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BKS AT A GLANCE

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Barnes & Noble (NYSE:BKS) is the largest bookseller in terms of sales revenue in the United States. As of the end of FY 2008, BKS operated 778 stores and an online retailer Barnes & Noble.com. Of the 778 stores, 726 were Barnes & Noble book and music superstores and the 52 remaining were mall-based B. Dalton booksellers.^[1] Its core business model relies on building local bookstores with comprehensive selection, attractive discounts and membership discount programs, and a community-gathering-place environment (e.g., the inclusion of a Starbucks cafe in each Barnes & Noble store).^[2]

Although Barnes & Noble achieved steady annual revenue growth until 2008, it has been suffering from diminishing margins, with its company-wide operating margin falling from 4.8% in 2006 to 2.8% in FY2008,^[3] despite aggressive closings of its under performing B. Dalton stores. Declining operating margins were mainly caused by higher discounts offered to compete with lower-priced online booksellers, one of the main negative pressures the print industry is facing right now. due to a number of negative industry trends. ^[4]

Compounding this digital effect is the onslaught from e-commerce companies such as Amazon.com (AMZN) and retail superstores such as Wal-Mart and Costco Wholesale (COST), which have the ability to significantly undercut brick and mortar retailers' prices on books, CDs, DVDs and other offerings. Though BKS has a website, 89% of their sales come from their B&N locations, and this pricing pressure from both online booksellers and retail giants has squeezed margins.^[3] In addition, the advent of digital media devices to facilitate book reading, such as the Kindle 2 produced by Amazon and the IPhone, also threaten the market share of print book retailers, as digital devices offer more portability (the Kindle 2 already has more than 200,000 books available) and price competition. In fact, BKS closed Q1 2009 with a 4% decrease in sales revenue,^[5] whereas Amazon.com (AMZN) saw its 1Q 2009 sales revenue for books, CDs, music, and DVDs jump by more than 7%, largely due to the popularity of its Kindle 2 device and Kindle books.^[6]

Company Overview

Barnes & Noble is the largest national general trade book publisher and retailer in terms of sales revenue. In 2008, the company's share of the consumer book market was approximately 16.2%.^[2]

Business Segments

Although the company does not give specific breakdowns of its business segments, it sells products in these general categories:^[2]

• Books: Barnes & Noble stores offer a comprehensive selection of titles of trade and mass market books, ranging from 60,000 to 200,000 titles per store. Bestsellers represent 3-5% of all BKS sales.
• Music/DVDs: Many Barnes & Noble stores have music/DVD departments, which range in size from 1,300 to 6,000 square feet and typically stock over 30,000 titles. The company’s DVD selection is focused on foreign films, documentaries and episodic TV shows.
• Periodicals: Stores sell popular magazines and journals
• Children's Books
• Cafe: Each Barnes & Noble store features a cafe, operated by its partner Starbucks (SBUX).

Business Operations

Barnes & Noble run four main business operations:

• Barnes & Noble Stores (89% of net sales): The company generates a majority of its revenue through its 726 Barnes and Noble stores which are located in all 50 states in the United States. These stores range from 10,000 to 60,000 sq. ft. in area depending on market size. The stores operate under a "community store" concept and provide more than just books to the public. Each is equip with a Starbucks cafe, children's, music/DVD, and magainze sections. In addition, each store has a calendar of events of which activities include author appearances and children’s activities.^[2]

• B. Dalton Bookstores (1% of net sales): Barnes & Noble operates a chain of bookstores called B. Dalton, a store that generally sells books between 15% and 30% off publishers’ suggested retail prices for hardcover bestsellers. At the end of FY 2008, the company operated 52 B. Dalton stores. Since 1989, Barnes & Noble has continued its controlled descent of the number of B. Dalton bookstores -- in 1989 there were 915 B. Dalton bookstores and in 2008, the company closed 33 stores.^[7]

• Barnes & Noble.com (9% of net sales): Customers can buy books directly from the company through the website, which receives 365 million visits annually.

• Other (1% of net sales): This section primarily includes all the sales of the Sterling Publishing, a wholly-owned subsidiary of Barnes & Noble. In July 2009, the company announced that it was consolidating its publishing functions and eliminating jobs as a result of weaker sales due to the recession.^[8]

The above chart shows a breakdown of BKS's net sales in FY2008 by operation. Sales from Barnes & Noble stores is by far the largest contributor to sales revenue, contributing 89% in FY2008.^[3]

Discount Pricing

Barnes & Noble offers discount pricing to compete with online discount retailers such as Amazon.com (AMZN) and EBay (EBAY) and large discount retailers such as Wal-Mart (WMT) and Costco Wholesale (COST). For hardcover bestsellers, the comopany offers discounts at 30% off suggested retail prices, and 20% discount off of select Children's books and computer reference books. The Barnes & Noble membership, for an annual fee of $25, offers greater discounts on all bestsellers and other merchandise for sale in Barnes & Noble stores.^[9]

Sale of Stake in Calendar Club

In an effort to cut under-performing segments of its business to compensate for pressures from decreasing profitability and the the recession, in early 2009, Barnes & Noble sold its 74% stake in Calendar Club, a maker and retailer of specialty calendar products, games, puzzles, and music, for after-tax proceeds of $9.7 million. In 2008, Calendar Club contributed $113 million to the company's total sales, but contributed negligibly to the company's earnings per share.^[10]

Business Growth

FY 2008 (ended Jan 31, 2009)^[3]

• At the end of FY2008, BKS operated 778 stores, a net decrease of 20 stores when compared to the 798 stores open at the end of FY2007. However, due to the fact that new stores opened were on average larger in area, BKS's retail square footage increased 2.2% to 18.9 million sq.ft. in FY2008.

• In FY2008, total sales was $5.12 billion, a decrease of 3.1% from $5.29 billion in FY2007.

• Comparable store sales decreased 5.4% in FY2008 for Barnes & Noble stores that have been opened one year or more, and comparable sales for Barnes & Noble.com decrease 1.3%. Sales per retail square footage decreased to $271.0 in FY2008, a 5.2% decrease from last year.

• Net income decreased 44.1% from FY2007, totaling $75.9 million, or 1.5% of net sales revenue.

• Operating profit margin decreased 100 bps from FY2007, totaling $143 million, or 2.8% of net sales revenue.

Q2 2009 (ended August 1, 2009)^[11]

• Barnes & Noble's net income decreased year-over-year, from -$15.41 million in Q2 2008 to -$15.41 million in Q2 2009 as a result of recessionary pressures from the economics downturn in 2008.

• Net sales was $1.16 billion in Q2 2009, down 5.3% from net sales of the prior-year quarter. The company attributes part of the loss to a 6.9% decrease in comparable store sales or $70.0 million.

• SG&A expenses decreased $11.1 million, or 3.7%, to $289 million.

• The company opened one new Barnes & Noble stores and closed three stores. The company also closed one B. Dalton bookstore. At the end of the quarter, Barnes & Noble operated a total of 774 stores.

Trends and Forces

E-Commerce and Digital Reading Devices Gaining Popularity

Much of the slowdown in the sales revenue of the print retailers may be attributed to the increasing popularity and convenience of online retailers, especially Amazon.com. Many online retailers are also a part of the CD and DVD retail segment, where Barnes & Noble has limited its exposure so as not to suffer from lagging sales of CDs due to digital media devices mp3s), another edge for online retailers. To compete in the e-commerce sphere, BKS established its own online retailing website, but sales from the online channel accounted for only 9% of its total sales in 2008 and grew less than 4% in total over the last 3 years.^[3]

In addition, the advent of digital reading devices such as Amazon's Kindle 2, which stores more than 1,500 books, has wireless connectivity, and an online bookstore of more than 200,000 books, poses a significant risk to BKS's success as a print retailer, as more customers switch to digital reading devices due to increased portability and price competitiveness. In fact, as most retailers suffered losses in the weak retail environment of 2008-2009, Amazon.com (AMZN) reported a 7% gain on its books, music, and DVDs segment in Q1 2009, largely due to the success of its e-commerce operations and sales of the Kindle 2 and Kindle books.^[6] In addition, analysts estimate that Amazon could sell more than $2.5 billion in e-books for the Kindle by 2012. ^[12]

However Barnes & Noble does not plan to give up on the e-book industry without a fight. On July 20, 2009, the company announced that it was launching an e-bookstore and an e-book reader that would sell more than 200,000 titles as well as give users access to 500,000 public domain books from Google Books. The device, called the Nook, uses an E-ink screen, a secondary touch screen, has wi-fi, and has the ability to share books with other devices for 14 days (a feature not available on the Kindle).^[13] The company plans to sell e-book titles for $9.99, the same price that Amazon charges. ^[14] The device is set to launch at the end of November 2009.

Dependence on Bestsellers to Drive Traffic

In 2008, bestsellers accounted for between 3% and 5% of total sales at Barnes & Noble,^[2] and that percentage has been on the rise, especially with the release of books like the Harry Potter series. For example, the Barnes & Noble Q2 2007 sales were up 17.9% after the release of Harry Potter and the Deathly Hallows, the seventh book (and possibly final book) of the popular series.^[15] The popularity of bestsellers is important, because the release of a popular title drives traffic to bookstores. Due to widespread availability of popular titles from both online retailers like Amazon.com and mass merchants like Wal-Mart, Barnes & Noble must discount bestsellers up to 40% off the publishers’ suggested retail price in order to be competitively priced to consumers. Because of the popularity of bestsellers, particularly around the holiday season, Barnes & Noble can produce strong same store sales numbers, but the heavy discounts negatively impact profit margins .

Member Program Drive Incremental Purchases

Barnes & Noble offers a discount card to its paid members ($25/year) for which customers receive 10% off on all items through both the online and retail stores as well as 40% of bestsellers and 20% off all adult hardcovers, up from 30% and 10%, respectively starting in October 2006.^[2] The increased discount has upped sales, but not enough to compensate for the loss in margin. In FY2008, BKS sales increased by a slight 1.5% but operating margins dropped from 3.8% in 2007 to 2.8% in 2008.^[3] By pioneering the program, Barnes & Noble has created substantial brand loyalty and also gave itself a boost in yearly sales as membership in the program has led to an increase in incremental sales. It's estimated that 10% of sales come from the paid members, not including the annual fee. In February 2006, BKS's main competitor, Borders, started their own reward program, which is free but offers a smaller discount.

Competition

The retail book market is slow to change and is at this point closed off from new superstore entrants. Barnes & Nobles looks to use its strong position as the leading U.S. bookseller to capitalize on its contracts with Starbucks for in-store cafes to maintain and grow its market share. BKS competes on two fronts, with other physical retailers and with internet booksellers. ^[16]

Traditional Book Retailers

Barnes & Noble competes with other companies who share its model of having massive book superstores with thousands of titles.

• Borders Group (BGP): Borders is the second largest book retailer in the U.S. and the largest mall-based bookseller in the country. As of February 2009 it operated 509 domestic superstores, 490 "Waldenbooks" mall-based locations, 32 international stores. ^[19] Barnes & Noble could take market share away from Borders as mall-based retail slows down in favor of one-stop shopping at retail megastores like Wal-Mart. Another advantage that BKS has over Borders is that their online store is much more established. Borders put itself up for sale in early 2008 and Barnes & Noble is considering a bid to acquire its closest competitor. However, the deal did not go through; coupled with the recent weak retail environment, BGP experienced a 12.9% drop in sales in FY2008 and mounting financial difficulties.^[20]

• Books-A-Million (BAMM): Book retailer primarily in the southeastern US and is the third-largest book retailing chain in the country. As of Jan 2009, BAMM operates 220 stores in 19 states and Washington, DC. BAMM has modeled its stores after BKS, promoting its larger Books A MIllion stores as an inviting community gathering location while placing smaller square-footage stores in malls.

Online Booksellers

Amazon.com is the largest online competition for Barnes & Noble. Formerly partnered with Borders, Amazon offers the convenience of never having to leave your home to buy a book. Additionally, without some of the overhead inherent for B&M stores, Amazon.com can offer low prices or free shipping, leading to further price competition. The increasing popularity of its digital reading device, the Kindle 2, has also prompted Amazon's book sales to increase by 7% in Q1 2009. The portability and price attractiveness of the Kindle 2 device is poised to compete for BKS's market share. ^[6]

Retail Megastores

Wal-Mart and Target are the main retail megastores, which sell everything from books to clothes to groceries. Despite not being a core sales segment of their business, these larger stores have had an impact on the sale of books by making best sellers more widely available. This puts pressure on traditional book retailers like Barnes & Noble to cut prices on bestsellers to retain store traffic, leading to diminished margins. In fact, BKS's operating margins has been steadily decreasing since 2006, from 4.8% to 2.8% in FY2008.

References

1. ↑ BKS 2008 10-K, Part 1, pg. 3, 7-8
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5} BKS 2008 10-K, Part 1, pg. 3
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7} BKS 2008 10-K, Exhibit 13, pg. F-1
4. ↑ MSN Money "Will Barnes & Noble win the book wars?" 16 April 2008
5. ↑ Yahoo Finance "Barnes & Noble posts $2.7M 1Q loss as sales drop" 21 May 2009
6. ↑ ^{6.0 6.1 6.2} Reuters "Amazon beats Q1 sales, profit estimates, shares up" 23 April 2009
7. ↑ 2008 10-K, Part 1, pg. 4
8. ↑ Yahoo Finance "Barnes & Noble consolidates publishing functions" 17 July 2009
9. ↑ BKS 2008 10-K, Part 1, pg. 5
10. ↑ Trading Markets "Barnes & Noble sells interest in Calendar Club" 27 Feb 2009
11. ↑ ^{11.0 11.1} BKS Q2 2009 Report, pg. 3 and 17
12. ↑ Seeking Alpha "Amazon Could Top $2.5B in E-Book Sales by 2012" 23 June 2008
13. ↑ MarketWatch "Barnes & Noble lifts wraps on Nook e-reader" 20 October 2009
14. ↑ Financial Times "Barnes & Noble launches online Kindle challenge" 21 July 2009
15. ↑ Internet Retailer "BN.com’s sales up 17.9% in Q2—thanks mostly to Harry Potter" 23 Aug 2007
16. ↑ BKS 2008 10-K, Part 1, pg. 11
17. ↑ BGP 2008 10-K, pg. 19
18. ↑ BAMM 2008 10-K, Exhibit 13, pg. 1
19. ↑ BGP FY2008 Earnings Release
20. ↑ The Deal "Borders could crumble like Tower Records" 1 April 2009