Circuit City FQ307 (Qtr End 11/30/07) Earnings Call Transcript

Circuit City Stores, Inc. (CC)

FQ307 Earnings Call

December 21, 2007 10:00 am ET

Executives

Bill Cimino - Director of Corporate Communications

Philip J. Schoonover - Chairman, President, and Chief Executive Officer

Bruce H. Besanko - Executive Vice President and Chief Financial Officer

Danny Clark - Executive Vice President of Multi-Channel Sales

John Kelly - Chief Merchant

Analysts

Danielle Fox - Merrill Lynch

Chris Horvers - Bear Stearns

Mike Baker - Deutsche Bank

Andy Hargreaves - Pacific Crest Securities

Scott Ciccarelli - RBC Capital Markets

Jonathan Cramer - Cowen & Company

Matthew Fassler - Goldman Sachs

Dan Binder - Jefferies & Company

Gary Balter - Credit Suisse

Presentation

Operator

Good morning. My name is Selena and I will be your conference operator today. At this time I would like to welcome everyone to the Circuit City third quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator Instructions) I would now turn the call over to Bill Cimino, Director of Corporate Communications. Thank you. You may begin your conference.

Bill Cimino

Good morning, and thank you for joining us today. Before we begin, I need to remind you that during this call we may make forward-looking statements which are subject to risks and uncertainties. We’ll 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. As we discussed in our press release this morning, we recorded a valuation allowance on our deferred tax assets. On today’s call we will make reference to net loss from continuing operations per diluted share excluding the impact of the valuation allowance. The reconciliation of net loss from continuing operations per share on a GAAP basis to the net loss from continuing operations per share excluding the impact of the valuation allowance has been provided in our earnings release which is available on our investor website and has been filed with the SEC on form 8-K.

Speaking on this call are Phil Schoonover, Chairman, President, and Chief Executive Officer and Bruce Besanko, the Executive Vice President and Chief Financial Officer. Danny Clark, Executive Vice President of Multi-Channel Sales, and our Chief Merchant John Kelly are here and will be available during the question and answer session.

With that, I’ll turn the call over to Phil.

Philip J. Schoonover

Thanks, Bill, and good morning. Today I’ll discuss the third quarter results and update you on the progress we’re making in both our transformation plans and our key priorities that position us for profitability in the near term and for sustainable growth in the longer term.

Clearly we are very dissatisfied with our third quarter results. Our operating profit performance was below the guidance we provided and we attribute the difference to underestimating the financial impact from the disruption of our store transformation work. The changes we made established a more efficient store operating model which reduces SG&A but contributed to poor execution, including lower close rates, reduced attachments of higher margin accessories and Fire Dog services, and lower sales of Circuit City Advantage Warranties.

Importantly, the issues are addressable, which saw the decline in our close rate reverse. The declines in our key TV attachment basket flattened out in August and then trended upward sequentially through the quarter. While challenging in the short term, we firmly believe that the transformation initiatives we have implemented were necessary as we needed to take immediate action to reduce our operating costs while improving the customer experience in our stores. As most of you are aware, over the past six months we changed the activities of more than 40,000 associates. In stores we reorganized the leadership structure, introduced seven new store operating procedures, and reduced the number of selling zones. We consolidated and restructured our corporate headquarters. This amount of change was disruptive.

As we went through the quarter, our store associates adjusted to the changes and our focus shifted back to customer service and selling. We experienced progress in execution levels on key metrics, including close rate and the TV basket. I am proud of how well our merchandising and marketing teams developed compelling offers and promotions, our inventory team delivered improved promotional in-stocks, our direct channel associates delivered strong growth, and our store associates leveraged our new SOPs to serve the needs of our customers. Our current focus is to rebuild our selling culture, which is critical to growing close rates, basket size, and our margin rate. We did advance our strategic goals during the quarter. The direct channel sales grew 31% in this quarter, which was in line with our expectation. This was on top of a 69% increase in the third quarter of last year. PC services and home theater installation revenues grew 29%, which was below our expectation, but strong growth nonetheless. We believe our services growth will improve as we further refine our stores’ focus back to selling attachments.

Turning to our real estate, we completed 21 domestic superstore openings in the quarter and we’re on track to open 61 to 63 incremental and relocated domestic superstores this year. Of the stores we opened in the third quarter, six are The City Stores, our next generation format. It is important to know that The City is more than just a better-looking store. The City is about fundamental change in the customer value proposition and transforms the experience for consumer electronics retailing into a seamless multi-channel journey with full service solutions. The differentiated experience also enables us to recruit and retain the most talented associates. The changes are significant and the initial data indicates that the customers and associates significantly prefer the approach over our previous model.

We remain on track to take $150 million out of SG&A expenses this year with annual expense savings of $200 million beginning in fiscal year 2009. We have reinvested a portion of these savings into initiatives to improve our business and prepare for future growth, including opening new stores and information technology investments. In addition, we ended the quarter with a solid balance sheet, including $483 million in cash. Net only inventory remained relatively flat from the third quarter of last year. As for other sources of liquidity, following quarter end, we signed a commitment letter with Banc of America to increase availability under our existing asset-based credit facility from $500 million to $1.3 billion.

Now turning to InterTAN. The leadership team in Canada has continued to gain traction on their transformation efforts. InterTAN improved its operating income five fold despite lower comp sales. Driven by improvements in gross margin, the team has done a solid job executing the plan over the past year and I want to acknowledge their success.

We are exploring our strategic options to maximize shareholder value with this asset and after pausing for the holiday season, we expect to revisit the plan in January. In summary, we’ve identified and are implementing changes necessary to bring about positive progress in our business. As we begin the fourth quarter, our top priority is to execute a retail recovery plan and master and refine the new processes and direction of our company. As we think more strategically about fiscal year ’09, we are focused on fixing our gross margin rate through merchandising, marketing, and pricing discipline; fixing our expenses to achieving our targeted reductions for next year and further aligning our work streams with our strategic goals; fixing our close rate and attachment by empowering our sales associates with the necessary knowledge and tools which improves both sales and margin. Growing the business by expanding the sales of our Fire Dog services and our direct channel businesses and relocating, remodeling, and selectively opening new stores. We remain committed to a strategy that leads us to improve sales and profitability in the near and long term.

Before I turn the call over to Bruce, I’d like to comment on the actions approved by our Board of Directors disclosed on Wednesday related to compensation. First, the Board approved a cash retention plan for all associates director level and above to help retain key members of our leadership team through our turnaround. In addition to the cash retention plan, the Board approved long-term stock awards under the company’s existing incentive plan. These stock-based awards align these individuals’ compensation with the company’s performance. Together, these actions bring our total rewards and compensation in line with the benchmark target set forth in our compensation philosophy.

My part of the plan includes only the performance stock option portion so that any benefit I receive is directly tied to the improved performance of the company. We look forward to continuing to update you as to our progress in the months ahead. Now let me turn the call over to Bruce.

Bruce H. Besanko

Thanks, Phil, and good morning, everyone. I’d like to cover three areas. First I’ll review our third quarter financial performance including analysis of the trends we saw in the quarter. Second I’ll discuss our near-term real estate activities, and finally I’ll share some of our financial plans for fiscal ’09.

Let me begin with a review of the financial performance for the third quarter starting first with our income statement. Net sales decreased 3.1% to $2.96 billion. Domestic segment sales declined 3.6% to $2.8 billion. The domestic sales decline was primarily driven by our comp store sales decline of 5.8% which compared to a comp store sales increase of 5.5% in last year’s third quarter. Comparable store sales declined in both September and October, with October significantly lower than September. In November, comparable store sales improved to a single-digit positive driven by a double-digit comp sales gain over the Black Friday weekend. However, we did experience sales weakness and states in the Southeast as well as the West, more so than other areas of the country which we attribute principally to the macroeconomic climate.

We underestimated the disruptive impact of our transformation activities on our third quarter results. On the positive side, we do see evidence that some efficiencies are being delivered from retail transformation, including an improvement in the time we take to greet the customer and customer perception of our associate availability. We will use the early part of next fiscal year to refine the platform and begin to master the work, including re-focusing on our selling behavior such as recommending accessories, warranties, and services. As we master the work over the next several months, we believe we’ll see continued improvements in attachment rates, close rates, overall sales and margin rate, while keeping expenses in line.

Turning to our international segment, sales increased 5.9% primarily reflecting the favorable impact of foreign exchange rates and offset by a comparable store sales decline of 1.1% in local currency and more than 70 store closings in the last year. Consolidated gross profit margin declined by 300 basis points from last year. Domestic segment gross margin rate declined 331 basis points. The decrease was driven by decreases in television margins, extended warranty net sales, and PC hardware margins, as well as a greater mix of PC hardware sales. International segment gross profit margin increased 152 basis points and did not materially impact the consolidated rate decline.

Consolidated SG&A expenses as a percentage of sales increased by 53 basis points. In the domestic segment, the key drivers of this increase were the overall de-leveraging impact of lower sales, an 80 basis point increase in expenses related to the 35 new domestic segment superstores that have opened during the past twelve months, and a 38 basis point increase in relocation and remodel expenses. The increase was partially offset by a 95 basis point decrease in compensation costs that resulted primarily from our expense reduction initiatives.

The international segments expense to sales ratio increased 36 basis points and impacted the consolidated rate increase by 17 basis points. We believe we remain on track to take out $150 million this year versus our run rate which annualizes the $200 million in fiscal 2009, although we expect these savings will be partially offset by incremental expenses associated with our long-term strategic plans.

Regarding taxes during the quarter, we recorded $103 million tax expense to establish a valuation allowance against deferred tax assets in the domestic segment based on FAS 109 guidelines. The net result for the third quarter was a loss from continuing operations of $1.26 per share compared with $0.12 per share last year. Excluding the valuation allowance our loss per share would have been $0.64 per share.

Now turning to the balance sheet, between our current cash position and the funding available to us through the amended credit facility, we believe we have more than enough available liquidity to sustain our multi-quarter turnaround efforts. Cash, cash equivalents, and short-term investments were $483 million at quarter end. Sequentially, this was up by about $59 million from $424 million at the end of the second quarter. As compared to the end of the third quarter last year, the balance declined by $415 million, principally driven by $315 million in cash used to purchase PP&E and $174 million to repurchase stock and pay dividends. These uses of cash were partially offset by proceeds of $66 million from the sales of property and equipment.

Let me provide a few more details about our amended credit facility. The facility would have an initial term of five years, is not conditioned on a successful syndication, and otherwise carries no financial covenants. This amended facility enhances our liquidity and flexibility and demonstrates that we continue to have adequate access to the capital markets. Consolidated merchandise inventories at quarter end were relatively flat with last year, even including the addition of 28 net new superstores. Our third quarter overall in-stock rates were approximately flat to the prior year, while in-stock rates for items in our promotions improved substantially. Net owned inventory was flat compared to the prior year despite our slower sales.

Turning to share repurchase activity, during the third quarter we didn’t buy back any shares and to date we’ve repurchased a total of $60 million shares for $966 million at an average cost of $16 per share. We have 234 million remaining under our current Board authorization. We opted not to repurchase stock during the quarter for several reasons, but primarily was the desire to maintain a strong level of cash on the balance sheet given the uncertain macroeconomic climate.

Turning to our outlook for the fourth quarter, assuming that current sales and margin trends continue for the balance of the fourth quarter, the company expects to deliver a modest loss from continuing operations before taxes for the quarter.

Regarding real estate, in my evaluation of the real estate activities, I focused first on our pipeline for store openings in fiscal 2009. We eliminated some specific sites that were not expected to deliver acceptable profitability. Our real estate team worked very diligently to shift the timing of store openings later in the year in order to maximize the economic contribution of the stores to the year’s results or into the following fiscal year if they could not be completed prior to the holiday. We continue to refine our pipeline for fiscal 2009 but we currently expect to open 50 to 60 new and relocated stores. I expect to share more conclusions from my review at a later date.

In total we’re planning domestic segment capital expenditures for fiscal 2009 to be within the range of $150 to $200 million. With that, I’d like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Danielle Fox from Merrill Lynch.

Danielle Fox - Merrill Lynch

Thanks, good morning. I was wondering if you could maybe compare and contrast some of thechanges you’ve made inthe plan for executive compensation with some of thechanges you’ve made to associate compensation because it seems like the top execs are getting paid more for poor performance and the rank and file associates... I don’t really see what the incentive is for them to perform or to stay with Circuit City, your best associates.

Bruce H. Besanko

Sure. So that’s a very fair question. September of last year we put a program in place for all management in the company, including our store directors and above, and I would characterize this as a retention program but also as an incentive for them to perform and it was incremental to their base and standard bonus program. The retention program that I discussed with the Board and that they approved was aimed at retaining the leadership necessary to continue this difficult turnaround. As you know, over the course of the last three years I’ve reassembled the management team and underneath our senior-most managers, they’ve assembled a set of senior vice presidents, vice presidents, and directors to lead this kind of transformation. This is very difficult work and is not for the faint of heart. It’s work that takes continued commitment and in light of the recent difficulties, I felt it was necessary to put a retention vehicle in atall levels or what I call our senior management director and above.

The base program that we have in place was a combination of stock options and restricted shares. Because of the current stock performance, that program for many of our executives was underwater and so far underwater that it didn’t have any meaningful value over time. In addition to that, our senior most executives did not receive a bonus for the last two years and will not receive a bonus based on this year’s performance. So we have two plans now to retain those leaders. One is our cash-based retention program and two is a stock-based incentive program which is in line with our annual stock-based incentive program and I feel I have the tools in place now to keep the management and leadership as well as the managers at all levels in the company engaged in this work.

Danielle Fox - Merrill Lynch

Okay, and could you maybe just address the issue of incentives atthe associate level.

Bruce H. Besanko

I think it’s fair to say that we have competitive salaries for entry-level associates and we payall of our supervisors and above a bonus in addition to their base salary based upon performance.

We’re ready for the next question, please.

Operator

The next question comes from the line of Chris Horvers from Bear Stearns.

Chris Horvers - Bear Stearns

Good morning and thank you. Given the difficulties that this turnaround is seeing and the fact that it seems every quarter comes as a surprise as to the amount of disruption, can you talk about your thoughts on taking a different strategic option and looking out to see if there’s anyone interested in acquiring Circuit City out there? The second question for Bruce, can you talk about the ability to drive cash, how much of the deferred tax asset is an NOL, the ability to drive payables higher and then finally, earlier inthe year you talked about net-owned inventory being down 125 year over year. Any comment on that now? Thank you.

Philip J. Schoonover

This is Phil, I’ll go first. We believe we’ve identified the structural issues that needed to be addressed in the company and we’re implementing the right initiatives to lead to profitability and sustain growth. We believe our efforts will lead to increased shareholder value and we’re staying the course on our longer-term strategic initiatives.

Because of the one-time change inthe television business last year, we had to take some costs out of our business. We were uncompetitive from an SG&A rate and we had obsolete standard operating platforms in our stores, so thechange that we introduced this year was significant. These are structural changes that we needed to get after in our multi-year turnaround and we think that we’ve materially done the right things to get our cost structure in line.

The consequences of this amount of change were more severe than we anticipated atthe beginning of the year. We believe that we have installed the SOPs. We think it’s known as the Circuit City way today. It’s a better way to run our store and it frees up time for our associates to serve our customers. The work we’re doing right now is to fixthe close ratein our stores and fixthe attachment of highly profitable accessories and services.

Bruce H. Besanko

Hey Chris, this is Bruce. I heard three parts to your question for me. One was around cash and the balance sheet, the second was around the NOLs and the tax issue, and then finally a little bit about net owned inventory, so let me start with the cash and then I’ll move onto the subsequent pieces.

So from a cash perspective, we’re actively managing the balance sheet and our cash position for strength. You should know that all of our, or nearly all of our stores are cash-flow positive and so we’re in a great position to continue to maintain a strong balance sheet as a consequence of the great cash that the stores produce.

Thechange year over year was principally driven and our cash position was principally driven by investments in PP&E and then the repurchase of stock late last year and the early part of this year, so that’s sort of what happened in terms of the sequential improvement, was in short was working capital efficiencies.

As it relates to the tax issue, as you know, we talked about impairing our deferred tax assets inthe third quarter. We were required to do that based on FAS-109. The result was a tax expense on top of the pre-tax loss. The three important elements of this, I think the tax impairment issue are first, this is a non-cash issue; second, we’ll be able to use the NOLs inthe future and I think that’s what you were asking about; and then finally, it doesn’t affect the income tax receivable that’s on the balance sheet.

Finally, as it relates to inventory, as we said inthe prepared remarks, consolidated inventories at quarter end were relatively flat with last year despite the fact that we opened 28 new superstores. Our net owned inventory was flat but I feel confident that we can achieve the goals of the $100 million to $150 million of net-owned inventory take out atthe end of the year.

Chris Horvers - Bear Stearns

Just one follow up to that; Phil, what exactly gives you the confidence that the changes being made are the right ones? You look at the new City concept and that does look really nice and great for the future, but you only have seven stores out there, so what are you seeing, are you seeing improvement in December? What exactly is it?

Philip J. Schoonover

We’ve been on a two-year journey to innovate our way to a new retail format. As you know, one of our major structural issues would be the age and condition of the fleet of Circuit City real estate. We think an opportunity is to change the physical real estate but also change the job of the store, so customer shopping patterns have changed a lot since we built the majority of these stores in the 80s and today they want the convenience for shopping online and picking up in the store and they want the full service when they’re looking to touch, feel, and compare.

So the job of the store is different, the actual economics of the 20,000 square foot box versus our standard 30,000 to 35,000 square foot box are different, and the look, sound, and feel of our new store is different.

We’ve been experimenting with elements of this for the last 24 months and our innovation work in Boston and Florida. These seven stores are the first full manifestation of all of our learnings in those stores. We have data that shows both the customer and the associate prefer this experience to our older stores and obviously we’ve announced the openings of 50 to 60 stores next year. They will be under the City format.

Bruce H. Besanko

I don’t know if we got all of your question, Chris, but I think we need to move on to the next question.

Operator

The next question comes from the line of Mike Baker from Deutsche Bank.

Mike Baker - Deutsche Bank

Thanks. I’m wondering if you could discuss a little bit the promotional environment in particular over Black Friday. So you comped double digits, some of the work I’ve done shows that you were a little bit more promotional but now you’ve become less promotional again. Is that a fair characterization and can you just describe ongoing, your philosophy on driving sales versus maintaining some sort of gross margin trend? Thanks.

Philip J. Schoonover

Let me introduce John Kelley, who is our general merchandise manager, and he’ll answer these questions.

John Kelley

I think the promotional activity over Black Friday was a little bit less than I’ve seen in the past years and I think we were able to capitalize on that with strong promotions in our TV and PC world. We also saw an increase in margin over that period of time also.

Philip J. Schoonover

I would share with you that it depends on the competitive set. In one way, our more traditional competitors were less promotional. I think the web was more promotional than ever and there is certainly more commerce flowing through the web these days and our new competitors, not the least of which are the warehouse clubs, are extraordinarily price and promotionally driven.

So we saw a balance of some opportunity in the insert promotions to improve profitability but we do not feel that the competitive climate in general in the consumer electronics industry is any less competitive than it was a year ago.

Mike Baker - Deutsche Bank

Okay, thanks. And if I could ask one more follow-up, I don’t know if you’re ready to talk about this, but within your store plans for next year, can you break out the number of remodels, relocations, new stores, and I guess what I’m getting at is should the net number -- should we expect the net number of stores over time to be going up, down, or about the same?

Bruce H. Besanko

So in terms of the mix next year, about 80% of the mix next year will be new stores. I think over time we will be moving it away from new stores, more towards relocated stores. As we think about our real estate more broadly though, I’d say the imperative here is that we have an aging store base on top of the fact that we have a competitive set that continues to open new stores at a very high rate and so I think it’s our view that we need to continue to grow in order to remain competitive.

And as we look through the future years, we’ll open the right number of stores in those years.

Mike Baker - Deutsche Bank

And so of that 50 to 60 next year, that sounds like a gross number. I wish you didn’t put net number in the release, so do you have a number of closures that you are planning?

Bruce H. Besanko

You know, I have looked at the real estate portfolio in some detail and the vast, vast majority of these stores are cash flow positive. If there’s going to be store closings, it would be very, very small. I mean, any stores that we would look at would have to be cash flow negative and there is just not many of those.

Mike Baker - Deutsche Bank

Okay, so then the net number is going up next year?

Bruce H. Besanko

Yeah.

Mike Baker - Deutsche Bank

Okay. Thank you.

Bill Cimino

Thanks, Mike. Operator, we’re ready for the next question, please.

Operator

The next question comes from the line of Andy Hargreaves from Pacific Crest Securities.

Andy Hargreaves - Pacific Crest Securities

You guys talked about linear improvement through fiscal Q3 in both attach rate and the close rate. Can you give us any commentary on whether that continued into the first part of December?

George D. Clark

Let me talk a little bit about quarter three here. We had began to settle down on our operating model and our same ticket attach and our basket really bottomed out at the beginning of Q3 and we’ve seen initial progress since then in terms of Circuit City advantage, Firedog, and accessory same ticket attach.

You know, as Phil commented earlier, we’re very focused on rebuilding our selling culture. We’re trying to settle down our operating model and focus in those particular areas, getting ready for our customers and helping our customers shop, find, enjoy. We have seen some initial progress but we have more work to do.

Bill Cimino

Thanks, Danny. And I just wanted to point out that we are not going to discuss December trends on the call. We are going to focus on the third quarter.

Andy Hargreaves - Pacific Crest Securities

Okay, can you expand real quick though on that point? What is it exactly that you are doing with the store level associates to help improve the selling culture? What do you think that they are missing right now that your competitors are doing better?

George D. Clark

I think put simply, we have a lot on their plate -- changing their operating model can be very complicated. We put seven new SOPs in place over the course of the summer. What we’ve done is we’ve narrowed the focus and we’ve gotten very focused on our selling culture -- what our experience is like with our customer, building the capabilities with our associates, and helping our managers focus on important Firedog services, Circuit City advantage and accessory attachment in our categories. Just simply narrowing the focus has helped us see some initial progress.

Andy Hargreaves - Pacific Crest Securities

Thanks.

Bill Cimino

Thanks, Andy. Operator, we’re ready for the next question, please.

Operator

The next question comes from the line of Scott Ciccarelli from RBC Capital Markets.

Scott Ciccarelli - RBC Capital Markets

I guess my question is how would you guys characterize your vendor relationships at this point? Because obviously the trends in the business are relatively soft, we’ve seen the change in the credit facility -- those are kind of signs consistent with companies having liquidity concerns, I guess. I guess what I’m asking is what kind of reaction have you had from the vendors and do you feel like you still have their support? Because if I’m sitting in their shoes, you have to at least raise an eyebrow. Thanks.

Bruce H. Besanko

Let me make a couple of comments about our vendor relationships and then I’ll ask John to make some additional comments. We maintain an ongoing dialog with our vendors. We have an excellent relationship certainly with our top vendors and they clearly understand where we are at in our turnaround plan.

Our vendors in my view are comfortable with our liquidity in large part because of the strength of our balance sheet and I think that the $1.3 billion amended credit facility, which extends us out for another five years has given them additional comfort. John.

John Kelley

I also feel that our vendor relationships are very strong and we’ve had a lot of support, specifically for Black Friday and I believe that overall, I think things are positive and vendors are rooting for us to win.

Scott Ciccarelli - RBC Capital Markets

Okay, and just a quick follow-up on a statement you had made, Bruce. You said you guys would expect to post a small loss in the quarter if the current trends continue or if it was the third quarter trends. Can you just clarify that for me?

Bruce H. Besanko

I was referring more towards the November trends.

Scott Ciccarelli - RBC Capital Markets

Okay, great. Thank you very much.

Bill Cimino

Thanks, Scott. Operator, we’re ready for the next caller, please.

Operator

The next question comes from the line of Jonathan Cramer from Cowen.

Jonathan Cramer - Cowen & Company

Good morning. Can you just go over what the status is of all your initiatives and then your thoughts about where you plan to take those going forward?

Philip J. Schoonover

I think at a high level, let’s start with the two transformation initiatives. We said retail transformation and then the SG&A takeout would be the two major structural transformations for the year. Retail transformation, the seven SOPs have been installed. We’ve made changes to our organizational structure at the RVP level, district level, store director level, and store management level. We’ve gone to the multiple zone model in the stores, so materially all the SOP work and structural work is behind us and we finished that work in early October.

The SG&A takeout, we’re right on track with the $150 million that we identified at the beginning of the year and have discussed all year. We think there is an opportunity to better align our investments next year with the strategic outcomes and actually narrow the focus given our current performance.

So in addition to the SG&A takeout, we’ve doubled down our efforts in execution, so we are going to continue to fix expenses, make sure we capture the balance of the work that we started this year and continue to focus on next year. We’re going to fix close rates and attachment by returning to a selling culture at Circuit City, specifically in the big ticket departments of TV, PC, imaging, and MP3.

We’re going to fix our margins through the work we are doing in assortment optimization, strategic sourcing, advertising and promotional effectiveness, and finally pricing, price elasticity and the way we manage our end of product lifecycle markdowns.

So under the heading of the two transformation efforts, those are well underway and we’re making progress. The four pillars of our strategy, the home entertainment pillar, we’re continuing to make this the stake-in-the-ground category and our number one focus for marketing, merchandising, and in-store selling efforts. We gave up some market share in the first half of this year and we have refocused our intensity on the larger flat panel televisions and frankly, we are focused on audio, the signal source, and other home entertainment categories and we’ve doubled down our commitment to that category.

We’ve made significant progress in multi-channel retailing, so 29% comp on top of a 31% comp in the same quarter last year. The services business, while we’re disappointed that we didn’t hit plan, we did increase the revenue 28% and that’s higher than the company’s average margin and we’re right on track with our real estate portfolio. We’ll open 61 to 63 new stores this year, and Bruce discussed our plans of 50 to 60 stores for next year.

So under the heading of the longer term strategic initiatives, we’re right on track with three of the four and we have some work to do in home entertainment.

Jonathan Cramer - Cowen & Company

Just a quick follow-up; what expenses can you take prior to -- take out of the system and two, can you give us where you are with your point-of-sale system and what you need to do in terms of cost to get it in and timeframe?

Bruce H. Besanko

I’ll answer the first part of the question about SG&A opportunities and then I’ll flip the rest of the question over to Danny to talk about RPOS implementation.

The short answer is I think that there is additional opportunities in the company to continue to reduce our expense structure. I would say that the areas such as indirect spend continue to be areas of improvement for us and I think we are going to continue to dig deep to be sure that our expense structure is commensurate with our sales and margin performance.

Danny, do you want to talk a little bit about RPOS?

George D. Clark

We have RPOS already in over 160 of our stores --

Philip J. Schoonover

Why don’t you explain what RPOS is, just for --

George D. Clark

It’s really a whole house system. It controls inventory inside the store. It’s a point-of-sale transaction system for our stores. It’s replacing a legacy system that’s been in the company for over a decade. It is up and operating in 160 of our stores. We worked on mastery and refinement of RPOS this fall and we plan on scaling it in the first two quarters of next year to the rest of the company.

Bill Cimino

Jonathan, just one last thing before we get to the next question, the cost of the rollout of RPOS is baked into the outlook we provided for you all for the fourth quarter. Operator, we’re ready for the next question.

Operator

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

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning. Two questions; the first, if you could just address the TV margins, I know that they were down for you and for the industry. Last year, our sense was that with tighter supply, industry margins were holding up somewhat better here in 2007, so if you could give us any color as to the drivers of those declines, please.

Bruce H. Besanko

I think one of the things that was a contributor to our TV margin was we over-indexed in some of the smaller and medium LCD products and you saw a -- we saw margin erosion in pretty much most of the categories but we over-indexed in opening price point merchandise also when we ran the ads. We saw an awful lot of opening price point merchandise.

George D. Clark

I want to emphasize again that we have to rebuild our selling culture. We’ve narrowed our focus in the third quarter and you know, we bottomed out early in the quarter on important attachments like Circuit City advantage, Firedog, and accessory same ticket attach. We’ve seen some initial progress and we are going to stay very focused on that progress.

Matthew Fassler - Goldman Sachs

Just to dig a little deeper, to the extent that industry dynamics were somewhat more rational, you all discussed Black Friday being a bit more rational, was this a function of your initial pricing stance? Was it something on the buy side that might have impacted you in this business?

Philip J. Schoonover

I’ll take a stab at this. We had a mix related issue and we made a decision to expand our revenue in the lower end flat panel TV business and it’s just a lower margin, and then we had a rate related issue.

We feel that it’s a very competitive marketplace and we think that the warehouse clubs, the mass merchants, and the online retailers were as competitive as last year. We have made a decision with our assortments and we carry certain brands to keep our customers and this had a rate impact on bigger flat panels.

Matthew Fassler - Goldman Sachs

Understood, and my second question, I want to follow up on the question of real estate. I understand that you have a real estate optimization opportunity. It looks like the financial performance, at least in the short run, has deteriorated faster than could be attributed to the real estate per se. And from a financial position, you clearly have lots of liquidity but your fixed charge coverage ratio is I think below one and you are operating at a level that I’m sure you’d like to improve upon. Is this the moment in time to focus on new real estate the way you are?

Philip J. Schoonover

Let me answer the structural part of the question and then Bruce is going to get into the financial. The company has roughly 400 stores that we’d call legacy real estate. The store was designed when we were in the appliance business and it was basically superstore retailing. We have 34,000 square foot stores with 18,000 square feet of selling space. It’s a major structural issue for the company and we have to get after that.

With that said, we also have to spend some time saying what’s the new job of a new customer experience in the stores? So we’ve spent the last 24 months in Boston and Florida testing our way to a new retail format.

We have committed to the 20,000 square foot box, which by the way has about 17,000 square feet of selling in a 20,000 square foot box and materially the same size show room, and we’ve -- we have seven in the city stores, which have a new job and it’s a very different look, sound, and feel. It’s also a very different employee value proposition. So it’s better for our customers and better for our associates.

We need to get after this structural issue and with the current trends, we need to do that carefully and cautiously and more prudently than ever. I asked Bruce Besanko to revisit our real estate strategy as soon as he entered the building and I’m going to have him comment on his thoughts and insights here.

Bruce H. Besanko

So I would tell you that there are probably two key learnings that I’ve seen. The first is that -- the first is that there are no quick fixes here and I think the second is that it is absolutely apparent that we, in light of the competitive marketplace, we need to continue to grow to remain competitive. I think our City format is a game-changer. It’s still very early from a financial perspective to comment on it but we can comment on the 20K format and that is a more productive format than we’ve had. And in the future, most of our stores, if not all of our stores, will be in the 20K format.

As it relates to the number of new stores, we are going to make sure that we optimize the number of new stores. We’ll open the right amount based on the facts and circumstances at the time and -- but I do know that we need to remain competitive in the marketplace and that does require investments in our real estate portfolio.

Matthew Fassler - Goldman Sachs

Thanks so much.

Bill Cimino

Thanks, Matt. Operator, we’re ready for the next question, please.

Operator

The next question comes from the line of Dan Binder from Jefferies.

Dan Binder - Jefferies & Company

I have two sets of questions; first, can you give us a little color on the traffic versus ticket, whether or not they were significantly different from each other? And then within that line of questioning, what about Black Friday did you do right that just didn’t really come through the rest of the quarter?

And then the second set of questions had to do with merchandising. Last year you had some merchandising issues in TVs and just curious, as you look across the store now, are there any sore points or areas that need to be addressed? And maybe if you could include in those comments what you see for the cycles, the major product cycles next year versus this year in terms of growth?

Philip J. Schoonover

You know, Dan, the first question is traffic versus close rate, I think we’d want to add average ticket to that, just so you can get a sense for this. So our traffic was down slightly, as anticipated. The entertainment and software business in general is deteriorating, particularly in music and movies. Games was actually improving, so we are seeing some bump but it’s not helping the overall traffic.

We really focused on close rate. Danny talked about sequential improvement throughout the quarter and the other thing is we did see improvement in our average ticket driven by the mix of hardware versus entertainment software but also driven specifically by notebook PCs, TVs, imaging and MP3, so we have seen improvement in the average ticket throughout the quarter.

Bill Cimino

Dan, can you repeat the last question that you had there?

Dan Binder - Jefferies & Company

There were really a couple of questions there. One was what about Black Friday went right for you that just didn’t come through the rest of the quarter? And the other set of questions was regarding merchandising, if there were any issues that you thought were really glaring there today and perhaps thoughts on the cycles, the major cycles for next year.

Philip J. Schoonover

I mentioned it in the conference call, under the heading of multi-channel retailing, the alignment of the web promotions, the insert, and the in-store experience really helped us for the full holiday period. We did a great job coordinating the web and the insert promotions and the cadence of that and I think we optimized the opportunity with the customer.

In store with the new SOPs, they had a lot more -- I’ll call it head room to execute. So when we had the crush of business on Black Friday, when we had significant traffic on Saturday and Sunday and then when the cyber Monday customers came back to our stores to pick up the product, the stores executed crisply and that’s because we freed up non-customer facing labor with the new SOPs for us to better serve the customer year over year.

So why that weekend? I think there is a customer sort on that and then there is a Circuit City sort. I think customers are responding to promotions right now. It’s a sign of the economy and a sign of the competitive industry we are in, online and in the store. I think customers are also looking for bargains in this economy. I think that all the reports that I see about our industry and about broader luxury goods point in that direction.

And then finally, I think that the shape of this holiday weekend, we really had eight or nine days of solid promotional opportunity and it drove traffic for the entire end of the month.

We were ready. It took us most of September and October to get ready. We hired the occasional seasonal help in October and we were ready for this Thanksgiving day holiday so if the traffic is there, the stores can better serve the customer.

John, do you have any comment?

John Kelley

As far as the TV cycle matures, I think you are going to see a proliferation of the volume moving to larger screen sizes, 50-inch and above, 120-hertz product and of course, 1080 continuing to grow and expand, and there’s a great outlook for the future with those categories.

Bill Cimino

Thanks, Dan, and Operator, I believe we have time for one last question, please.

Operator

Your final question comes from the line of Gary Balter from Credit Suisse.

Gary Balter - Credit Suisse

I have a three-part question, just like everybody else. One is when I visit your stores or when I purchase stuff, it looks like your pricing on TVs tends to be a few hundred dollars on the big screens lower than Best Buy or others. Have you thought about maybe you’re too low and that’s hurting you? Is it really driving additional traffic? That’s number one.

Number two is, you talked on this call about the trends stabilizing and things getting better yet you significantly lowered the fourth quarter outlook, so could you tie those two together? And then a longer term question, Phil, is over the last couple of years, we’ve seen projections to 5% margins and I understand the whole macro has changed but could you talk to us about some of the learnings from things that haven’t worked and how that impacts your thinking going forward? Thank you.

Philip J. Schoonover

Sure. Do you want to take the question, John Kelley?

John Kelley

I think that we’re really surgically looking and strategically looking at exactly what our pricing is in comparison to the competition and we have a lot of initiatives in the sort ops and the ad effectiveness and just overall pricing initiatives to make sure that A, we’re competitive and give a great value proposition to the customer but also that we also are making money at the same time.

Philip J. Schoonover

I would add that we watch pricing on our own and we -- our data is inconsistent, maybe, Gary, with you’re saying we’re typically $300 lower than the competition. Eighty-five percent of the time, we are at or have similar pricing to our general competition and we watch that pretty carefully.

I think there’s an opportunity to tune our pricing, given perhaps some of our competitors are seeing just sort of less competitive pressure. I think there is an opportunity there. I would also point out that the warehouse clubs are very aggressive in pricing and the online prices are stronger than ever, so you have to be careful in today’s competitive environment to only look at traditional brick-and-mortar competitors. And we have a policy of multi-channel, therefore sometimes that translates into the store.

Do you want to take --

Bruce H. Besanko

I’ll talk a little bit about the outlook in the fourth quarter and then I’ll flip it back to Phil for the comments on learnings.

I don’t think anyone would ask us to be anything but cautious in terms of our outlook for the fourth quarter, given the fact that we’ve -- our outlook has not, hadn’t been accurate for the last few quarters, so in an overabundance of caution based on trends that I saw through the third quarter, I’m suggesting that there could be a slight loss in the fourth quarter.

I think we are making modest progress, as Danny and Phil had talked about in terms of close rate. We’re making modest progress in terms of our ability to attach goods. I think we’ll continue to make progress into the fourth quarter.

We’re also making progress in terms of some of the values we are seeing from our mystery shops, and we talked about that in the earlier part of the call. So there is progress being made but frankly with an overabundance of caution on my part, I’m suggesting that therefore we’re going to have a slight loss.

I would also tell you that this week in particular and this weekend, more specifically and into next week, really drive a good portion of our fourth quarter performance and frankly, I’d like to wait and see how that turns out.

Philip J. Schoonover

And finally, Gary, I think that we have the right long term strategy. We put some plans into effect this year to change our cost structure. I think we needed to cut the expenses, so we have a competitive cost structure and we reacted to the permanent change in the margin in our business.

The consequences were more severe than I expected. The changed management side of this is not as predictable as I would like it to be but I think we installed seven SOPs that permanently take work out of the stores so we can aim that labor at the customer and that was the right thing to do.

We bumped up against the peak selling season and when we’re still in the midst of that kind of change and we need to sell product, it sometimes is difficult for the associates to learn both at the same time.

I guess what I would have done is considered the rate and pace of change more carefully but I really didn’t know exactly how that was going to unfold. I think the structural changes we made were necessary and I think many of the deeper things we are getting at in the business, whether it’s the systems upgrade, the real estate upgrade, the capability around services, the capability around multi-channel, these are the right investments for the company to make.

What we need is a stronger economy and we need to execute more crisply against the declared, you know, I will call it fix the business issues that we’ve discussed on the call today. We have execution opportunities.

Gary Balter - Credit Suisse

Great. That’s very helpful.

Bill Cimino

Thanks, Gary and thanks to everybody for participating in today’s call and for your questions. Before we conclude the call, I’d like to remind you that a replay will be available by approximately 2:00 p.m. Eastern Standard Time today and will remain available through December 28th. 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 27434675. A replay of the call also will be available on the Circuit City investor home page at investor.circuitcity.com.

This concludes our call. Thank you.

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