Borders Group Q2 Conference Call
A Fool Conference Call Synopsis*
By Gregory Markus (TMF Boring)
ANN ARBOR, MI (August 12, 1998)-- Borders Group today announced results for the second quarter of fiscal 1998 ended July 26, 1998.
The company reported net income of $2.4 million or $0.03 diluted earnings per share compared to $0.5 million or $0.01 diluted earnings per share in the second quarter of 1997. Consolidated sales for the quarter were $546.0 million, a 17.1% increase over the prior year sales of $466.3 million.
Borders sales increased to $339.6 million, a 25.8% increase over last year sales of $269.9 million. The sales increase at Borders reflects an increase in the number of stores during the preceding 12 months from 171 to 213. Waldenbooks reported sales of $186.3 million, a 3.9% decline from prior year sales of $193.9 million.
Comparable Store Sales. On a comparable store basis, Borders sales increased 5.4%, which compares favorably with the 4.5% comparable-store sales generated in the first quarter of this year. Sales results at Waldenbooks reflects a comparable store sales decrease of 2.5% and a reduction in stores from 929 to 899 over the prior 12 months. A softness in Waldenbooks sales in May, possibly weather-related, negatively impacted the quarter; excluding May sales, the comparable sales decrease was 1.2% compared to the first quarter comparable sales decrease of 0.9%.
Store Openings, Closings. Seven Borders superstores opened in the quarter, bringing the total to 213. Waldenbooks closed six stores and opened one, at Dulles International Airport, ending the quarter with 899 stores. "Books etc." ended the quarter with a total of 23 stores.
Income Statement Highlights. Consolidated gross margin rose to 25.6% of sales for the second quarter of fiscal 1998 compared to 24.7% for the second quarter of fiscal 1997. Management attributed the increase in gross margin to a number of factors, including continued improvements in buying, distribution and inventory shrinkage results. Selling, general, and administrative expenses as a percentage of sales increased slightly to 23.9% from 23.8% due to increased spending on strategic initiatives.
Balance Sheet Highlights. Inventories increased to $888.8 million in the second quarter of fiscal 1998 from $719.4 million in the second quarter of 1997, a 23.5% increase. The increase was primarily due to 42 more Borders stores, the addition of the fulfillment center and Books etc., which occurred in the later part of fiscal 1997, earlier receipt of calendar merchandise, and earlier staging of stores to be opened in the third quarter. Short term debt net of cash and cash equivalents was $246.7 million at quarter-end compared to $55.2 million last year. The increase in borrowings primarily reflects the Books etc. acquisition, share repurchase activity, fixed asset additions, and typical working capital requirements.
E-commerce Initiative. A public preview of the Borders.com e-commerce site was launched in May. As has been stated before, the strategy there is to extend the Borders brand internationally, to provide an online alternative for Borders customers, and to create a sustainably profitable business. Additionally, the company plans to leverage the knowledge gained about customers online to make the retail stores even more effective. During the preview period, the company has been listening to its customers and working to enhance the features and functionality of the site, based on customer feedback and the company's own ideas. The grand opening of the site is planned for September, and you will see a continually improving site as well as stepped-up marketing efforts during this period.
International Initiatives. Sales at Books etc. in the U.K. are very strong. The second international Borders Books and Music superstore opened successfully on August 1 on Oxford Street in London. The store opening was very successful, ranking among the company's best in its history. Management continues to be impressed by both the opportunities but also the complexities of the international challenge. An additional three international stores are planned to open later this year, two in the United Kingdom (Brighton and Glasgow) and one in Australia (Melbourne).
Other Initiatives. The Dulles opening was the fourth airport store opening for Waldenbooks. Those, together with six Books etc. airport stores, yield a total of ten stores currently at airports. Airport book retailing continues to be an area of interest to Borders Group, and plans are to open two more airport-based stores later this year. Borders continues to test a pilot program for stores based at discount outlets. There are currently 14 stores operating at outlets, with the plan to end the year with 15. Also, the company looks forward to having kiosk-based sales of calendars and other items that will meet or exceed last year's levels.
Store Openings, Closings. The current expectation is to open 46 Borders superstores for the year, 42 domestically and four internationally. This is an increase from prior guidance by two domestic stores. By quarter, the prior guidance was for 3, 9, 22, and 10 store openings; current guidance is 3, 7, 26, and 10. On the Waldenbooks side, approximately 20 net closings are expected for the year, comprised of 14 openings and 34 closings. That compares with previous guidance of 23 net closings.
EPS Guidance. Management continues to endorse full-year earnings estimates of $1.22 per share, which would be a 25% increase over the prior year. Guidance for the third and fourth quarters has been revised slightly to reflect a shift in the timing of new store openings. Guidance for the fourth quarter has been increased a penny to $1.14, and guidance for the third quarter has been trimmed by a penny, from break-even to a one-cent loss. Comparable store sales through the balance of the year are expected to be in line with the pattern year-to-date, with the third quarter expected to be at the lower end of the range of 4.5% to 5.4% and the fourth quarter at the higher end of the range. For the full year, comparable-store sales are expected to be in the low 5% range for Borders and flat to -1% for Waldenbooks.
Management believes they have been "very realistic" in their internal forecasting assumptions for the Borders.com and international initiatives and does not believe there is much risk to their earnings forecasts for the balance of the year as a result of those initiatives.
Capital Expenditures. Guidance for the full year has been revised, primarily to reflect the increase in planned store openings, to $175 million from $160 million.
Management believes that there has been some speculation recently regarding the company's quarterly comparable-store sales and earnings and that this may have negatively impacted the stock price. Management reiterates that the company's policy has been and continues to be to provide detailed guidance at the beginning of each quarter and then not to comment further during the period. As a result, a "no comment" from the company is therefore not indicative of anything positively or negatively.
Borders Group has met analysts' expectations in every quarter since the company's initial public offering. If there is a material variance from earnings expectations, the company would anticipate giving advance notice of that, to the extent that they are aware of it.
Highlights of Responses to Questions
It is difficult to know precisely the impact that Internet-based sales have had upon the bricks-and-mortar retail business. Given that the company completed the quarter basically in line with its sales plan, which did not anticipate a particularly large impact from Internet-based sales, the inference is that much of the Internet-based sales are incremental to the industry. At the same time, the troubles faced by some retail booksellers -- such as the recent announcement by Crown Books -- may be indicative of some dislocation of sales from certain bricks-and-mortar stores. That could present an opportunity for Borders.
Management continues to believe that the Internet offers a great opportunity to drive the overall brand and drive customer satisfaction. At the same time, the costs of some of the Internet marketing arrangements and partnerships in the industry are hard to justify on an economic basis, either in the short-term or the long-term. Borders has, therefore, chosen not to play as aggressively in that area as some others have. Having said that, the company does have a number of Internet partnerships and is satisfied with them.
Borders is currently using internally-generated funds to finance its initiatives and has no need to raise any additional equity at this point.
Stock Options. Senior management has taken stock options in lieu of compensation this year, with a strike price of $29.81. Other options granted this year vest over a range of time periods, stretching out as far as six years. The combination of incentives is intended to align the interests of senior management and shareholders over both the short term and the long term.
* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.