Borders: Earning Call Notables

| About: Borders Group, (BGPIQ)

I think people are missing just how good a job Borders (BGP) CEO George Jones is doing.

Notes from the earnings call:

  • In the first half of this year, cash flow from continuing operations improved by $195.7 million compared to a year ago.
  • SG&A dollar expenses from continuing operations were $16.7 million lower than last year and are on track with stated plan to reduce annual expenses by $120 million.
  • Approximately half of the $120 million in savings is related to corporate office expense reductions and the other half is reductions in store and distribution expenses. Most of the actions necessary to realize these savings have been taken.
  • The company is on track to realize approximately half of the expense savings, or about $60 million in 2008 and expect to be operating at a level to realize $120 million in annualized expense savings at the beginning of fiscal 2009.
  • More than 28 million Borders rewards loyalty program members exist. This program continues to attract new members at a rapid pace, averaging over 131,000 new members a week. will be rolled out to stores later this year.
  • Inventory reduction in music inventory, which declined over 30% from last year. Floor space dedicated to music has been reduced in all stores by about a third, on average. Music now occupies approximately 7% of total store floor space. The space previously occupied by music was reallocated to growth categories, such as children’s and bargain books.
  • More space in stores due to inventory reduction allows a focus on driving profitable sales by better using that space to expand growing categories, such as children’s and bargain, as well as to face out more books and make some merchandising improvements.
  • These strategies work in new concept stores and the they are performing very well on the whole. BGP will be applying them in all of its stores.

    From Q&A

    Regarding Pershing Square and Bill Ackman
    Matthew Fassler - Goldman Sachs
    "And just a really basic question on the Pershing warrants, the benefit to you is a result of what specifically be"

    Edward W. Wilhelm
    "Well, the warrants again have a strike price of $7, the stock being under $7 results in a downward adjustment, an income item. If things were to go the other way, it would be a -- obviously an expense item if things were to, if the stock were to be over $7. And again, this is all non-cash too."

    Matthew Fassler - Goldman Sachs
    "And as it moves closer to or further away from $7, you take -- you book something there?"

    Edward W. Wilhelm
    "That’s right. And again, non-cash item."

    Cost Cutting:
    George L. Jones
    "One thing to note in this expense initiative, this is something we started last year looking at and had some outside help, even beginning last year, looking at the fact that we really needed lower overhead and we thought there was an opportunity to [do there]. Obviously we stepped this up quite a bit in the first of the year as we saw sales softening and what was happening with the economy and brought in some additional outside help, which really helped us focus on it at the beginning of the year. And as we put this in in second quarter, this was something that we did quite surgically with a lot of focus and literally, it was a process that was not just concentrated on let’s eliminate some jobs or do this, et cetera, which all that happened but we really literally turned over every possible stone within the company in every area and that’s the reason we are so confident that we can deliver more than the $120 million in expense reductions. And we’re still finding things."

    More on Pershing and PaperChase:
    David Weiner - Deutsche Bank
    "Okay, and then just one final separate question and I’ll pass it on -- if you can just remind me what the implications are of not selling the Paperchase business within your agreement with Pershing? Are there kind of certain levers that happen, if I remember the Paperchase business doesn’t get sold to an outside party by the fourth quarter?"

    Edward W. Wilhelm
    "No, there are no implications of that, and just to be clear, the put that we have available that remains for our ability to put the Paperchase business back to Pershing Square remains in effect. We haven’t exercise the put and we obviously haven’t sold the Paperchase business either. And I would just say that as we sit here today, we’ve got plenty of available capacity to get through the peak debt season for this year and we can sit here even without the sale of Paperchase or the exercising of that put and we can say that with a high degree of confidence because that peak debt occurs early next month. So we are sitting in a very comfortable position, again even without the sale of Paperchase as we look out through the remainder of this year and again, there are no implications of not exercising that put."

    George L. Jones
    "The Pershing put was really a back-stop for us to give people confidence that we had the wherewithal going forward, et cetera. That’s why it was done. It was never necessarily our intent that we would exercise it but it was there if we needed it. It was a safety net, so to speak.

    Since that happened, I mean, we’ve dramatically improved the financial strength of this company and the balance sheet, as evidenced by the debt and our improvement in cash flow and everything that we have reported here. We feel really, really good about that and the expense reductions, everything we’ve got. So we’re just in a much, much stronger position financially than we were."

    More on the $120 million costs saving:
    Aaron Stein - J.P. Morgan
    "Okay, and then of the $120 million of annual savings, can you break out how much of that you think comes from either store closures or business spin-outs, so on and so forth versus existing operational savings?"

    Edward W. Wilhelm
    "None. It’s all from existing operational savings."

    What to think? This is even better than yesterday's initial news. Why? There were another $60 million in savings minimum this year, results, $7 million in sales were really only after 2 to 3 weeks of operations in Q2. Management's reaction to the new concept stores gets better each quarter. Debt reduction continues.

    Let's look at the second half of the year. Last year the company lost $97 million in Qs 3 and 4. Some real rough math gives us the above mentioned $60m in cost saving, $12m in debt interest savings, ought to contribute $35m in sales at a real conservative minimum giving about a $8.4 m profit (using 24% gross margin). Should Paperchase be sold to Pershing, that saves another $10 million in cash flow and reduces debt even further, bettering results.

    I think those folks that believe Borders won't turn a profit for the second half of the year are going to be disappointed. Should the economy collapse, clearly we are in a different situation. But, if the worst is over and the consumer mood changes or even just stays the same, things could get a whole lot better real fast.

    The cost cuts that have been made are in areas that will not really involve cost increases when sales return (leases, utilities, marketing, labor, corporate expenses). The short of that is increasing dollars are falling to the bottom line rather than being absorbed by expenses.

    Disclosure: Long BGP

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