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Mark Bierley – CFO

Ron Marshall – CEO


Matt Fassler – Goldman Sachs

David Weiner – Deutsche Bank

Borders Group, Inc. (BGP) F4Q08 Earnings Call April 1, 2009 8:00 AM ET


(Operator Instructions) Welcome to the Borders Group, Inc. Fourth Quarter Full Year 2008 financial results conference call. I would like to turn the call over to Borders management.

Mark Bierley

This is Mark Bierley, Borders Group CFO. I’m here this morning with our CEO, Ron Marshall. Thanks for being with us on the call today.

Before we begin, I need to point out that this conference call includes forward looking statements. These statements, among others, include sales and earnings expectations and information related to corporate initiatives. Please refer to the news release issued last evening and our most recently filed 10-K for information related to forward looking statements, including factors that could cause actual results and plans to differ.

Now I’ll turn it over to Ron who will get started with today’s call.

Ron Marshall

When I joined Borders Group as CEO three months ago I came to the job fully appreciating the magnitude and the urgency of the financial and operational challenges that we face. At the same time I came in knowing just as surely that this company had a tremendous potential that can be unlocked once we overcome our challenges, that’s why I’m here.

Borders is focused on four priorities. First and foremost, getting our financial house in order. We’ve engaged in a dramatic financial transformation that will allow us first to survive and then later create meaningful shareholder value. Next, reengaging with our customers and reclaiming our status as the book seller for serious readers. Reaching out and making connections with our customers in their communities, developing impactful assortment plans, further leveraging our Borders Reward loyalty program, and creating an editorial voice for our customers.

Third, improving execution, in my opinion this is the heart of the performance gap between us and our competitors. After all we have the same products to sell so when you strip away all the other reasons and excuses it all boils down to execution. We need to do just about everything we do today from store service to IT to logistics better then we’ve been doing it, a lot better. We must establish the discipline to do it better consistently. Finally, addressing just intermediation in our industry, identifying and acting on our best opportunities as in music, DVD, even book categories face digital challenges.

Clearly the first priority, getting our financial house in order is where I’ve invested the majority of my time to date. I’m focused, along with Mark and others, on doing whatever is necessary to ensure that Borders has the financial runway to be successful, including improving cash flow. As noted in last evenings new release, operating cash flow improved at year end by approximately $129 million, driven by a $96.5 million reduction in SG&A and inventory reductions of nearly $327 million.

To drive even further inventory productivity our company recently implemented more frequent replenishment order cycles with publishers about three times faster then in the past, and with a far greater level of automated ordering. This means fewer out of stocks, faster response to sales trends, and more cash flow. The result will be increased sales, reduced returns, and other efficiencies that will translate to the bottom line.

As a result, debt reduction initiatives have been progressing well as we cut debt by over 39% or nearly $218 million in 2008. We’ll continue to pay down debt as we improve cash flow. All in all, we are doing whatever is necessary to get back on firm financial footing. That said we understand you can’t save your way to prosperity. We must sell our way to success. This is where our second and third priorities, reengaging our customers and improving execution come in.

As I told associates last week in a series of town hall sessions, I know from my personal experience working for competing book sellers years ago that Borders was once the envy of the industry. Borders brand connected to serious readers and held a coveted spot in the minds of heavy book buyers. Not for being the lowest cost retailer or the one that necessarily appealed to the masses, but for being the place real book people belong.

Borders is where they invested their time and their money. Our brand promise must recapture this. Each customer walks into one of our stores should leave the store feeling smarter then when she walked in. While these skills this is still very much within the DNA of Borders today. It may need to be reignited but the underlying talent is there and I believe we can reinvigorate it and recreate an organization committed to superior shareholder value.

Reaching out to our customers is essential in this regard. For the last couple of years our outreach has primarily been directed at our best customers. The nearly 32 million members of our Borders Rewards loyalty program increasingly we have relied on discount offers to entice them to shop and over time these offers have lost effectiveness. We are focused now on improving gross margins through being smarter and controlling promotional offers and in store discounts.

In fact, we did a test late last year removing many of the ongoing in store discounts in a control group of stores. Customers didn’t miss these discounts and we saw an appreciable up tick in margin. Now we’ve rolled this out to all stores and are pleased with the results. We’re also researching and experimenting with a variety of offer types and combinations of offers to be more effective and hit the right sales margin balance in our future promotional spending.

At the end of the day in today’s environment, its gross margin dollars that count. We’re doing more outreach, moving beyond preaching to the choir and working to attract new customers by reaching out to local literacy organizations, schools, children’s charities and the news media among others to drive more positive associations and exposure for our stores.

Further, as we continue to appropriately scale back our multimedia inventory we are freeing up space in our stores to expand and drive sales of certain categories that we know have more sales growth potential, these include children’s, cooking and wellness. We’re also launching a biography section this summer and are expanding book clubs both in store and online.

As we develop a sales driven organization we’re also focusing our store staff on key items and make books. Our buying teams discover and really get behind with the objective of making these house favorites national best sellers. Here’s an example, recently we designed Kelly Corrigan’s The Middle Place as a make book. This book did fine in hard cover but when our team saw Kelly’s viral video and taped an interview with here for online programming we knew that when the trade paper version of this title arrived we had a special opportunity to connect Kelly’s book with our customers.

In a relatively short period of time that we focused on this title, with content on our site, features on our weekly email short list and hand selling in our stores, this book went from not being listed on the New York Times Best Seller List to number two now. We had 59%, that’s 59%, market share on this title just last week.

This process works with new fiction hardcover releases as well. Our buyers decided to get behind debut author, Jamie Ford’s, Hotel on the Corner of Bitter and Sweet. Our store has been actively hand selling this title as one of our make books. These efforts have helped put this book on the New York Times Best Seller List at 15. Our market share of this title last week was over 55%.

In addition to getting behind these make books and key items, our booksellers are now much more focused on executing against new and measurable customer service standards that we’re initiating. Adherence to these standards will vastly improve the consistency of our in store customer experience. While that experience grows more enriching through sharing our editorial voice and recommendation with our customers.

Moving on to my fourth and final priority, I want to spend just a minute talking about this intermediation. We all know what’s happened to CD sales and now what is happening to DVD sales, as technology has removed the retailer as the middle man for these physical products. While I believe that books are different then music and movies in the sense that there’s a tactile and emotional element to them, digitization is having an effect on our industry as well and this impact will grow.

We have a long standing relationship with Sony, which includes selling the digital book reader in all of our stores and also includes co-branded e-bookstore online which now has an additional 500,000 free books available due to Sony’s recent alliance with Google. Our site will over time play an increasingly important role in supporting and sometimes leading our efforts to deliver content whether it is digital content or enriching exclusive video content that you find on our site now.

We believe that this exclusive content is some of the best stuff in the industry and is a distinguishing feature of our site and our brand. We have some work to do improving the operations of the site but I believe that will, in the future, be a core strategic asset of our company.

Although we see 2009 as a year of continued negative sales trends due to the economy, and we are managing our business accordingly, Borders certainly can and must do better on the sales line. The effort that I’ve described here today will be key.

Before I turn it over to Mark, I’ll close by saying that I’m confident that Borders will come through these challenging times and emerge on the other side a much stronger company. This turnaround will not be complete though until Borders makes that first buck and I’m committed to making sure that happens.

Mark Bierley

I want to start by addressing sales. Obviously, as Ron said, our sales performance must improve. Certainly the overall economic environment which has impacted nearly all retailers is a key factor, yet it’s not the only factor. Simply put, the gap between our comp store sales and the competition is too wide.

In the fourth quarter at Borders Superstores, comp store sales in books decline by 11.7%, an overall store comps declined by 15.3%. This result was driven to a large degree by a decline in comps with our multimedia category as we continue to implement a planned inventory and space reduction in our stores. By the end of the fourth quarter we have removed 29% of total multimedia inventory. This reduction, in addition to overall sales trends in these categories, drove comps for music that were down 36% and DVD comps that were down 39.7%.

While this inventory reduction contributed to negative comps within the multimedia category, it gives us the important opportunity to increase inventory and space devoted to growth categories such as children’s, cooking, bargain books, wellness and Paperchase. In fact, children’s had a positive 16.2% comp in the fourth quarter and Paperchase gifts and stationary had a positive 7.5% comp. We believe that expanding these growth categories as we contract others gives us the significant opportunity to increase sales and profit.

The comp decline of 4.7% at Waldens in the fourth quarter reflects the impact of continued store closures as we right size the chain to allow focus on our highest performing stores. While we’re focused on driving sales, we must do so profitably and therefore are aggressively addressing gross margins as well. Let me walk you through gross margins in some detail to point out where we made progress in the fourth quarter.

Superstore product margin improved by 80 basis points over last year due to product mix which shifted to higher margin categories such as bargain books, café, and Paperchase gifts and stationary. Promotional discounting improved by 80 basis points as well. We continue to evaluate our return on promotional programs and will maintain a focus on positive gross margin dollar promotions in 2009. Shrink improved by 40 basis points driven by improvements in café waste and the control actions implemented over the prior year to reduce DVD shrink.

These improvements were offset by a number of other factors; de-leveraging of occupancy with the current sales performance, higher capitalized inventory expenses due to our reductions in inventory, a decline in electronic gift card revenue, margin at that was not to plan, and the impact of discount promotions for store closures, primarily Waldens. These factors combined to offset the progress we made and resulted in a decreasing in gross margins of 280 basis points.

As Ron noted, we made significant progress on improving our overall cost structure in the fourth quarter. Operating SG&A was reduced by $52 million, driven by store payroll and store expense efficiency as well as reduced corporate overhead costs. Supply chain costs were reduced by over $5 million. For the year, SG&A costs declined by $96.5 million.

In addition to the work we did in 2008, we’ve identified an additional $70 million in new cost reductions and have already taken actions to realize these reductions in early 2009. From 2007 levels we’ve initiated over $210 million in total cost reductions.

Turning to our balance sheet, as our release last evening point out, we reduced inventory by $326.8 million, a 26.3% reduction. The major drivers are as follows: our total multimedia inventory was reduced by $68.3 million, our trade book inventory was reduced by $166.5 million realized from improvements and receipt of product returns, assortment work and ordering efficiency.

Inventory in our Waldenbooks specialty retail segment was reduced by $64.2 million due to store closures and supply chain improvements. Debt was reduced by $218 million, driven primarily by the cost reductions, the improvements in inventory, and the sale of our Asia/Pacific business. I want to note that we’re in compliance with all of our debt agreements as of year end 2008.

We significantly reduced capital spending in 2008 compared to the $131.3 million invested in 2007. For the full year 2008 CapEx was $79.9 million with $6.2 million of that in the fourth quarter. Our view as we begin 2009 is that we’ll continue to decrease capital spending and have very little committed capital for this year, which we view as prudent given the current economic environment and the projection of continued negative sales trends.

Before I close out remarks today I want to note that we provided a summary table of non-operating charges in our press release last evening. These charges were primarily non-cash and totaled $34.9 million in the fourth quarter and $168.5 million for the full year.

Overall I want to close by stressing again that our management team remains keenly focused on driving sales, maximizing cash flow and improving the profitability of our business even in the face of a weak consumer environment.

Now Ron and I will open it up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Matt Fassler – Goldman Sachs

Matt Fassler – Goldman Sachs

As you look at the drags on gross margin, the offsets to the progress that you made, I presume that you delivered them in the order of their impact but if you could quantify in particular the impact of occupancy de-leverage on gross margin that’d be very helpful.

Mark Bierley

Occupancy de-leverage was a little bit north of 100 basis points in the fourth quarter.

Matt Fassler – Goldman Sachs

On the promotional front, as you look at your revenues and you look at your grosses, clearly you’re doing some things differently. Could you go into some more detail on some of the steps you’re taking to presumably drive gross profit dollars through that effort and just give us a sense as to how far along you are on those efforts? In other words, at what point do you cycle some of the things that you’ve already started to do.

Mark Bierley

Ron described it well. In the fourth quarter, I think we talked about this at the end of our third quarter, we launched a series of stepping back and looking at some of those in store promotions that we’ve run over a number of years and really tested out what that return on investment was. We literally went table by table through the store and were able to determine, basically the return characteristics of each of these promotions. As Ron said, we like the results; we saw a nice bump in overall gross margins. We executed that at the end of January after we saw a good amount of results come through the fourth quarter.

It really is all about the next significant investment that we’ve made in terms of promotional discounting which is our Rewards program. I’ll let Ron talk a little bit about that as well. I would tell you that that is an area that we’re going to continue to look at in terms of a couple key things. One, the way in which we communicate with those segments of customers. We have 18 segments and we want to get to being able to communicate more on the content side, talk about authors that they may like as well as other value or content messages versus just a discount. I would say that that is probably the single largest next opportunity that we’re focused on.

Matt Fassler – Goldman Sachs

Would that involve potentially pulling back on the magnitude of the discount that you’re currently offering through the program?

Ron Marshall

No, not necessarily. Promotional spending and discounting is important but you need to do it with a plan. Mark did a really good job of describing the factors that go into developing that plan. If we have in store activities where we need to drive traffic that’s a perfect opportunity. We had an example last week where we had three in store promotions going; one in the multimedia side, one in bargain books, and one in the traditional trade book category. We used a deep in store discount to drive traffic and we had a phenomenal week. It has to be done with a well coordinated plan.

In terms of cycling, this year is a totally clean comparison till you get to probably the middle of period 12, the middle of January is when we start cycling the stuff.

Matt Fassler – Goldman Sachs

The $96.5 million of SG&A reduction does that include the reduction associated with the sale of international or that only for businesses that you continue to operate.

Mark Bierley

Those are continued owned and operated businesses.

Matt Fassler – Goldman Sachs

On your debt situation you said you’re in compliance with all of your covenants and debt agreements. Your debt is down quite dramatically, Persian continues to roll and extend its $42.5 million loan to you. It would seem like that those monies are relatively modest from the context of your broader debt reduction yet from the constant rolling of that paper it almost seems as if it’s quite important for your liquidity. Can you help put that in some context? Understanding that money is scarce these days in general is that loan decisive for your solvency at this point?

Ron Marshall

I think you hit on the key point. In today’s environment we need to keep access with the liquidity pool that we have. I think it’s really in that context more than anything else.

Matt Fassler – Goldman Sachs

Is that $42.5 million is not essentially your margin of liquidity right now, it’s not in its entirety what’s keeping you liquid?

Ron Marshall

I think that’s right.


Your next question comes from David Weiner – Deutsche Bank

David Weiner – Deutsche Bank

You had mentioned incremental cost reductions of $70 million for 2009. Can you quantify what are the total amount of cost reductions you have planned for 2009, is it the $70 million or are there others as well?

Mark Bierley

What you’ll have is the carry over of the cost reductions that we put in place last year so that helps cost structure. We identified $140 million on an annualized basis last year. The $70 million of new cost reductions really two large buckets; one relates to store costs, store payroll, store expenses and the other relates to corporate overhead costs.

As we’ve simplified the business over the last couple years we talked about the fact that we’re going to be smart with capital. It allows us to really focus on the investments we’ve already made so it allows us to really simplify things here both in Ann Arbor but also the inventory, the supply chain work allows us to take some non-customer facing costs out of the system. We have initiated these cost reductions, you’ve seen us do these press releases over the last few weeks and we’re very confident that we’re going to deliver those reductions based on the efficiencies we put to work.

Ron Marshall

What’s important is while I don’t think that we’re going to have another grand announcement on cost reductions this year. I think what you will see and what we’ll be able to talk about as the quarters click off is a continual improvement in some of our core processes. One of the things we’ve talked a lot about is reducing cycle times inside our organization.

A really good example is we used to order from most of our large vendors once every 12 weeks, essentially once a quarter. We’ve already compressed that cycle time from 12 weeks to four weeks. Four weeks isn’t the right number, its either two weeks or one week but four weeks is a lot easier and a lot better to deal with then 12.

As we do that the ability to take additional inventory add as we compress safety stock and obviously it’s easier to forecast four weeks out then 12 weeks out. You’ll see some inventory improvements but you’ll also see some operating cost improvements as we’re only handling the product once rather than two or three times.

David Weiner – Deutsche Bank

On your leases, can you comment a little bit on what your strategy is there on going back to your landlords and trying to renegotiate terms if that’s possible or exit leases of underperforming stores. I guess this would be for both the Superstores and Walden. I looked at your K this morning; it looks like for Walden very significant number of stores, the leases for those stores expire within the next year. What’s the plan for Walden as a concept?

Ron Marshall

We’re having some really productive conversations with all of our constituencies but particularly the landlords. You’re right; we have a lot of flexibility in the Walden business right now. What I can tell you is that we are making unemotional business decisions about our entire store base as we go forward and as things occur and develop we’ll let you know.

David Weiner – Deutsche Bank

Forgetting about the leases for a second, but just as a concept overall Walden its one that I guess you’re sticking with as a segment of your business?

Ron Marshall

Obviously once upon a time there were 1,200 Walden stores. A strategic decision was made at some point to begin to exit that business. The mall based business just because of the dynamics of book discounting and the size of the stores and the inability to margin out over a large assortment it’s not a particularly attractive business.

There are Walden stores that are very profitable for us. We have north of 300 stores today. As you look at this business we’ll be somewhere between zero and 300 and probably closer to 50 or 60 range as we really focus on the stores that are long term keepers for us. It’s a tactical asset for the company right now and we want to make sure we utilize it properly.

David Weiner – Deutsche Bank

Obviously you’ve been cutting inventories pretty substantially. Can you talk about what impact that has on your credit line availability, I think your total line is over a billion dollars but as you cut inventories how does this impact the amount that maybe you can actually borrow?

Mark Bierley

I think the key thing here is we look at the productivity of the inventory. If we’re taking inventory out we’re taking out inventory that quite frankly we own. So it allows us to recapture cash flow and improve our overall liquidity position. What we’re doing with inventory and Ron described it as getting smarter in terms of the replenishment, how frequently we order, how we order our front list.

We’ve sped up our return channel back through the returns process from our stores this year. Quite frankly just getting to a point where you’re improving the overall optimization of that inventory and quite frankly good things come from that in the cash flow and the liquidity standpoint.


At this time we have no further questions.

Ron Marshall

Thank all of you for being on the call with us today. Our next scheduled news release will be our first quarter results toward the end of May. Thanks a lot.

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