Borders Group Q3 Conference Call
A Fool Conference Call Synopsis*
By Gregory Markus (TMF Boring)
Borders Group Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %>
500 E. Washington St.
Ann Arbor, MI 48104
(734) 913-1100
http://www.bordersstores.com
ANN ARBOR, Mich. (Nov. 12, 1998) /FOOLWIRE/ -- Borders Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %> today announced results for the third quarter of fiscal 1998 ended October 25, 1998. In addition, the company announced a change in management.
New CEO.
Philip M. Pfeffer, age 53, has been elected CEO and a director of the company. Robert F. DiRomualdo, formerly board chairman and CEO, will continue as chairman, focusing on strategic issues.
Pfeffer served as President and Chief Operating Officer of Random House from 1996 until its acquisition by Bertelsman earlier this year. Random House operated through 11 divisions, including operations in the United States, Canada, the United Kingdom, Australia, New Zealand and South Africa. Prior to that, Pfeffer served as chairman and CEO of Ingram Distribution Group Inc., whose Ingram Book subsidiary is the world's largest trade book distributor.
DiRomualdo said that he had been working with the board on succession planning for more than a year and a half, and when the sale of Random House was announced, DiRomualdo said it didn't take him long to mobilize. DiRomualdo said that Pfeffer is a person of vision, with the utmost integrity, a passion for what Borders sells, energy, a hunger to succeed, and a deep respect for Borders Group employees.
Third Quarter Results
For the 14th consecutive quarter, the company met earnings expectations consistent with prior guidance, reporting a loss from operations of $0.8 million or $0.01 diluted per share compared to $0.4 million net income or $0.00 diluted earnings per share in the third quarter of 1997. Consolidated sales for the quarter were $558.3 million, a 17.0% increase over the prior year sales of $477.3 million.
Borders sales, including four international stores, increased to $349.4 million, a 24.5% increase over last year sales of $280.7 million. The sales improvement at Borders reflects an increase in the number of stores during the preceding 12 months from 189 to 238. During the quarter, a record 25 stores were opened, including two in the U.K. and one in Australia. On a comparable store basis, Borders sales increased 3.6%, slightly below the guidance provided at the beginning of the quarter.
Waldenbooks reported sales of $187.3 million, a 3.5% decline from the prior year sales of $194.1 million. Sales results at Waldenbooks reflects a comparable store sales decrease of 1.5% and a reduction in stores from 927 to 896 over the prior 12 months. Waldenbooks operates four airport stores (along with six Books etc. airport stores), and this continues to be an area of interest for the company.
Other sales, comprised primarily of Books etc., Borders.com, and Borders outlet were $21.6 compared to $2.5 million last year. Sales at Books etc. continue to be strong, outperforming expectations. Books etc. opened two stores during the quarter, ending at 25 stores. There are currently 15 Borders outlet stores, and the company continues to monitor this program.
The company consolidated two west coast distribution facilities into one state of the art facility in Mira Loma, California. This new facility will improve delivery times and in-stock levels at both Borders and Waldenbooks stores. An unplanned distribution center backlog during the startup of the new facility, attributable partly to software startup problems, negatively impacted comparable sales during the quarter by 50 basis points at Borders and 90 basis points at Waldenbooks. The flow of products was affected for about eight weeks. The problems have since been resolved, the facility is up to speed, and the current quarter should benefit from this new facility.
Income statement highlights. Consolidated gross margin increased to 26.0 % of sales for the third quarter of fiscal 1998 compared to 25.6% for the third quarter of fiscal 1997 due primarily to reduced shrinkage. Selling, general and administrative expenses as a percentage of sales increased slightly to 24.8% from 24.7% due to continued spending on strategic initiatives. Interest expense was $4.6 million compared to $1.7 million last year. The increase in net borrowings reflects share repurchases, the Books etc. acquisition, and fixed and working capital spending.
Balance sheet highlights. Inventories increased to $1,128.6 million in the third quarter of fiscal 1998 from $987.8 million in the third quarter of 1997, a 14.3% increase. The increase was primarily due to 49 more Borders stores and the addition of the fulfillment center which occurred in the later part of 1997. Short term debt net of cash and cash equivalents was $307.9 million at quarter-end compared to $194.2 million last year.
Strategic Initiatives
Borders completed several initiatives during the third quarter that will help achieve fourth quarter sales targets and contribute to continued sales growth over time. Among them is the opening of four international Borders stores including Oxford Street in London, 40,000 square feet; Brighton, England, 15,500 square feet; Melbourne, Australia, 27,500 square feet; and Glasgow, Scotland, 40,000 square feet. The customer reaction to each store has been extremely enthusiastic and confirms our optimism regarding the magnitude of the international opportunity. The Singapore store, opened in November 1997, continues to perform at a high level despite difficult economic conditions.
The new Waldenbooks Expert System, which is based on the principles of the Borders Expert System, was installed to improve the selection and availability of Waldenbooks backlist titles.
A record number of kiosks were opened during the quarter, including the company's first international kiosks.
Borders.com
The fall premiere of Borders.com took place at the end of September, featuring improved search functionality, increased content and a streamlined order process. Feedback on the site from customers is encouraging and enhanced marketing efforts have been initiated. As consistently communicated, Borders.com's objective is to extend the Borders brand globally, provide an on-line alternative for Borders customers and to create a sustainable, profitable business. Borders.com is part of the company's long term strategic plan, and the company continues to develop the business prudently, with a focus on disciplined spending until management sees a profitable model for this new channel of business. Management does not anticipate breaking out sales from Borders.com until they reach at least 5% of total sales.
Borders has begun to leverage the investment in Borders.com and the fulfillment center with the piloting of enhanced special order fulfillment for stores. This service enables customers to order from the three million books, music and video titles currently available through our fulfillment center. Availability and delivery are confirmed online from the fulfillment center at the time of the order and orders are shipped to the store within 24 hours for the customer to pick up. Over time, this should provide Borders with an important strategic advantage.
Regarding the impact of Internet commerce, the data suggest approximately a 50 to 80 basis-point impact on comparable store sales.
Management believes that the penetration rate for Internet-based sales of books, music, and video has been very rapid due to the more highly educated nature and computer access levels of the customer base and that additional penetration will occur at a far slower rate in the near future. Moreover, Internet-based book and music sales is a high-cost business, contrary to popular perceptions.
Competitors' Activity
Recently, Borders Group's largest competitor [Barnes & Noble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKS)") else Response.Write("(NYSE: BKS)") end if %>] announced the sale of half of its Internet site to Bertelsman. Borders had always anticipated that Bertelsman would enter the Internet bookselling market, and so this announcement is viewed as a net positive for Borders, because it removes another competitor. Along the same lines, CDNow <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CDNW)") else Response.Write("(Nasdaq: CDNW)") end if %> and N2K <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NTKI)") else Response.Write("(Nasdaq: NTKI)") end if %> also announced a merger. Borders views this as two struggling Internet competitors coming together to strengthen their position and eliminate the duplication of investment and losses. In both cases, it is surprisingly early in the cycle for consolidation to be occurring and might suggest something about the ultimate size of this market.
Borders Group's largest competitor also announced its intention to acquire Ingram Distribution Group. The announced price for Ingram was 10-times EBITDA, while Borders currently trades at less than nine-times EBITDA. Such an acquisition would not have been in Borders best interest for a number of reasons. First, Borders already fulfills nearly all of its own distribution requirements, including a facility that is across the street from Ingram. Second, Ingram is a very slow-growth business, and retail competitors may already be looking for alternatives in light of the announced acquisition, which may further impact Ingram's growth prospects. Third, Ingram's Spring Arbor division is the largest distributor of religious books, and from Borders's point of view, that linkage would have been an uncomfortable one for Borders. Finally, if Borders had acquired Ingram, it is management's opinion that Ingram might well have lost its wholesaler status with respect to its shipments to Borders. Having said that, Ingram's acquisition by a key competitor will have no impact on Borders, since Borders has long relied on its own internal distribution assets.
On the competitive front internationally, the major competitor in the U.K. is Waterstone, and that company has significant debt challenges. In Australia, there is nothing that begins to compare with Borders.
Guidance
Guidance for full year 1998 earnings remains unchanged at $1.22 per share, an increase of 25% over 1997. Fourth quarter comparable-store sales guidance is set at 4.0% to 4.5% for Borders stores and 0.0% to -1.0% for Waldenbooks stores. Now expect to open a total of 47 Borders superstores for the current fiscal year; 12 openings are planned for the fourth quarter. Management expects Waldenbooks net closings to be approximately 23 for the fiscal year. As has been the case in past years, management declines to provide precise guidance for the coming fiscal year until the crucial fourth quarter of this year is completed. Borders has announced plans to open three more stores in the U.K. next year, but final plans for international openings have not been completed.
New offerings in books, music, and video are all very strong for the holiday season.