UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended August 31, 2003
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 or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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 an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No ___
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 September 30, 2003
Common Stock, par value $0.50 209,462,914
A Table of Contents is included on Page 2 and an Index for Exhibits is included
on Page 34.
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Operations -
Three Months and Six Months Ended August 31, 2003 and 2002 3
Consolidated Balance Sheets -
August 31, 2003 and February 28, 2003 4
Consolidated Statements of Cash Flows -
Six Months Ended August 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 33
EXHIBIT INDEX 34
Page 2 of 34
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 Six Months Ended
August 31 August 31
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net sales and operating revenues $2,155,700 $2,221,204 $4,089,020 $4,339,447
Cost of sales, buying and warehousing 1,668,325 1,695,316 3,153,335 3,300,209
---------- ---------- ---------- ----------
Gross profit 487,375 525,888 935,685 1,039,238
Finance (loss) income [Notes 1, 4,10 and 13] (133,310) 25,970 (155,415) 46,389
Selling, general and administrative expenses 547,176 569,349 1,043,795 1,105,143
Interest expense 303 550 1,310 550
---------- ---------- ---------- ----------
Loss from continuing operations
before income taxes (193,414) (18,041) (264,835) (20,066)
Income tax benefit (69,169) (6,856) (96,666) (7,625)
---------- ---------- ---------- ----------
Net loss from continuing operations (124,245) (11,185) (168,169) (12,441)
Net earnings from discontinued operations - 31,714 - 60,952
---------- ---------- ---------- ----------
Net (loss) earnings $ (124,245) $ 20,529 $ (168,169) $ 48,511
========== ========== ========== ==========
Net (loss) earnings from:
Continuing operations $ (124,245) $ (11,185) $ (168,169) $ (12,441)
========== ========== ========== ==========
Discontinued operations attributed to:
Circuit City common stock $ - $ 20,298 $ - $ 39,020
========== ========== ========== ==========
CarMax Group common stock $ - $ 11,416 $ - $ 21,932
========== ========== ========== ==========
Weighted average common shares:
Circuit City:
Basic 206,177 207,202 206,003 206,956
========== ========== ========== ==========
Diluted 206,177 207,202 206,003 206,956
========== ========== ========== ==========
CarMax Group:
Basic - 37,065 - 37,013
========== ========== ========== ==========
Diluted - 38,618 - 38,722
========== ========== ========== ==========
Net (loss) earnings per share:
Basic:
Continuing operations $ (0.60) $ (0.05) $ (0.82) $ (0.06)
Discontinued operations attributed to
Circuit City common stock - 0.10 - 0.19
---------- ---------- ---------- ----------
$ (0.60) $ 0.04 $ (0.82) $ 0.13
========== ========== ========== ==========
Discontinued operations attributed to
CarMax Group common stock $ - $ 0.31 $ - $ 0.59
========== ========== ========== ==========
Diluted:
Continuing operations $ (0.60) $ (0.05) $ (0.82) $ (0.06)
Discontinued operations attributed to
Circuit City common stock - 0.10 - 0.19
---------- ---------- ---------- ----------
$ (0.60) $ 0.04 $ (0.82) $ 0.13
========== ========== ========== ==========
Discontinued operations attributed to
CarMax Group common stock $ - $ 0.30 $ - $ 0.57
========== ========== ========== ==========
Cash dividends paid per share on
Circuit City common stock $ 0.0175 $ 0.0175 $ 0.0350 $ 0.0350
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
Page 3 of 34
Circuit City Stores, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands except share data)
Aug. 31, 2003 Feb. 28, 2003
( Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 633,072 $ 884,670
Accounts receivable, net of allowance for doubtful accounts
of $1,058 and $1,075 168,450 215,125
Retained interests in securitized receivables 617,860 560,214
Merchandise inventory 1,554,432 1,409,736
Prepaid expenses and other current assets 60,179 33,165
---------- ----------
Total current assets 3,033,993 3,102,910
Property and equipment, net 625,532 649,593
Deferred income taxes 25,435 22,362
Other assets 35,477 24,252
---------- ----------
TOTAL ASSETS $3,720,437 $3,799,117
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,186,880 $ 963,701
Accrued expenses and other current liabilities 126,685 128,776
Accrued income taxes - 44,453
Deferred income taxes 68,962 141,729
Current installments of long-term debt 1,366 1,410
---------- ----------
Total current liabilities 1,383,893 1,280,069
Long-term debt, excluding current installments 10,630 11,254
Accrued straight-line rent 101,242 97,427
Other liabilities 68,169 68,792
---------- ----------
TOTAL LIABILITIES 1,563,934 1,457,542
---------- ----------
Stockholders' equity:
Circuit City common stock, $0.50 par value; 525,000,000 shares authorized;
209,467,002 shares issued and outstanding at August 31, 2003
(209,954,840 at February 28, 2003) 104,734 104,977
Capital in excess of par value 839,724 849,083
Retained earnings 1,212,045 1,387,515
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 2,156,503 2,341,575
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,720,437 $3,799,117
========== ==========
See accompanying notes to consolidated financial statements.
Page 4 of 34
Circuit City Stores, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Six Months Ended
August 31
2003 2002
---------- ----------
Operating Activities:
Net (loss) earnings $(168,169) $ 48,511
Adjustments to reconcile net (loss) earnings to net cash used in
operating activities of continuing operations:
Net earnings from discontinued operations - (60,952)
Depreciation and amortization 97,719 76,546
Amortization of restricted stock awards 6,808 9,892
(Gain) loss on dispositions of property and equipment (14) 5,275
Provision for deferred income taxes (75,840) (12,768)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable, net 46,675 (14,705)
Increase in retained interests in securitized receivables (57,646) (73,357)
Increase in merchandise inventory (144,696) (423,120)
Increase in prepaid expenses and other current assets (27,014) (774)
(Increase) decrease in other assets (11,225) 3,872
Increase in accounts payable 223,179 160,462
Decrease in accrued expenses and other current liabilities
and accrued income taxes (48,460) (105,508)
Increase in accrued straight-line rent and other liabilities 3,192 7,176
--------- ----------
Net cash used in operating activities of continuing operations (155,491) (379,450)
--------- ----------
Investing Activities:
Purchases of property and equipment (85,698) (75,278)
Proceeds from sales of property and equipment, net 12,055 15,641
--------- ----------
Net cash used in investing activities of continuing operations (73,643) (59,637)
--------- ----------
Financing Activities:
Payments on short-term debt, net - (397)
Principal payments on long-term debt (668) (24,227)
Repurchase and retirement of common stock (13,941) -
Issuances of Circuit City common stock, net (555) 8,682
Issuances of CarMax Group common stock, net - 744
Dividends paid (7,300) (7,330)
--------- ----------
Net cash used in financing activities of continuing operations (22,464) (22,528)
--------- ----------
Cash used in discontinued operations - CarMax - (4,025)
Cash used in discontinued operations - Divx - (10,500)
--------- ----------
Decrease in cash and cash equivalents (251,598) (476,140)
Cash and cash equivalents at beginning of year 884,670 1,248,246
--------- ----------
Cash and cash equivalents at end of period $ 633,072 $ 772,106
========= ==========
See accompanying notes to consolidated financial statements.
Page 5 of 34
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
From February 7, 1997, to October 1, 2002, the common stock of Circuit City
Stores, Inc. consisted of two common stock series that were intended to
reflect the performance of the company's two businesses. The Circuit City
Group common stock was intended to reflect the performance of the Circuit
City consumer electronics stores and related operations and the shares of
CarMax Group common stock reserved for the Circuit City Group or for
issuance to holders of Circuit City Group common stock. The CarMax Group
common stock was intended to reflect the performance of the CarMax auto
superstores and related operations.
Effective October 1, 2002, the CarMax auto superstore business was
separated from the Circuit City consumer electronics business through a
tax-free transaction in which CarMax, Inc., formerly a wholly owned
subsidiary of Circuit City Stores, Inc., became an independent, separately
traded public company. Following the separation, the Circuit City Group
common stock was renamed Circuit City common stock. All CarMax results
prior to the separation date are presented as results from discontinued
operations. See Note 3 for an additional discussion of the separation.
As of August 31, 2002, 65,923,200 shares of CarMax Group common stock were
reserved for the Circuit City Group or for issuance to holders of Circuit
City Group common stock. Excluding shares reserved for CarMax employee
stock incentive plans, the reserved CarMax Group shares represented 64.0
percent of the total outstanding and reserved shares of CarMax Group common
stock at August 31, 2002.
The company announced plans to sell its bankcard operation in August 2003.
The company has received bids for the bankcard operation from a number of
interested parties. While the sales process is not final, based on these
bids, the company expects to incur a loss on the sale of the bankcard
operation of approximately $163 million, approximately $105 million after
income taxes or 51 cents per share. Of the total estimated loss, $148
million, approximately $95 million after income taxes, has been reflected
in the second quarter. The remaining $15 million, approximately $10 million
after income taxes, includes anticipated lease termination and severance
costs. The company expects the sale of the bankcard operation to generate
approximately $295 million in cash and expects to complete the sale before
the end of the calendar year. Timing for presentation of the bankcard
business as a discontinued operation on the company's consolidated
financial statements will be affected by the extent and duration of
transition services required by a prospective purchaser.
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 herein should be read
in conjunction with the notes to the audited financial statements included
in the company's fiscal 2003 Annual Report on Form 10-K.
2. Accounting Policies
The consolidated financial statements of the company conform to accounting
principles generally accepted in the United States of America. The interim
period financial statements are unaudited; however, in the opinion of
management, all adjustments, which consist only of normal, recurring
adjustments, necessary for a fair presentation of the interim consolidated
financial statements have been included. The February 28, 2003, balance
sheet data was derived from the audited consolidated financial statements
included in the company's fiscal 2003 Annual Report on Form 10-K.
Page 6 of 34
3. Discontinued Operations
Cash flows related to discontinued operations have been segregated on the
consolidated statements of cash flows.
(A)CarMax:
On September 10, 2002, the company's shareholders approved the separation
of the CarMax Group from Circuit City Stores, Inc. and the company's board
of directors authorized the redemption of the company's CarMax Group common
stock and the distribution of CarMax, Inc. common stock to effect the
separation. On October 1, 2002, the separation was effective and CarMax,
Inc. became an independent, separately traded public company. Each
outstanding share of CarMax Group common stock was redeemed in exchange for
one share of CarMax, Inc. common stock. In addition, each holder of Circuit
City Group common stock received as a tax-free distribution 0.313879 of a
share of CarMax, Inc. common stock for each share of Circuit City Group
common stock owned as of September 16, 2002, the record date for the
distribution. All CarMax results prior to the separation date are presented
as results from discontinued operations. The company recorded no gain or
loss as a result of the separation.
With the separation, CarMax paid a special dividend of $28.4 million to
Circuit City Stores, Inc. in recognition of the company's continuing
contingent liability for leases related to 23 CarMax locations. At August
31, 2003, the future minimum fixed lease obligations on these 23 leases
totaled approximately $466.4 million.
The relationship between the company and CarMax is governed by a transition
services agreement, under which the company provides CarMax services,
including human resources, administrative services, special technical
services, payroll processing, benefits administration, payroll tax
services, computer center support and telecommunication services, with
initial terms ranging from six to 24 months and varying renewal options.
Under the agreement, CarMax pays the company the allocable portion of all
direct and indirect costs of providing these services plus 10 percent.
Including the 10 percent markup, the company billed CarMax $2.2 million
during the second quarter of fiscal 2004 and $5.5 million during the six
months ended August 31, 2003, for services provided under the agreement. A
tax allocation agreement, which generally provides that pre-separation
taxes attributable to the business of each party will be borne solely by
that party, also was executed upon the separation.
For the quarter ended August 31, 2002, net earnings from the discontinued
CarMax operations were $31.7 million. For the six months ended August 31,
2002, net earnings from the discontinued CarMax operations were $61.0
million.
(B)Divx:
On June 16, 1999, Digital Video Express announced that it would cease
marketing the Divx home video system and discontinue operations. At August
31, 2003, and at February 28, 2003, current liabilities of $8.0 million
related to the former Divx operations were reflected in accrued expenses
and other current liabilities on the consolidated balance sheets. Payments
of $10.5 million were made during the second quarter of fiscal 2003 and are
reflected on the consolidated statement of cash flows for the six months
ended August 31, 2002. For the three- and six-month periods ended August
31, 2003 and 2002, the discontinued Divx operations had no impact on the
company's results of operations.
Page 7 of 34
4. Finance (Loss) Income
For the three- and six-month periods ended August 31, 2003 and 2002, the
components of pretax finance (loss) income were as follows:
Three Months Ended Three Months Ended
August 31, 2003 August 31, 2002
(Amounts in millions) Private-Label Bankcard Total Private-Label Bankcard Total
-------------------------------------- ---------------------------------------- --------------------------------------
Securitization income (loss).......... $29.2 $(133.6) $(104.4) $30.8 $24.7 $55.5
Less: Payroll and fringe benefit
expenses.................. 7.1 2.9 10.0 7.3 3.3 10.6
Other direct expenses......... 13.1 5.8 18.9 10.3 8.6 18.9
---------------------------------------- --------------------------------------
Finance income (loss)................. $ 9.0 $(142.3) $(133.3) $13.2 $12.8 $26.0
======================================== ======================================
Six Months Ended Six Months Ended
August 31, 2003 August 31, 2002
(Amounts in millions) Private-Label Bankcard Total Private-Label Bankcard Total
-------------------------------------- ---------------------------------------- --------------------------------------
Securitization income (loss).......... $57.6 $(148.9) $ (91.3) $59.9 $46.1 $106.0
Less: Payroll and fringe benefit
expenses.................. 14.7 6.1 20.8 14.7 6.6 21.3
Other direct expenses......... 26.2 17.1 43.3 20.4 17.9 38.3
Finance income (loss)................. $16.7 $(172.1) $(155.4) $24.8 $21.6 $ 46.4
======================================== ======================================
The securitization loss for this year's second quarter includes the impact
of pretax charges of $148.0 million to reduce the carrying value of the
company's retained interests in the bankcard portfolio to reflect the
estimated net proceeds from the planned sale of the bankcard operation.
Securitization income primarily is comprised of the gain on the sale of
receivables generated by the company's finance operations, income from
retained interests in the receivables and income related to servicing the
receivables, as well as the impact of increases or decreases in the fair
value of the retained interests. Finance (loss) income does not include any
allocation of indirect costs or income. The company presents information on
the performance of its finance operations on a direct basis to avoid making
arbitrary decisions regarding the periodic indirect benefits or costs that
could be attributed to these operations. Examples of indirect costs not
included are corporate expenses such as human resources, administrative
services, marketing, information systems, accounting, legal, treasury and
executive payroll, as well as retail store expenses.
5. Stock-Based Compensation
The company accounts for stock options granted to employees and directors
using the intrinsic value method of accounting in accordance with
Accounting Principles Board Opinion No. 25, "Accounting For Stock Issued to
Employees," and related interpretations. As the exercise price of all
options granted was equal to the market price of the underlying common
stock on the grant date, no stock-based compensation cost has been
recognized. The following table summarizes the effect on net (loss)
earnings and net (loss) earnings per share if the company had applied the
fair value recognition provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation." The pro forma
effect on the three- and six-month periods ended August 31, 2003 and 2002
may not be representative of the pro forma effects on net (loss) earnings
for future quarters.
Page 8 of 34
Three Months Ended Six Months Ended
(Amounts in thousands August 31 August 31
except per share data) 2003 2002 2003 2002
----------------------------------------------------------- ---------------------- ---------------------
Net loss from continuing operations:
As reported............................................. $(124,245) $(11,185) $(168,169) $(12,441)
Less: fair value impact of employee
stock compensation costs............................. 5,468 4,803 8,153 9,423
---------------------- ---------------------
Pro forma............................................... $(129,713) $(15,988) $(176,322) $(21,864)
====================== =====================
Net (loss) earnings attributed to Circuit City
common stock:
Continuing operations, as reported...................... $(124,245) $(11,185) $(168,169) $(12,441)
Discontinued operations, as reported.................... - 20,298 - 39,020
Less: fair value impact of employee
stock compensation costs............................. 5,468 4,803 8,153 9,423
----------------------- ---------------------
Pro forma............................................... $(129,713) $ 4,310 $(176,322) $ 17,156
====================== =====================
Net loss per share from continuing operations:
Basic - as reported..................................... $ (0.60) $ (0.05) $ (0.82) $ (0.06)
Basic - pro forma ...................................... (0.63) (0.08) (0.86) (0.11)
Diluted - as reported .................................. (0.60) (0.05) (0.82) (0.06)
Diluted - pro forma .................................... (0.63) (0.08) (0.86) (0.11)
Net (loss) earnings per share attributed to
Circuit City common stock:
Basic - as reported..................................... $ (0.60) $ 0.04 $ (0.82) $ 0.13
Basic - pro forma....................................... (0.63) 0.02 (0.86) 0.08
Diluted - as reported .................................. (0.60) 0.04 (0.82) 0.13
Diluted - pro forma..................................... (0.63) 0.02 (0.86) 0.08
For the purpose of computing the pro forma amounts indicated above, the
fair value of each option on the date of grant was estimated using the
Black-Scholes option-pricing model. The weighted average assumptions used
in the model were as follows:
Three Months Ended Six Months Ended
August 31 August 31
2003 2002 2003 2002
------------------------ -------------------------
Expected dividend yield.......................... 1.0% 0.3% 1.1% 0.3%
Expected stock volatility........................ 75.7% 69.8% 75.8% 69.8%
Risk-free interest rates......................... 2.2% 4.7% 2.5% 4.7%
Expected lives (in years)........................ 4.7 4.6 4.6 4.6
Using these assumptions in the Black-Scholes model, the weighted average
fair value of options granted was $4 per option for the three- and
six-month periods ended August 31, 2003, and $13 per option for the three-
and six-month periods ended August 31, 2002.
6. Income Taxes
The effective income tax rate was 35.8 percent for the three months ended
August 31, 2003, and 36.5 percent for the six months ended August 31, 2003,
compared with 38.0 percent for the three- and six-month periods ended
August 31, 2002. The decrease is attributed to lower state and local income
taxes.
7. Net (Loss) Earnings per Share
The company reported a loss from continuing operations for the three- and
six-month periods ended August 31, 2003 and 2002. The diluted net loss per
share is the same as the basic net loss per share for
Page 9 of 34
those periods because including any potentially dilutive securities would
be antidilutive to the net loss per share from continuing operations.
For the three- and six-month periods ended August 31, 2003, no options or
restricted stock were included in the computation of diluted net loss per
share because the company reported a loss from continuing operations.
Options to purchase 20.2 million shares of Circuit City common stock with
exercise prices ranging from $5.61 to $27.21 and restricted stock amounting
to 3.6 million shares were outstanding at August 31, 2003. For the three-
and six-month periods ended August 31, 2002, no options or restricted stock
were included in the computation of diluted net loss per share because the
company reported a loss from continuing operations. Options to purchase
12.0 million shares of Circuit City common stock with exercise prices
ranging from $9.94 to $40.81 per share and restricted stock amounting to
2.6 million shares were outstanding at August 31, 2002.
Basic net earnings per share from discontinued operations attributed to
CarMax Group common stock is computed by dividing net earnings from
discontinued operations attributed to CarMax Group common stock by the
weighted average number of shares of CarMax Group common stock outstanding.
Diluted net earnings per share from discontinued operations attributed to
CarMax Group common stock is computed by dividing net earnings from
discontinued operations attributed to CarMax Group common stock by the sum
of the weighted average number of shares of CarMax Group common stock
outstanding and the dilutive potential CarMax Group common stock. CarMax
became an independent, separately traded public company on October 1, 2002.
All CarMax results prior to the separation date are presented as results
from discontinued operations.
Reconciliations of the numerator and denominator of the basic and diluted
net earnings per share calculations for the CarMax Group are presented
below.
(Amounts in thousands Three Months Ended Six Months Ended
except per share data) August 31, 2002 August 31, 2002
----------------------------------------------------------- ---------------------- --------------------
Weighted average common shares............................. 37,065 37,013
Dilutive potential common shares:
Options................................................. 1,548 1,697
Restricted stock........................................ 5 12
------ ------
Weighted average common shares and
dilutive potential common shares........................ 38,618 38,722
====== ======
Net earnings available to common shareholders.............. $11,416 $21,932
Basic net earnings per share............................... $ 0.31 $ 0.59
Diluted net earnings per share............................. $ 0.30 $ 0.57
8. Restricted Cash
Cash and cash equivalents held by the company's regulated subsidiaries and
not available for general corporate purposes were $102.1 million at August
31, 2003, and $48.8 million at February 28, 2003.
9. Common Stock Repurchased
In January 2003, the company's board of directors authorized the repurchase
of up to $200 million of common stock. As of August 31, 2003, the company
had repurchased and retired approximately 2.7 million shares of common
stock at a cost of $13.9 million. Based on the market value of the common
stock at August 31, 2003, the remaining $186.1 million authorized would
allow the company to repurchase up to approximately 9 percent of the 209.5
million shares then outstanding.
Page 10 of 34
10. Securitizations
The company enters into securitization transactions to finance credit card
receivables originated by its finance operations. The company has created
two special purpose subsidiaries to facilitate these securitization
transactions in accordance with the isolation provisions of SFAS No. 140.
The finance operations sell credit card receivables to the special purpose
subsidiaries, which, in turn, sell these receivables to securitization
master trusts. At the time of these sales, the company recognizes gains or
losses as a component of finance income. See Note 4. Private-label and
co-branded Visa credit card receivables, collectively referred to as
private-label receivables, are securitized through one master trust, and
MasterCard and Visa credit card receivables, collectively referred to as
bankcard receivables, are securitized through a separate master trust.
The company has plans to sell its bankcard operation and expects to
complete the sale before the end of the calendar year. The company may
continue to provide transition services required by a prospective
purchaser.
Each master trust periodically issues securities backed by the receivables
in that master trust. Each master trust has issued multiple series of term
asset-backed securities having fixed initial principal amounts. In
addition, each master trust has issued a series of variable funding
asset-backed securities having a variable principal amount. Investors in
the variable funding asset-backed securities are generally entitled to
receive monthly interest payments and have committed to acquire additional
variable funding interests up to a stated amount until a stated commitment
termination date. Neither master trust agreement provides for recourse to
the company for credit losses on the securitized receivables. However, the
fair value of the company's retained interests in securitized receivables
will be directly affected by credit losses on those securitized
receivables. The finance operations continue to service the securitized
receivables for a fee.
Circuit City retains the rights to receive the excess of the finance
charges and fees generated by the securitized receivables over the related
interest paid to investors, servicing costs and credit losses. The company
also holds various subordinated asset-backed securities, which serve as
credit enhancement for the asset-backed securities held by third-party
investors.
The securitization agreements require that the aggregate outstanding
principal balance of the securitized receivables exceed a specified amount
and that the yield on the securitized receivables exceed specified rates.
In addition, the variable funding securitization agreements require that
the company meet financial tests relating to minimum tangible net worth,
current ratios and debt-to-capital ratios and that the securitized
receivables meet specified performance levels relating to delinquency rates
and principal payment rates. If these financial tests or performance levels
are not met, or if certain other events occur, it would constitute an early
amortization event, in which case the principal payment dates for the term
series would be accelerated, the variable funding commitments would
terminate and the variable funding investors would begin to receive monthly
principal payments until paid in full. The company and the securitized
receivables were in compliance with these financial tests and performance
levels at August 31, 2003.
The finance operations receive annual servicing fees approximating 2
percent of the outstanding principal balance of the securitized
receivables. The servicing fees specified in the securitization agreements
adequately compensate the finance operations for servicing the securitized
receivables. Accordingly, no servicing asset or liability has been
recorded.
Page 11 of 34
(A)Private-Label:
At August 31 At February 28
(Dollar amounts in millions) 2003 2003
------------------------------------------------------------------------------- ------------- ---------------
Total principal amount of credit card receivables managed...................... $1,595.5 $1,636.1
Principal amount of receivables securitized.................................... $1,569.2 $1,592.2
Principal amount of receivables held for sale.................................. $ 26.3 $ 43.9
Unused capacity of the private-label variable funding program.................. $ 90.9 $ 29.5
Aggregate receivables 31 days or more delinquent............................... $ 88.6 $ 72.1
Aggregate receivables 31 days or more delinquent as a percent
of total principal amount of credit card receivables managed................ 5.6% 4.4%
The principal amount of defaults net of recoveries was $25.1 million for
the three-month period ended August 31, 2003, and $16.7 million for the
three-month period ended August 31, 2002. For the three months ended August
31, 2003, serviced receivables averaged $1,559.7 million, compared with
$1,289.2 million for the same period last fiscal year. The principal amount
of defaults net of recoveries as an annualized percent of average serviced
receivables was 6.4 percent for the three-month period ended August 31,
2003, and 5.2 percent for the three-month period ended August 31, 2002.
The principal amount of defaults net of recoveries was $47.6 million for
the six-month period ended August 31, 2003, and $34.2 million for the
six-month period ended August 31, 2002. For the six months ended August 31,
2003, serviced receivables averaged $1,564.2 million, compared with
$1,292.9 million for the same period last fiscal year. The principal amount
of defaults net of recoveries as an annualized percent of average serviced
receivables was 6.1 percent for the six-month period ended August 31, 2003,
and 5.3 percent for the six-month period ended August 31, 2002.
No new private-label credit card receivable securitization transactions
were completed during the second quarter of fiscal 2004. The company
completed a $500 million private-label credit card receivable
securitization transaction during the first quarter of fiscal 2004 to
replace maturing term securitizations. In addition, the company renewed its
private-label variable funding program, which the company also refers to as
a warehouse conduit, during the first quarter of fiscal 2004. The company
completed a $300 million private-label credit card receivable
securitization transaction during the first quarter of fiscal 2003 to
replace maturing term securitizations.
The following table summarizes cash flows received from and paid to the
securitization trust.
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in millions) 2003 2002 2003 2002
----------------------------------------------------------- ------------------ ------------------
Proceeds from new securitizations.......................... $ 52.5 $192.0* $ 88.1 $422.0*
Proceeds from collections reinvested
in previous credit card securitizations................ $543.8 $257.0* $870.7 $420.3*
Servicing fees received.................................... $ 7.7 $ 5.7 $ 15.1 $ 11.4
Other cash flows received on
retained interests**................................... $ 30.8 $ 19.8 $ 61.9 $ 46.0
*To be consistent with the fiscal 2004 presentation, the fiscal 2003
amounts reflect changes in the presentation of securitization cash flows.
**This amount represents cash flows received from retained interests other
than servicing fees, including cash flows from the interest-only strip and
cash above the minimum required level in cash collateral accounts.
In accordance with the allocated carrying value method as prescribed by
SFAS No. 140, gains on sales of receivables sold to the securitization
trusts were $12.9 million for the quarter ended August 31, 2003, and $19.5
million for the quarter ended August 31, 2002. Gains on sales of
receivables sold to the securitization trusts were $21.9 million for the
six months ended August 31, 2003, and $33.0 million for the six months
ended August 31, 2002.
Page 12 of 34
The sum of the excess cash flows from receivables that are sold to the
securitization trust is referred to as an interest-only strip and is
carried at fair value based on estimates of these future cash flows. When
determining the fair value of the interest-only strip, the company
estimates future cash flows using estimates of key assumptions such as
finance charge income; charge-offs, net of recoveries; payment rates; and
discount rates appropriate for the type of asset and risk. Expected future
cash flows also are based upon the market's expectation about future
movements in interest rates as reflected in forward interest rate curves.
Retained interests in securitized private-label receivables are comprised
of the following components.
(Amounts in millions) At August 31, 2003 At February 28, 2003
------------------------------------------------------ -------------------- ----------------------
Interest-only strip................................... $ 90.9 $ 79.1
Subordinated securities............................... 276.9 160.1
------ ------
Retained interests in securitized
private-label receivables.......................... $367.8 $239.2
====== ======
At August 31, 2003, the weighted-average life of the retained interests in
securitized receivables ranged from 0.3 years to 1.6 years. At February 28,
2003, the weighted-average life of the retained interests in securitized
receivables ranged from 0.5 years to 2.2 years.
The following tables present the key economic assumptions used in measuring
the fair value of private-label retained interests at August 31, 2003, and
February 28, 2003, and a sensitivity analysis showing the hypothetical
effect on the fair value of those interests when there are unfavorable
variations from the assumptions used. Key valuation assumptions at August
31, 2003, and February 28, 2003, are based on portfolio performance and
market conditions. The discount rates are used to calculate the fair value
of the subordinated asset-backed securities and the interest-only strip.
The subordinated asset-backed securities were valued primarily using a
discount rate of 9 percent. The interest-only strip was valued with a 15
percent discount rate. The default rates used in valuing the interest-only
strip are forecasted for future months and represent a loss curve
associated with a static pool of receivables. The ranges provided in the
tables below reflect the high and low months on the loss curve. The
weighted average default rates are weighted by the relative receivable
balance for each month and incorporate an adjustment for net present value.
These sensitivities are hypothetical and should be used with caution. In
the following tables, the effect of a variation in a particular assumption
on the fair value of the private-label retained interests is calculated
without changing any other assumption; in actual circumstances, changes in
one factor may result in changes in another, which might magnify or
counteract the sensitivities.
At August 31, 2003
Impact on Fair Impact on Fair
Assumptions Weighted-Average Value of 10% Value of 20%
(Dollar amounts in millions) Used Assumptions Adverse Change Adverse Change
---------------------------------- -------------------------------------------------------------------------------------
Monthly payment rate.............. 11.3% 11.3% $4.9 $ 9.8
Annual default rate............... 7.1%-13.3% 9.5% $7.4 $14.6
Annual discount rate.............. 5.1%-15.0% 9.8% $3.4 $ 6.7
At February 28, 2003
Impact on Fair Impact on Fair
Assumptions Weighted-Average Value of 10% Value of 20%
(Dollar amounts in millions) Used Assumptions Adverse Change Adverse Change
---------------------------------- -------------------------------------------------------------------------------------
Monthly payment rate.............. 10.9% 10.9% $6.1 $10.7
Annual default rate............... 7.1%-12.9% 8.9% $7.1 $14.2
Annual discount rate.............. 8.3%-15.0% 10.7% $1.6 $ 3.2
Page 13 of 34
(B)Bankcard:
At August 31 At February 28
(Dollar amounts in millions) 2003 2003
-------------------------------------------------------------------------------- ---------------- ------------------
Total principal amount of credit card receivables managed....................... $1,420.6 $1,537.8
Principal amount of receivables securitized..................................... $1,380.6 $1,527.0
Principal amount of receivables held for sale................................... $ 40.1 $ 10.7
Unused capacity of the bankcard variable funding program........................ $ 129.1 $ 166.8
Aggregate receivables 31 days or more delinquent................................ $ 120.2 $ 127.9
Aggregate receivables 31 days or more delinquent as a percent of
total principal amount of credit card receivables managed.................... 8.5% 8.3%
The principal amount of defaults net of recoveries was $54.4 million for
the three-month period ended August 31, 2003, and $46.2 million for the
three-month period ended August 31, 2002. For the three months ended August
31, 2003, serviced receivables averaged $1,451.0 million, compared with
$1,490.5 million for the same period last fiscal year. The principal amount
of defaults net of recoveries as an annualized percent of average serviced
receivables was 15.0 percent for the three-month period ended August 31,
2003, and 12.4 percent for the three-month period ended August 31, 2002.
The principal amount of defaults net of recoveries was $110.9 million for
the six-month period ended August 31, 2003, and $99.6 million for the
six-month period ended August 31, 2002. For the six months ended August 31,
2003, serviced receivables averaged $1,477.0 million, compared with
$1,493.0 million for the same period last fiscal year. The principal amount
of defaults net of recoveries as an annualized percent of average serviced
receivables was 15.0 percent for the six-month period ended August 31,
2003, and 13.3 percent for the six-month period ended August 31, 2002.
No new bankcard receivable securitization transactions were completed
during the second quarter of fiscal 2004. The company completed a $550
million bankcard receivable securitization transaction during the first
quarter of fiscal 2004 to replace maturing term securitizations. In
addition, the company renewed its bankcard variable funding program, which
the company also refers to as a warehouse conduit, during the first quarter
of fiscal 2004. The company completed a $470 million bankcard receivable
securitization transaction during the second quarter of fiscal 2003 to
replace maturing term securitizations.
The following table summarizes cash flows received from and paid to the
securitization trust.
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in millions) 2003 2002 2003 2002
----------------------------------------------------------- --------------------- -----------------------
Proceeds from new securitizations.......................... $ - $155.2* $ 56.7 $285.2*
Proceeds from collections reinvested
in previous credit card securitizations................ $262.1 $147.8* $385.5 $310.7*
Servicing fees received.................................... $ 6.8 $ 6.7 $ 14.0 $ 13.9
Other cash flows received on
retained interests**................................... $ 7.4 $ 23.8 $ 18.8 $ 48.2
*To be consistent with the fiscal 2004 presentation, the fiscal 2003
amounts reflect changes in the presentation of securitization cash flows.
**This amount represents cash flows received from retained interests other
than servicing fees, including cash flows from the interest-only strip and
cash above the minimum required level in cash collateral accounts.
In accordance with the allocated carrying value method as prescribed by
SFAS No. 140, losses on sales of receivables sold to the securitization
trusts were $2.4 million for the quarter ended August 31, 2003, compared
with gains on sales of receivables of $1.6 million for the quarter ended
August 31, 2002. Losses on sales of receivables sold to the securitization
trusts were $4.4 million for the six months ended August 31, 2003, compared
with gains on sales of receivables of $6.3 million for the six months ended
August 31, 2002.
Page 14 of 34
At August 31, 2003, the fair value of the retained interests in securitized
bankcard receivables was $250.0 million. The fair value of the retained
interests in the bankcard portfolio at August 31, 2003, was determined
based on the estimated net proceeds from the planned sale of the bankcard
operation. At February 28, 2003, the fair value of the retained interests
in securitized bankcard receivables was $321.0 million. The fair value of
the retained interests in the bankcard portfolio at February 28, 2003, was
determined based on the present value of expected future cash flows.
11. Financial Derivatives
The company enters into interest rate cap agreements in connection with its
private-label receivable securitization transactions. During the first six
months of fiscal 2004, the company did not purchase or sell any interest
rate caps. The total notional amount of interest rate caps outstanding was
$512.9 million at August 31, 2003, and at February 28, 2003. Purchased
interest rate caps are included in net accounts receivable on the
consolidated balance sheets and had a fair value of $5.6 million at August
31, 2003, and $4.2 million at February 28, 2003. Written interest rate caps
are included in accounts payable on the consolidated balance sheets and had
a fair value of $5.6 million at August 31, 2003, and $4.2 million at
February 28, 2003.
The market and credit risks associated with interest rate caps are similar
to those relating to other types of financial instruments. Market risk is
the exposure created by potential fluctuations in interest rates and is
directly related to the product type, agreement terms and transaction
volume. The company has entered into offsetting interest rate cap positions
and, therefore, does not anticipate significant market risk arising from
interest rate caps. Credit risk is the exposure to nonperformance of
another party to an agreement. The company mitigates credit risk by dealing
with highly rated bank counterparties.
12. Recent Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board issued Emerging
Issues Task Force No. 00-21, "Accounting for Revenue Arrangements with
Multiple Deliverables." EITF No. 00-21 addresses when and how an
arrangement involving multiple deliverables should be divided into separate
units of accounting, as well as how the arrangement consideration should be
measured and allocated to the separate units of accounting in the
arrangement. The provisions of EITF No. 00-21 will be effective for the
company's third quarter of fiscal 2004. The company does not expect the
adoption of this standard to have a material impact on the company's
financial position, results of operations or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities." FIN No. 46 addresses how to identify
variable interest entities and provides guidance as to how a company may
assess its interests in a variable interest entity for purposes of deciding
whether consolidation of that entity is required. Effective September 1,
2003, the company adopted FIN No. 46. The adoption of this standard did not
have a material impact on the company's financial position, results of
operations or cash flows.
13. Segment Information
Due to changes in the management reporting structure that occurred during
the first quarter of fiscal 2004, the company has identified its retail
operation and its finance operations as reportable segments in accordance
with the provisions of SFAS No. 131, "Segment Reporting." These segments
are identified and managed by the company based on the company's management
reporting structure and on the nature of the products and services offered
by each segment. The retail operation segment is engaged in the business of
selling brand-name consumer electronics, personal computers and
entertainment software. The finance operations issue and service bankcard
and private-label credit cards, including a co-branded Visa credit card.
The finance operations are conducted through the company's wholly owned
subsidiary First North American National Bank, which is a limited-purpose
credit card bank. FNANB sells its credit card receivables to consolidated
special purpose subsidiaries wholly owned by the company, which, in
Page 15 of 34
turn, sell these receivables to securitization master trusts that are
off-balance-sheet qualifying special purpose entities. See Note 4 and Note
10 for additional discussion of the finance operations.
The company's finance operations segment is evaluated by management on a
pretax basis. The company includes substantially all depreciation and
amortization and interest expense within the retail operation segment. The
accounting policies of the segments are the same as those set forth in Note
2 to the company's audited consolidated financial statements incorporated
by reference in the company's fiscal 2003 Annual Report on Form 10-K.
Revenue by reportable segment and the reconciliation to the consolidated
statements of operations were as follows:
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in millions) 2003 2002 2003 2002
---------------------------------------------------------- -------------------- ------------------------
Retail operation.......................................... $2,155.7 $2,221.2 $4,089.0 $4,339.4
Finance operations........................................ (104.4) 55.5 (91.3) 106.0
-------------------- ------------------------
Total revenue............................................. 2,051.3 2,276.7 3,997.7 4,445.4
Less: finance operations revenue not included
in net sales and operating revenues*................. (104.4) 55.5 (91.3) 106.0
-------------------- ------------------------
Net sales and operating revenues ......................... $2,155.7 $2,221.2 $4,089.0 $4,339.4
==================== ========================
*Finance operations revenue is included in finance (loss) income, which is
reported separately on the statements of operations.
(Loss) earnings from continuing operations before income taxes by
reportable segment and the reconciliation to the consolidated statements of
operations were as follows:
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in millions) 2003 2002 2003 2002
---------------------------------------------------------- ------------------------ ----------------------
Retail operation*......................................... $ (60.1) $(44.0) $(109.4) $(66.5)
Finance operations........................................ (133.3) 26.0 (155.4) 46.4
------------------------ ----------------------
Loss from continuing operations before income
taxes................................................. $(193.4) $(18.0) $(264.8) $(20.1)
======================== ======================
*All corporate expenses are included in the retail operation.
Total assets by reportable segment and the reconciliation to the
consolidated balance sheets were as follows:
At August 31 At February 28
(Amounts in millions) 2003 2003
--------------------------------------------------------- ------------- ----------------
Retail operation......................................... $4,542.8 $4,439.7
Finance operations....................................... 1,318.5 762.4
-------- --------
Total assets before intercompany eliminations............ 5,861.3 5,202.1
Less: intercompany eliminations......................... 2,140.9 1,403.0
-------- --------
Total assets............................................. $3,720.4 $3,799.1
======== ========
14. Reclassifications
Certain prior year amounts have been reclassified to conform to the current
presentation.
Page 16 of 34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
From February 7, 1997, to October 1, 2002, the common stock of Circuit City
Stores, Inc. consisted of two common stock series that were intended to reflect
the performance of our two businesses. The Circuit City Group common stock was
intended to reflect the performance of the Circuit City consumer electronics
stores and related operations and the shares of CarMax Group common stock
reserved for the Circuit City Group or for issuance to holders of Circuit City
Group common stock. The CarMax Group common stock was intended to reflect the
performance of the CarMax auto superstores and related operations.
Effective October 1, 2002, the CarMax auto superstore business was separated
from the Circuit City consumer electronics business through a tax-free
transaction in which CarMax, Inc., formerly a wholly owned subsidiary of Circuit
City Stores, Inc., became an independent, separately traded public company.
Following the separation, the Circuit City Group common stock was renamed
Circuit City common stock. All CarMax results prior to the separation date are
presented as results from discontinued operations. See Note 3 for an additional
discussion of the separation.
As of August 31, 2002, 65,923,200 shares of CarMax Group common stock were
reserved for the Circuit City Group or for issuance to holders of Circuit City
Group common stock. Excluding shares reserved for CarMax employee stock
incentive plans, the reserved CarMax Group shares represented 64.0 percent of
the total outstanding and reserved shares of CarMax Group common stock at August
31, 2002.
We announced plans to sell our bankcard operation in August 2003. We have
received bids for the bankcard operation from a number of interested parties.
While the sales process is not final, based on these bids, we expect to incur a
loss on the sale of the bankcard operation of approximately $163 million,
approximately $105 million after income taxes or 51 cents per share. Of the
total estimated loss, $148 million, approximately $95 million after income
taxes, has been reflected in the second quarter. The remaining $15 million,
approximately $10 million after income taxes, includes anticipated lease
termination and severance costs. We expect the sale of the bankcard operation to
generate approximately $295 million in cash. We expect to complete the sale
before the end of the calendar year. Timing for presentation of the bankcard
business as a discontinued operation on our consolidated financial statements
may be affected by the extent and duration of transition services required by a
prospective purchaser.
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies under Management's Discussion
and Analysis of Results of Operations and Financial Condition incorporated by
reference in our fiscal 2003 Annual Report on Form 10-K. These policies relate
to the calculation of the value of retained interests in securitization
transactions, the calculation of the liability for lease termination costs,
accounting for pension liabilities and accounting for cash consideration
received from vendors. The fair value of the retained interests in securitized
private-label receivables at August 31, 2003, and at February 28, 2003, was
based on the present value of expected future cash flows. The fair value of the
retained interests in securitized bankcard receivables at February 28, 2003,
also was based on the present value of expected future cash flows. Due to our
decision to sell the bankcard operation, the fair value of the retained
interests in securitized bankcard receivables at August 31, 2003, was based on
the estimated net proceeds from the planned sale of the bankcard operation.
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.
Page 17 of 34
Non-GAAP Financial Measures
In this Management's Discussion and Analysis, we present information that
includes and excludes individual cost items to provide greater understanding of
the effects of these items on our operating performance. These operating
performance measures provide a basis for investors to evaluate our performance
and financial position. Our method of computing these measures may differ from
the methods used by other companies. In addition, these measures do not replace
financial measures computed in accordance with accounting principles generally
accepted in the United States of America as a measure of our results of
operations and financial condition.
Net Sales and Operating Revenues
Total sales for the second quarter of fiscal 2004 decreased 3 percent to $2.16
billion from $2.22 billion in last fiscal year's second quarter. Comparable
store sales decreased 5 percent for the second quarter of fiscal 2004. Total
sales for the first six months of fiscal 2004 decreased 6 percent to $4.09
billion from $4.34 billion for the first six months of last fiscal year.
Comparable store sales decreased 7 percent for the first six months of fiscal
2004. A store is included in comparable store sales after the store has been
open for a full year. Relocated stores are included immediately in the
comparable store base.
Our sales pace during the first two months of the quarter reflected significant
drops in average retail prices as well as slight declines in store traffic. The
sales pace improved in virtually all categories during the month of August, when
we produced a comparable store sales increase of 1 percent against a strong
prior year increase of 12 percent. Throughout the quarter, we generated strong
sales growth in new video technologies, including digital big-screens and LCD
and plasma thin-screen products; digital imaging; and DVD movie titles. The
strengthening during the month of August was especially pronounced in
back-to-school products such as personal computer hardware and software, game
software, wireless communications, portable audio and portable video. We believe
that these categories all benefited from a new back-to-school advertising
program, including both print and television, that helped drive traffic
increases. At the end of the quarter, we successfully completed our transition
to two new wireless carriers - Verizon Wireless and T-Mobile USA.
The percent of merchandise sales represented by each major product category for
the three- and six-month periods ended August 31, 2003 and 2002 was as follows:
Three Months Ended Six Months Ended
August 31 August 31
2003 2002 2003 2002
---------------------- ----------------------
Video..................................................... 39% 39% 39% 39%
Audio..................................................... 14 14 14 15
Information technology.................................... 36 36 35 35
Entertainment............................................. 11 11 12 11
---------------------- ----------------------
Total..................................................... 100% 100% 100% 100%
====================== ======================
We sell extended warranty programs on behalf of unrelated third parties that are
the primary obligors. Under these third-party warranty programs, we have no
contractual liability to the customer. The total extended warranty revenue
included in total sales was $77.8 million, or 3.6 percent of sales, in the
second quarter of fiscal 2004, compared with $84.0 million, or 3.8 percent of
sales, in last fiscal year's second quarter. The total extended warranty revenue
included in total sales was $150.2 million, or 3.7 percent of sales, in the
first half of fiscal 2004, compared with $171.9 million, or 4.0 percent of
sales, in last fiscal year's second half. The decrease primarily is due to
declines in average retail prices, which result in consumers purchasing warranty
contracts on fewer products.
Page 18 of 34
The following table provides details on our retail units:
Aug. 31, 2003 Feb. 28, 2003 Aug. 31, 2002
------------- ------------- -------------
Superstores....................................... 612 611 606
Mall-based Express stores......................... 13 15 17
--- --- ---
Total............................................. 625 626 623
=== === ===
We expect to open approximately 10 Superstores and relocate 15 Superstores to 18
Superstores in the current fiscal year. In the second quarter of fiscal 2004, we
opened one Superstore, relocated one Superstore, fully remodeled three
Superstores and closed two mall-based Express stores. For the first half of
fiscal 2004, we opened one Superstore, relocated four Superstores, fully
remodeled four Superstores and closed two mall-based Express stores.
The following table provides details on our fiscal 2004 new, relocated and fully
remodeled Superstores.
First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal 2004
Actual Actual Estimated Estimated Estimated
-------------------------------------- ------------------------------------------------------------------------------------------
New Superstores....................... - 1 6 3 10
Relocated Superstores................. 3 1 6 5 - 8 15 - 18
Fully remodeled Superstores........... 1 3 - - 4
------------------------------------------------------------------------------------------
Total................................. 4 5 12 8 - 11 29 - 32
==========================================================================================
Cost of Sales, Buying and Warehousing
The gross profit margin was 22.6 percent of sales in the second quarter of
fiscal 2004, compared with 23.7 percent in the same period last fiscal year. For
the first six months of fiscal 2004, the gross profit margin was 22.9 percent of
sales, compared with 23.9 percent for the same period last fiscal year. The
lower gross profit margin reflects competitive pricing and shifts in the
merchandise mix within the major product categories; increased inventory shrink
as we move more product onto the sales floor; and the reduction in extended
warranty sales, which carry above average gross profit margins.
Finance (Loss) Income
Our finance operations are conducted through our wholly owned subsidiary First
North American National Bank, which is a limited-purpose credit card bank. FNANB
sells its credit card receivables to consolidated, special purpose, wholly owned
subsidiaries which, in turn, sell these receivables to securitization master
trusts that are off-balance-sheet qualifying special purpose entities. We
collectively refer to the private-label and the co-branded Visa credit card
programs as the private-label program, and we collectively refer to the
MasterCard and Visa credit card programs as the bankcard program. We have plans
to sell our bankcard operation and expect to complete the sale before the end of
the calendar year.
We securitize the private-label credit card receivables through one master trust
and the bankcard receivables through a separate master trust. At August 31,
2003, approximately 58 percent of the total principal amount of private-label
receivables outstanding had been created under the co-branded Visa credit card
program. At February 28, 2003, approximately 47 percent of the total principal
amount of private-label receivables outstanding had been created under the
co-branded Visa credit card program. We expect that principal receivables
created under the co-branded Visa credit card program will continue to represent
a greater percentage of the private-label principal receivables.
Securitizations are accounted for as sales in accordance with Statement of
Financial Accounting Standards No. 140, and securitization income is recognized
at the time the receivables are securitized. Gains or losses on sales of
receivables primarily reflect the difference between the carrying amount of the
receivables sold and the sum of the cash proceeds received and the fair value of
the retained interests in the securitized receivables. When receivables are
sold, we receive cash, retain subordinated securities and retain rights to
Page 19 of 34
receive the excess cash flows, referred to as interest-only strips, that the
receivables will produce during their life. The excess cash flows represent the
excess of the finance charges and fees generated by the securitized receivables
over the related interest paid to investors, servicing costs and credit losses.
We continue to service the securitized receivables for a fee. For the three- and
six-month periods ended August 31, 2003, serviced private-label receivables
averaged $1.56 billion, compared with $1.29 billion for the same periods last
fiscal year. Serviced bankcard receivables averaged $1.45 billion for the three
months ended August 31, 2003, compared with $1.49 billion for the same period
last fiscal year. For the six months ended August 31, 2003, serviced bankcard
receivables averaged $1.48 billion, compared with $1.49 billion for the six
months ended August 31, 2002.
The finance operations produced a pretax loss of $133.3 million in this year's
second quarter, compared with pretax income of $26.0 million in the same period
last fiscal year. This year's second quarter loss includes pretax income of $9.0
million from the private-label credit card operation, compared with pretax
income of $13.2 million in last fiscal year's second quarter. Private-label
securitization income was reduced by increased charge-offs, which were partly
offset by increased finance charge collections in this year's second quarter.
Other direct expenses increased as the number of active private-label accounts
increased.
This year's second quarter finance loss also includes a pretax loss of $142.3
million from the bankcard operation, compared with pretax income of $12.8
million in the same period last fiscal year. This year's second quarter pretax
loss from the bankcard operation includes pretax charges of $148.0 million to
reduce the carrying value of our retained interests in the bankcard portfolio to
reflect the estimated net proceeds from the planned sale of the bankcard
operation. In connection with the planned sale, we expect to incur additional
pretax charges, including lease termination and severance costs, of
approximately $15 million.
The fair value of the private-label interest-only strip totaled $90.9 million at
August 31, 2003, and $79.1 million at February 28, 2003. The increase in the
fair value of the interest-only strip was primarily due to an increase in the
amount of receivables in the master trust that were impacted by the
implementation of discounting. We began to sell private-label receivables to the
master trust at a discount in December 2002. As a result, 2 percent of the
principal amount of receivables sold on or after December 1, 2002, are treated
as finance charge receivables in the securitization trust and collections of
those receivables are treated as finance charge collections, thereby boosting
yield to the securitization trust. This causes an increase in the fair value of
the interest-only strip and a corresponding decrease in proceeds received on the
sale of receivables.
When determining the fair value of the private-label interest-only strip, we
estimate future cash flows using estimates of key assumptions such as finance
charge income; charge-offs, net of recoveries; payment rates; and discount rates
appropriate for the type of asset and risk. Expected future cash flows also are
based upon the market's expectation about future movements in interest rates as
reflected in forward interest rate curves. We review the assumptions and
estimates used in determining the fair value of the private-label interest-only
strip on a quarterly basis. If the assumptions change or the actual results
differ from the projected results, securitization income will be affected.
Finance income is reduced by payroll, fringe benefits and other costs directly
associated with the management and securitization of the credit card portfolios.
Payroll and fringe benefit expenses generally vary with the amount of serviced
receivables. Other direct expenses include third-party data processing fees,
rent, credit promotion expenses, Visa and MasterCard fees and other operating
expenses. Finance income does not include any allocation of indirect costs or
income. Examples of indirect costs not included are corporate expenses such as
human resources, administrative services, marketing, information systems,
accounting, legal, treasury and executive payroll, as well as retail store
expenses. See Note 1, Note 4, Note 10 and Note 13 to the consolidated financial
statements in this report for additional information about our finance
operations.
Selling, General and Administrative Expenses
The selling, general and administrative expense ratio was 25.4 percent of sales
in the second quarter of fiscal 2004, compared with 25.6 percent for the same
period last fiscal year. For the first six months of both fiscal
Page 20 of 34
2004 and fiscal 2003, the ratio was 25.5 percent of sales. Interest income
recorded as a reduction to selling, general and administrative expenses was $1.7
million for the three-month period ended August 31, 2003, compared with $2.2
million for the same period last fiscal year. For the six months ended August
31, 2003, interest income was $4.1 million, compared with $5.0 million for the
same period last fiscal year.
Reductions in payroll and fringe benefits were the largest contributors to the
second quarter expense reduction. The second quarter expense savings also
reflect a shift in advertising expenditures from the lower volume periods of the
year, which included the first two months of the second quarter, to the higher
volume back-to-school and holiday periods. Savings from payroll, fringe benefits
and advertising were partly offset by higher rent and occupancy expenses related
to new and relocated stores and costs associated with new merchandising
displays. Improvement in the expense ratio was limited by the sales decline.
The fiscal 2004 second quarter expenses included $18.2 million of remodel costs
and $4.0 million of relocation costs, and the fiscal 2003 second quarter
expenses included $21.3 million of remodel costs and $4.5 million of relocation
costs. Remodeling and relocation costs for the second quarter of fiscal 2004
included accelerated depreciation on assets planned to be taken out of service
as a result of the store remodeling and relocation program. As of August 31,
2003, we had relocated one Superstore in each of the St. Louis, Mo.; Chicago,
Ill.; Fort Myers, Fla.; and Harrisonburg, Va. markets, fully remodeled one
Superstore in each of the Los Angeles, Calif.; and San Francisco, Calif.,
markets and two Superstores in the Washington, D.C. market, and completed the
refixturing of 217 Superstores. Pre-opening expenses, including marketing,
payroll, and building maintenance and utility costs, for new and relocated
stores were $1.4 million for the three months ended August 31, 2003, and $3.1
million for the six months ended August 31, 2003. As of August 31, 2002, we had
relocated two Superstores, completed more than 225 of the approximately 300
video department remodels planned for fiscal 2003 and completed substantially
all of the approximately 300 full-store lighting upgrades scheduled for
completion during fiscal 2003. Pre-opening expenses for new and relocated stores
were $2.1 million for the three months ended August 31, 2002, and $2.8 million
for the six months ended August 31, 2002.
Excluding remodel and relocation expenses, the selling, general and
administrative expense ratio for the second quarter was 24.4 percent of sales
this year, compared with 24.5 percent in last fiscal year's second quarter. For
these same periods, selling, general and administrative expenses, excluding
remodel and relocation costs, declined $18.5 million, or 3 percent. For the
first half of fiscal 2004, the selling, general and administrative expense
ratio, excluding remodel and relocation expenses, was 24.6 percent, compared
with 24.7 percent in the first half of fiscal 2003.
The impact of remodel and relocation costs on the expense ratio is presented in
the following tables.
Three Months Ended
August 31
(Amounts in millions) 2003 2002
------------------------------------------------------------------ --------------------------------------------
Before remodel and relocation expenses............................ $525.0 24.4% $543.5 24.5%
Remodel expenses.................................................. 18.2 0.8 21.3 0.9
Relocation expenses............................................... 4.0 0.2 4.5 0.2
--------------------------------------------
Selling, general and administrative expenses...................... $547.2 25.4% $569.3 25.6%
============================================
Six Months Ended
August 31
(Amounts in millions) 2003 2002
------------------------------------------------------------------ ------------------------------------------------
Before remodel and relocation expenses............................ $1,005.1 24.6% $1,071.3 24.7%
Remodel expenses.................................................. 29.5 0.7 27.8 0.7
Relocation expenses............................................... 9.2 0.2 6.0 0.1
------------------------------------------------
Selling, general and administrative expenses...................... $1,043.8 25.5% $1,105.1 25.5%
================================================
Page 21 of 34
Interest Expense
Interest expense was $0.3 million for the three months ended August 31, 2003,
and $1.3 million for the six months ended August 31, 2003. Interest expense was
$0.6 million for both the three- and six-month periods ended August 31, 2002.
The increase in interest expense for the six months ended August 31, 2003,
reflects interest paid as a result of completed audits of prior year income tax
returns.
Income Taxes
The effective income tax rate was 35.8 percent for the three months ended August
31, 2003, and 36.5 percent for the six months ended August 31, 2003, compared
with 38.0 percent for the three- and six-month periods ended August 31, 2002.
The decrease is attributed to lower state and local income taxes.
Net (Loss) Earnings from Continuing Operations
The net loss from continuing operations was $124.2 million, or 60 cents per
share, in the second quarter ended August 31, 2003, compared with the net loss
from continuing operations of $11.2 million, or 5 cents per share, in the second
quarter of last fiscal year. For the six-month period ended August 31, 2003, the
net loss from continuing operations was $168.2 million, or 82 cents per share,
compared with the net loss from continuing operations of $12.4 million, or 6
cents per share, for the same period last fiscal year.
The net loss from continuing operations in this year's second quarter includes
the impact of pretax charges of $148.0 million to reduce the carrying value of
our retained interests in the bankcard portfolio to reflect the estimated net
proceeds from the planned sale of the bankcard operation, pretax expenses of
$18.2 million related to the full remodeling of three stores and the refixturing
of 208 stores and $4.0 million in pretax relocation expenses. The relocation
expenses include accelerated depreciation on assets planned to be taken out of
service as a result of future relocations. Excluding valuation reductions
related to the bankcard portfolio, the net loss per share from continuing
operations would have been 14 cents in this year's second quarter, compared with
4 cents in the same period last fiscal year. Second quarter fiscal 2004 and
second quarter fiscal 2003 remodel and relocation costs totaled 7 cents per
share. Excluding valuation reductions and the remodel and relocation expenses,
the net loss per share from continuing operations would have been 7 cents in
this year's second quarter, compared with net earnings per share of 3 cents in
last fiscal year's second quarter.
The net loss from continuing operations for the first six months of this fiscal
year includes the impact of the pretax valuation reductions of $177.9 million
related to the bankcard portfolio, pretax expenses of $29.5 million related to
the full remodeling of four stores and the refixturing of 217 stores and $9.2
million in pretax relocation expenses. Excluding valuation reductions related to
the bankcard portfolio, the net loss per share from continuing operations would
have been 27 cents in this year's first half, compared with 4 cents in the same
period last fiscal year. For the first six months of fiscal 2004, remodel and
relocation costs totaled 12 cents per share, compared with 10 cents per share
for the first six months of fiscal 2003. Excluding valuation reductions and the
remodel and relocation expenses, the net loss per share from continuing
operations would have been 15 cents in this year's first half, compared with net
earnings per share of 6 cents in last fiscal year's first half.
Page 22 of 34
The impact of the bankcard valuation reductions and the remodel and relocation
costs on the net loss per share from continuing operations is presented in the
following table.
Three Months Ended Six Months Ended
August 31 August 31
2003 2002 2003 2002
----------------------- ----------------------
Net (loss) earnings per share before bankcard
valuation reductions, remodel and
relocation expenses................................. $(0.07) $ 0.03 $(0.15) $ 0.06
Remodel expenses.......................................... (0.06) (0.06) 0.09) (0.08)
Relocation expenses....................................... (0.01) (0.01) (0.03) (0.02)
----------------------- ----------------------
Net loss per share before bankcard valuation
reductions........................................... (0.14) (0.04) (0.27) (0.04)
Bankcard valuation reductions*............................ (0.46) (0.01) (0.55) (0.02)
---------------------- ----------------------
Net loss per share from continuing operations............. $(0.60) $(0.05) $(0.82) $(0.06)
====================== ======================
* The bankcard valuation reductions for the periods ended August 31, 2003,
reflect the expected net cash proceeds from the planned sale of the bankcard
portfolio. The bankcard valuation reductions for the periods ended August 31,
2002, reflect projected cash flows from the bankcard portfolio.
Net Earnings from Discontinued Operations
On October 1, 2002, we completed the separation of the CarMax auto superstore
business from the Circuit City consumer electronics business through a tax-free
transaction in which CarMax, Inc., formerly a wholly owned subsidiary of Circuit
City Stores, Inc., became an independent, separately traded public company. All
CarMax results for periods prior to the separation date are presented as results
from discontinued operations. For the quarter ended August 31, 2002, net
earnings from the discontinued CarMax operations were $31.7 million. For the six
months ended August 31, 2002, net earnings from the discontinued CarMax
operations were $61.0 million.
Operations Outlook
In August 2003, we announced plans to sell the bankcard operation. Based on bids
received from a number of interested parties, we expect to incur an after-tax
loss of approximately $105 million, or 51 cents per share, $95 million of which
we recognized in the second quarter. The remaining $10 million includes
anticipated lease termination and severance costs. We expect the sale of the
bankcard operation to generate approximately $295 million in cash. We expect to
complete the sale of the bankcard operation by the end of the calendar year,
enabling us to further focus our attention on the core retail business and to
eliminate a source of earnings volatility from our business. Timing for
presentation of the bankcard business as a discontinued operation on our
consolidated financial statements will be affected by the extent and duration of
transition services required by a prospective purchaser. Our private-label
finance operation plays a strategic role in our operations, and therefore, any
analysis of options for the private-label operation, including a possible sale
or outsourcing arrangement, must reflect that role.
Our store revitalization program reflects the importance that we place on
improving sales as a means to drive earnings growth. While we are focused on
reducing our cost structure, we believe that the gross profit earned from
incremental sales combined with the fixed expense leverage resulting from higher
sales will also contribute to an increase in earnings. Our efforts to provide
superior consumer electronics solutions through the improved store base will
continue into fiscal 2005 and beyond.
At August 31, 2003, 111 Superstores, or 18 percent of our 612 Superstores, had
been newly constructed, relocated or fully remodeled since the beginning of
fiscal 2001. We expect that percentage to reach approximately 20 percent by the
end of the current fiscal year and approximately 30 percent by the end of next
fiscal year.
Page 23 of 34
We have identified approximately 100 trade areas that are suitable for new
stores. We have not announced a plan to build new stores in these trade areas,
but they represent potential for geographic expansion. We expect to open
approximately 10 new stores in the current fiscal year.
We now have 18 relocated stores that have been open for more than six months. In
the first full six months following grand opening, these 18 stores produced an
average sales lift that was 28 percentage points higher than the remainder of
the store base in the same time period and produced an internal rate of return
of approximately 20 percent. Based on these strong results, we accelerated our
relocation program to include 15 Superstores to 18 Superstores this fiscal year
and a target of 50 Superstores in the next fiscal year, primarily depending on
real estate availability. We anticipate that the results from our relocation
program may moderate as we relocate additional stores.
In addition to new construction, relocations and full remodels, our store
revitalization program also involves changes to existing store fixtures and
operations. During the first half of this fiscal year, we completed the
refixturing of 217 Superstores. We plan to complete the refixturing program in
the final five stores in the third quarter of the current fiscal year. The new
fixtures make virtually all products available on the sales floor and create
better product adjacencies. In February 2003, we simplified our store operating
model to reduce compensation costs and create a staffing model that supports the
way customers prefer to shop today.
We expect net cash expenditures and non-cash expenses related to remodeling,
relocations and refixturings to total approximately $140 million in this fiscal
year. We anticipate that approximately $80 million of that amount will be
capitalized and approximately $60 million will be expensed, reducing fiscal 2004
earnings per share by an estimated 21 cents. The capital expenditures are net of
landlord reimbursements for property improvement expenditures. The estimated
expense amount includes approximately $50 million of non-cash expenses for
leasehold impairment reserves on stores we plan to relocate and accelerated
depreciation on assets we plan to take out of service as a result of our
remodelings and relocations. As we continue to relocate stores, we expect to
incur additional leasehold termination costs, with the amount primarily
dependent on the length of remaining lease terms and sublease opportunities.
Recent Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board issued Emerging
Issues Task Force No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF No. 00-21 addresses when and how an arrangement involving
multiple deliverables should be divided into separate units of accounting, as
well as how the arrangement consideration should be measured and allocated to
the separate units of accounting in the arrangement. The provisions of EITF No.
00-21 will be effective for our third quarter of fiscal 2004. We do not expect
the adoption of this standard to have a material impact on our financial
position, results of operations or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities." FIN No. 46 addresses how to identify variable
interest entities and provides guidance as to how a company may assess its
interests in a variable interest entity for purposes of deciding whether
consolidation of that entity is required. Effective September 1, 2003, we
adopted FIN No. 46. The adoption of this standard did not have a material impact
on our financial position, results of operations or cash flows.
FINANCIAL CONDITION
Liquidity and Capital Resources
At August 31, 2003, we had cash and cash equivalents of $633.1 million, compared
with $884.7 million at February 28, 2003. The lower cash balance primarily
reflects the merchandise inventory increase related to anticipated increased
sales during the back-to-school and holiday seasons.
Operating Activities. In the six months ended August 31, 2003, Circuit City used
net cash of $155.5 million in operating activities, compared with net cash of
$379.5 million used in the six months ended August 31, 2002.
Page 24 of 34
The net cash used of $155.5 million is primarily due to the net loss, the
increase in merchandise inventory and the increase in retained interests in
securitized receivables, partially offset by the increase in accounts payable.
Merchandise inventory increased $144.7 million in the first six months of fiscal
2004, compared with an increase of $423.1 million in the same period last fiscal
year. The $278.4 million difference primarily reflects the fiscal 2003 inventory
build occurring earlier than in the current fiscal year. Accounts payable
increased by $223.2 million in the first six months of fiscal 2004, compared
with an increase of $160.5 million in the first six months of last fiscal year.
The $62.7 million difference also relates to the earlier inventory build in
fiscal 2003.
Retained interests in securitized receivables increased by $57.6 million in the
first six months of this fiscal year, compared with an increase of $73.4 million
in the first six months of last fiscal year. The current year increase in
retained interests in securitized receivables reflects the new securitizations
entered into during the first quarter of this fiscal year, partly offset by the
$148.0 million of pretax valuation reductions related to the planned sale of the
bankcard operation. We completed a $550 million bankcard receivable
securitization transaction and a $500 million private-label credit card
receivable securitization transaction during the first quarter of fiscal 2004 to
replace maturing term securitizations. We also renewed variable funding
asset-backed securities programs, which we refer to as warehouse conduits,
during the first quarter of fiscal 2004. We completed a $470 million bankcard
receivable securitization transaction and a $300 million private-label credit
card receivable securitization transaction during the first half of fiscal 2003
to replace maturing term securitizations.
Investing Activities. Net cash used in investing activities was $73.6 million in
the six months ended August 31, 2003, compared with net cash of $59.6 million
used in investing activities in the first six months of last fiscal year.
Capital expenditures increased to $85.7 million in the first six months of
fiscal 2004 from $75.3 million in the comparable period last fiscal year.
Capital spending in the first six months of fiscal 2004 includes spending
related to the opening of one new Superstore, the relocation of four
Superstores, the remodeling of four Superstores and the refixturing of the
merchandise areas in 217 Superstores. Capital spending in the first half of
fiscal 2003 includes spending related to the opening of three new Superstores,
four relocated Superstores, video department remodeling in approximately 225
Superstores and full-store lighting upgrades in approximately 300 Superstores.
Financing Activities. Net cash used in financing activities was $22.5 million in
the first six months of both fiscal 2004 and fiscal 2003. In January 2003, our
board of directors authorized the repurchase of up to $200 million of common
stock. As of August 31, 2003, we had repurchased and retired 2.7 million shares
of common stock at a cost of $13.9 million. Based on the market value of the
common stock at August 31, 2003, the remaining $186.1 million authorized would
allow for the repurchase of up to approximately 9 percent of the 209.5 million
shares then outstanding.
On June 27, 2003, we entered into a $500 million, four-year revolving credit
facility secured by inventory and certain accounts receivables. This facility
will be used to support letters of credit as well as for short-term borrowing
needs and generally will bear interest at a spread over LIBOR or at prime. The
facility is scheduled to mature in June 2007 and provides for an option to
extend the facility by one year. The maximum credit extensions, including loans
and outstanding letters of credit, permitted under the credit facility on any
date will be determined using a borrowing base calculated as a percentage of our
eligible inventory and accounts receivable as of that date. If the remaining
borrowing availability under the facility falls below $100 million, cash
dividends and stock repurchases are limited to an aggregate of $75 million in
any fiscal year. In addition, if the difference between the borrowing base and
the outstanding credit extensions under the facility falls below $50 million for
five consecutive business days, all proceeds from the sale of inventory must be
applied on a daily basis to payment of amounts owed under the facility. The
facility has customary representations and warranties, covenants and events of
default. This credit facility replaced the $210 million in committed seasonal
lines, which were terminated on the same date. At August 31, 2003, there were no
short-term borrowings on this facility. At August 31, 2003, outstanding letters
of credit related to this facility were $43.6 million, leaving $456.4 million
available for borrowing.
Page 25 of 34
At August 31, 2003, the aggregate principal amount of securitized credit card
receivables totaled $1.60 billion under the private-label program and $1.42
billion under the bankcard program. At August 31, 2003, the unused capacity of
the private-label variable funding program was $90.9 million and the unused
capacity of the bankcard variable funding program was $129.1 million. Our
securitization agreements do not provide recourse to the company for credit
losses on securitized receivables.
During the second quarter, our private-label finance operation began selectively
extending 18-month, interest-free promotional financing. In the past, our
private-label finance operation had generally limited promotional financing to
12-month terms. Depending on the financial success of the promotion, our
private-label receivables may increase significantly. This potential increase
could require additional financing, which could include additional or larger
public or private securitizations during the current fiscal year.
We anticipate that we will be able to expand or enter into new securitization
agreements to meet the future needs of our finance operations. However, adverse
changes in the performance of our credit card portfolios or changes in the
asset-backed securities market could result in our having to hold larger
retained interests in future securitizations. The private-label and bankcard
securitization agreements require that the aggregate principal balance of the
securitized receivables exceed a specified amount and that the yield on the
securitized receivables exceed specified rates. In addition, the variable
funding securitization agreements require that we meet financial tests relating
to minimum tangible net worth, current ratios and debt-to-capital ratios and
that the securitized receivables meet specified performance levels relating to
delinquency rates and principal payment rates. If these financial tests or
performance levels are not met, or if certain other events occur, it would
constitute an early amortization event, in which case the principal payment
dates for the term series would be accelerated, the variable funding commitments
would terminate and the variable funding investors would begin to receive
monthly principal payments until paid in full.
We expect that available cash resources, credit facilities, sale-leaseback
transactions, landlord reimbursements and cash generated by operations will be
sufficient to fund capital expenditures and working capital for the foreseeable
future.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, which are subject to risks and
uncertainties. 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 expectations for
fiscal 2004 and beyond, are forward-looking statements and involve various risks
and uncertainties.
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 United States 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:
o When or whether we will be successful in selling the bankcard operation and
the terms of any such sale;
o The timing and amount of any charges to income that may be required as a
result of selling the bankcard operation;
o Changes in the amount and degree of promotional intensity exerted by
current competitors and potential new competition from competitors using
either similar or alternative methods or channels of distribution such as
online and telephone shopping services and mail order;
o Changes in general U.S. or regional U.S. economic conditions including, but
not limited to, consumer credit availability, consumer credit delinquency
and default rates, interest rates, inflation, personal discretionary
Page 26 of 34
spending levels, trends in consumer retail spending, both in general and in
our product categories, and consumer sentiment about the economy in
general;
o The presence or absence of, or consumer acceptance of, new products or
product features in the merchandise categories we sell and changes in our
actual merchandise sales mix;
o Significant changes in retail prices for products we sell;
o Changes in availability or cost of financing for working capital and
capital expenditures, including securitization financing and financing to
support development of our business;
o Lack of availability or access to sources of inventory;
o Inability to liquidate excess inventory should excess inventory develop;
o Failure to successfully implement sales and profitability improvement
programs for our Circuit City Superstores, including our remodeling and
relocation process and our recent change in compensation structure;
o Changes in the performance of the private-label or bankcard portfolios,
including material changes in cardholder default rates or payment rates;
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 Changes in production or distribution costs or costs of materials for our
advertising;
o Availability of appropriate real estate locations for relocations and new
stores;
o Successful implementation of our various customer service initiatives;
o Negative investment returns in our pension plan;
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 us or our competitors, the imposition of new environmental
restrictions, 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; and
o Significant adverse results in litigation matters.
We believe our forward-looking statements are reasonable; however, undue
reliance should not be placed on any forward-looking statements, which are based
on current expectations.
Page 27 of 34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Receivables Risk. We manage the market risk associated with the revolving credit
card portfolios of our finance operations. Portions of these portfolios have
been securitized in transactions accounted for as sales in accordance with SFAS
No. 140 and, therefore, are not presented on the consolidated balance sheets.
The majority of accounts in the credit card portfolios are charged interest at
rates indexed to the prime rate, adjustable on a monthly basis subject to
certain limitations. The remaining accounts are charged interest at fixed annual
percentage rates. The following table presents the breakdown by interest rate
structure of the gross principal receivables outstanding prior to discounting at
August 31, 2003, and February 28, 2003.
(A) Private-Label
(Amounts in millions) August 31 February 28
----------------------------------------- ----------- -----------
Indexed to prime rate..................... $1,455 $1,460
Fixed APR................................. 140 176
------ ------
Total..................................... $1,595 $1,636
====== ======
(B) Bankcard
(Amounts in millions) August 31 February 28
----------------------------------------- ----------- -----------
Indexed to prime rate..................... $1,421 $1,538
Fixed APR................................. - -
------ ------
Total..................................... $1,421 $1,538
====== ======
Financing for the credit card receivables is achieved through asset
securitization programs that, in turn, issue both private and public market
debt, principally at floating rates based on LIBOR and commercial paper rates.
Receivables held for sale are financed with working capital. At August 31, 2003,
and February 28, 2003, the total principal amount of receivables securitized or
held for sale prior to discounting was as follows:
(A) Private-Label
(Amounts in millions) August 31 February 28
----------------------------------------- ----------- -----------
Floating-rate securitizations............. $1,569 $1,592
Held for sale............................. 26 44
------ ------
Total..................................... $1,595 $1,636
====== ======
(B) Bankcard
(Amounts in millions) August 31 February 28
----------------------------------------- ----------- -----------
Floating-rate securitizations............. $1,381 $1,527
Held for sale............................. 40 11
------ ------
Total..................................... $1,421 $1,538
====== ======
Interest Rate Exposure. Interest rate exposure relating to the credit card
receivable securitizations represents a market risk exposure that we manage
primarily with matched funding. We also have the ability to adjust fixed-APR
revolving credit cards and the index on floating-rate credit cards, subject to
cardholder ratification, but we do not currently anticipate the need to do so.
Our ability to effect these changes may be limited by competitive conditions.
The majority of our cardholder accounts have interest rates indexed to prime,
but the rates we charge our cardholders may not change as frequently or to the
same extent as our funding costs. This is the result of a combination of factors
such as interest rate floors on the accounts which are above the current level
of prime rate, interest-free promotional financing, and by differences between
changes in prime and LIBOR or commercial paper rates. Accordingly, our
securitization income and the value of our retained interests in the securitized
receivables could be adversely impacted by increases in interest rates.
Page 28 of 34
We use a sensitivity analysis to quantify interest rate risk relating to our
retained interests in securitized private-label receivables. This analysis
calculates the impact on net earnings from a 200 basis point increase in the
yield curve applied equally over the next four quarters. Assuming that no other
assumptions change, this increase in interest rates would result in a decrease
in our private-label securitization income of approximately $8.6 million for the
quarter ended August 31, 2003, compared with a decrease of approximately $8.5
million for the quarter ended August 31, 2002. Due to our decision to sell the
bankcard operation, we did not use a sensitivity analysis to quantify interest
rate risk because the fair value of the retained interests in the securitized
bankcard receivables is now based on the estimated net proceeds as determined by
bids received.
The market and credit risks associated with interest rate caps are similar to
those relating to other types of financial instruments. Market risk is the
exposure created by potential fluctuations in interest rates and is directly
related to the product type, agreement terms and transaction volume. We have
entered into offsetting interest rate cap positions and, therefore, do not
anticipate significant market risk arising from interest rate caps. Credit risk
is the exposure to nonperformance of another party to an agreement. We mitigate
credit risk by dealing with highly rated bank counterparties.
ITEM 4. CONTROLS AND PROCEDURES
The company's principal executive officer and principal financial officer have
evaluated the effectiveness of the company's disclosure controls and procedures
as 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 principal executive officer and principal financial
officer concluded that the company's disclosure controls and procedures are
effective. There have been no changes in internal control over financial
reporting for the period covered by this report that have materially affected,
or are reasonably likely to materially affect, the company's internal control
over financial reporting.
Page 29 of 34
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of the company's shareholders was
held June 17, 2003.
(b)(i) At the annual meeting, the shareholders of the
company elected Ronald M. Brill, Barbara S. Feigin,
W. Alan McCollough and Mikael Salovaara as directors
for three-year terms and Alan Kane as a director for
a two-year term. The elections were approved by the
following votes:
Directors For Withheld
------------------------- ----------- ------------
Ronald M. Brill 177,255,056 9,830,160
Barbara S. Feigin 177,117,325 9,967,891
Alan Kane 178,128,440 8,956,776
W. Alan McCollough 176,203,440 10,881,776
Mikael Salovaara 177,228,525 9,858,691
(ii) At the annual meeting, the shareholders of the
company voted in favor of a proposal to approve the
company's 2003 Stock Incentive Plan. This proposal
was approved by the following votes:
2003 Stock Incentive Plan
Broker
For Against Abstain Non-Votes
----------- ------------ ---------- ---------
161,478,309 19,242,079 6,364,828 0
(iii) At the annual meeting, the shareholders of the
company voted in favor of a proposal to approve the
company's 2003 Annual Performance-Based Bonus Plan.
This proposal was approved by the following votes:
2003 Annual Performance-Based Bonus Plan
Broker
For Against Abstain Non-Votes
----------- ----------- ----------- ---------
173,649,847 10,237,701 3,197,668 0
(iv) At the annual meeting, the shareholders of the
company voted in favor of a shareholder proposal
regarding the company's shareholder rights plan. This
proposal was approved by the following votes:
Shareholder Proposal
Broker
For Against Abstain Non-Votes
---------- ---------- ---------- ----------
88,040,248 22,923,227 8,759,077 67,362,664
ITEM 5. OTHER INFORMATION
Effective September 30, 2003, Paula G. Rosput resigned from the
company's Board of Directors, citing the need to focus additional
time on her primary responsibilities.
Page 30 of 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Articles of Incorporation of the
company, effective February 3,1997, as amended
through October 1, 2002, filed as Exhibit 3(i) to the
company's Quarterly Report on Form 10-Q for the
quarter ended November 30, 2002 (File No. 1-5767),
expressly incorporated herein by this reference
3.2 Bylaws of the company, as amended and restated June
17, 2003, filed as Exhibit (3)(iii) to the company's
Quarterly Report on Form 10-Q for the quarter ended
May 31, 2003 (File No. 1-5767), expressly
incorporated herein by this reference
4.1 Third Amended and Restated Rights Agreement dated as
of October 1, 2002, between he company and Wells
Fargo Bank Minnesota, N.A., as Rights Agent, filed as
Exhibit 1 to the company's Form 8-A/A filed on
October 1, 2002 (File No. 1-5767), expressly
incorporated herein by this reference
10.1 Credit Agreement dated as of June 27, 2003 among the
company, the Lenders party thereto, Fleet National
Bank, Fleet Retail Finance Inc., Bank of America,
N.A. Congress Financial Corporation, General Electric
Capital Corporation, Bank One, NA, JPMorgan Chase
Bank, National City Commercial Finance, Inc., The CIT
Group/Business Credit, Inc. and Wells Fargo Foothill,
LLC, filed herewith*
10.2 Form of Employment Agreement between the company and
certain executive officers, filed herewith**
10.3 The company's 2003 Stock Incentive Plan, filed as
Appendix B to the company's Definitive Proxy
Statement dated May 9, 2003, for the Annual Meeting
of Shareholders held on June 17, 2003 (File No.
1-5767), expressly incorporated herein by this
reference**
10.4 The company's 2003 Annual Performance-Based Bonus
Plan, filed as Appendix C to the company's Definitive
Proxy Statement dated May 9, 2003, for the Annual
Meeting of Shareholders held on June 17, 2003 (File
No. 1-5767), expressly incorporated herein by this
reference**
31.1 Certification by Registrant's Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith
31.2 Certification by Registrant's Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith
32.1 Certification of CEO under Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith
32.2 Certification of CFO under Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith
* Portions of this exhibit have been omitted and filed
separately with the SEC pursuant to the company's
application for confidential treatment of the omitted
information pursuant to Rule 24b-A of the Exchange
Act.
** Indicates management contracts, compensatory plans or
arrangements of the company required to be filed as
an exhibit.
Page 31 of 34
(b) Reports on Form 8-K
The exhibits listed below were furnished to the SEC during
the period covered by this report pursuant to Item 12 of
Form 8-K and shall not be deemed "filed" for purposes of
the Securities Exchange Act of 1934, as amended, or
incorporated by reference into any document filed under the
Securities Act of 1933, as amended, except as shall be
expressly set forth by specific reference in such filing.
The company furnished a Form 8-K to the SEC on June 5,
2003, announcing the company's first quarter fiscal year
2004 sales and earnings expectations.
The company furnished a Form 8-K to the SEC on June 17,
2003, announcing the company's first quarter fiscal year
2004 results.
Page 32 of 34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CIRCUIT CITY STORES, INC.
(Registrant)
By: /s/ W. Alan McCollough
-------------------------------------
W. Alan McCollough
Chairman, President and
Chief Executive Officer
By: /s/ Michael E. Foss
-------------------------------------
Michael E. Foss
Senior Vice President and
Chief Financial Officer
By: /s/ Philip J. Dunn
-------------------------------------
Philip J. Dunn
Senior Vice President, Treasurer,
Corporate Controller and
Chief Accounting Officer
October 14, 2003
Page 33 of 34
EXHIBIT INDEX
3.1 Amended and Restated Articles of Incorporation of the
company, effective February 3,1997, as amended
through October 1, 2002, filed as Exhibit 3(i) to the
company's Quarterly Report on Form 10-Q for the
quarter ended November 30, 2002 (File No. 1-5767),
expressly incorporated herein by this reference
3.2 Bylaws of the company, as amended and restated June
17, 2003, filed as Exhibit (3)(iii) to the company's
Quarterly Report on Form 10-Q for the quarter ended
May 31, 2003 (File No. 1-5767), expressly
incorporated herein by this reference
4.1 Third Amended and Restated Rights Agreement dated as
of October 1, 2002, between he company and Wells
Fargo Bank Minnesota, N.A., as Rights Agent, filed as
Exhibit 1 to the company's Form 8-A/A filed on
October 1, 2002 (File No. 1-5767), expressly
incorporated herein by this reference
10.1 Credit Agreement dated as of June 27, 2003 among the
company, the Lenders party thereto, Fleet National
Bank, Fleet Retail Finance Inc., Bank of America,
N.A. Congress Financial Corporation, General Electric
Capital Corporation, Bank One, NA, JPMorgan Chase
Bank, National City Commercial Finance, Inc., The CIT
Group/Business Credit, Inc. and Wells Fargo Foothill,
LLC, filed herewith*
10.2 Form of Employment Agreement between the company and
certain executive officers, filed herewith**
10.3 The company's 2003 Stock Incentive Plan, filed as
Appendix B to the company's Definitive Proxy
Statement dated May 9, 2003, for the Annual Meeting
of Shareholders held on June 17, 2003 (File No.
1-5767), expressly incorporated herein by this
reference**
10.4 The company's 2003 Annual Performance-Based Bonus
Plan, filed as Appendix C to the company's Definitive
Proxy Statement dated May 9, 2003, for the Annual
Meeting of Shareholders held on June 17, 2003 (File
No. 1-5767), expressly incorporated herein by this
reference**
31.1 Certification by Registrant's Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith
31.2 Certification by Registrant's Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith
32.1 Certification of CEO under Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith
32.2 Certification of CFO under Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith
* Portions of this exhibit have been omitted and filed
separately with the SEC pursuant to the company's
application for confidential treatment of the omitted
information pursuant to Rule 24b-A of the Exchange
Act.
** Indicates management contracts, compensatory plans or
arrangements of the company required to be filed as
an exhibit.
Page 34 of 34