UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended November 30, 2006
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from ___ to ___
Commission file number: 1-5767
CIRCUIT CITY STORES, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-0493875
(State of Incorporation) (I.R.S. Employer Identification No.)
9950 Mayland Drive
Richmond, Virginia 23233
(Address of principal executive offices) (Zip Code)
(804) 527- 4000
(Registrant's telephone number, including area code)
N/A
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No__
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |X| Accelerated filer __ Non-accelerated filer __
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes___ No |X|
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 30, 2006
Common Stock, par value $0.50 175,721,602
A Table of Contents is included on Page 2 and an Exhibit Index is included on
Page 35.
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Operations -
Three Months and Nine Months Ended November 30, 2006 and 2005 3
Consolidated Balance Sheets -
November 30, 2006, and February 28, 2006 4
Consolidated Statements of Cash Flows -
Nine Months Ended November 30, 2006 and 2005 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 1A. Risk Factors 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 6. Exhibits 33
SIGNATURES 34
EXHIBIT INDEX 35
Page 2 of 35
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Circuit City Stores, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(Amounts in thousands except per share data)
Three Months Ended Nine Months Ended
November 30 November 30
2006 2005 2006 2005
------------ ------------ ------------ -------------
Net sales $ 3,102,299 $ 2,901,385 $ 8,558,465 $ 7,686,326
Cost of sales, buying and warehousing 2,413,492 2,201,371 6,553,442 5,818,778
------------ ------------- ------------ -------------
Gross profit 688,807 700,014 2,005,023 1,867,548
Selling, general and administrative expenses 720,921 686,668 2,023,080 1,877,775
------------ ------------- ------------ -------------
Operating (loss) income (32,114) 13,346 (18,057) (10,227)
Interest income 5,744 4,334 18,584 15,228
Interest expense 1,034 1,113 1,359 1,743
------------ ------------- ------------ -------------
(Loss) earnings from continuing operations
before income taxes (27,404) 16,567 (832) 3,258
Income tax (benefit) provision (11,778) 6,415 (1,591) 1,124
------------ ------------- ------------ -------------
Net (loss) earnings from continuing operations (15,626) 10,152 759 2,134
Loss from discontinued operations, net of tax (364) (10) (2,109) (3,753)
Cumulative effect of change in accounting
principle, net of tax - - 1,773 -
------------ ------------- ------------ -------------
Net (loss) earnings $ (15,990) $ 10,142 $ 423 $ (1,619)
============ ============= ============ =============
Weighted average common shares:
Basic 171,063 174,438 170,695 179,426
Diluted 171,063 177,509 175,332 182,328
(Loss) earnings per share:
Basic:
Continuing operations $ (0.09) $ 0.06 $ - $ 0.01
Discontinued operations $ - $ - $ (0.01) $ (0.02)
Cumulative effect of change in
accounting principle $ - $ - $ 0.01 $ -
Net (loss) earnings $ (0.09) $ 0.06 $ - $ (0.01)
Diluted:
Continuing operations $ (0.09) $ 0.06 $ - $ 0.01
Discontinued operations $ - $ - $ (0.01) $ (0.02)
Cumulative effect of change in
accounting principle $ - $ - $ 0.01 $ -
Net (loss) earnings $ (0.09) $ 0.06 $ - $ (0.01)
Cash dividends paid per share $ 0.04 $ 0.0175 $ 0.075 $ 0.0525
See accompanying notes to consolidated financial statements.
Page 3 of 35
Circuit City Stores, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands except share data)
Nov. 30, 2006 Feb. 28, 2006
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 446,705 $ 315,970
Short-term investments 451,182 521,992
Accounts receivable, net of allowance for doubtful accounts 420,876 220,869
Merchandise inventory 2,531,486 1,698,026
Deferred income taxes 39,663 29,598
Income tax recoverable 22,810 5,571
Prepaid expenses and other current assets 65,323 41,315
---------- ----------
Total current assets 3,978,045 2,833,341
Property and equipment, net of accumulated depreciation of
$1,285,500 and $1,179,481 935,872 839,356
Deferred income taxes 70,104 97,889
Goodwill 218,739 223,999
Other intangible assets, net of accumulated amortization of
$13,280 and $6,123 23,278 30,372
Other assets 43,238 44,087
---------- ----------
TOTAL ASSETS $5,269,276 $4,069,044
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Merchandise payable $1,872,936 $ 850,359
Expenses payable 410,291 202,300
Accrued expenses and other current liabilities 550,096 464,511
Accrued income taxes - 75,909
Short-term debt 35,012 22,003
Current installments of long-term debt 7,301 7,248
---------- ----------
Total current liabilities 2,875,636 1,622,330
Long-term debt, excluding current installments 47,479 51,985
Accrued straight-line rent and deferred rent credits 269,629 256,120
Accrued lease termination costs 58,738 79,091
Other liabilities 99,791 104,885
---------- ----------
TOTAL LIABILITIES 3,351,273 2,114,411
---------- ----------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, $0.50 par value;
525,000,000 shares authorized; 175,721,602 shares
issued and outstanding at November 30, 2006
(174,789,390 at February 28, 2006) 87,861 87,395
Capital in excess of par value 435,773 458,211
Retained earnings 1,351,994 1,364,740
Accumulated other comprehensive income 42,375 44,287
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 1,918,003 1,954,633
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $5,269,276 $4,069,044
========== ===========
See accompanying notes to consolidated financial statements.
Page 4 of 35
Circuit City Stores, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Nine Months Ended
November 30
2006 2005
-------------- ------------
(Restated - Note 2)
Operating Activities:
Net earnings (loss) $ 423 $ (1,619)
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities:
Net loss from discontinued operations 2,109 3,753
Depreciation expense 132,048 115,535
Amortization expense 7,294 2,371
Stock-based compensation expense 22,393 17,692
Gain on dispositions of property and equipment (1,947) (485)
Provision for deferred income taxes 16,918 (10,734)
Cumulative effect of change in accounting principle (1,773) -
Other 41 (670)
Changes in operating assets and liabilities:
Accounts receivable, net (180,549) (61,500)
Merchandise inventory (834,731) (1,212,395)
Prepaid expenses and other current assets (26,817) (40,817)
Other assets 861 327
Merchandise payable 1,023,374 1,016,695
Expenses payable 91,990 100,426
Accrued expenses, other current liabilities and accrued income taxes (12,566) 5,863
Other long-term liabilities (19,742) (22,846)
--------------- ------------
Net cash provided by (used in) operating activities of continuing operations 219,326 (88,404)
--------------- ------------
Investing Activities:
--------------------
Purchases of property and equipment (216,898) (190,894)
Proceeds from sales of property and equipment 17,297 49,913
Purchases of investment securities (664,705) (676,603)
Sales and maturities of investment securities 736,173 670,600
Other investing activities (9,841) -
-------------- ------------
Net cash used in investing activities of continuing operations (137,974) (146,984)
-------------- ------------
Financing Activities:
--------------------
Proceeds from short-term borrowings 35,657 67,299
Principal payments on short-term borrowings (22,158) -
Proceeds from long-term borrowings 1,216 -
Principal payments on long-term borrowings (6,028) (1,078)
Change in overdraft balances 92,131 11,613
Excess tax benefit from stock-based payments 15,595 -
Repurchases of common stock (137,094) (298,479)
Issuances of common stock 88,112 25,719
Dividends paid (13,162) (9,737)
Redemption of preferred share purchase rights - (1,876)
Other financing activities (1,422) -
-------------- ------------
Net cash provided by (used in) financing activities of continuing operations 52,847 (206,539)
-------------- ------------
Discontinued Operations:
-----------------------
Operating cash flows (5,547) (10,476)
Investing cash flows 2,997 (9,230)
Financing cash flows (650) 60
-------------- ------------
Net cash used in discontinued operations (3,200) (19,646)
-------------- ------------
Effect of exchange rate changes on cash (264) (285)
-------------- ------------
Increase (decrease) in cash and cash equivalents 130,735 (461,858)
Cash and cash equivalents at beginning of year 315,970 879,660
-------------- ------------
Cash and cash equivalents at end of period $ 446,705 $ 417,802
============== ============
See accompanying notes to consolidated financial statements.
Page 5 of 35
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
Description of Business: Circuit City Stores, Inc. is a leading specialty
retailer of consumer electronics, home office products, entertainment
software, and related services. The company has two reportable segments:
its domestic segment and its international segment.
The domestic segment is primarily engaged in the business of selling
brand-name consumer electronics, personal computers, entertainment
software, and related services in Circuit City stores in the United States
and via the Web at www.circuitcity.com and www.firedog.com. At November 30,
2006, the company's domestic segment operated 640 Superstores and 11 other
stores in 158 U.S. media markets.
The international segment, which is comprised of the operations of
InterTAN, Inc., is primarily engaged in the business of selling
private-label and brand-name consumer electronics in Canada. The
international segment's headquarters are located in Barrie, Ontario,
Canada, and it operates through retail stores and dealer outlets in Canada
primarily under the trade names The Source By Circuit CitySM, Rogers
Plus(R) and Battery Plus(R). At November 30, 2006, the international
segment conducted business through 955 retail stores and dealer outlets,
which consisted of 547 company-owned stores, 300 dealer outlets, 92 Rogers
Plus(R) stores and 16 Battery Plus(R) stores. The international segment
also operates a Web site at www.thesource.ca.
In accordance with the Amending Agreement dated March 27, 2004, between
Rogers Wireless Inc. ("Rogers") and InterTAN Canada Ltd., Rogers has
notified InterTAN that they do not intend to continue the existing
arrangement with respect to InterTAN's operation of the Rogers Plus(R)
stores after January 28, 2007. Exit costs related to the transition are
expected to be inconsequential. The company expects to classify the results
of operations attributable to the Roger Plus(R) stores as results from
discontinued operations in the fourth quarter of fiscal 2007.
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and the disclosure of contingent assets and
liabilities. Actual results may differ from those estimates. In the opinion
of management, the accompanying unaudited financial statements contain all
adjustments, which consist only of normal, recurring adjustments, necessary
for a fair presentation. Due to the seasonal nature of the company's
business, interim results are not necessarily indicative of results for the
entire fiscal year. The company's consolidated financial statements
included in this report should be read in conjunction with the notes to the
audited financial statements in the company's fiscal 2006 Annual Report on
Form 10-K.
Reclassifications and Adjustments: The company has made revisions and
reclassifications to its fiscal 2006 consolidated statement of operations
as disclosed in Note 1, Basis of Presentation, of the Notes to the
Consolidated Financial Statements, included in Item 8, Financial Statements
and Supplementary Data, of the company's fiscal 2006 Annual Report on Form
10-K. Such revisions and reclassifications include the following:
o Amounts previously reported as rent expense related to financing lease
obligations have been reclassified to interest expense.
o Interest income has been reclassified from selling, general and
administrative expenses to a separate line item on the consolidated
statement of operations.
o The results of a domestic segment operation that is held for sale and a
domestic segment subsidiary, MusicNow, LLC, have been presented as
results from discontinued operations.
Page 6 of 35
During the first quarter of fiscal 2007, the company reclassified fiscal
2006 stock-based compensation expense from a separate line item on the
consolidated statement of operations to selling, general and administrative
expenses.
2. Restatement of Cash Flows
As disclosed in Note 22, Quarterly Financial Data (Unaudited), of the Notes
to Consolidated Financial Statements, included in Item 8, Financial
Statements and Supplementary Data, of the company's fiscal 2006 Annual
Report on Form 10-K, the company identified errors in its previously filed
consolidated statement of cash flows for the nine months ended November 30,
2005, and restated the consolidated statement of cash flows for the nine
months ended November 30, 2005. The company had classified variable rate
demand notes as cash and cash equivalents; however, these notes should have
been classified as short-term investments and their purchases and sales as
investing activities. The company incorrectly reflected bank overdrafts as
a change in accounts payable in operating activities rather than in
financing activities. The company incorrectly included accruals for
purchases of property and equipment in operating activities and investing
activities. The company incorrectly reflected deposits in transit as a
reduction to accounts payable.
In addition, the company sold the assets of a domestic segment subsidiary,
MusicNow, LLC, during the third quarter of fiscal 2006 and began holding
the assets of a domestic segment operation for sale during the fourth
quarter of fiscal 2006. The cash flow activities related to MusicNow, LLC,
and the domestic segment operation have been reclassified and reported
separately as cash flows from discontinued operations.
The following table summarizes the cash flow activities as previously
reported for the nine months ended November 30, 2005, compared with the
revised cash flow activities to reflect correction of the errors and cash
flows from discontinued operations.
Nine Months Ended
(Amounts in millions) November 30, 2005
--------------------------------------------------------------------------------------------
Operating cash flows as previously reported.................. $ (78.5)
Operating cash flows as revised.............................. $ (88.4)
Investing cash flows as previously reported.................. $ (89.1)
Investing cash flows as revised.............................. $(147.0)
Financing cash flows as previously reported.................. $(218.2)
Financing cash flows as revised.............................. $(206.5)
Discontinued operations cash flows as previously
reported.................................................. $ -
Discontinued operations cash flows as revised................ $ (19.6)
Decrease in cash and cash equivalents as
previously reported....................................... $(386.0)
Decrease in cash and cash equivalents as revised............ $(461.9)
3. Stock-Based Compensation
Effective March 1, 2006, the company adopted Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment," (SFAS
No. 123(R)), using the modified prospective transition method. Prior to the
adoption of SFAS No. 123(R), the company accounted for stock-based
compensation using a fair value-based method in accordance with SFAS No.
123, "Stock-Based Compensation." Because the fair value recognition
provisions of SFAS No. 123 and SFAS No. 123(R) were materially consistent
under the company's stock-based incentive plans, the adoption of SFAS No.
123(R) did not have a material impact on the company's financial position,
results of operations or cash flows.
Page 7 of 35
Under SFAS No. 123(R), companies are required to report excess tax benefits
as a financing cash inflow rather than as a reduction of taxes paid. Under
SFAS No. 123, benefits of tax deductions in excess of recognized
compensation costs were reported as operating cash flows.
SFAS No. 123(R) requires companies to estimate the number of equity awards
granted that are expected to be forfeited, recognize compensation cost
based on the number of awards that are expected to vest, and subsequently
adjust estimated forfeitures to reflect actual forfeitures. Under SFAS No.
123, the company recognized forfeitures when they occurred. During the
first quarter of fiscal 2007, the company recorded an after-tax benefit of
$1.8 million, $2.8 million pretax, as a cumulative effect of a change in
accounting principle to adjust for awards granted prior to March 1, 2006,
that are not expected to vest.
Under the company's stock-based incentive plans, nonqualified stock
options, nonvested stock, nonvested stock units and other equity-based
awards may be granted to management, key employees and non-employee
directors. The company previously referred to nonvested stock as restricted
stock and nonvested stock units as restricted stock units. At November 30,
2006, 3.9 million shares of common stock were available for future grants
of options, nonvested stock or nonvested stock units. Upon the exercise of
stock options, the grant of nonvested stock, or the vesting of or lapse of
restrictions on nonvested stock units, common shares are issued from
authorized and unissued shares.
Stock-based compensation cost is recorded in cost of sales, buying and
warehousing or selling, general and administrative expenses depending on
the classification of the related employee's payroll cost. Compensation
cost for stock-based incentive plans is summarized in the table below.
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- ----------------------
Compensation cost recognized:
Stock options........................................... $1.8 $3.6 $ 8.8 $ 9.8
Nonvested stock and nonvested stock units............... 4.2 4.6 13.5 7.9
Phantom stock........................................... 0.3 0.8 1.5 0.8
Employee stock purchase plan............................ 0.2 0.3 0.6 0.7
Other................................................... - - 0.2 0.2
------------------------ ----------------------
Total compensation cost recognized................. $6.5 $9.3 $24.6 $19.4
======================== ======================
Tax benefit recognized..................................... $2.3 $3.3 $ 8.4 $ 6.9
(A) Stock Options: Under the terms of the company's stock-based incentive
plans, the exercise price for nonqualified options must be equal to, or
greater than, the market value at the grant date. Options generally are
exercisable over a period of one year to ten years from the grant date. The
company values stock options issued using the Black-Scholes option-pricing
model and recognizes this value as an expense over the period in which the
options vest. Option valuation models require the company to make
subjective assumptions. Changes in the subjective assumptions can
materially affect the fair value estimate. The expected dividend yield is
based on expected annual dividends and the market value of the company's
stock on the grant date. The expected stock volatility assumption is based
on historical volatility of the company's stock. The risk-free interest
rate is based on the U.S. Treasury Strip rate posted at the grant date for
the expected term of the option. The expected term represents the period of
time that options granted are expected to be outstanding and is primarily
based on the historical exercise experience and post-vesting employment
termination behavior of the company's employees. The company evaluates
historical exercise behavior for two separate groups based on the
employee's position in the company.
During the first quarter of fiscal 2007, a stock option grant with a
vesting period of five years and an expiration date of ten years was made
to the chairman, president and chief executive officer. Due to the lack of
historical exercise behavior for an option with similar vesting provisions,
the company used a simplified method to estimate the expected term of the
grant. An average of the award's weighted average vesting period and its
contractual term was calculated and resulted in an expected term of seven
years.
Page 8 of 35
The fair value of each option granted is estimated on the grant date using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
Three Months Ended Nine Months Ended
November 30 November 30
2006 2005 2006 2005
------------------------------------------------------------------------------ -----------------------
Expected dividend yield.......................... 0.6% 0.4% 0.3% 0.4%
Expected stock volatility........................ 51% 53% 60% 59%
Risk-free interest rates......................... 5% 4% 5% 4%
Expected term (in years)......................... 5 4 7 5
The weighted average fair value of options granted, the total intrinsic
value of options exercised, the tax benefits realized from stock options
exercised and the fair value of stock options that vested are summarized in
the table below.
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions except per share data) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- ----------------------
Weighted average fair value of options
granted (per share)..................................... $13.37 $7.97 $14.86 $ 8.51
Total intrinsic value of options exercised................. $25.5 $2.0 $63.8 $19.6
Tax benefits realized from stock options
exercised............................................... $(0.2) $1.7 $ 8.5 $ 4.1
Fair value of stock options that vested.................... $ 3.5 $1.6 $14.3 $14.2
Total unrecognized compensation cost related to unvested stock options at
November 30, 2006, was $27.1 million and is expected to be recognized over
a weighted average period of three years.
The company's stock option activity is summarized in the table below.
Weighted
Average
Weighted Remaining Aggregate
Shares Average Contractual Life Intrinsic Value
(in thousands) Exercise Price (in years) (in millions)
-------------------------------------------------------------------------------------------------------------------------------
Outstanding at February 28, 2006................. 14,109 $16.41
Granted.......................................... 1,105 $24.32
Exercised........................................ (1,439) $11.86
Forfeited or expired............................. (225) $15.37
---------
Outstanding at May 31, 2006...................... 13,550 $17.55
Granted.......................................... 91 $27.16
Exercised........................................ (1,414) $14.82
Forfeited or expired............................. (23) $16.71
---------
Outstanding at August 31, 2006................... 12,204 $17.94
Granted.......................................... 66 $27.23
Exercised........................................ (2,835) $18.09
Forfeited or expired............................. (254) $16.66
---------
Outstanding at November 30, 2006................. 9,181 $18.00 5.3 $66.7
=========
Exercisable at November 30, 2006................. 6,179 $17.15 3.6 $50.4
(B) Nonvested Stock and Nonvested Stock Units: Under the company's
stock-based incentive plans, shares of nonvested stock are granted in the
name of an employee or a non-employee director, who has all the rights of a
shareholder, including the right to receive dividends, subject to certain
restrictions and possible forfeitures. Restrictions on nonvested stock
generally expire one year to four years from the grant date, when the stock
typically becomes fully vested. Beginning June 2005, certain awards made to
employees who are named executive officers in the proxy statement for the
fiscal year end prior to the
Page 9 of 35
completion of the service condition also are subject to a market condition.
The market condition could extend the vesting period up to an additional
three years and could result in the awards being forfeited if the market
condition is not satisfied. The fair value of nonvested stock is the market
value on the grant date and is expensed over the vesting period.
A portion of the outstanding nonvested stock awards is
performance-accelerated shares that are eligible for accelerated vesting if
the company achieves earnings from continuing operations before income
taxes as a percentage of net sales targets in fiscal 2007, fiscal 2008 or
fiscal 2009. If vesting is not accelerated, the shares vest on July 1,
2009, except for awards that are subject to the market condition.
The company also issues nonvested stock units. Nonvested stock units are
granted in the name of an employee or a non-employee director. Once
granted, nonvested stock units are eligible for dividends but have no
voting rights. The nonvested stock units are redeemed for company stock
once the vesting period and any applicable deferral restrictions have been
satisfied. The fair value of nonvested stock units is the market value on
the grant date. Compensation cost is recognized over the vesting period,
which is generally one year to three years.
The weighted average fair value of nonvested stock granted, the weighted
average fair value of nonvested stock units granted and the fair value of
nonvested stock and nonvested stock units that vested are summarized in the
table below.
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions except per share data) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- ----------------------
Weighted average fair value of nonvested stock
granted (per share)..................................... $26.14 $17.13 $25.98 $16.96
Weighted average fair value of nonvested stock
units granted (per share)............................... $ - $ - $26.88 $16.62
Fair value of nonvested stock and nonvested
stock units that vested................................. $ 0.3 $ 0.6 $ 1.1 $ 2.8
Total unrecognized compensation cost related to nonvested stock and
nonvested stock units at November 30, 2006, was $50.4 million and is
expected to be recognized over a weighted average period of three years. If
nonvested stock or nonvested stock units are forfeited or cancelled, the
shares issued as nonvested stock or the shares reserved for the nonvested
stock units are available for future granting.
The company's nonvested stock and nonvested stock unit activity is
summarized in the table below.
Weighted Aggregate
Average Intrinsic
Shares Grant Date Value
(in thousands) Fair Value (in millions)
-----------------------------------------------------------------------------------------------------------
Nonvested at February 28, 2006.............. 3,825 $17.08
Granted..................................... 491 $25.44
Vested...................................... (10) $12.26
Forfeited................................... (231) $16.95
-------
Nonvested at May 31, 2006................... 4,075 $18.11
Granted..................................... 483 $26.57
Vested...................................... (64) $11.40
Forfeited................................... (76) $18.13
-------
Nonvested at August 31, 2006................ 4,418 $19.13
Granted..................................... 108 $26.14
Vested...................................... (16) $14.77
Forfeited................................... (360) $18.47
-------
Nonvested at November 30, 2006.............. 4,150 $19.39 $103.6
=======
Page 10 of 35
(C) Phantom Stock Program: The company issues phantom stock units through a
long-term incentive program. An employee does not receive rights of a
shareholder as a result of holding these units, nor is any stock
transferred. The value of one unit is based on the market value of one
share of common stock on the vesting date. The units will be paid out in
cash at the end of the two-year vesting period. The cost of the grants is
recognized over the vesting period, and the related liability is included
in accrued expenses and other current liabilities on the consolidated
balance sheets. At November 30, 2006, 0.2 million phantom stock units were
outstanding. No phantom stock units were granted during the three months
and nine months ended November 30, 2006. A total of 0.3 million units was
granted during the three months and nine months ended November 30, 2005.
(D) Employee Stock Purchase Plan: The company has an employee stock
purchase plan for all domestic segment employees meeting eligibility
criteria. Under the plan, eligible employees may, subject to limitations,
purchase shares of common stock. The company matches $0.15 for each $1.00
contributed by employees. Purchases are limited to 10 percent of an
employee's eligible compensation, up to a maximum of $13,000 per year. The
company has authorized 18.5 million shares of common stock for purchase
under the plan since the plan was adopted in 1984. At November 30, 2006, a
total of 1.5 million shares remained available under the plan. The
obligation for the company match is included in accrued expenses and other
current liabilities on the consolidated balance sheets.
The company's employee stock purchase plan activity is summarized in the
table below.
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions except per share data) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- ----------------------
Number of shares issued to or purchased on
the open market on behalf of employees.................. 0.1 0.1 0.2 0.3
Average price per share of common stock
purchased............................................... $25.85 $18.80 $26.77 $17.26
4. Comprehensive (Loss) Income
The components of the company's comprehensive (loss) income consist of the
net (loss) earnings and foreign currency translation adjustments. Foreign
currency translation adjustments are recorded net of deferred income taxes
directly as a component of stockholders' equity.
The components of comprehensive (loss) income, net of taxes, were as
follows:
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- ------------------------
Net (loss) earnings........................................ $(16.0) $10.1 $ 0.4 $(1.6)
Foreign currency translation............................... (8.7) 4.0 (1.9) 12.5
--------------------------- ------------------------
Comprehensive (loss) income................................ $(24.7) $14.2 $(1.5) $10.9
========================= ========================
Page 11 of 35
5. Net (Loss) Earnings Per Share
The following table presents a reconciliation of the denominators used in
the net (loss) earnings per share calculations.
Three Months Ended Nine Months Ended
November 30 November 30
(Shares in millions) 2006 2005 2006 2005
----------------------------------------------------------------------------------------- -----------------------
Weighted average common shares............................. 171.1 174.4 170.7 179.4
Dilutive potential common shares:
Options................................................ - 2.6 3.1 2.6
Nonvested stock and nonvested stock units.............. - 0.5 1.5 0.3
------------------------- -----------------------
Weighted average common shares and potentially
dilutive common equivalent shares...................... 171.1 177.5 175.3 182.3
========================= =======================
For the nine months ended November 30, 2006, and the three months and nine
months ended November 30, 2005, the computations of potentially dilutive
common equivalent shares excluded certain options to purchase shares of
common stock because the exercise prices were greater than the average
market price of the common shares and, therefore, the effect would be
anti-dilutive. Shares excluded were as follows:
Three Months Ended Nine Months Ended
November 30 November 30
(Shares in millions) 2005 2006 2005
----------------------------------------------------------------------------------------- -----------------------
Options to purchase common stock........................... 5.6 1.1 5.5
For the three months ended November 30, 2006, 9.2 million stock options and
4.2 million shares of nonvested stock and nonvested stock units were
excluded from the calculation of diluted net loss per share because the
company reported a net loss from continuing operations.
6. Accrued Lease Termination Costs
At a location's cease-use date, estimated lease termination costs to close
a store, distribution center or service center are recorded in selling,
general and administrative expenses on the consolidated statements of
operations. The calculation of accrued lease termination costs includes
future minimum lease payments, taxes, insurance and maintenance costs from
the date of closure to the end of the remaining lease term. The calculation
also includes estimated sublease income, net of tenant improvement
allowances and broker fees. The liability for lease termination costs is
discounted using a credit-adjusted risk-free rate of interest. The company
evaluates these assumptions each quarter and adjusts the liability
accordingly.
Page 12 of 35
The accrual for lease termination costs for the domestic segment includes
the following activity:
Nine Months Ended
November 30
(Amounts in millions) 2006 2005
--------------------------------------------------------------------------------------------------------------
Accrued lease termination costs at beginning of period...................... $110.0 $128.2
Provisions for closed locations............................................. 6.2 4.3
Changes in assumptions about future sublease income and
terminations............................................................ 4.9 5.2
Reversals of accruals for locations returned to operation(a)................ (12.9) -
Interest accretion.......................................................... 6.3 8.2
Cash payments, net of cash received on subleased locations.................. (25.8) (39.5)
-----------------------------
Accrued lease termination costs at end of period............................ 88.7 106.4
Less current portion of accrued lease termination costs..................... 30.0 41.5
-----------------------------
Non-current portion of accrued lease termination costs...................... $ 58.7 $ 64.9
=============================
(a)The company reversed $12.9 million of lease termination charges for
seven previously vacant locations that have re-opened or will re-open as
outlet stores.
The current portion of accrued lease termination costs is included in
accrued expenses and other current liabilities, and the non-current portion
is presented separately on the consolidated balance sheets.
7. Common Stock Repurchased
In June 2006, the company's board of directors authorized a $400 million
increase in its stock repurchase authorization for an aggregate
authorization of $1.2 billion, of which $380.4 million remained available
at November 30, 2006. As of November 30, 2006, the company had repurchased
52.9 million shares of common stock at a cost of $819.6 million, excluding
commission fees, cumulatively since inception of the stock repurchase
program.
The company's stock repurchase activity for the three months and nine
months ended November 30, 2006, was as follows:
Three Months Ended Nine Months Ended
(Amounts in millions) November 30, 2006 November 30, 2006
-------------------------------------------------------------------------------------------------------------------
Total number of shares repurchased........................... 0.7 5.0
Cost, excluding commission fees.............................. $19.9 $136.9
8. Pension Plans
The company's domestic segment has a noncontributory defined benefit
pension plan that was frozen as of February 28, 2005, except for employees
who (i) were within three years of their early retirement date or normal
retirement date; (ii) had reached their early or normal retirement date; or
(iii) were permanently disabled before March 1, 2005. As a result, all
employees affected by the plan freeze retain any benefits accumulated to
the effective date, but are no longer eligible to increase their benefit.
The company also has an unfunded nonqualified benefit restoration plan that
restored retirement benefits for domestic segment senior executives who
were affected by Internal Revenue Code limitations on benefits provided
under the company's pension plan. The benefit restoration plan was frozen
as of February 28, 2005, and will provide benefits for participants who, as
of that date, were within 10 years of attaining their early retirement date
or normal retirement date.
On December 22, 2005, the benefit restoration plan was amended to allow W.
Alan McCollough to elect to receive a lump-sum payment following his
retirement. Mr. McCollough received additional age and service credit under
the benefit restoration plan, which is expected to result in Mr. McCollough
receiving the maximum benefit payable under the plan.
Page 13 of 35
The components of the net pension expense (income) for the plans were as
follows:
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in thousands) 2006 2005 2006 2005
----------------------------------------------------------------------------------- --------------------------
Service cost........................................... $ 675 $ 703 $ 2,110 $ 2,332
Interest cost......................................... 3,820 3,455 11,403 10,367
Expected return on plan assets........................ (4,775) (4,507) (14,332) (13,522)
Recognized prior service cost......................... 54 54 162 161
Recognized actuarial loss............................. 609 265 1,827 794
Loss due to settlement................................ - - 254 -
-------------------- --------------------------
Net pension expense (income).......................... $ 383 $ (30) $ 1,424 $ 132
====================== ==========================
The company did not make a contribution to the defined benefit pension plan
during the nine months ended November 30, 2006. No contributions are
required during fiscal 2007 under applicable law to meet ERISA minimum
funding standards. However, the company may make voluntary contributions to
the defined benefit pension plan to ensure that the fair value of plan
assets at February 28, 2007, exceeds the accumulated benefit obligation.
The company does not expect to make a contribution in fiscal 2007.
A contribution of $5.1 million, which is equal to the expected benefit
payments for fiscal 2007, is expected to be made to the restoration plan
during fiscal 2007. The expected benefit payments for fiscal 2007 include a
lump-sum payment to Mr. McCollough of $4.4 million, which is expected to be
paid during the fourth quarter. The impact of this lump sum payment is
reflected as a loss due to settlement in the preceding table. Benefit
payments during the nine months ended November 30, 2006, were $0.5 million.
9. Discontinued Operations
For the quarter ended November 30, 2006, the net loss from discontinued
operations totaled $0.4 million, which is net of $0.2 million of income
taxes, and related to a domestic segment operation that is held for sale.
For the nine months ended November 30, 2006, the net loss from discontinued
operations totaled $2.1 million, which is net of $0.9 million of income
taxes, and related to a domestic segment operation that is held for sale.
For the first nine months of fiscal 2007, this $0.9 million of income tax
benefit was offset by $0.6 million of income tax expense resulting from a
revision of management's estimate regarding certain tax uncertainties
associated with the discontinued bankcard operations.
For the quarter ended November 30, 2005, the net loss from discontinued
operations related to a domestic segment operation that is held for sale
and a domestic segment subsidiary, MusicNow, LLC, which was sold in October
2005. For the nine months ended November 30, 2005, the net loss from
discontinued operations totaled $3.8 million, which is net of $2.1 million
of income taxes, and related to a domestic segment operation that is held
for sale and MusicNow.
10. Segment Information
The company has two reportable segments: its domestic segment and its
international segment. The company identified these segments based on its
management reporting structure and the nature of the products and services
offered by each segment. The domestic segment is primarily engaged in the
business of selling brand-name consumer electronics, personal computers,
entertainment software, and related services in the United States. The
international segment is primarily engaged in the business of selling
private-label and brand-name consumer electronics products in Canada.
Page 14 of 35
Net sales by reportable segment were as follows:
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions) 2006 2005 2006 2005
---------------------------------------------------------------------------------------- --------------------------
Domestic segment.......................................... $2,930.7 $2,730.8 $8,096.9 $7,259.5
International segment..................................... 171.6 170.6 461.6 426.9
--------------------------- -------------------------
Net sales................................................. $3,102.3 $2,901.4 $8,558.5 $7,686.3
=========================== =========================
Net (loss) earnings from continuing operations by reportable segment were
as follows:
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in millions) 2006 2005 2006 2005
---------------------------------------------------------------------------------------- -------------------------
Domestic segment.......................................... $(15.4) $13.1 $4.4 $11.6
International segment..................................... (0.3) (3.0) (3.7) (9.5)
--------------------------- -------------------------
Net (loss) earnings from continuing operations............ $(15.6) $10.2 $0.8 $ 2.1
=========================== =========================
Total assets by reportable segment were as follows:
At November 30 At February 28
(Amounts in millions) 2006 2006
--------------------------------------------------------------------------------------------------
Domestic segment......................................... $4,742.0 $3,594.4
International segment.................................... 527.3 474.6
-------------------------------------
Total assets............................................. $5,269.3 $4,069.0
=====================================
11. Supplemental Consolidated Statements of Cash Flows Information
The following table summarizes supplemental cash flow information.
Nine Months Ended
November 30
(Amounts in millions) 2006 2005
--------------------------------------------------------------------------------------------------------------
Supplemental schedule of non-cash investing and financing activities:
Change in capital expenditure accrual..................................... $25.2 $23.1
Capital lease obligation.................................................. $ - $17.5
Acquisition(a):
Fair value of assets acquired............................................. $ - $13.6
Less: liabilities assumed................................................. - 0.3
----- -----
Acquisition............................................................... $ - $13.3
===== =====
(a)The acquisition is reflected in investing cash flows for discontinued
operations on the consolidated statement of cash flows.
12. Recent Accounting Pronouncements
As discussed in Note 3, Stock-Based Compensation, the company adopted SFAS
No. 123(R) during the first quarter of fiscal 2007.
In October 2005, the Financial Accounting Standards Board issued FASB Staff
Position (FSP) No. FAS 13-1, "Accounting for Rental Costs Incurred During a
Construction Period." FSP No. FAS 13-1 requires companies to expense rent
payments for building or ground leases incurred during a construction
period. The company adopted FSP No. FAS 13-1 on a prospective basis in the
first quarter of fiscal 2007. The
Page 15 of 35
adoption of this new standard did not have a material impact on the
company's financial position, results of operations or cash flows.
In June 2006, the FASB issued Interpretation ("FIN") No. 48, "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
109." FIN No. 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. This Interpretation
also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. The
provisions of FIN No. 48 are effective for the company beginning with the
first quarter of fiscal 2008. The company has not yet determined the impact
of adopting this standard.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements."
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value and requires additional disclosures about fair value measurements.
The provisions of SFAS No. 157 are effective for the company beginning with
the first quarter of fiscal 2009. The company has not yet determined the
impact of adopting this standard.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of
FASB Statements No. 87, 88, 106, and 132(R)." SFAS No. 158 requires an
employer to recognize a plan's overfunded or underfunded status in its
balance sheets and recognize the changes in a plan's funded status in
comprehensive income in the year in which the changes occur. These
provisions of SFAS No. 158 are effective for the company's fiscal year
ending February 28, 2007. The company has not yet determined the impact of
adopting these provisions. In addition, SFAS No. 158 requires an employer
to measure plan assets and obligations that determine its funded status as
of the end of its fiscal year, with limited exceptions. This provision of
SFAS No. 158 is effective for the company's fiscal year ending February 28,
2009. The company is currently in compliance with this provision.
In September 2006, the Securities and Exchange Commission staff released
Staff Accounting Bulletin (SAB) No. 108, "Considering the Effects of Prior
Year Misstatements When Quantifying Misstatements in Current Year Financial
Statements." In SAB 108, the SEC staff established an approach that
requires quantification of financial statement misstatements using both the
roll-over and the iron curtain methods. This model is commonly referred to
as a "dual approach" because it requires quantification of errors under
both methods. The provisions of SAB 108 are effective for the company's
fiscal year ending February 28, 2007. The company has not yet determined
the impact of adopting this standard.
13. Litigation
As previously reported in the company's Annual Report on Form 10-K for the
year ended February 28, 2006, the company was involved in litigation with
RadioShack Corporation ("RadioShack") related to various agreements between
InterTAN and RadioShack and its subsidiaries. In September 2006, RadioShack
and Circuit City reached an agreement that settles the litigation between
the two companies.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 primarily engaged in the business of selling brand-name
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 November 30, 2006, the domestic
segment operated 640 Superstores and 11 other stores in 158 U.S. media markets.
Page 16 of 35
Our international segment, which is comprised of the operations of InterTAN,
Inc., is primarily engaged in the business of selling private-label and
brand-name consumer electronics in Canada. The international segment's
headquarters are located in Barrie, Ontario, Canada, and it operates through
retail stores and dealer outlets in Canada primarily under the trade names The
Source By Circuit CitySM, Rogers Plus(R) and Battery Plus(R). At November 30,
2006, the international segment conducted business through 955 retail stores and
dealer outlets, which consisted of 547 company-owned stores, 300 dealer outlets,
92 Rogers Plus(R) stores and 16 Battery Plus(R) stores. The international
segment also operates a Web site at www.thesource.ca.
In accordance with the Amending Agreement dated March 27, 2004, between Rogers
Wireless Inc. ("Rogers") and InterTAN Canada Ltd., Rogers has notified InterTAN
that they do not intend to continue the existing arrangement with respect to
InterTAN's operation of the Rogers Plus(R) stores after January 28, 2007. Exit
costs related to the transition are expected to be inconsequential. We expect to
classify the results of operations attributable to Rogers Plus(R) stores as
results from discontinued operations in the fourth quarter of fiscal 2007.
Management'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:
o Executive Summary
o Critical Accounting Policies
o Results of Operations
o Recent Accounting Pronouncements
o Financial Condition
o Updated Fiscal 2007 Outlook
o Fiscal 2008 and Beyond Outlook
o Forward-Looking Statements
This discussion should be read in conjunction with our consolidated financial
statements and notes to the financial statements included in this report, the
Annual Report on Form 10-K for the fiscal year ended February 28, 2006, as well
as our reports on Form 8-K and other SEC filings.
EXECUTIVE SUMMARY
Fiscal 2007 Third Quarter Performance
o Net sales grew 6.9 percent, driven by a comparable store sales gain of 5.1
percent on top of a comparable store sales gain of 13.1 percent in the same
period last year.
o In the domestic segment, Web-originated sales grew 67 percent, call center
sales grew 84 percent and services revenues grew 72 percent over the same
period last year.
o Gross profit margin declined 192 basis points compared with the same period
last year due to a decline in merchandise margin for televisions, PC
hardware, and entertainment software, as well as a decrease in extended
warranty net sales as a percentage of domestic segment net sales.
o SG&A expenses as a percentage of net sales, which included approximately
120 basis points in net incremental expenses related to investments in
information technology, multi-channel capabilities and innovation
activities, declined 43 basis points from the same period last year.
o The loss from continuing operations before income taxes was 0.9 percent of
sales compared with earnings from continuing operations before income taxes
of 0.6 percent of sales in the same period last year.
o We reported a net loss from continuing operations of 9 cents per diluted
share compared with net earnings of 6 cents per diluted share in the same
period last year.
Page 17 of 35
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies under Management's Discussion
and Analysis of Financial Condition and Results of Operations in our fiscal 2006
Annual Report on Form 10-K. These policies relate to accounting for cash
consideration received from vendors, the calculation of the liability for lease
termination costs, accounting for goodwill and other identified intangible
assets, accounting for pension plans and accounting for income taxes. We have
updated the discussion of our critical accounting policy for Stock-Based
Compensation due to our adoption of Statement of Financial Accounting Standards
No. 123(R), "Share-Based Payment," (SFAS No. 123(R)).
Accounting for Stock-Based Compensation
We account for stock-based compensation using a fair value-based method in
accordance with SFAS No. 123(R). The Black-Scholes option valuation model is
used to determine the fair value of stock options at the grant date, and expense
is recognized over the period in which the options vest. Option valuation models
require us to make subjective assumptions, including the expected future
volatility of the stock price, expected dividend yield, and expected term of the
option. Changes in the subjective assumptions can materially affect the fair
value estimate. We estimate the number of equity awards granted that are
expected to be forfeited, recognize compensation cost based on the number of
awards that are expected to vest, and subsequently adjust the estimated
forfeitures to reflect actual forfeitures.
RESULTS OF OPERATIONS
Our operations, in common 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 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.
Reclassifications and Adjustments
We have made revisions and reclassifications to our fiscal 2006 consolidated
statement of operations as disclosed in Note 1, Basis of Presentation, of the
Notes to the Consolidated Financial Statements, included in Item 8, Financial
Statements and Supplementary Data, of our fiscal 2006 Annual Report on Form
10-K. Such revisions and reclassifications include the following:
o Amounts previously reported as rent expense related to financing lease
obligations have been reclassified to interest expense.
o Interest income has been reclassified from selling, general and
administrative expenses to a separate line item on the consolidated
statement of operations.
o The results of a domestic segment operation that is held for sale and a
domestic segment subsidiary, MusicNow, LLC, have been presented as results
from discontinued operations.
During the first quarter of fiscal 2007, we reclassified fiscal 2006 stock-based
compensation expense from a separate line item on the consolidated statement of
operations to selling, general and administrative expenses.
Page 18 of 35
Summary of Segment Performance
Where relevant, we have included separate discussions of our domestic and
international segments. The following tables summarize performance by segment.
SEGMENT PERFORMANCE SUMMARY
Three Months Ended Nine Months Ended
November 30, 2006 November 30, 2006
(Amounts in millions) Domestic International Consolidated Domestic International Consolidated
---------------------------------------------------------------------------------- ------------------------------------------
Net sales........................... $2,930.7 $171.6 $3,102.3 $8,096.9 $461.6 $8,558.5
Gross profit........................ $ 632.4 $ 56.4 $ 688.8 $1,846.9 $158.1 $2,005.0
Selling, general and
administrative expenses......... $ 664.7 $ 56.2 $ 720.9 $1,860.7 $162.4 $2,023.1
Net (loss) earnings from
continuing operations........... $ (15.4) $ (0.3) $ (15.6) $ 4.4 $ (3.7) $ 0.8
Three Months Ended Nine Months Ended
November 30, 2005 November 30, 2005
(Amounts in millions) Domestic International Consolidated Domestic International Consolidated
---------------------------------------------------------------------------------- ------------------------------------------
Net sales........................... $2,730.8 $170.6 $2,901.4 $7,259.5 $426.9 $7,686.3
Gross profit........................ $ 641.1 $ 58.9 $ 700.0 $1,711.8 $155.8 $1,867.5
Selling, general and
administrative expenses......... $ 623.9 $ 62.8 $ 686.7 $1,707.5 $170.3 $1,877.8
Net earnings (loss) from
continuing operations........... $ 13.1 $ (3.0) $ 10.2 $ 11.6 $ (9.5) $ 2.1
Net Sales
Consolidated
For the third quarter of fiscal 2007, our net sales increased 6.9 percent to
$3.10 billion, and comparable store sales increased 5.1 percent from the same
period last year. Net sales for the first nine months of fiscal 2007 increased
11.3 percent to $8.56 billion from $7.69 billion for the first nine months of
last fiscal year. Comparable store sales increased 8.9 percent for the first
nine months of fiscal 2007. A store's sales are included in comparable store
sales after the store has been open for a full 12 months. Comparable store sales
include Web-originated sales and sales from relocated stores. The calculation of
comparable store sales excludes the impact of fluctuations in foreign currency
exchange rates.
Domestic Segment
For the third quarter of fiscal 2007, the domestic segment's net sales were
$2.93 billion, an increase of 7.3 percent over the same period last fiscal year.
Comparable store sales increased 5.5 percent. For the quarter, our sales growth
was driven by the addition of 15 net new Superstores over the past four
quarters. In addition, domestic segment Web-originated sales grew 67 percent,
domestic segment services revenues grew 72 percent and domestic segment call
center sales grew 84 percent over the same period last year. Services revenues
are comprised of home theater installations and computer-related services.
For the nine months ended November 30, 2006, domestic segment sales were $8.10
billion, an increase of 11.5 percent over the same period last fiscal year.
Comparable store sales increased 9.5 percent.
The domestic segment's major product categories are
o video, which includes televisions, imaging products, DVD hardware,
camcorders, digital cameras, digital video services, furniture, and related
accessories;
Page 19 of 35
o information technology, which includes personal computer hardware, personal
computer services, telecommunications products and services, and related
accessories;
o audio, which includes home audio products, mobile audio products, portable
audio products, and related accessories; and
o entertainment, which includes movie software, music software, game
software, game hardware and personal computer software.
The percent of domestic segment sales represented by each major product category
for the periods ended November 30, 2006 and 2005, is shown below.
PERCENT OF DOMESTIC SEGMENT SALES BY CATEGORY(a)
Three Months Ended Nine Months Ended
November 30 November 30
2006 2005 2006 2005
-------------------------------------------------------------------------------------- -----------------------
Video..................................................... 47% 46% 45% 43%
Information technology.................................... 27 28 29 30
Audio..................................................... 15 15 15 16
Entertainment............................................. 11 11 11 11
---------------------- -----------------------
Total..................................................... 100% 100% 100% 100%
====================== ======================
(a)Excludes extended warranty net sales and installation revenue
In the video category, we produced a high-single-digit comparable store sales
increase in the third quarter. Total television comparable store sales increased
by double digits, led by double-digit comparable store sales growth in flat
panel televisions. Comparable store sales of digital imaging products and
accessories also increased by double digits. Growth in the category was
partially offset by a single-digit decline in comparable store sales of
camcorders and a double-digit decline in DVD hardware.
In the information technology category, we produced comparable store sales that
were approximately flat compared to the prior year. Comparable store sales in PC
hardware declined by low-single digits as a high-single-digit increase in
notebook computers was more than offset by a double-digit decline in desktop
computers.
In the audio category, we produced comparable store sales that were
approximately flat compared to the prior year. A triple-digit comparable store
sales increase in navigation products was offset by a high-single-digit decline
in home audio products and a double-digit decline in satellite radio products.
Comparable store sales of portable digital audio products were approximately
flat to last year while portable digital audio accessories grew by high-single
digits.
In the entertainment category, we produced a high-single-digit comparable store
sales increase in the third quarter, reflecting a strong-double-digit comparable
store sales increase in video gaming products and a double-digit comparable
store sales increase in PC software. Comparable store sales of video software
declined by mid-single digits and comparable store sales in music software
declined by double digits.
The following table provides the number of our domestic segment stores:
DOMESTIC SEGMENT STORE MIX
Nov. 30, 2006 Feb. 28, 2006 Nov. 30, 2005
----------------------------------------------------------------------------------------------------------------
Superstores....................................... 640 626 625
Outlet and mall stores............................ 11 5 6
----------------------------------------------------------
Total domestic segment stores..................... 651 631 631
==========================================================
Page 20 of 35
In the first nine months of fiscal 2007, we relocated six Superstores and opened
thirteen new Superstores. One of the relocated Superstores replaced a store that
was closed in February 2006. We opened seven outlet stores, opened one test
store and closed two mall stores. We also completed two remodels, one of which
consisted of rebuilding a storm-damaged store.
Extended Warranty Net Sales. The domestic segment sells extended warranty
programs on behalf of unrelated third parties who are the primary obligors. The
extended warranty net sales were $103.3 million, or 3.5 percent of domestic
segment net sales, in the third quarter of fiscal 2007, compared with $104.7
million, or 3.8 percent of domestic segment net sales, in the same period last
fiscal year. The extended warranty net sales were $303.3 million for the first
nine months of fiscal 2007, or 3.7 percent of domestic segment net sales,
compared with $287.1 million, or 4.0 percent of domestic segment net sales, for
the first nine months of last fiscal year. Effective fiscal year 2008, we will
no longer report extended warranty net sales separately from consolidated net
sales. Management views warranty revenue as one component of many that
contribute to both sales and gross margin, reflecting our expanded ability to
provide high value services in a growing number of ways. We will continue
reporting domestic segment extended warranty net sales for the balance of fiscal
year 2007.
International Segment
The international segment's net sales increased 0.6 percent to $171.6 million
for the third quarter of fiscal 2007, compared with $170.6 million for the third
quarter of last fiscal year. The increase was driven by the effect of
fluctuations in foreign currency exchange rates, which accounted for
approximately 4 percentage points of the international segment's third quarter
net sales increase. Sales from our dealer relationships had a single-digit
percentage increase for the third quarter in local currency, and the
international segment added 5 net new retail stores during the past four
quarters. Comparable store sales decreased 3.7 percent for the quarter in local
currency.
For the nine months ended November 30, 2006, the international segment's net
sales increased 8.1 percent to $461.6 million, compared with $426.9 million for
the nine months ended November 30, 2005. The increase was driven primarily by
the effect of fluctuations in foreign currency exchange rates, which accounted
for approximately 7 percentage points of the international segment's
year-over-year net sales increase. Comparable store sales decreased 1.4 percent
in local currency for the first nine months of fiscal 2007.
INTERNATIONAL SEGMENT STORE MIX
Nov. 30, 2006 Feb. 28, 2006 Nov. 30, 2005
----------------------------------------------------------------------------------------------------------------
Company-owned stores.............................. 547 540 533
Dealer outlets.................................... 300 300 304
Rogers Plus(R) stores............................... 92 93 93
Battery Plus(R) stores.............................. 16 21 24
---------------------------------------------------------
Total international segment stores................ 955 954 954
=========================================================
Gross Profit Margin
Consolidated
The gross profit margin was 22.2 percent of net sales in the third quarter of
fiscal 2007, compared with 24.1 percent for the same period last fiscal year.
For the first nine months of fiscal 2007, the gross profit margin was 23.4
percent of net sales, compared with 24.3 percent for the same period last fiscal
year.
Domestic Segment
For the third quarter of fiscal 2007, the domestic segment's gross profit margin
declined 190 basis points from the prior year, driven by a decline in
merchandise margin primarily in televisions, PC hardware, and
Page 21 of 35
entertainment software, as well as a decrease in extended warranty net sales as
a percentage of domestic segment net sales.
For the first nine months of fiscal 2007, the domestic segment's gross profit
margin was 22.8 percent of net sales, compared with 23.6 percent for the same
period last fiscal year. The margin rate decline resulted primarily from a
decline in merchandise margin for PC hardware, advanced televisions, and
entertainment software, as well as a decrease in extended warranty net sales as
a percentage of domestic segment net sales.
International Segment
For the third quarter of fiscal 2007, the international segment gross profit
margin rate decline of 165 basis points did not materially impact the
consolidated gross profit margin rate. The decrease resulted primarily from
margin rate declines within digital products, such as name-brand computer
hardware and portable digital audio players, as well as a sales mix shift to a
higher level of sales of these products. Also contributing to the gross profit
margin rate decline were clearance activities related to assortment
rationalization.
For the first nine months of fiscal 2007, the international segment's gross
profit margin was 34.3 percent of net sales, compared with 36.5 percent for the
same period last fiscal year. The decrease resulted primarily from margin rate
declines within the personal electronics, computer hardware, video and gadgets
categories. Also, a sales mix shift from higher-margin categories, such as
batteries, to lower-margin high-growth categories contributed to the decline.
Selling, General and Administrative Expenses
Consolidated
Three Months Ended November 30 Nine Months Ended November 30
2006 2005 2006 2005
% of % of % of % of
(Dollar amounts in millions) $ Sales $ Sales $ Sales $ Sales
------------------------------------------------------------------------------------ ---------------------------------------------
Store expenses.......................... $637.7 20.6% $583.8 20.1% $1,743.2 20.4% $ 1,604.2 20.9%
General and administrative
expenses........................... 79.8 2.6 86.6 3.0 253.6 3.0 242.9 3.2
Stock-based compensation
expense.......................... 5.4 0.2 9.3 0.3 20.7 0.2 19.1 0.2
Remodel expenses........................ 0.1 - - - 0.6 - - -
Relocation expenses(a).................. (7.0) (0.2) 2.6 0.1 (4.9) (0.1) 4.9 0.1
Pre-opening expenses.................... 4.9 0.2 4.3 0.2 9.9 0.1 6.7 0.1
------------------------------------------ ---------------------------------------------
Total ................................. $720.9 23.2% $686.7 23.7% $2,023.1 23.6% $1,877.8 24.4%
========================================= ============================================
(a) Results for the three months ended November 30, 2006, include a benefit from
the reversal of lease termination charges for seven previously vacant stores
that have re-opened or will re-open as outlet stores, partially offset by
expenses associated with completing four relocations during the quarter.
Selling, general and administrative expenses as a percentage of net sales
declined 43 basis points to 23.2 percent of net sales in the third quarter of
this fiscal year. The domestic segment's expense-to-sales ratio decreased 17
basis points from the same period last year. The international segment
contributed 26 basis points to the decrease in the consolidated expense-to-sales
ratio.
For the first nine months of fiscal 2007, selling, general and administrative
expenses as a percentage of net sales declined 79 basis points from the same
period last fiscal year. The domestic segment's expense-to-sales ratio decreased
54 basis points from the same period last year. The international segment
contributed 25 basis points to the decrease in the consolidated expense-to-sales
ratio.
Page 22 of 35
Domestic Segment
Three Months Ended November 30 Nine Months Ended November 30
2006 2005 2006 2005
% of % of % of % of
(Dollar amounts in millions) $ Sales $ Sales $ Sales $ Sales
------------------------------------------------------------------------------------ ---------------------------------------------
Store expenses.......................... $592.2 20.2% $539.5 19.8% $1,613.3 19.9% $ 1,489.4 20.5%
General and administrative
expenses........................... 69.4 2.4 68.5 2.5 222.7 2.8 188.1 2.6
Stock-based compensation
expense.......................... 5.1 0.2 9.0 0.3 19.1 0.2 18.5 0.3
Remodel expenses........................ 0.1 - - - 0.6 - - -
Relocation expenses(a).................. (7.0) (0.2) 2.6 0.1 (4.9) (0.1) 4.9 0.1
Pre-opening expenses.................... 4.9 0.2 4.3 0.2 9.9 0.1 6.7 0.1
------------------------------------------ ---------------------------------------------
Total ................................. $664.7 22.7% $623.9 22.8% $1,860.7 23.0% $1,707.5 23.5%
========================================= ============================================
(a) Results for the three months ended November 30, 2006, include a benefit from
the reversal of lease termination charges for seven previously vacant stores
that have re-opened or will re-open as outlet stores, partially offset by
expenses associated with completing four relocations during the quarter.
For the three months ended November 30, 2006, the domestic segment's improvement
primarily reflects a decrease in advertising expenses and leverage of payroll
expenses. We also recorded a net benefit of $7.0 million in relocation expenses.
This net benefit resulted from the reversal of lease termination charges of
$12.9 million for seven previously vacant locations that have re-opened or will
re-open as outlet stores, partially offset by expenses associated with
completing four relocations during the quarter. These improvements were
partially offset by net incremental expenses, primarily related to investments
in information technology, multi-channel capabilities and innovation activities
that amounted to approximately 120 basis points as a percentage of consolidated
net sales. During the third quarter of fiscal 2006, we recorded our portion of
the Visa/MasterCard antitrust litigation settlement. The $9.4 million gain was
reflected as a reduction to domestic segment store expenses.
For the nine months ended November 30, 2006, the domestic segment's improvement
primarily reflects leverage of payroll; rent and occupancy; and advertising
expenses. These improvements were partially offset by incremental store expenses
related to multi-channel capabilities and innovation activities as well as by
general and administrative expenses related to information systems and
innovation activities.
International Segment
Three Months Ended November 30 Nine Months Ended November 30
2006 2005 2006 2005
% of % of % of % of
(Dollar amounts in millions) $ Sales $ Sales $ Sales $ Sales
------------------------------------------------------------------------------------ ---------------------------------------------
Store expenses.......................... $45.5 26.5% $44.3 26.0% $ 129.9 28.1% $114.8 26.9%
General and administrative
expenses........................... 10.4 6.1 18.1 10.6 31.0 6.7 54.8 12.8
Stock-based compensation
expense.......................... 0.3 0.2 0.3 0.2 1.6 0.3 0.7 0.2
------------------------------------------ ---------------------------------------------
Total ................................. $56.2 32.8% $62.8 36.8% $162.4 35.2% $170.3 39.9%
========================================= ============================================
For the third quarter of fiscal 2007, the international segment's
expense-to-sales ratio decreased 403 basis points from the same period last
year. The international segment's general and administrative expenses in the
third quarter of fiscal 2006 included expenses of $8.3 million associated with
the brand transition in Canada.
For the nine months ended November 30, 2006, the international segment's
expense-to-sales ratio decreased 471 basis points from the same period last
fiscal year. The international segment's general and administrative expenses in
the first nine months of fiscal 2006 included expenses of $29.8 million
associated with the brand transition in Canada.
Page 23 of 35
Income Tax Provision
The income tax benefit recognized for the nine months ended November 30, 2006,
was $1.6 million on a loss from continuing operations before income taxes of
$0.8 million for an effective rate of 192 percent. This rate is a result of the
impact of discrete items and the return-to-provision impact associated with the
filing of the February 28, 2006, tax returns. The effective income tax rate
applicable to results from continuing operations was 34.5 percent for the nine
months ended November 30, 2005.
Net (Loss) Earnings from Continuing Operations
The net loss from continuing operations was $15.6 million, or 9 cents per share,
in the three months ended November 30, 2006, compared with net earnings from
continuing operations of $10.2 million, or 6 cents per share, in the same period
last fiscal year.
For the nine months ended November 30, 2006, the net earnings from continuing
operations were $0.8 million, or zero cents per share, compared with net
earnings from continuing operations of $2.1 million, or 1 cent per share, for
the same period last fiscal year.
Net Loss from Discontinued Operations
For the quarter ended November 30, 2006, the net loss from discontinued
operations totaled $0.4 million, which is net of $0.2 million of income taxes,
and related to a domestic segment operation that is held for sale. For the nine
months ended November 30, 2006, the net loss from discontinued operations
totaled $2.1 million, which is net of $0.9 million of income taxes, and related
to a domestic segment operation that is held for sale. For the first nine months
of fiscal 2007, this $0.9 million of income tax benefit was offset by $0.6
million of income tax expense resulting from a revision of management's estimate
regarding certain tax uncertainties associated with our discontinued bankcard
operations.
For the quarter ended November 30, 2005, the net loss from discontinued
operations related to a domestic segment operation that is held for sale and a
domestic segment subsidiary, MusicNow, LLC, which was sold in October 2005. For
the nine months ended November 30, 2005, the net loss from discontinued
operations totaled $3.8 million, which is net of $2.1 million of income taxes,
and related to a domestic segment operation that is held for sale and MusicNow.
Cumulative Effect of Change in Accounting Principle
In the first quarter of fiscal 2007, we adopted SFAS No. 123(R) using the
modified prospective transition method, resulting in a non-cash after-tax
benefit of $1.8 million.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective March 1, 2006, we adopted SFAS No. 123(R), which requires companies to
record compensation expense based on the fair value of employee stock-based
compensation awards. The statement also requires that the compensation expense
be recognized over the period during which the employee is required to provide
service in exchange for the award. Prior to the adoption of SFAS No. 123(R), we
accounted for stock-based compensation using a fair-value based method in
accordance with SFAS No. 123, "Stock-Based Compensation." We adopted SFAS No.
123(R) using the modified prospective transition method. The adoption of SFAS
No. 123(R) did not have a material impact on our financial position, results of
operations or cash flows.
In October 2005, the Financial Accounting Standards Board issued FASB Staff
Position (FSP) No. FAS 13-1, "Accounting for Rental Costs Incurred During a
Construction Period." FSP No. FAS 13-1 requires companies to expense rent
payments for building or ground leases incurred during a construction period. We
adopted FSP No. FAS 13-1 on a prospective basis in the first quarter of fiscal
2007. The adoption of this new standard did not have a material impact on our
financial position, results of operations or cash flows.
Page 24 of 35
In June 2006, the FASB issued Interpretation ("FIN") No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109." FIN
No. 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. This Interpretation also provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The provisions of FIN No. 48 are effective
for us beginning with the first quarter of fiscal 2008. We have not yet
determined the impact of adopting this standard.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS
No. 157 defines fair value, establishes a framework for measuring fair value and
requires additional disclosures about fair value measurements. The provisions of
SFAS No. 157 are effective for us beginning with the first quarter of fiscal
2009. We have not yet determined the impact of adopting this standard.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." SFAS No. 158 requires an employer to
recognize a plan's overfunded or underfunded status in its balance sheets and
recognize the changes in a plan's funded status in comprehensive income in the
year in which the changes occur. These provisions of SFAS No. 158 are effective
for our fiscal year ending February 28, 2007. We have not yet determined the
impact of adopting these provisions. In addition, SFAS No. 158 requires an
employer to measure plan assets and obligations that determine its funded status
as of the end of its fiscal year, with limited exceptions. This provision of
SFAS No. 158 is effective for our fiscal year ending February 28, 2009. We are
currently in compliance with this provision.
In September 2006, the Securities and Exchange Commission staff released Staff
Accounting Bulletin (SAB) No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements." In SAB 108, the SEC staff established an approach that requires
quantification of financial statement misstatements using both the roll-over and
iron curtain methods. This model is commonly referred to as a "dual approach"
because it requires quantification of errors under both methods. The provisions
of SAB 108 are effective for our fiscal year ending February 28, 2007. We have
not yet determined the impact of adopting this standard.
FINANCIAL CONDITION
Liquidity and Capital Resources
Cash Flows
Restatement of Cash Flows
As disclosed in Note 22, Quarterly Financial Data (Unaudited), of the Notes to
Consolidated Financial Statements, included in Item 8, Financial Statements and
Supplementary Data, of our fiscal 2006 Annual Report on Form 10-K, we identified
errors in our previously filed consolidated statement of cash flows for the nine
months ended November 30, 2005, and restated the consolidated statement of cash
flows for the nine months ended November 30, 2005. We had classified variable
rate demand notes as cash and cash equivalents; however, these notes should have
been classified as short-term investments and their purchases and sales as
investing activities. We incorrectly reflected bank overdrafts as a change in
accounts payable in operating activities rather than in financing activities. We
incorrectly included accruals for purchases of property and equipment in
operating activities and investing activities. We incorrectly reflected deposits
in transit as a reduction to accounts payable.
Page 25 of 35
Cash Flows Summary
The following table summarizes our cash flows for the nine months ended November
30, 2006 and 2005:
Nine Months Ended
November 30
(Amounts in millions) 2006 2005
----------------------------------------------------------------------------------------
Net cash provided by (used in):
Operating activities.................................... $ 219.3 $ (88.4)
Investing activities.................................... (138.0) (147.0)
Financing activities.................................... 52.8 (206.5)
Discontinued operations................................. (3.2) (19.6)
Effect of exchange rate changes on cash................... (0.3) (0.3)
----------------------------
Increase (decrease) in cash and
cash equivalents........................................ $ 130.7 $ (461.9)
============================
Operating Activities
For the nine months ended November 30, 2006, net cash provided by operating
activities was $219.3 million, compared with net cash used in operating
activities of $88.4 million in the nine months ended November 30, 2005. The
change was due primarily to a lower seasonal inventory build during the nine
months ended November 30, 2006, compared with the nine months ended November 30,
2005. The lower inventory build was driven by improved supply chain and
inventory management execution, including a reduction in slower-moving and
at-risk inventories. During the nine months ended November 30, 2006, the
decrease in merchandise inventory, net of merchandise payable, was $189.1
million. During the nine months ended November 30, 2005, merchandise inventory,
net of merchandise payable, increased $201.7 million. The cash provided by the
reduction in inventory build was partially offset by an increase in accounts
receivable, driven by an increase in vendor receivables.
Investing Activities
We used net cash from investing activities of $138.0 million in the nine months
ended November 30, 2006, compared with $147.0 million in the nine months ended
November 30, 2005. The change was due primarily to an increase in the proceeds
from sales and maturities of investment securities, partially offset by a
decrease in proceeds from sales of property and equipment and an increase in
capital expenditures as we make investments in new Superstores.
Financing Activities
For the nine months ended November 30, 2006, net cash provided by financing
activities was $52.8 million, compared with net cash used in financing
activities of $206.5 million in the nine months ended November 30, 2005. The
change was due primarily to a decrease in cash used to repurchase common stock
under the stock repurchase authorization, coupled with an increase in cash
provided by the issuance of common stock. In June 2006, the board authorized a
$400 million increase in the stock repurchase authorization resulting in a total
stock repurchase authorization of up to $1.2 billion, of which $380.4 million
remained available at November 30, 2006. During the nine months ended November
30, 2006, we used cash to repurchase 5.0 million shares of common stock at a
total price of $136.9 million, excluding commission fees. During the same period
last fiscal year, we used cash to repurchase 17.8 million shares of common stock
at a total price of $298.5 million, excluding commission fees. As of November
30, 2006, we had repurchased a cumulative 52.9 million shares of common stock at
a total price of $819.6 million, excluding commission fees.
Also in June 2006, the board of directors authorized an increase in our
quarterly dividend rate to $0.04 per share from the previous quarterly dividend
of $0.0175 per share on our common stock. The dividend rate change was effective
with the declaration of the quarterly dividend in the third quarter of fiscal
2007.
Cash, Cash Equivalents and Short-term Investments
At November 30, 2006, we had cash, cash equivalents and short-term investments
of $897.9 million, compared with $838.0 million at February 28, 2006. The
increase in the cash position is primarily due to cash provided by operations,
driven by the reduction in net-owned inventory, and cash provided by the
issuance of
Page 26 of 35
common stock. The increase was partially offset by cash used to purchase
property and equipment and to repurchase common stock. During the first nine
months of fiscal 2006, we used cash of $216.9 million to purchase property and
equipment. In addition, during the first nine months of fiscal 2007, we used
cash to repurchase 5.0 million shares of common stock at a total price of $136.9
million, excluding commission fees. At November 30, 2005, we had cash, cash
equivalents and short-term investments of $550.3 million. The year-over-year
change in the cash position reflects cash provided by operations, including a
reduction in net-owned inventory, partially offset by the use of cash to
purchase property and equipment and to repurchase common stock.
Net-owned Inventory
Merchandise inventory increased to $2.53 billion at November 30, 2006, from
$1.70 billion at February 28, 2006, driven by an increase in domestic segment
inventory of $793.9 million due to an increase in inventory purchases to support
seasonal sales trends and customer encountered in-stock positions. Net-owned
inventory, calculated as merchandise inventory less merchandise payable,
decreased by $189.1 million from February 28, 2006, to November 30, 2006.
Domestic segment net-owned inventory decreased by $185.2 million from February
28, 2006 to November 30, 2006, driven by improved supply chain and inventory
management execution, including a reduction in slower-moving and at-risk
inventories while improving customer-encountered in-stock levels.
Capital Expenditures
Capital expenditures, net of landlord reimbursements, were $215.3 million in the
nine months ended November 30, 2006, compared with $161.9 million in the same
period last fiscal year.
Sources of Liquidity
We have a $500 million revolving credit facility secured by inventory and
accounts receivable. This facility is scheduled to mature in June 2009. The
credit facility provides for a $400 million borrowing limit for the domestic
segment and a $100 million borrowing limit for the international segment. At
November 30, 2006, short-term borrowings were $35.0 million and related to our
international segment. At November 30, 2006, outstanding letters of credit were
$62.4 million, leaving $402.6 million available for borrowing. We were in
compliance with all covenants at November 30, 2006.
Our primary sources of liquidity include available cash, borrowing capacity
under the credit facility and landlord reimbursements. We expect that our
primary sources of liquidity will be sufficient to fund capital expenditures and
working capital for the foreseeable future.
UPDATED FISCAL 2007 OUTLOOK
We expect to generate the following results in fiscal 2007, excluding the impact
of classifying the results from the Rogers Plus(R) stores as results from
discontinued operations:
o consolidated net sales growth of 9 percent to 10 percent
o domestic segment comparable store sales growth of 7 percent to 8 percent
o earnings from continuing operations before income taxes (EBT) as a
percentage of consolidated net sales of 1.2 percent to 1.4 percent
The outlook also includes the following expectations:
o incremental expenses in information technology, multi-channel capabilities
and innovation activities, primarily related to expenses for investments,
that will total approximately 90 basis points as a percentage of
consolidated net sales
o expenses related to domestic segment store relocations, remodeling and
store refresh activities of approximately $25 million, which excludes the
$12.9 million reversal of lease termination charges recorded in the third
quarter for seven previously vacant locations that have re-opened or will
re-open as outlet stores
o consolidated effective income tax rate applicable to results from
continuing operations of 35.8 percent
o the classification of net income of approximately $5.1 million, all of
which relates to the fourth quarter, as results from discontinued
operations in the fourth quarter as the result of returning management of
92 Rogers Plus(R) stores to Rogers Wireless Inc. in January 2007
Page 27 of 35
o capital expenditures, net of landlord reimbursements, of approximately $275
million
o depreciation and amortization expense of approximately $190 million
o a reduction in domestic segment net-owned inventory from February 28, 2006,
to February 28, 2007, of $75 million to $125 million
Domestic segment Superstore openings and estimates are shown in the following
table. The timing of store openings depends on a number of factors and can
change during the year. Ten of the fourth quarter openings are planned for
February. We expect approximately one third of the openings to be in the 20,000
square foot format. We have completed the planned remodel of two locations.
Domestic Segment Superstore Openings(a)
Q1 Q2 Q3 Q4 FY07
-------------------------------------------------------------------------------------
Incremental Superstores.................... 3 2 8 9 -10 22 - 23
Relocated Superstores...................... 2 - 4 4 - 6 10 - 12
-----------------------------------------
Total expected Superstore openings......... 5 2 12 13 - 16 32 - 35
===========================================
(a) First, second and third quarter openings are actual. On February 28, 2006,
we closed one store in advance of opening a replacement store in the first
quarter of fiscal 2007. The replacement store is included in relocations for the
first quarter of fiscal 2007.
Our estimate of capital expenditures includes $126 million for relocations, new
store construction, store refreshes and category resets. Information technology
capital expenditures are expected to total $115 million. Distribution and other
capital expenditures are expected to total $23 million. Net capital expenditures
of $11 million are anticipated for the international segment.
The fiscal 2007 outlook, as updated, is based on the following assumptions:
o a continuation of current competitive and macroeconomic environments
o continued gross margin pressure in key product areas
o continued sales growth in key product areas including flat panel
televisions, video game hardware, notebook computers, digital imaging and
portable digital audio players as well as related accessories and services
o continued growth in Web-originated sales
o improved customer-encountered inventory in-stock levels
o no realization of benefits in fiscal 2007 from initiatives to accelerate
sales growth, gross margin improvement or expense reductions, nor any
potential costs or expenses associated with those initiatives
In the second quarter, we conducted our annual review of goodwill associated
with the international segment for impairment and determined that no impairment
existed. We are carefully monitoring sales and margin trends in the fourth
quarter to determine whether it will be necessary to re-evaluate the asset for
impairment. Future valuation adjustments based upon this review could cause
actual results to vary materially from expected results.
FISCAL 2008 AND BEYOND OUTLOOK
We expect to generate earnings from continuing operations before income taxes
(EBT) as a percentage of consolidated net sales of approximately 5.0 percent,
excluding the impact of classifying the results from the Rogers Plus(R) stores
as results from discontinued operations, in a three- to five-year timeframe.
In fiscal 2008, we expect to open 60 to 65 Superstores, of which 15 to 20 will
be relocated stores. In fiscal 2009, we expect to open 75 to 100 Superstores.
FORWARD-LOOKING STATEMENTS
The provisions of the Private Securities Litigation Reform Act of 1995 provide
companies with a "safe harbor" when making forward-looking statements. This
"safe harbor" encourages companies to provide prospective information about
their companies without fear of litigation. We wish to take advantage of the
"safe harbor" provisions of the Act. Our statements that are not historical
facts, including statements about management's
Page 28 of 35
expectations for fiscal 2007 and beyond, are forward-looking statements and
involve various risks and uncertainties. In most cases, you can identify our
forward-looking statements by words such as "expect," "anticipate," "believe,"
"should," "may," "plan," "will" or similar words.
Forward-looking statements are estimates and projections reflecting our judgment
and involve a number of risks and uncertainties that could cause actual results
to differ materially from those suggested by the forward-looking statements.
Although we believe that the estimates and projections reflected in the
forward-looking statements are reasonable, our expectations may prove to be
incorrect. The retail industry and the specialty retail industry in particular,
are dynamic by nature and have undergone significant changes in recent years.
Our ability to anticipate and successfully respond to the continuing challenges
of our industry is key to achieving our expectations. Important factors that
could cause actual results to differ materially from estimates or projections
contained in our forward-looking statements include the following:
o changes in the amount and degree of competition, pricing and promotional
pressure exerted by current competitors and potential new competition from
competitors using either similar or alternative methods or channels of
distribution such as the Internet, telephone shopping services and mail
order;
o our response to pricing and promotional activities of our competitors;
o changes in general economic conditions including, but not limited to,
financial market performance, consumer credit availability, interest rates,
inflation, energy prices, personal discretionary spending levels, trends in
consumer retail spending, (both in general and in our product categories),
unemployment and consumer sentiment about the economy in general;
o the level of consumer response to new products or product features in the
merchandise categories we sell and changes in our merchandise sales mix;
o the pace of commoditization of digital products;
o the impact of inventory and supply chain management initiatives on
inventory levels and profitability;
o our ability to generate sales and margin growth through expanded services
offerings;
o the impact of new products and product features on the demand for existing
products and the pricing and profit margins associated with the products we
sell;
o significant changes in retail prices for products and services we sell;
o changes in availability or cost of financing for working capital and
capital expenditures, including financing to support development of our
business;
o the lack of availability or access to sources of inventory or the loss or
disruption in supply from one of our major suppliers;
o our inability to liquidate excess inventory should excess inventory
develop;
o our inability to maintain sales and profitability improvement programs for
our Circuit City Superstores, including our store revitalization plan;
o our ability to continue to generate strong sales growth through our direct
sales channel;
o the availability of appropriate real estate locations for relocations and
new stores;
o the cost and timeliness of new store openings and relocations;
o consumer reaction to new store locations and changes in our store design
and merchandise;
o our ability and the ability of Chase Card Services to successfully market
and promote the third party credit card program being offered by Chase Card
Services;
o the extent to which customers respond to promotional financing offers and
the types of promotional terms we offer;
o our ability to attract and retain an effective management team or changes
in the costs or availability of a suitable work force to manage and support
our service-driven operating strategies;
o the impact of initiatives related to upgrading merchandising, marketing and
information systems on revenue and operating margin and the costs
associated with these investments;
o our ability to control and leverage expenses as a percentage of sales;
o changes in production or distribution costs or costs of materials for our
advertising;
o effectiveness of our advertising and marketing programs for increasing
consumer traffic and sales;
o the successful implementation of our initiatives to accelerate sales
growth, gross margin improvement and expense reductions;
o the imposition of new restrictions or regulations regarding the sale of
products and/or services we sell, changes in tax rules and regulations
applicable to, the imposition of new environmental restrictions,
Page 29 of 35
regulations or laws or the discovery of environmental conditions at current
or future locations, or any failure to comply with such laws or any adverse
change in such laws;
o failure to successfully implement sales and profitability improvement
programs for our international segment;
o deterioration of the expected future performance of our international
segment may result in a goodwill impairment charge;
o the timely production and delivery of private-label merchandise and level
of consumer demand for those products;
o reduced investment returns or other changes relative to the assumptions for
our pension plans that impact our pension expense;
o changes in our anticipated cash flow;
o whether, when and in what amounts share repurchases may be made under our
stock buyback program;
o adverse results in significant litigation matters;
o currency exchange rate fluctuations between Canadian and U.S. dollars and
other currencies;
o the global regulatory and trade environment;
o the disruption of global, national or regional transportation systems;
o the occurrence of severe weather events or natural disasters that could
significantly damage or destroy stores or prohibit consumers from traveling
to our retail locations, especially during peak selling periods; and
o the successful execution of the initiatives to achieve revenue growth and
increase operating margin and the accuracy of the assumptions underlying
our projected 2007 results as discussed under "Updated Fiscal 2007 Outlook"
in MD&A.
We believe our forward-looking statements are reasonable. However, undue
reliance should not be placed on forward-looking statements, which are based on
current expectations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from potential changes in the U.S./Canadian
currency exchange rates as they relate to inventory purchases and the
translation of our international segment's financial results.
Inventory Purchases
A portion of InterTAN's purchases are from vendors requiring payment in U.S.
dollars. Accordingly, there is risk that the value of the Canadian dollar could
fluctuate relative to the U.S. dollar from the time the goods are ordered until
payment is made. InterTAN's management monitors the foreign exchange risk
associated with its U.S. dollar open orders on a regular basis by reviewing the
amount of such open orders; exchange rates, including forecasts from major
financial institutions; local news; and other economic factors. At November 30,
2006, U.S. dollar purchase orders totaled approximately $10.8 million. A 10
percent decline in the value of the Canadian dollar would result in an increase
in product cost of approximately $1.1 million for those orders. The incremental
cost of such a decline in currency values, if incurred, would be reflected in
higher cost of sales in future periods. In these circumstances, management would
take product pricing action, to the degree commercially feasible.
Translation of Financial Results
Because we translate our international segment's financial results from Canadian
dollars to U.S. dollars, fluctuations in the value of the Canadian dollar have a
direct effect on reported consolidated results. We do not hedge against the
possible impact of this risk. A 10 percent adverse change in the foreign
currency exchange rate would not have a significant impact on our consolidated
results of operations or financial position.
Page 30 of 35
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of the company's management,
including the chief executive officer and chief financial officer, the company
has evaluated the effectiveness of its "disclosure controls and procedures," as
that term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934,
as amended, as of the end of the period covered by this Quarterly Report on Form
10-Q. Based upon their evaluation, the chief executive officer and chief
financial officer concluded that the company's disclosure controls and
procedures are effective.
Changes in Internal Control over Financial Reporting
There were no changes in the company's internal control over financial reporting
in the quarter ended November 30, 2006, that have materially affected, or are
reasonably likely to materially affect, the company's internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported in the company's Annual Report on Form 10-K for the year
ended February 28, 2006, the company was involved in litigation with RadioShack
Corporation ("RadioShack") related to various agreements between InterTAN and
RadioShack and its subsidiaries. In September 2006, RadioShack and Circuit City
reached an agreement that settles the litigation between the two companies.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended February 28, 2006, which could
materially affect our business, financial condition or future results. There
have been no material changes to those risk factors since we filed our 2006
Annual Report on Form 10-K. The risks described in our Annual Report on Form
10-K are not the only risks facing our company. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and/or operating results.
Page 31 of 35
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information about common stock repurchases by or on
behalf of the company during the quarter ended November 30, 2006:
Approximate
Total Number Dollar Value of
Shares that Share that
Average Purchased as May Yet Be
Total Number Price Part of Publicly Purchased
of Shares Paid Announced Under
(Amounts in millions except per share data) Purchased per Share Program the Program(a)
-----------------------------------------------------------------------------------------------------------------------------------
September 1 - September 30, 2006................. - $ - - $400.3
October 1 - October 31, 2006..................... 0.7 $27.19 0.7 $380.4
November 1 - November 30, 2006................... - $ - - $380.4
----------------- -----------------
Total fiscal 2007 third quarter.................. 0.7 $27.19 0.7
================= =================
(a) In January 2003, the company announced that the board of directors had
authorized the repurchase of up to $200 million of common stock. In June 2004,
the company announced a $200 million increase in its stock repurchase
authorization, raising the repurchase capacity to $400 million. In March 2005,
the company announced a $400 million increase in its stock repurchase
authorization, raising the repurchase capacity to $800 million. In June 2006,
the company announced a $400 million increase in its stock repurchase
authorization, raising the repurchase capacity to $1.2 billion. There is no
expiration date under the authorization. At November 30, 2006, $380.4 million
remained available for stock repurchases under the $1.2 billion stock repurchase
authorization.
Page 32 of 35
ITEM 6. EXHIBITS
Articles of Incorporation and Bylaws
3.1 Circuit City Stores, Inc. Amended and Restated Articles of
Incorporation, effective February 3, 1997, as amended through August
16, 2005, filed as Exhibit 3.1 to the company's Form 8-A/A filed
September 13, 2005 (File No. 1-5767), are expressly incorporated herein
by this reference.
3.2 Circuit City Stores, Inc. Bylaws, as amended December 17, 2005, filed
as Exhibit 3.1 to the company's Current Report on Form 8-K filed
December 22, 2005 (File No. 1-5767), are expressly incorporated herein
by this reference.
Material Contracts
10.1 Circuit City Stores, Inc. 2003 Stock Incentive Plan, as Amended and
Restated, effective December 14, 2006, filed herewith.*
10.2 Circuit City Stores, Inc. 2000 Non-Employee Directors Stock Incentive
Plan, as Amended and Restated, effective December 14, 2006, filed
herewith.*
Rule 13a-14(a)/15d-14(a) Certifications
31.1 Certification of CEO under Rule 13a-14(a) of the Securities Exchange
Act of 1934
31.2 Certification of CFO under Rule 13a-14(a) of the Securities Exchange
Act of 1934
Section 1350 Certifications
32.1 Certification of CEO under Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of CFO under Section 906 of the Sarbanes-Oxley Act of
2002
*Indicates management contracts, compensatory plans or arrangements of the
company required to be filed as an exhibit.
Page 33 of 35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CIRCUIT CITY STORES, INC.
(Registrant)
By: /s/ Philip J. Schoonover
--------------------------------------
Philip J. Schoonover
Chairman, President and Chief Executive Officer
By: /s/ Michael E. Foss
--------------------------------------
Michael E. Foss
Executive Vice President and
Chief Financial Officer
By: /s/ Philip J. Dunn
--------------------------------------
Philip J. Dunn
Senior Vice President, Treasurer,
Controller and
Chief Accounting Officer
January 5, 2007
Page 34 of 35
EXHIBIT INDEX
Articles of Incorporation and Bylaws
3.1 Circuit City Stores, Inc. Amended and Restated Articles of
Incorporation, effective February 3, 1997, as amended through
August 16, 2005, filed as Exhibit 3.1 to the company's Form 8-A/A
filed September 13, 2005 (File No. 1-5767), are expressly
incorporated herein by this reference.
3.2 Circuit City Stores, Inc. Bylaws, as amended December 17, 2005,
filed as Exhibit 3.1 to the company's Current Report on Form 8-K
filed December 22, 2005 (File No. 1-5767), are expressly
incorporated herein by this reference.
Material Contracts
10.1 Circuit City Stores, Inc. 2003 Stock Incentive Plan, as Amended
and Restated, effective December 14, 2006, filed herewith.*
10.2 Circuit City Stores, Inc. 2000 Non-Employee Directors Stock
Incentive Plan, as Amended and Restated, effective December 14,
2006, filed herewith.*
Rule 13a-14(a)/15d-14(a) Certifications
31.1 Certification of CEO under Rule 13a-14(a) of the Securities
Exchange Act of 1934
31.2 Certification of CFO under Rule 13a-14(a) of the Securities
Exchange Act of 1934
Section 1350 Certifications
32.1 Certification of CEO under Section 906 of the Sarbanes-Oxley Act
of 2002
32.2 Certification of CFO under Section 906 of the Sarbanes-Oxley Act
of 2002
*Indicates management contracts, compensatory plans or arrangements of the
company required to be filed as an exhibit.
Page 35 of 35