Updated: B&N’s Digital Sales Up, Can’t Compensate For Falling Store Sales

Barnes & Noble’s digital sales continue to increase–but not enough to make up for falling in-store sales, the company announced in its Q1 2012 earnings report this morning.

First, the good news: BN.com (NYSE: BKS) sales are up 37 percent compared to Q1 2011, hitting $198 million in this quarter. The company attributes that success to the Nook. Digital content sales have quadrupled over this time last year. In an investor call following the company’s previous earnings report in June, Barnes & Noble CEO William Lynch said that the Nook now has about 27 percent market share, and will probably announce an updated figure in the conference call following today’s report. (Update: Nook market share is still around 26 to 27 percent, Lynch said today’s call.)

Nook business across all the company’s segments, including sales of digital content, device hardware and related accessories, increased 140 percent, to $277 million. The company expects that business to double this year, to $1.8 billion from $880 million last year.

In-Store Sales Not So Hot–Not A Problem, Company Says

Sales in Barnes & Noble’s roughly 700 brick-and-mortar stores fell 3 percent this quarter, to $1 billion, and were flat compared to this time last year. “While traditional physical book sales declined during the quarter, the stores posted large increases in sales of the NOOK product line and Toys & Games,” the company said in its release. As in the last quarter, decreased store sales could be partly due to competition from liquidating Borders stores. (The company expects store sales to rise again as Borders stores complete the liquidation process.)

Barnes & Noble has attempted to lure shoppers into its stores by selling more games and and toys. In June, it announced that its stores were the first official Rovio Angry Birds “Magic Places.” Nook Color users who owned the $2.99 Angry Birds Nook app could visit any physical B&N store to add the new “Mighty Eagle” character to their game for free. In the investor call, Lynch

B&N attributed decreased in-store sales to its ongoing strategy to expand the digital side: “Our strategy of growing market share in the exploding digital content business while maximizing cash flow and EBITDA from our retail operations is paying off,” Lynch said in the release. “We plan to continue investing in the significant growth areas of our business, and in fiscal 2012, we expect to see leverage as our digital sales growth is projected to exceed the growth of investment spend. Additionally, the return on investment is expected to increase in future years, as readers purchase increasing amounts of digital content on the platform we have built.”

Agency Pricing: A Weapon Against Amazon

The agency pricing model for e-books, in which book publishers set the retail price and retailers take a commission, is working well for Barnes & Noble: Amazon now can’t undercut it on e-books from the “big 6” publishers, all of whom use the agency model. (And are being sued for it.) “We think agency is going to take hold as the dominant form of pricing for e-books going forward. It makes a lot of sense for a lot of reasons,” Lynch said in an investor call this morning. “Clearly, agency expands our gross margins.”

Going Forward

Following the release of the earnings report, Barnes & Noble stock is up by about 10 percent. In a note to investors, Standard & Poors retail analyst Michael Souers recommended a hold on stock: “While we think growth will improve over the remainder of FY 12 given the liquidation of Borders stores, we believe long-term growth prospects remain lackluster.”

Earlier this summer, *Liberty Media* expressed interest in buying about 70 percent of the company for about $1 billion. Liberty CEO John Malone said he was betting on the fact that B&N could become a major competitor to Apple (NSDQ: AAPL) and Amazon (NSDQ: AMZN). The ultimate deal, though, fell far shy of a billion-dollar buyout: Earlier this month Liberty made a strategic investment of $204 million in the company, becoming its third largest shareholder.