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Circuit City Files for Chapter 11 Protection
Credit Hard to Come by as Sales Drop, Stores Close

By Ylan Q. Mui
Washington Post Staff Writer
Tuesday, November 11, 2008

Circuit City Stores, the nation's second-largest consumer electronics retailer, said yesterday that tightened credit and rapidly declining consumer spending have forced it to file for bankruptcy protection, underscoring the perils facing retailers as they head into the crucial holiday season during the worst economic crisis in a generation.

The season generally accounts for about 20 percent of all retail sales, providing the cash that stores use to pay for merchandise ordered on credit earlier in the year. But as Circuit City's troubles mounted, its suppliers feared that it would not be able to pay its bills.

Just a week ago, Circuit City said it would shut down 155 stores and cut 17 percent of its workforce to try to stave off bankruptcy. But suppliers remained skittish, in some cases demanding payment before merchandise was received and refusing to increase credit for new purchases. On Friday, it let go an additional 1,300 employees, including staff at its headquarters in Richmond. It filed for Chapter 11 bankruptcy protection yesterday to begin reorganizing its business.

Chief executive James A. Marcum said in a statement that the filing would "ultimately position the company to compete more effectively." Circuit City stores will remain open, and customer warranty and service plans will not be affected, the company said.

The retail industry has been rattled over the past year as shoppers slashed their spending by the largest amount in nearly three decades. Sales in nearly every category have plummeted as Wall Street imploded and housing prices remained depressed. Holiday sales are expected to have their weakest growth in years. Circuit City was the latest in a long line of retailers to fall this year.

"That's one of the issues of the bad economy. People aren't buying, stores aren't paying [suppliers], and their cash flow is restricted," said Thomas Dunn, president of Dunn Consulting Group, which works with corporations in bankruptcy protection.

Circuit City, founded in 1949 as a Richmond appliance store, recorded annual profit of nearly $200 million just a few years ago. But the past year has included an attempted coup by an activist investor and a rescinded takeover bid by Blockbuster. Circuit City posted nearly $320 million in losses in the last fiscal year, its second consecutive annual shortfall. In a filing with the U.S. Bankruptcy Court in Richmond, Chief Financial Officer Bruce H. Besanko said the losses were driven by a double-digit-percentage drop in traffic in its stores compared with the previous year.

Vendors began to worry that Circuit City would not have the cash to pay them. The company's most recent quarterly filing showed that it had total assets of $3.4 billion with $2.3 billion in liabilities. According to court filings, Hewlett-Packard holds the most unsecured debt, more than $118.8 million. Samsung Electronics is due nearly $116 million, while Sony has more than $60 million in claims. Circuit City tried to assuage its suppliers by holding face-to-face meetings and closing unprofitable stores, court documents show. But vendors were skeptical, and credit tightened.

In addition, Circuit City had a revolving line of credit with Bank of America that was based in part on the value of its inventory. But as inventory levels fell and value decreased, its line of credit shrunk, as well -- which in turn limited its ability to buy new inventory, keep its shelves stocked and draw in shoppers, according to the company's filing.

"The company's efforts did not instill the widespread vendor confidence the company needed," Besanko said in the filing.

As home-equity loans became harder to get and credit card companies have reduced spending limits, shoppers have found it harder to get credit. That has been a major blow to the retailer because 75 percent of its sales are generated with credit cards, Besanko said.

"All the trajectories for the consumer are of course still worsening," said David Schick, an analyst with Stifel Nicolaus. "If you're a company under pressure a year ago or two weeks ago, everything's going to be worse now."

Under the terms of the bankruptcy, Circuit City has negotiated a $1.1 billion revolving line of credit with Bank of America that will allow it to buy merchandise for Black Friday -- the all-important day after Thanksgiving -- and the remainder of the holiday season. On Dec. 29, the credit amount will drop to $900 million.

"What you can't afford to have as a retailer is a much worse holiday shopping season than your competitors," said Lorenzo Marinuzzi, a bankruptcy lawyer with Morrison & Foerster.

Bankruptcy also allows Circuit City to terminate leases at the 155 stores that it announced it would close last week. In court documents, Circuit City said it hopes to emerge from bankruptcy protection in the first half of 2009. Marcum said he hopes the filing will give vendors confidence in the company's ability to pay them and create a more efficient operation.

The New York Stock Exchange suspended trading of Circuit City shares yesterday, the company said in a statement. The stock has lost more than 96 percent of its value over the past year.

Several analysts said they expect the retailer to shut down more stores as it reorganizes. Anthony Chukumba, an analyst with FTN Midwest Securities, said Circuit City might also end up in Chapter 7 bankruptcy, in which the company would liquidate its assets.

"These are very big forces at work in the economy, very significant negative forces," Schick said. "We can't rule anything out."

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