to reflect the impact of the Palo Alto relocations. The benefit, net of closing related costs, of $5.7 million for the quarter was primarily driven by the reversal of previously deferred rent liabilities upon exiting the facility. In addition, cost of goods sold and occupancy included the recognition of a $6.8 million benefit on the settlement of previously estimated and accrued parts and components liabilities.

Excluding these benefits, cost of goods sold and occupancy as a percentage of sales improved on lower device markdowns and a higher mix of higher margin content sales during the quarter.

Gross Margin 13 weeks ended August 2, % of July 27, % of Dollars in thousands 2014 Sales 2013 Sales B&N Retail $ 294,642 30.9 % $ 300,726 29.8 % B&N College 47,438 21.0 % 50,249 22.2 % NOOK 40,612 73.1 % 17,226 18.1 % Total Gross Margin $ 382,692 31.0 % $ 368,201 27.7 % The Company's consolidated gross margin increased $14.5 million, or 3.9%, to $382.7 million during the 13 weeks ended August 2, 2014 from $368.2 million during the 13 weeks ended July 27, 2013. This increase was due to the matters discussed above.

Selling and Administrative Expenses 13 weeks ended August 2, % of July 27, % of Dollars in thousands 2014 Sales 2013 Sales B&N Retail $ 228,502 23.9 % $ 235,965 23.4 % B&N College 79,441 35.1 % 69,344 30.7 % NOOK 45,198 81.4 % 71,837 75.4 % Total Selling and Administrative Expenses $ 353,141 28.6 % $ 377,146 28.4 % Selling and administrative expenses decreased $24.0 million, or 6.4%, to $353.1 million during the 13 weeks ended August 2, 2014 from $377.1 million during the 13 weeks ended July 27, 2013. Selling and administrative expenses increased as a percentage of sales to 28.6% from 28.4% during the same period one year ago. The change as a percentage of sales by segment is as follows: • B&N Retail selling and administrative expenses increased as a percentage of sales to 23.9% from 23.4% during the same period one year ago primarily attributable to expense deleverage against the sales decline.

40 -------------------------------------------------------------------------------- • B&N College selling and administrative expenses increased as a percentage of sales to 35.1% from 30.7% during the same period one year ago primarily due to new store growth, planned costs to support growth of the business and continued investments in YuzuTM, B&N College's digital education platform.

• NOOK selling and administrative expenses increased as a percentage of sales to 81.4% from 75.4% during the same period one year ago primarily due to expense deleverage against the sales decline. Expense dollars declined on lower payroll, legal, severance, consulting costs and the sales decline as compared to the same period one year ago.

Depreciation and Amortization 13 weeks ended August 2, % of July 27, % of Dollars in thousands 2014 Sales 2013 Sales B&N Retail $ 27,404 2.9 % $ 32,224 3.2 % B&N College 12,544 5.5 % 11,641 5.2 % NOOK 10,321 18.6 % 11,134 11.7 % Total Depreciation and Amortization $ 50,269 4.1 % $ 54,999 4.1 % During the 13 weeks ended August 2, 2014, depreciation and amortization decreased $4.7 million, or 8.6%, to $50.3 million from $55.0 million during the same period one year ago. This decrease was primarily attributable to fully depreciated assets and store closings at Retail, partially offset by additional capital expenditures.

Operating Profit (Loss) 13 weeks ended August 2, % of July 27, % of Dollars in thousands 2014 Sales 2013 Sales B&N Retail $ 38,736 4.1 % $ 32,537 3.2 % B&N College (44,547 ) (19.7 )% (30,736 ) (13.6 )% NOOK (14,907 ) (26.8 )% (65,745 ) (69.0 )% Total Operating Loss $ (20,718 ) (1.7 )% $ (63,944 ) (4.8 )% The Company's consolidated operating loss decreased $43.2 million, or 67.6%, to an operating loss of $20.7 million during the 13 weeks ended August 2, 2014 from an operating loss of $63.9 million during the 13 weeks ended July 27, 2013. This decrease was due to the matters discussed above.

Interest Expense, Net and Amortization of Deferred Financing Fees 13 weeks ended August 2, July 27, % of Dollars in thousands 2014 2013 Change Interest Expense, Net and Amortization of Deferred Financing Fees $ 5,920 $ 7,552 (21.6 )% 41 -------------------------------------------------------------------------------- Net interest expense and amortization of deferred financing fees decreased $1.6 million, or 21.6%, to $5.9 million during the 13 weeks ended August 2, 2014 from $7.6 million from the same period one year ago. This decrease was due to lower interest related to the Microsoft Commercial Agreement and lower average borrowings.

Income Taxes 13 weeks ended August 2, Effective July 27, Effective Dollars in thousands 2014 Rate 2013 Rate Income Taxes $ 1,811 (6.8 )% $ 15,526 (21.7 )% The Company recorded an income tax provision of $1.8 million during the 13 weeks ended August 2, 2014 compared with an income tax provision of $15.5 million during the 13 weeks ended July 27, 2013. The Company's effective tax rate was (6.8)% and (21.7)% for the 13 weeks ended August 2, 2014 and July 27, 2013, respectively. The income tax provision for the 13 weeks ended August 2, 2014 does not include income tax benefits on losses incurred by certain domestic operations as the Company previously recorded (and continues to maintain) valuation allowance against the associated deferred assets. The income tax provision is principally comprised of expense from profitable jurisdictions.

In accordance with Accounting Standards Codification (ASC) 740-10, Accounting for Income Taxes, the Company evaluates the realizability of its deferred tax assets at each reporting date. The Company records a valuation allowance when it determines that it is more likely than not that all or a portion of a particular deferred tax asset will not be realized. As part of this evaluation, the Company reviews all evidence, both positive and negative, to determine if a valuation allowance is needed. The Company's review of positive evidence included the review of feasible tax planning strategies that may be implemented and the reversal of temporary items. The Company determined that there was sufficient negative evidence to establish valuation allowances against certain deferred tax assets generated during this quarter. The Company will monitor the need for additional valuation allowances at each quarter in the future and, if the negative evidence outweighs the positive evidence, an allowance will be recorded.

Net Loss 13 weeks ended August 2, July 27, Dollars in thousands 2014 2013 Net Loss Attributable to Barnes & Noble, Inc. $ (28,449 ) $ (87,022 ) As a result of the factors discussed above, the Company reported consolidated net loss of $28.4 million during the 13 weeks ended August 2, 2014, compared with consolidated net loss of $87.0 million during the 13 weeks ended July 27, 2013.

Critical Accounting Policies During the first quarter of fiscal 2015, there were no changes in the Company's policies regarding the use of estimates and other critical accounting policies.

See "Management's Discussion and Analysis of 42 -------------------------------------------------------------------------------- Financial Condition and Results of Operations," found in the Company's Annual Report on Form 10-K for the fiscal year ended May 3, 2014 for additional information relating to the Company's use of estimates and other critical accounting policies.

Disclosure Regarding Forward-Looking Statements This quarterly report on Form 10-Q contains certain forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended) and information relating to Barnes & Noble that are based on the beliefs of the management of Barnes & Noble as well as assumptions made by and information currently available to the management of Barnes & Noble. When used in this communication, the words "anticipate," "believe," "estimate," "expect," "intend," "plan," "will," "forecasts," "projections," and similar expressions, as they relate to Barnes & Noble or the management of Barnes & Noble, identify forward-looking statements.

Such statements reflect the current views of Barnes & Noble with respect to future events, the outcome of which is subject to certain risks, including, among others, the general economic environment and consumer spending patterns, decreased consumer demand for Barnes & Noble's products, low growth or declining sales and net income due to various factors, possible disruptions in Barnes & Noble's computer systems, telephone systems or supply chain, possible risks associated with data privacy, information security and intellectual property, possible work stoppages or increases in labor costs, possible increases in shipping rates or interruptions in shipping service, effects of competition, possible risks that inventory in channels of distribution may be larger than able to be sold, possible risks associated with changes in the strategic direction of the device business, including possible reduction in sales of content, accessories and other merchandise and other adverse financial impacts, possible risk that component parts will be rendered obsolete or otherwise not be able to be effectively utilized in devices to be sold, possible risk that financial and operational forecasts and projections are not achieved, possible risk that returns from consumers or channels of distribution may be greater than estimated, the risk that digital sales growth is less than expectations and the risk that it does not exceed the rate of investment spend, higher-than-anticipated store closing or relocation costs, higher interest rates, the performance of Barnes & Noble's online, digital and other initiatives, the success of Barnes & Noble's strategic investments, unanticipated increases in merchandise, component or occupancy costs, unanticipated adverse litigation results or effects, product and component shortages, risks associated with NOOK Media's commercial agreement with Samsung, the potential adverse impact on Barnes & Noble's businesses resulting from Barnes & Noble's prior reviews of strategic alternatives and the potential separation of Barnes & Noble's businesses, the risk that the transactions with Microsoft, Pearson and Samsung do not achieve the expected benefits for the parties or impose costs on Barnes & Noble in excess of what Barnes & Noble anticipates, including the risk that NOOK Media's applications are not commercially successful or that the expected distribution of those applications is not achieved, the risks associated with the international expansion contemplated by the relationship with Microsoft, including the risk that it is not successful or is delayed, the risk that NOOK Media is not able to perform its obligations under the Microsoft, Pearson and Samsung commercial agreements and the consequences thereof, the risk that Barnes & Noble College Booksellers, LLC does not continue to grow, including the risk that its growth rate declines, the risk of possible delays in the launch of our higher education digital products, the risks associated with the SEC investigation and associated risks, and other factors which may be outside of Barnes & Noble's control, including those factors discussed in detail in Item 1A, "Risk Factors," in Barnes & Noble's Annual Report on Form 10-K for the fiscal year ended May 3, 2014, and in Barnes & Noble's other filings made hereafter from time to time with the SEC.

43 -------------------------------------------------------------------------------- Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described as anticipated, believed, estimated, expected, intended or planned. Subsequent written and oral forward-looking statements attributable to Barnes & Noble or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements in this paragraph.

Barnes & Noble undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Form 10-Q.

[ Back To TMCnet.com's Homepage ]