Filed with the SEC from Apr 24 to Apr 30:
Circuit City Stores (CC)
HBK Investments urged the electronics retailer to allow due diligence by Blockbuster (ticker: BBI), following the video chain's acquisition proposal. The hedge fund also urged Circuit City's board to create a competitive bidding process in order to maximize shareholder value, saying the firm itself might be prepared to offer financing for a Blockbuster purchase. HBK reported holding about 15.42 million shares (9.1% of the total outstanding). HBK's funds also own about 8% of Blockbuster's Class A stock and roughly 5% of its Class B shares.
Circuit City Stores, Inc. is a leading specialty retailer of consumer electronics, home office products, entertainment software, and related services. Circuit City was incorporated under the laws of the Commonwealth of Virginia in 1949. Its corporate headquarters are located at 9950 Mayland Drive, Richmond, Virginia. The company has two reportable segments: its domestic segment and its international segment. For fiscal 2008, net sales were $11.14 billion for the domestic segment and $600.9 million for the international segment.
The domestic segment is engaged in the business of selling brand-name and private-label consumer electronics, personal computers, entertainment software, and related services in its stores in the United States and via the Web at www.circuitcity.com and www.firedog.com. At February 29, 2008, the companyâ€™s domestic segment operated 682 Superstores and 11 other stores in 158 U.S. media markets.
The company is in the midst of a turnaround, with the goal of rebuilding its customer service and selling culture in its domestic segment Superstores. In fiscal 2008, the company implemented numerous changes that had a negative financial impact. In fiscal 2009, the company will continue to focus on its growth pillars to win in home entertainment, grow its services business, leverage the shift to multi-channel retailing and significantly improve its real estate position.
The international segment, which is comprised of the operations of InterTAN, Inc., is engaged in the business of selling private-label and brand-name consumer electronics in Canada. At February 29, 2008, the international segment conducted business through 779 retail stores and dealer outlets, which consisted of 502 company-owned stores and 277 dealer outlets. The international segment re-branded most of its company-owned stores and dealer outlets to The Source By Circuit City SM during fiscal 2006. The international segment operates a Web site at www.thesource.ca. In February 2007, the board of directors authorized management to explore strategic alternatives for InterTAN, Inc., which could include the sale of the operation.
Additional discussion of Circuit Cityâ€™s operating segments is included in Item 7, Managementâ€™s Discussion and Analysis of Financial Condition and Results of Operations, and Note 17, Segment Information, of the Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this annual report on Form 10-K.
Circuit City has a highly integrated multi-channel business model, which allows customers to shop in its stores, on the Web and via the telephone. Store operations are managed primarily by an executive vice president and chief operating officer who oversees the companyâ€™s domestic segment Circuit City retail stores, real estate, information technology and supply chain. An executive vice president - new business development oversees the companyâ€™s domestic segment the city TM retail stores, firedog SM services and ongoing innovation work. Direct channel operations, including the Web site, call centers and catalog, are managed by a senior vice president - multi-channel.
During fiscal 2008, the domestic segment retail operations were divided into eight regions, which are under the supervision of regional vice presidents. The regions are comprised of 64 districts, which are managed by district managers who regularly visit stores to monitor store operations and meet with store directors.
During fiscal 2008, the store management model for the companyâ€™s domestic segment Superstores changed. Previously, all domestic segment Superstores had five store management positions: a store director, an operations manager and three sales managers. Under the current model, stores are led by a store director, an operations manager and between one and three sales managers, depending on the storeâ€™s sales volume. The change better aligns expenses with store productivity. The company also created a new supervisor position. Each store has five to seven supervisors who oversee specific areas such as home entertainment, technology, firedog SM home theater installation and PC services, firedog SM car electronics services and customer service. The supervisors provide additional leadership on the sales floor, and the supervisor position creates a more defined career path for store Associates.
The company also updated seven key standard operating procedures (SOPs) in domestic segment Superstores during fiscal 2008. One of the SOP changes included the creation of a product flow team in the store. Previously, store Associates were responsible for both selling activities, such as answering customer questions, and tasking activities, such as stocking shelves. Under the current model, the product flow team Associates are responsible for receiving, stocking, displaying and tagging store inventory from the delivery truck to the shelf. Product specialists are dedicated solely to customer-assistance activities. Customer service Associates are responsible for opening and closing the store, cashiering and greeting.
Domestic segment Superstores are typically staffed with an average of 59 full-time and part-time Associates, including customer service Associates; product specialists; product flow team members; in-store technicians and installers; supervisors; one or more sales managers; an operations manager; and a store director.
The companyâ€™s direct-to-consumer business has grown rapidly since the launch of its Web site in 1999. Through www.circuitcity.com, www.firedog.com and telephone call centers, customers have access to a wide selection of consumer electronics, technology and entertainment products, and related services as well as to customer service. The companyâ€™s Web site at www.circuitcity.com offers nearly 150,000 customer ratings and reviews of products, as well as in-depth product and technology information. Customers may view real-time in-store inventory of products selected on www.circuitcity.com, purchase products online, and pick up eligible products in a nearby store. As an enhancement of its multi-channel capabilities, Circuit City offers a 24/24 Pickup Guarantee SM for qualifying purchases made through its Web site or telephone call centers. Under this policy, qualifying purchases will be ready for customers to pick up at their designated store within 24 minutes of purchase confirmation, or the customer will receive a $24 Circuit City gift card. During fiscal 2008, approximately 55 percent of online sales were picked up in a store.
At February 29, 2008, the domestic segment had 42,974 hourly and salaried Associates. None of these Associates is subject to a collective bargaining agreement. The company employs additional personnel during peak selling seasons. The company has an hourly pay structure for the domestic segmentâ€™s non-management sales force.
International segment retail stores are divided into four regions, which are managed by regional vice presidents. The 4 regions are further divided into 21 districts, which are under the supervision of district managers who regularly visit stores to monitor store operations. Dealer outlets are divided into seven areas across Canada, each of which is under the supervision of an area sales manager.
International segment stores operating under the trade name The Source By Circuit City SM typically have a small store format and are strategically located in malls and shopping centers. Each store provides readily available products and services to meet a wide range of consumer electronic needs. Dealer outlets are independent retail businesses that operate under their own trade names but are permitted, under dealer agreements, to purchase any of the products sold by The Source By Circuit City SM . The dealer agreements contain a sub-license permitting the dealers to designate their consumer electronics department or business as a The Source By Circuit City SM dealer.
International segment retail stores are typically staffed by 5 to 20 Associates, including full-time and part-time commissioned sales Associates and a store manager. At February 29, 2008, the international segment had 2,911 hourly and salaried Associates. Approximately 95 of these Associates, who are engaged in warehousing and distribution operations, are represented by a union. The terms of a three-year collective bargaining agreement ending in April 2009 were ratified with these employees. The company considers its relationship with the union-represented employees to be good.
Domestic segment and international segment Associates receive frequent training and development through interactive e-learning courses; paper-based exercises; interactive in-store communications; team meetings; and peer mentorship. This blended training approach focuses on improving Associate selling skills; developing product knowledge with an emphasis on new technology; performing store operations; and building Circuit City culture. In addition, Associates use the companyâ€™s customer Web sites and the internal Associate Web sites as additional resources for product and service knowledge. Management training programs are designed to prepare the companyâ€™s leaders and include Web-based training, in-store activities and classroom instruction.
Prior to fiscal 2001, the companyâ€™s Superstore prototypes utilized a showroom model, which required sales assistance for each transaction to retrieve product that was stocked in the large warehouse portion of the store. Approximately 55 percent of the companyâ€™s domestic segment Superstores were constructed as showroom prototypes, and today they have excess square footage in the warehouse area that is unused. The showroom prototypes on average include approximately 60 percent of the total square footage as selling area and approximately 40 percent as non-selling area, which includes areas such as warehouse space, mobile installation bays, training rooms and restrooms.
During fiscal 2001, Circuit City introduced a new Superstore format that features a brighter, more contemporary look and an open, easily navigable floor plan conducive to browsing that comprises approximately 30,000 square feet per store. The format allows the company to put all products, except those that are too large for customers to carry, on the sales floor. These post-showroom prototypes on average include approximately 72 percent of the total square footage as selling area.
During fiscal 2008, Circuit City introduced a new Superstore format called the city TM that features a highly interactive environment with 20,000 square feet per store. Store Associates use headsets and tablet PCs to assist in the sales process. The merchandising strategy for the city TM includes carrying a reduced assortment in the store compared with traditional Circuit City Superstores, while maintaining strong assortments and inventory levels in key categories. Circuit Cityâ€™s the city TM prototype includes approximately 75 percent of the total square footage as selling area.
To ensure consistency, each domestic segment store follows standard operating procedures and merchandising programs, including procedures for inventory maintenance and merchandise displays. Merchandise pricing may vary by channel or by market to reflect local competitive conditions.
Circuit Cityâ€™s sourcing strategy is to find products with the best value for the cost. The company identifies products suitable for sourcing through a direct relationship with manufacturers overseas with the support of the Circuit City Global Sourcing staff in Hong Kong, Shenzhen (Peopleâ€™s Republic of China) and Taipei (Taiwan). For more complex products, Circuit City sourcing Associates collaborate with the companyâ€™s existing supplier base to reduce costs and development time as well as improve overall profitability. Circuit City offers an increasing amount of private-label merchandise to complement its branded strategy. These unique private-label brands offer customers choice and value while supplementing one of the best selections of brand-name products in the consumer electronics industry.
The international segmentâ€™s merchandise offering is designed to increase both sales and gross profit dollars. In fiscal 2007, the segment underwent a number of transformation activities designed to increase sales and gross profit margin, including optimizing assortments, managing lifecycle transitions, implementing a formal pricing strategy and reducing non-working inventory. The segment continued its transformation activities in fiscal 2008 and is focused on improving the effectiveness of assortment planning, category management, lifecycle transitions and pricing.
In fiscal 2008, Circuit City launched a new brand position based upon consumer insights and support of the multi-channel strategy. The new brand position is titled simplicity guaranteed TM . The company is building and accelerating upon its turnaround work designed to deliver consumers a better and more valuable shopping experience, wherever and whenever they shop for consumer electronics. Circuit Cityâ€™s brand position is focused on the premise that consumer electronics can be confusing, time-consuming and difficult to install and set up. The companyâ€™s marketing promotes that Circuit City makes it simple to shop, buy and enjoy consumer electronics.
Circuit City utilizes multiple marketing vehicles to build brand awareness and promote specific products and offers. The domestic segment uses newspaper advertisements, television, direct mailings and online marketing. The company also offers a rewards credit card in partnership with Chase Card Services. Cardholders can choose rewards points or promotional financing for qualifying purchases at Circuit City. The points can be redeemed for future purchases, enabling Circuit City to reward its loyal customers while encouraging repeat traffic to its stores.
During fiscal 2007, the domestic segment launched the firedog SM brand to provide home theater installation and PC services in-store, at home and remotely. The brand name captures the attributes that the company wants its technicians and installers to embody: helpful, knowledgeable, friendly and reliable. The decision to build an integrated brand for both PC services and home theater installation was based on customer research and was more cost-efficient than building multiple brands.
The international segment is among the largest retail advertisers in Canada and advertises through multiple channels, including newspaper, television, direct mailings and radio. During fiscal 2006, the international segment completed the brand transition to The Source By Circuit City SM .
The company has a vertically-integrated supply chain organization encompassing logistics; distribution and warehousing; inventory management; space planning; and lifecycle process re-engineering. Due to this structural alignment, the company expects, over time, to be able to identify and react rapidly to changes in consumer demand as well as reduce the time from buying decision through replenishment and display of the product at the point of sale. The company is in the process of upgrading its merchandising, marketing and supply chain information systems, which will enable additional improvements and efficiencies in processes.
As a retailer primarily of branded consumer electronics that relies upon its ability to offer consumers a comprehensive and attractive assortment of merchandise and services, Circuit City depends upon strong and stable supplier relationships. During fiscal 2008, the domestic segmentâ€™s five largest suppliers accounted for approximately 47 percent of merchandise purchased. The major suppliers were Sony, Hewlett-Packard, Samsung, Toshiba and Canon USA. The international segmentâ€™s five largest suppliers accounted for approximately 35 percent of its merchandise purchased and were Acer, Rogers Wireless, Apple, Hewlett-Packard and Ingram Micro.
The loss or disruption in supply from any one of these major suppliers could have a material adverse effect on the companyâ€™s revenue and earnings. Circuit City has no indication that any of its major suppliers will discontinue selling merchandise to the company. The company has not experienced significant difficulty in maintaining satisfactory sources of supply and generally expects that adequate sources of supply will continue to exist for the types of merchandise sold in its stores.
At February 29, 2008, the domestic segment operated six automated regional electronics distribution centers; one smaller automated distribution center that primarily handles large non-conveyable products, such as big screen televisions; and one import consolidation and distribution center. In fiscal 2010, the company plans to open a new distribution center that will replace two facilities. The new center will provide additional capacity to support new stores and direct channel growth.
Most products are shipped from manufacturers directly to the distribution centers. Circuit City believes that the use of distribution centers enables it to efficiently distribute a broad selection of merchandise to its stores, reduce inventory levels at individual stores, benefit from volume purchasing and maintain inventory control. Some products are received directly from the manufacturer by the stores in order to reduce costs and time-to-shelf.
The international segmentâ€™s stores are replenished primarily through one automated distribution center in Barrie, Ontario, Canada.
The company is undertaking a series of critical initiatives designed to transform its information technology (IT) systems and organization. Through this multi-year process, the IT organization will
utilize IT solutions available in the marketplace with minimal customization, resulting in a more flexible infrastructure to reduce costs;
develop strong partnerships with IT vendors, providing a deeper pool of talent, more flexible resources and access to expertise in retail systems; and
reduce lifetime costs and mitigate risks through simplification.
Late in fiscal 2007, the company consolidated the IT organizations that supported Circuit Cityâ€™s domestic segment Superstores, direct channel and international segment. The change eliminated duplication of processes and allowed the unified IT organization to build solutions that serve the companyâ€™s multi-channel needs. In fiscal 2008, the company entered into an agreement with IBM to outsource its IT infrastructure operations. Areas that IBM manages for Circuit City include data center operations, store support services, e-commerce hosting operations, service desk operations, network management, network services, desktop support, enterprise systems management and IT security administration.
The domestic segmentâ€™s in-store point-of-sale (POS) systems maintain a record of all transactions and allow management to track performance by region, store and store Associate on a near real-time basis. The information gathered by the systems supports automatic replenishment of in-store inventory from the regional distribution centers and is incorporated into product buying decisions. The in-store POS systems are integrated with the companyâ€™s e-commerce Web site. This integration provides the capability for in-store pickup of merchandise ordered online and allows for in-store ordering of merchandise for shipment directly to the customerâ€™s home. As part of an effort to eliminate complex, custom-developed information systems, the domestic segment began deployment of a new POS system to a limited number of locations during fiscal 2007. The new POS system is more flexible and scalable in support of the companyâ€™s new store growth and other initiatives; allows for easier and faster training; provides enhanced data security; and enables additional capabilities for services and in-store pickup of merchandise. At February 29, 2008, the company had deployed the new POS system to 26 percent of its domestic segment Superstores. As part of the focus on slowing the volume of changes that are introduced to the stores, the company has decided to slow deployment of the new POS system. A more deliberate rollout will ensure the POS conversion processes are effective, thereby minimizing disruption to the stores.
For the international segment, each of the retail stores has one or more computers that serve as POS terminals and are linked to the operational headquarters. This information network provides detailed sales and margin information on a daily basis, updates the customer database and acts as a monitor of individual store performance. The POS systems also are linked directly to a system used to automatically replenish a storeâ€™s stock as inventory is sold.
The company has implemented new data warehousing capabilities that will improve internal processes, streamline applications and allow more timely analysis of data for the domestic segment. In fiscal 2007, the domestic segment began implementing an extensive suite of systems, the majority of which are provided by Oracle Retail, to transform its merchandising, supply chain, planning and marketing processes. The systems implementation, known internally as the merchandising systems transformation (MST), is expected to enhance speed, flexibility, visibility and optimization across all channels and better integrate financial, assortment and space planning with forecasting and replenishment. The rollout will be a series of discrete system releases, and each can deliver benefits upon implementation. The new systems are designed to allow the company to collaborate with its vendors and optimize pricing and space allocation in its stores. During fiscal 2008, the company implemented six modules of the new merchandising systems.
The consumer electronics retail industry is highly competitive. Competitors include
other consumer electronics retailers,
warehouse club retailers,
home office retailers,
Internet-based retailers and
Discount and warehouse club retailers continue to increase consumer electronics offerings, particularly of entry-level and less complex products. In addition, many of the companyâ€™s vendors and suppliers have opened retail store locations and increased their direct sales to consumers. The companyâ€™s competitors may offer products and services at lower prices; promote products and services more aggressively; offer more attractive financing; and receive more favorable product allocations than the company does. Any of these actions could adversely affect the companyâ€™s sales and profit margin.
In response, Circuit City continues to build a differentiated offering based primarily on the companyâ€™s growth pillars of home entertainment, services and multi-channel integration. Circuit Cityâ€™s domestic segment differentiates itself from competitors by offering a high level of customer service; competitive prices; complete product and service assortments; financing alternatives; and the option of multi-channel shopping. The international segment differentiates itself from other consumer electronics retailers in Canada through its range of products and its service orientation.
BARBARA S. FEIGIN, 69, consultant specializing in strategic marketing and branding since February 1999. She served as Executive Vice President, Worldwide Director of Strategic Services and a member of the Agency Policy Council of Grey Global Group, Inc. (formerly Grey Advertising, Inc.), the principal business of which is advertising and marketing communications, from 1983 until her retirement in February 1999. She is a director of VF Corporation. She has been a director of the Company since 1994.
ALLEN B. KING, 60, Chairman and Chief Executive Officer of Universal Corporation, a diversified corporation with operations in tobacco and agri-products, and Chairman and Chief Executive Officer of Universal Leaf Tobacco Company, Inc., international buyers and processors of leaf tobacco, since 2003. Prior to his election as Chief Executive Officer, Mr. King was Chief Operating Officer for more than five years. He is a director of Universal Corporation and Universal Leaf Tobacco Co., Inc. He has been a director of the Company since 2003.
CAROLYN Y. WOO, 53, Dean of the Mendoza College of Business, University of Notre Dame, since 1997. She is a director of AON Corporation and NISource, Inc. She has been a director of the Company since 2001.
JAMES F. HARDYMON, 72, retired as Chairman of Textron, Inc. in January 1999. Mr. Hardymon joined Textron, Inc., a public company that produces aircraft, fastening systems, and industrial components and products, in 1989 as President and Chief Operating Officer. He became Chief Executive Officer in 1992 and assumed the title of Chairman in 1993. He is a director of American Standard Companies, Inc. and Lexmark International, Inc. He has been a director of the Company since 1998.
RONALD M. BRILL, 63, Private Investor. Mr. Brill served as Executive Vice President and Chief Administrative Officer of The Home Depot, Inc., a home improvement retailer, from 1995 until 2000 and as a director of the same company from 1987 until 2000. He is a director of Pharmaca Integrative Pharmacy, Inc. He has been a director of the Company since 2002. His present term will expire in 2009.
CAROLYN H. BYRD, 58, Chairman and Chief Executive Officer of GlobalTech Financial, LLC, a financial services company, since May 2000. She was President of Coca-Cola Financial Corporation from 1997 to May 2000. She is a director of Rare Hospitality International, Inc. and AFC Enterprises, Inc. She has been a director of the Company since 2001. Her present term will expire in 2008.
URSULA O. FAIRBAIRN, 64, President and Chief Executive Officer of Fairbairn Group LLC, a human resources and executive management consulting company, since April 2005. She served as Executive Vice President, Human Resources and Quality for American Express Company, a diversified global travel and financial services company, from December 1996 until her retirement in April 2005. She is a director of Air Products and Chemicals, Inc., Centex Corporation, Sunoco, Inc. and VF Corporation. She has been director of the Company since 2005. Her present term will expire in 2008.
ALAN KANE, 65, Dean of the School of Business and Technology at the Fashion Institute of Technology (FIT) since 2005. From 1997 to 2006, he was Professor of Retailing at the Columbia Graduate School of Business. Before joining the faculty at Columbia, Mr. Kane spent 28 years in the retailing industry with Federated Department Stores, The May Company, Grossmanâ€™s Inc. and a privately held retailer. He is a director of American Eagle Outfitters. He has been a director of the Company since 2003. His present term will expire in 2008.
MIKAEL SALOVAARA, 53, Private Investor. Mr. Salovaara is a retired partner from Goldman, Sachs & Co., an investment banking firm, from 1980 to 1991 and from Greycliff Partners, a merchant banking firm, from 1991 to 2002. He has been a director of the Company since 1995. His present term will expire in 2009.
PHILIP J. SCHOONOVER, 47, Chairman, President and Chief Executive Officer of the Company. Mr. Schoonover joined the Company in 2004 as executive vice president and chief merchandising officer. He was elected president in 2005 and chief executive officer in March 2006. Before joining the Company, he was executive vice president â€“ customer segments at Best Buy Co., Inc., from April 2004 until September 2004; executive vice president â€“ new business development from February 2002 until April 2004; and senior vice president merchandising for five years. He has been a director of the Company since December 2005. His present term will expire in 2009.
J. PATRICK SPAINHOUR, 57, Chairman and Chief Executive Officer of The ServiceMaster Company, a provider of lawn, housekeeping, pest-control and maintenance services since May 2006. He served as Chairman and Chief Executive Officer of Ann Taylor Stores Corporation, a specialty retailer of womenâ€™s apparel, shoes and accessories, from 1996 to 2005. He is a director of The ServiceMaster Company and Tupperware Brands Corporation. He has been a director of the Company since 2004. His present term will expire in 2008.
MANAGEMENT DISCUSSION FROM LATEST 10K
We are a leading specialty retailer of consumer electronics, home office products, entertainment software, and related services. We have two reportable segments: our domestic segment and our international segment.
Our domestic segment is engaged in the business of selling brand-name and private-label consumer electronics, personal computers, entertainment software, and related services in our stores in the United States and via the Web at www.circuitcity.com and www.firedog.com. At February 29, 2008, the domestic segment operated 682 Superstores and 11 other stores in 158 U.S. media markets.
Our international segment, which is comprised of the operations of InterTAN, Inc., is engaged in the business of selling private-label and brand-name consumer electronics in Canada. The international segmentâ€™s headquarters are located in Barrie, Ontario, Canada, and it operates through retail stores and dealer outlets in Canada primarily under the trade name The Source By Circuit City SM . At February 29, 2008, the international segment conducted business through 779 retail stores and dealer outlets, which consisted of 502 company-owned stores and 277 dealer outlets. The international segment also operates a Web site at www.thesource.ca. In February 2007, the board of directors authorized management to explore strategic alternatives for InterTAN, Inc., which could include the sale of the operation.
Effective January 28, 2007, we returned the management of 92 Rogers Plus Â® stores to Rogers Wireless Inc. Results from the Rogers Plus Â® stores are presented as results from discontinued operations in all periods presented.
Managementâ€™s Discussion and Analysis (MD&A) is designed to provide the reader of financial statements with a narrative discussion of our results of operations; financial position, liquidity and capital resources; critical accounting policies and significant estimates; and the impact of recently issued accounting standards. Our MD&A is presented in eight sections:
Critical Accounting Policies
Results of Operations
Recent Accounting Pronouncements
Domestic Segment Superstore Revitalization Program
Fiscal 2009 Outlook
This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying Notes included in Item 8, Financial Statements and Supplementary Data, as well as with Item 1A, Risk Factors, included in this annual report on Form 10-K. All per share amounts in this discussion are presented on a fully diluted basis.
The terms â€śCircuit City,â€ť â€śthe company,â€ť â€śwe,â€ť â€śourâ€ť and â€śusâ€ť are used throughout this report and, depending on the context of their use, may represent any of the following: the legal entity, Circuit City Stores, Inc., a Virginia corporation, one of Circuit Cityâ€™s operating segments or the entirety of Circuit City Stores, Inc. and its consolidated subsidiaries.
Within the financial tables in this annual report on Form 10-K, certain columns and rows may not sum due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts.
Fiscal 2008 Performance Summary
Net sales were $11.74 billion compared with $12.43 billion in the prior year, a decrease of 5.5 percent. Comparable store sales decreased 7.7 percent compared with a 5.8 percent increase in fiscal 2007. The fiscal 2008 sales decrease primarily reflects the domestic segment comparable store sales decline of 8.1 percent, partially offset by the net sales contribution of 40 net additional domestic segment Superstores.
The gross profit margin decreased by 291 basis points from fiscal 2007 to 20.7 percent of net sales primarily due to decreases in domestic segment merchandise margin and extended warranty net sales as well as an increase in shrink.
Selling, general and administrative (SG&A) expenses as a percent of net sales increased 73 basis points from fiscal 2007 to 23.6 percent of net sales, primarily reflecting the overall deleveraging impact of lower domestic segment sales.
We recorded an impairment charge of $26.0 million, or 22 basis points of consolidated net sales, associated with the international segmentâ€™s goodwill.
The loss from continuing operations before income taxes was 3.0 percent of net sales in fiscal 2008. Earnings from continuing operations before income taxes were 0.2 percent of net sales in fiscal 2007. The decrease primarily results from declines in domestic segment comparable store sales and gross profit margin.
During fiscal 2008, we recorded a valuation allowance of $127.4 million against the net deferred tax assets of our U.S. operations. Also during fiscal 2008, we recorded a benefit of $36.1 million related to a change in our position regarding repatriation of the undistributed earnings of our Canadian subsidiaries.
The net loss from continuing operations was $321.4 million, or $1.95 per share, compared with $10.2 million, or 6 cents per share, in fiscal 2007.
Fiscal 2008 Significant Events
During fiscal 2008, we induced a lot of change in our organization that led to disappointing financial results but that we believe ultimately positioned the company for future success.
As a result of intensified gross margin pressures within the consumer electronics industry, in the fall of 2006 we launched efforts to accelerate the timing of initiatives that were developed to improve financial performance for the domestic segment. These initiatives included retail transformation work, services growth, multi-channel growth, price optimization, sourcing, inventory optimization and expense reductions. The accelerated transformation efforts that we began in fiscal 2007 were largely implemented in fiscal 2008.
Our retail transformation activities in fiscal 2008 included reducing the number of retail operating regions; aligning pay bands in our stores; introducing a redefined store operating and staffing model; establishing regional and district learning centers to support the process of change management in our stores; and implementing simplified standard operating procedures in our stores. We believe that these changes were implemented too quickly, resulting in lower sales and gross margins from lower close rates and a decline in attachments of accessories, services and warranties to the products we sold.
Despite the difficulties that arose from our retail transformation activities, we were able to achieve progress in other areas of our business.
We made significant progress in our four strategic growth pillars:
Win in Home Entertainment . We capitalized on a strong flat panel television cycle, posting strong growth in sales of large LCD televisions, which partially offset declines in older technologies such as tube and projection televisions. Though our transformation activities negatively impacted our ability to attach higher-margin accessories and services at the rate we saw in fiscal 2007, during the fourth quarter, we were able to increase our TV basket size by 10 percent over the third quarter.
Services . We launched the firedog SM brand in September 2006 to assist customers with home theater installations, consumer PC services and the convergence and integration of multiple technology products. In fiscal 2008, we delivered PC services and home theater installation revenue growth of 29 percent from the prior year to reach nearly $270 million in sales.
Multi-channel . Domestic segment direct channel sales grew 21 percent for the year, reaching $1.35 billion for fiscal 2008.
Real Estate . We delivered on our domestic segment Superstore opening plans for the year with 43 incremental Superstores and 18 relocated Superstores. During the year, we also launched a new store prototype, called the city TM . The city TM has a smaller
footprint, approximately 20,000 square feet, and offers a differentiated and improved customer experience compared with our traditional stores. Of the fiscal 2008 incremental and relocated openings, 21 were in the city TM format. We also completed one full remodel of an existing store into the new format. We expect to open 45 to 55 incremental and relocated stores in fiscal 2009, virtually all in the city TM format.
Information Technology . We outsourced our information technology infrastructure, implemented six modules of our new merchandising systems, and ended the fiscal year with 26 percent of domestic segment Superstores operating on our new point-of-sale platform.
Expense Reductions . We continued our SG&A reduction activities with a focus on all layers of the business. We measured the savings compared with our spending plan at the time that we made the decision to accelerate our transformation initiatives and identified areas of spend to reduce. We planned to achieve savings of $150 million and exceeded that target by $50 million, achieving approximately $200 million of savings compared with our planned spending. These savings were partially offset by investments to support strategic initiatives, including incremental and relocated stores and information technology.
Enhanced Liquidity . We enhanced liquidity in three primary steps. We amended and increased our asset-based credit facility to $1.3 billion from $500 million. We reduced domestic segment net-owned inventory by $107 million. We also reduced our capital expenditures for fiscal 2008 by 11 percent compared with our originally planned fiscal 2008 expenditures.
Strengthened Management Team. In fiscal 2008, we hired three experienced senior retail executives to execute the next phase of the turnaround. These three executive vice presidents include the chief operating officer, chief financial officer and head of new business development, including the city TM format stores, firedog SM services and ongoing innovation work.
In fiscal 2009, we will continue to focus on our long-term strategy and transformation efforts. Our four growth pillars of win in home entertainment , services, multi-channel and real estate serve as the foundation for our strategic initiatives.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of financial statements requires us to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. We use our historical experience and other relevant factors when developing our estimates and assumptions, which we continually evaluate. Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this annual report on Form 10-K includes a discussion of our significant accounting policies. The following accounting policies are those we consider critical to an understanding of the consolidated financial statements because their application places the most significant demands on our judgment. Our financial results might have been different if other assumptions had been used or other conditions had prevailed.
We value our inventory using the average cost method and include the cost of freight from the vendor to our distribution centers, or in the case of direct shipments, the cost of freight from the vendor to our stores. We estimate the realizable value of inventory based on assumptions about forecasted consumer demand, market conditions and obsolescence. If the estimated realizable value is less than cost, the inventory value is reduced to its estimated realizable value through a markdown recorded against the cost of the inventory. If estimates regarding consumer demand and market conditions are inaccurate or unexpected changes in technology affect demand, it is possible that actual results could differ from recorded reserves. A 10 percent change in our markdown reserve at February 29, 2008, would not be significant to the consolidated financial statements.
Our inventory loss reserve represents estimated physical inventory losses that have occurred since the last physical inventory date. Independent physical inventory counts are taken on a regular basis to ensure that the inventory reported in the consolidated financial statements is accurately stated. During the interim period between physical inventory counts, we reserve for anticipated physical inventory losses on a location-by-location basis. Our inventory loss reserve contains uncertainties because the calculation requires management to make assumptions and apply judgment regarding a number of factors, including current inventory loss trends. The loss reserve recorded at February 29, 2008, represents estimated physical inventory losses for the interim period since the last independent physical count was performed. A 10 percent change in this estimate would not be significant to the consolidated financial statements.
Results of Operations
Reclassifications and Adjustments
To improve presentation and comparability, amounts previously reported in the consolidated financial statements have been reclassified to conform to current-year presentation.
Summary of Segment Performance
For the fiscal year ended February 29, 2008, our net sales decreased 5.5 percent to $11.74 billion, and comparable store sales decreased 7.7 percent. For the fiscal year ended February 28, 2007, our net sales increased 8.0 percent to $12.43 billion, and comparable store sales increased 5.8 percent.
A storeâ€™s sales are included in comparable store sales after the store has been open for a full 12 months. Comparable store sales include Web- and call center-originated sales and sales from relocated and remodeled stores. Sales from closed stores are included in comparable store sales until the month in which the stores are closed. International segment sales are included in comparable stores sales and are calculated in local currency. The calculation of comparable store sales excludes the impact of fluctuations in foreign currency exchange rates.
The fiscal 2008 net sales decrease primarily reflects the decrease in domestic segment comparable store sales, partially offset by the net sales contribution of 40 net additional domestic segment Superstores.
The fiscal 2007 net sales increase primarily reflects the increase in domestic segment comparable store sales and the net sales contribution of 16 net additional domestic segment Superstores.
Our major sales categories are:
video , which includes televisions, imaging products, DVD hardware, camcorders, furniture, and related accessories;
information technology , which includes PC hardware, telecommunications products and related accessories;
audio , which includes home audio, mobile audio, portable audio and navigation products, and related accessories;
entertainment , which includes movie software, music software, game software, game hardware and PC software; and
warranty, services and other, which includes extended warranty net sales; revenues from PC services, mobile installations, home theater installations and product repairs; net financing; and revenues received from third parties for services subscriptions.
The domestic segmentâ€™s fiscal 2008 net sales were $11.14 billion, a decrease of 6.0 percent from fiscal 2007 sales of $11.86 billion. Comparable store sales decreased 8.1 percent. The fiscal 2008 sales decrease primarily reflects the decrease in the comparable store sales partially offset by the net sales contribution of 40 net additional Superstores. The comparable store sales decrease is due primarily to decreases in store traffic and close rates compared to fiscal 2007, partially offset by an increase in average ticket associated with Superstore sales.
The domestic segmentâ€™s fiscal 2007 net sales were $11.86 billion, an increase of 8.1 percent over fiscal 2006 sales of $10.97 billion. Comparable store sales increased 6.1 percent. The fiscal 2007 sales increase primarily reflects the increase in the comparable store sales and the net sales contribution of 16 net additional Superstores. The comparable store sales increase is due primarily to an increase in Web- and call center-originated sales as well as an increase in the average ticket associated with Superstore sales. A strong increase in sales of flat panel televisions drove the increase in average ticket.
For fiscal 2008, our sales decline was primarily driven by strong-double digit comparable store sales declines of projection, tube and plasma televisions as well as portable digital audio products. Partially offsetting these declines were very strong double-digit growth in large LCD televisions and double-digit growth in video game hardware, software and accessories, notebook computers and navigation products. For fiscal 2008, direct channel sales, including Web- and call center-originated sales, grew 21 percent to $1.35 billion; firedog SM PC services and home theater installation revenues grew 29 percent to $268.9 million.
For fiscal 2007, our growth was primarily driven by strong double-digit comparable store sales growth of flat panel televisions. Comparable store sales of notebook computers, video gaming products and digital imaging products grew double digits and comparable store sales of navigation products grew by triple digits. Strong sales growth in these areas was partially offset by double digit declines in sales of tube and projection televisions. For fiscal 2007 in the domestic segment, Web-originated sales grew 52 percent; firedog SM services revenues, including PC services and home theater installations, grew 77 percent; and call center sales grew 73 percent from the prior year. For fiscal 2007, Web-originated sales reached $1 billion and firedog SM services revenues exceeded $200 million.
The domestic segment sells extended warranty programs on behalf of unrelated third parties who are the primary obligors. The commission revenue for extended warranty net sales is included in net sales. Reflecting our expanded ability to provide high-value services in a growing number of ways, we view extended warranty net sales as one component of many that contributes to both sales and gross margin. Our customer service approach focuses on selling solutions, with warranties being only one of many available solutions.
The percent of domestic segment sales attributable to net sales of extended warranties was 2.5 percent in fiscal 2008, 3.5 percent in fiscal 2007 and 3.8 percent in fiscal 2006. As average selling prices on many products declined during fiscal 2008, extended warranty net sales as a percentage of domestic segment net sales also declined compared to fiscal 2007. We believe that consumers perceive a reduced need for an extended warranty when the product price has declined.
The international segmentâ€™s fiscal 2008 net sales were $600.9 million, an increase of 5.4 percent over fiscal 2007 sales of $570.2 million. The sales increase was driven by the favorable impact of fluctuations in foreign currency exchange rates of 10 percent and an increase in comparable store sales of 2.4 percent for the year in local currency. These increases were partially offset by the impact of the year-over-year net decrease of 27 retail stores and dealer outlets.
The international segmentâ€™s fiscal 2007 net sales were $570.2 million, an increase of 5.6 percent over fiscal 2006 sales of $540.2 million. The sales increase was driven by the effect of fluctuations in foreign currency exchange rates, which accounted for approximately 4 percentage points of the increase. Comparable store sales decreased 0.8 percent in fiscal 2007 in local currency.
Gross Profit Margin
The gross profit margin rate was 20.7 percent in fiscal 2008, 23.6 percent in fiscal 2007 and 24.4 percent in fiscal 2006.
The gross profit margin rate declined 291 basis points in fiscal 2008 from fiscal 2007. The domestic segment contributed 320 basis points to the decline which was partially offset by an increase of 30 basis points contributed by the international segment.
The gross profit margin rate declined 85 basis points in fiscal 2007 from fiscal 2006. The domestic segment contributed 58 basis points to the decline, and the international segment contributed 27 basis points to the decline.
The domestic segmentâ€™s gross profit margin rate was 19.9 percent in fiscal 2008, 23.1 percent in fiscal 2007 and 23.7 percent in fiscal 2006.
The domestic segmentâ€™s gross profit margin rate decreased 325 basis points in fiscal 2008 from fiscal 2007, driven by a decrease in merchandise margins, primarily due to the maturation of the television product cycle and competitive pressures across many product categories, including PC hardware, imaging products and mobile audio products and accessories, as well as a decrease in extended warranty net sales and an increase in shrink.
The domestic segmentâ€™s gross profit margin rate decreased 63 basis points in fiscal 2007 from fiscal 2006, driven by a decrease in merchandise margins primarily in televisions, PC hardware, and entertainment software, as well as a decrease in extended warranty net sales as a percentage of domestic segment net sales.
The international segmentâ€™s gross profit margin rate was 35.5 percent in fiscal 2008, 33.0 percent in fiscal 2007 and 38.1 percent in fiscal 2006.
The gross profit margin increase from fiscal 2007 to fiscal 2008 is primarily due to a decreased level of merchandise markdowns compared with the prior year. Fiscal 2007 results also include $3.3 million, or 58 basis points of international segment net sales, for inventory write-offs associated with plans to exit certain product lines, clearance sales associated with store closures, and other actions to align the international segment merchandise assortment with consumer demand. Similar costs were not incurred in fiscal 2008. The gross profit margin increase is partially offset by the unfavorable impact of the continued shift in the product sales mix from higher-margin categories, including batteries, gadgets and parts and accessories, to lower-margin categories, including video games, navigation products and personal electronics.
The gross profit margin decrease from fiscal 2006 to fiscal 2007 is due to an increased level of inventory write-offs and merchandise markdowns compared with the prior year as well as a shift in the product sales mix from higher-margin categories, including batteries, to lower-margin, higher-growth categories, including personal electronics and navigation products. Results also include $3.3 million, or 58 basis points of international segment net sales, for inventory write-offs associated with restructuring activities in fiscal 2007 as described above.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Fiscal 2008 Third Quarter Performance
Net sales declined 3.1 percent to $2.96 billion from $3.06 billion in the same period last year, driven by a comparable store sales decline of 5.6 percent. Comparable store sales increased 5.2 percent for the same period last year.
Gross profit margin was 19.1 percent of consolidated net sales compared with 22.1 percent in the same period last year primarily due to domestic segment decreases in television margins, extended warranty net sales and PC hardware margins and a greater mix of lower margin domestic segment PC hardware sales.
Selling, general and administrative (SG&A) expenses were 23.9 percent of consolidated net sales, compared with 23.4 percent of consolidated net sales in the same period last year.
Income tax expense was $67.8 million, which includes a $141.6 million, or $0.86 per share, expense to establish a valuation allowance against deferred tax assets in the domestic segment and a $38.8 million benefit to record previously unrecognized foreign tax credits in the international segment. The income tax benefit was $14.3 million for the same period last year.
The net loss from continuing operations was $208.0 million, or $1.26 per share, compared to a net loss from continuing operations of $19.9 million, or $0.12 per share, in the same period last year.
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies under Managementâ€™s Discussion and Analysis of Financial Condition and Results of Operations in our fiscal 2007 Annual Report on Form 10-K. These policies relate to inventory valuation, goodwill, accrued lease termination costs, stock-based compensation and pension plans. We have updated our critical accounting policy for income taxes due to our adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, â€śAccounting for Uncertainty in Income Taxes â€“ an interpretation of FASB Statement No. 109â€ť (FIN 48).
We account for income taxes in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, â€śAccounting for Income Taxes,â€ť which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of the temporary differences between the book and tax basis of recorded assets and liabilities. We make estimates and judgments with regard to the calculation of certain tax assets and liabilities. SFAS No. 109 requires that deferred tax assets be reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be objectively verified. Quarterly, we evaluate our deferred income taxes to determine if valuation allowances are required by considering available evidence, including historical and projected taxable income and tax planning strategies. In prior periods, based on our evaluation of all available objective evidence, we believed that it was more likely than not that we would realize the benefit of the existing deferred tax assets, net of the valuation allowance for foreign tax credits and capital loss carryforwards. As of November 30, 2007, our U.S. operations had generated a cumulative three-year loss. Based on the cumulative three-year loss and other available objective evidence, we concluded that a valuation allowance of $141.6 million should be recorded against the net deferred tax assets of the U.S. operations. The establishment of the valuation allowance was a non-cash expense. Upon a return to profitability, we would expect to utilize our loss carryforwards and other deferred tax assets.
On March 1, 2007, we adopted FIN 48. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Positions taken by an entity in its income tax returns must satisfy a more-likely-than-not recognition threshold, assuming that the positions will be examined by taxing authorities with full knowledge of all relevant information, in order for the positions to be recognized in the consolidated financial statements. Quarterly, we evaluate the income tax positions taken, or expected to be taken, to determine whether these positions meet the more-likely-than-not threshold prescribed by FIN 48. We are required to make subjective judgments and assumptions regarding our income tax exposures and must consider a variety of factors, including the current tax statutes, the current status of audits performed by tax authorities, and the statute of limitations in each tax jurisdiction. To the extent an uncertain tax position is resolved for an amount that varies from the recorded estimated liability, our income tax expense in a given financial statement period could be materially affected.
Our unrecognized tax benefits were $34.8 million at November 30, 2007, and $15.2 million at February 28, 2007. In conjunction with the adoption of FIN 48, we have classified unrecognized tax benefits not expected to be settled within one year as other liabilities on the consolidated balance sheet. Additional discussion and the impact of adopting this Interpretation are included in Note 4, Income Taxes, of the Notes to Consolidated Financial Statements, of this Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS
Our operations, consistent with other retailers in general, are subject to seasonal influences. Historically, we have realized more of our net sales and net earnings in the fourth quarter, which includes the majority of the holiday selling season, than in any other fiscal quarter. The net earnings (loss) of any quarter are seasonally disproportionate to net sales since administrative and certain operating expenses remain relatively constant during the year. Therefore, quarterly results should not be relied upon as necessarily indicative of results for the entire fiscal year.
Summary of Segment Performance
For the third quarter of fiscal 2008, our net sales decreased 3.1 percent to $2.96 billion, and comparable store sales decreased 5.6 percent from the same period last fiscal year. Net sales for the first nine months of fiscal 2008 decreased 4.5 percent to $8.09 billion from $8.48 billion for the first nine months of last fiscal year. Comparable store sales decreased 6.4 percent for the first nine months of fiscal 2008.
A storeâ€™s sales are included in comparable store sales after the store has been open for a full 12 months. Comparable store sales include Web- and call center-originated sales and sales from relocated and remodeled stores. Sales from closed stores are included in comparable store sales until the month in which the stores are closed. The calculation of comparable store sales excludes the impact of fluctuations in foreign currency exchange rates.
Our major sales categories are
video , which includes televisions, imaging products, DVD hardware, camcorders, digital cameras, furniture, and related accessories;
information technology , which includes PC hardware, telecommunications products and related accessories;
audio , which includes home audio products, mobile audio products, portable audio products, navigation products, and related accessories;
entertainment , which includes movie software, music software, game software, game hardware and personal computer software; and
warranty, services and other, which includes extended warranty net sales; revenues from PC services, mobile installations, home theater installations and product repairs; net financing; and revenues received from third parties for services subscriptions.
For the third quarter of fiscal 2008, the domestic segmentâ€™s net sales were $2.80 billion, a decrease of 3.6 percent from the same period last fiscal year. Comparable store sales decreased 5.8 percent driven primarily by the disruptive impact of our transformation activities, including a re-organized store leadership structure, new store operating procedures, implementation of the new point-of-sale system and a reduced number of selling zones. In addition, we experienced sales weakness in states in the Southeast and the West, which we attribute to the macroeconomic climate. For the quarter, direct channel sales, including Web- and call center-originated sales, grew 31 percent, and PC services and home theater installation revenues grew 29 percent over the same period last fiscal year.
For the nine months ended November 30, 2007, the domestic segmentâ€™s net sales were $7.69 billion, a decrease of 4.7 percent over the same period last fiscal year. Comparable store sales decreased 6.6 percent.
The domestic segmentâ€™s net sales represented by each major sales category for the three months and nine months ended November 30, 2007 and 2006, are shown below.
NET SALES BY CATEGORY
In the video category, we generated a high-single-digit comparable store sales decrease in the third quarter. Comparable store sales of flat panel televisions increased by double digits. Total television comparable store
sales decreased by a high single digit, as significant comparable store sales decreases in projection and tube televisions more than offset the flat panel television increase. Comparable store sales of camcorders and DVD hardware declined by double digits. Comparable store sales of digital imaging products and accessories decreased by a low single digit.
In the information technology category, we generated a low-single-digit comparable store sales increase in the third quarter. Comparable store sales of notebook computers increased by double digits, and comparable store sales of desktop computers declined by double digits.
In the audio category, we generated a double-digit comparable store sales decrease in the third quarter. Comparable store sales of navigation products increased by triple digits. Comparable store sales of portable digital audio, home audio, mobile and digital satellite radio products declined by double digits.
In the entertainment category, we generated a double-digit comparable store sales increase in the third quarter, reflecting a strong double-digit comparable store sales increase in video gaming products. Comparable store sales of video software and music software declined by double digits.
Domestic segment extended warranty net sales were $67.4 million, or 2.4 percent of domestic segment net sales, in the third quarter, compared with $103.3 million, or 3.6 percent of domestic segment net sales, in the same period last year. PC services and home theater installation revenues increased 29 percent to $66.7 million from $51.8 million in the same period last year.
During the third quarter of fiscal 2008, we opened 16 incremental Superstores, relocated 5 Superstores and remodeled 1 Superstore. Six of these stores were in our newest concept, The City TM . At the end of the quarter, we operated a total of seven The City TM stores.
The international segmentâ€™s net sales increased 5.9 percent to $159.1 million for the third quarter of fiscal 2008, compared with $150.2 million for the third quarter of last fiscal year. The increase was driven by the favorable impact of fluctuations in foreign currency exchange rates of 13 percent. This increase was partially offset by the impact of the year-over-year decrease of 74 retail stores and dealer outlets, net of openings, as well as the comparable store sales decline of 1.1 percent in local currency for the quarter.
For the nine months ended November 30, 2007, the international segmentâ€™s net sales increased 0.3 percent to $400.3 million, compared with $399.2 million for the nine months ended November 30, 2006. The effect of fluctuations in foreign currency exchange rates favorably impacted the sales increase by approximately 7 percent. Comparable store sales decreased 0.6 percent in local currency for the first nine months of fiscal 2008.