Can teens and lattes help stem Borders' losses?

Those cheap CDs and DVDs you bought on sale this spring and summer cost Borders bookstores dearly, but kids' books and coffee hold future profits.

Borders Group Inc. (BGP) posted a loss of $45.6 million, nearly five times the losses of $9.2 million it showed last year. But after factoring out $32.9 million in restructuring charges, the net loss dropped to $12.7 million, or 21 cents per share. Still, that is worse than analysts' expectations of a loss of 16 cents per share.

Borders is restructuring operations, cutting down its stock of DVDs and CDs and increasing sales of children's and teen books where it is seeing stronger sales and better profits.

But the changes in the stores caused a big disruption in sales during the quarter ended August 1. Total sales were $616.8 million, down 17.7 percent below the same period last year; same-store sales dropped 17.9 percent at Borders and 10.8 percent at Waldenbooks.

CEO Ron Marshall said the chain was on "flat-out sprint" during the quarter, resetting all its stores to shrink its music and movies departments and use that space to grow its kids' books areas and add new teen departments focused on young adult and graphic novels. Additionally, Marshall said Borders is expanding its paper gifts and stationery selection and revitalizing its cafes. The in-store coffeehouses, which had been a money-losing attraction, have begun to show a profit after years of losses, he said.

In a conference call with analysts, Chief Financial Officer Mark Bierly blamed a large part of the quarter's sales drop on inventory changes. Inventory dropped 18.5 percent at the end of the second quarter from the year-ago period, mainly due to the shrinkage in movies and music and the closing of a number of Waldenbooks stores.

Multimedia -- including DVDs and CDs -- now makes up only eight percent of Borders' sales, compared to 23 percent in 2008. That was achieved through some heavy markdowns, which affected sales for the quarter, said Marshall. Also, some more profitable books categories suffered during the reset period, such as biography -- a popular category which now has its own section in the store -- and garden books.

The stores should all be ready for the holiday season, said Marshall.

Management didn't give guidance for the rest of 2009, but the executives referred to the second quarter as a period of transition, and said the second half of 2009 should be better, as the new changes take hold. Borders will continue spending on stores this year, including added seating and display tables to encourage browsing, said Bierly.

Just like its rivals, Borders has been struck by the recession, but management admitted that the company had taken its eye off the ball and failed in keeping up stores and merchandising for this difficult economy.

Rival Barnes & Noble (BKS) last week beat analysts expectations when it reported a second-quarter profit of $12.3 million, down 20 percent from last year, and a drop of 5.3 percent in same-store sales. At the time, management said a drop in store traffic is its biggest problem going forward.

Shoppers are increasingly buying books online and at discounters. Last month, Amazon (AMZN) reported sales rose 15 percent, but it disappointed analysts who expected more from the online store.

Borders management said it expects to make gains in the e-book area eventually. While Amazon has cast its lot with the Kindle reader and Barnes & Noble is reportedly planning its own hardware, Marshall said Borders will wait for the segment to become "device-agnostic" and will take advantage of the membership lists of its rewards program to tap that market.

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