Fool contributor Stephen Simpson recently checked up on Circuit City
In the opening remarks for Circuit City's conference call, CEO Phil Schoonover used the term "sustainable growth" quite a bit. So Bodhi Zappa and Hank Schofield will join me in examining just how the company is planning on keeping the growth going for its shareholders.
Service with a smile ... and a dollar sign
Jeremy: Hank, one growth opportunity highlighted in the call is service offerings, which management sees as a major market, given the influence of consumer electronics in today's world. My Foolish colleague Stephen Simpson isn't exactly enamored with the idea, however. While recognizing there is some growth potential, he doubts whether it's significant enough "to really make a difference." In light of management's remarks during the call, what is your read on its increased emphasis on servicing?
Hank: As you know, Jeremy, where there is doubt and skepticism, I am usually lingering nearby. Schoonover pointed out that the servicing for consumer electronics and personal computers is estimated to be a $20 billion consumer market by 2010. So the company should jump all over the opportunity, right? I'm not so sure. What are the investment costs in making such a move into servicing? How profitable is it? And realistically, as Simpson countered, will it make that big of difference to the bottom line?
Bodhi: If it doesn't get in on the action, Best Buy
Servicing ... a drag?
Jeremy: The time portion of it is what concerns the skeptics, I believe. Obviously, there are some upfront investment costs in such a venture. In the quarterly report, we can read between the lines to find that "innovation" investments are currently a drag on profitability. It was noted that improvements in sales, general, and administrative expenses were used to offset expenses related to investments in information technology and innovation activities. In the second and third quarter, the effect of these investments is expected to be "disproportionately large," with a drop-off effect in the fourth quarter. This gets us back to Hank's questions -- how long, and will it be worth the wait?
Bodhi: But one thing skeptics are missing is that with consumer electronics and personal-computer sales, the margin for profitability can at times be extremely thin, given the saturation of these products on the market. For example, one analyst asked about the price-point situation for flat-panel displays. Schoonover indicated that the company is seeing "some declines in price points," but -- and this is the key -- as the company ramps up its home-theater installation service, it thereby increases the opportunity to achieve greater revenue per transaction, simply by selling things like brackets and mounts and other related accessories.
Jeremy: A valid point. Even later in the call, Schoonover reiterated that the TV category is so important to the company not simply because of TV sales alone, but rather because those sales drive its "high-margin services," such as cables and home theater. When you put it all together, what Schoonover referred to as a "basket" of services is the "major profit driver for the company" (emphasis mine). I suspect that once Circuit City can take advantage of scale, incurring these initial investment expenses, servicing could indeed be a highly profitable portion of its business.
Hank: Well, I can't sit here and deny that servicing is profitable. When an analyst made the assumption that servicing carried with it lower margins than products generate, Schoonover was quick to counter, "Typically, our services are higher than product margins." That said, as of today, we know that margins for the full year will be negatively affected by approximately 100 basis points as the company expenses these investment costs. Can it then do a turnaround and expand profit margins next year? This remains to be seen.
Foolish final word
Jeremy: Circuit City posted strong results this quarter, and top-line performance should remain relatively stout throughout the year. However, its bottom-line performance may be weighted down, particularly in the second and third quarter, as it bears these innovation and IT investment costs. The question remains: Will Circuit City begin raking in the profits from servicing next year and beyond? Despite skeptics' concerns, there is compelling evidence that this strong push to capture a piece of the $20 billion pie may go a long way toward achieving sustainable growth . all while the company rakes in the profits.
Read on for more Foolish conference-call analysis:
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(NASDAQ:SONC) healthy comps? - One analyst questioned whether it's time for Pier 1
(NYSE:PIR) to go to Plan B. - And World Wrestling Entertainment
(NYSE:WWE) still has a few growth tricks up its sleeve.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy.
