Borders Group Q1 2007 Earnings Call Transcript

May.30.07 | About: Borders Group, (BGPIQ)
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Borders Group, Inc. (BGP)

Q1 2007 Earnings Call

May 30, 2007 8:00 am ET

Executives:

George L. Jones – President, CEO, & Director

Edward W. Wilhelm – CFO & EVP

Analysts:

Matt Fassler - Goldman Sachs

Danielle Fox – Merrill Lynch

Nancy Hoch – JP Morgan

David Schick - Stifel Nicolaus & Co.

Presentation

Operator

Welcome to the BGP first quarter financial results conference call. All participants will be in a listen-only mode until the question-and-answer session of the call. To ask a question please press star one. Today’s conference is being recorded, if you have any objections you may disconnect at this time. I would now like to turn the call over to the Borders Management. Sir, you may begin.

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Edward W. Wilhelm

Thank you operator, good morning everyone, thanks for joining us today. I’m Ed Wilhelm, the CFO of Borders Group and I’m here with our CEO George Jones. We appreciate your time 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 corporate initiatives. Please refer to the news release issued yesterday afternoon and our most recently filed 10-K for information relating to forward-looking statements including factors that could cause actual results and plans to differ. I will start the discussion today with a review of the first quarter and then I’ll turn it over to George for an update on the strategic plan progress.

As a reminder, back in March when we communicated the details of our strategic plan for the turnaround of the company, we indicated that 2007 would be a year of transition and investment. As a result we confined our guidance to longer term goals including returning the company to EPS growth in 2008. In addition, we projected that by 2009 we would achieve consolidated EBIT margins of 5-6% driven primarily by sustained same-store sales growth in the low-to-mid single digits in our domestic Borders Superstore segment. Obviously we are very early in the process of executing the strategic plan. We have just begun working towards these goals and clearly we have a lot of work to do.

Let me start by saying that we do see some early signs that our strategic plan is working. At Borders Superstores we drove an increase in average check-out of about 2% and generated a 4% increase in units per transaction within the first quarter. This improvement is the result of the focus George and team have placed on strengthening execution of key retailing practices in our stores.

While studying these increases, we saw a drop in traffic of about 4% at Borders Superstores. This decrease in traffic was the leading contributor to the -1.9% comparable-store sales decline at our superstores for the quarter.

We moved from a slight operating profit in the first quarter of last year to an operating loss in Borders Superstores in the period. The loss was driven by the decline in comp-store sales that I just mentioned as well as a decline in gross margin, increased expenses, and non-operating charges. The decline in gross margin was attributable to increased promotional discounts in part due to stronger bestsellers but also due to promotional programs including the cost of Borders Rewards that was designed to address the traffic issue.

SG&A increased within the Borders Superstore segment due to higher store payroll and related benefits, as well as investments and initiatives that will drive future benefits such as e-commerce site development and rich systems amongst others.

Clearly, the continued execution of our strategic plans is vital to improving these numbers and we are urgently focused on it. In order to provide the flexibility to fund the execution of our strategic plan we expect to proceed with internal loan financing in the range of $150-200 million to be completed in the second quarter.

Now I will turn it over to George for an update on specific elements of the strategic plan.

George L. Jones

Thanks Ed, good morning everyone. As we said in our news release, the first quarter results were in line with our internal expectations. We were able to make up the sales shortfall in the expense side and ended up about where we expected to be for the first quarter.

In March, when we communicated the strategic plan and set forth our long range goals we indicated that we would keep you posted on the progress we are making related to the key elements of the plan. This morning I’ll highlight some of the significant strides we have already made.

For example, the tactics to get customers to buy more once they are in our stores, the efforts to do a better job with the impact items, the key items, our queue lines, and all of the things we mentioned before, is really working as evidenced by the 4% increase in units per transaction and the growth of our average ticket for the first quarter.

We are also very pleased that we are able during the first quarter to stem the dramatic sales decline we’ve been experiencing for quite some time in our Waldenbooks specialty retail segment stores. We are doing a more effective job there of pulling more customers into our stores as a result of more compelling merchandising and signing of the lead lines.

As Ed said, the sales shortfall in Borders Superstores can be directly attributed to a lack of customer traffic. Clearly, we need to increase traffic, and frankly that is a challenge we have not yet been able to adequately resolve. We feel confident there are new concepts which I will talk about further in a few minutes. They will go a long way to address this traffic challenge but we also realize that in the meantime we must find a way to address this issue without depending solely on heavy discounting.

We do expect that our revamped quarters will play a role in driving traffic. The transition time between moving from our former program structure to the new revamped program took longer than we would have liked. Therefore it did not have an impact on first quarter results.

We have not yet issued our first Borders Bucks, which is the new customer benefit of the revamped program, but we are hopeful that this benefit will motivate our customers to make additional visits throughout the year. The change in the program is so recent I have to say that the verdict is still out on the overall effectiveness of this revamped Borders Rewards program. We will continue to monitor customer response very closely and we do know however that Borders Rewards continues to attract new members at a rapid rate and a database is created consistently proving to be a very valuable and effective marketing tool. We are now over 18 million on our database and that is still growing at a rapid pace.

We are also in the final stages of negotiating several strategic partnerships which we also should be able to use to drive additional traffic. Of course, moving forward this year we will also receive a traffic boost when the final installment of the Harry Potter series arrives. Reservations for this title are running well ahead of what we experienced with the sixth book in the series and we are fully prepared to make the most of this final installment with events in all of our stores.

As we said previously, technology will play a major role in our strategic plan. Leading this plan is our pressing priority to improve merchandising systems. We have moved forward on an aggressive path to improve these systems and have already began to make changes to result in increased capabilities.

I’m also pleased to report that we have selected a new Chief Information Officer to lead our technology transformation. A formal announcement will be forthcoming but I can tell you that Susan Harwood, most recently the CEO for Books-A-Million has been selected as our new CIO. Susan is a proven professional with an extent of experience in our industry not only at Books-A-Million but also at Crown where she served as CIO earlier in her career. Due to contractual obligations she will join us in September and we are very excited to have her coming on board.

We are also very pleased about the progress being made on the development of our proprietary Borders.com e-commerce website which is on track to debut in early 2008. Since last fall we have been designing the site and look forward to future revenue and profit contributions we expect it will generate.

Another key element of our strategic plan is to drive more consistent store execution. To accomplish this we realize that the shift in the culture of our organization would be necessary and that it is a very challenging thing to achieve. I think we have started to make significant progress in this area as Kenneth Armstrong, our recently hired executive VP of the US stores really hit the ground running after joining the company just a couple of months ago. We have tried some things that have worked and we are now seeing our store management teams really get fired up about the opportunities that they can address in driving sales and turning our business round in our stores. In my past turnaround experience, this has been an important precursor of future success.

The development of our new concept store prototype is progressing as scheduled and is very exciting. We are on track to open the first concept store in the first quarter of 2008, as planned. With this store we will create the first true cross channel retail store, a real headquarters for technology and entertainment like no other incorporating not only the physical products we sell such as books, CDs, and DVDs, but also the internet and the digital world with the distinctive offering of products and services that will not only set Borders apart from our brick and mortar competition, but will also give customers a compelling reason to spend time and shop at our stores versus shopping on the internet.

We are also extremely enthused about out proprietary publishing program which is progressing quite well. This program is expected not only to drive margin improvements but also to drive traffic in the long run and can differentiate us from our competitors because Borders, and only Borders, will carry these compelling titles.

Our first proprietary novel, Slip and Fall by Nick Santora, hits our shelves June 11th and of course will be sold exclusively at Borders stores. Slip and Fall is only the beginning of this proprietary publishing initiative. Upcoming titles will include an exclusive John Legend book and a 50th anniversary Grammy book all with a number above their titles.

As you know, as we focus tightly on the Superstore business in the US we have begun a process of seeking strategic alternatives for the majority of our international segment. We will train Merrill Lynch to assist us in the UK and Ireland and KPMG for Australia and New Zealand. The process is proceeding as planned. Of course there is our ongoing policy of not to disclose the specific developments with respect to the exploration of strategic alternatives unless or until we are able to determine the specific course of action and it should be noted also that there can be no assurances that the expiration of strategic alternatives will result in transaction.

Also consistent with our plans, we have continued to right size our Golden book retail segment by aggressively closing underperforming stores. In the first quarter, we've closed 11 such stores and will continue towards our goal to close approximately 200 underperforming stores by the end of 2008. The majority of these closures will occur in the fourth quarter of this year and in the fourth quarter of 2008 as its leases expire.

As we close underperforming locations, we continue to work on the profitable stores that we plan to keep with changes to product assortment and presentation. Our airport security off and paying wall offers segment sales numbers better than we've seen in recent quarters and better than our internal plan.

Overall, it's important to emphasize that we are currently at the early stages of a turnaround. The business and the challenges we're facing are complex. There is no single or silver bullet ideal program that will immediately solve everything. That's why we continue to reinforce our company and we will use 2007 as the year for transition. Although it's an appropriate time to implement this strategic plan that will (inaudible) result that I know we can generate. I am confident that we are making the right investments in addition, such as the conference store, E-commerce, technology and merchandising systems.

In addition, we are restructuring parts of the organization's new resources away from segments to deduct from our return. There are costs associated with some of these initiatives as well, including the strategic alternatives process for international.

Our strategic plan has us positioned in company for a swing in 2008, when we expect not only to see profitability improve but also to build momentum that will carry forward in future years as well.

People often ask me, is there a bigger challenge here than you expect when you took the job as CEO and they ask for the difficulties and compelling environment of the book and music industry is greater than you anticipated, and what surprises have you had, and now that you've been at work for 10 months, do you still feel the same about the opportunity? I hear these questions a lot.

In response to those questions, I will say, that I really did my homework before accepting the Borders Rewards CEO position. I was fully aware of the challenges facing this company and the industry, but I still liked what I saw. I saw a company that was a strong brand and superstores which customers really enjoyed spending their discretionary leisure time. I saw a company where a lot of basic merchandising presentation and execution principles were not being applied well. And most importantly, I felt then, as I do now, that an opportunity exists to create a true headquarters for knowledge and entertainment that would compete effectively with the internet as well as greater motor stores.

Yeah, I've had a few surprises, such as the condition and capabilities of our merchandise planning and replenishing systems, I talked about that before…but they can be fixed, and are being fixed, albeit with somewhat more time and investment required that I had originally suspected.

The main thing is, the opportunity I saw when I first joined Borders have not diminished one iota. I am more confident than ever that by following our strategic plan, we can and will cash in on those opportunities, but it will take some time, as I knew it would.

I was well aware of all the challenges and conditions, but I also knew from the start that turning this company around was not a six month, or even a 12 month project.

More so, even with an excellent strategic plan, it will take time as an investment for this (inaudible) corporation.

Many of these plans and investments will gain little or no financial return this year, but I am confident that they are necessary to get Borders back on track and going in the right direction for the long run. They are the right thing to do.

That's where we are currently at Borders, and although the first quarter numbers certainly weren't what we wanted, I think we are on track with our strategic plan which will result on fulfilling the opportunity that certainly exists for our company.

I will now take your questions.

Question-and-Answer Session

Operator

Matt Fassler with Goldman Sachs, your line is open.

Matt Fassler - Goldman Sachs

Thanks a lot and good morning.

I'd like to ask a couple of questions. First of all, just to review the math around the comps. I believe you said that ticket was up 2% percent, unit per transaction up 4%, traffic down 4%, can you just help us figure out how that translates to, I guess, to the negative number?

George L. Jones

Yeah, the ticket traffic being down for the transaction comps being down 4%, was offset by an increase of 2% in the average ticket, which gives the 2% down for the comps.

Matt Fassler - Goldman Sachs

OK, fair enough.

George L. Jones

The unit search is part of the hours ticket increase.

Matt Fassler - Goldman Sachs

Understood. OK, so that's part of the ticket, it's not a three part equation.

George L. Jones

No.

Matt Fassler - Goldman Sachs

And can you talk to us about where the ticket trend had been in prior quarters?

George L. Jones

Yeah, ticket has been flat to maybe up to tick, not to the 2% increase that we've been seeing, and units per transactions were the same, so it was really an increase over previous quarterly trends.

Edward W. Wilhelm

Actually if you look, the average ticket has not been growing. This is the first time we've had any kind of meaningful growth and the units per transactions, there have not been changes.

So that was really the single drive of the ticket.

George L. Jones

And again I'll say, you know the things we've talked about (inaudible), and I feel good about this, you know the things we've talked about from the start about trying to get people to buy more when they're in the store, you know as far as trying to do a better job with our incast, and the queue items, and the impulse items, and things like that, but we call it basic retailing and you know, was one of the things that I saw before I took the job.

Those things are working, and so we really feel good about that. They're working and we've got the proper resources.

Matt Fassler - Goldman Sachs

Based on what you saw from a mixed perspective, and the (inaudible) bookseller back list etc. You know where, kind of which segments, and to which competitive channels you think you usher for the first quarter?

George L. Jones

I think we did, as far as the competitive channels, I would guess, without seeing all the numbers, I bet we lost it to the internet. If you look overall within there, the business has been certainly challenging in terms of the best seller business has certainly been challenged, it's been increasing its focus in price competitiveness with the mass guys.

You know, you have guys like Cosco and Walmart, who are prospectively aggressive out there. We monitor this very closely and we know that they're very vulnerable on their bestsellers.

Bestsellers still represents not as much, not as large of a portion of our business, as people sometimes think, however there is still quite some traffic, and the internet, if you've been looking at the numbers in recent times, the internet was thoroughly used by competitors.

And that's the reason, maybe, if you looked at the shares that they gained, certainly in fourth quarter, I think that most of you guys have seen the numbers. We heard, looking at the Forrester's numbers, which tracks internet sales, I think they showed that internet sales of last year 2006, went up 39%, that even outpace the numbers we've seen for Amazon.

So it's also growing, and there are other guys out there as well. So, you know, we have to make sure, and that's one of the reasons we're focusing our concepts on development. We can't just look at (inaudible) for more competition, the other guys out there are taking share.

Matt Fassler - Goldman Sachs

And finally, could just remind us of the differences of the New Rewards program versus the legacy program, and once implemented, where do you think that impacts on revenue line?

George L. Jones

Well basically, you know, it continues to be a pre-loyalty problem and again, that's working quite well.

As far as what we did with the other program we used, by the way a good thing to know, we anticipated originally as we were planning this year, that this would be a quick transition. We're working hard to get everything placed in line, so that we would have it displaced early and in the first quarter we'd go to the new program.

The new program basically pays out more frequently than the other program. We have banked on Borders Bucks that we've put in so that when the customer hits the $150 level, they get a $5 voucher.

If any of you are familiar with companies like BestBuy, that is if you shop there, you get to a point where you start getting something sent to you as far as something useful.

This is a more frequent pay out, as opposed to our old program, which you know, I inherited, and obviously created a lot of problems because it built up these huge balances and paid it out during the holiday season.

So this pays out more frequently during the year, but it did mean, however, and also basically, currently it's a more efficient force. It's not as costly as the previous program.

However, we didn’t get the benefit of that in the first quarter, as we'd originally expected, because by the time we did what we needed to do in terms of getting this in place, the variety of reasons for getting this in place, it wasn't really done until the end of first quarter, and so first quarter's bucks haven't really even gone out yet.

Matt Fassler - Goldman Sachs

So this is something that should kick in midway through Q2?

George L. Jones

Yeah, actually it's kicked in already, as far as when the payouts start. The way it works is if you spend $150, whenever you reach that point, and then the following month you get the pay out. Since we just started it, you know, the first pay out starts coming in June.

Matt Fassler - Goldman Sachs

Thank you so much.

George L. Jones

Sure man.

Operator

Danielle Fox from Merrill Lynch, the line is open.

Danielle Fox – Merrill Lynch

Thanks, good morning.

George L. Jones

How are you?

Danielle Fox – Merrill Lynch

Good thanks.

I was wondering if you could comment a little bit on balance sheet and cash flow charges. And I know you mentioned you're seeking a term loan for $100-250 million, but it looks like your leverage is moving up, and we don't have all the detail on cash flow.

I know that first quarter was recently weak. Maybe you could speak a little bit to the trends we're seeing and help us separate what's seasonal versus what's maybe the ongoing some operational standpoint.

Edward W. Wilhelm

Yeah, in the first quarter, our actual free cash flow, the use of free cash was down compared to a year ago.

However, there are still opportunities on that our inventory growth outpaced our sales growth still continues to be a big opportunity force, a high priority force in factors like debts which bring our inventories down more in line with sales trend and just a little bit for the quarter.

The way we cut off accounts payable given a May 5th cut off this year versus a late April cut off in the prior year, had a little bit of a negative impact on the payables cut off and the ratio there and so that’s more of a timing issue than anything else, but we’ll continue to see debt increase in the first three quarters of the year due to seasonal needs in the way our capital spending rolls out in the fourth quarter which for us is the quarter where the free cash flow comes in so debt will continue to increase throughout the year and then peak in the third quarter due to seasonal needs.

Danielle Fox – Merrill Lynch

So should we expect debt levels, net debt to be up or down at the end of the year?

Edward W. Wilhelm

At the end of the year…flattish with where we were a year ago. The expectation for free cash flow is flat for this year.

Danielle Fox – Merrill Lynch

OK. And I guess just a couple of additional questions on the comp. I was wondering if you could maybe just speak to the comp differential with Barnes and Noble because you mentioned some of your competitors from outside the superstore channel but I think Barnes and Noble had the gap between the two of you and what you think may have contributed to the different, I think they spoke to a very strong bestseller title. They’ve been expanding the benefits on their loyalty program while you’re refining yours, so just a general sense within your channel what’s going on from the sales perspective?

George L. Jones

Sure obviously this is just speculation without knowing the breakdown on their comps, but I would say several things. One, right off the bat, they’re going to be influenced by the music segment than we would be because we have a larger penetration in music. Sales of music continued to be very difficult, costs were down in the high teens for the quarter in music which is about where this has been, so this is not a big change there so that affects us more.

We know that they have certain things that help them more from a traffic standpoint. They have a more developed cafe than we do. Starbucks is clearly…we’re very pleased with the results we’re seeing on our sales café, but clearly Starbucks is a very strong brand, it’s a traffic driver to help them in a period like this.

The other thing, when they’re comparing last year they have a more aggressive discount program, a considerably more aggressive program than they do with their royalty program, and that ended a year ago. So I would think with the way they update everything they do, decisions back in October, this past year October 23rd exactly when they ramped out more aggressive discounting with certain numbers and obviously that’s doing something for them, they’re able to grab the comps on it, although they said it was not really profitably so that’s a variable comparison versus a year ago they’ve had to and I would think that’s probably doing something to drive their best seller business.

Danielle Fox – Merrill Lynch

Then I guess the final question…that was helpful thank you. The final question would just be about the Walden Books comp. You mentioned that it came in a bit ahead of expectations and actually I don’t recall the last time they had a comp that was higher than the Borders superstores. I’m wondering what you think helped Walden Books and if this at all changes your view of what the ultimate strategy should be for Walden Books.

George L. Jones

Well, we’re very pleased about some of the things we’re seeing happen in Walden Books. I want to make it very clear though, you know we’re starting to get a group going out and opening up a bunch of specialty stores in the fall. I think frankly what we’re doing, we still think our plan’s the right plan in terms of, you know we would close the stores that don’t make sense, and as we said we think we can do a lot better even than the three hundred stores that opened and this isn’t yet a result of mixed changes. We’re testing some things that we think could frankly be real beneficial for us. A lot of this is basically some retailing principles that we applied and that I think have helped us.

You know it’s really important, our stores are located in malls and what you have is there’s a lot of conversation out there about the demise the malls etc. But we’re in really good malls so they have a lot of traffic out there. And for us there’s an opportunity that we seem to be able to get more people, pull more people from out of the malls, and across our lease line.

If you step back and look at what we have been doing in our mall stores in terms of presentation to our customer whose just not destination on coming in our store but just in the mall and passing by, if you look in our windows and if you look at our lease line presentation of merchandise, signings, and this type of thing, what would pull them in the store, I don’t think we’re very compelling and while we’re continuing to still hone it better, it clearly begs improvements in that area.

I’ll give you an example, last year when I arrived in July and coming into August, in our windows in our mall stores we didn’t change the signs for a period of about six months, and we’re just now going to start getting into the benefit of that. But you know we watched Borders Awards in February and it said Borders Awards easy to join, sign up now or whatever the sign said and that’s what we had in all of our windows. We didn’t change it for about six months. Think about how significant that is to a customer walking down a mall and someone walking down a mall going the same way. You know I wasn’t planning on going into that bookstore there but now that I see that there’s a Borders Awards program I’m just going to dart in through the doors, and that didn’t really happen.

I don’t think that it hasn’t really done anything spectacular yet about our mix. There are things that we’re going to do that I think would be quite meaningful, but I think bringing better traffic into these stores is simply about putting something more compelling in the lease line which customers could see. And that’s where it’s paying back loss. It’s not been anything more aggressive than pricing or anything like that it’s just some basic things there.

I think frankly we should continue…you know make more. One of the things we’ve done for our specialty stores which I think could also be a big deal, we’ve done an internal reorganization where before, you know we made a decision back within the past couple of years, in order to save on costs and some other things, what we did is basically collapsed our Walden organization within Borders in terms of the buyers that were buying for the Borders stores now also buy for the Walden stores. This way our district managers, etc. for the Walden stores, would report to the same people, regional, etc. that they did for the superstores.

One of the things that’s current about that is the specialty business is, I think, I expect has become a sort of a step-child so everyone’s focusing primarily on the domestic business and it takes the focus away from our specialty business. We made some changes to try to correct that in that we put what we call an entire team, a special group of people out of our merchandising organization, particularly planning and allocation which was not really set up that way yet but we pulled some people out to focus on the planning and allocation of these specialty stores. We just did this during first quarter that allows our buyers and people on the superstores going forward which should help us to do a better job of keeping them focused on that because right now the people on our superstores have to look at two completely different systems to do this.

They have to look at everything that they’re looking at, data for superstores and turnaround completely different for the specialty stores. This goes back to systems issues.

This will at least be able to keep people focused on the specialty stores and free up the superstores, likewise in the regions. We have a designated VP responsible for the specialty stores so at least someone out there has a full time job of doing nothing but paying attention at that level to the specialty stores, so I think we’ve got some upside opportunities going into the future.

But don’t get us wrong, that doesn’t mean that everything’s really fixed here and we’re going to go open up another bunch of specialty stores.

Danielle Fox – Merrill Lynch

Thank you.

Operator

Nancy Hoch with JP Morgan, your line is open.

Nancy Hoch – JP Morgan

Great, thank you and good morning.

I was wondering if you could comment on traffic trends for the quarter. I know Barnes in the first two weeks, the first month, and pick up in the late April. I was just curious if you’d seen a similar pattern?

George L. Jones

Unfortunately not. We’ve seen our traffic has been tough throughout the quarter and that’s the consistent thing we’ve done. We really need to get a solution to. There’s probably more traffic in our stores and we’d like to be able to do that without giving away the farm in terms of taking incredibly high discounts in terms of doing it because we don’t think that’s the answer.

I’ve said this before; we will never win on price. We’ve got to have something more compelling in our stores to be able to do that. That doesn’t mean we can ignore competitive pricing. We can’t, and that’s obviously one of the things that drove some of the higher discounting that we have was through competitive pressures but we’ve got to do a better job of this.

And as you know we’re looking at doing a better job and focusing on our rewards program in terms of better mining this information and targeting it. That is something that we think can be very effective for us and we think new concepts for it are going to go a long way in terms of doing that too. We think we’re putting the right things in the concept store and that it will make a difference and drive people to our store and build a better mouse trap, but we won’t have this concept store out until the first quarter of next year and we just know that in the meantime we can’t just sit here and say gee traffic’s really tough. What are we going to do about it in the meantime and that’s what we’ve got to get a handle on.

Nancy Hoch – JP Morgan

OK, great and then just a follow up on the Rewards program.

I don't know is there some way you can give us some color on how to think about expense impact in Q1 and then also how to think about the accrual relative to the prior program, going forward?

Edward W. Wilhelm

Yeah, last year's program had the holiday component to it, so the accrual of bills throughout the first three quarters and then was reversed in the fourth quarter, so there will be a VAT component that we had a year ago that we won't have with the current program changes that we've made.

So, as George mentioned earlier, the current program was really designed to do two things. One, to lower the overall costs of Rewards as related to the promotional discount costs piece, and then secondly, to express benefits throughout the year and give customers those benefits in lower dollar denominations. Both of those changes are much more likely to draw on incremental sales.

So lower costs and incremental sales are the benefits that will draw out from this year's program changes.

Nancy Hoch – JP Morgan

OK, so that should give you a little tail on the gross margins for the next few quarters?

Edward W. Wilhelm

It should be, yeah.

Nancy Hoch – JP Morgan

OK, and just on the expense side, were there any one time expenses in Q1 with the program changes?

Edward W. Wilhelm

Nothing significant.

Nancy Hoch – JP Morgan

Great, thank you.

Operator

Once again to ask a question, please press Star One. David Schick, the line is open.

David Schick - Stifel Nicolaus & Co.

Hi, Good morning

George L. Jones

Hey David.

David Schick - Stifel Nicolaus & Co.

First question. You talked about Rewards signups are still happening. You've talked in the past about opening up emails and how effective that is. Could you talk about the trend with members, not the numbers of members, but what members are doing in response to your communication?

George L. Jones

Yeah, we're still finding that email open rate is the much higher one. I certainly agree with the original plan we thought about too. It's become a very, very effective Rewards program for us. We're now on our Rewards program too, I think we're getting better at it, we're creating more content.

If you go on and encourage everyone to do this, please go on, if you're on our mailing list, which we certainly hope you are a Rewards member, and you are our email list. Go on and get the short list and links that we have for some of the content we're putting on. We have a program called Live Musical 1, which is where we're interviewing authors doing some of the musical performances we have on our stores put up on there.

This is going to be a dual force that not only makes it more interesting and draws more people, but these emails that also as they go to the cross channel retail we're talking about in our stores, we can use this content within the stores to be a differentiating factor, such as if you're thinking about an author that you like, once you've read the books, lets say you're searching for other things, you can pull up there an interview of the author about why they wrote the book or comments about it in the end.

We're getting very, very positives responses from them. Not only from customers, but it's interesting, from the publishing community as well, and from authors and musicians etc. People are seeing this and saying hey they want to do it, and it's really great.

We've had, we did a cooking thing on there recently with awards a couple of years ago for the best chef in the country, and we did a cooking (inaudible) new book out, and we did this too.

When people saw that, we had other authors, well known authors call and say, I'd like to do something like this as well.

(Inaudible) part of that gift back and offering something besides just the merchandise era, and the other part of it, and as a result, the open right we've had on this, had been very, very strong.

You start thinking about that, and we have 18 million members now, and you start looking at that you should put things out weekly. That could be very effective, and you start getting four to five million people to open these, think about that versus, for example an avenue that should be half of that in terms of the actual new leadership on it.

David Schick - Stifel Nicolaus & Co.

Right, it's very meaningful.

We’ve obviously been hearing about the strategic alternatives for international but business has been sort of on a growth perspective better than the last couple of quarters. Could you maybe give an update on what’s going on there?

George L. Jones

Well, basically I’ll tell you, as far as even the strategic alternatives, we’re obviously proceeding on plan on that. As far as the business on it, our Australia, New Zealand business is humming along really nicely. I went over there this quarter. It was actually my first chance I had to go over and see it. I was really impressed with the operation there. It’s doing really well. We’re just very well positioned, we think that this is a very desirable business and we’re just very pleased by what we see over there.

UK business, frankly we got a nice spurt out of it in terms of comps. We started picking back up in fourth quarter. It was challenging again for the first quarter of this year and we need to have concerns about it too. Very, very competitive market over there. Very competitive. If you look for example, our comps in UK while we were down, if you look at the Waterstones and the other book players there comps were even worse than ours. They’re really, really tough.

David Schick - Stifel Nicolaus & Co.

OK.

George L. Jones

It’s a very tough market over there. I feel confident. We’ve got a good management team in place there. I think we’re doing some of the right things but again same thing, over there we need traffic.

George L. Jones

Right. Last question. You’ve talked in the past about the goal of inventory turns but inventory’s been growing a little faster than sales. Can you talk about when we should expect that to turn?

George L. Jones

Our inventory turn was actually about on plan for the first quarter but what happened was we started off a little under planned in inventory and we had more purchases coming through there too. Right now we’re taking steps on our inventory to be able to put back in some purchases in second quarter which we think we can do without any problem at all.

As I’ve said a number of times, I still think we have more inventory in our stores than we really need. The key thing is taking it out surgically and that’s what we’re doing, we’re cutting purchases in the second quarter to come. This all isn’t dramatic. We’re still, we’re really, really focused on improving our turnover within our stores so within the first quarter it was about where we thought it would be but we obviously need to step up those efforts going forward and we’re putting a lot of emphasis on this.

People ask, well you know you’ve said one of the positive things has been merchandising systems and replenishing systems are not really what you hoped it would be. It’s a big surprise and it does make it more difficult to do this until we get our systems right, which we’re diligently working on. However that doesn’t mean we can’t make progress on this and we will.

But you know, it’s interesting, We wanted to bring back our purchase this coming second quarter and seek the organizational assistance we need. Everybody takes some and slashes it. It’s not the way to do it. And that’s the reason when we tried to so this before we’ve had problems because you just can’t do this with an ax. It has to be done surgically. So we’re doing it surgically, and it may be a lot more tedious than it would be the other way, but I think it’s the right way to do it without giving up a lot of sales dollars.

George L. Jones

Right. Thank you.

David Schick - Stifel Nicolaus & Co.

Thank you.

Operator

And at this time, there are no further questions.

Edward W. Wilhelm

Thank you for your participation today everyone. Our next financial conference call will be on August 29th. We will discuss second quarter results which will be issued August 28th. Thank you.

Operator

Thank you ladies and gentlemen, this does conclude today’s call. You may now disconnect.

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