Another Lawsuit Highlights Trouble for Barnes & Noble

Source: Wikimedia Commons

Should lack of integrity by management curtail an investment in a company's stock? Barnes & Noble (NYSE: BKS) recently received another class action lawsuit case; this time related to the manipulation of financial statements. The hardship Barnes & Noble has faced in recent years makes it a dangerous investment, especially as it has incurred negative operating margins for the past three fiscal years. However should the retailer turn itself around it could make a fantastic investment so, naturally, Foolish investors would be wise to look closely at the troubled book retailer. Of particular interest for investors is this latest lawsuit and the company's competitive position. 

Recent lawsuit & SEC
Recently, Levi & Korsinsky LLP, a law firm with expertise in prosecuting securities litigation involving financial fraud announced a class action lawsuit against Barnes & Noble. The case alleges that Barnes and Noble misrepresented and/or failed to disclose that Nook e-reader sales had drastically declined, Nook manufacturing ceased to continue, and inventory realting to the Nook was overstated by $133 million.

This recent lawsuit is in addition to a Securities and Exchange Commission (SEC) investigation into Barnes & Noble begun on October 16, 2013. The SEC claimed they were looking into an allegation by a former employee that expenses between Nook and Retail segments were improperly allocated.

 

Fraud triangle
Financial fraud by companies typically have three characteristics, which are incentives or pressures, opportunity through poor internal controls, and rationalization to get through a difficult time. Each of these factors exist within Barnes and Noble. It has publicly stated the existence of poor material internal controls. The pressure from competition has certainly made recent years difficult for Barnes & Noble. Barnes & Noble's "Executive Performance Plan" and "2009 restated incentive plan" might provide a clearer picture of why management would prolonge bad results and delay its public filings.

Sales decline by segment
The Nook segment has raised the majority of concern. The most recent quarterly statement filed in December 2013 displayed segmented sales.

 

26 weeks ended

 
 

October, 2012

October, 2013

 % Change

 

B&N Retail

 $2,115,415

 $1,929,225

-10%

 

B&N College

$993,725

 $963,555

-3%

NOOK

 $352,322

 $261,870

-35%

Elimination

 $(123,423)

 $(90,989)

-36%

       

Total

 $3,338,039

 $3,063,661

-9%

Source: Barnes & Noble SEC Filings

The Nook featured segment sales fell 35% from the prior year in the 26-week period. The decrease of retail and college segments are also concerning. How will the company report results in future periods if the slide continues?

Competition
Barnes & Noble's sales have been sliding due to the competitive landscape-particularly competitition from the likes of Amazon.com (NASDAQ: AMZN). Amazons' easy to use platform has driven many customers away from stores such as Barnes & Noble. Interestingly, while Barnes and Noble's NOOK and retail segments decreased 35% and 10%, Amazon's North American electronics and general merchandise increased 29%. There seems to be no slowing down of this trend.

Earnings
Barnes & Noble's earnings have also taken a hit in recent years. The competitive pressure from Amazon has hurt the company's margins. Barnes and Noble had an operating profit margin of 5% back in 2005, but has suffered operating losses over the past 3 years. The company is clearly having a hard time keeping it's head above water.

Foolish investment
The declining performance and potential of future accounting shenanigans cannot be ignored. Given the volume of lawsuits Barnes & Noble is currently involved in, it appears unlikely that the culture will change. This lack of confidence, mixed with a business model that has been squeezed by innovative competitors makes Barnes & Noble a poor investment choice for even the most venturesome investors.

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