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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 May 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-5767
CIRCUIT CITY STORES, INC.
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-0493875
-------- ----------
(State of Incorporation) (I.R.S. Employer
Identification No.)
9950 MAYLAND DRIVE, RICHMOND, VIRGINIA 23233
(Address of Principal Executive Offices and Zip Code)
(804) 527-4000
(Registrant's Telephone Number, Including Area Code)
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 the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date.
Class Outstanding at June 30, 2002
- ----------------------------------------------------------------------------- ----------------------------
Circuit City Stores, Inc. - Circuit City Group Common Stock, par value $0.50 209,961,358
Circuit City Stores, Inc. - CarMax Group Common Stock, par value $0.50 37,063,940
An Index is included on Page 2 and a separate Index for Exhibits is included on
Page 60.
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
INDEX
Page
No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Financial Statements:
---------------------------------
Consolidated Balance Sheets -
May 31, 2002, and February 28, 2002 4
Consolidated Statements of Earnings -
Three Months Ended May 31, 2002 and 2001 5
Consolidated Statements of Cash Flows -
Three Months Ended May 31, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Circuit City Group Financial Statements:
---------------------------------------
Circuit City Group Balance Sheets -
May 31, 2002, and February 28, 2002 29
Circuit City Group Statements of Earnings -
Three Months Ended May 31, 2002 and 2001 30
Circuit City Group Statements of Cash Flows -
Three Months Ended May 31, 2002 and 2001 31
Notes to Circuit City Group Financial Statements 32
CarMax Group Financial Statements:
---------------------------------
CarMax Group Balance Sheets -
May 31, 2002, and February 28, 2002 44
CarMax Group Statements of Earnings -
Three Months Ended May 31, 2002 and 2001 45
CarMax Group Statements of Cash Flows -
Three Months Ended May 31, 2002 and 2001 46
Notes to CarMax Group Financial Statements 47
Item 2. Management's Discussion and Analysis:
------------------------------------
Circuit City Stores, Inc. Management's Discussion and Analysis
of Financial Condition and Results of Operations 16
Circuit City Group Management's Discussion and Analysis
of Financial Condition and Results of Operations 37
CarMax Group Management's Discussion and Analysis
of Financial Condition and Results of Operations 51
Page 2 of 62
Item 3. Quantitative and Qualitative Disclosures About Market Risk:
----------------------------------------------------------
Circuit City Stores, Inc. Quantitative and Qualitative Disclosures 27
About Market Risk
Circuit City Group Quantitative and Qualitative Disclosures 43
About Market Risk
CarMax Group Quantitative and Qualitative Disclosures 58
About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal proceedings 59
Item 4. Submission of Matters to a Vote of Security Holders 59
Item 6. Exhibits and Reports on Form 8-K 60
Page 3 of 62
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Amounts in thousands except share data)
May 31, 2002 Feb. 28, 2002
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $1,176,002 $1,251,532
Net accounts receivable 201,208 211,402
Retained interests in securitized receivables 544,036 515,139
Inventory 1,742,485 1,633,327
Prepaid expenses and other current assets 36,538 41,311
---------- ----------
Total current assets 3,700,269 3,652,711
Property and equipment, net 858,505 853,778
Deferred income taxes 6,785 -
Other assets 31,537 32,897
---------- ----------
TOTAL ASSETS $4,597,096 $4,539,386
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,108,731 $1,106,679
Accrued expenses and other current liabilities 170,837 183,336
Accrued income taxes 21,207 100,696
Deferred income taxes 140,503 138,306
Short-term debt 10,855 10,237
Current installments of long-term debt 102,102 102,073
---------- ----------
Total current liabilities 1,554,235 1,641,327
Long-term debt, excluding current installments 113,734 14,064
Other liabilities 156,694 149,269
Deferred income taxes - 288
---------- ----------
TOTAL LIABILITIES 1,824,663 1,804,948
---------- ----------
Stockholders' equity:
Circuit City Group Common Stock, $0.50 par value;
350,000,000 shares authorized; 209,912,599 shares
issued and outstanding as of May 31, 2002 104,956 104,411
CarMax Group Common Stock, $0.50 par value;
175,000,000 shares authorized; 37,061,535 shares
issued and outstanding as of May 31, 2002 18,531 18,426
Capital in excess of par value 823,066 810,047
Retained earnings 1,825,880 1,801,554
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 2,772,433 2,734,438
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4,597,096 $4,539,386
========== ==========
See accompanying notes to consolidated financial statements.
Page 4 of 62
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings (Unaudited)
(Amounts in thousands except per share data)
Three Months Ended
May 31,
2002 2001
---------- ----------
Net sales and operating revenues $3,119,807 $2,749,621
Cost of sales, buying and warehousing 2,488,554 2,183,268
---------- ----------
Gross profit 631,253 566,353
---------- ----------
Selling, general and administrative expenses (net of
finance income of $44,496 as of May 31, 2002,
and $49,055 as of May 31, 2001) 583,925 535,994
Interest expense 1,026 2,992
---------- ----------
Total expenses 584,951 538,986
---------- ----------
Earnings before income taxes 46,302 27,367
Provision for income taxes 18,320 10,400
---------- ----------
Net earnings $ 27,982 $ 16,967
========== ==========
Net earnings attributed to:
Circuit City Group Common Stock $ 17,466 $ 10,135
CarMax Group Common Stock 10,516 6,832
---------- ----------
$ 27,982 $ 16,967
========== ==========
Weighted average common shares:
Circuit City Group:
Basic 206,710 204,936
========== ==========
Diluted 209,257 205,491
========== ==========
CarMax Group:
Basic 36,962 25,934
========== ==========
Diluted 38,826 27,704
========== ==========
Net earnings per share attributed to:
Circuit City Group:
Basic $ 0.08 $ 0.05
========== ==========
Diluted $ 0.08 $ 0.05
========== ==========
CarMax Group:
Basic $ 0.28 $ 0.26
========== ==========
Diluted $ 0.27 $ 0.25
========== ==========
Dividends paid per share:
Circuit City Group Common Stock $ 0.0175 $ 0.0175
========== ==========
CarMax Group Common Stock $ - $ -
========== ==========
See accompanying notes to consolidated financial statements.
Page 5 of 62
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Three Months Ended
May 31,
2002 2001
---------- --------
Operating Activities:
- --------------------
Net earnings $ 27,982 $ 16,967
Adjustments to reconcile net earnings to net cash
used in operating activities of continuing operations:
Depreciation and amortization 39,884 39,182
Amortization of restricted stock awards 5,403 3,598
Loss (gain) on disposition of property and equipment 2,069 (959)
Provision for deferred income taxes (4,876) 6,066
Changes in operating assets and liabilities:
Increase in net accounts receivable and retained
interests in securitized receivables (18,703) (8,463)
(Increase) decrease in inventory (109,158) 25,831
Decrease (increase) in prepaid expenses and other
current assets 4,773 (11,287)
Decrease in other assets 1,143 237
Decrease in accounts payable, accrued expenses and
other current liabilities and accrued income taxes (88,162) (81,088)
Increase in other liabilities 7,425 2,289
---------- --------
Net cash used in operating activities of continuing operations (132,220) (7,627)
---------- --------
Investing Activities:
- --------------------
Purchases of property and equipment (50,888) (32,852)
Proceeds from sales of property and equipment, net 4,425 3,248
---------- --------
Net cash used in investing activities of continuing operations (46,463) (29,604)
---------- --------
Financing Activities:
- --------------------
Proceeds from issuance of short-term debt, net 618 1,640
Proceeds from issuance of long-term debt 100,000 -
Principal payments on long-term debt (301) (275)
Issuances of Circuit City Group Common Stock, net 5,585 3,541
Issuances of CarMax Group Common Stock, net 907 (224)
Dividends paid on Circuit City Group Common Stock (3,656) (3,621)
---------- --------
Net cash provided by financing activities of continuing operations 103,153 1,061
---------- --------
Cash used in discontinued operations - (5,460)
---------- ---------
Decrease in cash and cash equivalents (75,530) (41,630)
Cash and cash equivalents at beginning of year 1,251,532 446,131
---------- --------
Cash and cash equivalents at end of period $1,176,002 $404,501
========== ========
See accompanying notes to consolidated financial statements.
Page 6 of 62
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. consists of two common stock
series that are intended to reflect the performance of the Company's two
businesses. The Circuit City Group Common Stock is intended to reflect the
performance of the Circuit City 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 is intended to reflect the performance of the CarMax
stores and related operations. The reserved CarMax Group shares are not
outstanding CarMax Group Common Stock. Therefore, net earnings attributed
to the reserved CarMax Group shares are included in the net earnings and
earnings per share attributed to the Circuit City Group Common Stock.
During the second quarter of fiscal 2002, Circuit City Stores completed the
public offering of 9,516,800 shares of CarMax Group Common Stock. The
shares sold in the offering were shares of CarMax Group Common Stock that
previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group Common Stock. As of May 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 May 31,
2002; 64.1 percent at February 28, 2002; and 74.1 percent at May 31, 2001.
The terms of each series of common stock are discussed in detail in the
Company's Form 8-A registration statement on file with the Securities and
Exchange Commission.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would
separate the CarMax auto superstore business from the Circuit City consumer
electronics business through a tax-free transaction in which CarMax, Inc.,
presently a wholly owned subsidiary of Circuit City Stores, Inc., would
become an independent, separately traded public company. CarMax, Inc. holds
substantially all of the businesses, assets and liabilities of the CarMax
Group. The separation plan calls for Circuit City Stores, Inc. to redeem
the outstanding shares of CarMax Group Common Stock in exchange for shares
of common stock of CarMax, Inc. Simultaneously, shares of CarMax, Inc.
common stock, representing the shares of CarMax Group Common Stock reserved
for the holders of Circuit City Group Common Stock, would be distributed as
a tax-free dividend to the holders of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax
Group Common Stock redeemed by the Company. Management anticipates that the
holders of Circuit City Group Common Stock would receive a fraction of a
share of CarMax, Inc. common stock for each share of Circuit City Group
Common Stock they hold. The exact fraction would be determined on the
record date for the distribution. The separation is expected to be
completed by late summer or early fall, subject to shareholder approval and
final approval from the board of directors.
Notwithstanding the attribution of the Company's assets and liabilities,
including contingent liabilities, and stockholders' equity between the
Circuit City Group and the CarMax Group for the purposes of preparing the
financial statements, holders of Circuit City Group Common Stock and
holders of CarMax Group Common Stock are shareholders of the Company and as
such are subject to all of the risks associated with an investment in the
Company and all of its businesses, assets and liabilities. Such attribution
and the equity structure of the Company do not affect title to the assets
or responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of Circuit City Group Common Stock nor shares
of CarMax Group
Page 7 of 62
Common Stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular Group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one Group could affect the results of operations or financial
condition of the other Group. Net losses of either Group and dividends or
distributions on, or repurchases of, Circuit City Group Common Stock or
CarMax Group Common Stock would reduce funds legally available for
dividends on, or repurchases of, both stocks. Accordingly, the Company's
consolidated financial statements included herein should be read in
conjunction with the financial statements of each Group and the Company's
SEC filings.
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 fiscal year-end balance sheet
data was derived from the audited financial statements included in the
Company's fiscal 2002 Annual Report on Form 10-K.
3. Net Earnings per Share
Reconciliations of the numerator and denominator of the basic and diluted
net earnings per share calculations are presented below.
Three Months Ended
(Amounts in thousands May 31,
except per share data) 2002 2001
----------------------------------------------------------------------------------
Circuit City Group:
Weighted average common shares...................... 206,710 204,936
Dilutive potential common shares:
Options.......................................... 1,308 114
Restricted stock................................. 1,239 441
---------------------------
Weighted average common shares and
dilutive potential common shares................. 209,257 205,491
===========================
Net earnings available to common shareholders....... $ 17,466 $ 10,135
Basic net earnings per share ....................... $ 0.08 $ 0.05
Diluted net earnings per share ..................... $ 0.08 $ 0.05
CarMax Group:
Weighted average common shares...................... 36,962 25,934
Dilutive potential common shares:
Options.......................................... 1,845 1,714
Restricted stock................................. 19 56
---------------------------
Weighted average common shares and
dilutive potential common shares................. 38,826 27,704
===========================
Net earnings available to common shareholders....... $ 10,516 $ 6,832
Basic net earnings per share........................ $ 0.28 $ 0.26
Diluted net earnings per share...................... $ 0.27 $ 0.25
In a public offering completed during the second quarter of fiscal 2002,
Circuit City Stores, Inc. sold 9,516,800 CarMax Group shares that had
previously been reserved for the Circuit City Group. Because both the
Page 8 of 62
earnings allocation and the outstanding CarMax shares were adjusted to
reflect the impact of the sale, net earnings per CarMax Group share were
not diluted by the sale. With the impact of the offering, 64.0 percent of
the CarMax Group's fiscal 2003 first quarter earnings were allocated to the
Circuit City Group. For the same period last year, 74.3 percent of the
CarMax Group's earnings were allocated to the Circuit City Group.
Certain options were outstanding and not included in the computation of
diluted net earnings per share because the options' exercise prices were
greater than the average market price of the shares. For the three-month
period ended May 31, 2002, options to purchase 5,678,317 shares of Circuit
City Group Common Stock at prices ranging from $21.68 to $43.03 per share
were outstanding and not included in the calculation. For the three-month
period ended May 31, 2001, options to purchase 8,371,534 shares of Circuit
City Group Common Stock at prices ranging from $13.88 to $47.53 per share
were outstanding and not included in the calculation.
For the three-month period ended May 31, 2002, options to purchase all
4,411,582 outstanding shares of CarMax Group Common Stock were included in
the calculation. For the three-month period ended May 31, 2001, options to
purchase 289,427 shares of CarMax Group Common Stock at prices ranging from
$9.19 to $16.31 per share were outstanding and not included in the
calculation.
4. Debt
On May 17, 2002, CarMax entered into a $200 million credit agreement
secured by vehicle inventory. The credit agreement includes a $100 million
revolving loan commitment and a $100 million term loan commitment.
Principal is due in full at maturity with interest payable monthly at a
LIBOR-based rate. The agreement currently is scheduled to expire in May
2004 and provides for annual one-year extensions of the final maturity
beginning on May 17, 2003, and each May 17 thereafter. The aggregate
principal amount outstanding under the credit facility on any date may not
exceed 150 percent of the value of CarMax's eligible motor vehicle
inventory as of that date. As of May 31, 2002, the amount outstanding under
this credit agreement was $100 million. Under this agreement, CarMax must
meet financial covenants relating to minimum current ratio, minimum
tangible net worth and minimum fixed charge coverage ratio. CarMax was in
compliance with these covenants at May 31, 2002.
5. Supplemental Financial Statement Information
For the first quarter of fiscal 2003 and 2002, pretax finance operation
income, which is recorded as a reduction to selling, general and
administrative expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
---------------------------------------------------------------------------
Circuit City Group:
Securitization income............. $50.5 $59.7
Payroll and fringe expenses....... 10.7 10.3
Other direct expenses............. 19.4 19.9
-------------------------------------
Finance operation income.......... 20.4 29.5
-------------------------------------
CarMax Group:
Securitization income............. 23.3 18.4
Payroll and fringe expenses....... 1.7 1.3
Other direct expenses............. 1.7 1.4
-------------------------------------
Finance operation income.......... 19.9 15.7
Third-party financing fees........ 4.2 3.8
-------------------------------------
Total finance income.............. 24.1 19.5
-------------------------------------
Circuit City Stores, Inc.:
Consolidated finance income....... $44.5 $49.0
=====================================
Page 9 of 62
For both the Circuit City Group and the CarMax Group, the finance operation
income does not include any allocation of indirect costs or income. The
Company presents this information on a direct basis to avoid making
arbitrary decisions regarding the periodic indirect benefit or costs that
could be attributed to this operation. 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.
6. Securitizations
(A) Credit Card Securitizations:
Circuit City's finance operation enters into securitization transactions to
finance its consumer revolving credit card receivables. In accordance with
the isolation provisions of Statement of Financial Accounting Standards No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," special purpose subsidiaries were created
for the sole purpose of facilitating these securitization transactions.
Credit card receivables are sold to the special purpose subsidiaries,
which, in turn, transfer these receivables to securitization master trusts.
Private-label and co-branded Visa credit card receivables are securitized
through one master trust and MasterCard and Visa credit card, referred to
as bankcard, receivables are securitized through a second master trust.
Each master trust periodically issues securities backed by the receivables
in that master trust. For transfers of receivables that qualify as sales,
Circuit City recognizes gains or losses as a component of the finance
operation's profits, which are recorded as reductions to selling, general
and administrative expenses. In these securitizations, Circuit City's
finance operation continues to service the securitized receivables for a
fee and the special purpose subsidiaries retain an undivided interest in
the transferred receivables and hold various subordinated asset-backed
securities that serve as credit enhancements for the asset-backed
securities held by outside investors. Neither master trust agreement
provides for recourse to the Company for credit losses on the securitized
receivables. Circuit City employs a risk-based pricing strategy that
increases the stated annual percentage rate for accounts that have a higher
predicted risk of default. Accounts with a lower risk profile may qualify
for promotional financing. Under certain of these securitization programs,
Circuit City must meet financial guidelines relating to minimum tangible
net worth, debt to net worth and the current ratio. The securitized
receivables must meet performance levels relating to portfolio yield,
default rates, principal payment rates and delinquency rates. Circuit City
was in compliance with these guidelines at May 31, 2002, and February 28,
2002.
The total principal amount of credit card receivables managed was $2.74
billion at May 31, 2002, and $2.85 billion at February 28, 2002. During the
first quarter of fiscal 2003, the Company completed a $300 million
private-label credit card receivable securitization transaction. Of the
total principal amounts managed, the principal amount of receivables
securitized was $2.70 billion at May 31, 2002, and $2.80 billion at
February 28, 2002, and the principal amount of receivables held for sale
was $39.2 million at May 31, 2002, and $49.2 million at February 28, 2002.
At May 31, 2002, the unused capacity of the private-label variable funding
program was $557.8 million and the unused capacity of the bankcard variable
funding program was $393.2 million. At February 28, 2002, the unused
capacity of the private-label variable funding program was $22.9 million
and the unused capacity of the bankcard variable funding program was $496.5
million. The aggregate amount of receivables that were 31 days or more
delinquent was $171.0 million at May 31, 2002, and $198.4 million at
February 28, 2002. The principal amount of losses net of recoveries totaled
$70.8 million for the quarter ended May 31, 2002, and $69.6 million for the
quarter ended May 31, 2001.
Circuit City receives annual servicing fees approximating 2 percent of the
outstanding principal balance of the credit card receivables and retains
the rights to future cash flows available after the investors in the
asset-backed securities have received the return for which they contracted.
The servicing fees specified in the credit card securitization agreements
adequately compensate the finance operation for servicing the securitized
receivables. Accordingly, no servicing asset or liability has been
recorded.
Page 10 of 62
The table below summarizes certain cash flows received from and paid to the
securitization trusts:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
-----------------------------------------------------------------------------------------------
Proceeds from new securitizations.................... $ 401.8 $ 174.2
Proceeds from collections reinvested
in previous credit card securitizations............ $ 245.6 $ 359.6
Servicing fees received.............................. $ 13.0 $ 13.3
Other cash flows received on retained interests*..... $ 50.7 $ 44.2
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
When determining the fair value of retained interests, Circuit City
estimates future cash flows using management's projections of key factors,
such as finance charge income, default rates, payment rates, forward
interest rate curves and discount rates appropriate for the type of asset
and risk.
Future finance income from securitized credit card receivables that exceeds
the sum of the contractually specified investor returns and servicing fees
(interest-only strips) is carried at fair value and amounted to $126.8
million at May 31, 2002, and $134.8 million at May 31, 2001. These amounts
are included in retained interests in securitized receivables on the
consolidated balance sheets. The change in the interest-only strip for
securitization transaction was a $5.1 million decrease for the three months
ended May 31, 2002 and a $3.8 million increase for the three months ended
May 31, 2001.
The fair value of retained interests at May 31, 2002, was $416.2 million,
with a weighted-average life ranging from 0.2 years to 3.0 years. The fair
value of retained interests at February 28, 2002, was $394.5 million, with
a weighted-average life ranging from 0.2 years to 1.8 years. The following
table shows the key economic assumptions used in measuring the fair value
of retained interests at May 31, 2002, 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 economic assumptions
at May 31, 2002, are not materially different from assumptions used to
measure the fair value of retained interests at the time of securitization.
These sensitivities are hypothetical and should be used with caution. In
this table, the effect of a variation in a particular assumption on the
fair value of the retained interest 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.
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(Dollar amounts in millions) Used Adverse Change Adverse Change
------------------------------------------------------------------------------------------
Monthly payment rate............. 6.7%-10.3% $ 8.3 $ 15.4
Annual default rate.............. 8.1%-17.5% $ 22.3 $ 44.0
Annual discount rate............. 8.3%-15.0% $ 2.9 $ 5.8
(B). Automobile Loan Securitizations:
CarMax has asset securitization programs to finance the automobile loan
receivables generated by its finance operation. CarMax's finance operation
sells its automobile loan receivables to a special purpose subsidiary,
which, in turn, transfers those receivables to a group of third-party
investors. For transfers of receivables that qualify as sales, CarMax
recognizes gains or losses as a component of the finance operation's
profits, which are recorded as reductions to selling, general and
administrative expenses. The special purpose subsidiary retains a
subordinated interest in the transferred receivables. CarMax's finance
Page 11 of 62
operation continues to service securitized receivables for a fee. The
automobile loan securitization agreements do not provide for recourse to
the Company for credit losses on the securitized receivables. CarMax
employs a risk-based pricing strategy that increases the stated annual
percentage rate for accounts that have a higher predicted risk of default.
Under certain of these securitization programs, CarMax must meet financial
guidelines relating to minimum tangible net worth, debt to net worth, net
worth to managed assets, current ratio, minimum cash balance or borrowing
capacity and minimum coverage of rent and interest expense. The securitized
receivables must meet performance levels relating to portfolio yield,
default rates and delinquency rates. CarMax was in compliance with these
guidelines at May 31, 2002, and February 28, 2002.
The total principal amount of automobile loan receivables managed was $1.63
billion at May 31, 2002, and $1.55 billion at February 28, 2002. Of the
total principal amounts managed, the principal amount of automobile loan
receivables securitized was $1.61 billion at May 31, 2002, and $1.54
billion at February 28, 2002, and the principal amount of automobile loan
receivables held for sale or investment was $20.5 million at May 31, 2002,
and $13.9 million at February 28, 2002. The unused capacity of the
automobile loan variable funding program was $115.0 million at May 31,
2002, and $211.0 million at February 28, 2002. The aggregate principal
amount of automobile loans that were 31 days or more delinquent was $21.2
million at May 31, 2002, and $22.3 million at February 28, 2002. The
principal amount of losses net of recoveries totaled $3.3 million for the
three months ended May 31, 2002, and $1.9 million for the three months
ended May 31, 2001.
CarMax receives annual servicing fees approximating 1 percent of the
outstanding principal balance of the securitized automobile loan
receivables and retains the rights to future cash flows available after the
investors in the asset-backed securities have received the return for which
they contracted. The servicing fees specified in the automobile loan
securitization agreements adequately compensate the finance operation for
servicing the securitized receivables. Accordingly, no servicing asset or
liability has been recorded.
The table below summarizes certain cash flows received from and paid to the
securitization trusts:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
-----------------------------------------------------------------------------------------------
Proceeds from new securitizations..................... $ 221.0 $ 195.0
Proceeds from collections reinvested
in previous automobile loan securitizations......... $ 134.5 $ 91.5
Servicing fees received............................... $ 3.9 $ 3.3
Other cash flows received on retained interests*...... $ 20.0 $ 12.5
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
When determining the fair value of retained interests, CarMax estimates
future cash flows using management's projections of key factors, such as
finance charge income, default rates, payment rates and discount rates
appropriate for the type of asset and risk.
Future finance income from securitized automobile loan receivables that
exceeds the sum of the contractually specified investor returns and
servicing fees (interest-only strips) is carried at fair value and amounted
to $76.1 million at May 31, 2002, and $51.4 million at May 31, 2001. These
amounts are included in retained interests in securitized receivables on
the consolidated balance sheets. Gains of $15.6 million on sales of
automobile loan receivables were recorded for the three months ended May
31, 2002; gains of $13.1 million on sales of automobile loan receivables
were recorded for the three months ended May 31, 2001.
The fair value of retained interests at May 31, 2002, was $127.9 million,
with a weighted-average life of 1.6 years. The fair value of retained
interests at February 28, 2002, was $120.7 million, with a weighted-average
life of 1.6 years. The following table shows the key economic assumptions
used in measuring the fair value
Page 12 of 62
of retained interests at May 31, 2002, 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 economic assumptions
at May 31, 2002, are not materially different from assumptions used to
measure the fair value of retained interests at the time of securitization.
These sensitivities are hypothetical and should be used with caution. In
this table, the effect of a variation in a particular assumption on the
fair value of the retained interest 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.
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(Dollar amounts in millions) Used Adverse Change Adverse Change
----------------------------------------------------------------------------------------
Prepayment rate................... 1.5%-1.6% $3.8 $ 7.8
Annual default rate............... 1.0%-1.2% $2.1 $ 4.3
Annual discount rate.............. 12.0% $1.4 $ 2.8
7. Financial Derivatives
On behalf of Circuit City, the Company enters into interest rate cap
agreements to meet the requirements of the credit card receivable
securitization transactions. During the first quarter of fiscal 2003 and in
conjunction with the private-label public securitization, the Company
purchased and sold three offsetting interest rate caps with an aggregate
initial notional amount of $280.5 million. The total notional amount of
interest rate caps outstanding was $935.4 million at May 31, 2002, and
$654.9 million at February 28, 2002. Purchased interest rate caps were
included in net accounts receivable and had a fair value of $9.0 million as
of May 31, 2002, and $2.4 million as of February 28, 2002. Written interest
rate caps were included in accounts payable and had a fair value of $9.0
million as of May 31, 2002, and $2.4 million as of February 28, 2002.
On behalf of CarMax, the Company enters into amortizing swaps relating to
automobile loan receivable securitizations to convert variable-rate
financing costs to fixed-rate obligations to better match funding costs to
the receivables being securitized. During the first quarter of fiscal 2003,
the Company entered into three 40-month amortizing interest rate swaps with
an initial notional amount totaling approximately $248.0 million. The
current amortized notional amount of all outstanding swaps related to the
automobile loan receivable securitizations was approximately $633.7 million
at May 31, 2002, and $413.3 million at February 28, 2002. At May 31, 2002,
the fair value of swaps totaled a net liability of $2.1 million and were
included in accounts payable. At February 28, 2002, the fair value of swaps
totaled a net liability of $841,000 and were included in accounts payable.
The market and credit risks associated with interest rate caps and interest
rate swaps 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. The Company does not
anticipate significant market risk from swaps because they are used on a
monthly basis to match funding costs to the use of the funding. 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.
8. Appliance Exit Costs
In the second quarter of fiscal 2001, the Company began to exit the major
appliance category and expand its selection of key consumer electronics and
home office products in all Circuit City Superstores. This process was
completed in November 2000. To exit the appliance business, the Company
closed eight distribution centers and eight service centers. The Company
leases the majority of these closed properties. While the Company has
entered into contracts to sublease some of these properties, it continues
the process of marketing the remaining properties to be subleased.
Page 13 of 62
In the second quarter of fiscal 2001, the Company recorded appliance exit
costs of $30.0 million. In the fourth quarter of fiscal 2002, the Company
recorded additional lease termination costs of $10.0 million to reflect the
current rental market for these leased properties. These expenses are
reported separately on the fiscal 2002 and 2001 consolidated statements of
earnings. The appliance exit cost liability is included in accrued expenses
and other current liabilities on the consolidated balance sheets.
The appliance exit cost accrual activity and the remaining liability at May
31, 2002, are presented in the following table.
Total Fiscal 2001 Fiscal 2002 Fiscal 2002 Fiscal 2003
Original Payments Liability at Adjustments Payments Liability at Payments Liability at
Exit Cost or February 28, to Exit Cost or February 28, or May 31,
(Amounts in millions) Accrual Write-Downs 2001 Accrual Write-Downs 2002 Write-Downs 2002
- --------------------------------------------------------------------------------------------------------------------------------
Lease termination costs... $17.8 $ 1.8 $16.0 $10.0 $6.3 $19.7 $ 1.7 $18.0
Fixed asset write-downs,
net...................... 5.0 5.0 - - - - - -
Employee termination
benefits................. 4.4 2.2 2.2 - 2.2 - - -
Other .................... 2.8 2.8 - - - - - -
-----------------------------------------------------------------------------------------------------
Appliance exit costs...... $30.0 $ 11.8 $18.2 $10.0 $8.5 $19.7 $ 1.7 $18.0
=====================================================================================================
9. Operating Segment Information
The Company conducts business in two operating segments: Circuit City and
CarMax. These segments are identified and managed by the Company based on
the different products and services offered by each. Circuit City refers to
the retail operations bearing the Circuit City name and to all related
operations, such as Circuit City's finance operation. This segment is
engaged in the business of selling brand-name consumer electronics,
personal computers and entertainment software. CarMax refers to the used-
and new-car retail locations bearing the CarMax name and to all related
operations, such as CarMax's finance operation.
Financial information for these segments for the three-month periods ended
May 31, 2002 and 2001, is presented in the following tables.
Three Months Ended May 31, 2002
Total
(Amounts in thousands) Circuit City CarMax Segments
-----------------------------------------------------------------------------------
Revenues from external customers........ $2,118,243 $1,001,564 $3,119,807
Interest expense........................ - 1,026 1,026
Depreciation and amortization.......... 35,746 4,138 39,884
(Loss) earnings before income taxes..... (2,025) 48,327 46,302
Income tax (benefit) provision ......... (769) 19,089 18,320
Net (loss) earnings..................... (1,256) 29,238 27,982
Total assets............................ $3,769,322 $ 830,218 $4,597,096
Page 14 of 62
Three Months Ended May 31, 2001
Total
(Amounts in thousands) Circuit City CarMax Segments
-----------------------------------------------------------------------------------
Revenues from external customers........ $1,870,621 $879,000 $2,749,621
Interest expense........................ 441 2,551 2,992
Depreciation and amortization........... 34,489 4,693 39,182
(Loss) earnings before income taxes..... (15,492) 42,859 27,367
Income tax (benefit) provision.......... (5,887) 16,287 10,400
Net (loss) earnings..................... (9,605) 26,572 16,967
Total assets............................ $3,019,010 $795,402 $3,814,412
In the preceding tables, the net loss for Circuit City excludes the net
earnings attributed to the reserved CarMax Group shares. Total assets for
Circuit City exclude the reserved CarMax Group shares. As of May 31, 2001,
total assets for Circuit City also exclude the discontinued Divx
operations, which are discussed in Note 10.
10. Discontinued Operations
On June 16, 1999, Digital Video Express announced that it would cease
marketing the Divx home video system and discontinue operations. As of
February 28, 2002, entities comprising the Divx operations were dissolved
and the related liabilities had been assumed by the Company. Current
liabilities of $18.5 million related to the former Divx operations were
reflected in the consolidated balance sheets as of May 31, 2002, and
February 28, 2002. For the three-month periods ended May 31, 2002 and 2001,
the discontinued Divx operations had no impact on the net earnings of
Circuit City Stores, Inc. Discontinued operations have been segregated on
the consolidated statements of cash flows.
11. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued SFAS No. 142,
"Goodwill and Other Intangible Assets," effective for fiscal years
beginning after December 15, 2001. Under the provisions of SFAS No. 142,
goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but instead are subject to annual impairment tests in
accordance with the pronouncement. Other intangible assets that are
identified to have finite useful lives continue to be amortized in a manner
that reflects the estimated decline in the economic value of the intangible
asset and are subject to review when events or circumstances arise which
indicate impairment. Application of the nonamortization provisions of SFAS
No. 142 in the first quarter of fiscal 2003 did not have a material impact
on the financial position, results of operations or cash flows of the
Company. During fiscal 2003, the Company will perform the first of the
required impairment tests of goodwill and indefinite-lived intangible
assets, as outlined in the pronouncement. Based on preliminary estimates,
as well as ongoing periodic assessments of goodwill, the Company does not
expect to recognize any material impairment losses from these tests.
In August 2001, the FASB issued SFAS No. 143, "Accounting For Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. It applies to
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and/or the normal
operation of a long-lived asset, except for certain obligations of lessees.
This standard requires entities to record the fair value of a liability for
an asset retirement obligation in the period incurred. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002. The Company has
not yet determined the impact, if any, of adopting this standard.
Page 15 of 62
12. Reclassifications
Certain prior year amounts have been reclassified to conform to the current
presentation. Effective in the first quarter of fiscal 2003, Circuit City
Stores adopted Emerging Issues Task Force No. 00-14, "Accounting for
Certain Sales Incentives," which provides that sales incentives, such as
mail-in rebates, offered to customers should be classified as a reduction
of revenue. Previously, the Company recorded these rebates in cost of
sales, buying and warehousing. For the quarter ended May 31, 2001, the
reclassification of rebates from cost of sales, buying and warehousing to
sales decreased sales and cost of sales, buying and warehousing by $11.0
million.
For the quarter ended May 31, 2001, CarMax wholesale sales have been
reclassified and reported in net sales and operating revenues. In previous
periods, wholesale sales were recorded as reductions to cost of sales. The
reclassification of wholesale sales to sales increased sales and cost of
sales by $84.5 million for the quarter ended May 31, 2001. An additional
reclassification between sales and cost of sales made to conform to the
current presentation decreased sales and cost of sales by $2.3 million for
the quarter ended May 31, 2001.
ITEM 2.
CIRCUIT CITY STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "Circuit City business" and "Circuit City" refer to the retail
operations bearing the Circuit City name and to all related operations such as
product service and Circuit City's finance operation. "Circuit City Group"
refers to the Circuit City business and the reserved CarMax Group shares.
"CarMax business," "CarMax" and "CarMax Group" refer to retail locations bearing
the CarMax name and to all related operations such as CarMax's finance
operation. All references to "month," "quarter" and "year" refer to our fiscal
year periods rather than calendar year periods unless stated otherwise.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would separate
the CarMax auto superstore business from the Circuit City consumer electronics
business through a tax-free transaction in which CarMax, Inc., presently a
wholly owned subsidiary of Circuit City Stores, Inc., would become an
independent, separately traded public company. CarMax, Inc. holds substantially
all of the businesses, assets and liabilities of the CarMax Group. The
separation plan calls for Circuit City Stores, Inc. to redeem the outstanding
shares of CarMax Group Common Stock in exchange for shares of common stock of
CarMax, Inc. Simultaneously, shares of CarMax, Inc. common stock, representing
the shares of CarMax Group Common Stock reserved for the holders of Circuit City
Group Common Stock, would be distributed as a tax-free dividend to the holders
of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax Group
Common Stock redeemed by the Company. Management anticipates that the holders of
Circuit City Group Common Stock would receive a fraction of a share of CarMax,
Inc. common stock for each share of Circuit City Group Common Stock they hold.
The exact fraction would be determined on the record date for the distribution.
The separation is expected to be completed by late summer or early fall, subject
to shareholder approval and final approval from the board of directors.
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies included in the Circuit City
Stores, Inc. 2002 Annual Report to Shareholders. These policies relate to the
calculation of the value of retained interests in securitization transactions
and the calculation of the liability for lease termination costs.
Page 16 of 62
RESULTS OF OPERATIONS
Effective in the first quarter of fiscal 2003, Circuit City Stores adopted
Emerging Issues Task Force No. 00-14, "Accounting for Certain Sales Incentives,"
which provides that sales incentives, such as mail-in rebates, offered to
customers should be classified as a reduction of revenue. Previously, the
Company recorded these rebates in cost of sales, buying and warehousing. These
rebate amounts totaled $11.0 million in the first quarter of fiscal 2002 and
have been reclassified on the statement of earnings.
Effective in the first quarter of fiscal 2003, CarMax classifies revenue from
the sale of wholesale vehicles in net sales and operating revenues. Previously,
CarMax wholesale vehicle sales were recorded as reductions to cost of sales. The
reclassification of wholesale sales to sales increased sales and cost of sales
by $84.5 million for the quarter ended May 31, 2001. An additional
reclassification between sales and cost of sales made to conform to the current
presentation decreased sales and cost of sales by $2.3 million for the quarter
ended May 31, 2001.
Net Sales and Operating Revenues and General Comments
Circuit City Stores, Inc. Total sales for Circuit City Stores for the first
quarter of fiscal 2003 were $3.12 billion, an increase of 13 percent from $2.75
billion for the same period last year.
Our operations, in common with other retailers in general, are subject to
seasonal influences. Historically, the Circuit City business has realized more
of its net sales and net earnings in the fourth quarter, which includes the
December holiday selling season, than in any other fiscal quarter. The CarMax
business, however, has experienced more of its net sales in the first half of
the fiscal year. The net earnings of any quarter are seasonally disproportionate
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.
Circuit City Group. Total sales for the Circuit City Group for the first quarter
of fiscal 2003 increased 13 percent to $2.12 billion from $1.87 billion in last
year's first quarter. Comparable store sales increased 12 percent for the first
quarter of fiscal 2003 and decreased 25 percent for the first quarter of fiscal
2002. Circuit City stores are included in comparable store sales after the store
has been open for a full year.
The comparable store sales pace strengthened as the first quarter progressed,
reflecting the growing consumer response to our customer service initiatives,
aggressive promotions in traffic-building categories and on entry-level products
and a stronger inventory position in specific product categories.
First quarter Circuit City sales for fiscal 2003 reflected continued progress in
both the high-service and packaged goods arenas. We posted strong sales growth
in focus categories such as video, including big-screen televisions, DVD players
and digital satellite systems; and wireless communications, and in self-serve
product selections, including DVD software and video game hardware, software and
accessories. We experienced improving trends in information technology products,
with PC sales growth driven by strong sales of notebook computers and a more
competitive promotional stance compared with last fiscal year's first quarter.
Page 17 of 62
The percent of merchandise sales represented by each major product category
during the first quarter of fiscal years 2003 and 2002 were as follows:
================================== ==============================
1st Quarter
------------------------------
Product Mix FY03 FY02
---------------------------------- -------------- ---------------
Video 40% 37%
---------------------------------- -------------- ---------------
Audio 15 17
---------------------------------- -------------- ---------------
Information technology 34 36
---------------------------------- -------------- ---------------
Entertainment 11 10
---------------------------------- -------------- ---------------
Total 100% 100%
================================== ============== ===============
In most states, Circuit City sells 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. In the
three states where third-party warranty sales are not permitted, Circuit City
sells an extended warranty for which we are the primary obligor. The total
extended warranty revenue that is reported in total sales was $87.9 million, or
4.2 percent of sales, in the first quarter of fiscal 2003, compared with $80.1
million, or 4.3 percent of sales, in last year's first quarter.
The following table provides details on the Circuit City retail units:
======================== =================== =================== ================== ===================
Estimate
Store Mix May 31, 2002 May 31, 2001 Feb. 28, 2003 Feb. 28, 2002
------------------------ ------------------- ------------------- ------------------ -------------------
Superstores 603 594 611 604
------------------------ ------------------- ------------------- ------------------ -------------------
Express stores 19 32 18 20
------------------------ ------------------- ------------------- ------------------ -------------------
Total 622 626 629 624
======================== =================== =================== ================== ===================
Circuit City expects to open approximately eight Superstores and relocate an
estimated 10 Superstores in the current fiscal year. In the first quarter of
fiscal 2003, we closed one Superstore, relocated two Superstores and closed one
mall-based Express store.
CarMax Group. Total sales for the CarMax Group for the first quarter of fiscal
2003 increased 14 percent to $1.00 billion from $879.0 million in last year's
first quarter.
Retail Vehicle Sales. Retail vehicle sales for CarMax increased 14 percent to
$870.1 million in the first quarter of fiscal 2003 from $761.0 million in the
first quarter of fiscal 2002. In the first quarter of fiscal 2003, used vehicle
sales increased 20 percent to $737.8 million from $615.1 million in the first
quarter of fiscal 2002. In the first quarter of fiscal 2003, new vehicle sales
decreased 9 percent to $132.3 million from $145.8 million in the first quarter
of fiscal 2002.
Page 18 of 62
CarMax stores are included in comparable store retail sales after the store has
been open for a full year. Comparable store vehicle dollar and unit sales for
the first quarter of fiscal years 2003 and 2002 were as follows:
================================== ==============================
1st Quarter
Comparable Store ------------------------------
Sales Change FY03 FY02
---------------------------------- -------------- ---------------
Vehicle dollars:
---------------------------------- -------------- ---------------
Used vehicles 14 % 28%
---------------------------------- -------------- ---------------
New vehicles (4)% 23%
---------------------------------- -------------- ---------------
Total 11 % 27%
---------------------------------- -------------- ---------------
---------------------------------- -------------- ---------------
Vehicle units:
---------------------------------- -------------- ---------------
Used vehicles 12 % 20%
---------------------------------- -------------- ---------------
New vehicles (4)% 19%
---------------------------------- -------------- ---------------
Total 10 % 20%
================================== ============== ===============
The overall increase in retail sales is attributed to the 12 percent sales
growth in comparable store used-unit sales, the three additional CarMax stores
opened since the first quarter of fiscal 2002 and the slight increase in the
average retail selling price for used vehicles. The comparable store new-unit
sales decline was in line with the new-car industry's performance.
================================== ================================
1st Quarter
Average Retail --------------------------------
Selling Prices FY03 FY02
---------------------------------- --------------- ----------------
Used vehicles $15,500 $15,100
---------------------------------- --------------- ----------------
New vehicles $23,000 $23,200
---------------------------------- --------------- ----------------
Blended average $16,300 $16,200
================================== =============== ================
================================== ==============================
1st Quarter
------------------------------
Retail Vehicle Sales Mix FY03 FY02
---------------------------------- -------------- ---------------
Vehicle dollars:
---------------------------------- -------------- ---------------
Used vehicles 85% 81%
---------------------------------- -------------- ---------------
New vehicles 15 19
---------------------------------- -------------- ---------------
Total 100% 100%
---------------------------------- -------------- ---------------
---------------------------------- -------------- ---------------
Vehicle units:
---------------------------------- -------------- ---------------
Used vehicles 89% 87%
---------------------------------- -------------- ---------------
New vehicles 11 13
---------------------------------- -------------- ---------------
Total 100% 100%
================================== ============== ===============
Wholesale Vehicle Sales. Wholesale vehicle sales totaled $92.5 million in the
first quarter of fiscal 2003, compared with $84.5 million in the same period
last year. The increase was consistent with increased traffic at CarMax Stores.
Page 19 of 62
Other Sales and Revenues. Other sales and revenues include extended warranty
revenues, service department sales and processing fees collected from consumers
for the purchase of their vehicles at a CarMax retail location and totaled $39.0
million in the first quarter of fiscal 2003, compared with $33.5 million in the
same period last year.
CarMax sells extended warranties on behalf of unrelated third parties who are
the primary obligors. Under these third-party warranty programs, CarMax has no
contractual liability to the customer. Extended warranty revenue was $16.7
million in the first quarter of fiscal 2003 and $13.5 million in the first
quarter of fiscal 2002. The increase reflects improved penetration and strong
sales growth for used cars, which achieve a higher extended warranty penetration
rate than new cars.
Service sales were $15.5 million in the first quarter of fiscal 2003, compared
with $13.9 million in the same period last year. The increase relates to the
overall increase in CarMax's customer base.
Processing fees were $6.8 million in the first quarter of fiscal 2003, compared
with $6.1 million in the same period last year. Consumers are assessed this fee
when selling a vehicle to a CarMax retail location after the appraisal process.
The increase was the result of increased traffic and increased consumer response
to CarMax's vehicle purchase program.
Retail Stores. During the first quarter of fiscal 2003, we integrated the
new-car stand-alone Chrysler franchise in the Orlando, Fla., market with an
existing CarMax superstore and opened a standard-sized superstore in the
mid-sized market of Sacramento, Calif. CarMax expects to open four to five
stores in the second half of the fiscal year, including entries into the
Knoxville, Tenn., and Las Vegas, Nev., markets.
The following table provides detail on the CarMax retail stores:
====================================== ==================== =================== =================== ==================
Estimate Feb. 28,
Store Mix May 31, 2002 May 31, 2001 2003 Feb. 28, 2002
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Mega superstores 13 13 13 13
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Standard superstores 18 16 20 17
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Prototype satellite stores 5 4 8 5
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Co-located new-car stores 2 2 2 2
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Stand-alone new-car stores 2 5 2 3
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Total 40 40 45 40
====================================== ==================== =================== =================== ==================
Cost of Sales, Buying and Warehousing
Circuit City Stores, Inc. The gross profit margin for Circuit City Stores was
20.2 percent of sales in the first quarter of fiscal 2003, compared with 20.6
percent in the same period last year.
Circuit City Group. The gross profit margin for the Circuit City Group was 24.2
percent of sales in the first quarter of fiscal 2003, compared with 24.7 percent
in the same period last year. The first quarter gross profit margin decline
reflects our more competitive product selection and pricing throughout the
quarter, as well as our response to more aggressive offers from competitors, and
the resulting sales mix. Circuit City experienced some trade-off in gross margin
for sales growth, as we chose to be more aggressive in promoting traffic-driving
and entry-level products.
CarMax Group. Total gross profit margin for the CarMax Group was 11.8 percent of
sales in the first quarter of both fiscal 2003 and fiscal 2002.
Page 20 of 62
Retail Vehicle Gross Profit Margin. The retail vehicle gross profit margin was
9.9 percent in the first quarter of fiscal 2003 versus 10.0 percent for the same
period last year. CarMax achieved its average per unit gross profit targets on
used cars; however, the positive gross margin impact of a higher percentage of
used cars in the mix was substantially offset by the higher average retails on
used cars, which reduced the used-car margin on a percentage basis. The result
was a retail vehicle gross profit margin that slightly declined in relation to
last year's first quarter.
Wholesale Vehicle Gross Profit Margin. The wholesale vehicle gross profit margin
was 6.7 percent in the first quarter of fiscal 2003, compared with 5.6 percent
for the same period last year. Both the average wholesale cost and average
wholesale sales price declined compared with the first quarter of fiscal 2002;
however, the decrease in the average wholesale sales price was less than the
decrease in the average wholesale cost.
Other Gross Profit Margin. The gross profit margin for other sales and revenues
was 66.5 percent in the first quarter of fiscal 2003, compared with 68.1 percent
for the same period last year.
Selling, General and Administrative Expenses
Circuit City Stores, Inc. The selling, general and administrative expense ratio
for Circuit City Stores was 18.7 percent of sales in the first quarter of fiscal
2003, compared with 19.5 percent for the same period last year. See below for
finance income disclosure.
Circuit City Group. The selling, general and administrative expense ratio for
the Circuit City Group was 24.3 percent of sales in the first quarter of fiscal
2003, compared with 25.5 percent for the same period last year. This decline was
principally a result of the leverage achieved through increased sales.
Finance Operations. For the first quarter of fiscal 2003 and 2002, pretax
finance operation income, which is recorded as a reduction to selling, general
and administrative expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
---------------------------------------------------------------------------
Securitization income.............. $50.5 $59.7
Payroll and fringe expenses........ 10.7 10.3
Other direct expenses.............. 19.4 19.9
--------------------------------------
Finance operation income........... $20.4 $29.5
======================================
Receivables generated by the Circuit City finance operation are sold through
securitization transactions. Circuit City continues to service the securitized
receivables for a fee. For the quarter ended May 31, 2002 serviced receivables
averaged $2.78 billion, compared to $2.64 billion for the quarter ended May 31,
2001.
Included in securitization income is the gain on the sale of these receivables
and other income related to servicing these receivables. Future finance income
from securitized credit card receivables that exceeds the sum of the
contractually specified investor returns and servicing fees (interest-only
strips) is carried at fair value and amounted to $126.8 million at May 31, 2002
and $134.8 million at May 31, 2001. The key assumptions and estimates in
determining the fair value of interest-only strips include management's
projections of key factors, such as finance charge income, default rates,
payment rates, forward interest rate curves and discount rates appropriate for
the type of asset and risk. Based on these assumptions and estimates and the
operation's securitization volume, the change in the interest-only strip for
securitization transactions was a $5.1 million decrease for the three months
ended May 31, 2002 and a $3.8 million increase for the three months ended May
31, 2001. Management reviews the assumptions and estimates used in determining
the fair value of the interest-only strip on a quarterly basis. If these
assumptions change or the actual results differ from the projected results,
securitization income would be affected.
Page 21 of 62
For the Circuit City Group, the finance operation 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. Other direct expenses, which did not
change significantly for the three months ended May 31, 2002 compared to May 31,
2001, include third party data processing, rent, credit promotion expenses, Visa
and MasterCard fees, and other operating expenses. Payroll expenses generally
vary with the size of the serviced portfolio, and increased only slightly during
the quarter ended May 31, 2002 compared to May 31, 2001.
The fiscal 2003 expense ratio also includes approximately $8 million of costs
associated with remodeling and relocation activities, while the fiscal 2002
ratio includes approximately $3 million of relocation costs. As of May 31, 2002,
the Company had completed the initial phases of the video department remodeling
program planned for roll out to approximately 300 Circuit City Superstores in
fiscal 2003. As of May 31, 2002, we had completed the video reset in 20 Circuit
City Superstores, including 18 in the first quarter, and the lighting upgrade in
more than 100 Superstores. Based on our experience with the progress of the
remodeling process to date, we now anticipate that it can be completed in
approximately one week per store, rather than our initial two-week expectation.
We anticipate that the cost will not exceed our initial estimate of 18 cents per
Circuit City Group share.
CarMax Group. The selling, general and administrative expense ratio for the
CarMax Group increased to 6.8 percent of sales in the first quarter of fiscal
2003 from 6.7 percent of sales for the same period last year. The higher expense
ratio in this year's first quarter compared with last year's first quarter
reflects expenses associated with geographic expansion and $1.9 million of
one-time separation costs, partly offset by increased income from financing.
Finance Income. For the first quarter of fiscal 2003 and 2002, pretax finance
income, which is recorded as a reduction to selling, general and administrative
expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
-------------------------------------------------------------------------
Securitization income............ $23.3 $18.4
Payroll and fringe expenses...... 1.7 1.3
Other direct expenses............ 1.7 1.4
----------------------------------------
Finance operation income......... 19.9 15.7
Third-party financing fees....... 4.2 3.8
----------------------------------------
Total finance income............. $24.1 $19.5
========================================
Receivables generated by the CarMax finance operation are sold through
securitization transactions. CarMax continues to service these receivables in
exchange for a contractually specified servicing fee. For the quarter ended May
31, 2002 serviced receivables averaged $1.56 billion, compared to $1.28 billion
for the period ended May 31, 2001.
For the CarMax Group, securitization income includes the gain on sale of
receivables and other income related to servicing these receivables. CarMax
recorded gains on sale of receivables totaling $15.6 million for the quarter
ended May 31, 2002 compared to gains of $13.1 million for the period ended May
31, 2001. This change resulted from an increase in loan origination volume
driven by increased sales. In recording these gains, management estimates key
assumptions such as finance charge income, default rates, payment rates and
discount rates appropriate for the type of asset and risk. If these assumptions
change, or the actual results differ from the projected results, securitization
income would be affected.
For the CarMax Group, finance operation 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
Page 22 of 62
store expenses. Direct expenses include collection expenses, rent and facility
expenses and loan processing costs. Payroll, fringes and other direct expenses
increased proportionately to the average managed receivable balance.
Fees received from arranging customer automobile financing through third parties
increased by $0.4 million over the same period last year. The increase was a
result of the total increase in retail vehicle sales.
Interest Expense
Interest expense for Circuit City Stores declined to $1.0 million for the first
quarter of fiscal 2003 from $3.0 million in the same period last year,
reflecting both lower debt levels and lower interest rates.
Income Taxes
The effective income tax rate increased to 39.6 percent for the first quarter of
fiscal 2003 from 38.0 percent for the first quarter of fiscal 2002. The increase
reflects the $1.9 million of one-time, non-tax-deductible costs associated with
the proposed separation of CarMax from Circuit City Stores, Inc.
Net Earnings (Loss)
Circuit City Stores, Inc. Net earnings for Circuit City Stores increased to
$28.0 million in the first quarter of fiscal 2003 from $17.0 million in last
year's first quarter.
Circuit City Group. Excluding the earnings attributed to the reserved CarMax
Group shares, the Circuit City business produced a loss of $1.3 million, or 1
cent per Circuit City Group share, in the first quarter ended May 31, 2002,
compared with a loss of $9.6 million, or 5 cents per Circuit City Group share,
for the same period last year.
The net earnings attributed to the reserved CarMax Group shares were $18.7
million in the first quarter of this fiscal year, compared with $19.7 million in
last fiscal year's first quarter.
Net earnings of the Circuit City Group were $17.5 million, or 8 cents per share,
in the first quarter of fiscal 2003, compared with $10.1 million, or 5 cents per
share, in the first quarter of fiscal 2002.
CarMax Group. The CarMax Group's first quarter fiscal 2003 net earnings rose 10
percent to $29.2 million from $26.6 million in the first quarter of fiscal 2002.
First quarter fiscal 2003 earnings include $1.9 million of one-time,
non-tax-deductible costs associated with the proposed separation of CarMax from
Circuit City Stores. Excluding the one-time separation costs, net earnings
increased 17 percent to $31.1 million.
In the first quarter of fiscal 2003, net earnings attributed to the CarMax Group
Common Stock were $10.5 million, or 27 cents per CarMax Group share, compared
with $6.8 million, or 25 cents per CarMax Group share, in the first quarter of
last year. The remainder of the CarMax Group's net earnings was attributed to
the shares of CarMax Group Common Stock reserved for the Circuit City Group or
for issuance to the holders of Circuit City Group Common Stock.
Operations Outlook
Circuit City Group. In fiscal 2001, we introduced a store design that includes a
more customer-friendly layout with better product adjacencies; a brighter more
contemporary appearance; additional product on the sales floor; shopping carts
and easily accessible cash registers. All new stores continue to follow this
design. In fiscal 2001 and fiscal 2002, we also undertook several remodels and
product category tests to evaluate how best to add these features into existing
stores. We decided to begin in fiscal 2003 a three-year multi-phased remodeling
program that will cover approximately 300 stores. As part of this remodeling
program, we will in fiscal 2003 introduce a remodeled video department and
upgrade the lighting in these stores, spending an average of $325,000 to
$350,000 per store. We believe that rolling out this remodeled department will
enable us to increase Circuit City's market share in the growing and highly
profitable big-screen television category and further solidify our position in
the overall video category. The Consumer Electronics Association projects
Page 23 of 62
that big-screen television sales will grow at a double-digit rate in calendar
2002. By beginning with the video department, we believe that we can affect a
large number of Circuit City Superstores in a manner that has significant
potential for incremental benefit while minimizing the disruptive impact of the
remodeling process.
In addition to remodeling, we expect to relocate approximately 10 Superstores in
the current fiscal year. We expect that fiscal 2003 expenditures for Circuit
City remodeling and relocations will total approximately $130 million, of which
we expect to capitalize approximately $70 million and expense approximately $60
million, or no more than 18 cents per Circuit City Group share.
In fiscal 2003, we also will continue testing design ideas for other departments
in the Circuit City Superstores. In fiscal 2004 and fiscal 2005, we expect to
introduce these design ideas into many of the approximately 300 stores being
remodeled under the three-year remodeling plan. We continue to review the
suitability of our remaining Superstore base for either remodeling or relocation
and also anticipate relocating additional stores in fiscal 2004 and fiscal 2005.
We currently anticipate that in fiscal 2004 and fiscal 2005 the impact of
remodeling and relocations on earnings per share will be similar to the fiscal
2003 impact.
Given our presence in virtually all of the nation's top metropolitan markets,
new Superstores are being added only in small markets or to increase our
penetration in existing major markets. We plan to open approximately eight
Circuit City Superstores in fiscal 2003. Because of limited planned geographic
expansion, we expect total Circuit City sales growth to only slightly exceed
comparable store sales growth. We expect that categories where we expanded
selection following our exit from the appliance business and categories, such as
big-screen televisions, that are benefiting from digital product innovation,
will contribute to Circuit City's total and comparable store sales growth.
However, we also anticipate that Circuit City's sales growth will reflect our
focus on sales counselor training and customer service, store remodeling,
effective marketing programs and a competitive merchandise assortment with
attractive prices. We expect that the gross profit margin will reflect the mix
of merchandise sold and our efforts to remain competitive and achieve profitable
market share growth and that the expense ratio will reflect increases in Circuit
City expenses associated with remodeling and relocation as discussed above,
advertising and systems enhancements and the total sales volume achieved. For
the full year, we expect the fiscal 2003 profit contribution from Circuit City's
finance operation to be similar to the contribution in fiscal 2002.
With existing Circuit City initiatives, additional efforts to enhance the
business and a relatively stable economy, we believe Circuit City will
contribute 57 cents per share to 67 cents per share to the fiscal 2003 earnings
of the Circuit City Group, including remodeling and relocation expenses.
Excluding these expenses, we expect the Circuit City business will contribute 75
cents per share to 85 cents per share to the earnings of the Circuit City Group.
CarMax Group. For more than two years, CarMax has demonstrated that its consumer
offer and business model can produce strong sales and earnings growth. At the
beginning of fiscal 2002, CarMax announced that it would resume geographic
growth, opening two superstores in fiscal 2002, four to six superstores in
fiscal 2003 and six to eight stores in each of fiscal years 2004, 2005 and 2006.
This expansion is proceeding as planned with four or five more used-car
superstores scheduled to open during the second half of the fiscal year.
Comparable store used-unit sales growth drives CarMax's profitability. We
currently anticipate that comparable store used-unit growth will most likely be
in the low teens in the first half of fiscal 2003. For the second half of the
fiscal year, we continue to expect used-unit comparable store growth in the
high-single to low-double digits.
Our earnings expectations for fiscal 2003 remain unchanged at 95 cents to $1.00
per CarMax Group share, excluding approximately 8 cents per share of one-time,
non-tax-deductible costs associated with the separation. We expect fiscal 2003
to be a year of transition for CarMax as we ramp up the growth pace. Additional
growth-related costs, such as training, recruiting and employee relocation for
our new stores, and additional expenses expected in the second half if the
planned separation is approved will moderate earnings growth, offsetting the
expense leverage we would otherwise expect from used-unit comparable store
growth.
Page 24 of 62
In addition, we had anticipated that interest rates would rise above the low
levels experienced in fiscal 2002 resulting in reduced yield spreads from the
CarMax finance operation throughout fiscal 2003. If the current favorable
interest rate environment continues, CarMax may not experience the reduction in
yield spreads that we originally anticipated.
Recent Accounting Pronouncements
On March 1, 2002, Circuit City Stores adopted EITF No. 00-14, "Accounting for
Certain Sales Incentives," which provides that sales incentives, such as mail-in
rebates, offered to customers should be classified as a reduction to revenue.
The Company reclassified these rebate expenses from cost of sales, buying and
warehousing to net sales and operating revenues. The adoption did not have a
material impact on the Company's financial position, results of operations or
cash flows.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets,"
effective for fiscal years beginning after December 15, 2001. Under the
provisions of SFAS No. 142, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized but instead are subject to annual
impairment tests in accordance with the pronouncement. Other intangible assets
that are identified to have finite useful lives continue to be amortized in a
manner that reflects the estimated decline in the economic value of the
intangible asset and are subject to review when events or circumstances arise
which indicate impairment. Application of the nonamortization provisions of SFAS
No. 142 in the first quarter of fiscal 2003 did not have a material impact on
the financial position, results of operations or cash flows of the Company.
During fiscal 2003, the Company will perform the first of the required
impairment tests of goodwill and indefinite-lived intangible assets, as outlined
in the pronouncement. Based on preliminary estimates, as well as ongoing
periodic assessments of goodwill, the Company does not expect to recognize any
material impairment losses from these tests.
In August 2001, the FASB issued SFAS No. 143, "Accounting For Asset Retirement
Obligations." This statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and/or the normal operation of a long-lived asset,
except for certain obligations of lessees. This standard requires entities to
record the fair value of a liability for an asset retirement obligation in the
period incurred. SFAS No. 143 is effective for fiscal years beginning after June
15, 2002. The Company has not yet determined the impact, if any, of adopting
this standard.
On March 1, 2002, Circuit City Stores adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The adoption of SFAS No. 144 did
not have a material impact on the Company's financial position, results of
operations or cash flows.
FINANCIAL CONDITION
Liquidity and Capital Resources
Operating Activities. For the first three months ended May 31, 2002, net cash
used in operating activities was $132.2 million compared with net cash used in
operating activities of $7.6 million in the first quarter of fiscal 2002. The
increase primarily reflects an increase in inventory purchases to meet
anticipated sales demands.
Investing Activities. Net cash used in investing activities was $46.5 million in
the three months ended May 31, 2002, compared with $29.6 million in the first
three months of last year. Capital expenditures increased to $50.9 million in
the first three months of fiscal 2003 from $32.9 million in the comparable
period last year. Circuit City capital expenditures in the first three months of
fiscal 2003 included spending for the initial phases of rolling out a remodeled
video department, which was completed in 18 Superstores, lighting upgrades in
more than 100 Circuit City Superstores and the relocation of two Circuit City
Superstores. Capital expenditures in the first three months of fiscal 2002
included spending for the relocation of one Circuit City
Page 25 of 62
Superstore. During the first quarter of fiscal 2003, CarMax's capital
expenditures increased $25.2 million in connection with geographic expansion.
Proceeds from sales of property and equipment increased to $4.4 million in the
first three months of the current fiscal year from $3.2 million in the
comparable period of last fiscal year.
Financing Activities. Net cash provided by financing activities increased to
$103.2 million in the first quarter of fiscal 2003 from $1.1 million in the
comparable period last year. In the first quarter of fiscal 2003, CarMax entered
into a $200 million credit agreement with DaimlerChrysler Services North
America, LLC and Toyota Financial Services. This agreement, which is secured by
vehicle inventory, includes a $100 million revolving loan commitment and a $100
million term loan commitment. The terms for both commitments are LIBOR-based and
have initial two-year terms. As of May 31, 2002, the amount outstanding under
this credit agreement was $100 million. CarMax anticipates that some of the
proceeds from the agreement will be used for the repayment of allocated debt,
the payment on the separation date of a one-time special dividend to Circuit
City Stores of $28.4 million, the payment of transaction expenses incurred in
connection with the separation and general corporate purposes.
In December 2001, CarMax entered into an $8.5 million secured promissory note in
conjunction with the purchase of land for new store construction. This note,
which is payable in August 2002, was included in short-term debt as of May 31,
2002. At May 31, 2002, a $100 million outstanding term loan due in July 2002 was
classified as a current liability. Although the Company has the ability to
refinance this debt, we intend to repay it using existing working capital.
At May 31, 2002, the Company had cash and cash equivalents of $1.18 billion and
total outstanding debt of $226.7 million. Circuit City Stores maintains a $150
million unsecured revolving credit facility that expires on August 31, 2002. The
Company does not anticipate renewing this facility. The Company also maintains
$195 million in committed seasonal lines of credit that are renewed annually
with various banks. At May 31, 2002, total balances of $2.4 million were
outstanding under these facilities.
At May 31, 2002, the aggregate principal amount of securitized credit card
receivables totaled $1.25 billion under the private-label program and $1.44
billion under the bankcard program. During the first quarter of fiscal 2003, the
Company completed a $300 million private-label credit card receivable
securitization transaction. At May 31, 2002, the unused capacity of the
private-label variable funding program was $557.8 million and the unused
capacity of the bankcard variable funding program was $393.2 million. At May 31,
2002, there were no provisions providing recourse to the Company for credit
losses on the receivables securitized through the private-label or bankcard
master trusts.
During the first quarter, we announced plans to offer consumers a co-branded
Visa credit card rather than the private-label credit card. We began introducing
the new card early in the second quarter and ceased to open private-label
accounts. Existing private-label credit card holders may continue using their
accounts. Receivables generated under the co-branded program will be funded
through the private-label master trust.
At May 31, 2002, the aggregate principal amount of securitized automobile loan
receivables totaled $1.61 billion. During the second quarter of fiscal 2003,
CarMax completed an asset securitization transaction totaling $512.6 million of
automobile loan receivables. At May 31, 2002, the unused capacity of the
automobile loan variable funding program was $115.0 million. At May 31, 2002,
there were no provisions providing recourse to the Company for credit losses on
the securitized automobile loan receivables. We anticipate that we will be able
to expand or enter into new securitization arrangements to meet future needs of
both the Circuit City and CarMax finance operations.
For the Company, we expect that available cash resources, CarMax's credit
agreement secured by vehicle inventory, sale-leaseback transactions, landlord
reimbursements and cash generated by operations will be sufficient to fund
capital expenditures for the foreseeable future.
Page 26 of 62
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties, including, but not limited to, risks
associated with plans to separate the CarMax business from Circuit City Stores,
Inc. and create an independent, separately traded public company. Additional
discussion of factors that could cause actual results to differ materially from
management's projections, forecasts, estimates and expectations is contained in
the Company's SEC filings, including the Company's Annual Report on Form 10-K
for the year ended February 28, 2002, and the registration statement on Form S-4
filed by CarMax, Inc. (File No. 333-85240) related to the proposed separation.
ITEM 3.
CIRCUIT CITY STORES, INC. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
RECEIVABLES RISK
The Company manages the market risk associated with the private-label credit
card and bankcard revolving loan portfolios of Circuit City's finance operation
and the automobile installment loan portfolio of CarMax's finance operation.
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 Company's consolidated balance sheets.
Consumer Revolving Credit Receivables. The majority of accounts in the
private-label credit card and bankcard portfolios are charged interest at rates
indexed to the prime rate, adjustable on a monthly basis subject to certain
limitations. The balance of the accounts are charged interest at a fixed annual
percentage rate. As of May 31, 2002, and February 28, 2002, the total
outstanding principal amount of private-label credit card and bankcard
receivables had the following interest rate structure:
(Amounts in millions) May 31 Feb. 28
- -----------------------------------------------------------------
Indexed to prime rate..................... $2,543 $2,645
Fixed APR................................. 192 202
----------------------
Total..................................... $2,735 $2,847
======================
Financing for the private-label credit card and bankcard 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. The
total principal amount of receivables securitized or held for sale at May 31,
2002, and February 28, 2002, was as follows:
(Amounts in millions) May 31 Feb. 28
- -----------------------------------------------------------------
Floating-rate securitizations............. $2,696 $2,798
Held for sale............................. 39 49
--------------------
Total..................................... $2,735 $2,847
====================
Automobile Installment Loan Receivables. At May 31, 2002, and February 28, 2002,
all loans in the portfolio of automobile loan receivables were fixed-rate
installment loans. Financing for these automobile loan receivables is achieved
through asset securitization programs that, in turn, issue both fixed- and
floating-rate
Page 27 of 62
securities. Interest rate exposure relating to floating rate securitizations is
managed through the use of interest rate swaps. Receivables held for investment
or sale are financed with working capital.
The total principal amount of receivables securitized or held for investment or
sale as of May 31, 2002, and February 28, 2002, was as follows:
(Amounts in millions) May 31 Feb. 28
- -----------------------------------------------------------------
Fixed-rate securitizations................ $ 979 $1,122
Floating-rate securitizations
synthetically altered to fixed......... 634 413
Floating-rate securitizations............. 1 1
Held for investment(1).................... 18 12
Held for sale............................. 3 2
---------------------
Total..................................... $1,635 $1,550
=====================
(1) Held by a bankruptcy-remote special purpose subsidiary.
Interest Rate Exposure. The Company is exposed to interest rate risk on Circuit
City's securitized credit card portfolio, especially when interest rates move
dramatically over a relatively short period of time. Market risk is the exposure
created by potential fluctuations in interest rates. We have mitigated this risk
through matched funding. However, our ability to increase the finance charge
yield of Circuit City's variable rate credit cards may be contractually limited
or limited at some point by competitive conditions. On behalf of Circuit City,
the Company enters into interest rate cap agreements to meet the requirements of
the credit card receivable securitization transactions. The Company has entered
into offsetting interest rate cap positions and, therefore, does not anticipate
significant market risk arising from interest rate caps. Interest rate exposure
relating to CarMax's securitized automobile loan receivables represents a market
risk exposure that we manage with matched funding and interest rate swaps
matched to projected payoffs. The Company does not anticipate significant market
risk from swaps because they are used on a monthly basis to match funding costs
to the use of the funding. Generally, changes only in interest rates do not have
a material impact on the Company's results of operations.
Credit risk is the exposure to nonperformance of another party to an agreement.
Credit risk is mitigated by dealing with highly rated bank counterparties. The
market and credit risks associated with financial derivatives are similar to
those relating to other types of financial instruments. Refer to Note 7 to the
Company's consolidated financial statements for a description of these items.
Page 28 of 62
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Balance Sheets
(Amounts in thousands)
May 31, 2002 Feb. 28, 2002
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $1,114,557 $1,248,246
Net accounts receivable 146,301 158,817
Retained interests in securitized receivables 416,176 394,456
Merchandise inventory 1,325,024 1,234,243
Prepaid expenses and other current assets 34,892 39,246
---------- ----------
Total current assets 3,036,950 3,075,008
Property and equipment, net 712,933 732,802
Deferred income taxes 9,229 2,647
Reserved CarMax Group shares 331,198 311,386
Other assets 10,210 11,354
---------- ----------
TOTAL ASSETS $4,100,520 $4,133,197
========== ==========
LIABILITIES AND GROUP EQUITY
Current liabilities:
Accounts payable $1,017,252 $1,019,519
Accrued expenses and other current liabilities 148,143 157,561
Accrued income taxes 21,207 100,696
Deferred income taxes 118,589 116,297
Allocated short-term debt 1,094 397
Current installments of allocated long-term debt 46,778 23,465
---------- ----------
Total current liabilities 1,353,063 1,417,935
Allocated long-term debt, excluding current installments 13,734 14,064
Other liabilities 147,508 140,853
---------- ----------
TOTAL LIABILITIES 1,514,305 1,572,852
GROUP EQUITY 2,586,215 2,560,345
---------- ----------
TOTAL LIABILITIES AND GROUP EQUITY $4,100,520 $4,133,197
========== ==========
See accompanying notes to Group financial statements.
Page 28 of 62
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Statements of Earnings (Unaudited)
(Amounts in thousands)
Three Months Ended
May 31,
2002 2001
---------- ----------
Net sales and operating revenues $2,118,243 $1,870,621
Cost of sales, buying and warehousing 1,604,893 1,408,228
---------- ----------
Gross profit 513,350 462,393
---------- ----------
Selling, general and administrative expenses (net of
finance income of $20,419 as of May 31, 2002,
and $29,545 as of May 31, 2001) 515,375 477,444
Interest expense - 441
---------- ----------
Total expenses 515,375 477,885
---------- ----------
Loss before income taxes and income
attributed to the reserved CarMax Group shares (2,025) (15,492)
Income tax benefit (769) (5,887)
---------- ----------
Loss before income attributed to
the reserved CarMax Group shares (1,256) (9,605)
Net earnings attributed to the reserved CarMax Group shares 18,722 19,740
---------- ----------
Net earnings $ 17,466 $ 10,135
========== ==========
See accompanying notes to Group financial statements.
Page 30 of 62
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Three Months Ended
May 31,
2002 2001
---------- ---------
Operating Activities:
- --------------------
Net earnings $ 17,466 $ 10,135
Adjustments to reconcile net earnings to net cash (used in)
provided by operating activities of continuing operations:
Net earnings attributed to the reserved CarMax Group shares (18,722) (19,740)
Depreciation and amortization 35,746 34,489
Amortization of restricted stock awards 5,385 3,561
Loss (gain) on disposition of property and equipment 2,059 (959)
Provision for deferred income taxes (4,290) 4,785
Changes in operating assets and liabilities:
(Increase) decrease in net accounts receivable and
retained interests in securitized receivables (9,204) 21,551
(Increase) decrease in merchandise inventory (90,781) 81,669
Decrease (increase) in prepaid expenses and
other current assets 4,354 (13,062)
Decrease in other assets 1,144 242
Decrease in accounts payable, accrued expenses
and other current liabilities and accrued income taxes (91,174) (113,516)
Increase in other liabilities 6,655 2,271
---------- ---------
Net cash (used in) provided by operating activities
of continuing operations (141,362) 11,426
---------- ---------
Investing Activities:
- --------------------
Purchases of property and equipment (26,051) (29,505)
Proceeds from sales of property and equipment, net 8,115 3,248
---------- ---------
Net cash used in investing activities of continuing operations (17,936) (26,257)
---------- ---------
Financing Activities:
- --------------------
Increase in allocated short-term debt, net 697 11
Increase (decrease) in allocated long-term debt, net 22,983 (22,983)
Equity issuances, net 5,585 3,541
Dividends paid (3,656) (3,621)
---------- ---------
Net cash provided by (used in) financing activities
of continuing operations 25,609 (23,052)
---------- ---------
Cash used in discontinued operations - (5,460)
---------- ---------
Decrease in cash and cash equivalents (133,689) (43,343)
Cash and cash equivalents at beginning of year 1,248,246 437,329
---------- ---------
Cash and cash equivalents at end of period $1,114,557 $ 393,986
========== =========
See accompanying notes to Group financial statements.
Page 31 of 62
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Notes to Group Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. consists of two common stock
series that are intended to reflect the performance of the Company's two
businesses. The Circuit City Group Common Stock is intended to reflect the
performance of the Circuit City 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 is intended to reflect the performance of the CarMax
stores and related operations. The reserved CarMax Group shares are not
outstanding CarMax Group Common Stock. Therefore, net earnings attributed
to the reserved CarMax Group shares are included in the net earnings
attributed to the Circuit City Group Common Stock.
During the second quarter of fiscal 2002, Circuit City Stores completed the
public offering of 9,516,800 shares of CarMax Group Common Stock. The
shares sold in the offering were shares of CarMax Group Common Stock that
previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group Common Stock. As of May 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 May 31,
2002, 64.1 percent at February 28, 2002, and 74.1 percent at May 31, 2001.
The terms of each series of common stock are discussed in detail in the
Company's Form 8-A registration statement on file with the Securities and
Exchange Commission.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would
separate the CarMax auto superstore business from the Circuit City consumer
electronics business through a tax-free transaction in which CarMax, Inc.,
presently a wholly owned subsidiary of Circuit City Stores, Inc., would
become an independent, separately traded public company. CarMax, Inc. holds
substantially all of the businesses, assets and liabilities of the CarMax
Group. The separation plan calls for Circuit City Stores, Inc. to redeem
the outstanding shares of CarMax Group Common Stock in exchange for shares
of common stock of CarMax, Inc. Simultaneously, shares of CarMax, Inc.
common stock, representing the shares of CarMax Group Common Stock reserved
for the holders of Circuit City Group Common Stock, would be distributed as
a tax-free dividend to the holders of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax
Group Common Stock redeemed by the Company. Management anticipates that the
holders of Circuit City Group Common Stock would receive a fraction of a
share of CarMax, Inc. common stock for each share of Circuit City Group
Common Stock they hold. The exact fraction would be determined on the
record date for the distribution. The separation is expected to be
completed by late summer or early fall, subject to shareholder approval and
final approval from the board of directors.
Notwithstanding the attribution of the Company's assets and liabilities,
including contingent liabilities, and stockholders' equity between the
Circuit City Group and the CarMax Group for the purposes of preparing the
financial statements, holders of Circuit City Group Common Stock and
holders of CarMax Group Common Stock are shareholders of the Company and as
such are subject to all of the risks associated with an investment in the
Company and all of its businesses, assets and liabilities. Such attribution
and the equity structure of the Company do not affect title to the assets
or responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of Circuit City Group Common Stock nor shares
of CarMax Group
Page 32 of 62
Common Stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular Group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one Group could affect the results of operations or financial
condition of the other Group. Net losses of either Group and dividends or
distributions on, or repurchases of, Circuit City Group Common Stock or
CarMax Group Common Stock would reduce funds legally available for
dividends on, or repurchases of, both stocks. Accordingly, the Circuit City
Group financial statements included herein should be read in conjunction
with the Company's consolidated financial statements, the CarMax Group
financial statements and the Company's SEC filings.
2. Accounting Policies
The Circuit City Group has accounted for the reserved CarMax Group shares
in a manner similar to the equity method of accounting. Accounting
principles generally accepted in the United States of America require that
the CarMax Group be consolidated with the Circuit City Group. Except for
the effects of not consolidating the CarMax Group with the Circuit City
Group, the financial statements of the Circuit City Group 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
group financial statements have been included. The fiscal year-end balance
sheet data was derived from the audited financial statements included in
the Company's fiscal 2002 Annual Report on Form 10-K.
3. Supplemental Financial Statement Information
For the first quarter of fiscal 2003 and 2002, pretax finance operation
income, which is recorded as a reduction to selling, general and
administrative expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
---------------------------------------------------------------------------
Securitization income............... $50.5 $59.7
Payroll and fringe expenses......... 10.7 10.3
Other direct expenses............... 19.4 19.9
--------------------------------------
Finance operation income............ $20.4 $29.5
======================================
The finance operation income does not include any allocation of indirect
costs or income. The Company presents this information on a direct basis to
avoid making arbitrary decisions regarding the periodic indirect benefit or
costs that could be attributed to this operation. 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.
4. Securitizations
Circuit City's finance operation enters into securitization transactions to
finance its consumer revolving credit card receivables. In accordance with
the isolation provisions of Statement of Financial Accounting Standards No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," special purpose subsidiaries were created
for the sole purpose of facilitating these securitization transactions.
Credit card receivables are sold to the special purpose subsidiaries,
which, in turn, transfer these receivables to securitization master trusts.
Private-label and co-branded Visa credit card receivables are securitized
through one master trust and MasterCard and Visa credit card, referred to
as bankcard, receivables are securitized through a second master trust.
Each master trust periodically issues securities backed by the receivables
in that master trust. For transfers of receivables that qualify as sales,
Circuit City recognizes gains or losses as a component of the finance
operation's profits, which are recorded as reductions to selling, general
and administrative expenses. In these securitizations, Circuit City's
finance operation continues to service the securitized receivables for a
fee and the special purpose subsidiaries retain an undivided interest in
the transferred receivables and hold various subordinated asset-backed
securities that serve as credit
Page 33 of 62
enhancements for the asset-backed securities held by outside investors.
Neither master trust agreement provides for recourse to the Company for
credit losses on the securitized receivables. Circuit City employs a
risk-based pricing strategy that increases the stated annual percentage
rate for accounts that have a higher predicted risk of default. Accounts
with a lower risk profile may qualify for promotional financing. Under
certain of these securitization programs, Circuit City must meet financial
guidelines relating to minimum tangible net worth, debt to net worth and
the current ratio. The securitized receivables must meet performance levels
relating to portfolio yield, default rates, principal payment rates and
delinquency rates. Circuit City was in compliance with these guidelines at
May 31, 2002, and February 28, 2002.
The total principal amount of credit card receivables managed was $2.74
billion at May 31, 2002, and $2.85 billion at February 28, 2002. During the
first quarter of fiscal 2003, the Company completed a $300 million
private-label credit card receivable securitization transaction. Of the
total principal amounts managed, the principal amount of receivables
securitized was $2.70 billion at May 31, 2002, and $2.80 billion at
February 28, 2002, and the principal amount of receivables held for sale
was $39.2 million at May 31, 2002, and $49.2 million at February 28, 2002.
At May 31, 2002, the unused capacity of the private-label variable funding
program was $557.8 million and the unused capacity of the bankcard variable
funding program was $393.2 million. At February 28, 2002, the unused
capacity of the private-label variable funding program was $22.9 million
and the unused capacity of the bankcard variable funding program was $496.5
million. The aggregate amount of receivables that were 31 days or more
delinquent was $171.0 million at May 31, 2002, and $198.4 million at
February 28, 2002. The principal amount of losses net of recoveries totaled
$70.8 million for the quarter ended May 31, 2002, and $69.6 million for the
quarter ended May 31, 2001.
Circuit City receives annual servicing fees approximating 2 percent of the
outstanding principal balance of the credit card receivables and retains
the rights to future cash flows available after the investors in the
asset-backed securities have received the return for which they contracted.
The servicing fees specified in the credit card securitization agreements
adequately compensate the finance operation for servicing the securitized
receivables. Accordingly, no servicing asset or liability has been
recorded.
The table below summarizes certain cash flows received from and paid to the
securitization trusts:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
---------------------------------------------------------------------------------------------
Proceeds from new securitizations...................... $401.8 $174.2
Proceeds from collections reinvested
in previous credit card securitizations.............. $245.6 $359.6
Servicing fees received................................ $ 13.0 $ 13.3
Other cash flows received on retained interests*....... $ 50.7 $ 44.2
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
When determining the fair value of retained interests, Circuit City
estimates future cash flows using management's projections of key factors,
such as finance charge income, default rates, payment rates, forward
interest rate curves and discount rates appropriate for the type of asset
and risk.
Future finance income from securitized credit card receivables that exceeds
the sum of the contractually specified investor returns and servicing fees
(interest-only strips) is carried at fair value and amounted to $126.8
million at May 31, 2002, and $134.8 million at May 31, 2001. These amounts
are included in retained interests in securitized receivables on the
consolidated balance sheets. The change in the interest-only strip for
securitization transaction was a $5.1 million decrease for the three months
ended May 31, 2002 and a $3.8 million increase for the three months ended
May 31, 2001.
The fair value of retained interests at May 31, 2002, was $416.2 million,
with a weighted-average life ranging from 0.2 years to 3.0 years. The fair
value of retained interests at February 28, 2002, was $394.5 million,
Page 34 of 62
with a weighted-average life ranging from 0.2 years to 1.8 years. The
following table shows the key economic assumptions used in measuring the
fair value of retained interests at May 31, 2002, 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 economic assumptions at May 31, 2002, are not materially different from
assumptions used to measure the fair value of retained interests at the
time of securitization. These sensitivities are hypothetical and should be
used with caution. In this table, the effect of a variation in a particular
assumption on the fair value of the retained interest 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.
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(Dollar amounts in millions) Used Adverse Change Adverse Change
------------------------------------------------------------------------------------
Monthly payment rate............ 6.7%-10.3% $ 8.3 $15.4
Annual default rate............. 8.1%-17.5% $22.3 $44.0
Annual discount rate............ 8.3%-15.0% $ 2.9 $ 5.8
5. Financial Derivatives
On behalf of Circuit City, the Company enters into interest rate cap
agreements to meet the requirements of the credit card receivable
securitization transactions. During the first quarter of fiscal 2003 and in
conjunction with the private-label public securitization, the Company
purchased and sold three offsetting interest rate caps with an aggregate
initial notional amount of $280.5 million. The total notional amount of
interest rate caps outstanding was $935.4 million at May 31, 2002, and
$654.9 million at February 28, 2002. Purchased interest rate caps were
included in net accounts receivable and had a fair value of $9.0 million as
of May 31, 2002, and $2.4 million as of February 28, 2002. Written interest
rate caps were included in accounts payable and had a fair value of $9.0
million as of May 31, 2002, and $2.4 million as of February 28, 2002.
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.
6. Appliance Exit Costs
In the second quarter of fiscal 2001, the Company began to exit the major
appliance category and expand its selection of key consumer electronics and
home office products in all Circuit City Superstores. This process was
completed in November 2000. To exit the appliance business, the Company
closed eight distribution centers and eight service centers. The Company
leases the majority of these closed properties. While the Company has
entered into contracts to sublease some of these properties, it continues
the process of marketing the remaining properties to be subleased.
In the second quarter of fiscal 2001, the Company recorded appliance exit
costs of $30.0 million. In the fourth quarter of fiscal 2002, the Company
recorded additional lease termination costs of $10.0 million to reflect the
current rental market for these leased properties. These expenses are
reported separately on the fiscal 2002 and 2001 statements of earnings. The
appliance exit cost liability is included in accrued expenses and other
current liabilities on the balance sheets.
Page 35 of 62
The appliance exit cost accrual activity and the remaining liability at May
31, 2002, are presented in the following table.
Total Fiscal 2001 Fiscal 2002 Fiscal 2002 Fiscal 2003
Original Payments Liability at Adjustments Payments Liability at Payments Liability at
Exit Cost or February 28, to Exit Cost or February 28, or May 31,
(Amounts in millions) Accrual Write-Downs 2001 Accrual Write-Downs 2002 Write-Downs 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Lease termination costs..... $17.8 $ 1.8 $16.0 $10.0 $6.3 $19.7 $ 1.7 $18.0
Fixed asset write-downs,
net....................... 5.0 5.0 - - - - - -
Employee termination
benefits.................. 4.4 2.2 2.2 - 2.2 - - -
Other....................... 2.8 2.8 - - - - - -
-----------------------------------------------------------------------------------------------------
Appliance exit costs........ $30.0 $ 11.8 $18.2 $10.0 $8.5 $19.7 $ 1.7 $18.0
=====================================================================================================
7. Discontinued Operations
On June 16, 1999, Digital Video Express announced that it would cease
marketing the Divx home video system and discontinue operations. As of
February 28, 2002, entities comprising the Divx operations were dissolved
and the related liabilities had been assumed by the Company. Current
liabilities of $18.5 million related to the former Divx operations were
reflected in the balance sheets as of May 31, 2002, and February 28, 2002.
For the three-month periods ended May 31, 2002 and 2001, the discontinued
Divx operations had no impact on the net earnings of the Circuit City
Group. Discontinued operations have been segregated on the statements of
cash flows.
8. Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, "Accounting For Asset Retirement Obligations." This statement
addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition,
construction, development and/or the normal operation of a long-lived
asset, except for certain obligations of lessees. This standard requires
entities to record the fair value of a liability for an asset retirement
obligation in the period incurred. SFAS No. 143 is effective for fiscal
years beginning after June 15, 2002. The Company has not yet determined the
impact, if any, of adopting this standard.
9. Reclassifications
Certain prior year amounts have been reclassified to conform to the current
presentation. Effective in the first quarter of fiscal 2003, Circuit City
Stores adopted Emerging Issues Task Force No. 00-14, "Accounting for
Certain Sales Incentives," which provides that sales incentives, such as
mail-in rebates, offered to customers should be classified as a reduction
of revenue. Previously, the Company recorded these rebates in cost of
sales, buying and warehousing. For the quarter ended May 31, 2001, the
reclassification of rebates from cost of sales, buying and warehousing to
sales decreased sales and cost of sales, buying and warehousing by $11.0
million.
Page 36 of 62
ITEM 2.
CIRCUIT CITY GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "Circuit City business" and "Circuit City" refer to the retail
operations bearing the Circuit City name and to all related operations such as
product service and Circuit City's finance operation. "Circuit City Group"
refers to the Circuit City business and the reserved CarMax Group shares.
"CarMax business," "CarMax" and "CarMax Group" refer to retail locations bearing
the CarMax name and to all related operations such as CarMax's finance
operation. All references to "month," "quarter" and "year" refer to our fiscal
year periods rather than calendar year periods unless stated otherwise.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would separate
the CarMax auto superstore business from the Circuit City consumer electronics
business through a tax-free transaction in which CarMax, Inc., presently a
wholly owned subsidiary of Circuit City Stores, Inc., would become an
independent, separately traded public company. CarMax, Inc. holds substantially
all of the businesses, assets and liabilities of the CarMax Group. The
separation plan calls for Circuit City Stores, Inc. to redeem the outstanding
shares of CarMax Group Common Stock in exchange for shares of common stock of
CarMax, Inc. Simultaneously, shares of CarMax, Inc. common stock, representing
the shares of CarMax Group Common Stock reserved for the holders of Circuit City
Group Common Stock, would be distributed as a tax-free dividend to the holders
of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax Group
Common Stock redeemed by the Company. Management anticipates that the holders of
Circuit City Group Common Stock would receive a fraction of a share of CarMax,
Inc. common stock for each share of Circuit City Group Common Stock they hold.
The exact fraction would be determined on the record date for the distribution.
The separation is expected to be completed by late summer or early fall, subject
to shareholder approval and final approval from the board of directors.
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies included in the Circuit City
Stores, Inc. 2002 Annual Report to Shareholders. These policies relate to the
calculation of the value of retained interests in securitization transactions
and the calculation of the liability for lease termination costs.
RESULTS OF OPERATIONS
Effective in the first quarter of fiscal 2003, Circuit City Stores adopted
Emerging Issues Task Force No. 00-14, "Accounting for Certain Sales Incentives,"
which provides that sales incentives, such as mail-in rebates, offered to
customers should be classified as a reduction of revenue. Previously, the
Company recorded these rebates in cost of sales, buying and warehousing. These
rebate amounts totaled $11.0 million in the first quarter of fiscal 2002 and
have been reclassified on the statement of earnings.
Net Sales and Operating Revenues and General Comments
Total sales for the Circuit City Group for the first quarter of fiscal 2003
increased 13 percent to $2.12 billion from $1.87 billion in last year's first
quarter. Comparable store sales increased 12 percent for the first quarter of
fiscal 2003 and decreased 25 percent for the first quarter of fiscal 2002.
Circuit City stores are included in comparable store sales after the store has
been open for a full year.
Page 37 of 62
The comparable store sales pace strengthened as the first quarter progressed,
reflecting the growing consumer response to our customer service initiatives,
aggressive promotions in traffic-building categories and on entry-level products
and a stronger inventory position in specific product categories.
First quarter Circuit City sales for fiscal 2003 reflected continued progress in
both the high-service and packaged goods arenas. We posted strong sales growth
in focus categories such as video, including big-screen televisions, DVD players
and digital satellite systems; and wireless communications, and in self-serve
product selections, including DVD software and video game hardware, software and
accessories. We experienced improving trends in information technology products,
with PC sales growth driven by strong sales of notebook computers and a more
competitive promotional stance compared with last fiscal year's first quarter.
The percent of merchandise sales represented by each major product category
during the first quarter of fiscal years 2003 and 2002 were as follows:
================================== ============================
1st Quarter
----------------------------
Product Mix FY03 FY02
---------------------------------- -------------- -------------
Video 40% 37%
---------------------------------- -------------- -------------
Audio 15 17
---------------------------------- -------------- -------------
Information technology 34 36
---------------------------------- -------------- -------------
Entertainment 11 10
---------------------------------- -------------- -------------
Total 100% 100%
================================== ============== =============
In most states, Circuit City sells 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. In the
three states where third-party warranty sales are not permitted, Circuit City
sells an extended warranty for which we are the primary obligor. The total
extended warranty revenue that is reported in total sales was $87.9 million, or
4.2 percent of sales, in the first quarter of fiscal 2003, compared with $80.1
million, or 4.3 percent of sales, in last year's first quarter.
The following table provides details on the Circuit City retail units:
======================== =================== =================== ================== ===================
Estimate
Store Mix May 31, 2002 May 31, 2001 Feb. 28, 2003 Feb. 28, 2002
------------------------ ------------------- ------------------- ------------------ -------------------
Superstores 603 594 611 604
------------------------ ------------------- ------------------- ------------------ -------------------
Mall-based
Express stores 19 32 18 20
------------------------ ------------------- ------------------- ------------------ -------------------
Total 622 626 629 624
======================== =================== =================== ================== ===================
Circuit City expects to open approximately eight Superstores and relocate an
estimated 10 Superstores in the current fiscal year. In the first quarter of
fiscal 2003, we closed one Superstore, relocated two Superstores and closed one
mall-based Express store.
Our operations, in common with other retailers in general, are subject to
seasonal influences. Historically, the Circuit City business has realized more
of its net sales and net earnings in the fourth quarter, which includes the
December holiday selling season, than in any other fiscal quarter. The net
earnings of any quarter are seasonally disproportionate 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 38 of 62
Cost of Sales, Buying and Warehousing
The gross profit margin for the Circuit City Group was 24.2 percent of sales in
the first quarter of fiscal 2003, compared with 24.7 percent in the same period
last year. The first quarter gross profit margin decline reflects our more
competitive product selection and pricing throughout the quarter, as well as our
response to more aggressive offers from competitors, and the resulting sales
mix. Circuit City experienced some trade-off in gross margin for sales growth,
as we chose to be more aggressive in promoting traffic-driving and entry-level
products.
Selling, General and Administrative Expenses
The selling, general and administrative expense ratio for the Circuit City Group
was 24.3 percent of sales in the first quarter of fiscal 2003, compared with
25.5 percent for the same period last year. This decline was principally a
result of the leverage achieved through increased sales.
Finance Operations. For the first quarter of fiscal 2003 and 2002, pretax
finance operation income, which is recorded as a reduction to selling, general
and administrative expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
--------------------------------------------------------------------------
Securitization income........... $50.5 $59.7
Payroll and fringe expenses..... 10.7 10.3
Other direct expenses........... 19.4 19.9
----------------------------------------
Finance operation income........ $20.4 $29.5
========================================
Receivables generated by the Circuit City finance operation are sold through
securitization transactions. Circuit City continues to service the securitized
receivables for a fee. For the quarter ended May 31, 2002 serviced receivables
averaged $2.78 billion, compared to $2.64 billion for the quarter ended May 31,
2001.
Included in securitization income is the gain on the sale of these receivables
and other income related to servicing these receivables. Future finance income
from securitized credit card receivables that exceeds the sum of the
contractually specified investor returns and servicing fees (interest-only
strips) is carried at fair value and amounted to $126.8 million at May 31, 2002
and $134.8 million at May 31, 2001. The key assumptions and estimates in
determining the fair value of interest-only strips include management's
projections of key factors, such as finance charge income, default rates,
payment rates, forward interest rate curves and discount rates appropriate for
the type of asset and risk. Based on these assumptions and estimates and the
operation's securitization volume, the change in the interest-only strip for
securitization transactions was a $5.1 million decrease for the three months
ended May 31, 2002 and a $3.8 million increase for the three months ended May
31, 2001. Management reviews the assumptions and estimates used in determining
the fair value of the interest-only strip on a quarterly basis. If these
assumptions change or the actual results differ from the projected results,
securitization income would be affected.
For the Circuit City Group, the finance operation 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. Other direct expenses, which did not
change significantly for the three months ended May 31, 2002 compared to May 31,
2001, include third party data processing, rent, credit promotion expenses, Visa
and MasterCard fees, and other operating expenses. Payroll expenses generally
vary with the size of the serviced portfolio, and increased only slightly during
the quarter ended May 31, 2002 compared to May 31, 2001.
Page 39 of 62
The fiscal 2003 expense ratio also includes approximately $8 million of costs
associated with remodeling and relocation activities, while the fiscal 2002
ratio includes approximately $3 million of relocation costs. As of May 31, 2002,
the Company had completed the initial phases of the video department remodeling
program planned for roll out to approximately 300 Circuit City Superstores in
fiscal 2003. As of May 31, 2002, we had completed the video reset in 20 Circuit
City Superstores, including 18 in the first quarter, and the lighting upgrade in
more than 100 Superstores. Based on our experience with the progress of the
remodeling process to date, we now anticipate that it can be completed in
approximately one week per store, rather than our initial two-week expectation.
Interest Expense
Circuit City reported no interest expense for the first quarter of fiscal 2003,
compared with $441,000 for the same period last year.
Income Taxes
The effective income tax rate was 38.0 percent for the first quarter of both
fiscal 2003 and 2002.
Loss Before Income Attributed to the Reserved CarMax Group Shares
Excluding the earnings attributed to the reserved CarMax Group shares, the
Circuit City business produced a loss of $1.3 million in the first quarter ended
May 31, 2002, compared with a loss of $9.6 million for the same period last
year.
Net Earnings Attributed to the Reserved CarMax Group Shares
The net earnings attributed to the reserved CarMax Group shares were $18.7
million in the first quarter of this fiscal year compared with $19.7 million in
last fiscal year's first quarter.
Net Earnings
Net earnings of the Circuit City Group were $17.5 million in the first quarter
of fiscal 2003, compared with $10.1 million in the first quarter of fiscal 2002.
Operations Outlook
In fiscal 2001, we introduced a store design that includes a more
customer-friendly layout with better product adjacencies; a brighter more
contemporary appearance; additional product on the sales floor; shopping carts
and easily accessible cash registers. All new stores continue to follow this
design. In fiscal 2001 and fiscal 2002, we also undertook several remodels and
product category tests to evaluate how best to add these features into existing
stores. We decided to begin in fiscal 2003 a three-year multi-phased remodeling
program that will cover approximately 300 stores. As part of this remodeling
program, we will in fiscal 2003 introduce a remodeled video department and
upgrade the lighting in these stores, spending an average of $325,000 to
$350,000 per store. We believe that rolling out this remodeled department will
enable us to increase Circuit City's market share in the growing and highly
profitable big-screen television category and further solidify our position in
the overall video category. The Consumer Electronics Association projects that
big-screen television sales will grow at a double-digit rate in calendar 2002.
By beginning with the video department, we believe that we can affect a large
number of Circuit City Superstores in a manner that has significant potential
for incremental benefit while minimizing the disruptive impact of the remodeling
process.
In addition to remodeling, we expect to relocate approximately 10 Superstores in
the current fiscal year. We expect that fiscal 2003 expenditures for Circuit
City remodeling and relocations will total approximately $130 million, of which
we expect to capitalize approximately $70 million and expense approximately $60
million, or no more than 18 cents per Circuit City Group share.
Page 40 of 62
In fiscal 2003, we also will continue testing design ideas for other departments
in the Circuit City Superstores. In fiscal 2004 and fiscal 2005, we expect to
introduce these design ideas into many of the approximately 300 stores being
remodeled under the three-year remodeling plan. We continue to review the
suitability of our remaining Superstore base for either remodeling or relocation
and also anticipate relocating additional stores in fiscal 2004 and fiscal 2005.
We currently anticipate that in fiscal 2004 and fiscal 2005 the impact of
remodeling and relocations on earnings per share will be similar to the fiscal
2003 impact.
Given our presence in virtually all of the nation's top metropolitan markets,
new Superstores are being added only in small markets or to increase our
penetration in existing major markets. We plan to open approximately eight
Circuit City Superstores in fiscal 2003. Because of limited planned geographic
expansion, we expect total Circuit City sales growth to only slightly exceed
comparable store sales growth. We expect that categories where we expanded
selection following our exit from the appliance business and categories, such as
big-screen televisions, that are benefiting from digital product innovation,
will contribute to Circuit City's total and comparable store sales growth.
However, we also anticipate that Circuit City's sales growth will reflect our
focus on sales counselor training and customer service, store remodeling,
effective marketing programs and a competitive merchandise assortment with
attractive prices. We expect that the gross profit margin will reflect the mix
of merchandise sold and our efforts to remain competitive and achieve profitable
market share growth and that the expense ratio will reflect increases in Circuit
City expenses associated with remodeling and relocation as discussed above,
advertising and systems enhancements and the total sales volume achieved. For
the full year, we expect the fiscal 2003 profit contribution from Circuit City's
finance operation to be similar to the contribution in fiscal 2002.
Refer to the "Circuit City Stores, Inc. Management's Discussion and Analysis of
Results of Operations and Financial Condition" for the estimated contribution of
the Circuit City business earnings attributed to the Circuit City Group Common
Stock in fiscal 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to the "Circuit City Stores, Inc. Management's Discussion and Analysis of
Results of Operations and Financial Condition" for a review of recent accounting
pronouncements.
FINANCIAL CONDITION
Liquidity and Capital Resources
Operating Activities. In the first quarter of fiscal 2003, Circuit City used
cash of $141.3 million for operating activities. In last year's first quarter,
Circuit City generated cash from operating activities of $11.4 million. The
increase primarily reflects an increase in inventory purchases to meet
anticipated sales demands.
Investing Activities. Net cash used in investing activities was $17.9 million in
the three months ended May 31, 2002, compared with $26.3 million in the first
three months of last year. Capital expenditures decreased to $26.1 million in
the first three months of fiscal 2003 from $29.5 million in the comparable
period last year. Circuit City capital expenditures in the first three months of
fiscal 2003 included spending for the initial phases of rolling out a remodeled
video department, which was completed in 18 Superstores, lighting upgrades in
more than 100 Circuit City Superstores and the relocation of two Circuit City
Superstores. Capital expenditures in the first three months of fiscal 2002
included spending for the relocation of one Circuit City Superstore. Proceeds
from sales of property and equipment increased to $8.1 million in the first
three months of the current fiscal year from $3.2 million in the comparable
period of last fiscal year.
Page 41 of 62
Financing Activities. Net cash provided by financing activities was $25.6
million in the first quarter of fiscal 2003, compared to the use of $23.1
million in the first quarter of last year. At May 31, 2002, a $100 million
outstanding term loan due in July 2002 was classified as a current liability.
Although the Company has the ability to refinance this debt, we intend to repay
it using existing working capital.
At May 31, 2002, the Company allocated cash and cash equivalents of $1.11
billion and debt of $61.6 million to the Circuit City Group. Circuit City Stores
maintains a $150 million unsecured revolving credit facility that expires on
August 31, 2002. The Company does not anticipate renewing this facility. The
Company also maintains $195 million in committed seasonal lines of credit that
are renewed annually with various banks. At May 31, 2002, total balances of $2.4
million were outstanding under these facilities.
At May 31, 2002, the aggregate principal amount of securitized credit card
receivables totaled $1.25 billion under the private-label program and $1.44
billion under the bankcard program. During the first quarter of fiscal 2003, the
Company completed a $300 million private-label credit card receivable
securitization transaction. At May 31, 2002, the unused capacity of the
private-label variable funding program was $557.8 million and the unused
capacity of the bankcard variable funding program was $393.2 million. At May 31,
2002, there were no provisions providing recourse to the Company for credit
losses on the receivables securitized through the private-label or bankcard
master trusts. We anticipate that we will be able to expand or enter into new
securitization arrangements to meet future needs of the finance operation.
During the first quarter, we announced plans to offer consumers a co-branded
Visa credit card rather than the private-label credit card. We began introducing
the new card early in the second quarter and ceased to open private-label
accounts. Existing private-label credit card holders may continue using their
accounts. Receivables generated under the co-branded program will be funded
through the private-label master trust.
We expect that available cash resources, sale-leaseback transactions, landlord
reimbursements and cash generated by operations will be sufficient to fund
capital expenditures of the Circuit City business for the foreseeable future.
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties, including, but not limited to, risks
associated with plans to separate the CarMax business from Circuit City Stores,
Inc. and create an independent, separately traded public company. Additional
discussion of factors that could cause actual results to differ materially from
management's projections, forecasts, estimates and expectations is contained in
the Company's SEC filings, including the Company's Annual Report on Form 10-K
for the year ended February 28, 2002, and the registration statement on Form S-4
filed by CarMax, Inc. (File No. 333-85240) related to the proposed separation.
Page 42 of 62
ITEM 3.
CIRCUIT CITY GROUP QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
RECEIVABLES RISK
The Company manages the market risk associated with the private-label credit
card and bankcard revolving loan portfolios of Circuit City's finance operation.
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 Group balance sheets.
Consumer Revolving Credit Receivables. The majority of accounts in the
private-label credit card and bankcard portfolios are charged interest at rates
indexed to the prime rate, adjustable on a monthly basis subject to certain
limitations. The balance of the accounts are charged interest at a fixed annual
percentage rate. As of May 31, 2002, and February 28, 2002, the total
outstanding principal amount of private-label credit card and bankcard
receivables had the following interest rate structure:
(Amounts in millions) May 31 Feb. 28
- ----------------------------------------------------
Indexed to prime rate......... $2,543 $2,645
Fixed APR..................... 192 202
-------------------
Total......................... $2,735 $2,847
===================
Financing for the private-label credit card and bankcard 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. The
total principal amount of receivables securitized or held for sale at May 31,
2002, and February 28, 2002, was as follows:
(Amounts in millions) May 31 Feb. 28
- --------------------------------------------------------
Floating-rate securitizations..... $2,696 $2,798
Held for sale..................... 39 49
-------------------
Total............................. $2,735 $2,847
===================
Interest Rate Exposure. Circuit City is exposed to interest rate risk on its
securitized credit card portfolio, especially when interest rates move
dramatically over a relatively short period of time. Market risk is the exposure
created by potential fluctuations in interest rates. We have mitigated this risk
through matched funding. However, our ability to increase the finance charge
yield of our variable rate credit cards may be contractually limited or limited
at some point by competitive conditions. On behalf of Circuit City, the Company
enters into interest rate cap agreements to meet the requirements of the credit
card receivable securitization transactions. The Company has entered into
offsetting interest rate cap positions and, therefore, does not anticipate
significant market risk arising from interest rate caps. Generally, changes only
in interest rates do not have a material impact on the Group results of
operations.
Credit risk is the exposure to nonperformance of another party to an agreement.
Credit risk is mitigated by dealing with highly rated bank counterparties. The
market and credit risks associated with financial derivatives are similar to
those relating to other types of financial instruments. Refer to Note 5 to the
Circuit City Group consolidated financial statements for a description of these
items.
Page 43 of 62
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Balance Sheets
(Amounts in thousands)
May 31, 2002 Feb. 28, 2002
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 61,445 $ 3,286
Net accounts receivable 54,907 52,585
Retained interests in securitized receivables 127,860 120,683
Inventory 417,461 399,084
Prepaid expenses and other current assets 1,646 2,065
-------- --------
Total current assets 663,319 577,703
Property and equipment, net 145,572 120,976
Other assets 21,327 21,543
-------- --------
TOTAL ASSETS $830,218 $720,222
======== ========
LIABILITIES AND GROUP EQUITY
Current liabilities:
Accounts payable $ 91,479 $ 87,160
Accrued expenses and other current liabilities 22,694 25,775
Deferred income taxes 21,914 22,009
Allocated short-term debt 9,761 9,840
Current installments of allocated long-term debt 55,324 78,608
-------- --------
Total current liabilities 201,172 223,392
Allocated long-term debt, excluding current installments 100,000 -
Deferred revenue and other liabilities 9,186 8,416
Deferred income taxes 2,444 2,935
-------- --------
TOTAL LIABILITIES 312,802 234,743
GROUP EQUITY 517,416 485,479
-------- --------
TOTAL LIABILITIES AND GROUP EQUITY $830,218 $720,222
======== ========
See accompanying notes to Group financial statements.
Page 44 of 62
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Statements of Earnings (Unaudited)
(Amounts in thousands)
Three Months Ended
May 31,
2002 2001
---------- --------
Net sales and operating revenues $1,001,564 $879,000
Cost of sales 883,661 775,040
---------- --------
Gross profit 117,903 103,960
---------- --------
Selling, general and administrative expenses (net of
finance income of $24,077 as of May 31, 2002,
and $19,510 as of May 31, 2001) 68,550 58,550
Interest expense 1,026 2,551
---------- --------
Total expenses 69,576 61,101
---------- --------
Earnings before income taxes 48,327 42,859
Provision for income taxes 19,089 16,287
---------- --------
Net earnings $ 29,238 $ 26,572
========== ========
Net earnings attributed to:
Circuit City Group Common Stock $ 18,722 $ 19,740
CarMax Group Common Stock 10,516 6,832
---------- --------
$ 29,238 $ 26,572
========== ========
See accompanying notes to Group financial statements.
Page 45 of 62
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Three Months Ended
May 31,
2002 2001
-------- --------
Operating Activities:
- --------------------
Net earnings $ 29,238 $ 26,572
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Depreciation and amortization 4,138 4,693
Amortization of restricted stock awards 18 37
Loss on disposition of property and equipment 10 -
Provision for deferred income taxes (586) 1,281
Changes in operating assets and liabilities:
Increase in net accounts receivable and retained
interests in securitized receivables (9,499) (30,014)
Increase in inventory (18,377) (55,838)
Decrease in prepaid expenses and other current assets 419 1,775
Increase in other assets (1) (5)
Increase in accounts payable, accrued expenses and other
current liabilities 3,012 32,428
Increase in deferred revenue and other liabilities 770 18
-------- --------
Net cash provided by (used in) operating activities 9,142 (19,053)
-------- --------
Investing Activities:
- --------------------
Purchases of property and equipment (28,533) (3,347)
Proceeds from sales of property and equipment, net 6 -
-------- --------
Net cash used in investing activities (28,527) (3,347)
-------- --------
Financing Activities:
- --------------------
(Decrease) increase in allocated short-term debt, net (79) 1,629
Increase in allocated long-term debt, net 76,716 22,708
Equity issuances, net 907 (224)
-------- --------
Net cash provided by financing activities 77,544 24,113
-------- --------
Increase in cash and cash equivalents 58,159 1,713
Cash and cash equivalents at beginning of year 3,286 8,802
-------- --------
Cash and cash equivalents at end of period $ 61,445 $ 10,515
======== ========
See accompanying notes to Group financial statements.
Page 46 of 62
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Notes to Group Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. consists of two common stock
series that are intended to reflect the performance of the Company's two
businesses. The CarMax Group Common Stock is intended to reflect the
performance of the CarMax stores and related operations. The Circuit City
Group Common Stock is intended to reflect the performance of the Circuit
City 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 reserved CarMax Group shares are not
outstanding CarMax Group Common Stock. Therefore, net earnings attributed
to the reserved CarMax Group shares are included in the net earnings
attributed to the Circuit City Group Common Stock.
During the second quarter of fiscal 2002, Circuit City Stores completed the
public offering of 9,516,800 shares of CarMax Group Common Stock. The
shares sold in the offering were shares of CarMax Group Common Stock that
previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group Common Stock. As of May 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 May 31,
2002, 64.1 percent at February 28, 2002, and 74.1 percent at May 31, 2001.
The terms of each series of common stock are discussed in detail in the
Company's Form 8-A registration statement on file with the Securities and
Exchange Commission.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would
separate the CarMax auto superstore business from the Circuit City consumer
electronics business through a tax-free transaction in which CarMax, Inc.,
presently a wholly owned subsidiary of Circuit City Stores, Inc., would
become an independent, separately traded public company. CarMax, Inc. holds
substantially all of the businesses, assets and liabilities of the CarMax
Group. The separation plan calls for Circuit City Stores, Inc. to redeem
the outstanding shares of CarMax Group Common Stock in exchange for shares
of common stock of CarMax, Inc. Simultaneously, shares of CarMax, Inc.
common stock, representing the shares of CarMax Group Common Stock reserved
for the holders of Circuit City Group Common Stock, would be distributed as
a tax-free dividend to the holders of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax
Group Common Stock redeemed by the Company. Management anticipates that the
holders of Circuit City Group Common Stock would receive a fraction of a
share of CarMax, Inc. common stock for each share of Circuit City Group
Common Stock they hold. The exact fraction would be determined on the
record date for the distribution. The separation is expected to be
completed by late summer or early fall, subject to shareholder approval and
final approval from the board of directors.
Notwithstanding the attribution of the Company's assets and liabilities,
including contingent liabilities, and stockholders' equity between the
CarMax Group and the Circuit City Group for the purposes of preparing the
financial statements, holders of CarMax Group Common Stock and holders of
Circuit City Group Common Stock are shareholders of the Company and as such
are subject to all of the risks associated with an investment in the
Company and all of its businesses, assets and liabilities. Such attribution
and the equity structure of the Company do not affect title to the assets
or responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of CarMax Group Common Stock nor shares of
Circuit City Group
Page 47 of 62
Common Stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular Group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one Group could affect the results of operations or financial
condition of the other Group. Net losses of either Group and dividends or
distributions on, or repurchases of, CarMax Group Common Stock or Circuit
City Group Common Stock would reduce funds legally available for dividends
on, or repurchases of, both stocks. Accordingly, the CarMax Group financial
statements included herein should be read in conjunction with the Company's
consolidated financial statements, the Circuit City Group financial
statements and the Company's SEC filings.
2. Accounting Policies
The financial statements of the CarMax Group 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 group
financial statements have been included. The fiscal year-end balance sheet
data was derived from the audited financial statements included in the
Company's fiscal 2002 Annual Report on Form 10-K.
3. Debt
On May 17, 2002, CarMax entered into a $200 million credit agreement
secured by vehicle inventory. The credit agreement includes a $100 million
revolving loan commitment and a $100 million term loan commitment.
Principal is due in full at maturity with interest payable monthly at a
LIBOR-based rate. The agreement currently is scheduled to expire in May
2004 and provides for annual one-year extensions of the final maturity
beginning on May 17, 2003, and each May 17 thereafter. The aggregate
principal amount outstanding under the credit facility on any date may not
exceed 150 percent of the value of CarMax's eligible motor vehicle
inventory as of that date. As of May 31, 2002, the amount outstanding under
this credit agreement was $100 million. Under this agreement, CarMax must
meet financial covenants relating to minimum current ratio, minimum
tangible net worth and minimum fixed charge coverage ratio. CarMax was in
compliance with these covenants at May 31, 2002.
4. Supplemental Financial Statement Information
For the first quarter of fiscal 2003 and 2002, pretax finance income, which
is recorded as a reduction to selling, general and administrative expenses,
was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
-------------------------------------------------------------------------
Securitization income........... $23.3 $18.4
Payroll and fringe expenses..... 1.7 1.3
Other direct expenses........... 1.7 1.4
---------------------------------------
Finance operation income........ 19.9 15.7
Third-party financing fees...... 4.2 3.8
---------------------------------------
Total finance income............ $24.1 $19.5
=======================================
For the CarMax Group, finance operation income does not include any
allocation of indirect costs or income. The Company presents this
information on a direct basis to avoid making arbitrary decisions regarding
the periodic indirect benefit or costs that could be attributed to this
operation. 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.
Page 48 of 62
5. Securitizations
CarMax has asset securitization programs to finance the automobile loan
receivables generated by its finance operation. CarMax's finance operation
sells its automobile loan receivables to a special purpose subsidiary,
which, in turn, transfers those receivables to a group of third-party
investors. For transfers of receivables that qualify as sales, CarMax
recognizes gains or losses as a component of the finance operation's
profits, which are recorded as reductions to selling, general and
administrative expenses. The special purpose subsidiary retains a
subordinated interest in the transferred receivables. CarMax's finance
operation continues to service securitized receivables for a fee. The
automobile loan securitization agreements do not provide for recourse to
the Company for credit losses on the securitized receivables. CarMax
employs a risk-based pricing strategy that increases the stated annual
percentage rate for accounts that have a higher predicted risk of default.
Under certain of these securitization programs, CarMax must meet financial
guidelines relating to minimum tangible net worth, debt to net worth, net
worth to managed assets, current ratio, minimum cash balance or borrowing
capacity and minimum coverage of rent and interest expense. The securitized
receivables must meet performance levels relating to portfolio yield,
default rates and delinquency rates. CarMax was in compliance with these
guidelines at May 31, 2002, and February 28, 2002.
The total principal amount of automobile loan receivables managed was $1.63
billion at May 31, 2002, and $1.55 billion at February 28, 2002. Of the
total principal amounts managed, the principal amount of automobile loan
receivables securitized was $1.61 billion at May 31, 2002, and $1.54
billion at February 28, 2002, and the principal amount of automobile loan
receivables held for sale or investment was $20.5 million at May 31, 2002,
and $13.9 million at February 28, 2002. The unused capacity of the
automobile loan variable funding program was $115.0 million at May 31,
2002, and $211.0 million at February 28, 2002. The aggregate principal
amount of automobile loans that were 31 days or more delinquent was $21.2
million at May 31, 2002, and $22.3 million at February 28, 2002. The
principal amount of losses net of recoveries totaled $3.3 million for the
three months ended May 31, 2002, and $1.9 million for the three months
ended May 31, 2001.
CarMax receives annual servicing fees approximating 1 percent of the
outstanding principal balance of the securitized automobile loan
receivables and retains the rights to future cash flows available after the
investors in the asset-backed securities have received the return for which
they contracted. The servicing fees specified in the automobile loan
securitization agreements adequately compensate the finance operation for
servicing the securitized receivables. Accordingly, no servicing asset or
liability has been recorded.
The table below summarizes certain cash flows received from and paid to the
securitization trusts:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
----------------------------------------------------------------------------------------------
Proceeds from new securitizations..................... $221.0 $195.0
Proceeds from collections reinvested
in previous automobile loan securitizations......... $134.5 $ 91.5
Servicing fees received............................... $ 3.9 $ 3.3
Other cash flows received on retained interests*...... $ 20.0 $ 12.5
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
When determining the fair value of retained interests, CarMax estimates
future cash flows using management's projections of key factors, such as
finance charge income, default rates, payment rates and discount rates
appropriate for the type of asset and risk.
Future finance income from securitized automobile loan receivables that
exceeds the sum of the contractually specified investor returns and
servicing fees (interest-only strips) is carried at fair value and amounted
to
Page 49 of 62
$76.1 million at May 31, 2002, and $51.4 million at May 31, 2001. These
amounts are included in retained interests in securitized receivables on
the consolidated balance sheets. Gains of $15.6 million on sales of
automobile loan receivables were recorded for the three months ended May
31, 2002; gains of $13.1 million on sales of automobile loan receivables
were recorded for the three months ended May 31, 2001.
The fair value of retained interests at May 31, 2002, was $127.9 million,
with a weighted-average life of 1.6 years. The fair value of retained
interests at February 28, 2002, was $120.7 million, with a weighted-average
life of 1.6 years. The following table shows the key economic assumptions
used in measuring the fair value of retained interests at May 31, 2002, 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 economic assumptions at May 31, 2002, are not materially
different from assumptions used to measure the fair value of retained
interests at the time of securitization. These sensitivities are
hypothetical and should be used with caution. In this table, the effect of
a variation in a particular assumption on the fair value of the retained
interest 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.
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(Dollar amounts in millions) Used Adverse Change Adverse Change
------------------------------------------------------------------------------------
Prepayment rate................. 1.5%-1.6% $3.8 $7.8
Annual default rate............. 1.0%-1.2% $2.1 $4.3
Annual discount rate............ 12.0% $1.4 $2.8
6. Financial Derivatives
On behalf of CarMax, the Company enters into amortizing swaps relating to
automobile loan receivable securitizations to convert variable-rate
financing costs to fixed-rate obligations to better match funding costs to
the receivables being securitized. During the first quarter of fiscal 2003,
the Company entered into three 40-month amortizing interest rate swaps with
an initial notional amount totaling approximately $248.0 million. The
current amortized notional amount of all outstanding swaps related to the
automobile loan receivable securitizations was approximately $633.7 million
at May 31, 2002, and $413.3 million at February 28, 2002. At May 31, 2002,
the fair value of swaps totaled a net liability of $2.1 million and were
included in accounts payable. At February 28, 2002, the fair value of swaps
totaled a net liability of $841,000 and were included in accounts payable.
The market and credit risks associated with interest rate swaps are similar
to those relating to other types of financial instruments. Market risk is
the exposure created by potential fluctuations in interest rates. The
Company does not anticipate significant market risk from swaps because they
are used on a monthly basis to match funding costs to the use of the
funding. 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.
7. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets," effective for fiscal years beginning after December 15, 2001.
Under the provisions of SFAS No. 142, goodwill and intangible assets deemed
to have indefinite lives are no longer amortized but instead are subject to
annual impairment tests in accordance with the pronouncement. Other
intangible assets that are identified to have finite useful lives continue
to be amortized in a manner that reflects the estimated decline in the
economic value of the intangible asset and are subject to review when
events or circumstances arise which indicate impairment. Application of the
nonamortization provisions of SFAS No. 142 in the first quarter of fiscal
2003 did not have a material impact on the financial position, results of
operations or cash flows of the CarMax Group. During fiscal 2003, the
Company will perform the first of the required impairment tests of goodwill
and indefinite-lived intangible
Page 50 of 62
assets, as outlined in the pronouncement. Based on preliminary estimates,
as well as ongoing periodic assessments of goodwill, the Company does not
expect to recognize any material impairment losses from these tests.
In August 2001, the FASB issued SFAS No. 143, "Accounting For Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. It applies to
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and/or the normal
operation of a long-lived asset, except for certain obligations of lessees.
This standard requires entities to record the fair value of a liability for
an asset retirement obligation in the period incurred. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002. The Company has
not yet determined the impact, if any, of adopting this standard.
8. Reclassifications
Certain prior year amounts have been reclassified to conform to the current
presentation. For the quarter ended May 31, 2001, wholesale sales have been
reclassified and reported in net sales and operating revenues. In previous
periods, wholesale sales were recorded as a reduction to cost of sales. The
reclassification of wholesale sales to sales increased sales and cost of
sales by $84.5 million for the quarter ended May 31, 2001. An additional
reclassification between sales and cost of sales made to conform to the
current presentation decreased sales and cost of sales by $2.3 million for
the quarter ended May 31, 2001.
ITEM 2.
CARMAX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "Circuit City business" and "Circuit City" refer to the retail
operations bearing the Circuit City name and to all related operations such as
product service and Circuit City's finance operation. "Circuit City Group"
refers to the Circuit City business and the reserved CarMax Group shares.
"CarMax business," "CarMax" and "CarMax Group" refer to retail locations bearing
the CarMax name and to all related operations such as CarMax's finance
operation. All references to "month," "quarter" and "year" refer to our fiscal
year periods rather than calendar year periods unless stated otherwise.
On February 22, 2002, Circuit City Stores, Inc. announced that its board of
directors had authorized management to initiate a process that would separate
the CarMax auto superstore business from the Circuit City consumer electronics
business through a tax-free transaction in which CarMax, Inc., presently a
wholly owned subsidiary of Circuit City Stores, Inc., would become an
independent, separately traded public company. CarMax, Inc. holds substantially
all of the businesses, assets and liabilities of the CarMax Group. The
separation plan calls for Circuit City Stores, Inc. to redeem the outstanding
shares of CarMax Group Common Stock in exchange for shares of common stock of
CarMax, Inc. Simultaneously, shares of CarMax, Inc. common stock, representing
the shares of CarMax Group Common Stock reserved for the holders of Circuit City
Group Common Stock, would be distributed as a tax-free dividend to the holders
of Circuit City Group Common Stock.
In the proposed separation, the holders of CarMax Group Common Stock would
receive one share of CarMax, Inc. common stock for each share of CarMax Group
Common Stock redeemed by the Company. Management anticipates that the holders of
Circuit City Group Common Stock would receive a fraction of a share of CarMax,
Inc. common stock for each share of Circuit City Group Common Stock they hold.
The exact fraction would be
Page 51 of 62
determined on the record date for the distribution. The separation is expected
to be completed by late summer or early fall, subject to shareholder approval
and final approval from the board of directors.
CRITICAL ACCOUNTING POLICIES
See the discussion of critical accounting policies included on the Circuit City
Stores, Inc. 2002 Annual Report to Shareholders. These policies relate to the
calculation of the value of retained interests in securitization transactions.
RESULTS OF OPERATIONS
Effective in the first quarter of fiscal 2003, CarMax classifies revenue from
the sale of wholesale vehicles in net sales and operating revenues. Previously,
CarMax wholesale vehicle sales were recorded as reductions to cost of sales. The
reclassification of wholesale sales to sales increased sales and cost of sales
by $84.5 million for the quarter ended May 31, 2001. An additional
reclassification between sales and cost of sales made to conform to the current
presentation decreased sales and cost of sales by $2.3 million for the quarter
ended May 31, 2001.
Net Sales and Operating Revenues and General Comments
Total sales for the CarMax Group for the first quarter of fiscal 2003 increased
14 percent to $1.00 billion from $879.0 million in last year's first quarter.
Retail Vehicle Sales. Retail vehicle sales increased 14 percent to $870.1
million in the first quarter of fiscal 2003 from $761.0 million in the first
quarter of fiscal 2002. In the first quarter of fiscal 2003, used vehicle sales
increased 20 percent to $737.8 million from $615.1 million in the first quarter
of fiscal 2002. In the first quarter of fiscal 2003, new vehicle sales decreased
9 percent to $132.3 million from $145.8 million in the first quarter of fiscal
2002. CarMax stores are included in comparable store retail sales after the
store has been open for a full year. Comparable store vehicle dollar and unit
sales for the first quarter of fiscal years 2003 and 2002 were as follows:
================================== ==============================
1st Quarter
Comparable Store ------------------------------
Sales Change FY03 FY02
---------------------------------- -------------- ---------------
Vehicle dollars:
---------------------------------- -------------- ---------------
Used vehicles 14 % 28%
---------------------------------- -------------- ---------------
New vehicles (4)% 23%
---------------------------------- -------------- ---------------
Total 11 % 27%
---------------------------------- -------------- ---------------
---------------------------------- -------------- ---------------
Vehicle units:
---------------------------------- -------------- ---------------
Used vehicles 12 % 20%
---------------------------------- -------------- ---------------
New vehicles (4)% 19%
---------------------------------- -------------- ---------------
Total 10 % 20%
================================== ============== ===============
Page 52 of 62
The overall increase in retail sales is attributed to the 12 percent sales
growth in comparable store used-unit sales, the three additional CarMax stores
opened since the first quarter of fiscal 2002 and the slight increase in the
average retail selling price for used vehicles. The comparable store new-unit
sales decline was in line with the new-car industry's performance.
================================== ================================
1st Quarter
Average Retail --------------------------------
Selling Prices FY03 FY02
---------------------------------- --------------- ----------------
Used vehicles $15,500 $15,100
---------------------------------- --------------- ----------------
New vehicles $23,000 $23,200
---------------------------------- --------------- ----------------
Blended average $16,300 $16,200
================================== =============== ================
================================== ==============================
1st Quarter
Retail Vehicle ------------------------------
Sales Mix FY03 FY02
---------------------------------- -------------- ---------------
Vehicle dollars:
---------------------------------- -------------- ---------------
Used vehicles 85% 81%
---------------------------------- -------------- ---------------
New vehicles 15 19
---------------------------------- -------------- ---------------
Total 100% 100%
---------------------------------- -------------- ---------------
---------------------------------- -------------- ---------------
Vehicle units:
---------------------------------- -------------- ---------------
Used vehicles 89% 87%
---------------------------------- -------------- ---------------
New vehicles 11 13
---------------------------------- -------------- ---------------
Total 100% 100%
================================== ============== ===============
Wholesale Vehicle Sales. Wholesale vehicle sales totaled $92.5 million in the
first quarter of fiscal 2003, compared with $84.5 million in the same period
last year. The increase was consistent with increased traffic at CarMax stores.
Other Sales and Revenues. Other sales and revenues include extended warranty
revenues, service department sales and processing fees collected from consumers
for the purchase of their vehicles at a CarMax retail location and totaled $39.0
million in the first quarter of fiscal 2003, compared with $33.5 million in the
same period last year.
CarMax sells extended warranties on behalf of unrelated third parties who are
the primary obligors. Under these third-party warranty programs, CarMax has no
contractual liability to the customer. Extended warranty revenue was $16.7
million in the first quarter of fiscal 2003 and $13.5 million in the first
quarter of fiscal 2002. The increase reflects improved penetration and strong
sales growth for used cars, which achieve a higher extended warranty penetration
rate than new cars.
Service sales were $15.5 million in the first quarter of fiscal 2003, compared
with $13.9 million in the same period last year. The increase relates to the
overall increase in CarMax's customer base.
Processing fees were $6.8 million in the first quarter of fiscal 2003, compared
with $6.1 million in the same period last year. Consumers are assessed this fee
when selling a vehicle to a CarMax retail location after the appraisal process.
The increase was the result of increased traffic and increased consumer response
to CarMax's vehicle purchase program.
Page 53 of 62
Seasonality. Our operations, in common with other retailers in general, are
subject to seasonal influences. Historically, the CarMax business has
experienced more of its net sales in the first half of the fiscal year. 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.
Retail Stores. During the first quarter of fiscal 2003, CarMax integrated the
new-car stand-alone Chrysler franchise in the Orlando, Fla., market with an
existing CarMax superstore and opened a standard-sized superstore in the
mid-sized market of Sacramento, Calif. CarMax expects to open four to five
stores in the second half of the fiscal year, including entries into the
Knoxville, Tenn., and Las Vegas, Nev., markets.
The following table provides detail on the CarMax retail stores:
====================================== ==================== =================== =================== ==================
Estimate Feb. 28,
Store Mix May 31, 2002 May 31, 2001 2003 Feb. 28, 2002
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Mega superstores 13 13 13 13
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Standard superstores 18 16 20 17
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Prototype satellite stores 5 4 8 5
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Co-located new-car stores 2 2 2 2
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Stand-alone new-car stores 2 5 2 3
-------------------------------------- -------------------- ------------------- ------------------- ------------------
Total 40 40 45 40
====================================== ==================== =================== =================== ==================
Cost of Sales
Total gross profit margin for the CarMax Group was 11.8 percent of sales in the
first quarter of both fiscal 2003 and fiscal 2002.
Retail Vehicle Gross Profit Margin. The retail vehicle gross profit margin was
9.9 percent in the first quarter of fiscal 2003 versus 10.0 percent for the same
period last year. CarMax achieved its average per unit gross profit targets on
used cars; however, the positive gross margin impact of a higher percentage of
used cars in the mix was substantially offset by the higher average retails on
used cars, which reduced the used-car margin on a percentage basis. The result
was a retail vehicle gross profit margin that slightly declined in relation to
last year's first quarter.
Wholesale Vehicle Gross Profit Margin. The wholesale vehicle gross profit margin
was 6.7 percent in the first quarter of fiscal 2003, compared with 5.6 percent
for the same period last year. Both the average wholesale cost and average
wholesale sales price declined compared with the first quarter of fiscal 2002;
however, the decrease in the average wholesale sales price was less than the
decrease in the average wholesale cost.
Other Gross Profit Margin. The gross profit margin for other sales and revenues
was 66.5 percent in the first quarter of fiscal 2003, compared with 68.1 percent
for the same period last year.
Selling, General and Administrative Expenses
The selling, general and administrative expense ratio for the CarMax Group
increased to 6.8 percent of sales in the first quarter of fiscal 2003 from 6.7
percent of sales for the same period last year. The higher expense ratio in this
year's first quarter compared with last year's first quarter reflects expenses
associated with geographic expansion and $1.9 million of one-time separation
costs, partly offset by increased income from financing.
Page 54 of 62
Finance Income. For the first quarter of fiscal 2003 and 2002, pretax finance
income, which is recorded as a reduction to selling, general and administrative
expenses, was as follows:
Three Months Ended Three Months Ended
(Amounts in millions) May 31, 2002 May 31, 2001
--------------------------------------------------------------------------
Securitization income.......... $23.3 $18.4
Payroll and fringe expenses.... 1.7 1.3
Other direct expenses.......... 1.7 1.4
---------------------------------------
Finance operation income....... 19.9 15.7
Third-party financing fees..... 4.2 3.8
---------------------------------------
Total finance income........... $24.1 $19.5
=======================================
Receivables generated by the CarMax finance operation are sold through
securitization transactions. CarMax continues to service these receivables in
exchange for a contractually specified servicing fee. For the quarter ended May
31, 2002 serviced receivables averaged $1.56 billion, compared to $1.28 billion
for the period ended May 31, 2001.
For the CarMax Group, securitization income includes the gain on sale of
receivables and other income related to servicing these receivables. CarMax
recorded gains on sale of receivables totaling $15.6 million for the quarter
ended May 31, 2002 compared to gains of $13.1 million for the period ended May
31, 2001. This change resulted from an increase in loan origination volume
driven by increased sales. In recording these gains, management estimates key
assumptions such as finance charge income, default rates, payment rates and
discount rates appropriate for the type of asset and risk. If these assumptions
change, or the actual results differ from the projected results, securitization
income would be affected.
For the CarMax Group, finance operation 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. Direct expenses include collection expenses, rent and
facility expenses and loan processing costs. Payroll, fringes and other direct
expenses increased proportionately to the average managed receivable balance.
Fees received from arranging customer automobile financing through third parties
increased by $0.4 million over the same period last year. The increase was a
result of the total increase in retail vehicle sales.
Interest Expense
Interest expense for the CarMax Group declined to $1.0 million for the first
quarter of fiscal 2003 from $2.6 million in the same period last year,
reflecting both lower average debt levels and lower interest rates.
Income Taxes
The effective income tax rate increased to 39.5 percent for the first quarter of
fiscal 2003 from 38.0 percent for the first quarter of fiscal 2002. The increase
reflects the $1.9 million of one-time, non-tax-deductible costs associated with
the proposed separation of CarMax from Circuit City Stores, Inc.
Net Earnings
The CarMax Group's first quarter fiscal 2003 net earnings rose 10 percent to
$29.2 million from $26.6 million in the first quarter of fiscal 2002. First
quarter fiscal 2003 earnings include $1.9 million of one-time,
non-tax-deductible costs associated with the proposed separation of CarMax from
Circuit City Stores. Excluding the one-time separation costs, net earnings
increased 17 percent to $31.1 million.
Page 55 of 62
In the first quarter of fiscal 2003, net earnings attributed to the CarMax Group
Common Stock were $10.5 million compared with $6.8 million in the first quarter
of last fiscal year. The remainder of the CarMax Group's net earnings was
attributed to the shares of CarMax Group Common Stock reserved for the Circuit
City Group or for issuance to the holders of Circuit City Group Common Stock.
Operations Outlook
For more than two years, CarMax has demonstrated that its consumer offer and
business model can produce strong sales and earnings growth. At the beginning of
fiscal 2002, CarMax announced that it would resume geographic growth, opening
two superstores in fiscal 2002, four to six superstores in fiscal 2003 and six
to eight stores in each of fiscal years 2004, 2005 and 2006. This expansion is
proceeding as planned with four or five more used-car superstores scheduled to
open during the second half of the fiscal year.
Comparable store used-unit sales growth drives CarMax's profitability. We
currently anticipate that comparable store used-unit growth will most likely be
in the low teens in the first half of fiscal 2003. For the second half of the
fiscal year, we continue to expect used-unit comparable store growth in the
high-single to low-double digits.
We expect fiscal 2003 to be a year of transition for CarMax as we ramp up the
growth pace. Additional growth-related costs, such as training, recruiting and
employee relocation for our new stores, and additional expenses expected in the
second half if the planned separation is approved will moderate earnings growth,
offsetting the expense leverage we would otherwise expect from used-unit
comparable store growth. In addition, we had anticipated that interest rates
would rise above the low levels experienced in fiscal 2002 resulting in reduced
yield spreads from the CarMax finance operation throughout fiscal 2003. If the
current favorable interest rate environment continues, CarMax may not experience
the reduction in yield spreads that we originally anticipated.
Refer to the "Circuit City Stores, Inc. Management's Discussion and Analysis of
Results of Operations and Financial Condition" for the estimated contribution of
the CarMax business earnings attributed to the outstanding Carmax Group Common
Stock in fiscal 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to the "Circuit City Stores, Inc. Management's Discussion and Analysis of
Results of Operations and Financial Condition" for a review of recent accounting
pronouncements.
FINANCIAL CONDITION
Liquidity and Capital Resources
Operating Activities. In the first quarter of fiscal 2003, CarMax generated cash
from operating activities of $9.1 million. In last year's first quarter, CarMax
used cash of $19.1 million for operating activities. The improvement was
primarily the result of CarMax's enhanced ability to better manage its inventory
levels to meet sales demands.
Investing Activities. Net cash used in investing activities was $28.5 million in
the first quarter of fiscal 2003, compared with $3.3 million in the first
quarter of last year. The increase of $25.2 million reflects capital
expenditures for geographic expansion.
Financing Activities. Net cash provided by financing activities was $77.5
million in the first quarter of fiscal 2003, compared with $24.1 million in the
first quarter of last year. In the first quarter of fiscal 2003, CarMax entered
into a $200 million credit agreement with DaimlerChrysler Services North
America, LLC and Toyota Financial Services. This agreement, which is secured by
vehicle inventory, includes a $100 million revolving loan commitment and a $100
million term loan commitment. The terms for both commitments are LIBOR-based and
have initial two-year terms. As of May 31, 2002, the amount outstanding under
this credit agreement was $100 million. CarMax anticipates that some of the
proceeds from the agreement will be used
Page 56 of 62
for the repayment of allocated debt, the payment on the separation date of a
one-time special dividend to Circuit City Stores of $28.4 million, the payment
of transaction expenses incurred in connection with the separation and general
corporate purposes.
In December 2001, CarMax entered into an $8.5 million secured promissory note in
conjunction with the purchase of land for new store construction. This note,
which is payable in August 2002, was included in short-term debt as of May 31,
2002. At May 31, 2002, a $100 million outstanding term loan due in July 2002 was
classified as a current liability. Although the Company has the ability to
refinance this debt, we intend to repay it using existing working capital.
At May 31, 2002, the Company allocated cash and cash equivalents of $61.4
million and debt of $165.1 million to the CarMax Group. Circuit City Stores
maintains a $150 million unsecured revolving credit facility that expires on
August 31, 2002. The Company does not anticipate renewing this facility. The
Company also maintains $195 million in committed seasonal lines of credit that
are renewed annually with various banks. At May 31, 2002, total balances of $2.4
million were outstanding under these facilities.
At May 31, 2002, the aggregate principal amount of securitized automobile loan
receivables totaled $1.61 billion. During the second quarter of fiscal 2003,
CarMax completed an asset securitization transaction totaling $512.6 million of
automobile loan receivables. At May 31, 2002, the unused capacity of the
automobile loan variable funding program was $115.0 million. At May 31, 2002,
there were no provisions providing recourse to the Company for credit losses on
the securitized automobile loan receivables. CarMax anticipates that it will be
able to expand or enter into new securitization arrangements to meet the future
needs of the automobile loan finance operation.
We expect that proceeds from the credit agreement secured by vehicle inventory,
sale-leaseback transactions and cash generated by operations will be sufficient
to fund capital expenditures of the CarMax business for the foreseeable future.
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties, including, but not limited to, risks
associated with plans to separate the CarMax business from Circuit City Stores,
Inc. and create an independent, separately traded public company. Additional
discussion of factors that could cause actual results to differ materially from
management's projections, forecasts, estimates and expectations is contained in
the Company's SEC filings, including the Company's Annual Report on Form 10-K
for the year ended February 28, 2002, and the registration statement on Form S-4
filed by CarMax, Inc. (File No. 333-85240) related to the proposed separation.
Page 57 of 62
ITEM 3.
CARMAX GROUP QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
RECEIVABLES RISK
The Company manages the market risk associated with the automobile installment
loan portfolio of CarMax's finance operation. A portion of this portfolio has
been securitized in transactions accounted for as sales in accordance with SFAS
No. 140 and, therefore, is not presented on the Group balance sheets.
Automobile Installment Loan Receivables. At May 31, 2002, and February 28, 2002,
all loans in the portfolio of automobile loan receivables were fixed-rate
installment loans. Financing for these automobile loan receivables is achieved
through asset securitization programs that, in turn, issue both fixed- and
floating-rate securities. Interest rate exposure relating to floating rate
securitizations is managed through the use of interest rate swaps. Receivables
held for investment or sale are financed with working capital.
The total principal amount of receivables securitized or held for investment or
sale as of May 31, 2002, and February 28, 2002, was as follows:
(Amounts in millions) May 31 Feb. 28
- ------------------------------------------------------------------
Fixed-rate securitizations................ $ 979 $1,122
Floating-rate securitizations
synthetically altered to fixed......... 634 413
Floating-rate securitizations............. 1 1
Held for investment(1).................... 18 12
Held for sale............................. 3 2
-----------------------
Total..................................... $1,635 $1,550
=======================
(1) Held by a bankruptcy-remote special purpose subsidiary.
Interest Rate Exposure. Interest rate exposure relating to the securitized
automobile loan receivables represents a market risk exposure that we manage
with matched funding and interest rate swaps matched to projected payoffs. The
Company does not anticipate significant market risk from swaps because they are
used on a monthly basis to match funding costs to the use of the funding. Market
risk is the exposure created by potential fluctuations in interest rates.
Generally, changes only in interest rates do not have a material impact on the
Company's results of operations.
Credit risk is the exposure to nonperformance of another party to an agreement.
Credit risk is mitigated by dealing with highly rated bank counterparties. The
market and credit risks associated with financial derivatives are similar to
those relating to other types of financial instruments. Refer to Note 6 to the
CarMax Group consolidated financial statements for a description of these items.
Page 58 of 62
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As previously reported in the Company's Annual Report on Form 10-K for
the fiscal year ended February 28, 2002, Kevin Smith, individually and
on behalf of all others similarly situated, filed a complaint alleging
federal securities law violations against the Company and W. Alan
McCollough in the United States District Court for the Eastern
District of Virginia, Richmond Division. On May 16, 2002 and May 29,
2002, the Company and Mr. McCollough were served with two additional
complaints filed by Douglass Nichols and Patricia Beaupre,
respectively, on behalf of themselves and all others similarly
situated. Both complaints allege similar facts, assert similar claims
and seek similar damages as those in the Smith case. The Company
expects that the three cases will be consolidated. As in the Smith
case, the Company believes that the allegations in these two
additional cases are without merit and that the Company has
substantial defenses to the claims alleged. As a result, the Company
intends to defend these actions vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of the Company's shareholders was held June
18, 2002.
(b) (i) At the annual meeting, the shareholders of the Company
elected Carolyn H. Byrd, Michael T. Chalifoux, Paula
G. Rosput and John W. Snow as directors for three-year
terms. The elections were approved by the following
votes:
=====================================================================
Directors For Withheld
=====================================================================
Carolyn H. Byrd 211,412,961 3,738,189
- ---------------------------------------------------------------------
Michael T. Chalifoux 211,454,813 3,696,337
- ---------------------------------------------------------------------
Paula G. Rosput 211,426,074 3,725,076
- ---------------------------------------------------------------------
John W. Snow 211,477,061 3,674,089
- ---------------------------------------------------------------------
(ii) 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:
==============================================================================
Broker
Shareholder Proposal For Against Abstain Non-Votes
=======================================================
123,326,840 44,873,754 2,430,150 44,520,406
==============================================================================
Page 59 of 62
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(3) (i) Articles of Incorporation
(a) Amended and Restated Articles of
Incorporation of Circuit City Stores,
Inc., effective February 3, 1997, filed as
Exhibit 3 (i)(a) to the Company's Amended
Quarterly Report on Form 10-Q/A for the
quarter ended May 31, 1999 (File No.
1-5767), are expressly incorporated herein
by this reference.
(b) Articles of Amendment to the Amended and
Restated Articles of Incorporation,
effective April 28, 1998, filed as Exhibit
3(i)(b) to the Company's Amended Quarterly
Report on Form 10-Q/A for the quarter
ended May 31, 1999 (File No. 1-5767), are
expressly incorporated herein by this
reference.
(c) Articles of Amendment to the Amended and
Restated Articles of Incorporation,
effective June 22, 1999, filed as Exhibit
3(i)(c) to the Company's Amended Quarterly
Report on Form 10-Q/A for the quarter
ended May 31, 1999 (File No. 1-5767), are
expressly incorporated herein by this
reference.
(3) (ii) Bylaws
(a) Bylaws of Circuit City Stores, Inc., as
amended and restated June 18, 2002, filed
herewith.
(10) Material Contracts
(a) Employee agreement between the Company and
W. Alan McCollough effective March 1,
2002, filed herewith.*
(b) Employee agreement between the Company and
John W. Froman effective March 1, 2002,
filed herewith.*
(c) Employee agreement between the Company and
Michael T. Chalifoux effective March 1,
2002, filed herewith.*
(d) Employee agreement between the Company and
Dennis J. Bowman effective March 1, 2002,
filed herewith.*
(e) Employee agreement between the Company and
W. Austin Ligon effective March 1, 2002,
filed as Exhibit 10.4 to the CarMax, Inc.
Form S-4/Amendment No. 2 (File No.
333-85240) is incorporated herein by this
reference.*
(f) Credit Agreement, dated May 17, 2002,
among CarMax Auto Superstores, Inc.,
CarMax, Inc., Various Financial
Institutions and DaimlerChrysler Services
North America LLC filed as Exhibit 10.11
to the CarMax, Inc. Form S-4/Amendment No.
2 (File No. 333-85240) is incorporated
herein by this reference.
(g) Security Agreement, dated May 17, 2002,
among CarMax Auto Superstores, Inc.,
various other debtors and DaimlerChrysler
Service North America LLC filed as Exhibit
10.12 to the CarMax, Inc. Form
S-4/Amendment No. 2 (File No. 333-85240)
is incorporated herein by this reference.
Page 60 of 62
(h) Guaranty, dated May 17, 2002, executed by
certain CarMax subsidiaries in favor of
DaimerChrysler North America LLC and the
Lender Parties filed as Exhibit 10.13 to
the CarMax, Inc. Form S-4/Amendment No. 2
(File No. 333-85240) is incorporated
herein by this reference.
*Management contracts, compensatory plans
or arrangements of the Company required to
be filed as an exhibit
(b) Reports on Form 8-K
The Company filed a Form 8-K on June 19, 2002, reporting
that the Company had issued a press release reporting
first quarter results for the Company, the Circuit City
Group and the CarMax Group.
Page 61 of 62
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.
By: s/ W. Alan McCollough
--------------------------------------
W. Alan McCollough
Chairman, President and
Chief Executive Officer
By: s/ Michael T. Chalifoux
--------------------------------------
Michael T. Chalifoux
Executive Vice President,
Chief Financial Officer and
Corporate Secretary
By: s/ Philip J. Dunn
--------------------------------------
Philip J. Dunn
Senior Vice President, Treasurer,
Corporate Controller and
Chief Accounting Officer
July 15, 2002
Page 62 of 62