updated 12/19/2006 11:42:20 AM ET 2006-12-19T16:42:20

Circuit City Stores Inc. reported a surprise quarterly loss on Tuesday after it cut prices on hot electronics like flat-panel TVs and computers to lure customers during the holiday shopping season.

The No. 2 U.S. consumer electronics chain, whose results came a week after larger rival Best Buy Co. Inc. posted disappointing earnings, also cut its fiscal-year outlook.

“It’s much worse than expected,” said Sanford C. Bernstein & Co. analyst Colin McGranahan of the results.

“The gross margin situation is very concerning.”

The shares dropped 17 percent in early trading on the New York Stock Exchange. Best Buy fell 3.3 percent to $47.70.

Circuit City, which has been working to turn around its business and regain market share from Best Buy, had a loss of $16 million, or 9 cents per share, for the fiscal third quarter ended November 30 compared with a profit of $10.1 million, or 6 cents per share, a year earlier.

Analysts, on average, had expected a profit of 5 cents per share, according to Reuters Estimates.

Sales rose 6.9 percent to $3.10 billion, while analysts were expecting $3.12 billion.

Retailers like Best Buy and Circuit City have notched up strong sales gains in recent quarters as consumers replace clunky tube TVs with snazzy new plasma and LCD flat-panel televisions that can cost thousands of dollars.

With the fight to win flat-panel TV sales intensifying, specialty electronics retailers, and discounters like Wal-Mart Stores Inc., heavily promoted the TVs during the Thanksgiving holiday shopping weekend.

But while this boosted sales, it ate into profits.

Falling margins
“The pace of the decline in flat panel television prices accelerated during the quarter as manufacturers and retailers competed aggressively for market share, and prices fell to unanticipated levels,” Philip Schoonover, Circuit City chairman, president and chief executive, said in a statement.

Circuit City could not sell enough TVs to offset price drops, he said.

The company said its gross profit margin declined 192 basis points from a year ago due to a falling margins for TVs, personal computers and entertainment software.

The lackluster results and lowered outlook are a ”significant step backwards in the company’s turnaround efforts,” UBS analyst Brian Nagel said in a research note.

“The consumer electronics sector has been plagued by aggressive promotions early in the holiday shopping season,” he said. “Circuit City is not managing through this environment well.”

Circuit City now expects fiscal-year consolidated net sales to rise by 8 percent to 9 percent, down from its previous forecast of 9 percent to 11 percent.

It also expects earnings from continuing operations before income taxes as a percentage of consolidated net sales of 1.0 percent to 1.4 percent, down from 2.0 percent to 2.4 percent.

The outlook excludes the impact of classifying the results from the Rogers Plus stores as discontinued operations.

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