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Executives

Scott Henry - EVP and CFO

Mike Edwards - President and CEO

Glen Tomaszewski - CAO

Analysts

Bill Armstrong - C.L. King & Associates

Borders Group, Inc. (BGP) Q3 2010 Earnings Call December 9, 2010 4:30 PM ET

Operator

Good afternoon and welcome to the Borders Group Incorporated third quarter 2010 financial results conference call. (Operator Instructions) Now, I would like to turn the call over to Mr. Scott Henry, Borders Group Chief Financial Officer.

Scott Henry

Thank you, Stephanie. Good afternoon, everyone. I am here today with Mike Edwards, President and Chief Executive Officer of Borders Inc, and Glen Tomaszewski, our Chief Accounting Officer. Thank you for joining us on the call this afternoon.

Let me note 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 afternoon and to our most recently filed 10-Q for information relating to forward-looking statements, including factors that could cause actual results and plans to differ.

Before we begin the formal presentation of our results for the past quarter, let me turn the call over to Mike Edwards, our CEO for some initial comments.

Mike Edwards

Thank you, Scott. First, let me address the recent news contained in the SEC filing made by Pershing Square on December 6. In that filing, Pershing Square Capital, one of our largest shareholders states that's it's prepared to finance on mutually acceptable terms and offer to buy Borders to purchase all the equity securities of Barnes & Noble for either $16 per share in cash or a mix stock in cash consideration.

In response we have confirmed that Mr. Ackman of Pershing Square has shared with us his perspective that the business combination of Borders and Barnes & Noble could create significant synergy. We have also confirmed that Mr. Ackman has expressed his willingness to provide financing for such a transaction and we welcome his participation.

In addition, we noted that we have previously expressed to Barnes & Noble our interest in such a business combination and we look forward to continuing those discussions. With that said, we will now comment further on this call regarding the matter today.

Now, let me turn to a general overview of the quarter. Quarter ended October 30, 2010 is one which we began the transformation process of Borders, as we start to implement to our new strategy in business. We are confident that the process we are undertaking is strategically responsive to the challenges facing our industry. However, we are not far enough along in the process for to have meaningful positive effect on our last quarter's performance.

I'll elaborate on our strategy a little later in the call in greater detail. I now want to turn the presentation about our past quarter back to Scott, and I will return later to elaborate more on the strategy.

Scott Henry

Thank you, Mike. The quarter among other things reflected challenges on the topline. Specifically, our bookstores had negative comp store sales of 12.6% in the third quarter, largely due to the performance of our trade book category. Digital devices and our Kids Toys and Games categories outperformed the rest of the store, however, and generated positive comps for the quarter of 93.6% and 6.6% respectively. Transaction comps were down 9% and average ticket was down 4.1%.

Borders.com sales were lower than a year ago for the quarter by 8.6% or $1.1 million. With that said, we made substantial improvements to Borders.com during the quarter, including the addition of new product categories such as used books, textbook rentals, posters and craft supplies. As a result, we did not engage in every promotional activity during the quarter in anticipation of the relaunch of the site, which was announced on November 15.

The gross margin rate for the quarter was 310 basis points lower than a year ago. The largest driver of this decline was higher occupancy cost of 140 basis points due to cost deleverage. Shrink continue to provide a lift to the gross margin rate, however, improving by 80 basis points over last year, as we continue to benefit from improved store level execution and compliance. Promotional spending was 50 basis points lower than a year ago, and we continued to move away from the in-stores promotions and focus discount spend on promotions designed to increase traffic in to our stores.

With regard to SG&A, our continued efforts to simplify and streamline our business, as well as our reduced store count helped us achieve a reduction of SG&A cost compared to the prior year of 13.1%. As a percentage of sales, SG&A increased 1.6%, however, due to cost deleverage, cost by the decline in comparable store sales.

The company did strategically increase spending during the quarter in key areas, including the launch of Borders Rewards Plus and the redesign of in-store signage to improve the shopability of our brick and mortar stores. Also impacting the quarter was the launch of our Area-e digital shops within our stores and we invested in store payroll and capital spending related to this initiative.

Although our operating results for the quarter were disappointing, we continue to focus on the following important financial initiatives. Enhancing the profitability of our existing stores is one of our key priorities. We are addressing this in two ways, through the end of the third quarter on year-to-date basis we completed lease buyouts and closed 10 stores which were diluted to our EBTIDA.

We have negotiated in additional four lease terminations and these stores will close during the fourth quarter. We will continue to opportunistically exit additional store leases in order to benefit the bottom-line and improve working capital, including the closure of 12 underperforming stores which have reached the end of their lease life.

We are taking a vigorous approach to negotiation with our landlords to attain occupancy reductions, and have to-date negotiated approximately $10 million reductions for 2011. These negotiations with landlords will continue throughout the fourth quarter and into 2011 as we continue to rightsize our occupancy costs and our store footprint.

We are very focused on increasing the efficiency of our supply chain. Our efforts to reengineer all access of our supply chain moved forward during the third quarter and will continue into fiscal 2011. This project is expected to provide both working capital benefits as well as lower operating cost structure without impacting the customer experience.

At the end of the third quarter, inventory levels were $895.8 million, $233.7 million lower than where we were a year ago, representing a 20.7% reduction.

We are also very pleased with the success of our recently launched Paid Loyalty Program, "Borders Rewards Plus". To-date we have signed up over 580,000 Borders Rewards Plus members and have collected nearly $12 million in membership fees. We received the cash benefit from the collection of Borders Rewards Plus membership fees immediately. However, revenues are recognized over the life of the membership period for accounting purposes.

At the end of the third quarter, net debt of cash totaled approximately $331 million, a reduction of 12.7% compared to the end of the third quarter of last year.

That is it for my comments for now. Let me please turn this over to Mike.

Mike Edwards

Thanks, Scott. In the 13 months I've been at Borders first as a Chief Merchandising Officer and now as a CEO, I've witnessed tremendous change in the industry, fueled by the expansion of digital content and eReading. This upheaval is not unlike what I saw in the electronics industry back in the 90s when retailers were focused. And for us, the differentiation saw us in an ever-changing marketplace.

I and our management team believe we can win in the retail space by transforming the retail experience at large. We have a comprehensive plan that supports our goals to transform the iconic Borders Brands into a profitable economic model over time. And it is designed to position the company for an attractive long-term growth and value enhancement potential.

While we are still very early in the brand transformation process, I am pleased to tell you that we are seeing success with the plan elements that we have executed so far. As discussed with Scott, we are experiencing excellent results with our Borders Rewards Plus Program. We are seeing some noteworthy trends among the Borders Rewards Plus members. These customers shop more frequently, they have a higher average ticket, driven significantly by higher units per transaction. We will continue to market heavily our Borders Rewards members and membership growth through segmented and personalized e-mail campaigns.

In Q3 we initiated some other important steps to reposition our brand, enhancing our stores with the addition of Area-e digital sections, which is contributed to the growth of our digital category and e-books at large. In addition, we also expanded the Kid section in 51 stores nationwide with book and non-book products and leading brands such as Sesame Street, American Girl, Dr. Seuss and more. We expect strong sales and profit potential with this business.

The Kid's category will be one, we'll focus heavily on in the upcoming months and years. Moving to the online arena, we made strategic investments in our e-commerce during the third quarter. We redesigned the site adding a number of services and programs designed to improve the customer experience, with e-commerce business as expansion of our stores. And we will continue to make modest investments on all our sites to ensure to effectively support and enhances the in-store experience. We're already seeing notable improvements in every statistics that we look at from our Borders.com experience and shopping.

We have also remained focus on growing our digital category, adding such devices as the Kobo Wireless eReader, the Velocity Micro Cruz Tablet to our growing selection of eReaders. We plan to utilize marketing campaigns, capitalizing on our brand equity to position Borders as a destination for digital content and e-reading.

I want to share with you our next major steps and our plans to transform our retail experience. In 2011, we will begin piloting a host of an enhanced features in service offerings that will differentiate Borders from other book retailers. We'll start with a handful stores in Washington DC and the New York City markets.

The pilot stores are expected to include the following. An expanded selection of eReaders and other electronic devices, an exciting Kids destination area with significant assortment of high quality educational toys and games, a new section also featuring new signage and a lot of inspiration and educational components that provide both comfort as well as a focus on the quality of the educational experience.

Children's educational environment enrichment programs will be further enhanced with strategic partnerships. In addition, in partnership with Starbucks, and a division of Seattle best coffee our primary cafe will be included for the expanded menus and expanded cafe experiences in our test stores as well. The changes that we are implementing is part of a very comprehensive, well thought out strategic plan grounded in the extensive research we have conducted with the Boston Consulting Group. We have a talented and highly experienced management team already executing this plan.

With the mission of transforming the retail experience over the next couple of months, we will continue to work with leading brands to provide a great in-store experience with the right combination of exciting book and non-book product. Service offerings and great customer service are the key to our long term success.

That concludes today's discussion. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bill Armstrong with C.L. King & Associates.

Bill Armstrong - C.L. King & Associates

In light of your comments on liquidity, can you comment on whether vendors are shipping product to meet your needs or are you having any problems with deliveries from vendors?

Mike Edwards

As we indicated in our press release, Bill, our vendors have been very supportive.

Bill Armstrong - C.L. King & Associates

So you are getting enough inventory then?

Mike Edwards

We are getting plenty of inventory and plenty of support from our vendors.

Scott Henry

And our in-stock premium's consistent with last year.

Bill Armstrong - C.L. King & Associates

The store closings that you mentioned for the fourth quarter, I might have missed it a little bit. Are these in addition to lease expirations? In other words, are these negotiated closings or are these just closings of stores that are expiring.

Mike Edwards

Of the 16 stores that are slated for closure in the fourth quarter, four of those represent early lease terminations with the balance representing natural lease terminations.

Operator

(Operator Instructions)

Mike Edwards

Well, thank you everyone. We really appreciate your participation on the call today, and have a great day and a great evening.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Borders Group CEO Discusses Q3 2010 Results - Earnings Call Transcript

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