10-Q 1 k66524e10-q.txt FORM 10-Q FOR THE QTR. ENDING OCTOBER 28, 2001 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10 - Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 28, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______. Commission file number 1-13740 BORDERS GROUP, INC. ------------------- (Exact name of registrant as specified in its charter) MICHIGAN 38-3294588 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Phoenix Drive, Ann Arbor, Michigan 48108 -------------------------------------------- (Address of principal executive offices) (zip code) (734) 477-1100 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------------- -------------- Title of Class Shares Outstanding As of -------------- December 5, 2001 Common Stock ---------------- 81,487,380 BORDERS GROUP, INC. INDEX Part I - Financial Information
Page Item 1. Financial Statements 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk N/A Part II - Other information Item 1. Legal Proceedings 17 Item 2. Changes in Securities and Use of Proceeds N/A Item 3. Defaults Upon Senior Securities N/A Item 4. Submission of Matters to a vote of N/A Securityholders Item 5. Other Information N/A Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18
BORDERS GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS EXCEPT COMMON SHARE DATA) (UNAUDITED)
13 WEEKS ENDED OCTOBER 28, OCTOBER 22, 2001 2000 ---------------------- --------------------- Sales $ 713.7 $ 701.1 Cost of merchandise sold, including occupancy costs 534.0 523.8 ---------------------- --------------------- Gross margin 179.7 177.3 Selling, general and administrative expenses 177.9 174.3 Pre-opening expense 2.5 2.3 Goodwill amortization 0.7 0.7 ---------------------- --------------------- Operating loss (1.4) - Interest expense 3.5 4.1 ---------------------- --------------------- Loss from continuing operations before income tax (4.9) (4.1) Income tax provision (benefit) (1.8) (1.5) ---------------------- --------------------- Loss from continuing operations (3.1) (2.6) Loss from discontinued operations, net of income tax credit of $1.5 - 2.4 ---------------------- --------------------- Net loss $ (3.1) $ (5.0) ====================== ===================== EARNINGS (LOSS) PER COMMON SHARE DATA -- Diluted earnings (loss) per common share: Continuing operations $ (0.04) $ (0.03) Discontinued operations - (0.03) ---------------------- --------------------- Net diluted loss per common share $ (0.04) $ (0.06) ====================== ===================== Diluted weighted average common shares outstanding (in thousands) 81,184 78,579 ====================== ===================== Basic earnings (loss) per common share: Continuing operations $ (0.04) $ (0.03) Discontinued operations - (0.03) ---------------------- --------------------- Net basic loss per common share $ (0.04) $ (0.06) ====================== ===================== Basic weighted average common shares outstanding (in thousands) 81,184 78,579 ====================== =====================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. (1) BORDERS GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS EXCEPT COMMON SHARE DATA) (UNAUDITED)
39 WEEKS ENDED OCTOBER 28, OCTOBER 22, 2001 2000 ---------------------- --------------------- Sales $ 2,183.4 $ 2,079.1 Cost of merchandise sold, including occupancy costs 1,632.8 1,545.6 Fulfillment center inventory writedowns 12.7 - ---------------------- --------------------- Gross margin 537.9 533.5 Selling, general and administrative expenses 536.2 519.9 Legal settlement expense 2.4 - Pre-opening expense 4.8 4.7 Asset impairments and other writedowns 15.8 - Goodwill amortization 2.0 2.1 ---------------------- --------------------- Operating income (loss) (23.3) 6.8 Interest expense 11.5 9.8 ---------------------- --------------------- Loss from continuing operations before income tax (34.8) (3.0) Income tax provision (benefit) (12.9) (1.1) ---------------------- --------------------- Loss from continuing operations (21.9) (1.9) Loss from discontinued operations, net of income tax credit of $3.6 - 5.6 ---------------------- --------------------- Net loss $ (21.9) $ (7.5) ====================== ===================== EARNINGS (LOSS) PER COMMON SHARE DATA -- Diluted earnings (loss) per common share: Continuing operations $ (0.27) $ (0.02) Discontinued operations - (0.07) ---------------------- --------------------- Net diluted loss per common share $ (0.27) $ (0.09) ====================== ===================== Diluted weighted average common shares outstanding (in thousands) 80,489 78,307 ====================== ===================== Basic earnings (loss) per common share: Continuing operations $ (0.27) $ (0.02) Discontinued operations - (0.07) ---------------------- --------------------- Net basic loss per common share $ (0.27) $ (0.09) ====================== ===================== Basic weighted average common shares outstanding (in thousands) 80,489 78,307 ====================== =====================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. (2) BORDERS GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)
OCTOBER 28, OCTOBER 22, JANUARY 28, 2001 2000 2001 ------------------ ------------------ ------------------ ASSETS Current Assets: Cash and cash equivalents $ 62.1 $ 56.4 $ 59.1 Merchandise inventories 1,405.0 1,386.5 1,201.2 Accounts receivable and other current assets 75.2 78.4 74.8 ------------------ ------------------ ------------------ Total Current Assets 1,542.3 1,521.3 1,335.1 Property and equipment, net of accumulated depreciation of $561.3, $456.8 and $515.9 at October 28, 2001, October 22, 2000, and January 28, 2001, respectively 533.8 566.4 562.3 Other assets and deferred charges 57.2 35.3 56.5 Goodwill, net of accumulated amortization of $55.1, $52.2 and $53.1 at October 28, 2001, October 22, 2000 and January 28, 2001, respectively 90.3 110.2 93.2 ------------------ ------------------ ------------------ Total Assets $ 2,223.6 $ 2,233.2 $ 2,047.1 ================== ================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Short-term debt and capital lease obligations due within one year $ 279.4 $ 386.7 $ 144.4 Trade accounts payable 789.1 754.1 623.6 Accrued payroll and other liabilities 188.2 183.5 256.6 Taxes, including income taxes 36.2 30.0 93.3 ------------------ ------------------ ------------------ Total Current Liabilities 1,292.9 1,354.3 1,117.9 Long-term debt and capital lease obligations 13.8 15.6 15.0 Other long-term liabilities 73.1 70.1 67.7 ------------------ ------------------ ------------------ Total Liabilities 1,379.8 1,440.0 1,200.6 ------------------ ------------------ ------------------ Stockholders' Equity: Common stock; 200,000,000 shares authorized; 81,307,005, 78,501,289 and 78,649,501 issued and outstanding at October 28, 2001, October 22, 2000, and January 28, 2001, respectively 711.2 684.0 685.2 Officers receivable and deferred compensation (0.5) (1.2) (1.0) Accumulated other comprehensive loss (15.3) (8.8) (8.0) Retained earnings 148.4 119.2 170.3 ------------------ ------------------ ------------------ Total Stockholders' Equity 843.8 793.2 846.5 ------------------ ------------------ ------------------ Total Liabilities & Stockholders' Equity $ 2,223.6 $ 2,233.2 $ 2,047.1 ================== ================== ==================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. (3) BORDERS GROUP, INC. CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE 39 WEEKS ENDED OCTOBER 28, 2001 (DOLLARS IN MILLIONS) (UNAUDITED)
DEFERRED ACCUMULATED COMPENSATION OTHER COMMON STOCK AND OFFICER COMPREHENSIVE RETAINED SHARES AMOUNT RECEIVABLES LOSS EARNINGS TOTAL -------------- ------------ ---------------- ----------------- ------------ ------------ BALANCE AT JANUARY 28, 2001 78,649,501 $ 685.2 $ (1.0) $ (8.0) $ 170.3 $ 846.5 -------------- ------------ ---------------- ----------------- ------------ ------------ Net loss - - - - (21.9) (21.9) Currency translation adjustment - - - (3.0) - (3.0) Cumulative effect of change in accounting method, net of tax - - - (1.6) - (1.6) Change in fair value of derivatives, net of tax - - - (2.7) - (2.7) ------------ Comprehensive income (loss) (29.2) Issuance of common stock 3,148,644 27.5 - - - 27.5 Repurchase and retirement of common stock (491,140) (7.0) - - - (7.0) Change in receivable and deferred compensation - - 0.5 - - 0.5 Tax benefit of equity compensation - 5.5 - - - 5.5 -------------- ------------ ---------------- ----------------- ------------ ------------ BALANCE AT OCTOBER 28, 2001 81,307,005 $ 711.2 $ (0.5) $ (15.3) $ 148.4 $ 843.8 ============== ============ ================ ================= ============ ============
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. (4) BORDERS GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
39 WEEKS ENDED OCTOBER 28, OCTOBER 22, 2001 2000 ------------------ ------------------- CASH PROVIDED BY (USED FOR): OPERATIONS Net loss from continuing operations $ (21.9) $ (1.9) Adjustments to reconcile net loss to operating cash flows: Depreciation and goodwill amortization 69.1 69.2 Change in other long-term assets and liabilities 4.5 4.9 Asset impairments and other writedowns 10.0 - Cash provided by (used for) current assets and current liabilities: Increase in inventories (204.5) (307.7) Decrease in accounts payable 166.5 179.3 Decrease in taxes payable (52.6) (47.4) Other, net (73.7) (45.2) ------------------ ------------------- Net cash used for continuing operations (102.6) (148.8) Net cash provided by (used for) discontinued operations 1.9 (19.5) ------------------ ------------------- Net cash used for operations (100.7) (168.3) INVESTING Capital expenditures (56.9) (84.1) Disposition of property and equipment 5.6 - Net investing activities of discontinued operations - (1.7) ------------------ ------------------- Net cash used for investing (51.3) (85.8) FINANCING Net funding from credit facility 137.2 263.8 Issuance of common stock 27.5 11.6 Repurchase of common stock (7.0) (7.2) Other, net (2.1) 0.9 ------------------ ------------------- Net cash provided by financing 155.6 269.1 Effect of exchange rates on cash and equivalents (0.6) (0.2) ------------------ ------------------- NET INCREASE IN CASH AND EQUIVALENTS 3.0 14.8 Cash and equivalents at beginning of year 59.1 41.6 ------------------ ------------------- Cash and equivalents at end of period $ 62.1 $ 56.4 ================== ===================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. (5) BORDERS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Borders Group, Inc. (the Company) have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all the information and notes required by accounting principles generally accepted in the United States for complete financial statements. All adjustments, consisting only of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. The unaudited condensed consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto for the fiscal year ended January 28, 2001. The Company's fiscal year ends on the Sunday immediately preceding the last Wednesday in January. At October 28, 2001, the Company operated 374 superstores primarily under the Borders name, including 11 in the United Kingdom, five in Australia, and one each in Singapore, New Zealand, and Puerto Rico. The Company also operated 856 mall-based and other bookstores primarily under the Waldenbooks name, and 34 bookstores under the Books etc. name in the United Kingdom. The Company also operated the Internet commerce site Borders.com through July 31, 2001. Effective August 1, 2001, the Company re-launched Borders.com as a co-branded Web site powered by Amazon.com's e-commerce platform. Amazon.com is the seller of record, providing inventory, fulfillment, site content and customer service for the co-branded site. NOTE 2 - COMMITMENTS AND CONTINGENCIES During 1994, the Company entered into agreements in which leases with respect to four Borders' locations serve as collateral for certain mortgage pass-through certificates. These mortgage pass-through certificates include a provision requiring the Company to repurchase the underlying mortgage notes in certain events, including the failure by the Company to make payments of rent under the related leases, the failure by Kmart Corporation to maintain required investment grade ratings or the termination of the guarantee by Kmart Corporation of the Company's obligations under the related leases (which would require the mutual consent of Kmart Corporation and Borders). In the event the Company is required to repurchase all of the underlying mortgage notes, the Company would be obligated to pay approximately $36.6. In August 1998, The Intimate Bookshop, Inc. ("Intimate") and its owner, Wallace Kuralt, filed a lawsuit in the United States District Court for the Southern District of New York against the Company, Barnes & Noble, Inc., and others alleging violation of the Robinson-Patman Act and other federal laws, New York statutes governing trade practices and common law. In response to Defendants' Motion to Dismiss the Complaint, plaintiff Kuralt withdrew his claims and plaintiff Intimate voluntarily dismissed all but its Robinson-Patman claims. Intimate has filed a Second Amended Complaint limited to allegations of violations of the Robinson-Patman act. The Second Amended Complaint alleges that Intimate has suffered $11.3 million or more in damages and requests treble damages, injunctive and declaratory relief, interest, costs, attorneys fees and other unspecified relief. The Company intends to vigorously defend the action. (6) BORDERS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions except per common share data) Two former employees, individually and on behalf of a purported class consisting of all current and former employees who worked as assistant managers in Borders stores in the state of California at any time between April 10, 1996, and the present, have filed an action against Borders in the Superior Court of California for the County of San Francisco. The action alleges that the individual plaintiffs and the purported class members worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law, and that they were classified as "exempt" store management employees but were forced to work more than 50% of their time in non-exempt tasks. The Amended Complaint, which names two additional plaintiffs, alleges violations of the California Labor Code and the California Business and Professions Code. The relief sought includes compensatory and punitive damages, penalties, preliminary and permanent injunctions requiring Borders to pay overtime compensation as required under California and Federal law, prejudgment interest, costs and attorneys fees and such other relief as the court deems proper. The hearing on the motion to certify the action as a class action has been rescheduled for April 19, 2002. The Company intends to vigorously defend the action, including contesting the certification of the action as a class action. The Company has not included any liability in its financial statements in connection with the lawsuits described above and has expensed as incurred all costs to date. In addition to the matters described above, the Company is from time to time involved in or affected by other litigation incidental to the conduct of its businesses. The Company does not believe that any such other litigation will have a material adverse effect on its liquidity or financial position. NOTE 3 - FINANCING Credit Facility: The Company has a $472.8 multicurrency credit agreement (the Credit Facility), which expires in October 2002. Borrowings under the Credit Facility bear interest at a base rate or an increment over LIBOR at the Company's option. The Credit Facility contains operating covenants which limit the Company's ability to incur indebtedness, grant liens, make acquisitions, merge, declare dividends, dispose of assets, issue or repurchase its common stock in excess of $100.0 million (plus any proceeds and tax benefits resulting from stock option exercises and tax benefits resulting from restricted shares purchased by employees from the Company), and require the Company to meet certain financial measures regarding fixed charge coverage, leverage and tangible net worth. The Company is prohibited under the Credit Facility from paying cash dividends on common shares. The Company had borrowings outstanding under the Credit Facility of $278.3 as of October 28, 2001 and $143.5 as of January 28, 2001. Lease Financing Facility: The Company has a $175.0 lease financing facility (the Lease Facility) to finance new stores and other property through operating leases, which expires in October 2002. The Lease Facility provides financing to lessors through loans from a third party lender for up to 95% of a project cost. It is expected that lessors will make equity contributions approximating 5% of each project. Independent of its obligations as lessee, the Company guarantees payment when due of all amounts required to be paid to the third party lender. The principal amount guaranteed is limited to approximately 89% of the original cost of a project so long as the Company is not in default under the lease relating to such project. The Lease Facility contains covenants and events of default that are similar to those contained in the Credit Facility described above. There was $132.1 outstanding under the Lease Facility as of October 28, 2001 and $163.1 as of January 28, 2001. (7) BORDERS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions except per common share data) NOTE 4 - ASSET IMPAIRMENTS AND OTHER WRITEDOWNS On March 15, 2001, the Company announced an agreement with Ingram Book Group ("Ingram"), a wholesaler of books, spoken audio and magazines, pursuant to which Ingram will provide book fulfillment services for the Company's special order sales. This agreement resulted in a pre-tax charge of $15.8 in the first quarter of 2001. This charge is primarily related to the writedown of assets used by the current Company-owned facility to fulfill special order sales, including warehouse equipment, hardware and software, and is categorized as "Asset impairments and other writedowns" on the Condensed Consolidated Statements of Operations. The agreement with Ingram also resulted in a $12.7 pre-tax charge for the writedown of Fulfillment center inventory. This charge is categorized as "Fulfillment center inventory writedowns" on the Condensed Consolidated Statements of Operations. NOTE 5 - LEGAL SETTLEMENT On April 19, 2001, the Company announced that a settlement had been reached in the action instituted by the American Booksellers Association and 26 independent bookstores against the Company and Barnes and Noble, Inc. The Company paid $2.4 under the agreement. The Company has categorized this charge as "Legal settlement expense" in the Condensed Consolidated Statements of Operations. NOTE 6 - CHANGE IN ACCOUNTING PRINCIPLE Effective January 29, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), as amended. FAS 133 requires the transition adjustment resulting from adoption to be reported in net income or other comprehensive income, as appropriate, as the cumulative effect of a change in accounting principle. Accordingly, the Company recorded a cumulative transition adjustment to decrease other comprehensive income by $1.6, net of tax, to recognize the fair value of its derivative financial instruments as of the date of adoption. The Company is subject to risk resulting from interest rate fluctuations, as interest on the Company's borrowings is principally based on variable rates. The Company's objective in managing its exposure to interest rate fluctuations is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. The Company primarily utilizes interest rate swaps to achieve this objective, effectively converting a portion of its variable-rate exposures to fixed interest rates. In accordance with the provisions of FAS 133, the Company has designated all of its interest rate swap agreements as cash flow hedges. The Company recognizes the fair value of its derivatives on the balance sheet. Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Amounts reclassified into earnings related to interest swap agreements are included in interest expense. During the quarter ended October 28, 2001, no unrealized after-tax net gains or losses related to interest rate swaps were recorded in other comprehensive income. As of October 28, 2001, $4.3 of net unrealized losses related to interest rate swaps was included in accumulated other comprehensive income, approximately $3.9 of which is expected to be reclassified into earnings during the next twelve months. The hedge ineffectiveness for the quarter ending October 28, 2001 was not material. (8) BORDERS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) NOTE 7 - SEGMENT INFORMATION The Company is organized based upon the following operating segments: domestic Borders stores, international Borders and Books etc. stores, Walden stores, and other (consisting of interest expense and certain corporate governance costs). Segment data includes charges allocating certain corporate headquarters costs to each segment. Transactions between segments, consisting principally of inventory transfers, are recorded primarily at cost. The Company evaluates the performance of its segments and allocates resources to them based on anticipated future contribution. Amounts relating to Borders.com, other than intercompany interest expense (net of related taxes) have been included in the Borders segment; intercompany interest charges (net of related taxes) relating to Borders.com have been included in the Other segment.
13 WEEKS ENDED 39 WEEKS ENDED OCTOBER 28, OCTOBER 22, OCTOBER 28, OCTOBER 22, 2001 2000 2001 2000 --------------- --------------- --------------- --------------- Sales: Borders $ 480.6 $ 464.3 $ 1,492.3 $ 1,377.9 Walden 173.8 185.3 526.2 555.5 International 59.3 51.5 164.9 145.7 --------------- --------------- --------------- --------------- Total sales $ 713.7 $ 701.1 $ 2,183.4 $ 2,079.1 =============== =============== =============== =============== Net income (loss): Borders $ 4.1 $ 2.6 $ 3.0 $ 14.0 Walden (1.3) 1.1 (3.5) 2.8 International (3.1) (3.8) (11.0) (11.2) Other (2.8) (2.5) (10.4) (7.5) --------------- --------------- --------------- --------------- Total continuing operations (3.1) (2.6) (21.9) (1.9) Discontinued operations - 2.4 - 5.6 --------------- --------------- --------------- --------------- Total net loss $ (3.1) $ (5.0) $ (21.9) $ (7.5) =============== =============== =============== =============== OCTOBER 28, OCTOBER 22, 2001 2000 --------------- --------------- Total assets: Borders $ 1,396.1 $ 1,378.3 Walden 492.8 527.5 International 233.7 204.3 Other 88.8 84.6 --------------- --------------- Total continuing operations 2,211.4 2,194.7 Discontinued operations 12.2 38.5 --------------- --------------- Total assets $ 2,223.6 $ 2,233.2 =============== ===============
(9) BORDERS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) NOTE 8 - NEW ACCOUNTING GUIDANCE In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the provisions of the Statements will have the impact of eliminating the Company's goodwill amortization commencing in the first quarter of fiscal 2002. The Company has not yet determined what the effect of this new rule will be on the earnings and financial position of the Company. In August 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 is effective for fiscal years beginning after December 15, 2001. The Company expects to adopt FAS 144 beginning in the first quarter of fiscal 2002, and it does not expect that the adoption of the Statement will have a significant impact on the Company's financial position and results of operations. NOTE 9 - EFFECT OF TERRORIST ATTACKS ON SEPTEMBER 11, 2001 As a result of the terrorist attacks on September 11, 2001, a Borders store that operated in the World Trade Center in New York City was destroyed. The loss of that store's sales and net income for the 13 and 39 weeks ended October 28, 2001 was not material to the consolidated results as a whole. The Company was fully insured for the cost of the assets destroyed at the store. Inventory of $3.5, fixed assets of $5.6, and accounts receivable and other of $0.9 have been removed from the accounts, offset by an insurance recovery to date of $10.0. In addition, the Company expects to recover additional property amounts and lost income for up to 24 months from business interruption insurance coverage, which will be recognized when collection of such recoveries is assured. (10) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company, through its subsidiaries, is the second largest operator of book and music superstores and the largest operator of mall-based bookstores in the world based upon both sales and number of stores. At October 28, 2001, the Company operated 374 superstores primarily under the Borders name, including 11 in the United Kingdom, five in Australia, and one each in Singapore, New Zealand, and Puerto Rico. The Company also operated 856 mall-based and other bookstores primarily under the Waldenbooks name, and 34 bookstores under the Books etc. name in the United Kingdom. The Company also operated the Internet commerce site Borders.com through July 31, 2001. Effective August 1, 2001, the Company re-launched Borders.com as a co-branded Web site powered by Amazon.com's e-commerce platform. Amazon.com is the seller of record, providing inventory, fulfillment, site content and customer service for the co-branded site. The Company's business strategy is to continue its growth and increase its profitability through (i) the continued expansion and refinement of its Borders superstore operation in the United States and internationally, (ii) the continued focus on opportunistic store openings in its mall-based bookstore operations and expansion of its kiosk operations, (iii) the development of web-based commerce technologies which enhance the customer experience in-store, and (iv) disciplined management of expenses and working capital. The Company's third quarters of 2001 and 2000 consisted of the 13 weeks ended October 28, 2001 and October 22, 2000, respectively. RESULTS OF OPERATIONS The following table presents the Company's consolidated statement of operations data, as a percentage of sales, for the periods indicated.
13 WEEKS ENDED 39 WEEKS ENDED OCTOBER 28, 2001 OCTOBER 22, 2000 OCTOBER 28, 2001 OCTOBER 22, 2000 ---------------- ---------------- ---------------- ---------------- RESULTS OF OPERATIONS Sales 100.0% 100.0% 100.0% 100.0% Cost of merchandise sold (includes occupancy) 74.8 74.7 74.8 74.3 Fulfillment center inventory writedowns -- -- 0.6 -- ----- ----- ----- ----- Gross margin 25.2 25.3 24.6 25.7 Selling, general and administrative expenses 24.9 24.9 24.6 25.0 Legal settlement expense -- -- 0.1 -- Pre-opening expense 0.4 0.3 0.2 0.2 Goodwill amortization 0.1 0.1 0.1 0.1 ----- ----- ----- ----- Operating income (loss) before asset impairments and other writedowns (0.2) -- (0.4) 0.4 Asset impairments and other writedowns -- -- 0.7 -- ----- ----- ----- ----- Operating income (loss) (0.2) -- (1.1) 0.4 Interest expense 0.5 0.6 0.5 0.5 ----- ----- ----- ----- Loss before income tax (0.7) (0.6) (1.6) (0.1) Income tax benefit (0.3) (0.2) (0.6) (0.1) ------ ------ ------ ------ Loss from continuing operations (0.4) (0.4) (1.0) -- ------ ------ ------ ----- Discontinued operations, net of tax: Loss from operations of All Wound Up -- 0.3 -- 0.3 Net loss (0.4)% (0.7)% (1.0)% (0.3)% ------ ------ ------ ------
(11) CONSOLIDATED RESULTS Consolidated sales increases in both the 13 and 39 weeks ended October 28, 2001 resulted primarily from the opening of new Borders superstores. Consolidated gross margin as a percentage of sales remained essentially flat in the third quarter of 2001 compared to the prior year. For the 39 weeks ended October 28, 2001, gross margin as a percentage of sales decreased compared to the prior year. The decrease primarily resulted from a $12.7 million pre-tax charge for the writedown of inventory affected by the Company's agreement with Ingram Book Company ("Ingram"). On March 15, 2001, the Company announced an agreement with Ingram, a wholesaler of books, spoken audio and magazines, pursuant to which Ingram will provide book fulfillment services for the Company's special order sales. The agreement included the sale to Ingram of a large percentage of the book inventory housed in the Company's fulfillment center in LaVergne, Tennessee, which handled the function assumed by Ingram. Also contributing to the lower gross margin percentage for the 39 weeks ended October 28, 2001 were increased store occupancy expenses as a percentage of sales. Consolidated selling, general and administrative expenses as a percentage of sales remained flat in the third quarter of 2001 compared to the prior year. Consolidated selling, general and administrative expenses decreased as a percentage of sales for the 39 weeks ended October 28, 2001 compared to the prior year primarily as a result of strong expense control. In particular, Borders store payroll costs and advertising costs decreased as a percentage of sales. On April 19, 2001, the Company announced that a settlement had been reached in the action instituted by the American Booksellers Association and 26 independent bookstores against the Company and Barnes and Noble, Inc. The Company paid $2.4 million under the agreement. The Company has categorized this charge as "Legal settlement expense" in the Condensed Consolidated Statements of Operations. In addition to the writedown of inventory discussed above, the Company's agreement with Ingram resulted in a pre-tax charge of $15.8 million in the first quarter of 2001. This charge is primarily related to the writedown of assets used by the current Company-owned facility to fulfill special order sales, including computer hardware and software, leasehold improvements, and warehouse equipment. Interest expense remained essentially flat as a percentage of sales in both the 13 and 39 weeks ended October 28, 2001 compared to the prior year. In January 2001, the Company adopted a plan to discontinue operations of All Wound Up, a seasonal retailer of interactive toys and novelty merchandise the Company had acquired in March 1999. All Wound Up is reflected in the Consolidated Statements of Operations as a discontinued operation. The Company includes certain distribution and other expenses in its inventory costs, particularly freight, distribution payroll, and certain occupancy expenses. In addition, certain selling, general and administrative expenses are included in inventory costs. These amounts approximate 2% of total inventory. As a result of the terrorist attacks on September 11, 2001, a Borders store that operated in the World Trade Center in New York City was destroyed. The loss of that store's sales and net income for the 13 and 39 weeks ended October 28, 2001 was not material to the consolidated results as a whole. The Company was fully insured for the cost of the assets destroyed at the store. Inventory of $3.5, fixed assets of $5.6, and accounts receivable and other of $0.9 have been removed from the accounts, offset by an insurance recovery to date of $10.0. In addition, the Company expects to recover additional property amounts and lost income for up to 24 months from business interruption insurance coverage, which will be recognized when collection of such recoveries is assured. (12) SEGMENT RESULTS The Company is organized based upon the following operating segments: domestic Borders stores, Waldenbooks stores, international Borders and Books etc. stores, and other (consisting of interest expense and certain corporate governance costs). See Note 7 of the Notes to Consolidated Financial Statements for further information relating to these segments. Segment data includes charges allocating certain corporate headquarters costs to each segment. Transactions between segments, consisting principally of inventory transfers, are recorded primarily at cost. The Company evaluates the performance of its segments and allocates resources to them based on anticipated future contribution. Amounts relating to Borders.com, other than intercompany interest expense (net of related taxes) have been included in the Borders segment; intercompany interest charges (net of related taxes) relating to Borders.com have been included in the Other segment.
13 WEEKS ENDED 39 WEEKS ENDED (DOLLAR AMOUNTS IN MILLIONS) BORDERS OCTOBER 28, 2001 OCTOBER 22, 2000 OCTOBER 28, 2001 OCTOBER 22, 2000 ---------------- ---------------- ---------------- ---------------- Sales $ 480.6 $ 464.3 $ 1,492.3 $ 1,377.9 Net income $ 4.1 $ 2.6 $ 3.0 $ 14.0 Net income as % of sales 0.9% 0.6% 0.2% 1.0% Depreciation and amortization expense $ 16.3 $ 14.8 $ 48.2 $ 45.3 Interest expense $ 2.7 $ 3.5 $ 8.5 $ 9.4 Store Openings 11 17 21 32 Store Closings 1 - 1 - Store Count 355 323 355 323 --------- --------- --------- ---------
The increases in Borders sales in 2001 compared to the prior year are primarily the result of new store openings. Borders operated 355 and 323 stores at the end of the third quarter of 2001 and 2000, respectively, and experienced comparable store sales decrease of 0.2% in the third quarter of 2001. The comparable store sales increase for the 39 weeks ended October 28, 2001 was 1.2%. For the third quarter of 2001, Borders generated net income of $4.1 million, or approximately 0.9% of sales. The increase in net income compared to the prior year was the result of store openings and Borders' ability to leverage fixed costs over a larger sales base. The increase in net income as a percentage of sales was the result of a reduction in Borders.com operating expenses in conjunction with the agreement with Amazon.com and lower store payroll expenses as a percentage of sales. For the 39 weeks ended October 28, 2001, the decrease in net income primarily resulted from the first quarter writeoff of certain assets and inventory pursuant to the alliance with Ingram. Net income decreased as a percentage of sales for the 39 weeks ended October 28, 2001, compared to the prior year primarily due to operating agreement with Amazon.com and the alliance with Ingram. Depreciation and amortization expense increased in 2001 compared to the prior year primarily as a result of the depreciation expense recognized on new stores' capital expenditures. Interest expense decreased in 2001 compared to the prior year primarily as a result of decreased borrowing needs.
13 WEEKS ENDED 39 WEEKS ENDED WALDENBOOKS OCTOBER 28, 2001 OCTOBER 22, 2000 OCTOBER 28, 2001 OCTOBER 22, 2000 ---------------- ---------------- ---------------- ---------------- Sales $ 173.8 $ 185.3 $ 526.2 $ 555.5 Net income (loss) $ (1.3) $ 1.1 $ (3.5) $ 2.8 Net income (loss) as % of sales (0.7)% 0.6% (0.7)% 0.5% Depreciation expense $ 4.8 $ 6.0 $ 14.3 $ 17.6 Interest income $ 6.8 $ 6.1 $ 20.4 $ 18.9 Store Openings 7 3 11 8 Store Closings 6 4 24 22 Store Count 856 890 856 890 ------- ------- ------- -------
The decreases in Waldenbooks sales in 2001 compared to the prior year are primarily the result of the decrease in store count coupled with comparable store sales decreases of 4.1% and 3.8% for the 13 and 39 weeks ended October 28, 2001, respectively. The net loss in 2001 (for both the 13 and 39 weeks ended October 28, 2001) resulted primarily from a decrease in gross margin from the prior year. (13) This was due to higher store occupancy costs and payroll costs as a percentage of sales resulting from the smaller store base and lower sales volume as compared to the prior year. Depreciation expense decreased in 2001 (for both the 13 and 39 weeks ended October 28, 2001) primarily as a result of the decrease in store count and the impairment of 103 underperforming stores' leaseholds and fixtures in the fourth quarter of 2000. Interest income increased in 2001 as a result of Waldenbooks' continued positive cash flow in the periods presented.
13 WEEKS ENDED 39 WEEKS ENDED INTERNATIONAL OCTOBER 28, 2001 OCTOBER 22, 2000 OCTOBER 28, 2001 OCTOBER 22, 2000 ---------------- ---------------- ---------------- ---------------- Sales $ 59.3 $ 51.5 $ 164.9 $ 145.7 Net loss $ 3.1 $ 3.8 $ 11.0 $ 11.2 Net loss as % of sales 5.2% 7.4% 6.7% 7.7% Depreciation and amortization $ 2.2 $ 2.2 $ 6.6 $ 6.3 expense Interest expense $ 3.4 $ 3.2 $ 10.0 $ 8.8 Superstore Store Openings 2 1 5 5 Superstore Store Count 19 14 19 14 Books etc. Store Openings 2 1 3 4 Books etc. Store Closings - - - - Books etc. Store Count 34 31 34 31 ------- ------- ------- -------
The increases in International sales in 2001 compared to the prior year resulted from new superstore openings and comparable store sales increases. Net loss and net loss as a percentage of sales for the 13 and the 39 weeks ended October 28, 2001, due to increased operating income generated from the maturation of the prior year's store base. Depreciation and amortization expense remained relatively flat in 2001. Interest expense increased in 2001 compared to the prior year due to higher average borrowing levels necessary to finance investments in new stores.
13 WEEKS ENDED 39 WEEKS ENDED OTHER OCTOBER 28, 2001 OCTOBER 22, 2000 OCTOBER 28, 2001 OCTOBER 22, 2000 ---------------- ---------------- ---------------- ---------------- Net loss $ 2.8 $ 2.5 $ 10.4 $ 7.5 Interest expense $ 4.2 $ 3.5 $ 13.4 $ 10.5 ------ ------ ------ ------
Net loss consists of various corporate governance costs and income. The net loss for the third quarter of 2001 increased from the same period in the prior year primarily due to increased interest expense for this segment, partially offset by lower legal costs associated with the American Booksellers Association litigation. The net loss for the 39 weeks ended October 28, 2001 increased from the prior year due to the settlement cost of the American Booksellers Association litigation, which totaled approximately $1.4 million after-tax. Interest expense represents corporate-level interest costs not charged to the Company's operating segments. Higher average borrowing levels for the 13 and 39 weeks ended October 28, 2001 resulted in increased interest expense compared to the prior year. LIQUIDITY AND CAPITAL RESOURCES The Company's principal capital requirements are to fund working capital needs, the opening of new stores, the refurbishment and expansion of existing stores, and continued development of information commerce technologies. Net cash used for continuing operations for the 39 weeks ended October 28, 2001, was $102.6 million as compared to $148.8 million in the corresponding period in the prior year. Cash from operations for the period primarily reflects operating results net of non-cash depreciation and amortization expense and an increase in inventories. Operating cash outflows for the period were primarily the result of decreases in accounts payable, taxes payable, and accrued liabilities during the period. Net cash provided by discontinued operations represents the cash provided by operations of All Wound Up in the first 39 weeks of 2001. (14) Net cash used by discontinued operations represents the cash needed for the operations of All Wound Up in the first 39 weeks of 2000. Net cash used for investing for the first 39 weeks of 2001 was $56.9 million as compared to $84.1 million in the first 39 weeks of 2000, and primarily represents capital expenditures for new stores. Net cash provided by financing in the first 39 weeks of 2001 was $155.6 million versus $269.1 million in the first 39 weeks of 2000, resulting primarily from net borrowings under the Credit Facility and the issuance of common stock under the Company's employee benefit plans. The Company has a $472.8 million multicurrency credit agreement (the Credit Facility), which expires in October 2002. Borrowings under the Credit Facility bear interest at a base rate or an increment over LIBOR at the Company's option. The Credit Facility contains covenants which limit, among other things, the Company's ability to incur indebtedness, grant liens, make acquisitions, merge, declare dividends, dispose of assets, issue or repurchase its common stock in excess of $100.0 million (plus any proceeds and tax benefits resulting from stock option exercises and tax benefits resulting from restricted shares purchased by employees from the Company), and require the Company to meet certain financial measures regarding fixed charge coverage, leverage and tangible net worth. The Company is prohibited under the Credit Facility from paying cash dividends on common shares. The Company believes that it can renew the Credit Facility or otherwise obtain capital necessary to fund the Company's business plan. The Company has a $175.0 million lease financing facility (the Lease Facility) to finance new stores and other property through operating leases that expires in October 2002. The Lease Facility provides financing to lessors through loans from a third party lender for up to 95% of a project cost. It is expected that lessors will make equity contributions approximating 5% of each project. Independent of its obligations as lessee, the Company guarantees payment when due of all amounts required to be paid to the third party lender. The principal amount guaranteed will be limited to approximately 89% of the original cost of a project, so long as the Company is not in default under the lease relating to such project. The Lease Facility contains covenants and events of default that are similar to those contained in the Credit Facility described above. There were 35 and 40 properties financed through the Lease Facility, with a financed value of $132.1 million and $163.1 million, as of October 28, 2001, and January 28, 2001, respectively. Management believes that the rental payments for properties financed through the Lease Facility may be lower than those which the Company could obtain elsewhere due to, among other factors, (i) the lower borrowing rates available to the Company's landlords under the facility, and (ii) the fact that rental payments for properties financed through the facility do not include amortization of the principal amounts of the landlords' indebtedness related to the properties. Rental payments relating to such properties will be adjusted when permanent financing is obtained to reflect the interest rates available at the time of the refinancing and the amortization of principal. During 1994, the Company entered into agreements in which leases with respect to four Borders' locations serve as collateral for certain mortgage pass-through certificates. These mortgage pass-through certificates include a provision requiring the Company to repurchase the underlying mortgage notes in certain events, including the failure by the Company to make payments of rent under the related leases, the failure by Kmart Corporation (the former parent of the Company) to maintain required investment grade ratings or the termination of the guarantee by Kmart of the Company's obligations under the related leases (which would require mutual consent of Kmart and Borders). In the event the Company is required to repurchase all of the underlying mortgage notes, the Company would be obligated to pay approximately $36.6 million. The Company would expect to fund this obligation through its line of credit. The Company currently has a share repurchase program in place with remaining authorization to repurchase approximately $90.2 million. (15) OTHER MATTERS NEW ACCOUNTING GUIDANCE In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the provisions of the Statements will have the impact of eliminating the Company's goodwill amortization commencing in the first quarter of fiscal 2002. The Company has not yet determined what the effect of this new rule will be on the earnings and financial position of the Company. In August 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 is effective for fiscal years beginning after December 15, 2001. The Company expects to adopt FAS 144 beginning in the first quarter of fiscal 2002, and it does not expect that the adoption of the Statement will have a significant impact on the Company's financial position and results of operations. FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect management's current expectations and are inherently uncertain. The Company's actual results may differ significantly from management's expectations. Exhibit 99.1 to this report, "Cautionary Statement under the Private Securities Litigation Reform Act of 1995", identifies the forward-looking statements and describes some, but not all, of the factors that could cause these differences. (16) PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company's Form 10-K Annual Report for the fiscal year ended January 28, 2001, describes pending lawsuits against the Company. An adverse judgment against the Company in any of these matters could have a material adverse effect on the Company. The status of such litigation has not changed in any material respect during the period covered by this Report. The hearing on the motion to certify as a class action the lawsuit relating to overtime pay initially instituted by Marissa Everett and Terry Blagsvedt in Superior Court of California has been rescheduled for April 19, 2002. In addition to the matters described above, the Company is from time to time involved in or affected by other litigation incidental to the conduct of its businesses. The Company does not believe that any such other litigation will have a material adverse effect on its liquidity, financial position or results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits: (a) Exhibits: 99.1 Cautionary Statement under the Private Securities Litigation Reform Act of 1995 - "Safe Harbor" for Forward-Looking Statements. (b) Reports on Form 8-K: None (17) SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. BORDERS GROUP, INC. ------------------- (REGISTRANT) Date: December 11, 2001 By: /s/ Edward W. Wilhelm -------------------------------- Edward W. Wilhelm Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) (18) Exhibit Index Exhibit No. ----------- 99.1 Cautionary Statement under the Private Securities Litigation Reform Act of 1995 - "Safe Harbor" for Forward-Looking Statements.