Barnes & Noble ‘Well Ahead of Plan’ on Digital Strategy, CEO Says

All of the “key metrics” for Barnes & Noble’s widening digital business “are well ahead of plan,” CEO William Lynch said in an earnings call. “The results of our digital investments to date embolden us further,” he said, saying: “In less than 12 months, we believe we have already captured a larger share of the digital book market in the U.S. than our 17 percent share of physical books.” But shares in the company fell after it reported a $62.5 million loss for Q1 ended July 31 and cut its fiscal year earnings per share forecast by 25 cents. Shares closed down 2.27 percent Tuesday, at $14.66.

Barnes & Noble’s share of the e-book market is “north of 17 percent and it’s growing quickly,” the company said. Given the retailer’s expansion plans across all the elements of its digital strategy, it predicted its market share gains will “continue through the holiday of this year and beyond,” Lynch said. The company sees “a great opportunity for our business” as the e-reading market grows rapidly “over the next five years,” he said. Barnes & Noble rebranded all aspects of e-reading to reflect the Nook name, he said. Nook for iPhone became “the number one downloaded e-reading app” on Apple’s App Store, he said.

While “some are saying” the e-book market will grow to $500 million this year, Barnes & Noble believes that forecast is “too low,” it said, not offering its own projection. E-book sales “continue to accelerate week after week,” said Chief Financial Officer Joseph Lombardi. Nook customers “have increased their spending” by about 20 percent, and the product “has also greatly expanded the Barnes & Noble customer base, with 25 percent of all Nook customers new to BN.com,” Lynch said.

The company recently shipped a $149 Nook Wi-Fi e-reader (CED June 22 p7) and “sellthrough has exceeded our expectations,” Lynch said. But he didn’t say how many units of that or its 3G Nook sold in Q1 or to date. The 3G model’s price was cut by $60 to $199 in June, when it introduced the Wi-Fi version. The company also didn’t give an update on Nook inventory levels but said Nook sales had been “consistently above plan” since launch and “sales momentum accelerated even further” since the price cut and Nook Wi-Fi introduction.

B&N is revamping its stores, cutting back some inventory and adding new categories. It continues “rolling out” Nook Boutique sections in its “top hundred stores before the holiday, and we're going to finish up the rest of the company right after the holiday,” said Mitchell Klipper, CEO of its Barnes & Noble retail group.

The company also already implemented a 50-store test of an expanded assortment of educational toys and games, including 4,000 SKUs available at B&N.com, and had planned to expand that to more than 400 outlets by late summer (CED June 30 p1). Lynch said the test has “exceeded our expectations, driving double-digit top-line growth for us in that category.” He called that a “big strategic growth opportunity” for its stores and e-commerce business. As of Saturday, the company will be “finishing the rollout” of the 400 departments nationwide, Klipper said.

But the investments are coming at a heavy cost. The company “is allocating significant financial resources to strengthen its digital businesses in fiscal 2011 to maximize our ability to power growth and capture share of the emerging digital market,” said Lynch. It’s financing investments in its digital strategy via working capital and a $1 billion revolving credit facility, of which $380 million was outstanding at the end of Q1, the company said.

The Q1 loss came after Barnes & Noble posted a $12.2 million profit, 21 cents per share, in Q1 last year. The loss included pre-tax legal expenses totaling $9.5 million, 11 cents per share, mainly from its legal battle with shareholder Ron Burkle’s investment company Yucaipa, the retailer said. Barnes & Noble said early this month it was “unable to conclude an agreement on mutually acceptable terms” with Yucaipa (CED Aug 13 p7), so the legal dispute between the companies continues.

But Q1 sales grew 21 percent to $1.4 billion. Online sales jumped 42 percent to $145 million, with comparable sales growing 53 percent. Barnes & Noble store sales dipped 2 percent to $1 billion, with comparable store sales down 0.9 percent, “slightly lower than” its projection, Lombardi said. Online gross margins were lower than last year for reasons including that last year’s results didn’t include sales of lower-margin Nooks, he said.

For Q2 ending Oct. 30, the company expects comparable store sales at Barnes & Noble stores will decrease 1-3 percent and it will report anywhere from a 25 cent loss to 5 cent gain in earnings per share, it said. It still expects comparable store sales at Barnes & Noble stores for the fiscal year to be flat to up 3 percent. But due to the “significant legal costs incurred” in Q1, “as well as anticipated future legal costs,” including those associated with its proxy battle, the company cut its fiscal year earnings forecast to a loss of 25-65 cents per share, it said. Excluding the legal costs, its estimate was “essentially unchanged,” calling for a loss of 0-40 cents, it said.