Barnes and Noble 2015 Annual Report Download - page 57

The commercial agreement provided for revenue sharing
for digital content purchased from the LLC by customers
using the LLC’s Windows  applications. Microsoft has
made and was obligated to continue to make guaranteed
advance payments to the LLC in connection with such
revenue sharing equal to , per year. Microsoft
also has paid and was obligated to continue to pay to the
LLC , each year for purposes of assisting the LLC
in acquiring local digital reading content and technology
development in the performance of the LLC’s obligations
under the commercial agreement.
The guaranteed advance payments in connection with rev-
enue sharing as well as the amounts received for purposes
of assisting the LLC in acquiring local digital reading con-
tent and technology development received from Microsoft
were treated as debt in accordance with ASC ---,
Sales of Future Revenues or Various Other Measures of Income.
The Company estimated the cash flows associated with
the commercial agreement and amortized the discount on
the debt to interest expense over the term of the agree-
ment in accordance with ASC ---, The Interest
Method. Upon termination of this agreement, the Company
has accounted for this transaction in accordance with
several accounting codifications covering this topic that
require transactions with related parties to be accounted
for as equity transactions and accordingly the remaining
debt balance of , included within other long-term
liabilities was converted to equity. Notwithstanding this
treatment, the limited liability company agreement of the
LLC provides that, under certain conditions, partnership
losses or deductions can be allocated for income tax pur-
poses to Microsoft in respect of amounts advanced to the
LLC under the terms of the commercial agreement.
Settlement and License Agreement
The patent agreement provided for Microsoft and its
subsidiaries to license to the Company and its affili-
ates certain intellectual property in exchange for royalty
payments based on sales of certain devices. Additionally,
the Company and Microsoft dismissed certain outstand-
ing patent litigation between the Company, Microsoft and
their respective affiliates in accordance with the settlement
and license agreement. The Company recorded the royalty
expense on NOOK® sales in the statement of operations in
cost of sales and occupancy with no expense or liability for
the sale of devices prior to this agreement.
12. PEARSON
On December , , the LLC entered into an agree-
ment with a subsidiary of Pearson plc (Pearson) to make
a strategic investment in the LLC. That transaction closed
on January , , and Pearson invested approximately
, of cash in the LLC in exchange for preferred
membership interests representing a  equity stake in
the LLC. Following the closing of the transaction, Barnes
& Noble owned approximately . of the LLC and
Microsoft owned approximately .. The preferred
membership interests had a liquidation preference equal
to the original investment. In addition, the LLC granted
warrants to Pearson to purchase up to an additional  of
the LLC under certain conditions. Upon the completion of
the acquisition of Pearson’s interest in the LLC, as stated
below, the temporary equity was converted to permanent
equity.
The fair value of the preferred membership interests war-
rant liability was calculated using the Monte Carlo simula-
tion approach.
This methodology values financial instruments whose
value is dependent on an underlying total equity value
by sampling random paths for the total equity value. The
assumptions that are analyzed and incorporated into the
model include closing date, valuation date, sales price of
the preferred membership interests and warrants, warrant
expiration date, time to liquidity event, risk-free rate, vola-
tility, various correlations and the probability of meeting
the net sales target. Based on Barnes & Nobles’ analysis, the
total fair value of preferred membership interests warrants
as of the valuation date was , and was recorded as a
noncurrent asset and a long-term liability. During the 
weeks ended January , , management determined
that the probability of meeting the net sales target by the
warrant measurement date was remote and fully wrote
down the value of the warrant accordingly.
At closing, the LLC and Pearson entered into a commercial
agreement with respect to distributing Pearson content in
connection with this strategic investment. On December
, , the LLC entered into an amendment to the com-
mercial agreement that extends the term of the agreement
and the timing of the measurement period to meet certain
revenue share milestones.
On December , , Barnes & Noble entered into a
Purchase Agreement (the Pearson Purchase Agreement)
among Barnes & Noble, Barnes & Noble Education, NOOK
Media Member Two LLC, a Delaware limited liability
2015 Annual Report 55