Barnes & Noble Banking on Microsoft Deal For Its Digital Content Share

Barnes & Noble holds 25-30 percent of the digital book market in the U.S., CEO William Lynch said on a fiscal Q4 earnings call Tuesday, as the company prepares for international expansion fueled by the company’s partnership with Microsoft. A major goal of the company is to “quickly increase content sales” while “sustaining or expanding” on its plus-30-percent gross margins in digital content, a formula that’s “key to scaling our digital business to profitability,” Lynch said. The company’s net loss for the fiscal year narrowed 7 percent to $68.9 million, it said.

Barnes & Noble is finalizing plans to go international this year, Lynch said, noting that Western Europe, led by the U.K., is two years “at least” behind the U.S. in e-book penetration. In large markets including Germany, e-books “haven’t taken hold at all,” he said, and Asia “is even more nascent than that.” He said Barnes & Noble is committed to providing content and digital bookstore services in the Windows 8 platform to 10 markets within the next year and then expanding beyond that.

Commenting on Microsoft’s tablet plans announced Monday, Lynch said Barnes & Noble is developing a Nook application that’s “deeply integrated” into Windows 8. He didn’t discuss Microsoft’s surface as a potential competitor to Nook Color. Assuming the Microsoft relationship produces the expected results, Barnes & Noble plans to “grow its digital content sales through the Windows 8 platform,” Lynch said.

Nook device sales were up 45 percent for fiscal 2012 but dropped in Q4 over Q4 2011 due to higher third-party channel partner returns, lower selling volume and lower average selling prices, the company said in a statement. In order to “optimize the supply chain for new products,” namely the Simple Touch with GlowLight, Barnes & Noble took back Simple Touch inventory following a shortfall in holiday season sales, Lynch said. Barnes & Noble expected the sub-$100 price point reader to “do better than it did, so Q4 was a bit of taking our medicine in terms of taking back channel stock,” he said. Digital content sales from third-party devices and from the Web increased during the year as a percentage of overall digital content sales, but Barnes & Noble is still relying on Nook device sales to drive “a significant part of the digital content business,” Lynch said.

On flatter hardware sales, Lynch said, “there’s no question we saw a slight deceleration in e-book growth in the market.” “We maintained or slightly grew share” following the holiday season, he said. The company grew digital content sales 65 percent in Q4, Lynch said, but on a larger base as the digital content world grows.

Barnes & Noble’s partnership with Microsoft, a subsidiary called Newco, will help fuel digital growth and international expansion, Lynch said, citing Microsoft’s initial $300 million investment in Newco when the deal closes in the fall. Under the agreement, Barnes & Noble will own 82.4 percent and Microsoft 17.6 percent of Newco, which will include Nook and college market businesses, said Barnes & Noble Chief Financial Officer Michael Huseby. Under a separate commercial agreement, Microsoft will make additional payments of $305 million to Newco, including $60 million annually for the first three years in the form of revenue-sharing advance payments and $25 million each of the first five years for assisting Newco in acquiring local digital content and technology development, Huseby said. The partnership will provide distribution for Nook technology and the availability of the Nook bookstore on “tens of millions of mobile screens worldwide” through Windows 8, Lynch said. Regarding the possibility of other investors in Newco, Lynch wouldn’t comment on specific partners “we may or not be looking at,” he said.

For fiscal 2013, Barnes & Noble expects retail comp bookstore sales to decrease by a low to mid single-digit percentage as the company cycles against the bump from increased traffic from Borders store closings, Huseby said. The Borders sales lift “exceeded our expectations,” he said, but the boost in 2013 from Borders business is expected to be less than what was expected for 2012, he said.

While Barnes & Noble stores showed a bump in sales -- 4.5 percent in comparable store sales for the quarter and 1.4 percent for the year -- due largely to the addition of former Borders locations and customers, the company continues to see digital content as the future, Lynch said. The company opened no new retail stores for the quarter and closed 14, said Huseby, and plans to open five and close 15 in fiscal 2013. Regarding Nook’s effect on in-store traffic, Lynch said having stores for consumers who purchase Nook devices online, or at Target, Best Buy or Walmart stores, is the company’s “number-one competitive advantage.” Customers come in and buy accessories and coffee, making it “the” symbiotic relationship between the divisions, he said.

BN.com sales continued to decline for the quarter as well as the fiscal year, the company said, while Nook content sales grew 65 percent for the quarter and 119 percent year over year, totaling $483 million for fiscal 2012, the company said. Consolidated sales for the year inched up 2 percent to $7.1 billion, Lynch said. Barnes & Noble shares closed down 4 percent Tuesday to $14.63.