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Executives

Michael Edwards – Interim President, Chief Executive Officer

Mark Bierley – Chief Executive Officer

Analysts

John Bachman – Goldman Sachs

Borders Group, Inc. (BGP) Q1 2010 Earnings Call May 27, 2010 10:00 AM ET

Operator

Welcome to the Borders Group, Inc. first quarter 2010 financial results conference call. (Operator Instructions) Now I would like to turn the call over to Mr. Mark Bierley, Borders Group CFO.

Mark Bierley

Good morning, everyone, and here today are Mike Edwards, Interim President and Chief Executive Officer of Borders Group. Thank you for joining both of us on the call this morning.

As always, I need to point out that today’s discussion 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, let me start by discussing the equity investment that we announced last week. As noted in the news release we issued on May 21, Ben LeBow invested $25 million in the company through a private purchase of 11.1 shares of the company’s common stock at a purchase price of $2.25 per share. We are extremely happy with the flexibility this investment, along with our recently completed debt refinancing, gives us in our efforts to strengthen our balance sheet.

Ben LeBow and Howard Lorber have joined the Board of Directors and Ben has been elected Chairman. We are extremely pleased to have both Ben and Howard on our Board and are looking forward to their contribution. Please refer to our recent 8-K filed with the Securities and Exchange Commission dated May 21, 2010 for further details on this transaction.

Now I want to touch briefly on our key financial priorities for the remainder of 2010. First, we are continuing to maximize the profitability of our stores. We have a number of stores, which are dilutive to our EBITDA. We intent to aggressively pursue lease buyouts from these stores. The buyout on these leases would, based on our assumptions, positively impact our long-term bottom line.

We’ve also created a comprehensive operational audit program to assess store level execution and controls designed to reduce shrink with a strong focus on stores that have historically seen high levels of loss.

Increasing the efficiency of our supply chain is another key priority for us in 2010. We’re currently analyzing alternatives for our supply chain including the benefits of increasing the amount of product that is shipped direct to our stores. Our overall goal is to reduce operating costs and to maximize the efficiency of our distribution capacity to reduce working capital requirements.

Finally, we’re maximizing the potential and profitability of Borders.com by making investments in both our upcoming digital bookstore powered by Kobo as well as in Borders.com to improve the overall customer experience.

Mike will discuss the progress we’ve made on executing our digital strategy as well as provide updates on all of our strategic initiatives in a minute. But before I turn it over to him, I’ll cover key aspects of our first quarter performance.

During the quarter, we continued to have a challenge on the top line. Specifically in the first quarter, our bookstores generated negative comp store sales of 11.4%. Our core categories excluding multi-media performed better, declining by 6.8%. Transaction comps were down 8% and average ticket was down 3.6% driven primarily by price per unit, as units per transaction were flat. Borders.com sales increased 34.7% in the first quarter.

Overall, for the company, inventory was down in the first quarter by 6.4% or $56.8 million compared to last year driven primarily by store closures. Excluding the effect of these store closures, inventory increased on a per store basis. Our in stock levels continue to outpace those of a year ago as we’ve invested inventory into broadening our assortment as well as adding new product in the kid and teen areas of our business.

Specific to gross margin, we had 50 basis points of improvement that was driven by initial markup resulting from shifting our product mix to higher margin goods including books, café, kids and gifts and stationary.

Promotional spending was flat compared to a year ago. Occupancy costs that were higher by 190 basis points due to cost deleverage and supply chain and freight costs that were higher by 110 basis points, due primarily to heavy return volume during the quarter.

We saw the benefit of our cost reductions during the quarter, and our SG&A was reduced by $30.9 million driven by store payroll, store expense, efficiencies as well as store closures and reduced corporate overhead costs.

Interest costs were up over the prior year given the higher cost of capital required by our recently completed financing arrangements. We continue to prudently manage capital expenditures, spending $5 million during the quarter. Spending was focused on developing our eBook store on Borders.com and on completion of the conversion of our small format floor system to that of our superstores. We expect full year capital expenditures to be flat with last year’s level.

That’s it for my comments. Now I’ll turn it over to Mike who will talk about our strategic path forward.

Michael Edwards

Thank you, Mark, and good morning everyone. We are extremely pleased to have the $25 million equity investment from Ben LeBow. This investment coupled with our company’s recently announced refinancing will strengthen our balance sheet and provide the necessary capital for funding the transformation of the Borders brand, which is believe must happen in order to affect a turnaround at Borders.

Our digital strategy is one of the key initiatives this investment will support. I want to take a minute to provide you with an update on our eBook and eReader plans. We believe the lion’s share of the eReader business, both for the under the $200 price point going into the fourth quarter.

As such, we plan to offer a strong selection of e-reading devices to fit all of our customer’s needs with a number of devices prices at $200 or below. In line with this approach, we recently began taking pre-orders for the Kobo eReader, which showcases the Borders brand eBook store. We are pleased with the number of pre-orders we’ve received for the device to date.

[Inaudible] because of its attractive features and a low price point of $149. The Kobo eReader is one of the most affordable e-reading devices available on the market. By offering this device, we are introducing e-reading to the consumers who would have considered buying other devices at $250 to $500.

We expect to announce next week, that we’ll take pre-orders for a second eReader and over the course of the coming weeks and months, we plan to introduce as many as ten devices. We are also on track to launch our Borders eBook store and mobile ops powered by Kobo next month. In fact, we’ll have an Apple application that will go live by the end of June.

We also said earlier, we’ll introduce our special in store digital shops, which we’re calling Area E in August. Within these shops, we’ll offer various e-reading devices as well as a comprehensive array of accessories and extended warranty programs. We’ll provide our customers with a supportive environment in which in explore and learn all about the devices we have available, guided through a knowledgeable and the expertise of our store associates.

EBooks and eReaders are just one part of the overall digital strategy. As Mark mentioned earlier, we are focusing on growing Borders.com. In the first quarter, we increased the frequency of our Borders.com specific email promotion to our awards members. We continue to invest in improving the customer interface, check out and search capabilities.

We’re also working to identify an Executive Vice President of our digital business to drive this business forward.

In maximizing our digital opportunity, we are focused on three other objectives; reinventing the Borders awards customer loyalty program, leveraging community education and the power of social media and improving the in store experience and increasing customer conversion.

I want to spend the next few minutes giving you a brief update on some of the progress we’ve made on these objectives. When we last talked, I said we were revamping the Borders reward customer loyalty program. Over 30 million members have signed up for the program since it was launched.

While we cannot share the details today, the program will be highly results focused. We’ll use it to drive in store and online sales by creating a high level of customer engagement through personalized emails containing rich and evolving content. We are preparing the launch of the new reward program and will share the news of our progress in the upcoming months.

In advance of the launch, we have already begun communicating with our rewards members through more meaningful email. For example, we now tell members about in store events happening in their communities. In addition, emails are personalized with specific title selections we feel our customers will love, as well as new releases by authors our customers have enjoyed in the past.

Before I leave the rewards program, I want to emphasize we are also in the process of testing new programs to acquire customers through multiple marketing techniques. Many of these will be deployed in the fourth quarter.

I said on our last conference call, another of our key objectives is to leverage community, education and the power of social media. We recognize that a rich events program is a key to driving customers, especially families, to our stores.

As such, we are deploying resources to ensure we have top notch event programs that include appearances by top authors, as well as meaningful local events that will resonate with our customers in the community throughout the nation.

Further, as a part of our commitment to communities, I am pleased to report we recently revamped our benefit day’s program to provide more support than ever to our schools hit hard by budget cuts as well as other budget constraints.

Under the revamped program, participating schools and organizations will receive a credit for as much as 30% of the total sale. Money can then be used to purchase classroom supplies and augment the school libraries. It’s a wonderful compliment that in many ways are already supporting schools and teachers including our twice a year educator appreciation week, where educators can enjoy a robust discount on nearly everything in the store and our exclusive book reseller for the nation’s first national teacher registry, plays an important part in our program.

As you know, offering a robust selection of titles is a key part of providing a great in store experience for our customers. We continue to focus on offering the most compelling assortment to our customers, working with our vendor and publisher partners, and stores, to ensure we maintain a strong regional assortment that resonates with our customers.

We conduct strategic monthly summary reviews tied with seasonality across all subjects and have identified key lifestyle categories for assortment addition which includes, cooking, crafts and collectibles as well as categories within the fiction book portfolio.

A compelling in store environment plays a key role in connecting with our customers. To ensure we are maximizing all opportunities to communicate our brand message through the store, we’ve engaged an outside firm to help us improve our in store visual execution.

This enables us to share a strong editorial voice and guide our customers through purchasing decisions from the time they walk through our door to the time they check out. They’ll be grounding in providing excitement, emotional connection and value at every touch point of our store. Our associates no doubt, will play an extremely important role in delivering a positive in store experience.

In addition, we recently rolled out staffing and scheduling model to shift additional payroll to the sales floor and ensure that we have the best coverage at the most busy times and create a winning high performance culture that is held accountable to a high customer service and engagement standard. In addition, our staff is encouraged to promote [staff fix] as well as cook clubs throughout all of our stores throughout the United States.

Our continued strong focus on these areas has resulted in outstanding feedback and customer service scores in the first quarter. The steps we have taken to support our brand position and assist us in achieving our overall goal both in improving profitability by store.

That’s a summary of where we’re heading strategically. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Bachman – Goldman Sachs.

John Bachman – Goldman Sachs

I was just getting a quick update on the integration of the eBook store, especially into the third party platforms. I think you mentioned that you will have an Apple app by the end of June. Should we also expect similar timing for other third party platforms?

Michael Edwards

Yes, most of our eBook initiatives in terms of providing digital content will be released through the month of June.

John Bachman – Goldman Sachs

I don’t know if you could give us any further insight into the economics of digital books as you sell through those different platforms.

Michael Edwards

I think it’s too early to tell. We will, as we get into the later part of the year, once the site is up and running, we’ll provide whatever feedback that we can at this point, but right now it’s just too early and the visibility is not clear yet.

Operator

There are no further questions at this time.

Michael Edwards

Thank you everyone. We appreciate your participation on the call, and have a great day.

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Source: Borders Group, Inc. Q1 2010 Earnings Call Transcript
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