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Executives

Ron Marshall - Chief Executive Officer

Mark Bierley - Chief Financial Officer

Analysts

Matt Fassler - Goldman Sachs

Robert Goth - MAK Capital

Borders Group Inc. (BGP) Q3 2009 Earnings Call November 24, 2009 10:00 AM ET

Operator

Good morning and welcome to the Borders Group Inc. third quarter 2009 financial results conference call. (Operator Instructions)

Now, I would like to turn the call over to Mr. Mark Bierley, Borders Group CFO. Sir, you may begin.

Mark Bierley

Good morning. I’m here today with Ron Marshall, our CEO. Thanks for being with us this morning. 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 this morning in our most recently filed 10-K for information related to forward-looking statements, including factors that could cause actual result and plans to differ.

With that, I’ll turn it over to Ron to begin.

Ron Marshall

Good morning, everyone. When we last talked, I reviewed the heavy lifting we did in our stores during the second quarter as we migrated from slower selling and lower profit category such as music and DVDs and expanded into categories such as children’s, bargain books and Paperchase, gifts and stationery.

While we accomplished a good deal during the second quarter, we ended the third quarter knowing that significant work remained for our stores to be fully prepared for this holiday season. This work revolved primarily around rebuilding our inventory assortment and in stock positions, which have become badly broken during the 2008 holiday season, because of the focus we put on these areas, I am, for the first time since joining the company, generally pleased with the overall condition of our stores as we approach the holiday selling season this year.

An exception certain pockets of our West Coast region, which require more work. We have dispatched additional resources to remediate the situation there. While this work was necessary, the cost of properly position our stores for the holiday selling season, unfortunately will much more expensive than we expected in the third quarter.

In addition, we found an increased promotional spending did not create the intended sales lift and we’re currently making the appropriate adjustments in our program. As a result of these two factors, we’re reporting third quarter results today that are both difficult and disappointing, as Mark will detail in a moment. Yet with this experience behind us, Borders is better positioned now than we have been in recent years for this holiday selling season.

Specifically, we believe we have five competitive tie breakers in our favor. First, enhanced inventory assortment to in-stock positions, which is supported by the book industry’s first ever in-stock guarantee, which gives customers free shipping on any items they don’t find in-stock in our stores.

The absolutely best customer service in the business as a result of our great service initiative, which is put in place earlier this year and extensive new toy and game assortment in virtually all of our Borders stores offering parents hundreds of great and affordable, educational and creative toys that are hard to find anywhere else.

In addition, we have dedicated team sections in our store that represent compelling book and non-book items to appeal to this growing segment. Our Paperchase gift and stationery shops that offer truly innovative items, journals, cards, gift wrap, photo frames, totes and hundreds of great items in exclusive designs they simply can’t get anywhere else.

Finally, our free orders awards customer royalty program with over 35 million members, who receive compelling discounts, special offers and on spending money with our purchases. This is an unpredictable holiday selling season as consumers remain unsettled and reactive to economic news, but we have taken the necessary steps and made the right investments to prepare our stores for this fourth quarter.

With that, I’ll turn it over to Mark.

Mark Bierley

Thanks Ron. As reported in the third quarter, Borders Superstores comp store sales declined by 12.1% and our core categories excluding multimedia were down 8.5%. Transaction comps were down 5.1% and average ticket comp was down 7% driven by price per unit as units per transaction were flat. The average ticket declines were driven by the increased promotional spend that Ron mentioned.

While in both comp store sales declined by 7.2% with transaction comps with the minus 4.5% and average ticket decline for approximately 2.7%. Units per transaction were up at Walden Books and average retail per item was down due to higher promotional investment.

Overall inventories down 7.9% or $99.1 million compared to last year, of that reduction, $70.4 million is multimedia and $45.5 million is related to inventory declines at Walden Book stores due to closures. We’ve invested $16.8 million at cost into our core inventory levels at Borders Superstores, which is inventory excluding multimedia. Going forward, we expect inventory levels on a per store basis in our core book category to be above fourth quarter levels last year and also to be at a better in-stock position.

Moving onto margin, there are three main components at Borders Superstore margin performance within the third quarter. 70 basis points of improvement was driven by initial markup based on our shifting product mix to higher margin goods. 190 basis points of negative impact came from the increased promotional spending.

The most significant was in store conversion programs that helped track sign ups with the Borders Rewards program, but at a higher short term cost than we expected. 90 basis points of negative impact resulting from deleveraging of occupancy cost. While we clearly need to improve, I think it’s important to put in context full year operating gross margins before occupancy through the third quarter, which are down 30 basis points to last year.

We’ve been able to move out underperforming multimedia inventory, improve our supply chain cost and expand initial margin with product mix shifts. We need to get better, but we’ve done some important things to set the stage for improvement. We made significant progress on improving our overall cost structure in the third quarter. Operating SG&A was reduced by $27.1 million, driven by store payroll and store expense efficiencies as well as reduced corporate overhead costs.

Supply chain costs were reduced by $6.4 million, but were higher than plan as we built up inventories to the fourth quarter. We continue to be on plan to realize $120 million of expected overhead and supply chain cost savings for 2009. Although we certainly have had our challenges on the top line, we’ve been able to improve our operating loss compared to last year and improve our net working capital position as well.

Adjusted operating EBITDA for the full year is a loss of $24.3 million versus a loss of $24.9 million last year with a sales differential of over $300 million; operating loss of $93.1 million versus $107.3 million last year. Interest cost of $14.2 versus $23.7 million. Operating loss before income taxes of $107.3 million, versus $131 million last year, a 23.7 million improved.

SG&A cost down by $111 million, significant reductions in the end of performing multimedia inventory. Multimedia inventory down $70.4 million at cost, which was reclaimed in cash flow through aggressive sales, and returns to the vendors, continued strong vendor support is evidence with our third quarter payable ratio at 52.2% versus 48.8% last year.

Debt, net of cash was reduced by $112 million from 2008 levels driven primarily by cost reduction, inventory improvements and the prudent use of capital. I want to note that we are in compliance with our debt agreements as of the third quarter of 2009. With significantly reduced capital spending to third quarter to $6.8 million compared to $17.9 million invested in the third quarter of 2008.

On a year-to-date basis, our 2009 capital spend is at $11.2 million versus $72 million last year, our due for the rest of 2009 is that we’ll continue to be prudent with our capital spend. Before I close out my remarks today, I’ll refer you to there’s a summary table with non-operating charges in our press release. These charges were primarily non-cash and totaled $23.8 million of pretax income in the third quarter with the cash component being approximately $3.6 million of expense.

On a year-to-date basis, our non-operating charges totaled $62.2 million pretax with a cash component being approximately $15.2 million. The most significant charges were related to the non-cash impact of Pershing warrants, revaluation and the write-off of the Paperchase puts in the first quarter.

That’s it for my recap. Now, I’ll open it up for questions. Teresa, will you take the first question, please.

Question-and-Answer Session

Operator

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

Matt Fassler - Goldman Sachs

I just want to inquire about inventory and your in-stock position for the fourth quarter. Obviously, you’ve had some transition in your stores over the past quarter or two. Can you compare, how you think you’re going to look from an inventory position in Q4 relative to where you were in Q2 and Q3 as to how you think it might impact you, or help perhaps your top line relative to the last couple of periods?

Mark Bierley

Based on our Borders Superstores inventory, when I talk about the core inventory, it’s basically music excluding. We expect our core inventory to be up either from 4% to 7% compared to last year throughout the entire quarter. As we sit at the end of the third quarter, we definitely made progress toward that goal. So as we head into the fourth quarter, anywhere from 4% to 7% ahead of last year as it relates to our core.

Ron Marshall

Yes, if you look at our sales results last year, Matt, in the fourth quarter, as our in-stock position and as our assortment came pretty significantly broken, you could see same-store sales really erode almost within stocks. I think we’re in a much better position this year, particularly in core categories to be frank with you, I think we still have some opportunities, secondary territory categories.

In the core categories that are going to drive the system, drive comps for the season. I think we’re in the shape we’ve been in a long time. We got in that shape in a relatively recently. I would say it’s only in the past two and a half to three weeks that I’m comfortable with where we are in the main categories.

Matt Fassler - Goldman Sachs

Was there a sales trajectory through the quarter that may have reflected a change in inventory position?

Ron Marshall

Third quarter or fourth quarter?

Matt Fassler - Goldman Sachs

Third quarter; or fourth quarter data if you like…

Ron Marshall

Not really in the third quarter, Matt. This inventory really began to come in at the end of the third quarter.

Mark Bierley

We really got to that increased level toward the tail end of October.

Matt Fassler - Goldman Sachs

Would you then care to comment on fourth quarter today?

Ron Marshall

The environment is so choppy right now, Matt. My crystal ball is as cloudy as anybody’s. I’d defer on that.

Matt Fassler - Goldman Sachs

My second question, I guess it’s a big issue for the industry. You didn’t discuss today the e-reader, or their sales of third party’s e-readers or your own perspective efforts in this sector. If you could talk about strategically, how the enterprise is approaching that opportunity?

Ron Marshall

Matt, we’ve said all along that working into the fourth quarter, we’d be able to talk about what our strategy and what our perspective is in that category. We’re still on target to do that and I would expect sometime in the next eight weeks that we’ll be able to have a meaningful conversation, but we do not to really report or announce right now.

Matt Fassler - Goldman Sachs

I guess one follow-up to that I know you do sell the Sony product in your stores. Is that driving any kind of meaningful revenue for you as you look at the mix?

Ron Marshall

No, it’s not a significant mix driver. I think we’ve been reasonably pleased with the activity we’ve had. As you might expect, with a lot of announcement, it has created some uncertainty in the customer’s mind and which deal with that as we go through the season, but it’s not a top selling SKU for us.

Operator

Your final question comes from Robert Goth - MAK Capital.

Robert Goth - MAK Capital

There was some press out, I believe yesterday on Borders U.K. and issues there confronting. Could you please just give me an update on the status of the Lease Guarantee, where that sort of potential liability lies today and what your thoughts are on that?

Mark Bierley

First and foremost, we no longer own Borders U.K. We do as you mentioned, have those Guaranteed Leases of four different properties. We have an on going relationship with Paperchase with Borders UK. We’ve taken the appropriate reserves in this release and you’ll see those disclosures when we file our 10-Q, but the reserves that we’ve established are in line with our expectations as it relates to this.

So, as you see the Q and also if you look back to last quarter’s Q as well as the K, you’ve got some pretty good disclosure as to our approach on these leases. So, at this point, we feel like we’re in a good position on those reserves and we’ve taken that into consideration.

Robert Goth - MAK Capital

Just in your last Q, you just discussed that potentially, I think there were two stores that were in the process or could have been sold to I guess, you described as a fashion retailer. Has that transaction occurred?

Mark Bierley

It has. Those stores are operating with that new retailer in there today.

Robert Goth - MAK Capital

So, X those stores, how many are currently, I know you guaranteed those stores as well, but how many stores X those stores?

Mark Bierley

Two.

Operator

There are no further questions at this time.

Ron Marshall

Okay, well, thank you. Thank you everyone and our next financial news release will be our holiday sales result, which we plan to issue in mid-January. Have a very pleasant holiday. Bye-bye.

Operator

This concludes today’s conference call. Thank you for your participation.

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