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Circuit City Set Aflame

Pia Sarkar

SAN FRANCISCO -- In a holiday season that is expected to be led by consumer electronics, Circuit City(CC Quote) says it will see a loss in its fourth quarter.

That disappointing forecast, along with a dreadful third-quarter report, sent shares of the country's second-largest electronics retailer plunging 25% Friday afternoon.

Circuit City reported a much worse-than-expected loss for the third quarter, with sharply lower sales and weakened margins. The retailer blamed the shortfall on its ongoing "transformation" efforts -- which have yet to transform the company.

"Circuit City's internal restructuring efforts appear to have gotten the better of its financial performance," wrote Goldman Sachs analyst Matthew Fassler in his research. "In our view, the company leaned on self-inflicted disruption from its 'transformation' process."

Indeed, even Circuit City's own executives admit that they brought their problems upon themselves.

"We are very dissatisfied with our third quarter results," said Philip Schoonover, chairman, president and chief executive of the company. "We underestimated the financial impact from the disruption of our transformation work, which contributed to lower close rates, reduced attachments of higher margin accessories and firedog services and lower extended warranty net sales as compared with the prior year."

Circuit City now expects a "moderate" loss in the fourth quarter, which includes a crucial holiday shopping season that will largely be driven by consumer-electronics sales. Analysts had expected earnings of 56 cents a share.

With Circuit City's weak positioning, rival Best Buy(BBY Quote) could emerge as a winner. Best Buy reported a 52% climb in third-quarter profit earlier this week, helped in part by a calendar shift.

In comparison, Circuit City's results were disastrous. The company reported a loss of $207.3 million, or $1.26 a share, widened from $20.4 million, or 12 cents a share, a year earlier.

The bottom line was in part weighed down by a $102.8 million charge to establish a valuation allowance for deferred tax assets. Excluding the charge, the loss was 64 cents a share, still well worse than analysts' expectation of 31 cents, based on Thomson Financial's mean estimate.

Sales fell to $2.96 billion from $3.06 billion the prior year, missing analysts' target of $3 billion. Same-store sales, or sales at stores open at least a year, dropped 5.6%.

The company's consolidated gross profit margin slid to 19.1% from 22.1% a year earlier. Circuit City said the decline was driven by drops in television margins, extended warranty sales and PC hardware margins.

Earlier this year, the company announced a sweeping restructuring, with one of its plans involving the layoff of 3,400 employees in favor of lower-paid workers. Analysts say that has come back to bite the company as inexperienced staff results in weaker levels of customer service and disorder in its stores.

"We believe that these issues are primarily self-induced and are within our control to improve," said Schoonover. "Though there is more work to be done, we started to address the execution issues and experienced sequential improvements in close rate, and our key TV attachment basket improved each month of the quarter after hitting a bottom in August."

Amid the losses, Circuit City received a $1.3 billion credit facility from Bank of America, the company said. That will replace its current $500 million credit line.

Despite Circuit City's disappointments, its executives won't be going anywhere. The company's board approved a special cash retention award for each of Circuit City's executive vice presidents and senior vice presidents.

Effective Jan. 1, the award will vest over a three-year period and amount to $1 million for each executive vice president and $600,000 for each senior vice president, according to Securities and Exchange Commission filings.

Additionally, the company's compensation and personnel committee approved long-term incentive awards to Schoonover and to each of Circuit City's executive vice presidents and senior vice presidents. The awards will be in the form of options to acquire shares of the company's common stock, valued at $2.9 million for the CEO and $775,000 for each executive vice president.

Scott Tilghman, an analyst for Soleil-Hudson Square Research, says the retention program shows that Circuit City is intent on keeping its management in place in order to ensure continuity on its transformation plans.

He believes that management has not had enough time to see those changes through, hampered by problems at the company that preceded them, as well as larger macroeconomic issues outside of their control.

Nonetheless, Tilghman says patience will wear thin if progress is not realized by next year.

For some shareholders, that patience has already worn out. The stock recently was down $1.82 to $4.84.