2nd UPDATE: Borders Loss Widens; Sales, Margins Keep Slumping

Borders Group Inc. (BGP) continued to struggle as its fiscal second-quarter loss widened as customer traffic and sales continued their sharp decline and margins kept falling.

The sales slide has weighed mightily on the No. 2 U.S. bookstore operator by sales. Management has changed, thanks to an investment from financier Bennett LeBow that has helped prop Borders up amid declining consumer spending in the recession. In July, it agreed to sell its Paperchase stationery and gifts business for $31 million to pare its heavy debt load, though its debt net of cash actually was 2.7% higher versus the year-ago period at $262.1 million.

Online sales at Borders.com were a bright spot, jumping more than 56% over last year, but at just $15.5 million for the quarter they are a long way from fixing Borders' large and more immediate problems.

An expanded rewards program for customers, that now offers deeper discounts and free online shipping to customers for a $20 annual fee, went into effect Wednesday, along with a $20 price reduction on two electronic-book readers it sells. Borders hopes this, along with better customer service and expanded nonbook offerings in its stores, like craft kits from Build-A-Bear Workshop Inc. (BBW), can drive the top-line turnaround it desperately craves.

For the quarter ended July 31, Borders' loss from continuing operations was $51.6 million, or 74 cents a share, compared with a year-earlier loss of $45.1 million, or 75 cents a share. Shares outstanding rose 15%, thanks to the purchase during the quarter by Vector Group Ltd.'s (VGR) chairman and tobacco magnate LeBow, of 11.1 million shares for $25 million. LeBow is now chairman and chief executive of Borders Group, with President Mike Edwards running the day-to-day operations of the stores.

Revenue fell 11.9% to $530.4 million, following last year's 18% drop, as same-store sales slid 6.8%, and gross margin slumped to 19.3% from around 23% amid higher promotional discounts. Same-store sales at the No. 1 bookstore chain, Barnes & Noble Inc. (BKS), which also is struggling amid a proxy fight and an potential sale of the company, unexpectedly fell during its most recent quarter, but by a much smaller degree.

Borders currently has $150 million available under its revolving credit facility, and Edwards in a Wednesday interview said Borders is comfortable with its capacity going into the crucial holiday season. Availability of items in stock at stores is the best it has ever been, he said, and efforts to manage its supply chain and inventory should yield fourth-quarter working capital improvements.

Borders, a late entrant to the e-book market, has cut prices on its Kobo and Aluratek Libre readers by about $20, making the Aluratek less than $100 in an effort to attract customers. In a Tuesday interview, Edwards said Borders knows it can't meet its goal of a 17% share of the e-book market by next summer if it doesn't sell more readers.

In a conference call to discuss results, Edwards said the majority of its e-reader sales take place in stores, not online, and its online growth is being driven by better online market share of the traditional book categories. Edwards said in the Wednesday interview he expects more than 90% of its e-reader sales to happen in stores, because customers can test drive different models with well-versed sales people before buying.

Borders stock was down 2 cents, or 1.8%, at $1.06 apiece in recent Wednesday trading, and is off almost 66% in the past year. The low price damps hopes that LeBow will soon exercise a warrant to acquire 35.1 million warrants to acquire the stock at $2.25 that he will receive in conjunction with the initial investment, assuming shareholders approve its issuance later this month. The warrant would ultimately provide Borders a much-needed, roughly $79 million infusion, and give LeBow around a 35% equity stake.

-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com

(Matt Jarzemsky contributed to this article.)

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