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Circuit City Says Restructuring Disrupted Q3 Sales

Richmond, Va. — Circuit City said its steep third-quarter loss was largely related to sales disruptions stemming from this year’s wholesale corporate restructuring.

Losses mounted more than tenfold to $208 million for the three months ended Nov. 30, while domestic sales fell 3.1 percent and comp-store sales sank 5.8 percent year-over-year.

In a conference call Friday, CEO Phil Schoonover said the massive changes, which included the institution of seven new store-level operating procedures, “bumped up against our peak selling season,” making it difficult for sales associates to assist back-to-school and early holiday shoppers while adapting to new work rules. This led to lower close rates, reduced attachments of higher-margin accessories and firedog branded services, and lower extended-warranty net sales compared with the prior year, he said.

Also affecting earnings were the de-leveraging impact of lower sales, the added cost of opening new stores and relocating or remodeling older ones, and a 331-basis-point decline in gross profit margin due to lower warranty sales and a greater mix of low-margin PCs and promotionally priced LCD TVs.

Schoonover said the problems were primarily self-induced and fixable, as demonstrated by the company’s double-digit comp-store sales increase over Thanksgiving weekend and monthly improvements in TV attachment rates following a low ebb in August. He said he was also encouraged by a 31 percent increase in Web- and call-center-originated sales during the quarter and, despite coming in below plan, a 29 percent spike in revenues from firedog PC services and home theater installation.

To keep the momentum going, Circuit City will award executive VPs $1 million and senior VPs $600,000 over a three-year period as an incentive to stay on board. Schoonover will not participate in the new retention plan.

The company will also work toward converting its entire store base to the new The City format, a 20,000-square-foot prototype that incorporates the most promising innovations from two years of lab store tests. All of next year’s 50 to 60 new or relocated stores will be in The City format, which offers an improved “multichannel shopping experience” and will help differentiate the chain in the marketplace, Schoonover said. The concept addresses changes in consumer shopping patterns since the 1980s, when most of Circuit’s stores were opened, and provides a smaller but more productive footprint that no longer has to accommodate major appliance inventory, he said.

Shorter term, store-level staff will return to a “selling culture,” said general merchandise manager John Kelly, with a narrower focus on selling larger-size flat-panel TVs and attaching accessories, firedog services and extended warranties.

The measures follow sweeping organizational, operational and cost-savings initiatives begun last February after a brutal round of flat-panel holiday promotions severely impacted profits. Those steps included the controversial dismissal of Circuit City’s 3,400 highest-paid and most experienced sales associates.

Financial analysts were troubled by the earnings report. “This is not good,” wrote Banc of America Securities’ David Strasser in a research note. “The franchise has been battered, and fixing it is going to take a long time, and hopefully they have the resources to get through this time.” Chief among his concerns is a 46 percent drop in cash to $483 million. “They are now dependent on a line of credit” — a new five-year, $1.3 billion commitment from Bank of America — “to get through the first half of next year, raising some liquidity concerns for 2008.”

Goldman, Sachs analyst Matthew Fassler similarly described the new asset-backed credit line as “a striking [move] for a firm that was cash rich and a big buyer of its stock in recent years.”

Schoonover addressed the issue during the conference call by explaining that the loan “gives us five years of additional comfort,” and assured analysts that “vendors are comfortable with our liquidity.”

During the call, a question from another analyst regarding the possible sale of the company went unanswered.