"T-t-talk is cheap" at Circuit City -- Time for Results

Electronics retailer Circuit City Stores Inc. ($18.47) said last week it lost $12.2 million, or 7 cents a share, in the fourth quarter, hurt by charges related to store closings and slower sales growth related to falling flat-panel television prices and uneven demand for computer hardware.

In the year-ago period it earned $141.4 million, or 81 cents a share. Results for the latest quarter include $144.6 million related to the impairment of goodwill, store and facility closures and other restructuring activities.

The Company also announced a ’wage management’ initiative under which approximately 3,400 store employees, or about eight percent of the work force, were notified on March 28, 2007 of their planned termination. The separations were effective immediately and were the result of a Company analysis, which identified employees who were paid well above the market-based salary range for their role.

To meet the changing nature of the consumer electronics retail marketplace, as well as improve its financial performance, Circuit City has announced other changes, too, including the disposition of long-lived assets (e.g. the reduction from ten retail operating regions to eight), losses from discontinued business activities and the associated lease termination costs (e.g. outsourcing of the IT infrastructure to IBM), and non-cash goodwill impairment charges.

"[This] and other aggressive actions [were taken] to improve our cost and expense structure, which will better position us for improved and sustainable returns in today's marketplace," said Philip J. Schoonover, chairman, president and chief executive officer of Circuit City Stores, Inc.

In the recent fiscal year ended February 28, 2007, operating margin as a percentage of net sales fell to 0.1%, down 90 basis points from the prior year.

According to a recent article in The New York Times, the laid-off Circuit City employees worked in the company’s stores and warehouses, selling electronics, unloading boxes and the like. Management recently said that about 60% of those associates were in customer-facing positions. They generally earned $10 to $20 an hour, making them typical of the broad middle of the American work force. Nationwide, the median hourly wage of all workers is about $15.

As a result of the wage manage—forget the euphemism, call it what it is—the gutting of higher-paid workers—the Company expects to record pretax expenses in the fourth quarter of fiscal 2007, totaling $9.9 million, related to the termination of these workers and their post-employment benefits.

The laid-off workers will get a chance to reapply for their former jobs—at lower pay—after 10 weeks, the company said. The Company did not return our call seeking comment on how much the new workers will make, or what the specific future savings will be from re-hiring the laid-off workers at lower wages.

It is a time not just for compassionate words, but compassionate action. – Children’s activist, Marian Wright Edelman

David Leonhardt, who penned the aforementioned New York Times article, says that the real message of the Circuit City layoff is that employees can no longer depend on the private sector as a retirement/health-care safety net.

Albeit we agree with Mr. Leonhardt, in our view, too, Circuit City’s focus on cost containment/ control is standard operating procedure for a retailer facing loss of pricing leverage with many of its key product-lines, such as flat-panel televisions, PC/computer products, and other electronics (camcorders, phones, etc.).

Grabbing the low-lying fruit approach will not stop the hemorrhaging or improve operating metrics, including sales per average square foot and gross margins.

In our view, save for slowing the downward pressure on the Company’s stock price, we look for the “intangible”—employee morale--to adversely impact the tangible—sales productivity.

Just how much will kicking loyal employees to the curb actually help the bottom-line?

Assuming that each displaced worker formerly made $15 an hour, multiply by a 40-hour week, and the Company paid out $31,200 per annum to each worker (excluding health/retirement expenses), or $106.1 million annually to all 3,400 workers.

Rehire 3,400 at $10 per hour, and the nominal cost is $70.7 million (excluding health/retirement benefits). The effective after-tax savings (36%) would approximate $22.7 million per year.

Anyone who has ever bought goods from Circuit City knows that it is the experienced sales persons that can unctuously get you to buy “Peace of Mind” with the Circuit City Advantage Protection plans. In the last twelve-months, net sales from these extended warranties were about 4.0 percent of domestic segment sales, or approximately $440.0 million!

Now tell us again, Mr. Schoonover, how a customer centric operating model will benefit from the loss of tenured sales persons?

In connection with his retirement (as Chairman) from the Company in July 2006, Mr. W. Alan McCollough forfeited his performance-accelerated and time-based restricted stock awards. This did not include, however, vested –and exercisable—stock grants worth an estimated $76.6 million. In addition, on December 22, 2005, he also elected to receive a lump-sum payment—in lieu of annual pension benefit payments—of $4.42 million.

If Circuit City were serious on delivering an improvement in SG&A margins, would it hurt for management to lead by example?

Granted, on its 4Q:07 earnings conference call, Phil Schoonover did say: “Changes [must] include instituting more discipline and expense controls around purchasing, travel, consultants, and many other forms of discretionary spending….”

I don’t wanna hear it
Mmm your talk is cheap
I dont wanna know
I dont wanna hear it
T-t-talk is cheap
I dont wanna know -- Cinderella (Still Climbing, Track Listing #3, “Talk is Cheap,” 1994)

Circuit City provides a number of perquisites to its executive officers. Executives at the level of Senior Vice President and above are eligible to (i) receive a car allowance of $858.00 per month, (ii) receive a financial planning allowance of up to $6,000 per year, and (iii) participate in the Company’s Officer Evaluation Program which provides consumer electronics merchandise to the executive for personal use in an amount of up to $8,000 retail value per year.

In addition, McCollough and Schoonover and CFO Michael Foss recorded expenses of $82,316 and $83,743, respectively, for their ‘entitled’ personal use of the Company aircraft.

In fiscal 2007, the Compensation Committee also approved an increase in Messer. Schoonover’s base salary from $725,000 to $900,000.

Talk—like the disposable 3,400 sales associates—is cheap.

The 25 percent drop in Circuit City's share price in the past 52-weeks would seem to discount the Company’s lackluster results and recently reduced fiscal 2008 guidance. Nonetheless, with the announced departure of CFO Foss, the consumer electronics provider’s inability to control the pricing sensitivity of their products, reliance on third-party software to stimulate PC hardware sales (witness slower-than expected demand for VISTA), and declining consumer confidence, we expect further gross margin reductions (as the Company continues to face increased competition from discounters and mass merchandisers alike).

Nonetheless, there are several bright spots, in an otherwise dreary landscape:

1. An expanded seven-year, $775 million Information Technology (IT) infrastructure services contract with IBM. The outsourcing of the Company’s IT infrastructure operation to IBM, will purportedly lend itself to benefits threefold. (i) it will reduce planned infrastructure cost by approximately 16% over the life of the contract; (ii) the retailer also will make used of IBM's extensive experience in managing high-volume Web sites with the company hosting and supporting the technology powering the Circuit City e-commerce channel. Circuit City will get some incremental financial benefits related to retail point of sale and merchandising system transformation with this IBM outsourcing; and, (iii) IBM will provide additional strategic support to assist the Company’s transformation effort;
2. Digital home services, the total market opportunity for home theater installation and consumer PC-related services are expected to reach $20 billion annually by the year 2010. Circuit City started offering PC services about two years ago and launched the FireDog brand last October. In less than two years, sales have already grown to more than $200 million, and management expects fiscal 2008 sales to approximately double to more than $400 million; and,
3. In multi-channel entertainment, Forrester forecasts online CE sales to grow by 16% on average for the next three years. Circuit City reached $1.12 billion in fiscal year '07 with web and call center sales and management expects the business to grow 30% to 40% in fiscal year '08.

The 10Q Detective would prefer to see visible signs of a turnaround—like sustainable improvements in cash flow and margins—before committing monies to this short-circuited retailer.

As for the laid off employees, our advice would be to head over and apply for jobs at either Best Buy (BBY-$48.45) or McDonalds (MCD-$45.78)--both Companies would probably treat you with with more respect and dignity.

Editor David J. Phillips does not hold a financial interest in any of the companies mentioned in this article. The 10Q Detective has a Full Disclosure Policy.