Borders Group, Inc. Q2 2009 Earnings Call Transcript

| About: Borders Group, (BGPIQ)

Borders Group, Inc. (BGP) Q2 2009 Earnings Call August 25, 2009 10:00 AM ET


Ron Marshall – President, Chief Executive Officer

Mark Bierley – Chief Financial Officer


Matthew Fassler – Goldman Sachs


(Operator Instructions) I would now like to introduce your host for today's call, Mark Bierley.

Mark Bierley

Good morning. I'm here today with our CEO Ron Marshall. Thanks for being with us on the call today.

Before we begin, I need to point out that this call may include forward-looking statements. These statements among others may include sales and earnings expectations and information related to corporate initiatives. Please refer to the news release issued earlier this morning 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. With that, I'll turn it over to Ron to begin.

Ron Marshall

Good morning everyone. Turn around's are often described as marathons. Now I've done my share of distance running in the past and I can more than identify with that; but I have to tell you that in the second quarter, Border's has done a flat out sprint as we've worked to get our stores in the best shape possible to drive sales in the back half of the year.

We executed on an aggressive set of initiatives to reset virtually every one of our stores. I'm proud of what we've accomplished in a short period of time. Now having said that, the second quarter was as anticipated, a challenging one. Like more retailers, we face difficult comparisons in Q2 and the overall consumer environment remains weak. But everyone in retail today is navigating the same waters, so we'll continue to deal with our reality and move on.

We talked in the past about the secular and cultural challenges specific to Borders. In the second quarter we faced head on these challenges and the opportunities they create. We recognized clearly that certain categories in our stores, music, DVD and newsstand for example, have been hard hit. We accept what these businesses are today and have shifted our strategic approach to leveraging them for profitability.

In the second quarter we took several significant steps to execute that strategy. Our multi-media business, music and DVD, we dramatically reduced store inventory by $150 million of retail which is approximately 50% less than last year. We moved out unproductive inventory through heavy promotional discounting. We pulled fixtures out of stores and totally transformed this category.

Now we are in the process of implementing what we believe is the right multi-media assortment for our stores and will merchandise the category appropriately.

While we are properly positioning these businesses, we have others that are profoundly under developed, and therefore hold potential for growth. We've expanded these categories into the space formerly occupied by multi-media. For example, we've completely revamped our children's section, increasing square footage by 20%.

We moved independent reader out of children's section and vastly expanded our toys and games offering. In fact, we almost doubled our SKU count in toys and games with a focus on educational, creative and imagination sparking items from leading brands such as Lego, Play mobile, Alex, Scientific Explorer, and others that complement our children's book offering which we've also expanded.

We fitted this transformation to teams developing a Borders Inc. store within a store, stocked with young adult titles, graphic novels and related non book items. We're actively using social media and unique in-store events as part of our outreach to teens.

Paperchase, gifts and stationery also represents opportunity for us in a couple of ways. First, we have the prospect of expanding the store base. We currently have Paperchase shops in over 335 of our Borders Stores with the possibility of expanding the store network by another 150 shops.

Second, we have the opportunity to more closely align these shops with how they operate in Europe where Paperchase is a highly successful brand. In fact, at our PentPlaza store in New York, we're in the process of recreating the new K model as a pilot project. We'll see how it goes and if it offers the advantages we expect, we'll move quickly to expand this approach. is another business ready for growth. We talked in the past about execution issues that have hampered the site's performance. We have focused on remediating these issues and continue to see improvement in performance against industry standards.

We've also worked hard to revitalize our café operations. The category is now making a positive contribution to the business after years of losses. There is still more to leverage here. And finally, we're addressing the opportunity we have to build up our bargain business.

Everything we did in the second quarter to address these opportunities and challenges was absolutely necessary, but disrupted our stores as we moved categories, expanded sections, shipped out fixtures and replaced inventory.

All of this activity, which also by the way included adding biography sections to all of our stores and simplifying categories to make them easier to shop, is largely behind us now. Still, in Q2, the disruption had an impact on sales. It's difficult to quantify the impact, but it was a factor.

I mentioned at the top of the call that we have cultural issues to fix as well. I've been forthright in saying since I arrived that we need to shift to a much more customer centric culture and must executive better and more consistently. Flawless execution must become a way of life at Borders. In fact, we recently made several leadership changes to drive improved execution.

We changed three out of four vice presidents in the field, putting in place demonstrated leaders with strong retail operations. We named a new Chief Information Officer, Scott Laverty to make strategic improvements in our corporate, on-line and in-store systems.

We appointed a new Senior Vice President of Marketing, [Art Keeney] to put much needed processes in place within marketing and develop effective strategies that maximize our brand as well as relationships with our vendor base and other allies.

We added 27 year publishing veteran, Larry Norton as Senior Vice President of Merchandising and Distribution and we organized our Paperchase U.S. leadership team, appointing a new Vice President of Operations to align much more closely with the successful U.K. business.

In addition, we very recently began working with an outside firm that has helped many national companies in the consumer sector to train, motivate and align the organizations are flawless execution. Overall, our goal has been to get the necessary changes behind us so that Borders is truly ready for business this upcoming holiday season.

It's important to note that even with our repositioning in Q2; we did not take our eye off the ball when it came to strengthening our financial foundation. We maintained discipline and exceeded our internal targets for EBITDA generating positive adjusted EBITDA in a highly negative sales environment. We generated positive cash flow and improved free cash flow. We reduced debt, detracted inventory, further reduced SG&A expenses and tightly managed working capital.

Today we continue to be focused on making progress against our four strategic priorities; getting our financial house in order, re-engaging with customers, improving execution and addressed this remediation in our industry.

We're looking forward to an improved second half as we have put the very necessary but highly disruptive work behind us. The important thing is that our stores today are better positioned now than they were a year ago to drive sales in the critical quarters to come.

And with that, I'll turn it over to Mark.

Mark Bierley

As reported, in the second quarter Border's Superstores, comp store sales declined by 17.9%. The differential in our result compared to others who recently reported is due to these four factors; the effect of our multi-media changes, inventory reduction, category issues and execution. All of these issues have been addressed with the actions taken in the second quarter and we expect to see the differential narrow in coming quarters.

I'll address multi-media first as this was the most significant impact in the comp differential. In the second quarter music comps were down 51% and DVD comps were down 48%. In fact, excluding multi-media, Border's Superstore comps declined by 13%.

The good news is that we've made the right strategic moves in this category as Ron explained and multi-media now represents just 8% of our sales mix compared to 2002 when the category was at its peak of over 23% of sales. This business has been rationalized and will continue to focus on increasing gross margin going forward.

Inventory reduction was another factor. Overall inventory is down 18.5% or $201.3 million compared to last year. Of that reduction, $57.3 million is in multi-media and $41.7 million is related to Waldenbooks store closures. The balance involves the trade book inventory at Borders which in past quarters we reduced too far. That said, we've been thoughtfully restoring our in-stock position to improve sales in this core category moving forward.

As far as categorical issues, we did the necessary but disruptive work in our stores to better position borders for the back half of the year. A few categories suffered in that transition including biography. As Ron mentioned, we made biography its own section in our stores and as we did the physical repositioning, the category took a sales hit.

In addition, we experienced weakness in our bargain category, but with our changes in multi-media, we now have the floor space to expand this offering which is critical given customer trends towards value items.

The last piece of our comp differential is pure and simple execution. As Ron said, we're highly focused on driving a more customer centric culture in our stores and are committed to flawless execution. To support this commitment, we made leadership changes, have introduced programs in the field and are engaged in an internal campaign now to drive improved execution.

Of course as we adjust the need to drive sales across our business, we're also aggressively working to improve our gross margins. We made progress once again in the second quarter as Superstore product margin improved by 50 basis points over last year due to product mix. Mix continues to shift to higher margin categories such as Bargain, Café and Paperchase with less of the mix coming from multi-media which carries our lowest initial mark up. However, these improvements were offset by 160 basis points resulting from de-leveraging in our occupancy.

As Ron noted, we made significant progress in improving our overall cost structure in the second quarter. Operating SG&A was reduced by $35.8 million driven by store payroll and store expense efficiencies as well as reduced corporate overhead costs. Supply chain costs were reduced by $4.7 million.

We continue to be on plan to realize $120 million of expected overhead and supply chain cost savings for 2009.

Debt net of cash was reduced by $40.1 million from 2008 year end levels, driven primarily by cost reductions, inventory improvements and prudent use of capital. It's worth pointing out that we're going into the back half of 2009 with $179.3 million less debt net of cash than this time one year ago. I also want to note that we're in compliance with our debt agreements as of the second quarter 2009.

We significantly reduced capital spending in the second quarter to $2 million compared to $27.1 million invested in the second quarter of 2008. On a year to date basis, our 2009 capital spend is at $4.4 million versus $54.1 million last year.

Our view for 2009 is that we'll continue to be prudent with our capital spend; however we will make appropriate investments in the stores in the back half of this year to ensure that we're in good shape for our customers.

Specifically, we're adding additional soft seating and display tables to our stores to better present the strong line up of new releases for the fall and provide a comfortable environment for browsing.

It should also be noted that our free cash flow, cash from operations less CapEx, this year is at $38.6 million positive versus last year when we were $100,000 free cash flow negative.

Before I close out my remarks today, I'll refer you to the summary table on non-operating charges in our press release this morning. These charges were primarily non cash and total $26.5 million pre-tax in the second quarter with the cash component being approximately $7.2 million. On a year to date basis, our non operating charges total $86 million pre-tax with the cash component being approximately $11.6 million.

The most significant charges were related to the non cash impact of the warrants revaluation and the write off of the Paperchase puts in the first quarter.

That's it for my recap. Now we'll open it up for questions.

Question-and-Answer Session


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

Matthew Fassler – Goldman Sachs

Where did the inventory write downs associated with the multi-media clearance show up on the P&L?

Mark Bierley

There would have been minor charges in promotional discounts. A lot of that quite frankly was done in the first quarter. In the second quarter we were more in the mode of returning the inventory back to our vendors.

Matthew Fassler – Goldman Sachs

And you were able to do that with no financial consequences?

Mark Bierley


Matthew Fassler – Goldman Sachs

So nothing in non operating phase would have embedded that clearance?

Mark Bierley


Matthew Fassler – Goldman Sachs

So the accelerated depreciation in multi-media space reduction really relates to fixturing as opposed to inventory?

Mark Bierley


Matthew Fassler – Goldman Sachs

If you could just quantify, give us a dollar reduction in trade book inventories. Could you give us a year on year percent reduction in book inventories in the Borders store so that we can compare that to your same store sales decline?

Mark Bierley

I can. Trade book inventory was down for Borders Superstore in the quarter by 16.5%. Kid's inventory was actually relatively flat to last year.

Ron Marshall

It's important to point out that the kids inventory had dipped down fairly significantly and was really just in the past two weeks of the second quarter that those inventories rebuilt.

Matthew Fassler – Goldman Sachs

The consultant fees that you book during the quarter, the $4.7 million I guess marginally more than Q1, can you just remind us what those related to?

Mark Bierley

I would say that a lot of that is behind us at this point. We had used some external parties to help with the inventory work and it was a split between costs associated with consultants that helped us move the fixtures out on multi-media about half of it, and the other half was the consultants that helped us on the inventory initiatives.

Matthew Fassler – Goldman Sachs

And in the first quarter was it similar use or was that more kind of transactional related?

Mark Bierley

The first quarter was more towards the consultant fee on the inventory and other cost reductions that we put in place.

Matthew Fassler – Goldman Sachs

Your other Superstore in the sector came out with an e-book strategy and obviously you have your hands full with some pretty core and important which you're working on and dealing with, but what is your initial thought process to how you might want to get into that game?

Ron Marshall

I think the other strategy announced was probably a pretty smart and pretty on-target strategy. I think it was very thoughtful and pretty targeted. Certainly we think that the window is not indefinite. That's why there's a real sense of urgency to move through the other issues so that we move into the beginning of 2010, we can really begin to focus on these things.

I think that the core considerations as we addressed, one is we believe that it's a device agnostic environment. We believe that when it becomes device agnostic, that you have a responsibility as a provider of content to provide that content to any device the customer has wherever that customer might be and wherever that customers wants it, that the two issues that are important is content and not just library, but additional content, and our folks have done a very good job to this point of creating a data base and a library of content that's very strong and very compelling.

But also relationships and having digital and electronic relationships with people, and I think the 34 million plus relationships that we have through Borders rewards, while not nearly enough relationships today, is a good start in positioning us in this business, and as we start talking at the end of the fourth quarter and at the beginning of the first quarter, I think we'll have much more to say on this.


There are no further questions as this time.

Ron Marshall

Thank you everyone for joining. Before we sign off I want to remind you that our next scheduled news release will be our third quarter results on November 24, and we'll speak to you then. Thanks guys.

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