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Circuit City Stores, Inc. (CC)

F1Q08 Earnings Call

June 20, 2007 11:00 am ET

Executives

Bill Cimino - IR

Phil Schoonover - Chairman, President, CEO

Dave Matthews – EVP Merchandising, Services and Marketing

Danny Clark - EVP Multi-Channel Sales

Phil Dunn - Controller

Analysts

Chris Horvers - Bear Stearns

Bill Armstrong - CL King & Associates

Robert - Goldman Sachs

Bill Sims - Citigroup

Dan Binder - Buckingham Research

Brian Nagel - UBS

Mitch Kaiser - Piper Jaffray

Sarah – Sanford Bernstein

Adam Sindler - Deutsche Bank

Presentation

Operator

At this time I would like to welcome everyone to the Circuit City first quarter results conference call. (Operator Instructions) Mr. Bill Cimino, Director of Corporate Communications, you may begin your conference.

Bill Cimino

Thank you, April and good morning. We appreciate your participation in today's call. I need to remind that you 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; Dave Matthews, Executive Vice President of Merchandising, Services and Marketing; and Danny Clark Executive Vice President of Multi-Channel Sales. I will cover the financial overview of the quarter.

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

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Phil Schoonover

Thanks, Bill and good morning to all. Today I'll discuss the progress we've made against our transformation plan, including the action we've taken within the last four months, the next steps we will take will be reviewed, an update on our fiscal 2008 financial outlook, an update on our CFO search, and an update on InterTAN.

First on our transformation so far. As you know, we are in the midst of a multi-year turnaround and we've accelerated our transformation plan to meet the profit challenges we face in our business model. Let me provide full context around how we view Circuit City's turnaround stages.

First, our Act 1 represented by early, more manual turnaround work we did to achieve low-hanging opportunities. We improved our talent base and we made initial process changes, but the gains from Act 1 are not sustainable on their own because of the margin change in our business. That led to Act 2.

During Act 2, we've been putting in new systems and establishing processes to enable us to do our work better and faster. As a result of the work we've done, we've seen great growth in our services and multi-channel businesses. We are broadening our focus from televisions to a larger view of winning in home entertainment, and we've made improvements in our real estate through new store openings. We're upgrading our systems with retail POS, Connect3 and our Oracle-powered merchandising systems. We're improving our processes through our new standard operating platform in the stores, and we've just reorganized the store support center to facilitate our future growth.

The actions we've already taken are expected to reduce Circuit City's SG&A by $200 million annually and give us the opportunity to invest in our four strategic growth pillars including additional store openings, IT systems, multi-channel capability build out and Firedog services. Act 2 frees up capacity and brings us up to industry standard practices and systems, but more can be done which will soon lead us to Act 3.

In Act 3, the new tools and processes will free up our associates to better serve our customers and will eliminate internal barriers to execution. We will smooth out the volatility through crisp execution on retail fundamentals and build sustainable earnings growth.

Turning to our structural changes. At the end of May we completed major activities to structure our field organization and our store support center around the long-term vision for our company, and we aligned our goals and incentives to support this activity. Danny Clark will touch more on the field organization and store changes later in this call.

In February, we aligned our executive organization at the store support center to have Danny Clark responsible for all retail sales channels and Dave Matthews responsible for all value proposition creation and communication through merchandising, our services business and our marketing function. In order to cascade that alignment, we built an organizational structure that supports our growth pillars and strategic architecture. We eliminated redundant function and some entire pieces of work. We integrated activities that will drive towards common financial outcomes.

As we've said previously, we wanted to make the major organizational changes to the company in the first part of the fiscal year, which allows us to get ready for the back-to-school and holiday selling seasons.

Remember, at the same time we are structuring a more lean organization, we will be adding associates to Firedog, our multi-channel efforts, and to fund our new store openings and support growth in all of these areas. The end result is that we are positioned for our long-term strategy and profitable growth. Goals and commitments throughout the company are aligned to execute this strategy, and we have freed up capacity through simplifying our work, enabling us to focus on execution in the coming year.

Second, let me talk about the next steps in our transformation. We will continue to move aggressively on our merchandising, supply chain and retail transformations. This is a massive amount of change to undertake, but we will move quickly and decisively. With the changes in the marketplace, it was obvious that the business as usual approach would lead us to a predictable and unacceptable outcome for our associates and our shareholders. We are focused on helping our associates with solid communications and we're reaching out to all associates so they understand the new direction. They also need to understand the changes we have made and how they will do their work in new and better ways.

Third, let me touch on our fiscal year 2008 financial outlook. We have talked about this year as the tale of two halves. We've expected the first half to be volatile based on the degree of change and the economic headwinds that we're facing at this phase of our transformation. We actually saw results come in below our original plan, but we met our revised guidance despite both the choppiness in the macro-economic environment and the amount of change that we introduced to the company during the quarter.

The volatility associated with the amount of change to the company combined with the unfavorable macro-economic environment make it difficult to project our annual performance at this time. In light of this we are withdrawing annual guidance for the time being.

The major structural changes are now complete, and I want to thank the management team for their courage to move with a sense of urgency and thank all 43,000 associates for their support and focus during these turbulent times.

Now let me provide a quick update on the CFO search. As you know, we started the search in late April. At this point we have two distinct candidates that are in the bull's eye of the profile I am looking for: an operating CFO who has the experience and energy for this phase of our transformation. We expect to have a decision shortly.

Turning to InterTAN. In late March we announced that we engaged Goldman Sachs to explore strategic alternatives around our Canadian operation, which could include divesting the business. We would expect to move forward with the process when and if the optimal shareholder value can be realized. While we explore alternatives, the major transformation work continues in our Canadian operations. Our team is making great progress driving the necessary changes to the business, as is evident in the year-over-year improvement in first quarter results. I'd like to take this opportunity to personally thank our associates in Canada for their hard work and dedication.

To further this transformation in Canada, we've asked Ron Cuthbertson to be President of InterTAN. Ron is a citizen of both Canada and the U.S., and his familiarity with Canadian retailing through Sears of Canada, Future Shop, Best Buy Canada and work he did for Best Buy U.S., combined with his knowledge of sourcing, supply chain and retail transformation give him the right skills to manage that business on a day-to-day basis. We have a strong bench in the supply chain and inventory teams here in the U.S.

Now I'll turn the call over to Dave Matthews.

Dave Matthews

Thank you, Phil. Good morning. This morning I'd like to discuss two of our strategic pillars, win in home entertainment and digital home services, our merchandising and supply chain transformation and our marketing initiatives. I will start with win in home entertainment.

First let me talk about the TV business. Comparable store sales of flat panel TVs grew 9% for the quarter and represented the largest comp dollar driver in a category. Triple-digit growth in large LCD screens was partially offset by a sharp decline in plasma and a modest decline in small and medium LCD. Projection and tube TV suffered sharp declines as well, continuing the trends we've seen in recent quarters.

Let me offer a few thoughts on what happened in Q1. The attachment on each ticket continued to grow in Q1 versus last year, but not enough to offset the television price decline. As a result, our total revenue and margin dollars per ticket both declined from last year. We focused on higher-end technology, such as 1080p, but missed sales opportunities for tube, projection and 720p flat panels. We missed opportunities for sales in small and medium LCD, where we were under assorted and under stocked. Sales of these TVs typically carry a lower basket size than larger LCD's, but provide incremental revenue that support the customer's perception of Circuit City as a television destination. We have an opportunity to rationalize our brand assortment to make sure we have the right number of good, better and best SKUs.

We're working to improve execution by addressing assortment, in stock and brand mix, with a goal of simplifying the selection for our customers and associates, and we're making strategic changes to place greater emphasis on solution selling with a goal to make shopping simple for our customers while improving revenue and margin per transaction.

We're moving beyond the television, focusing on the broader product category of home entertainment. To enhance both the customer experience and our own financial performance we must move beyond TVs and focus on audio, DVD, accessories, games, services, and digital lifestyle products that bring our individual products together.

Now I'll turn to digital home services. We continue to build out a world-class services business through our Firedog brand and we posted 70% year-over-year growth in revenues from that business. We will continue to build out operational capabilities including new systems. We will add new revenue streams this fall, such as the ability to process sales on Firedog.com, and expanded services offering on CircuitCity.com and new remote PC service stock-keeping units in more stores and on CircuitCity.com.

Along with the PC services and home theater installation our Firedog services brand will now include mobile installations, formerly known as Road Shop in our stores. The change moves us further down the path of creating a single service brand for consumers.

Next I'd like to talk about our merchandising and supply chain transformation. We realigned our merchandising services and marketing teams to support our strategic architecture and drive accountability for value proposition development, including merchandising, supply chain services and financing, and how we communicate through marketing. We consolidated the merchandising organizations for the stores and the web. In addition, we realigned the responsibilities of our general merchandise managers in order to accelerate initiatives focused on strategic priorities, building out new capabilities and improving accountability.

Another aspect of our merchandising transformation is the development of our cross-functional teams. The goal of these teams is to create and develop compelling value propositions for our customers. The cross-functional teams are comprised of members from merchandising, planning, services, inventory, marketing and sales development. These integrated teams enable speed to benefit and eliminate the roadblocks that come with operating in silos. Likewise, each team will work closely with our sales channels to align around our single strategy, making it simple for our customers and associates.

Turning to our merchandise systems transformation. We remain on track and on budget for the systems rollout. Two foundational modules were put in place in fiscal 2007. In June we rolled out our next two modules, pricing and promotions. The pricing module helps us measure price elasticity overtime to better manage markdowns. The promotion model, which you may have heard us refer to in the past as Connect3, enables us to price and promote items at the market level. It will take some time for our team to get full benefits from these enhancements; however we expect to start realizing benefits in the back-to-school and holiday seasons. Additional modules will go live this fall.

Next, an update on our supply chain. Last week we hosted a vendor summit for our top 60 partners. We discussed the transformation going on at Circuit City to make sure they understand where we are coming from, where we are going, and how it impacts them and the sales of their products. We also spoke to them about the ways that we can help our business work better. We aim to enhance communication, collaboration, transparency and accountability.

We are also investing in our distribution network. We are consolidating and relocating two distribution centers in a new center in the Scranton, Pennsylvania area. The new DC will be optimized for web shipments and will be able to ship small and large goods on the same truck to the northeast and Mid-Atlantic. Previously those areas were served by two DCs; one shipped large product, the other small. The new DC will be online next year and will help us improve productivity and in-stock levels.

And finally I'd like to touch on what's going on in the marketing area. We have consolidated our store and web marketing organizations to align and to improve accountability. We have begun the migration from a focus on mass marketing to a portfolio approach that will include more targeted marketing programs. We continue to focus on rebuilding the Circuit City brand and building the Firedog brand.

Now I'd like to turn the call over to Danny Clark.

Danny Clark

Thanks, Dave. I'd like to provide an update on the following: our multi-channel growth, real estate, and our retail transformation work. We continue to show strong growth from our multi-channel business. Our direct channel posted strong revenue growth this quarter of 21% on top of an 85% increase in Q1 of last year. We continue to see positive results from our in-store pickup offering and an increase in use in our extended web assortment to fill special orders in store.

To continue growing sales in this channel, as well as better integrating with our stores, we are adding capabilities that create customer relationships at the beginning of the shopping experience. We have micro sites that enable customer to say get detailed information about a specific product category. For example, our home theater micro sites enables consumers to learn how the products that make up the home theater work together and what products and services they would need to create their own home theater.

We also host forums which offer consumers and Circuit City associates the opportunity to interact with each other online. Other consumers can read the forum conversation and add their thoughts. Forums provide an opportunity for our customers to ask an expert a question or benefit from viewing other comments about products and services, and we will continue consumer reviews. We are becoming a true multi-channel retailer by creating a seamless customer experience regardless of the channel the customer prefers.

Now for real estate. In fiscal 2008 we plan to open 60 to 65 new and relocated stores, up from 35 openings last fiscal year. The majority of these new stores will be in our 20,000 square-foot format. These new locations will better serve our customers by extending our reach and updating the look, sound and feel of our stores.

I will now touch on our retail transformation. Circuit City has announced a number of changes and initiatives over the past few months, and many of them have been focused on updating our store operating platform and organization. These changes will improve the customer experience.

The last week in May we instituted a new management model in our stores. The new tiered model will provide a more supportive leader/teacher structure. We stratified the number of store managers based on store volume and we added a new supervisor position. The supervisor position provides more direct supervision and coaching on the sales floor, as well as a better career path. The net impact of the changes was neutral on average to the store associates, but pushed resources closer to the customer.

Also, we have designated some of our super stores as regional and district learning centers which will be the key conduit to drive change associated with our transformation initiatives. New initiatives will still begin in lab stores, but once results indicate that it's time to move to the next step, they will be rolled into the regional learning centers. There we can test across a number of store formats and geographic markets to confirm benefits prior to making scale decisions.

We are scaling our new tested and piloted standard operating processes to all stores beginning this month and concluding in August. The new procedures simplify key operational processes so that we can allocate time formerly spent on tasks to customer facing time. We expect to institute a workload planning system this summer, which will serve as a gatekeeping function for the work we pushed through the stores. Examples would include non-selling activities such as category resets and new signage packages. The end result should be less stress on stores, improved communication, and better execution. We'll allocate our resources to make the most impact.

We are also finalizing the selection process of a labor scheduling system, which will enable us to better match store labor with customer traffic. We will start to test the new system in a few stores before a holiday.

In addition, I would like to provide an update on RPOS our replacement point-of-sale system. RPOS is currently in place in 30 stores, and we are in the process of finalizing training and applications stabilization. We expect to begin our full deployment starting in the Atlanta market in July and go market by market until we are nationwide. All of these changes enhance the customer experience by making sure that our store resources are allocated appropriately. The changes enhance the associate experience by clarifying roles, providing a career path and establishing a culture to drive success. The company will support the changes by providing the tools, processes, training, and accountability that associates need to execute.

With that I will turn the call back to Bill Cimino.

Bill Cimino

Thanks, Danny. I'll now quickly review our first quarter financial results before we take your questions. For the quarter net sales decreased 4.3% to $2.49 billion. Domestic segment sales declined 4.4% to $2.38 billion. The domestic sales decline was primarily driven by our comp store sales decline of 6% from last year. In our stores, traffic declined by a low single-digit from the prior year, and our revenue per transaction was flat to last year, while close rates declined by a high single-digit.

On the product side, strength in categories, such as large LCD TVs, notebook PCs, navigation, gaming products and home installation services was more than offset by weakness in projection, tube and plasma TVs as well as MP3 players and CDs.

Our international segment posted comparable store sales growth of 4% in local currency, which was offset by the impact of 53 planned store closings net of openings during the fourth quarter to result in a total sales decline for the segment of 2%. Consolidated gross margin declined by 195 basis points from last year. Domestic gross margin declined 204 basis points, driven primarily by a decrease in extended warranty net sales as well as a lower merchandise margins that were driven by a greater mix of lower-margin PC hardware sales.

As Dave mentioned, our large flat panel TV sales were below plan, so we lost some gross profit dollar and margin benefit from those sales. The average basket for the flat panel TV category continues to grow, but the dollar growth is not enough to offset the continued average selling price declines.

International segment gross margin decreased 22 basis points, driven by the mix shift from higher-margin categories such as parts, batteries and accessories, to lower-margin categories, such as video games, navigation products and PC hardware. The international segment gross margin did not materially impact the consolidated gross margin. Compared with recent quarters, the improved performance is a direct result of the transformation work under way in Canada.

Consolidated SG&A expenses as a percentage of sales increased by 166 basis points. In the domestic segment, which contributed 201 basis points to the increase, net incremental expenses primarily related to strategic investments in IT, multichannel capabilities and innovation activities totaled about 90 basis points of consolidated net sales. The increase also reflects the overall deleveraging impact of lower sales.

In Q1 we incurred $4.9 million or 20 basis points of severance expense related to our restructuring initiatives. The international segments decline in expenses partially offset the domestic increase. International SG&A expenses as a percentage of segment net sales decreased 900 basis points, primarily due to a $7.5 million recovery related to a former subsidiary. Additionally, the segment benefited from the impact of store closings during the fourth quarter of last fiscal year.

Our earnings before taxes percentage declined to a loss of 3.3% this year compared with earnings of 0.3% last year. The pre-tax loss of $82 million was within the revised guidance we provided in late April. The net result for the first quarter was a loss from continuing operations of $0.33 per share compared with net earnings of $0.03 per share last year.

Turning to the balance sheet, at May 31 we continued to have a very strong balance sheet, with cash, cash equivalents and short-term investments of $364 million, only $56 million of long-term debt principally related to capital leases, and little short-term debt. The cash, cash equivalents and short-term investments position is down $270 million from the $634 million we had at May 31, 2006. The year-over-year decline was principally due to cash use for CapEx of $311 million and cash used to repurchase nearly 11 million shares of stock and to pay dividends totaling $258 million. The decrease was partly offset by the decrease in net owned inventory. We're very comfortable with our cash position today.

The increase in accounts receivable is primarily due to increased vendor receivables. Consolidated merchandise inventories declined 10% with last year, as we reduced at-risk inventories while improving in-stock levels. Inventories declined in both the domestic and international segments due to improved inventory management. Merchandise payables also declined, primarily due to reduced receipts of product. Our net owned inventory decreased $113 million, $92 million of which was in the domestic segment.

Turning to share repurchase. During the first quarter we bought back 2.5 million shares for $46.7 million for an average cost $18.68 per share. We now have bought back a total of 60 million shares for $966 million or an average cost of $16 per share. We have approximately $234 million for future share repurchases under our current board authorization.

Now I'd like to turn the call over for your questions. April, we're ready to take the first call.

Question-and- Answer Session

Operator

Your first question comes from the line of Chris Horvers - Bear Stearns.

Chris Horvers - Bear Stearns

On the InterTAN side, can you talk about how you're looking at driving shareholder value and how you measure? The business was unprofitable if you took out that $7.5 million gain. How do you measure the distraction value of running that business in Canada versus the core business in the United States, and has your thought process changed at all as to your commitment to the process?

Phil Schoonover

There were a number of questions in there, Chris. I think we made the decision that we would prefer to sell the company if we can get a reasonable price that optimizes shareholder value. As we went through the process there were a number of suggestions made, up to and including suggestions by Goldman how we could optimize the value of that company. Obviously there's a trade-off between profitability and value of the company, and if they had some suggestions that could be handled in the near term, up to and including the leadership changes we made putting Ron Cuthbertson responsible for execution up there that would improve shareholder value, we need to get those done.

So there is a distraction factor with InterTAN. There is also significant improvement in operating results year over year for the first quarter, and that will help improve shareholder value.

Chris Horvers - Bear Stearns

As we think about this investment spending for the year, the 90 basis points of pressure in the first quarter, how should we think about that in quarters 2 to 4 and when do we start seeing actually decline in spending year over year?

Bill Cimino

As we talked about the trends at the beginning of the year, we expected the first quarter to have the largest year-over-year impact in terms of the investment spend, and then the impact would decline in the second quarter, be roughly breakeven in the third quarter, and then turn to a benefit in the fourth quarter.

Phil Schoonover

So I think we're saying no change from our last guidance,

Bill Cimino

Correct.

Operator

Your next question comes from the line of Bill Armstrong - CL King & Associates.

Bill Armstrong - CL King & Associates

Could you discuss the environment concerning competitive pricing in both extended service contracts as well as installation or Firedog services? What you're seeing out there, and is that impacting the dollar attachment rates we're seeing?

Dave Matthews

Actually we've been spending a lot of time looking at our Circuit City Advantage Program and the value proposition for our customers. Obviously, as ASPs on televisions, as an example, come down we have to go back and really re-rationalize the value prop and the price points of the Circuit City Advantage Program. We do it internally, looking at the value prop that we've had as the fee comes down, but also relative to what the competition is doing with their extended warranty programs.

We think there are some unique benefits to our Circuit City Advantage Program that our competitors do not have, TV being an example. We provide a kit with value for our customer that they can realize immediately. We also have a program that is good for the life of the warranty, meaning if you exercise the warranty, it is still good for the balance of the term. Our competitors do not.

With all of that said, we're going back as we speak looking at the pricing of our Circuit City Advantage Program, making sure we're providing maximum value, trying to take costs out of the program in parallel. We think it's something we definitely need to go and do work on, and we have some of our best people tackling it.

Bill Armstrong - CL King & Associates

What sort of training are your employees getting to convey the benefits of these warranty programs to customers?

Danny Clark

What we do with our associates is every product specialist that works on our floors has an extensive training program really based on what the value proposition of the total sell is, not just exclusively about City Advantage, but it's really understanding what the customers’ needs are by asking questions, so what's the right product for the consumer, what are the right attachments for the consumer, what's the right services and what's the right City Advantage.

We use the kit as just a behavior that we want. We want to see the kit offered to every customer. We know what percentage of our customers are offered the kit, and we track that closely. We also do associate focus groups, where we listen to our associates and the customers on how they feel about the value propositions. And to Dave's point earlier, we listen to feedback on that continuously, and we're always working to make it a better value proposition for the customer and a easier to understand and simpler value proposition for our associates.

So we have work to do here. I do think it caused some pressure in the first quarter, but we're making some adjustments and think over time that we'll end up creating a better margin per transaction.

Phil Schoonover

Bill, this is Phil. The final point I will put on that is the tale of two halves. The first half we're creating capacity to do more during the all important back-to-school and holiday selling season. The overall value of our basket and the execution of consistent experience for the customer around all the things they need to make a computer or a home theater experience complete is where we're going to aim our capacity after the second half. We think there is upside in execution here.

Bill Armstrong - CL King & Associates

Just a quick balance sheet question. I see your income tax receivable jumped up by $100 million year over year. I was just wondering what that was and when you expect to actually be able to monetize that?

Phil Dunn

There's really two things going on here. We've got a loss in the first quarter. Obviously we haven't turned that into cash at this point in time, I think about $25 million or $28 million. Also we've got a refund claim in with the IRS. We've taken a tax position that we've got an agreement with the IRS from, and that should result in about $40 million.

Bill Armstrong - CL King & Associates

Do you expect to realize that within the next year?

Phil Dunn

Yes.

Operator

Your next question comes from the line of Matthew Fassler - Goldman Sachs.

Robert for Matthew Fassler - Goldman Sachs

Could you give us the drivers of the deceleration in TV dollar growth, split between units and ASP declines? You made some comments suggesting it was more on the ASP side, but if you can clarify that. Related to that, could you give us color on the shape of TV inventory, a split between 1080p versus 720p and then also rear projections versus flat panels? Thanks.

Dave Matthews

We actually had a lot of things going on in TV business, as both Bill Cimino and I touched on in our comments. We had tremendous upside and triple-digit growth in the large LCD business. We obviously had ASP declines in that business, but we had tremendous unit growth for a net win in revenue. As you go down through the portfolio, we had a combination in some businesses of ASP declining coupled with unit decline. In other businesses it was a mixed bag. So really the LCD business had overall strength, but we had challenges in plasma and tube. We had kind of a mix story in LCD, we had revenue growing, units growing, ASPs coming down, but that obviously is an opportunity for us.

Robert for Matthew Fassler - Goldman Sachs

Great, and the inventory?

Dave Matthews

I'm sorry, I didn't hear the second part of your question?

Robert for Matthew Fassler - Goldman Sachs

The inventory. In other words, can you give us color on what inventory looks like now between the technologies and formats?

Dave Matthews

Inventory's in relatively good shape right now. If anything, we found out through the course of Q1 that some of the upside opportunity that we had, we're actually bringing in inventory as we speak. Small LCD is actually an opportunity for us, and if we look at our brand mix, we under indexed on some brands in Q1 that we're placing purchase orders for as we speak. Overall inventory was down 16%.

Robert for Matthew Fassler - Goldman Sachs

Would you say you are heavy in the weaker TV categories, like projection and tube?

Phil Schoonover

I think what Dave's saying is the opposite of that. We're actually light in small LCD, we're light in 720p, and we may be light in some of the more aggressively-priced higher end television.

Operator

Your next question comes from the line of Bill Sims - Citigroup.

Bill Sims - Citigroup

Just to confirm, are you saying you're light in plasma displays as well?

Phil Schoonover

In plasma, no, absolutely not.

Bill Sims - Citigroup

Is there further markdown risk? Or I guess the broader question is, as manufacturers shift or as demand falls off for plasma in favor of LCD, are you seeing a glut of plasma inventory out there throughout the broader channel and is there a risk throughout the industry of a fair amount of markdown risk over the next quarter or so?

Dave Matthews

I think right now we're in pretty good shape on plasma inventory. What happens in the market place going forward I can't predict, but we'll definitely be watching the external marketplace closely.

Bill Sims - Citigroup

The same questions regarding warranty pricing. What can you share with us? What did you learn last year? Have you built in any more flexibility into your pricing or the agreements you made with your own insurers, so if we do get another aggressive price move in the back half of the year you'll have more flexibility in pricing this year than what we experienced last year?

Danny Clark

I think Dave highlighted earlier for you that in all categories to some extent we've experienced average unit retail decline, and we have to really work on and understand our value proposition, not only for City Advantage but what it is for services and other attachments inside the basket.

The way we think about this is we don't think about it as a single category. We think it about as a holistic solution for our consumer. With all that said, we've learned a lot over the last two quarters as AURs have declined rapidly in televisions of what we need to do to make the value proposition correct for the customer. We're always finetuning this. This is a constant thing. We do it month in, month out.

We have several different things in test and pilot right now that we're learning about. I talked earlier about, as we learn things in lab how we have regional learning centers and district learning centers that we could take it to scale inside the company and that's the work we're doing today. Bottom line is, we want to have the right value proposition for our customer every day in our store and we want to make it simple enough for the associate to understand.

Bill Sims - Citigroup

My final question is regarding share repurchases. I see you didn't announce the new buyback authorization, although you do have $234 million left in the existing one. How do you think about buybacks going forward? While it might be one of the highest return investments you got going right now, is there a consideration, given the investments that you're making and the uncertainty of the future, to pull back to the share repurchase activity?

Bill Cimino

Actually Bill, as a reminder we have the receivables in addition to our cash position, and we have cash flow from the base business, even in a worst case scenario, So I think our current share repurchase gets us through the near term, more opportunistic window, and we will be meeting with our board this month. Our board will look at share repurchase as well as other financial vehicles to improve shareholder value.

Operator

Your next question is from the line of Dan Binder - Buckingham Research.

Dan Binder - Buckingham Research

The cost savings that you have outlined in your release today are quite a bit higher than the original expectations that you said or outlined in a prior release. I'm just curious where you found the extra cost savings and whether or not you can group it into baskets of where it's coming from?

With that in consideration, it may seem a bit of a ridiculous question at this point, but any thoughts on the long-term pre-tax margins, given what you're seeing in the industry?

Phil Schoonover

Dan, first of all, the number I stated today is an annualized number, so getting a full-year of benefits we think that number is on or about the $200 million number I gave today, so we disclosed $140 million against that. The major pick up was, as we looked at opportunities here in the store support center, both in headcount and taking out whole pieces of work and in the not-for-resale purchasing we do, we made the biggest improvements in efficiencies over our last estimates as we really got into that work. There was some savings in my number this morning for InterTAN that were not in the original number. I think relatively small number, but the way I was thinking about that original number, so those were the major changes. And this is sort of on or off when you separate associates or you renegotiate purchases, these are pretty confirmed benefits, so we feel pretty confident about it.

As far as our long-term guidance, we've withdrawn our financial guidance for the balance of this year, and as such we're not prepared to discuss our long-term outlook. Despite the setback in timing we've experienced, we believe that the future of Circuit City is very bright and that our initiatives to improve the business will lead to better results in the second half of this fiscal year and for the long term.

Dan Binder - Buckingham Research

Just another question on the disruption that you experienced in Q1, fairly significant, following some significant changes in the organization. On a relative basis would you characterize the Q2 disruption that you expect to be more or less the same as what you saw in Q1?

Phil Schoonover

I'll let Danny be specific with what's going to go on in the stores this summer and then maybe Dave can talk about marketing, merchandising, and supply chain and services.

Danny Clark

The Q2 disruption is going to get better every day. We had some very big movements in the first quarter of the year where we really said we're going to stratify the management model, put supervisors positions in. One of the things that was a huge positive for us out of that work where it calls people to get into new roles and jobs and required to us put together on-the-job training programs so you had to learn while you were in the role. We had a very positive reaction out of the associates who really came back to us and said, it's great you've done this, wish we would have done this sooner. It made a clearer career path for people. They said, hey, you know what, I understand how I can move from a product specialist into a supervisory role into a management role and it narrowed the gap and skill set needed to make those transitions.

That piece of work happened at the end of May, and what we launched from there into is an eight-week on-the-job training program where literally you learn new tools, new skills every single week for the month of June and for the month of July.

The other thing is we put a message out to our retail stores, to people waiting on our customers and servicing them that the big changes were behind us. What this is really about is learning your new role and how you can work together better and better serve the customers, so I believe we're going to have the opposite of what you saw in the first quarter. I think you're going to see us steadily improving and I think by the time we get into the back-to-school season we're going to start catching a gear in terms of our execution and accountability at retail. Did that answer your question?

Dan Binder - Buckingham Research

Yes, it sounds like things are going to be a little less disruptive.

Danny Clark

I would expect people to learn their new roles and get more comfortable in their jobs and get better every day this summer.

Dan Binder - Buckingham Research

Obviously there seems to be a little bit more widespread weakness in the TVs in the industry. I'm just curious, you cited a lot of assortment issues and close rate issues. How much of the TV problem that you're seeing in your business now is more specific versus macro? I realize it's hard to quantify, but is it one-third macro, two-thirds company specific?

When we think about the fact that the wholesale clubs have been seeing a steady strong double-digit increase in their TV business and the consumer electronics channel has seen a little bit of a decline, do you think there is unit share shifting between channels?

Dave Matthews

I think your first question around how much of it would be issues internally that we can wrestle control over versus macro issues, I think it's actually both. Clearly, there are signs of a headwind in the marketplace. I think we see that as well as I think it's been reported by some of our competitors that they're seeing some headwind.

In terms of who is winning and losing, clearly the discounters are people that we need to keep an eye on. We also talked about improving short-term execution, but we also need to talk about how we compete long term and how we add value for our customers. So I talked earlier in my comments about solution selling and creating value for customers and our associates, making it simple. That's something we're going to put a lot of focus on.

Back to the marketplace, obviously the announcements at CompUSA, all of those things point to increasing headwind, but internally we're doing everything we can to improve execution and really bring to life some of the things we talked about, including solution selling.

Phil Schoonover

You know, I would add one thing, Dan. If you think about the TV business last year, we had opportunities in better collaboration with our vendors in supply and in pricing, so a lot of those agreements have been rethought through and there's opportunities in margin, and there's opportunity in velocity, just more rational second half here.

Our store pricing, in general we lost some controls over our store pricing, particularly in the second half of the year, as prices were plummeting weekly, and we have an initiative that is very direct around shoring up some of the self-induced margin issues. We've asked the team that develops baskets, whether it's furniture, accessories, cables, City Advantage or Firedog to actually be ready if then -- so if the price drops, then what is your new price going to be? Which we were not ready last year particularly in City Advantage, for the plummeting price drops.

The pressure or change, we made a decision to move the change into the first half of the last year, learning those tough lessons from last year. All of these point to Circuit City having some unique opportunities to better execute in the TV business in the second half.

Operator

Your next question comes from the line of Brian Nagel with UBS.

Brian Nagel - UBS

I have a question regarding 1080p. I attended the Display Search Conference out in California last week, and we talked a lot out there about 1080p and the promises for that technology, so I guess a few questions.

Phil, from your perspective is 1080p catching on with consumers faster than maybe you initially anticipated? What are some of the implications of this for your business? Looking back at some of the weakness we saw in April, could that have been a function of maybe some confusion in the consumer's mind as we shift from 720p to 1080p? And then, as we go into the holiday season if 1080p does keep margins higher or pricing higher, will that be a positive for you guys?

Phil Schoonover

I think I will let Dave answer this, but in general we've always tried to lead the new technologies, and we really emphasize 1080p, maybe to our detriment. Customers were voting and saying 720p may be good enough for me and at these value prices, I think we saw 720p, 42-inch product in the marketplace for less than $900, and some customers just said that's good enough for me. So if anything, we will continue to lead the charge on true high definition. which is 1080p, but we have to be aware that a $1,000 TV for a lot of customers is a high-end TV and 720 may be good enough for the nearer term. Anything to add, Dave?

Dave Matthews

No, I think you nailed it, Phil. I think we definitely want to be a destination for latest, greatest technologies in televisions, but I think the headwind that we talked a little about in the economy maybe gave consumers a reason to pause and more people gravitated to 720 perhaps than we thought would. So we have a huge opportunity here in the near term to optimized the assortment and really serve both customers, 720 and 1080.

Phil Schoonover

It's pretty clear to us Circuit City needs to be positioned at the high end of this given the competition we have at the low end.

Operator

The next question is from the line of Mitch Kaiser with Piper Jaffray.

Mitch Kaiser - Piper Jaffray

From looking at warranties, as I calculated it was down about 45% year over year. I was hoping you'd comment on why we saw such a big decline. Was it TV attachment, mix, pricing or was it related to the disruption on the changes in the store labor model?

Dave Matthews

I think we had two factors. The TV unit contributed a piece of the miss in Circuit City Advantage. We had some execution challenges. Danny talked about disruption in the store in the first part of the year. I think really we had both issues going on, execution challenges and clearly a piece of it tied to the ASP decline in televisions. That would be another factor as well as the unit miss in televisions.

Mitch Kaiser - Piper Jaffray

Okay. Do you see that getting better going forward? Is there a magic price that people stop attaching warranty?

Danny Clark

I think where Dave and I are focused as a team because we realize this is from what the price of the product is going to be all the way to how that basket fits with what the customer's looking for and how simple it is for the associate inside the store. We have several different things going now, but we're learning what is the right product mix, what is the right product price. We're always learning what City Advantage should be priced at.

But I want to go back to the point that it's more about just the City Advantage price. We're really trying to improve our margin per transaction. That's where we're focused right now. That's something we recognize we have to do. We've been able to improve the basket attach, as we said in the comments, but not enough to cover the ASP decline yet, so we have more work to do.

Phil Schoonover

Mitch, just to hit your question head on, we identified City Advantage as a separate issue. We're doing some testing, and we are unhappy with our performance in City Advantage. We're very happy with our performance and the 70% increase year over year in Firedog, and we're happy with most of our accessories and furniture attachment, but when we stand back from the overall basket, it can't be a net trade. City Advantage needs some attention.

Mitch Kaiser - Piper Jaffray

Okay. That's good. Maybe just one more. Looking at the cost saves you identified $135 million. I think it would be useful if we could just say how that spreads between the four quarters of this year. Did you recognize some in the first quarter and then how should that layer in for the remainder of quarters?

Phil Schoonover

I think we'll have the team call you back, but here's a way to think about this. These were one-off decisions, so the reduction in headcount, the separation of the associates in the field and here in the store support center, that is done and will be plus or minus a run rate number. Any permanent changes we make for not-for-resale purchasing, travel policies, any of the variable costs that we've reduced, those are decisions we've made and will be a run rate decision.

There's some phasing on the not-for-resale purchasing side, so we get to some of it today and some of it later in the summer. When we used the first number today, the $200 million number, that's a fully annualized number. Usually in the stores labor is a percentage of sales and in the expense structure, it's typically more of a fixed number. So we haven't broken out the monthly flow for today's call, but you might want to call the team to get a little more color.

Operator

Your next question comes from the line of Colin McGranahan - Sanford Bernstein.

Sarah for Colin McGranahan - Bernstein

I just had a question about your store growth plans. You're still targeting 60 to 65 this year, and I think you had said 90 to 100 in the following year. I was wondering if you were still planning for that number? If you could talk a little bit about how you're evaluating the stores, what kind of maturity curve you're expecting and how you test whether they're meeting your expectations? Thanks.

Danny Clark

We built a very robust pipeline that we feel really good about. We had over a number of years built very few new stores. We had replaced a few stores, but our store growth had pretty much stagnated. We are planning to open 60 to 65 stores this year. About half of those stores will be replacement stores. We have a need to update the look and feel of our stores. We think this also extends our reach into the communities.

That pipeline, we are planning to build somewhere between 75 and 100 next year. That really depends on individual real estate decisions. As time goes by we'll take a look at it. We want to make sure that we get the right location in the right trade area, and we're also working on our timing of when we open those stores up, but that is what we're doing with our pipeline.

Sarah for Colin McGranahan - Bernstein

I just wanted to see what kind of systems you had in place to test whether they're meeting your hurdle rates, if you have that?

Danny Clark

Absolutely. As we open stores and we have been opening a few stores, we feel really good about our analytics around our store openings. We can predict how they're going to perform. We have some stores that are above what we expected. We have stores below, but on the average we understand exactly how the stores are going to perform and they are adding and will add value to the company over time.

Operator

Your final question comes from Adam Sindler - Deutsche Bank.

Adam Sindler - Deutsche Bank

When you discussed the $200 million in annual savings earlier in the call, you also discussed four initiatives that would receive additional investment: the Firedog, the store growth, the IT and the multi-channel. Would you be able to quantify approximately how much of the savings will be reinvested in these four initiatives?

Bill Cimino

We haven't broken out that information. As we said, there will be some offsets to the savings that we've broken out today that'll enable us to fund that going forward, so we haven't broken out as a percentage basis which one of those investments and how much we're going to invest in each one year over year. If you want, we can talk off line a little more about this. I can help you guys try to understand that a little bit more.

Adam Sindler - Deutsche Bank

You discussed that close rates were down in the quarter. We were just wondering was there anything specific? To that point more specifically, was any of this possibly due to the change in employment comp? If that was the case, have you seen any difference between the control stores that did not have the change in compensation?

Danny Clark

So there's a couple of different questions in there. One is, we obviously changed out a lot of personnel. We shifted positions. That created a distraction in the first quarter. We think that that had a relative impact on conversion. On top of that, we have to really work on and think about how our store is set up in terms of things that drive traffic: our end caps, our bulk outs, and our displays. Dave and his team are doing a lot of work there, so there's a combination of activities.

How we merchandise the store, how we use traffic drivers inside our ad where consumers pick up things inside the store they didn't expect to pick up. That helps drive conversion. We had a lot of different things going on in the system in the first quarter. We think as we begin to gain traction on our new standard operating platform that the execution issues in the stores will improve over summer, and Dave has his team focused on traffic drivers and how that can affect conversion as well.

Phil Schoonover

So, Danny, remind people of the targeted results in how much labor did you want to free up?

Danny Clark

On the last call I covered the lab work that we had done in our 50 pilot stores that led to the scaling of our SOPs. Those stores all showed an improvement in our conversion, an improvement in the customer experience, and an improvement in the associate engagements, which are all positive indicators for the business.

One of the big reasons that happened is it took a dilemma that the associate had between tasking and waiting on the customer and got it out of the way. So the way that these policies work is that many of the task-oriented assignments in the store now take place before the store opens and/or after the store closes so that when you enter a store, the associate working in the department is freed up and able to wait on the consumer, and we know as a fact that will improve conversion.

As I mentioned earlier, all of that work is being scaled as we speak and will be completely in all of our stores by the end of August.

Bill Cimino

Thanks, Danny, and thanks to everyone for participating in today's call and for your questions. I know we covered a lot of ground today and provided a lot of information.

Before we conclude the call, I'd like to remind you that a replay of the call will be available by approximately 2 pm Eastern Daylight Time today and remain available through June 27th. Investors in the United States and Canada may access the recording at 1-800-642-1687 and other investors may dial area code 706-645-9291. The access code for the replay is 3865723. A replay of the call also will be available on the Circuit City investor home page at investor.CircuitCity.com.

This concludes our call and thank you for your time.

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Source: Circuit City F1Q08 (Qtr End 5/31/07) Earnings Call Transcript
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