Wednesday, April 25, 2007

Books-A-Million: Overdue for a Stumble?

For the quarter ending Feb. 3, Books-A-Million (BAMM-$17.40), which operates 206 retail bookstores concentrated primarily in the southeastern United States, said its net income grew to $15.1 million, or 90 cents per share, from $11.2 million, or 66 cents per share, in the prior-year quarter.

Sales increased to $174.6 million from $161.1 million.

On April 2, 2007, shares of the bookseller were up $3.32, closing at $17.49 in afternoon trading on the Nasdaq, their largest intra-day percentage gain since mid-2005.

For fiscal 2007, BAMM’s profit rose 45 percent to $18.9 million, or $1.12 per share, from $13.1 million, or 77 cents per share, in fiscal 2006. Revenue climbed 3 percent to $520.4 million from $503.8 million in the prior year.

Comparable store sales for the 52-week period ended January 27, 2007, decreased 0.6% when compared to the same 52-week period last year. The decrease in comparable store sales was primarily attributable to a decrease in magazines sales and café sales, with book and gift sales primarily flat with the previous year.

In a conference call with analysts, Chief Financial Officer Douglas Markham said the same-store sales decline was also due to the lack of a major book-related movie tie-in and an absence of strong nonfiction bestsellers. Offsetting the same-store sales decline, however, were better inventory management and discipline in cost controls.

Improved inventory management resulted in a decrease in inventory balances to $200.3 million at February 3, 2007, as compared to $204.8 million at January 28, 2006. Management said that the improvement in inventory management was driven by enhancements to the inventory replenishment systems, which allowed the Company to more effectively manage inventory levels at the individual store level.

Inventory turnover improved slightly in fiscal 2007, tallied at 1.75 times a year, up from 1.69 times in the prior year. Inventory efficiency, however, still fell short of competitors, Barnes & Noble (BKS) and Borders Group (BGP): 2.7 times and 2.1 times, respectively.

BAMM’s growth strategy is predicated on opening superstores in new and existing market areas, particularly in the Southeast. In general, stores are located on major high-traffic roads convenient to customers and have adequate parking.

In addition to opening new stores, management is constantly reviewing the profitability trends and prospects of existing stores, with an eye towards closing or relocating under-performing locations. Net store openings during fiscal 2007 and fiscal 2006 were one store and (loss of) one store, respectively.

For fiscal 2008, the Company currently expects to open approximately eight to ten new stores, relocate or remodel approximately five to ten stores and close approximately one to two stores.

BAMM’s store expansion plans imply confidence on management’s part that same-store revenue growth will rebound in fiscal 2008. This has not been lost on the investing public, who have pumped the book retailer’s share price up more than 31 percent in the last 52-weeks.

Of interest, management does not disclose its sales per square footage numbers.

In of itself, BAMM’s growth strategy is a little weak in the ‘book’s binding: (1) the industry is highly competitive and competitors include book retailers (Barnes and Noble, Inc., Borders Group, Inc.), mass merchandisers (such as Wal-Mart and Costco), and online retailers (Amazon); and, (2) if—as we suspect, consumer spending slows in the 2H:07, shareholders could be in for a nasty earnings surprise—to the downside!

The 10Q Detective postulates, too, that the reported earnings do not accurately reflect the Company’s true financial performance.

We have several concerns regarding the quality of BAMM’s sales/earnings. In our view, growth is actually being driven by artificial and/or temporary sources.

1) The Company sells gift cards to its customers in its retail stores. Historical redemption patterns show that the likelihood of a gift card remaining unredeemed (gift card breakage) is determined to be after 24 months of card inactivity. At that time, breakage income is recognized for those cards for which the likelihood of redemption is deemed to be remote.

During fiscal 2007, the Company recognized $3.2 million of gift card breakage income. This gift card breakage income is included in revenue, too.

The 10Q Detective calculated that gift card breakage represented 20 percent of the reported three percent rise in net sales for fiscal 2007. In addition, our analysis shows that the gift card windfall added 1.5 million in net income, or 9 cents per share, to EPS last year!

2) Related Party Transactions. The Company sold books to Anderson Media Corp. in the amounts of $2.43 million in fiscal 2006, up from $1.02 million and $115,000 in fiscal 2006 and 2005, respectively. Clyde B. Anderson, Executive Chairman of BAMM—and other members of the Anderson family (who collectively own 48.2 percent of the common stock of BAMM)--control Anderson Media. While the amount is relatively small, the influence the Anderson family has over sales and purchases to related parties raises a red flag with respect to quality of earnings and corporate governance.

3) The fourth-quarter of fiscal 2007 included an extra week of sales. Management said on its conference call that it “didn’t capture the number.” Nonetheless, the 10Q Detective estimates that the extra week added 6 cents to the bottom line.

4) In fiscal 2007, aided by a lower state tax rate, BAMM’s effective rate for income tax purposes dropped to 37.0 percent, down from 39.6% for fiscal 2006. We believe the lower overall tax rate added 4 cents to earnings.

We have identified several items that aided operating results in fiscal 2007. Via our modeling estimates—without the 19 cents boost from one-time windfalls—share-net in fiscal 2007 would have risen 20.7 percent.

Visibility remains low, dampened by a less than favorable consumer-spending environment. In our view, competitive pressures are many and potential for a downward revision in sales growth is high. Some investors maybe attracted to the stock’s 2.1% dividend yield, but we prefer to stay on the sidelines.

Editor David J. Phillips does not hold a financial interest in any of the stocks mentioned in this article. The 10Q Detective has a Full Disclosure policy.

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