Conference Call Transcript
March 31, 2004 / 11:00AM ET
PRESENTATION
Operator
Good morning and welcome to the Circuit City conference call. Hosting the call
today is Alan McCollough, Chairman, President and Chief Executive Officer of
Circuit City. My name is Mike and I'll be your operator today. Initially, all
participants will be on a listen only with a question and answer session to
follow at the end. If you do anticipate asking a question, please key star
followed by one. If anyone requires assistance, key star zero and one of our
operators will assist you. I will now turn the call over to Mr. McCollough.
Please proceed sir.
Alan McCollough - Circuit City Stores, Inc. - Chairman, President & CEO
Good morning. We appreciate your participation in today's call.
Let me start by reminding you that during the call, we may make some
forward-looking statements, which are subject to risks and uncertainties. We
refer you to today's release, to the MD&A in our annual report and most recent
10-Q filing and to our other SEC filings for additional discussion of these
risks and uncertainties.
Joining me this morning are John Froman, executive vice president and chief
operating officer; and Mike Foss, senior vice president and chief financial
officer of the company.
I'll begin our formal comments with an overview of the two acquisition
announcements that we made today. I'll then turn the call over to John for a
review of our sales performance for the quarter and year to date and update on
our store revitalization efforts and to Mike for a more detailed review of our
fourth quarter performance and the balance sheet.
This morning, we announced plans for two acquisitions. First, we have entered
into a definitive agreement to acquire InterTAN, Inc. InterTAN is a Delaware
corporation that has headquarters and operates retail concepts in Canada. The
company's stock is traded on the New York Stock Exchange.
InterTAN is a retailer of both private-label and internationally branded
products. It was formed through a spin-off from RadioShack Corporation in 1987
and continues to use the trade name RadioShack(R) under a license agreement with
RadioShack Corporation. RadioShack-branded merchandise accounted for only 9.5
percent of InterTAN's inventory purchases in the fiscal year ended June 30,
2003. InterTAN operates more than 980 company retail stores and dealer outlets
in Canada under the trade names RadioShack(R), Rogers Plus(R) and Battery
Plus(R).
Under the terms of our agreement, we will acquire InterTAN in a cash tender
offer for approximately $284 million, or $14 per InterTAN common share. We
expect this transaction to be accretive to earnings in the current fiscal year.
We believe this is an exciting opportunity for Circuit City to expand both our
geographic presence and our product offering, while creating tangible value for
our shareholders. InterTAN has an outstanding management team with strong
sourcing experience and exceptional talent for merchandising private-label
products. We expect to introduce a selection of their private-label products
into our stores by the fall of this year. Their strengths in the private-label
area will enable us to move much more quickly in our efforts to provide a unique
assortment to Circuit City customers. And, we believe this assortment will
generate a substantially higher margins than our average. In its fiscal year
ended June 30, 2003, InterTAN generated revenues of slightly more than $400
million, gross margins in excess of 40 percent and operating margins of almost 5
percent.
Obviously, this transaction would enable us to enter the Canadian marketplace
with a company that has a proven record of success. InterTAN will continue to
offer its product line through its retail stores and dealer outlets in Canada in
addition to obtaining an entry for their private-label products into the U.S.
market via the new merchandising initiatives in the Circuit City Superstores.
The combination of the two companies will create inventory purchasing synergies
for both.
The transaction was approved by each company's board of directors and is
contingent upon customary closing conditions, including regulatory and other
standard approvals. We expect to complete the tender offer in the second
calendar quarter and the merger as promptly as possible thereafter. At that
time, InterTAN would become a subsidiary of Circuit City, but its headquarters
will remain in Barrie. We have great respect for InterTAN's management and
Associates, and we do not expect to make any changes in InterTAN's Canadian
operations.
We also announced this morning that we have entered into an agreement to
purchase the assets of MusicNow, Inc. for cash.
MusicNow offers consumers an online digital music store and service with more
than 40 channels of original music programming and content from all five major
music labels and two independent labels. Customers may purchase tracks and
albums a la carte or through a subscription service that provides unlimited
access to the MusicNow library for a monthly subscription fee.
We have experienced strong growth in Web-originated sales throughout the past
year and we're committed to taking advantage of opportunities that would allow
us to expand the capabilities of our Web site and benefit in other ways from the
consumer's interest in the Web. We believe that MusicNow is one of those
opportunities. We plan to integrate MusicNow's platform into circuitcity.com and
into our Superstores nationwide. We also anticipate that our relationship with
MusicNow will enable them to continue expanding their content offering to
consumers and develop additional private-label or co-branded subscription sites
with other companies.
The financial terms of our deal with MusicNow have not been publicly disclosed,
but we do not expect them to be financially material to Circuit City.
Before reviewing the results for the fourth quarter and the year, I want to
direct your attention to the announcement we made on Monday of this week. We
announced then the adoption of the fair value recognition provisions of SFAS No.
123, as amended by SFAS No. 148. As a result, we have recognized an expense for
stock options in the fourth quarter and restated prior period results to reflect
the same accounting standard. In addition to options, stock-based compensation
includes restricted stock expense, which has previously been included in
selling, general and administrative expenses. Monday's release included the
historical results restated to include all stock-based compensation, and I'd
encourage you to access that release on our Web site if you have not already
done so.
For fiscal 2004 and fiscal 2003, looking at the top and bottom-line results for
the quarter, total sales increased 2 percent to $3.25 billion from $3.19
billion, comparable store merchandise sales increased 1 percent, net earnings
from continuing operations totaled $94.7 million, or 46 cents per share,
compared with $66.4 million, or 32 cents per share.
For the year, total sales decreased 2 percent to $9.75 billion from $9.95
billion, comparable store merchandise sales decreased 3 percent, and the net
loss from continuing operations totaled $787,000, which rounds to 0 cents per
share, compared with a net loss from continuing operations of $5.3 million, or 3
cents per share.
This year's fourth quarter results included a number of items that merit some
additional explanation. First, we incurred after-tax expenses of $24.4 million
related to the 19 Superstore closings in February. Second, we incurred
transaction costs of $3.9 million after tax related to the planned sale of the
private-label finance operation to Bank One, and third, we recorded a $3.7
million after-tax benefit that reflects an adjustment to gift card liabilities.
The fiscal 2003 fourth quarter results include an after-tax charge of $6.2
million related to the change in our store compensation program, which took
place in February of that year.
At this point, I would like to turn the call over to John and Mike to provide
more detail on our fourth quarter and fiscal year 2004 results. Mike also will
update you on some of our profit improvement initiatives.
John Froman - Circuit City Stores, Inc. - Executive VP and Chief Operating
Officer
Thanks Alan. Although we are pleased with our fourth quarter earnings
performance, relative to other quarters in the year, we recognize that the
improvement was driven by reductions in expenses. Expense reductions are an
important initiative and we are proud of the efforts that our Associates have
put forth to get us to this point and the diligence they continue to show.
Nevertheless, we recognize that consistent sales growth is an important key to
turning around our financial performance on a sustainable basis and we clearly
were not satisfied with our sales performance during the year and during the
fourth quarter.
Following a comparable stores sales decline of 2 percent in December, we
generated comparable store sales growth in both January and February. We remain
cautious in our sales expectations, particularly since we recognize that the
positive comps in the past two months reflect much softer year-over-year
comparisons.
Given the poor sales performance we experienced in fiscal 2004, we have to
critically assess all aspects of the sales process to drive towards sustainable
sales improvement. Whether talking about in-store execution, advertising, price
promotion strategies or merchandising mix we have to drive substantive
improvements across all areas. There is no single solution to address all of
these issues.
We believe the significant changes that we made in our store operating model --
beginning last February when we made the compensation change -- caused our
execution to suffer. In the new fiscal year, we are focusing less on change and
more on execution and the consistent delivery of outstanding service to our
customers.
For the quarter and the year, our product sales trends were relatively
consistent with industry trends. We generated strong growth in digital imaging
products and accessories, LCD and plasma display devices; digital televisions;
and notebook computers. We also produced strong growth in movies and music,
which we used to drive traffic into our stores.
In addition, we have been especially pleased with the strong sales growth from
our e-commerce business.
Web-originated sales increased strongly in every quarter of fiscal 2004 over
fiscal 2003 results. We are proud of the exceptional execution of our Web team.
While we know that these results benefited from strong integration between the
Web site and our bricks-and-mortar stores, we also believe that we can do more
across the company to promote our multiple channels of distribution. We want
customers to be able to access Circuit City products and services in the manner
that is most convenient for them.
We are focused on continuing this strong Web growth into the future through a
combination of introducing new capabilities, such as an outlet center; new
products; new Web-enabled services, including music downloads and subscriptions;
new partnerships and ongoing improvements in functionality and Web site
navigation.
Extended warranty sales were unchanged year-over-year for the fourth quarter -
at 3.1 percent of sales in both years. This is the first quarter of the fiscal
year that we did not have a year-to-year decline in warranties as a percentage
of total sales. Our warranty team has been working closely with our store
organization to stabilize this business. Initiatives launched during the third
and fourth quarters focused on store-level execution, price and term
optimization, and system changes to make bundling easier. We are working hard to
maintain this stability, but are cautious in our outlook given potential shifts
in the merchandise mix and the continued declines in average retails within our
industry.
Turning to the revitalization efforts, we continue to believe that we must focus
our attention on revitalizing our stores through better formats, better real
estate, and better in-store execution.
Our store revitalization program continues to produce strong results from
relocated stores.
We relocated 18 stores in fiscal 04 and have relocated a total of 38 over the
past four years.
We have periodically reported to you the combined results of these stores in
their first full six months of operation. We now have 24 stores in this group.
In their first full six months following grand opening, these stores have
averaged sales changes that are approximately 28 percentage points better than
the sales pace of the remainder of the store base during the same time periods.
The internal rate of return generated by these 24 relocations was approximately
16 percent.
We added three stores to the measurement group in this period. The IRR dropped
from earlier averages because two of the three stores performed below our
expectations for their first six months of operations. In Naples, Fla., we moved
a high-volume, 10-year-old, smaller store into a different location within the
same shopping center. The move enabled us to put up a larger store in our
current format to compete against a Best Buy that opened six months prior to our
relocation. Since the store remains in the same center in which it was
previously located, the geographic shift is not as significant as it might be in
many other relocations. Our store in Bloomingdale, Ill., is in a somewhat
similar situation. The old store opened in 1993. The move gave us a much more
competitive store in the same shopping center as a Best Buy. Although we do not
have the same lift with these stores as in the average of the stores that had
been in the relo base, we believe the alternative would have been a weakening in
our position in the market and the performance of the stores as they existed.
As we indicated earlier, we see the strongest improvement in results from
relocated stores. However, as you know, we also refixtured 222 stores in fiscal
2004, moving more products onto the sales floor, improving product adjacencies
and adding more flexible fixtures. These stores have not yet produced a
statistically significant improvement in sales. But, the refixturings will
facilitate the introduction of new products, as well as other assortment
adjustments in our merchandise displays.
Now I would like to turn to Mike Foss for a financial review of the fourth
quarter and the year.
Mike Foss - Circuit City Stores, Inc. - Senior VP and Chief Financial Officer
Great, thank you John. Looking at the quarter, the gross profit margin was 23.3
percent this year compared with 23.9 percent last year. For the year, the gross
profit margin declined to 22.9 percent from 23.6 percent. This really was a
disappointing performance.
The lower margin in the fourth quarter reflects heavy promotions on desktop
personal computers, particularly in December, and aggressive industry pricing on
big-screen and advanced televisions, as well as some shift in the merchandise
mix to lower margin products. These negative impacts more than offset the
positive benefits we received in margin through aggressive actions taken to
reduce service and distribution costs and inventory shrinkage.
Looking at Finance Income: finance income during the fourth quarter improved
about $8 million versus the fourth quarter of last year. This improvement was
despite incurring $6.1 million in transaction costs during the fourth quarter of
fiscal 2004 related to the pending sale of the private label credit card
business to Bank One. Several factors contributed to the finance income
increase.
First, as you know, we introduced the co-branded credit card in the second
quarter of fiscal 2003. Since that card is accepted anywhere that Visa is
accepted, we have built a higher level of interest-bearing receivables that
provide a higher yield.
Second, the increase in yield was partially offset by higher charge-offs.
Third, we were able to reduce marketing and operating expenses on the private
label side of the bank.
And finally, since the private-label receivables are now being carried at their
selling price, due to the pending sale to Bank One, they are not subject to the
volatility of quarterly fair value adjustments. Last year's fourth quarter
included a reduction of $3 million in the fair value of our retained interest in
the securitized receivables.
Last year, we made considerable progress towards refocusing our attention on the
core business by selling the bankcard finance operation to FleetBoston and
reaching an agreement to sell the private-label operation to Bank One.
The transition services agreement with FleetBoston is proceeding according to
our plan, and we expect to conclude the transition by the end of the first
fiscal quarter.
We continue to expect the sale of the private-label operation to be complete by
the end of June and continue to anticipate an after-tax loss of approximately
$10 million related to the sale.
We also continue to anticipate that the ongoing relationship with Bank One will
generate a pretax earnings contribution of approximately $30 million, which is
similar to the finance income we would generate if we maintained ownership of
the private-label operation.
And we are also pleased that Bank One has recently announced a management team
for this portfolio that includes most of the senior managers from our bank
operation. We believe that this decision on their part attests to the strong
capabilities of these individuals and will help create a strong continuing
relationship with Bank One.
Turning to SG&A, we achieved a significant improvement in the expense structure
during the fourth quarter and for the full year. The SG&A ratio was 18.8 percent
of sales in this year's fourth quarter, compared with 20.2 percent in the same
period last year.
This 140 basis point improvement in fiscal 2004 came despite the following
pre-tax items being incurred during the quarter:
First, $38.4 million related to the 19 store closings. These stores were
identified during an extensive analysis of stores across the country. They were
located in trade areas that we believed could no longer support a Circuit City
and where we could identify no near-term relocation opportunities. As a result,
we could not see a reasonable expectation of positive cash flow in the near
future. We announced the planned closings in early February and completed the
closings as anticipated in late February.
This charge reflects a fairly significant reduction over what we had announced
in early February. When we made our initial estimate, we were on the high side
with respect to expected lease termination costs. After we announced the
closures we were able to work with local real estate experts to make a better
assessment of the sublease potential for each of the closed properties and
adjusted our estimated closing costs accordingly.
Second, a $5.9 million benefit related to adjustment in gift card liabilities.
Historically, we have charged a $2 monthly fee on gift cards with unredeemed
balances after 24 months. However, as gift cards have increased in popularity,
there has been some consumer and regulatory concern regarding such policies, and
so we opted to discontinue this monthly fee. We have undertaken a thorough
analysis of gift card usage patterns and been able to determine that a
consistent percentage of gift balances are never redeemed. We now use this
historical usage pattern to adjust the liability associated with the gift card
balances
And finally, the fiscal 2003 expenses included costs of $10.0 million related to
the change in the store compensation structure.
Major drivers of the year-over-year improvement in SG&A include:
Store labor - In the fourth quarter, we continued to receive the year-over-year
expense benefit of the compensation change we made in February of 2003. This
clearly was the largest single impact on expenses both for the quarter and the
year. Overall store-level labor for comparable stores dropped approximately $44
million during the fourth quarter and $130 million for the full year 2004.
Non-store level labor - through consolidation of regions and districts, which
happened in early January, as well as other resource reductions we have taken
throughout the company, we drove another $10 million reduction during the
quarter.
Our advertising expenditures dropped by about $11 million during the quarter.
All of this year-to-year reduction happened in January and February. This was
driven by reduced configured tab pages and recently re-negotiated aggressive new
rates for tab printing and freight costs.
While we are encouraged by the progress we made are making driving expenses down
during the quarter, we have to keep maniacal focus on getting our cost and
expense structure aligned with a very conservative view of revenues.
Turning to the balance sheet....
We ended the year with cash and cash equivalents of $783 million compared with
$885 million at the end of fiscal 2003.
The reduction in cash primarily reflects higher retained interests in
securitized receivables, an increase in merchandise inventory, a decrease in
accounts payable, the net capital expenditures and cash used to repurchase
stock, all of which were partly offset by the cash proceeds from the sale of the
bankcard operation. Retained interests in securitized receivables rose $187
million, from $239 million last year to $426 million this year. This increase
reflects the required increase in subordination levels for the private-label
transactions that were completed in early fiscal 2004.
Inventory increased $107.5 million, which was substantially better than our
estimate of approximately $200 million following the disappointing December
sales results. If you will remember, we had said that we expected a
year-over-year increase that included excess inventory as well as planned
increases in selected categories. Our merchandising team did an outstanding job
of reducing inbound inventory. Their success coupled with the slightly better
sales pace in January and February resulted in an inventory increase that was in
line with our original plans. It primarily reflects planned growth in our
television selection, especially LCD and plasma displays, and in notebook
computers. All of these have been high-growth areas.
Accounts payable decreased $84.1 million as we reduced January and February
inventory purchases to correct the inventory levels.
We also used $84.6 million to repurchase a total of 9.3 million shares under our
stock buyback authorization program.
Net cash proceeds from the sale of the bankcard operation totaled $282 million
at closing. We expect that severance and other post-closing costs will
eventually reduce the proceeds by approximately $3 million, to $279 million.
Capital expenditures, net of tenant improvement allowances, totaled $127 million
in fiscal 2004. Of this total, approximately $43 million was related to
relocations and remodels, and approximately $33 million was related to the
refixturing of 222 stores, approximately $28 million was related to new stores
and another $23 million was related to information systems, store maintenance,
distribution and a variety of other items.
Expenses related to relocations and remodels totaled $54.4 million and are
included in selling, general and administrative expenses. Of this total,
approximately $31 million was related to relocations and remodels, $22 million
was related to the refixturings and the remainder was related to other projects.
In fiscal 2004, the average accelerated depreciation per relocated store was
$400,000 and the average lease impairment per relocated store was $1.2 million.
Our capital expenditure focus in fiscal 2005 will be on relocations and the
construction of new stores in new trade areas.
As we noted in today's release, we have changed the range of store openings for
the current fiscal year to 60 to 70, rather than the initial expectation of 65
to 70. We expect a relatively even split between new stores and relocations. The
change in the range and the slight change in split between new stores and
relocations reflects the recognition that the vast majority of the stores are
expected to open in the second half of fiscal 2005 with almost one third planned
during the fourth quarter. With such a back end loaded real estate outlook there
is always a risk that some of the sites could slip into early fiscal 2006 for a
number of reasons. We currently have signed leases for 30 of the locations
currently planned for fiscal 2005.
We anticipate that capital expenditures, net of sale-leasebacks and tenant
improvement allowances, will total approximately $165 million in fiscal 2005.
We expect the fiscal 2005 capital expenditures will include approximately $62
million for relocations and remodels, approximately $63 million for new store
construction and approximately $40 million for information systems, store
maintenance, distribution and other various items. We anticipate that expenses
related to relocations and remodels will total approximately $52 million in
fiscal 2005.
In his comments, Alan noted that we expect the purchase price for InterTAN to
total approximately $284 million. In addition, we expect our fiscal 2005 cash
balances to be favorably impacted by the net cash proceeds from the sale of the
private-label credit operation. When we announced the sale, we noted that actual
proceeds from the sale will depend upon our retained interest in the receivables
at the time of closing. Based on the receivable balances at February 29, 2004,
the after-tax net cash proceeds from the sale would be approximately $450
million. We expect that by the anticipated date of closing, seasonal receivable
declines will reduce our invested amount by about $80 million and will result in
a corresponding reduction in proceeds.
Finally, I want to spend a few minutes on some of the cost and expense and other
profit improvement actions we have taken or are in the process of taking. Over
the last six months, we have identified many different opportunities to reduce
spending across the company or improve margins.
Let me touch on a few examples.
Actions targeted toward helping gross margins include introduction of private
label products into our stores. Obviously we believe our pending acquisition of
InterTAN will drive this progress. Direct importation of selected branded
products from Asia, reverse auctions to drive better pricing on certain products
for resale, a significant rightsizing of our service organization, which shows
up in cost of goods sold, and involved consolidating from 17 service centers to
five in one year and concurrent reductions in the service overhead
organizations.
We also have changed our return policy. Approximately two years ago, we loosened
up our return policy. The net effect has been no discernable impact on sales but
a negative impact on profit as the return rate went up. So, in response, we
tightened up on return policy exceptions starting in February, and introduced
re-stocking fees for certain classes of products in late March.
We continue a strong focus on loss prevention to help combat a rise in shrinkage
we have seen over several years. And finally, we are focused on driving
attachment selling in the stores, whether it is extended warranties, cables,
memory cards or any thing else a customer needs with a main purchase.
With respect to SG&A, we clearly took aggressive actions in FY04, led, in
particular, by the change in store level compensation structure. In January, we
consolidated from 13 regions to 10 and from 66 districts to 58 within our field
organization. We closed 19 stores in February.
We have consolidated our indirect purchasing organizations together under one
leader and have changed how we procure. We have started to drive significant
procurement savings in paper, freight, printing, construction, fixtures,
facilities management, I/T equipment, and service parts.
In our MIS organization we have been re-examining everything we do and how we do
it. Through aggressive demand management and rightsizing the organization for a
new set of deliverables, we will get significant improvements.
We have also challenged most of our corporate overhead departments to identify
ways to reduce spending. We solicited our Associates for cost reduction
opportunities and are pleased with the suggestions that we received. We have
translated many of these reductions in operational budgets.
While we are not giving out specific reduction objectives we clearly are driving
to get the cost and expense structure of the company aligned such that we can
show reasonable levels of profitability at conservative sales levels.
Now I would like to turn the call back over to Alan.
Alan McCollough - Circuit City Stores, Inc. - Chairman, President & CEO
Thanks, Mike. Before turning the call over to questions, I would like to briefly
summarize actions we have recently taken or actions currently underway in
support of key initiatives.
We have talked about the need to revitalize our stores and Mike has already
covered our plans there in detail as we continue to aggressively pursue new
locations.
We have stated a clear objective to provide superior solutions to our customers.
We have also made clear the need to develop our own-brand merchandise. We have
talked about this from both a margin perspective, as well as the opportunity to
offer our customers unique and exciting products. I believe this morning's
announcement regarding our plan to acquire InterTAN squarely addresses both of
these objectives and should make it clear that we are playing to win in private
label business.
We have talked about the need to develop strong marketing programs that will
drive customers to our door. We recently released that we had selected Bromley
Communications to help us reach the important Hispanic market. We are going
through a complete evaluation of all aspects of our marketing programs and as
part of that are currently conducting a full agency review. And this morning in
a separate release, I had the pleasure of announcing that Ernie Speranza, a
35-year retail advertising veteran will join us as senior vice president of
marketing.
We have been clear about the need to drive down the cost to serve, and while
Mike has articulated some of the great work underway here, I wanted to bring you
up to date on a couple of other changes.
First, I am pleased to tell you that David Strauss has recently joined us as
vice president of procurement. David comes to us after a 19-year career at Home
Depot where he most recently held the position of vice president purchasing.
Second, we have recently named Dennis Bowman to the newly created position of
senior vice president of inventory planning and strategic sourcing. Dennis, who
was previously our CIO, brings a key understanding of systems as well as a
proven analytical approach to a complete review of our forecasting, planning and
replenishment systems.
We were fortunate that when we needed Dennis in another area of the business, we
could call on Mike Jones, who had done an excellent job at FNANB, to lead the
MIS function for our company.
Finally, we have shared our plans to significantly expand our Web presence. We
have already reviewed our acquisition of MusicNow and the role it plays in
expanding our digital services portfolio. I am also pleased to tell you that our
Web team is hard at work on a major site redesign, and we expect to re-launch
our site this summer. The design work for our new site was done in conjunction
with R/GA, which was selected in February by ADWEEK as the Interactive Agency of
the Year. We have made great progress in our Web business over the past year,
but the best is yet to come.
With that we will conclude our prepared comments and be happy to take your
questions.
QUESTIONS AND ANSWERS
Operator
Ladies and gentlemen, if you wish to ask a question, press star one on your
telephone. If your question has been answered or you wish to withdraw you
question, please press star two. Once again, please star one to ask a question.
And the first question comes from David Schick with Legg Mason. Please proceed.
David Schick - Legg Mason
Hi, good morning.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Good morning.
David Schick - Legg Mason
Just a few questions. What was the thought process, obviously it wasn't a huge
number involved with MusicNow, but what was the thought process about just using
or partnering with them as opposed to just owning the assets? Secondly, if you
could talk about the stores, with the refixtured, refurbished stores not showing
the improvement you wanted, can you break down for us whether it's traffic or
conversion or to what degree you think that's affecting that problem or causing
that problem? Or is it something else? And then very quickly, if Mike would be
willing to break out the shrink benefit that you saw in fourth quarter that
would be helpful. Thanks.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Thanks, David. Relative to MusicNow, I actually think we're -- a couple of
things. I think it's clear that the future for content delivery is in bits, not
in physical media and you see that today in sales of MP3 players and all the
folks in interest in this category. We believe it was better owning the assets
that we're in, something of a unique position to drive business to that site. To
drive business to digital content. Having both the distribution company and the
physical presence in store, as well as our web marketing effort. So, I think
it's just a choice you have to make. Do you just want to represent other folks?
Or do you want to be squarely in the business? This is a case where I think
being in the business, as the retailer, is a huge advantage for us.
Relative to refixturing, I think, we've talked a couple of times. What's a
little more difficult is I don't believe we ran the business in the stores that
we believe we could have rub this year with all the changes that we made, we
caused some disruption and we allowed the execution to suffer there. I think
we'll have to continue to run those and see if we can't drive more out of there.
It's difficult, because as you go in the stores, they look and feel better, but
having said that, the results didn't pan out. So, traffic conversion, it's
probably some of both of those. I think I'd like to see us continue to run them
a bit longer as we believe we've done a good job at stabilizing the in-store
operating environment and we're making progress in execution there, and see how
that goes.
The one thing that we did point out is that the refixturing work is not for
naught. It's as you change assortments, change plans, introduce new products, we
believe there's advantage in the flexibility we've provided ourselves in those
stores going forward. And, for example, as we begin to introduce InterTAN
products in our stores, it will be much easier in the stores where we've already
done the fixture conversion, just by virtue of having done that.
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Okay, with respect to shrink, Dave, I won't give you a specific number. We did
show an improvement in shrinkage in fourth quarter relative to declines we've
taken over the past several years, so, we were pretty happy with that. It's a
relatively small improvement, but I will not give the number out.
David Schick - Legg Mason
Okay. Was it generally internal or external shrink?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
It's really, David, it's almost impossible to tell that. Obviously, we watch for
both, but we haven't classified shrink -- when you look at the total shrink
number, we don't classify it between those two. For the most part because it's
shrink, we don't know whether it was internal or external.
David Schick - Legg Mason
Fair enough. Okay, thanks.
Operator
And the next question comes from Mark Rowen with Prudential. Please proceed.
Mark Rowen - Prudential Securities
Thanks. Good morning. A couple of questions. Number one, on the relocations: Two
of the three stores that came into the base you said you had lower than expected
results and you sort of explained why that was the case, that they hadn't moved
very far. But given that they did have lower than expected results, does that
give you any pause as far as the aggressive relocation plans that you've laid
out? That's the first question.
Second is: Alan, could you just talk a little bit about your philosophy on what
you do with the excess cash in the business? In this quarter you've done some
acquisitions, you've paid a dividend, you did some stock repurchase. But going
forward, you certainly have a lot of excess cash in the business. What would you
lean towards as far as those three things?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Sure. Relative to the relos, my enthusiasm for moving storage into better
locations and providing customers a better experience has not been dampened at
all. I have been fairly consistent, or we have in saying that we will give you
the number every quarter, we know the number will go up and down. Over time I
believe that this will demonstrate that it's the right thing to do and produce
the return that we'll be happy with. So, I continue to believe we need to
relocate stores.
Relative to cash uses, as you can appreciate, that's an ongoing discussion we
have with the Board at the end of the day. The question is how do we provide the
best return? As you pointed out, we did a number of things in the last quarter.
We did buy back stock and, obviously, this morning we announced a couple of
acquisitions where we believe that they would help drive earnings growth for the
future. So, I think you should expect us to not be singularly focused, but look
for the best alternatives for the cash that we have and that's an ongoing
discussion we will have with the Board.
Mark Rowen - Prudential Securities
Okay. One other question, if I could. You mentioned there was some margin
pressure on big screen TVs. Did that come from financing of the TVs? Or the
actual prices that you were charging? And where do you think the pressure really
came from? Was it from the discounters, from Gateway, from Best Buy?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
I think, we had expected big screens to be promotionally aggressive through the
end of the year. But the promotional level out there really never abated. To
this day it never abated. And when you ask is it pricing or is it interest, it's
hard to separate those two. I think from the customer's perspective, both of
them are incentive to buy. So, if you look at Best Buy's flyer this last week,
10% off or no interest for 24 months, they're actually positioning it that way,
that one is the equivalent of the other.
It's no one competitor in the market that I think - obviously Best Buy and we
are almost in every market together, typically there is other, what we would
refer to as a third box retailer in many of these markets. So, there is just a
lot of promotional activity around the television business and it stayed fairly
aggressive right beyond December into January and February.
I think you asked about Gateway and those. When you look specifically at the
flat panel business, obviously, there has been some promotional pressure on
entry-level flat panel that I guess you could argue that Gateway started at some
point when they got in this business, but now it's not just Gateway. There are a
number of folks out there promoting $2,500 to $3,000 42-inch plasma television
sets and we clearly expect that with the capacity in the world that will
continue.
Mark Rowen - Prudential Securities
Great, thanks.
Operator
And the next question comes from Bill Sims with Smith Barney. Please proceed.
Bill Sims - Salomon Smith Barney
Good morning, thank you. My questions are all tied to your InterTAN acquisition.
I was wondering if you could address five points, one, are you going to rebrand
these stores to the Circuit City name over the course of the year? And are there
any issues with the U.S. Radio Shack company has with you running a Radio
Shack-branded store? Two, can you talk to the product overlap between the
InterTAN or Radio Shack stores in Canada and your own products that you sell in
the U.S.
Three, can you comment on the store size relative to the U.S. stores? Four, are
they mall-based or stand-alone and can you give the percentage? And five, can
you comment on your experience with Circuit City Express and given the fact that
I think the formats are somewhat similar. What have you learned from Circuit
City Express and what are you running into with the Canadian stores? Thank you.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay. Relative to rebranding, the only comment I would really make on rebranding
is that there are -- if you would look in the InterTAN filings, there is
reference made to an arrangement, agreement they had with Radio Shack and the
use of the brand going forward. So I would refer you to there and you can read
that agreement for yourself, rather for me to comment on how that might evolve.
Product overlap, there clearly is product overlap where we're both obviously
selling cables and surge protectors and things like that, so, there is a
reasonable percentage of the product where there would be some overlap. In many
cases, we would carry a branded product and they'd carry their own branded
product.
But then if you would go into one of their stores today, you would also see a
fairly large assortment of things that we simply don't carry. Whether it be a
much more assortment of accessories that we today would too often send folks
down the street to buy and/or what we would call cool gift gadgets and gizmos,
if you will. This sort of high-tech fun items that are doing particularly well
these days. So, I think yes, there is overlap, but they also bring some exciting
new high-tech, high-fun content products, if you will.
We've talked about repeatedly trying to have the role of fashion going forward
and the importance of having distinctive merchandise that you couldn't find
anywhere else. And I think when you walk through their stores, that's really
what hits you, when you see the walls of some of these cool gifts and gadgets
that you're just not going to find at every other store that you walk into.
That's obviously very appealing.
The average store size for Radio Shack Canada is about 1,800 square feet but
size is -- average is a little deceptive there. I mean their ideal store size is
probably a little north of 2,000 square feet. They also, as we've pointed out,
operate Battery Plus stores, which are significantly smaller and Rogers Plus,
the Rogers Plus business in Canada -- Rogers communications is a provider of
wireless service, as well as cable and broadband access and so the InterTAN
folks operate stores on behalf of Rogers in Canada and those stores are also
generally slightly smaller. The pure Radio Shack stores are in the neighborhood
- -- average 1,800 square feet, but the target would be north of 2,000 square
feet.
Mall and stand-alone, they operate both. They have stores in major malls
throughout Canada but they also have strip center -- not really stand-alone, but
they have strip center stores, as well as mall stores.
And relative to our own CC Express, we only have a handful, I believe five of
those stores open at the moment. The difference is from what we had run before
at Circuit City Express, where we took a subset of our merchandise out of
Circuit City and the appearance of the Radio Shack stores in Canada, there's a
fairly distinct difference in the assortments carried in those stores and the
translation is margin.
That as we pointed out and you can look for yourself, that InterTAN is running
40% gross margins. Circuit City doesn't run anything like 40% gross margins. So,
when you take our assortment without the benefit of all the extra things that
they have in their assortment and bring them into a mall environment, which is
fairly high rent, that's a little more challenging than what they're trying to
do. So we were not successful in the past, as you point out, with our CC Express
stores, but we ran a very different model than what's being run in Canada.
Bill Sims - Salomon Smith Barney
Thank you.
Operator
And the next question comes from Jack Murphy with Credit Suisse First Boston.
Please proceed.
Jack Murphy - Credit Suisse First Boston
Good morning. A little more on the acquisition. I wonder if you could talk about
your use of cash going forward, how you look at it. Is the acquisitions equally
weighted with other options? What your process is on acquisitions? And on
InterTAN specifically, were there other bidders? And did you estimate synergies,
specific dollar of synergies when arriving at your bid? And if so, can you give
us a sense of what that is?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Your first question about waiting, and I will try again, the use of cash is a
conversation we have with the Board. And the question is what deployment of the
cash will produce the best return. What are we going to do to provide the best
return for our shareholders in the long-term. We're not fixated on any one
particular usage. This is not about all acquisitions or all stock buybacks. It's
looking at what the options available to us on an ongoing basis and trying to
make the best decision at that time. I don't think we can characterize we're
going to go exclusively down one path or another, other than you should
understand this is an ongoing process and discussion we have with the Board.
I really don't want to get into a lot of detail on how we arrived at what we
believe is a fair bid for InterTAN at this point. We clearly went through a
process over a number of months as we looked at InterTAN. Obviously, as we said,
we think it's a great culture, a great management team, great culture, at
bringing expertise in the private label and unique product business that we
think combined with our purchasing power or our size, when you bring those
together, there are great synergies and so while on a stand-alone basis, they're
making 40% gross margins and 5% operating margins when you look at the last
year, or close to 5% operating margins in the last year, it's a pretty
attractive company just like it is.
Clearly, we would expect some benefit both ways, from bringing the leverage of
our scale with their expertise in some of these private label products and
unique products together. We would expect benefit on both sides.
Jack Murphy - Credit Suisse First Boston
Equally weighted or you don't want to comment on that?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
I'm really not going to comment on that.
Jack Murphy - Credit Suisse First Boston
Okay, thanks.
Operator
And the next question comes from Bill Armstrong with C.L. King and Associates.
Please proceed.
Bill Armstrong - C.L. King & Associates
Good morning. I'll ask a couple of questions on the transaction. So, does Radio
Shack have the option with a change of control to withdraw its approval to use a
Radio Shack name? And have you had discussions with them about that, if that's
the case?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Again, I really -- I don't want to comment on that other than I would refer that
- -- if you will look in the InterTAN filings, there is reference made to the
agreement with Radio Shack and the conditions therein. And I would rather that
you looked at that and you make your own judgment.
Bill Armstrong - C.L. King & Associates
Okay.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
But I guess, we're clearly aware, again, the point to be made here is it's in
the filings, we're clearly aware that it was in the filings and took it into
consideration when we made our decision.
Bill Armstrong - C.L. King & Associates
All right. I'm not sure why you don't want to talk about that since I think it
is a material issue.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Well, all I'm suggesting is that it is -- I don't have it in front of me. It is
public information included in the InterTAN filings. The nature of the
arrangement they have with Radio Shack. So, I don't want to speculate on what it
says. It's there to get.
Bill Armstrong - C.L. King & Associates
Okay. Going forward, what type of private label products or categories do you
think you might really benefit from in bringing them into the Circuit City
stores? And would you have special marketing programs advertising that? Or would
you just sort of be stocking them, in the stores and let consumers sort of
figure it out?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
There's not a single answer to that. I think there are a number of phases. There
are clearly some products where there is overlap, where we will make evaluations
where we're buying branded product today and they're sourcing private label
product, what the best solution is to put in our stores and that's part of the
process of looking at the volume that we're buying compared with the process
they're going through and making the best decision for both sides, by the way.
Separately, there is a fairly large assortment of the more -- again, cool gift
gadget gizmo, electronic products that are not in our stores at all that we
think represent an opportunity to present to the customer some fun and exciting
products that will be very different and distinct in our Circuit City stores
than anywhere else you're going to go in a big box retailer.
Bill Armstrong - C.L. King & Associates
Okay. Is there a breakup fee in your deal in the event that for whatever reason
this transaction does not go through? And can you disclose how much that would
be?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Yes, there are customary breakup provisions in the deal, I would suggest that
all the details of that will be in the tender offer that will be filed shortly
with the SEC. But there are breakup provisions in the deal.
Bill Armstrong - C.L. King & Associates
Okay. And then just one final question. The $5.9 million benefit from the gift
card liabilities, I assume that's nonrecurring?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
That will be similar kind of benefit in follow-on, at least in the next year.
Bill Armstrong - C.L. King & Associates
Oh, really? Okay. Like on the magnitude of $6 million per quarter? Or that -
Mike Foss - Circuit City Stores Inc. - CFO & SVP
No. For the full year.
Bill Armstrong - C.L. King & Associates
$6 million for the full year?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
There will be slight -- it will be within a few million dollars of that. It
won't be $5 million in the quarter.
Bill Armstrong - C.L. King & Associates
Okay. Okay. And then it would no longer -- after this year is over, then, that's
done?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
We believe so.
Bill Armstrong - C.L. King & Associates
Okay.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Just let me be specific on the question you asked about the filings I referred
to with InterTAN. Reference to Radio Shack agreement is made specifically in
their 10K.
Bill Armstrong - C.L. King & Associates
Okay. All right, thanks.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay.
Operator
And the next question comes from Matthew Fassler with Goldman Sachs. Please
proceed.
Matthew Fassler - Goldman Sachs
Thanks a lot. Good morning. Good morning. My first question is directed towards
Mike. And it relates to your expense reduction efforts. Obviously, you more or
less made your targets for the year and it looks like the fourth quarter
reported SG&A was below to above the closing charges, so, clearly even better
than it looks. How far along are you in your expense reduction efforts? In other
words, would you still expect to be able to take dollars out of store
compensation? And, as we forecast going forward, if we eliminate some of the
one-time items, might we still see declines in expense dollars in your view for
the year?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
With focus on cost and expense, you're never done.
Matthew Fassler - Goldman Sachs
Sure.
Mike Foss - Circuit City Stores Inc. - CFO & SVP
So, we will have the benefit -- you will have multiple things happening. You
will have the benefit of full-year benefits of some of the changes that we've
made late in the year. You will also, obviously, as we build new stores we will
increase expenses related to store level staffing from those perspectives. So
there's going to be, a lot of put and takes, but we still have a aggressive
focus within the Company on attacking cost and expense throughout the business.
Clearly, we've got to get our gross margins at least stabilized in this
business, again, we were pretty disappointed with our gross margin performance.
Matthew Fassler - Goldman Sachs
And as you think about the savings implemented later in the year it seems like
the biggest dollars year-to-year to come out of SG&A were in the compensation
side. What would you just direct us to really focus on as we think about those
that kicked in later just so we can try to work the reductions into our model?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
I think you're going to get benefits out of a lot -- when I touched on the
indirect procurement, a lot of the contracts that we've negotiated over the last
couple of months kicked in late in the year, so there will be ongoing benefits
from that. I'm personally thrilled to death that David Strauss has joined us as
head of procurement. He is a rock star in my mind, and will continue to take us,
we suspect to levels that, in terms of benefits, that we haven't seen or haven't
even envisioned before. So we think there's a lot of opportunity there.
Within our merchandising organization, there is a lot of work going on trying to
help drive our margins. As we mentioned, the return policy changes have happened
very, very late in the calendar year and, we'll see what the impact of those
are. But again, throughout the Company this focus can not stop. You have to
continually look, regardless of how much you find, you've got to continually
attack the cost and expense structure of the business.
Matthew Fassler - Goldman Sachs
So, taking sales out of the picture for a moment, is it feasible that on a
per-store basis, your SG&A for comparable stores would be down in 2004?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
If I take -- I'm sorry, can you repeat the question?
Matthew Fassler - Goldman Sachs
I guess to phrase it simply, is it feasible that your SG&A per comparable store
could decline again in 2004?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Again, there's more than just store-level stuff. Obviously, we're looking very
hard at all the overhead functions of the Company. So clearly there will be
ongoing estimates or ongoing reductions. Somewhat offset by new store openings,
but again, I can't get into a specific target or dollar objective to give you.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
But specifically to your question about -- we obviously saved a lot of money in
store payroll this year. As we pointed out, it was $130 million. You shouldn't
expect that again. All right? We made a significant change in the store
operating model, our objective this year is on continuing -- we've seen
improvement execution over the last few months, we're going to continue to do
that and try to run those in a stable platform. Not that we won't make changes
and experiment with the model, but our challenge there is to run a better
business and take care of customers.
Matthew Fassler - Goldman Sachs
Second question. From an IRR perspective, you talked about the returns you're
seeing on relocations. Does that include decelerated appreciation and the other
[Inaudible] costs that you book?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Yeah, it's essentially -- it's pretty all-inclusive calculation. Yes, it does
take into account all of those.
Matthew Fassler - Goldman Sachs
Gotcha. And finally, you mentioned that you're still rather cautious on sales
and you focused on sort of macro factors that kick in later in the year. You
also spoke about sales in January and February being up on a year-to-year basis.
As we think about the sales trajectory for the year, can you talk about what
kind of numbers you'd expect, what kind of numbers will make you happy?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
We actually haven't made a sales projection for the year so I'm really not in
the position to talk about it at this time. January and February, as we pointed
out, were against pretty weak comparisons, so, while we believed -- we clearly
believe we made progress compared to what we've seen in December that we are a
way a long way from declaring victory here. We have a lot of work to do on
sales.
Matthew Fassler - Goldman Sachs
My final question, just another technical one, you have this SG&A breakout in
the release. Was the $38 million related to store closings included in that
store expense line?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Including in SG&A -
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Yes. Yes. But it's in the store expense line.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Store expense of SG&A.
Matthew Fassler - Goldman Sachs
So it's part of that 550?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Yes, it is.
Matthew Fassler - Goldman Sachs
Thank you so much.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Thank you.
Operator
And the next question comes from Alan Rifkin with Lehman Brothers. Please
proceed.
Alan Rifkin - Lehman Brothers
Yes, I have one question for Alan. Alan, you've obviously had some success here
with some of the store relos and over and above the 30 that you're going to do
in 2004, you've spoken about the opportunity to relocate 200 stores. Taking that
together with the fact that the refixturing program hasn't really yielded the
results that you were looking for, can you talk specifically as to how you're
going to increase revenues at the other 400 stores that will not ultimately be
relocated?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Well, clearly, I've touched on a number of things, as I've said, it is important
that we look at our marketing program sort of from head to toe and I think our
marketing folks are doing a good job. It is a matter of course of business,
every -- you should be continuing to look at that and try to drive traffic into
the stores, which we've talked about. We've talked about the InterTAN process. I
think bringing a lot of those products in the stores can help add some volume to
the existing stores. So, we can't go on hold waiting for new stores to try to
drive folks into our existing stores. We think we can do a better job of
executing in the stores and taking care of customers than we have before. So,
you pointed out correctly, we can't wait on reloing stores because, obviously
that's contingent on real estate and that's something we can't get done in a
very compressed period of time. So, we are -- whether it be advertising,
promotion, assortments and particularly store execution, taking care of
customers, we think we can do a better job in the stores that we have.
Particularly, also, we've talked about solution selling and I've talked about it
a number of times today. It's making sure we don't have to send the customer
down the street to get everything they need to get the job done, so, we're far
from complete to believe we have to sit and wait for new stores. There are
things we have to do in the stores we've got.
Alan Rifkin - Lehman Brothers
Okay. Thanks, Alan.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Thanks.
Operator
And the next question comes from Kelly Chase with Thomas Weisel Partners. Please
proceed.
Kelly Chase - Thomas Weisel Partners
Hi, gentlemen. A couple of quick questions. First of all, you were nice enough
to give us some of the data points with respect to the remodel and the 16% IRR
after six months. I'm wondering, however, that given that your grand opening
these stores, does the IRR change at all if you were to look for 12 months? And
then I don't necessarily need an exact number, but could you just tell me how it
is you're treating that grand opening in that calculation?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
We actually -- the grand opening month is not in the calculation.
Kelly Chase - Thomas Weisel Partners
Great, perfect.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Because you're trying to make sure you don't -- obviously you don't -- you want
to look at steady state calculations, so, the grand opening month isn't
included.
Kelly Chase - Thomas Weisel Partners
Great. And then with respect to the InterTAN acquisition, you mentioned in the
press release in the headline that it was immediately accretive, can you give us
any idea as far as accretion?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
We can't at this point. As we said, we expect it to be accretive this year, but
we haven't quantified the level.
Kelly Chase - Thomas Weisel Partners
Okay. And then with respect to sourcing, you talked about sourcing being one of
the benefits that you feel you're going to be able to get from the InterTAN
acquisitions. Given the size of the revenue base, do you really feel like buying
efficiencies and sourcing from the private label will be a significant benefit?
And if so, could you maybe talk about how you would leverage this company which
is relatively small revenue compared to your own?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
First of all, let me be clear, we haven't been working on sourcing here. We have
a group in Kim Maguire's organization who has been actively trying to ramp up
our own brand and sourcing operation. This is a group with a culture and
heritage of being in the private label business. It's the combination, I
believe, of the scale that we will bring to it with the skill and expertise at
getting this job done, all be it on a smaller level, that really causes a win
for both the InterTAN operation and the Circuit City operation. It wins on both
sides. When you combine the scale we bring with the culture and the expertise
that they have in -- some of it is in the process, some of it is in knowing what
products to pick. So, I think it's fairly -- obviously we're going to have to go
to work at this. But the great benefit in the synergy of bringing their heritage
and culture to the work we've done combined with the work we've already got
started with the sourcing team here.
Kelly Chase - Thomas Weisel Partners
Okay. So it would be fair to say that those benefits maybe aren't necessarily
over the next six months, but are something you're going to build upon?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Clearly we will try -- we expect this year to bring products that we would
source products jointly, all right, that we would -
Kelly Chase - Thomas Weisel Partners
Uh-huh.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Products that they are currently buying that we would add a much bigger pencil
to the hand of the person who's been placing the order and we believe everybody
wins when that happens. We get products that are well done in a process that's
already existing and we bring a volume scale to it and everybody wins from that
process. So, we would expect to have products in our stores this year. It's not
every product in every store, but products will be in our stores this year,
we're going to move very quickly to try to start introducing these products into
our stores.
Kelly Chase - Thomas Weisel Partners
Do you have any goals as far as percentage of mix that would go to private label
over time?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
We haven't made any public goals, set any public goals.
Kelly Chase - Thomas Weisel Partners
Okay. Thank you.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Thank you.
Operator
And the next question comes from Dan Wewer with CIBC. Please proceed.
Dan Wewer - CIBC World Markets
Thank you for taking my call. Alan, when the Board agreed to the compensation
package targeting a 4% operating margin, did that include or exclude
acquisitions of high margin businesses like InterTAN?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
It was simply a target of 4%. At that point in time there was no -- we hadn't
comprehended the notion of InterTAN. That was far from our radar screen. It was
simply a challenge to the Company or the management of the Company to find a way
to get to 4%.
Dan Wewer - CIBC World Markets
So, in reaching that bogey, will the Board exclude or include the results from
the acquisition?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
I'd assume they'd absolutely include them. Our challenge is to try to get to 4%.
We believe that's a good thing for everybody and -- and so -
Dan Wewer - CIBC World Markets
But there wasn't a return on investment constraint associated with that 4%? EBIT
target?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
There was a 4% EBIT target, obviously the return, having an appropriate return
is part of the consideration of making any decision like the acquisition of
InterTAN. So, the Board is clearly conscious of what we believe the potential
synergy would be and the benefits to us of having done this. We went through
that in great detail with the Board. It is a separate discussion of the target
that the Board set for management to find a way to achieve 4% operating margin.
Dan Wewer - CIBC World Markets
The second, last year, InterTAN's SG&A rate was up about 300 bps. I was curious
if you see an opportunity of getting that back down to the 30, 31% rates they
used to operate.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
I'm not going to comment InterTAN and their operations at this point, other than
to suggest, as I said earlier that we believe they're running a good business
right now and our objective is to have them continue to run a good business.
Dan Wewer - CIBC World Markets
And when we're working on our accretion analysis on the $284 million, Mike,
should we assume about a 2% return in what you would have received on that cash?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
Yeah, that's approximate.
Dan Wewer - CIBC World Markets
So, obviously the thing is going to be accretive by maybe $3 million or $4
million, just assuming you can replicate last year's profitability. And as I
recall, they had a good first half, as well. As of this new year.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
They did have a good first half.
Dan Wewer - CIBC World Markets
Yeah. And finally, I just want to make sure I understand on adding the cool
things and the gadgets, are these the Radio Shack-type cool things and gadgets,
like the small remote control cars and the wellness products that you will be
adding?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Remember, as I said earlier, that last year 9.5% of the purchases were Radio
Shack-branded. Which means, obviously the vast majority were not Radio
Shack-branded. In many cases today, InterTAN will carry similar products
perhaps, but they have their own set of brands. That if you're in their stores,
you will see that the primary brands -- you won't miss this. The primary brands
in their stores are NexxTech and Centrios. I was going to try to spell NexxTech,
but I decided I was unable. But NexxTech and Centrios, they do have a brand, a
separate brand for electronic toys called Wasaki. So, they own several brands
that they use exclusively that you won't find in the stores here. But they will
certainly have similar products in many cases but the vast majority of the
products in their stores, you're going to see labeled NexxTech and Centrios.
Dan Wewer - CIBC World Markets
I recall they had several hundred Radio Shack dealer stores, as well -
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
There are a number of dealer stores in the total. Do we have the number?
Mike Foss - Circuit City Stores Inc. - CFO & SVP
It's a little north of 300.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay. Just over 300 dealer stores throughout Canada.
Dan Wewer - CIBC World Markets
And so will you be able then, to, actually buy some of the Radio Shack cool
things and gadgets and possibly add to the Circuit City stores in the U.S.? Is
that permitted?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Understand that the vast majority in their stores is NexxTech and Centrios. So
we would be able to introduce NexxTech and Centrios brands into our stores,
which is, again, if you walked into their store, you'd appreciate the dominance
of those two brands in their stores. Those are the products we're talking about
introducing into our stores here.
Dan Wewer - CIBC World Markets
Okay, great. Thanks a lot and good luck with the acquisition.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Thank you.
Operator
And the next question comes from Dan Binder with Buckingham Research. Please
proceed.
Dan Binder - Buckingham Research
Thank you. A couple of questions. Sort of asking the question a different way, I
guess according to the amended agreement in the filings you refer to, it looks
like the merchandising and licensing agreements won't be terminated unless the
acquirer desires so. So, I guess the question is do you have an interest in
keeping that name? The other question I had is on -- it was regards to the
MusicNow acquisition? Who are the corporate customers that they enable and will
you keep them?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
To your first question, again, all I want to say is that as we did point you to
the agreement and suggest that we consider the agreement in our discussions
prior to making a decision to acquire InterTAN. So, no decisions beyond that
have been made. Relative to MusicNow, they have a number of partners today, SBC
Yahoo, DSL, Charter Communications, Microsoft, so, there are a number of folks
they're working with today and partnership arrangements, we assume that they
will continue to have those partnership arrangements, as well as expand others.
It's a combination of a B-to-B opportunity. They have a great service that we
think will be a value to other folks and obviously the ability to drive the
service through our stores and on our web site.
Dan Binder - Buckingham Research
I think, just in some of the questions I've gotten myself this morning, what
kind of level of distraction do you view the acquisitions to be? Is there a lot
of integration that needs to be done? And, who needs to really be paying
attention to it?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Remember, and I apologize for being repetitive, our number one job to Canada is
to make sure those folks continue to run their business as they're running it
today without interference. Obviously, there are products that we are going to
want to include in our stores this year, and so this is a merchandising
discussion and will be a merchandising -- with our sourcing team and their time
team, I'm assuming working together, to make sure we make the best decisions on
cost and who's buying the most and where are the better products and sharing
that information, but it's not a distraction for our store operators. These are
two companies that are running their own businesses with the benefit of product,
acquisition, talent and scale that we think will be the benefit of both
companies.
Dan Binder - Buckingham Research
Will you have to cut anything in the existing Circuit City stores to make room
for these new products?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Look, we are obviously early in this process, but I think there's room in the
stores to fit everything we need.
Dan Binder - Buckingham Research
Okay. Just a couple of other questions. If you could just touch on what you're
doing on the warranty side? And then given the upside in financing come this
quarter, should we be extrapolating for that, given your expectation that the
income will continue after the credit card business is sold? And then lastly,
what do you think explains the lumpiness in your business between November and
February?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Finance income, as we said before, that we looked at FY2003, when the finance
income, I believe, was just north of $27 million. We said if you looked through
the first three quarters of this year and extended it forward it would have been
similar number in the $27 to $30 million range. I think, you shouldn't look at
the last quarter, when we're in the process of trying to be sure we have a great
transition between ourselves and Bank One. But rather the guidance we gave
before was similar to 2003, which was 27-something , if you look at this year it
was close to 30. You're in the range we believe it will be going forward.
Dan Binder - Buckingham Research
Okay. And with regard to what you're doing on the warranties?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Warranties -- what respect to the warranties?
Dan Binder - Buckingham Research
You commented early in the call that you've been doing things on pricing and
terms to help stabilize that business.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Well, we've always said that warranties obviously are sensitive relative to the
product you're selling and the retail of the product you're selling and as in
other areas of the Company, we are and you should expect us to continue to run
sensitivity tests on warranties around the country to determine that optimum
balance. And so we've got a group doing that today, our expectation is that they
will continue to do that and push at the edges of that to make sure we have the
optimum balance. It is an ongoing process of really sort of defining what the
offer ought to be relative to the other products you're selling in the store.
John Froman - Circuit City Stores Inc. - COO & EVP
But the primary driver of the improved performance is good performance from our
store directors, our sales managers and our product specialists executing day in
and day out in the last quarter?
Dan Binder - Buckingham Research
Okay. And then with regard to my last question. You've had some lumpiness in the
business trends in the last several months. Is that a function of changes,
distractions, just volatility in the business? Anything that you can say about
that?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Well, look, while January and February were better, we're not happy with January
and February. I think what we said before and is still the case, is that we ran
a better business in January and February. I think the store execution improved,
we would expect it will continue to improve. It wasn't what we needed it to be
in December and so there is clearly some of that reflected in the sales results.
There are a lot of moving parts in every month. But first and foremost, we need
to make sure -- again, we think we're doing a much better job here and will
continue to. We need to do the right job to take care of folks in the store.
Dan Binder - Buckingham Research
Great, thanks.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay.
Operator
Next is Scot Ciccarelli from RBC Capital Markets. Please proceed.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Scot?
Operator
Do we have Mr. Ciccarelli on the line?
Scot Ciccarelli - RBC Capital Markets
Hello?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
If not -- Scot?
Scot Ciccarelli - RBC Capital Markets
Yeah.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay, go ahead.
Scot Ciccarelli - RBC Capital Markets
Sorry about that. The question I have relates to vendor community. You guys are
making a big push into private label business, obviously, the InterTANs and
other push there. What kind of reaction do you think you're going to get from
the vendor community? Do you think you're going to get a pushback with, you guys
have historically been a branded-type business, what do you think the vendors
are going to be thinking regarding this move and, you're pretty overt statements
that you're going to make a bigger push in the private label? Thanks.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
While we're going to make a big push into private label, understand that the
majority of our business will be branded. That there is no way that you're going
to replace Sony and Panasonic and Samsung and Hitachi and key brands like that
in your assortment. That they are important today as they have ever been. But in
sort of a brave new digital world, there are a lot of products out there and
brands show up very quickly these days in digital products. As you look at all
the peripherals and accessories and think of the brands that are predominant in
MP3 players that didn't exist a few years ago, I think we have a real
opportunity to increase both our own brand share and the fun and exciting pieces
of that that we can bring some unique styling and fashion and so forth that
we've been talking about needing to have, we're not going to impact the amount
of Sony TVs we sell or Panasonic and Hitachi and Samsung and so forth. Those are
great brands that we absolutely need in our assortment and will continue to
support aggressively.
Scot Ciccarelli - RBC Capital Markets
Okay, thank you very much.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
We can take one more question, please. We will make this the last question.
Operator
The last question will come from Budd Bugatch with Raymond James & Associates.
Please proceed.
Rex Henderson - Raymond James & Associates
Good afternoon. And this is Rex, Budd is on the road. Congratulations on a great
quarter. The questions I had, again, are on the acquisition. You've articulated
about three basic reasons for it. The private label opportunity, the sourcing
opportunities and, of course, the profitability of the business. Can you sort of
give me an idea of the importance of those in your mind and can you expand a
little bit around the profitability of that business? Is there an opportunity to
expand that profitability? You said it's about a 5% operating margin over the
last four quarters. Can that get better?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Look, to comment specifically on their business at this time, you're going to
have to address some of those questions to them. The nature of working
cooperatively on sourcing, taking our team and their team and making the best of
both, our expectation is there are benefits on both sides. They have a certain
skill and a culture expertise at getting this done and a great management team
and equally we have a good group of folks working on this and we bring an
element of scale, I think both sides benefit here.
Rex Henderson - Raymond James & Associates
Okay, so you think the sourcing is the principle strategic advantage in this
acquisition?
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Look, it is a strategic advantage. First and foremost, this is a company that we
think is a good company that will run a good business and do well. If we did
nothing else but say here's a company and a way to get into Canada and establish
a presence there, if we stop there, this is a good company that we think will do
well going forward. Having said that, there are obvious synergistic benefits of
taking what we do well and the scale that we bring to the culture and expertise
they have in sourcing in a private label orientation that we think will benefit
both sides.
And clearly there's also unique product assortments that we think we can
introduce into our stores that will help us have things that will bring
customers to our store that we don't have today. So, introduce new products that
don't exist in our stores today. New products, new product lines that obviously
we hope we'll sell some of. There is a series of benefits here, but it all
starts with the fact that they're running a good business and we want the same
folks running the same good business going forward.
Rex Henderson - Raymond James & Associates
Thank you very much.
Alan McCollough - Circuit City Stores Inc. - Chairman, President & CEO
Okay, and thank all of you for joining us today.
Operator
This concludes our Circuit City conference call. Thank you for your
participation today. You may now disconnect.
Additional Information
This announcement is neither an offer to purchase nor a solicitation of an offer
to sell securities of InterTAN. At the time the offer is commenced, Circuit City
will file a tender offer statement with the U.S. Securities and Exchange
Commission and InterTAN will file a solicitation/recommendation statement with
respect to the offer. Investors and InterTAN stockholders are strongly advised
to read the tender offer statement (including an offer purchase, letter of
transmittal and related tender documents) and the related
solicitation/recommendation statement because they will contain important
information. These documents will be made available to all InterTAN stockholders
at no expense to them and, when available, may be obtained at no charge at the
SEC's Web site at www.sec.gov.