Circuit City F2Q07 (Qtr End 8/31/06) Earnings Call Transcript (SeekingAlpha)

Sep.20.06 | About: Circuit City (CCTYQ)

Circuit City Stores, Inc. (NYSE:CC)

F2Q07 Earnings Conference Call

September 20, 2006 11:00 am ET

Executives

Bill Cimino - Director, Corporate Communications

Phillip Schoonover - President, Chairman, Chief Executive Officer

Marc Sieger - Senior Vice President, General Manager for Services

Mike Foss - Chief Financial Officer

Analysts

Bill Sims - Citigroup Investment Research

William Armstrong - C. L. King & Associates

Matthew Fassler - Goldman Sachs

Daniel Binder - Buckingham Research Group

Colin McGranahan - Sanford Bernstein

Alan Rifkin - Lehman Brothers

Chris Horvers - Bear Stearns

Mitch Kaiser - Piper Jaffray

Operator

Good morning. My name is Amanda and I will be your conference operator today. At this time, I would like to welcome everyone to the Circuit City second quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.

(Operator Instructions)

Mr. Cimino, you may begin your conference.

Bill Cimino

Thank you, and good morning. We appreciate your participation in today’s call. I need to remind you that during the call, we may make some forward-looking statements, which are subject to risks and uncertainties. We refer you to today’s release, the MD&A in our annual report on Form 10-K, and to our other SEC filings for additional discussion of these risks and uncertainties.

Speaking on this call are Phil Schoonover, Chairman, President, and Chief Executive Officer, who will review our second quarter performance and update you on the continuing efforts to improve the business; Marc Sieger, Senior Vice President and General Manager for Services, will speak about our new services brand and how it fits into our overall services strategy; and Mike Foss, our Chief Financial Officer, who will review our financial performance and provide an update on several topics.

With that, I will turn the call over to Phil.

Phillip Schoonover

Thank you, Bill. Good morning. I would like to thank each of you for joining us on the call this morning. I will start by letting you know that we are pleased with our results in Q2. We posted strong growth in sales and earnings while making progress in our turnaround plan. We did all of this against the backdrop of a somewhat volatile, macro-economic condition and increasingly competitive environment.

We worked on sales growth as well as the cost side to deliver this quarter’s results, and we are making progress on managing our business better during challenging times.

For this, I thank Circuit City’s 46,000 associates for their continued focus and intensity.

As for the second quarter performance, the quarter started off very strong, exceeding our plan. As the quarter progressed, we saw volatility and growth moderated somewhat. We also cycled through tougher comparisons from last year, which got stronger with each month.

Despite the volatility, our sales results for the quarter as a whole exceeded our plan. Our sales growth was driven by average ticket increases, which primarily resulted from sales growth in flat panel television. The sales in the third quarter have been strong to date.

Under the heading of portfolio management, we are building additional growth businesses as a result of taking deeper learnings from the TV business and applying them to additional stake-in-the-ground categories. Our plan for back to school was to use this sales drive time to build capabilities and performance in our technology and imaging businesses.

We grew sales in a number of categories, but were particularly pleased with the notebook, PC, PC services, and digital imaging businesses. The PC category is also a great example of using our multi-channel offering to extend our product assortment online and build recognition for Circuit City as a destination for PC services.

Now, on supply chain, we continue to expect to reduce domestic net own inventory by $50 million to $100 million at fiscal year end. Net own inventory actually increased year over year for Q2. While the increase in Q2 was less than the increase and Q1, we are not satisfied with the level of improvement, and will step up our efforts here.

Our in-stock levels continue to improve for both promotional and regular items. The areas of inventory increase at quarter end were largely in the growth categories, so we believe our inventory is healthy.

As I mentioned earlier, we saw volatility in the quarter, some of which was likely related to macro-economic environment and some related to the moves made by our competitors.

Regarding the macro-economic environment, we saw store traffic taper in the second month of the quarter, but rebound in August.

As we have mentioned, we have business rhythms in place to alert us to changes real time in business conditions. I am pleased to say that those processes allowed us to proactively address our expense structure during the quarter and reduce certain variable SG&A expenses.

Regarding the competitive environment, as expected, we saw home theatre and flat panel television resets by three of our major competitors. In addition, as the quarter progressed, we saw competitors sharpen their promotions, increase financing promotional lengths, and increase store labor in the television department.

While we did not know the exact timing of these competitive moves, our strategy attempted to anticipate them, and as we have said before, we will be competitive in our stake-in-the-ground businesses.

So let’s talk about Circuit City’s flat panel TV business. First, what we saw in Q2. As expected, our comp growth slowed to strong double digits from triple digits as we cycled against a growing base and strong increases last year. Keep in mind that we saw six consecutive quarters of triple digit growth in this category at Circuit City. The flat panel business is still fundamentally very strong, but let me tell you about some of the strategic steps we are taking to enhance our home entertainment offerings.

First, the learnings from last year’s innovation experiments in Boston and Florida, we began to reset the video department in more than 500 stores in August, and the work will be completed by the end of the October timeframe, just in time for the holiday selling season.

The scope of work in each store will be appropriate for its size, volume, and existing format. This will improve the customer experience in home entertainment.

Second, we have added new premium brands to our product assortment. We have started selling Mitsubishi TVs in mid-August. [KEF] speakers have now rolled out nationwide. Denon and Boston Acoustics home theater products will launch in October.

With those additional brands, we feel we have a compelling assortment for new and existing customers, and our associates can have even greater confidence in our selection of digital televisions and home theater products and services.

Third, based on our success we saw from last year’s event, we hosted our second annual national home theater training event, HDX. We did this in August. Our store directors and this year, our home entertainment managers, attended to prepare for the all important holiday season.

Finally, we launched our new services brand, Firedog, and that will greatly enhance the customer experience for home theater installation.

Moving to our long-term vision for the flat panel television business, we see long-term strength in this category, with shipments of flat panel TVs expected to post a five-year calculated annual growth rate of approximately 15%, according to CDEA’s numbers, which we agree with.

We expect to capitalize on that growth in television sales with the initiative we have already discussed today. Enhancements we are making to our home theater and audio businesses, a continued focus on selling a complete solution to the customer, including furniture, accessories, and the opportunity to provide an enhanced customer experience, with improved home theater installation capabilities.

Now let me shift to changes we have made in our leadership team.

We recently announced a new chief marketing officer, Peter Weedfald. He was the head of sales and marketing at Samsung Electronics America. He held senior positions in marketing and strategic businesses at ViewSonic. He spent many years in leadership positions at Ziff Davis Publishing, which gives him insights into media effectiveness. Peter brings a wealth of Internet marketing knowledge and finally, Peter also has a lot of experience with community support events, such as Samsung’s Four Seasons of Hope. We will use this talent to help with Circuit City’s community support work.

We will continue to build the bench of senior management and develop leaders in the store support center and in our retail stores.

I want to touch very briefly on a few other areas of strategic importance.

First, our cultural transformation at retail continues. Last quarter, Danny Clark, our head of retail stores, mentioned that we were piloting new operating procedures in several markets. We expect to roll out some early learnings before holiday and continue to refine others before we scale them.

Second, we are in the process of launching our services brand, Firedog. Marc Sieger will provide additional details on that brand, which includes both home theater installation and PC services, in just a moment.

Third, regarding the international segment, we are pleased that the segment returned to profitability. Mike Foss will talk to you in more detail about our status and the transformation journey in that area of our business.

Finally, looking out to holiday, we believe we have built a compelling offering for our customers. We have provided our associates with better tools to do their jobs this season, and we have developed a strategy to take advantage of the strong TV product cycle for holiday.

We are building an engine to drive sustainable growth, and we put a fine point on our long-term strategy, what we call our North Star. It is all about helping you, helping our customers, and helping our associates.

We will continue to use the innovation work to de-risk investments through our four strategic pillars -- home entertainment, digital home services, multi-channel, and new retail formats.

Before I turn the call over to Marc, I would like to again thank our team for delivering these results in a volatile environment, and special thanks to the technology team for great back-to-school performance.

I continue to believe that we are on the right track and I feel confident that we are on our way to creating a profitable, sustainable growth engine for Circuit City.

I will now turn the call over to Marc Sieger, who will provide further detail on our services business and the new brand launch.

Marc Sieger

Thanks, Phil. I am excited to provide you with an update on our services business. All of our work in this area ties back to the digital home services pillar of our strategic framework and supports future growth for the company.

Our focus is in two very high-growth areas for Circuit City. First, developing a deep seeded competency in home theater installation, and second, focusing on our fast-growing PC services business, in-store, at home and remote diagnostics.

We estimate these areas together represent a $20 billion market opportunity by 2010.

As we mention in today’s press release, services revenue doubled versus prior year, even as we went up against our national rollout of PC services last year. By putting these businesses together under a single leadership team and single brand, we can leverage synergies and customer offerings that deliver on the ever-growing category of convergent products.

A great example of convergence would be you or your kids enjoying high-def gaming in your home theater enabled by a wireless network. Imagine playing X-Box live against other family members across the country on your big screen and having this experience delivered through one trusted partner.

As the lines between the PC and the TV blur, we will be at the crossroads of this convergence with a single, distinctive voice. This will be a core element of differentiation from our competition. With PC Services, home theater installations, and convergent services all under one umbrella.

Some months ago, we retired the IQ Crew name. Our customer research indicated that existing PC services brands, including our own IQ Crew, were arrogant and intimidating. We began a journey to create a differentiated brand position for our overall services business, and we are very excited about the name we have chosen.

As many of you have read, our new brand name will be Firedog. Why Firedog? We considered more than 6,000 possible names, and in the end, we chose Firedog, a name that captures the attributes that we want our technicians and installers to embody -- helpful, knowledgeable, friendly, and reliable. It is simple, it is fun, and it is focused on our customers.

While the decision to build an integrated brand for both PC services and home theater installation was based on customer research, we also found it appealing from a cost perspective compared with building multiple brands.

We created our service business and brand from the ground up, ensuring that everything about it aligns with our North Star. It is all about helping you.

We chose an evocative name to highlight the brand values and commitment to the customer, rather than a descriptive name that limits the potential reach of the brand. Think Google or Starbucks versus Merry Maids or Auto Zone.

Firedog also provides an umbrella that can fit for new service offerings that we create in the future. Remember that most for the services that Firedog provides -- home theater installation, PC services in-store, at home and remote -- were available before the brand launch.

So what will be different?

First and foremost, customers will see the new Firedog persona coming alive at our stores, with a new logo, signage, uniforms, vehicles and fixtures. These changes are beginning to show up in the stores this month, and soon you will see advertising supporting the brand.

Second, customers will be able to schedule in-home service visits while in the store, at the time of purchase without having to reach out to make an additional call once they leave the store.

Third, customers get a single point of contact, coordinated help in meeting their whole house electronic needs versus being diverted to multiple brands or multiple companies.

Fourth, all Firedog technicians and installers are receiving extensive training to install, repair, and optimize consumer electronics technology products. We have partnered with vendors, for example, Microsoft, to pursue certification, such as Microsoft Certified Professional, to help ensure our readiness for the Vista launch and the opportunity that it will provide.

Fifth, stores will have new tools and materials to help customers and associates understand the complexity of installing home theater systems.

Finally, Firedog will be a multi-channel effort. We will be where the customer wants to find us -- in store at all Circuit City Superstores, online at firedog.com, or via phone at 1-800-Firedog.

We have discussed in prior calls the exceptional results of the elite teams in helping drive operational execution. This fall, the elite teams in each region will assist us in providing a targeted focus on building the Firedog culture and ensuring operational execution of this high priority, high margin business.

We continue to believe that the hybrid labor model is the best structure and provides the most flexible workforce. A hybrid model allows us to utilize both internal labor and a third-party workforce, who we call partners, to maximize customer satisfaction and product a profitable economic model.

In many cases, our partners have many years of experience, deep training, and a number of industry certifications, including CIDIA, the Custom Installation Industry Association, CDA, the Consumer Electronics Association, CompTia, and others.

Partners also provide a way to deal with variations in demand and peak periods, while keeping internal productivity high and costs in line, capitalizing on a high quality, variable cost model. It is critical to note that both labor formats, internal and partners, undergo the same core training and are held to the same high quality standards.

We monitor quality in a consistent manner for both groups through a third-party survey. We are pleased to say that we have seen substantial improvements this year in customer satisfaction scores, and the scores are very similar between the two labor formats.

In a continued focus on quality, we have dramatically reduced our overall number of partners this year to focus on the best of breed, and we have upgraded our minimum service standards in our agreements with our partners to ensure a consistent Firedog experience.

We have also recently implemented a web-based partner management tool. This will deliver real-time access to rich educational content, enhanced two-way communication, clear score card metrics, and online quality reporting, enabling the delivery of consistent quality service to each of our Firedog customers.

Our focus this year will be growth through leveraging inbound traffic in our stores, establishing systems and processes to continue to simplify the customer experience, and continuing to ramp up our in-home business.

As always, in the spirit of innovation, we continue to test new offerings and enhancements so that we may learn our way to even greater success in future years by providing greater value for our customers.

In closing, we are extremely excited about Firedog and its positive impact on our customers, associates, and our shareholders. Thanks for your time, and now I will turn the call over to Mike Foss.

Mike Foss

Thanks, Mark. In the next few minutes, as usual, I will provide a little more information about our second quarter performance, as well as an updated fiscal 2007 guidance. Then I will cover several other topics of interest, including returning capital to our shareholders, an update on our IP initiatives, a discussion about our domestic real estate progress, and finally, a discussion of our international segment.

First, in general, the second quarter demonstrated continued good progress in our efforts to get Circuit City’s long-term financial performance to levels that management has set as its goal. We continue to run our business better. We are able to react to trends and opportunities faster. We are building our innovation capabilities, and we are continually identifying more pockets of value that we can mine over time through improvements in people, process, and systems.

Now, turning to our second quarter performance, for the quarter, net sales increased 11% to $2.84 billion. Our domestic segment sales also grew 11%, due to the strong 8.9% comps, as well as the impact of the addition of 16 net new superstores over the past four quarters.

During the quarter, we continued to see very strong growth in two very strategic areas of the company. Our Circuit City Direct organization continued to demonstrate exceptional growth with 74% growth in web originated sales and 93% growth in call center sales.

As Mark talked about, our Services business, newly named Firedog, approximately doubled in sales during the quarter.

Our international segment sales also grew 11% due to the favorable impact of foreign currency exchange rates, which drove 9% of the sales growth, strong sales to the dealer channel, driven by a very successful national convention, and these were partially offset by 2.1% decline in comp store sales, as we cycled against a heavy advertising related to the successful brand launch of the Source by Circuit City in the second quarter of last year.

I will touch on the international segment in more detail later in my discussion.

Consolidated gross margin was approximately flat to last year. Domestic gross margin was also approximately flat. We saw a modest decline in merchandise margin. This was offset by a margin improvement from net financing costs, which were driven principally by less aggressive promotional financing terms, more than offsetting the effect of increased interest rates.

The international segment gross margin declined by 81 basis points, but did not have a material impact on the consolidated gross margin rate. The decline in the international gross margin is primarily driven by the mix impact of proportionately greater sales of PCs and monitors, as well as margin rate declines in video and personal electronics.

Overall, we are pleased with the stabilization in consolidated gross margin, which is consistent with our longer-term outlook for the business.

Consolidated SG&A expenses as a percentage of sales declined 44 basis points, with improvements in both segments. The SG&A rate improvement in our domestic segment drove 31 basis points of the improvement. We demonstrated strong leverage in payroll and fringes, as well as rent and occupancy, which more than offset increased investment spending, as well as increased advertising expenditures.

We incurred approximately 100 basis points of increased spending in Q2 for IT, Circuit City Direct and innovation. This was less than the 150-plus basis points we had thought would be incurred. This reduction was primarily due to the delay of the pilot of our new point of sale system for technical reasons from the second quarter into the third quarter, as well as some expense reductions that partially offset our investments.

Our international segment SG&A rate improvement contributed 13 basis points of the consolidated improvement. This improvement was principally driven by the lack of brand transition costs this year, partially offset by an increase in SG&A dollars, primarily reflecting the impact of currency movements, expenses related to the increase of the number of stores open versus last year, as well as a small increase in marketing.

EBT percentage improved to 0.7% this year, compared with 0.2% last year. For the first half, EBT percent improved to 0.5% compared with a loss in the prior year.

The net result for the second quarter was net earnings from continuing operations of $11 million, or $0.07 per share, compared with $4 million or $0.02 per share last year.

Turning to the balance sheet, at August 31st, we had cash, cash equivalents, and short-term investments of $600 million, down from $688 million as of August 31, 2005. The year-over-year change principally reflects cash flow generated from operations, offset by the use of $259 million to repurchase common stock during the past four quarters, as well as investments in property and equipment.

Consolidated merchandise inventories grew 11% over last year, in line with our sales increase. We are satisfied with our inventory position and its quality as of quarter end. Our net owned inventory increased $65 million, $50 million of which was in the domestic segment. This shows an improvement versus the first quarter, and we expect to show good improvement in both the third and fourth quarters.

As Phil said, we continue to expect that we will reduce fiscal year and domestic net owned inventory by $50 million to $100 million.

Next, an update on our fiscal ’07 financial guidance.

We provided a full list of fiscal 2007 expectations in this morning’s press release. We have made some revisions to our full-year guidance. We now expect total sales growth of 9% to 11%, up from 7% to 11%; Domestic comp store sales growth of 7% to 9%, up from 5% to 7%; capital expenditures, net of landlord reimbursements, of approximately $290 million. This is up $10 million from our last guidance. This increase is partly driven by an increase in the number of stores being built early in fiscal 2008, for which we will start incurring capital during this year.

The other guidance remains unchanged from our previous expectations of full year, including EBT margin of 2.0% to 2.4%. This includes a year-over-year increase of investment spend reflected in SG&A of approximately 100 basis points, and depreciation and amortization of approximately $180 million.

Now I would like to talk about our efforts to return capital to our shareholders. In June, we announced that the Board of Directors approved two recommendations that management has proposed. First, the approved more than doubling the quarterly dividend rate from $0.0175 per share to $0.04 per share. Second, they approved an increase in our share repurchase authorization by $400 million to $1.2 billion.

During the second quarter, we bought back 2.6 million shares for $67 million, or an average cost of $26.10 per share. We have now bought back a total of 52.1 million shares for $800 million, or an average cost of $15.34 per share. We have approximately $400 million for future share repurchases under our current board authorization.

Now, for a brief update on MIS. We continue to make great progress in our IT systems. We went live recently with a replacement point of sale system pilot, and this has gone exceptionally well. We will now be expanding the pilot with some additional stores and we continue to expect the full scale rollout to begin after the holiday selling season.

Our other large IT investment, our merchandising system transformation, or MST, remains generally on track and on budget.

Now, a quick discussion on our domestic real estate status. Our real estate team continues to make great progress on building the pipeline of strong new superstore locations. In fact, this afternoon, we have another real estate committee meeting where over 30 new sites are coming in for approval.

Having been through a preliminary review of the sites, I full expect the vast majority of them to be approved.

The bulk of the sites that we have been approving over the past six to nine months have been for fiscal 2008 and 2009 openings. You will see a significant increase in new stores next fiscal year, in line with our goal to get to 75 to 100 new and relocated stores a year by fiscal 2009.

Now, a quick update on our store refreshes. As we discussed at the analyst conference in May, a key element of our real estate strategy is refreshing the look and feel of a significant number of our existing stores that look old and tired. We believe a refresh will make a store a much better experience for both our customers as well as our associates. We expect our first run of refreshes will be complete by this coming holiday. This will involve refreshing more than 30 stores in three markets. We will assess the results of these refreshes and assuming warranted, we will continue to roll these out to other markets.

Finally, I will now give you some more color on our international segment. We clearly have been disappointed in the financial performance of the international segment over the past several quarters, and our teams on both sides of the border are working hard to improve the business.

I wanted to update you on some of the work we are doing to drive improved results there.

The first step in our efforts was to engage an outside consulting firm to help us do a 10-week value targeting assessment. That work has been completed and we are encouraged by the value creation opportunity that can be realized by the introduction of best practices and functions throughout the company.

The work to implement some of these recommendations will begin this year, and we expect to begin seeing benefits in fiscal ’08.

Secondly, we have conducted a thorough product portfolio review, similar to what we did in the U.S. two years ago. We have [inaudible] our product lines by strategic intent and to stake-in-the-ground grow, maintain, optimize and harvest categories and have just begun the work to redeploy our assets consistent with the strategic intent of each category.

Third, as we mentioned on our last quarter, there are two new areas of potential and significant revenue growth opportunity in our Canadian business -- direct channel sales and PC Services.

Regarding direct channel, the team is heavily focused on building up the e-commerce business in Canada. They have also heavily leveraged key learnings from our U.S. e-commerce business. As a result of this focus, the web originated sales in Canada grew by 114% this quarter.

In addition, our team has launched a call center sales capability, and we are encouraged by the initial sales results.

In addition, we are also pleased to say that we launched a suite of PC service offerings in Canada during the quarter.

The final area of key focus for the organization is on employee engagement. We clearly have seen the power of what increased engagement can do for us in our U.S. results. We have just started that work to unleash the power of our associates in Canada as well, and are receiving very strong feedback from our team.

We clearly have a lot of work to do in Canada and are excited about the opportunities, as well as leveraging the strengths of the folks on both sides of our border.

Now, we will open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bill Sims.

Bill Sims - Citigroup Investment Research

Thank you, and good morning. Two questions. First, Mike, on the 50 basis points of SG&A that you did not spend during the quarter, how much of that will roll over into the third and fourth quarter?

Mike Foss

There is a piece we would expect the basis points for investments to grow in the third quarter versus the second quarter, principally due to the delay of introduction of the point of sale system into the third quarter, so that is a piece of it.

We were able to make changes in infrastructure spend in our MIS organizations to offset some of the incremental investment spend in the second quarter, so not all of it will roll.

Bill Sims - Citigroup Investment Research

Second question is, can you help us understand the investment associated with Firedog? Is that part of your multi-channel/innovation initiatives, or is that an additional investment and where does it fall into the P&L?

Mike Foss

That is separate from the three categories that make up that investment spend, but it is contained in our full-year guidance.

Bill Sims - Citigroup Investment Research

Last question, just so I understood you correctly, did you say the September comps have accelerated from August?

Mike Foss

We made the, or Phil made in his session the comment that to date, September comps have been strong.

Bill Sims - Citigroup Investment Research

Thank you very much.

Operator

Your next question comes from Bill Armstrong.

William Armstrong - C. L. King & Associates

Good morning. So I guess to follow-up on that final question, the flat panel TV was up strong double-digits, down from triple-digits that you have been reporting. Best Buy continued with a triple-digit increase. Is there any concern there on your part? Do you think it is consumer weakness? Is it any inventory issues? Maybe shortages or pricing on your part? Could you just give us a little more color on that?

Phillip Schoonover

Frankly, we expected the comps to settle down as we cycled last year’s extraordinary performance. We think there is opportunity always to look for ways to be more competitive and as we said, we did see some slowing, kind of in the middle of this past quarter, which we took some action to address.

I laid out a plan where we are coming back for the second year in a row and resetting our video departments. We are adding the new brands, both in video and home theater, and we are spending money to train our associates to be better prepared. We spent it not only with store directors this year, but we trained the department managers.

This is a very important business for us. We think there is a great consumer demand for it. We are going to go after our fair share.

William Armstrong - C. L. King & Associates

Do you view pricing, and I mean overall pricing, inflate, deflation in the category? Do you see that continuing to drive traffic or to drive consumer interest?

Phillip Schoonover

You know, the new price points introduced for September 1, we attribute some of the early start in September to exciting new lower price points for consumers, and any time that happens, it drives consumer demand.

William Armstrong - C. L. King & Associates

Finally, you mentioned that average ticket increases helped to drive comps in the quarter. How about traffic and conversion rates? What were the trends there?

Mike Foss

Traffic was essentially flat, and close rates were just a little bit down.

Operator

Your next question comes from Matthew Fassler.

Matthew Fassler - Goldman Sachs

Following up on the expense question, going into the second quarter, you are pretty explicit about the 150, 170 basis points of spending you expected in each for the second and third quarters. You told us where you were in Q2. Would you care to be as explicit for Q3 as you had been at that time?

Phillip Schoonover

Again, we would expect, in terms of investment spend, it again up to the original 150 and maybe a little bit higher than that, simply because of the RPOS rollout.

Matthew Fassler - Goldman Sachs

But probably not adding 50 basis points to the initial 150, 175?

Phillip Schoonover

No, again, remember as I mentioned earlier, one of the reasons why we were able to keep the investment spending to only 100% is we were able to find some offsets within MIS in particular, and infrastructure and some other areas that help fund some of the investment spend without increasing net aggregate spend.

Matthew Fassler - Goldman Sachs

I guess the second question, clearly the earnings look good in the aggregate. If sales were essentially in line for the quarter overall, was it just the mid-quarter slowdown that you saw that led you to be a bit more disciplined on the cost front?

Phillip Schoonover

No, I think the macro-economic conditions have had us concerned for the first half, and we just built a set of disciplines about watching our weekly sales and adjusting any variable expenses accordingly.

We just want to get the point out there that we do have multiple leverage we can pull and we are prepared to pull the cost side levers if required.

Matthew Fassler - Goldman Sachs

Just a couple of follow-up questions, on TV as well. Obviously ASPs on like for like units are coming down pretty sharply year to year. Can you talk about what has gone on with the ASP for TVs that you sell? In other words, I would imagine your own ASP is not down as much as that of the market. Can you give us some color on that?

Phillip Schoonover

We are actually still experiencing the introduction of 10ADP and the larger screen size, plus the transfer from plasma to LCD improving our ASP, despite the declines in retail prices.

Matthew Fassler - Goldman Sachs

As you think about some of the innovation you saw from some of your competitors, with resets you said from three different competitors, if you think about the timing of their changes and the timing of your changes, it sounds like some of your changes are probably happening a little bit later in the year. Are you factoring in some improvement related to your own resets in the third quarter?

Phillip Schoonover

I guess the point there was we wanted to time our improvements with the season. We did not want to get the expenses out ahead of the real demand, so our timing was strategic and it was planned much earlier this year.

The thing to is we are not done yet. We think there is still a lot of opportunity to improve the customer experience in our stores, and we are making more investments, including the reset, the incremental brands, and better assortments for our customers, and the work that we are doing with Firedog services.

Operator

Your next question comes from Daniel Binder.

Daniel Binder - Buckingham Research Group

A couple of questions for you. I guess first, you talked about managing the business better, which is great. I am not sure that if you had hit a soft patch a couple of years ago we would have been able to navigate through it as well as it sounds like you did for a period of time this summer, so congratulations on that.

I am kind of curious. Have there been any fundamental changes to the labor model that will stretch beyond what you did this summer? Is there anything that is more permanent?

Secondly, the relocation, also on the expense side, the relocation costs were considerably lower than I expected in Q2. Can you give us some color how you think that will fall out between Q3 and Q4?

Lastly, just touching on what portion of the 50 basis points will roll over into the balance of the year. Should we still be thinking about 130 or 140 basis points of investment spending in Q3?

Phillip Schoonover

I will take the labor question. So, Danny Clark in the investor conference rolled out a long description in the work that we were doing in the stores in Texas to try to figure out how we could free up non-value added non-customer facing labor hours, and reinvest those in a better customer experience in those stake-in-the-ground businesses, and that work continues.

We moved from the 10 store pilot to a 50 store pilot -- 10 store test to a 50 store pilot of those, and I would call those material enhancements in our ability to be more productive with our labor dollars.

In addition to that, we continue to look at our labor scheduling week to week, hours within the week, and we have made some adjustments. I would call this kind of one-on-one retail operations. We talked a lot about the SOP work that we are doing in the stores. Some of it is quick action and some of it takes systems and process and actual piloting before we are ready to roll it out, so as soon as we learn about how to make our labor dollars more productive, we roll it out.

Specifically in the quarter and how it will affect the rest of the quarter, we have been very disciplined about keeping our labor spend in line with the sales trends, and we are doing that now on a week-to-week basis. We are not waiting for the close of a month to make adjustments. Frankly, we have seen some changes from some of our competitors that we are going to react to because we have said we are going to be competitive in those stakes-in-the-ground businesses.

So it is a never-ending set of challenges with labor. It is our biggest variable expense. We are watching it closely, but we are not going to do anything that permanently impacts the customer experience unless it is a positive thing.

Daniel Binder - Buckingham Research Group

Okay, and on the relocation costs?

Phillip Schoonover

Again, obviously you saw we have actually taken down the relocation costs in the latest release from $34 million. That is actually relocations, remodeling, and store refresh. It is aggregate. We have reduced that to about $30 million.

Again, as you have seen historically, most of our store builds, both relocations and new stores, are concentrated in the second half of the year.

Daniel Binder - Buckingham Research Group

The third part of the question was also about the investment spend for the rest of the year?

Mike Foss

Last quarter we had said that we expect it to ramp up to 150-ish basis points in investment spend in the second quarter and third quarter. We continue to think with the offsets and such that we will be on the order of around 150 basis points of investment spend in the third quarter, relative to last year. We continue to expect around 100 basis points in total for the year.

Daniel Binder - Buckingham Research Group

Just a couple of quick follow-ups -- on warranties, they popped back up as a percentage of sales. I guess I am just curious what helped drive that. Would you expect that level to hold steady at this point?

Then, on the POS rollout, I was under the impression that when you started the year that you might have that done before the holidays. It sounds lake maybe that is coming more post holidays. Is that an accurate statement? What portion of it would you have done before the holidays?

Mike Foss

Let me answer the second piece first. We will have just a handful of stores as part of the pilot before the holidays. Really, we do not want to take any material risk in the major sell time of the year.

I think if I go back maybe six months to a year ago, we probably intended to roll it a few months earlier, and we would therefore have a more sizable number of stores rolled out but clearly, the bulk of the rollout will happen post-holiday. But we will be done by the middle part of fiscal ’08.

On the warranty piece, again, you've seen -- I don't know, Phil?

Phil Schoonover

City Advantage is part of an overall basket of services we offer now at Circuit City. We want to sell the right solution to the right customer; and at lower price points certain customers may choose other services or accessories in exchange for warranty that they may have chosen in the past. On a holistic business level we're looking to enhance the total basket of accessories, furniture, installation, et cetera, and improve the profitability of the Company through that basket.

Mike Foss

One other comment, Dan. If you look back quarter by quarter you've seen the extended warranty percentage, it will slip back and forth between 4.0 on the high end and 3.5, 3.6, 3.7, so it it's going to vary each quarter.

Dan Binder - Buckingham Research Group

Great, thanks.

Mike Foss

Thanks, Dan.

Operator

Your next question comes from Colin McGranahan – Sanford Bernstein.

Colin McGranahan - Sanford Bernstein

Good morning. Thank you. First on gross margins, the merchandise margin down -- was that primarily or more mix, or was it product margins came down in certain categories?

Mike Foss

Again, it was a very small reduction in merchandise margin. I think it was more related to small amounts of markdowns as we continue to move products out, so it was not really related to mix or anything other than that. Again, it was a very, very modest decline.

Colin McGranahan - Sanford Bernstein

Was that essentially in line with your plan, flat gross margins year-over-year? It was a pretty easy comparison. I was hoping maybe we'd see a little better than that. Obviously it was better than the first quarter performance.

Mike Foss

I just can't make you happy.

Colin McGranahan - Sanford Bernstein

No, no, I just want to understand how the quarter played out versus your expectations.

Mike Foss

The only kind of gross margin guidance we've given is really long term where we think over a multi-year period we expect gross margins to be relatively flat. As Phil mentioned, our overall performance for the quarter exceeded our expectations.

Colin McGranahan - Sanford Bernstein

Okay. And then just on the promotional financing, obviously you had said at the end of the first quarter that you felt you were out a little bit ahead of the market. It feels like maybe you pulled back and were a little behind the market and the market competitors picked up their intensity a little bit. Is that a fair description and a clear choice that you're making to obviously be competitive, but not be as aggressive at this point?

Phil Schoonover

I think that what we saw in the first quarter led us to adjust our strategy for the second quarter. The two things we saw was competitors were faced with the same challenges with interest rates rising, and seemed to be backing off the length of term of financing. There must have been some reasons for it but we saw some competitive financing offers, particularly late in the quarter and early this quarter, and as we've stated right along, we will compete. We'd rather invest the money in other things that enhance the customer experience, like our services business, but in the stake-in-the-ground businesses, we will compete.

Colin McGranahan - Sanford Bernstein

Would you have chosen to be less competitive if that $17 million worth of POS expense had hit the second quarter?

Phil Schoonover

I don't think our overall plans unfolded around the POS investment. The overall plans unfolded around the volatility in the business. So we made cost adjustments based on real-time sales increases or decreases throughout the quarter. And we did, obviously when we decided to delay some expenses in RPOS -- some time ago, by the way -- we did take a look at how we could make up some of that ground in the third quarter, as Mike mentioned.

Colin McGranahan - Sanford Bernstein

That's fair. I know there's a lot of levers you can pull. On Firedog it looks like the pricing is pretty much at parity with Geek Squad. Can you just talk about how you think about pricing for services and what your strategy there is?

Marc Sieger

Our view is we want to provide a great customer experience at a fair price, and again, as Phil mentioned, as in the merchandising world, we will be competitive.

Colin McGranahan - Sanford Bernstein

Okay. Fair enough. Good luck.

Mike Foss

Hey, Colin, it's Mike. I want to clarify one thing. You made a comment that the impact of the point of sale push out was $17 million, that is incorrect. You're equating all 50 basis points to the impact of RPOS moving out which is not correct. That is a piece of the basis point reduction in investment spend, but again, another critical piece of it is physical actions that we’re taken to reduce spending in parts of our MIS organization that helps us offset some of the increased spending.

Colin McGranahan - Sanford Bernstein

That's fair, Mike. Would you say that those are sustainable, more efficient ways you're operating MIS or were these things that you decided weren't important or things you deferred to make up that difference?

Mike Foss

I think it's more, even though we know we have to invest very sizable amounts of money, we are continually looking at ways to run every aspect of our business better, to mine expense out of this business. So clearly we will intend to keep that focus in the third quarter and well beyond it.

Colin McGranahan - Sanford Bernstein

Okay. Thank you.

Mike Foss

Okay thanks, Colin.

Operator

Your next question comes from Alan Rifkin – Lehman Brothers.

Alan Rifkin - Lehman Brothers

Yes, thank you very much. It certainly looks like the results from the Boston and Florida resets are giving you great confidence to greatly accelerate the program in time for the holiday season. Wondering if maybe you can provide some measures as to what you've seen in the resets thus far, both from a revenue and profitability standpoint? Do you think that net-net it's helping drive traffic in other areas of the store?

Phil Schoonover

I don't think we can disclose the performance of the stores in Boston or Florida or the rollout of that, but overall we're just aiming this at enhancing the customer experience, and frankly staying one step ahead of some of our competitors. So the fact that we reset the video departments last year with the plasma wall and the fact that we took the learnings from Boston this year really says we're going to take our capital, we're going to take our expense and we're going to focus it on our most important business, which is the TV business, and we're going to do it just in time for the peak selling season. So two years in a row we will enhance the customer experience. I guess the other side is it's in line with our capital guidance and our sales guidance for the year. We knew that we were going to do this reset when we set the guidance.

Alan Rifkin - Lehman Brothers

With respect to the POS rollout, the fact that you'll only have a handful of the stores under the program in time for the holiday season, do you think that that is in any way curtailing the ability to drive comps in the fourth quarter?

Phil Schoonover

Absolutely not. Absolutely not. I just want to clarify that while we moved some expense from one quarter to another from an original plan, we're not behind on RPOS rollout. We're on time, on schedule.

Alan Rifkin - Lehman Brothers

Okay. Any sort of color on what your staffing expectations are for the holiday season on a store-to-store basis?

Mike Foss

Obviously there will be very sizable amount of seasonal hiring, but we're not in a position to communicate the level of that staffing at this point.

Alan Rifkin - Lehman Brothers

Okay. Thank you very much.

Mike Foss

Labor as a percentage of revenue is how we manage those seasonal hires. There's enhancements to the quality of work we're doing there, but it's the same basic philosophy.

Alan Rifkin - Lehman Brothers

Okay. Thank you very much.

Mike Foss

Thanks, Alan.

Operator

Your next question comes from Chris Horvers – Bear Stearns.

Chris Horvers - Bear Stearns

Good afternoon, everyone. I think it was a great quarter.

Phil Schoonover

Thanks, Chris.

Chris Horvers - Bear Stearns

First on the merchandise system transformation, could you give us a little more detail there? When we met with you earlier this year you talked about Retech and modules going live, and you also talked about the Connect 3 software. Could you give us some details on where you are with that, and do you still expect more specifically Connect 3 to be live this year?

Phil Schoonover

Yes. So overall we've prioritized the rollout of the suite of Retech to get the lowest hanging fruit first. We took a philosophy to pay as we go. I think we mentioned that we were on time, on budget with the rollout of the Retech suite, MSD, as we call it. As far as Connect 3, we will have some functionality this year to zone our overall promotions. The greater flexibility to zone specific SKUs and specific promotions by market comes into play early next year.

Chris Horvers - Bear Stearns

So what will you be able to zone this year if you can't do SKUs in markets?

Phil Schoonover

I think for your model purposes it's not material. We're building some muscle. Most of what we're doing now is testing and piloting. We do isolate some markets for some major changes, but I think the answer to your question, to be straightforward, is most of the benefits of Connect 3 will come into play next year.

Chris Horvers - Bear Stearns

Okay. Fair enough. On the competitive front, has there been a change at the margin so far in September? It seems like your biggest competitor has picked up the advertising quite significantly. I was curious what your plans are here on the advertising side in the back half of the year.

Bill Cimino

We're not going to comment on our advertising strategy going forward. That's just for competitive reasons there.

Chris Horvers - Bear Stearns

Okay. Fair enough. Thanks very much.

Bill Cimino

Thanks. Operator, we have time for one more call, please.

Operator

Okay. Your next question comes from Mitch Kaiser.

Mitch Kaiser - Piper Jaffray

Good morning, everyone. I was wondering if you could comment on flat panel TVs, how they progressed on a month-by-month basis, if you would, throughout the quarter. Were they up strong double-digits on monthly basis or did you see some pick up at the end? I know in July you talked about the promotional environment and the macro economic environment probably impacting customers, but gas prices have come down fairly dramatically. Is it possible that we could see triple-digit growth with the resets and the improved customer experience that you're talking about in the back half?

Phil Schoonover

Well, you know, I think that you're asking did we really see an unanticipated deceleration? We knew our competitors were going to take advantage of the hot TV cycle. We just didn't know exactly when. It turns out that all three of what we call our primary competitors made major changes to the physical store, their assortment, and one of the three made major changes by the labor model in the department. So I don't think any of that came as a surprise.

The big issue for us is we're up against very big increases at this same time last year, and what we said was over time, the overall growth of the industry and our share within that, the balance of the two, this would be a major growth engine for us. I think throughout the quarter, we were materially about where we thought we'd be.

Just within the business itself, I think that we are prepared now to come back with an aggressive strategy in this quarter, up to and including the resets in the store, the addition of the new brands, and the addition of our home theater installation services with Firedog. So, stay tuned. We don't know what our competitors are going to do.

Mitch Kaiser - Piper Jaffray

A lot of people have been trying to figure out what the longer term profitability of the services business is. Have you guys set any targets or anything you care to comment on how we should be thinking about the profitability of services relative to product?

Mike Foss

Let me try and answer that one. Clearly we have a five-year view of what our services business can build, and we're very interested in the profitability of it. Obviously there's a $20 billion revenue opportunity we see out there in aggregate for the industry in 2010, and we believe our services business can do extremely well and be a very profitable, a very good part of our business moving forward, but we're not in position where we would want to talk externally about what our financial model for service looks like.

Mitch Kaiser - Piper Jaffray

Okay. I knew the CFO would jump in and botch that question.

Mike Foss

I'm such a narrow-minded guy.

Mitch Kaiser - Piper Jaffray

Thank you, guys. Congratulations.

Bill Cimino

Thanks, Mitch. Thanks everyone for participating in today's call and for your questions. Before we conclude the call I'd like to remind you that a replay of the call will be available by approximately 2:00 p.m. Eastern Daylight Time today and will remain available through September 27th. Investors in the U.S. and Canada may access the recording at 1-800-642-1687 and other investors may dial 706-645-9291. The access code for the replay is 4003007. A replay of the call also will be available on the Circuit City investor information home page at investor.circuitcity.com. This concludes the call. Goodbye.

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