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, 2003
------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-31420
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CARMAX, INC.
------------
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-1821055
-------- ----------
(State of Incorporation) (I.R.S. Employer
Identification No.)
4900 COX ROAD, GLEN ALLEN, VIRGINIA 23060
-----------------------------------------
(Address of Principal Executive Offices and Zip Code)
(804) 747-0422
--------------
(Registrant's Telephone Number, Including Area Code)
N/A
---
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------ ------
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
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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, 2003
----------------------------- ----------------------------
Common Stock, par value $0.50 103,465,988
An Index is included on Page 2 and a separate Exhibit Index is included on Page
30.
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
INDEX
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Page
PART I. FINANCIAL INFORMATION No.
--------------------- ---
Item 1. Consolidated Financial Statements:
Consolidated Statements of Earnings -
Three Months Ended May 31, 2003 and 2002 3
Consolidated Balance Sheets -
May 31, 2003, and February 28, 2003 4
Consolidated Statements of Cash Flows -
Three Months Ended May 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
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SECTION 302 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER 28
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SECTION 302 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER 29
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EXHIBIT INDEX 30
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Page 2 of 30
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Earnings (Unaudited)
-----------------------------------------------
(Amounts in thousands except per share data)
Three Months Ended May 31
2003 %(1) 2002 %(1)
------ ---- ------ ----
Sales and operating revenues:
Used vehicle sales $ 890,142 75.9 $ 737,781 73.4
New vehicle sales 136,399 11.6 132,343 13.2
Wholesale vehicle sales 100,733 8.6 92,453 9.2
Other sales and revenues 45,561 3.9 43,226 4.3
---------------------------------------------
Net sales and operating revenues 1,172,835 100.0 1,005,803 100.0
Cost of sales 1,025,064 87.4 883,661 87.9
---------------------------------------------
Gross profit 147,771 12.6 122,142 12.1
CarMax Auto Finance income (Notes 6 and 7) 25,748 2.2 19,838 2.0
Selling, general and administrative expenses 115,553 9.9 93,037 9.3
Interest expense (Note 5) 754 0.1 694 0.1
Interest income 122 - 78 -
---------------------------------------------
Earnings before income taxes 57,334 4.9 48,327 4.8
Provision for income taxes 22,074 1.9 19,089 1.9
---------------------------------------------
Net earnings $ 35,260 3.0 $ 29,238 2.9
=============================================
Weighted average common shares (Note 3):
Basic 103,156 102,885
============ ===========
Diluted 104,762 104,753
============ ===========
Net earnings per share (Note 3):
Basic $ 0.34 $ 0.28
============ ===========
Diluted $ 0.34 $ 0.28
============ ===========
(1) Percents of net sales and operating revenues may not total due
to rounding.
See accompanying notes to consolidated financial statements.
Page 3 of 30
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Balance Sheets
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(Amounts in thousands except share data)
May 31, 2003 Feb. 28, 2003
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(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 32,029 $ 34,615
Accounts receivable, net 73,940 56,449
Automobile loan receivables held for sale (Note 7) 20,428 3,579
Retained interests in securitized receivables (Note 7) 145,020 135,016
Inventory 430,386 466,450
Prepaid expenses and other current assets 8,464 12,636
---------- ----------
Total current assets 710,267 708,745
Property and equipment, net 218,069 187,158
Deferred income taxes 3,098 -
Other assets 20,218 21,714
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TOTAL ASSETS $ 951,652 $ 917,617
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 139,824 $ 117,587
Accrued expenses and other current liabilities 47,125 44,682
Accrued income taxes 16,136 -
Deferred income taxes 29,948 29,783
Short-term debt (Note 5) 14,532 56,051
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Total current liabilities 247,565 248,103
Long-term debt, excluding current installments (Note 5) 100,000 100,000
Deferred revenue and other liabilities 11,984 10,904
Deferred income taxes - 4,041
---------- ----------
TOTAL LIABILITIES 359,549 363,048
Stockholders' equity (Note 1):
Common stock, par value $0.50; authorized: 350,000,000
shares, issued and outstanding 103,291,595 shares at
May 31, 2003 and 103,083,047 shares at February 28, 2003 51,646 51,542
Capital in excess of par value 474,915 472,745
Retained earnings 65,542 30,282
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TOTAL STOCKHOLDERS' EQUITY 592,103 554,569
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Commitments and contingent liabilities (Notes 1 and 5) - -
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 951,652 $ 917,617
========== ==========
See accompanying notes to consolidated financial statements.
Page 4 of 30
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Cash Flows (Unaudited)
-------------------------------------------------
(Amounts in thousands)
Three Months Ended May 31
2003 2002
----------- -----------
Operating Activities:
- ---------------------
Net earnings $ 35,260 $ 29,238
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 4,063 4,138
Amortization of restricted stock awards 32 18
Loss on disposition of property and equipment - 10
Provision for deferred income taxes (6,974) (586)
Changes in operating assets and liabilities:
Increase in accounts receivable, net (17,491) (1,890)
Increase in automobile loan receivables held
for sale (16,849) (432)
Increase in retained interests in securitized
receivables (10,004) (7,177)
Decrease (increase) in inventory 36,064 (18,377)
Decrease in prepaid expenses and
other current assets 4,172 419
Decrease (increase) in other assets 1,423 (1)
Increase in accounts payable, accrued
expenses and other current liabilities
and accrued income taxes 41,856 3,012
Increase in deferred revenue and other liabilities 1,080 770
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Net cash provided by operating activities 72,632 9,142
---------- ----------
Investing Activities:
- ---------------------
Purchases of property and equipment (34,901) (28,533)
Proceeds from sales of property and equipment - 6
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Net cash used in investing activities (34,901) (28,527)
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Financing Activities:
- ---------------------
Decrease in short-term debt, net (41,519) (79)
Issuance of long-term debt - 76,716
Equity issuances, net 1,202 907
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Net cash (used in) provided by financing activities (40,317) 77,544
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(Decrease) increase in cash and cash equivalents (2,586) 58,159
Cash and cash equivalents at beginning of year 34,615 3,286
---------- ----------
Cash and cash equivalents at end of period $ 32,029 $ 61,445
========== ==========
See accompanying notes to consolidated financial statements.
Page 5 of 30
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Notes to Consolidated Financial Statements
------------------------------------------
(Unaudited)
1. Basis of Presentation
---------------------
On September 10, 2002, Circuit City Stores, Inc. ("Circuit City Stores")
shareholders, which included Circuit City Stores, Inc.-Circuit City Group
Common Stock shareholders and Circuit City Stores, Inc.-CarMax Group Common
Stock shareholders, approved the separation of the CarMax business from
Circuit City Stores, and the Circuit City Stores board of directors
authorized the redemption of the CarMax Group Common Stock and the
distribution of CarMax, Inc. common stock to effect the separation. The
separation was effective October 1, 2002. Each outstanding share of CarMax
Group Common Stock was redeemed in exchange for one share of CarMax, Inc.
common stock. In addition, each holder of Circuit City Group Common Stock
received as a tax-free distribution, a 0.313879 share of CarMax, Inc.
common stock for each share of Circuit City Group Common Stock owned as of
September 16, 2002, the record date of the distribution. As a result of the
separation, all of the businesses, assets and liabilities of the CarMax
Group are now held in CarMax, Inc. ("CarMax" and "the company"), an
independent, separately traded public company. These consolidated financial
statements are presented as if CarMax existed as an entity separate from
the other businesses of Circuit City Stores during the periods presented.
In the separation, Circuit City Stores contributed to CarMax all of the
subsidiaries and net assets and liabilities that constituted the CarMax
Group. CarMax includes the same businesses, assets and liabilities whose
financial performance was intended to be reflected by the CarMax Group
Common Stock. CarMax's assets and liabilities are accounted for at the
historical values carried by Circuit City Stores prior to the separation.
In conjunction with the separation, all outstanding CarMax Group stock
options and restricted stock were replaced with CarMax, Inc. stock options
and restricted stock with the same terms and conditions, exercise prices
and restrictions as the CarMax Group stock options and restricted stock
they replaced.
The current relationship between Circuit City Stores and CarMax is governed
by a transition services agreement under which Circuit City Stores provides
CarMax services including human resources, payroll, benefits
administration, tax services, computer center support and
telecommunications services. These services have terms ranging from six to
24 months, with varying renewal options. A tax allocation agreement, which
generally provides that pre-separation taxes attributable to the business
of each party will be borne solely by that party, was also executed upon
separation.
2. Accounting Policies
-------------------
CarMax's consolidated financial statements 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 were
derived from the audited consolidated financial statements included in the
company's annual report on Form 10-K for the fiscal year ended February 28,
2003.
Page 6 of 30
3. Net Earnings per Share
----------------------
CarMax was a wholly owned subsidiary of Circuit City Stores for the three
months ended May 31, 2002. Earnings per share have been presented to
reflect the capital structure effective with the separation of CarMax from
Circuit City Stores.
All earnings per share calculations have been computed as if the separation
had occurred at the beginning of the periods presented.
Reconciliations of the numerator and denominator of the basic and diluted
net earnings per share are presented below:
Three Months Ended May 31
(Amounts in thousands except per share data) 2003 2002
- --------------------------------------------------------------------------------
Weighted average common shares................... 103,156 102,885
Dilutive potential common shares:
Options.......................................... 1,599 1,849
Restricted stock................................. 7 19
-------------------------
Weighted average common shares
and dilutive potential common shares........ 104,762 104,753
=========================
Net earnings available to common shareholders.... $ 35,260 $29,238
Basic net earnings per share..................... $ 0.34 $ 0.28
Diluted net earnings per share................... $ 0.34 $ 0.28
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 common shares. For the three
month period ended May 31, 2003, options to purchase 1,031,827 shares of
common stock at prices ranging from $18.60 to $43.44 per share were
outstanding and not included in the calculation. For the three month period
ended May 31, 2002, options to purchase 15,364 shares at prices ranging
from $37.49 to $43.44 per share were outstanding and not included in the
calculation.
4. Stock-Based Compensation
------------------------
The company accounts for its stock-based compensation plans under the
recognition and measurement principles of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense would be recorded on the
date of grant and amortized over the period of service only if the current
market value of the underlying stock exceeded the exercise price. No
stock-based employee compensation cost is reflected in net earnings, as
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting
for Stock-Based Compensation--Transition and Disclosure--an Amendment of
SFAS No. 123." The company adopted the disclosure provisions of SFAS No.
148 in the fourth quarter of fiscal 2003. The following table illustrates
the effect on net earnings per share as if the fair value method of
accounting had been applied to all outstanding stock awards in each
reported period as follows:
Page 7 of 30
Three Months Ended May 31
(Amounts in thousands except per share data) 2003 2002
- --------------------------------------------------------------------------------
Net earnings, as reported ........................ $ 35,260 $29,238
Total stock-based compensation expenses
determined under fair value based method
for all awards, net of related tax effects ... 1,538 1,078
---------------------------
Pro forma net earnings ........................... $ 33,722 $ 28,160
===========================
Earnings per share:
Basic, as reported ........................... $ 0.34 $ 0.28
Basic, pro forma ............................. $ 0.33 $ 0.27
Diluted, as reported ......................... $ 0.34 $ 0.28
Diluted, pro forma ........................... $ 0.32 $ 0.27
The pro forma effect on first quarter fiscal 2004 may not be representative
of the pro forma effects on net earnings for future periods.
5. Debt
----
On May 17, 2002, CarMax entered into a $200 million credit agreement
secured by vehicle inventory. During the fourth quarter of fiscal year
2003, the credit agreement was increased from $200 million to $300 million.
The credit agreement includes a $200 million revolving loan commitment and
a $100 million term loan. The borrowings under the revolving loan
commitment are classified as short-term debt on the company's consolidated
balance sheets. Principal is due in full at maturity with interest payable
monthly at a LIBOR-based rate. The credit agreement is scheduled to
terminate on May 17, 2005. The termination date of the agreement will be
automatically extended one year each May 17 unless CarMax or either lender
elects, prior to the extension date, not to extend the agreement.
As of May 31, 2003, the amount outstanding under this credit agreement was
$114.5 million. Under this agreement, CarMax must meet quarterly financial
covenants relating to minimum current ratio, maximum total liabilities to
tangible net worth ratio and minimum fixed charge coverage ratio. CarMax
was in compliance with these covenants at May 31, 2003.
6. CarMax Auto Finance Income
--------------------------
The company's finance operation, CarMax Auto Finance ("CAF"), originates
automobile loans to prime-rated customers at competitive market rates of
interest. The company sells substantially all of the loans it originates
each month in a securitization transaction discussed in Note 7. The
majority of the profit contribution from CAF is generated by the spread
between the interest rate charged to the customer and the cost of funds. A
gain, recorded at the time of the securitization transaction, results from
recording a receivable equal to the present value of the expected residual
cash flows generated by the securitized receivables. The cash flows are
calculated taking into account expected prepayment and default rates.
Page 8 of 30
CarMax Auto Finance income was as follows:
Three Months Ended May 31*
(Amounts in millions) 2003 2002
- --------------------------------------------------------------------------------
Gains on sales of loans......................... $ 19.7 $ 15.6
----------------------------
Other income:
Servicing fee income......................... 5.1 4.1
Interest income.............................. 5.1 3.6
----------------------------
Total other income.............................. 10.2 7.7
----------------------------
Direct expenses:
CAF payroll and fringe benefit expense....... 1.9 1.7
Other direct CAF expenses.................... 2.1 1.8
----------------------------
Total direct expenses........................... 4.1 3.5
----------------------------
CarMax Auto Finance income...................... $ 25.7 $ 19.8
============================
* Amounts in table may not total due to rounding
CarMax Auto Finance 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 indirect benefit or costs
that could be attributed to CAF. Examples of indirect costs not included
are retail store expenses, retail financing commissions and corporate
expenses such as human resources, administrative services, marketing,
information systems, accounting, legal, treasury and executive payroll.
7. Securitizations
---------------
The company uses a securitization program to fund substantially all of the
automobile loan receivables originated by CarMax Auto Finance. The company
sells the automobile loan receivables to a wholly owned, bankruptcy-remote,
special purpose entity that transfers an undivided interest in the
receivables to a group of third-party investors. The special purpose entity
and investors have no recourse to the company's assets for the principal
amount of the loans beyond the retained interests. The investors issue
commercial paper supported by the transferred receivables and the proceeds
from the sale of the commercial paper are used to pay for the securitized
receivables. This program is referred to as the warehouse facility.
The company periodically uses public securitizations to refinance the
receivables previously securitized through the warehouse facility. This
frees up capacity in the warehouse facility. In a public securitization, a
pool of automobile loan receivables are sold to a bankruptcy-remote,
qualified special purpose entity that in turn transfers the receivables to
a special purpose securitization trust. The securitization trust issues
asset-backed securities, secured or otherwise supported by the transferred
receivables, and the proceeds from the sale of the securities are used to
pay for the securitized receivables. The earnings impact of moving
receivables from the warehouse facility to a public securitization has not
been and is not expected to be material to the operations of the company.
The transfers of receivables are accounted for as sales in accordance with
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities." When the receivables are securitized,
the company recognizes a gain or loss on the sale of the receivables as
described in Note 6.
Page 9 of 30
Three Months Ended May 31
(Amounts in millions) 2003 2002
- ------------------------------------------------------------------------------------------
Net loans originated..................................... $ 368.9 $ 289.8
Loans sold............................................... $ 358.0 $ 283.1
Gains on sales of loans.................................. $ 19.7 $ 15.6
Gains on sales of loans as a percentage of loans sold.... 5.5% 5.5%
Retained Interests. The company retains various interests in the automobile
loan receivables that it securitizes. The retained interests, presented
as current assets on the company's consolidated balance sheets, serve as a
credit enhancement for the benefit of the investors in the securitized
receivables. These retained interests include the present value of the
expected residual cash flows generated by the securitized receivables, or
"interest-only strip receivables," the restricted cash on deposit in
various reserve accounts and an undivided ownership interest in the
receivables securitized through the warehouse facility, or "required excess
receivables" as described below. The special purpose entities and the
investors have no recourse to the company's assets beyond the retained
interests. The fair value of the retained interests may fluctuate depending
upon the performance of the securitized receivables. Retained interests
balances consisted of the following:
As of May 31 As of February 28
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
Interest-only strip receivables.................. $ 95.4 $ 76.1 $ 88.3 $ 74.3
Restricted cash.................................. 39.2 33.8 33.3 34.7
Required excess receivables...................... 10.4 18.0 13.4 11.7
----------------------------------------------------
Total $ 145.0 $ 127.9 $ 135.0 $ 120.7
====================================================
The retained interests had a weighted average life of 1.5 years as of May 31,
2003, and 1.6 years as of May 31, 2002. As defined in SFAS No. 140, the weighted
average life in periods (for example, months or years) of prepayable assets is
calculated by summing the product (a), the sum of the principal collections
expected in each future period, times (b), the number of periods until
collection, and then dividing that total by (c), the initial principal balance.
Interest-only strip receivables. Interest-only strip receivables represent the
- --------------------------------
present value of residual cash flows the company expects to receive over the
life of the securitized receivables. The value of these receivables is
determined by estimating the future cash flows using management's projections of
key factors, such as finance charge income, default rates, prepayment rates and
discount rates appropriate for the type of asset and risk. The value of
interest-only strip receivables may be affected by external factors, such as
changes in the behavior patterns of customers, changes in the strength of the
economy and developments in the interest rate markets; therefore, actual
performance may differ from these projections. Management evaluates the
performance of the receivables relative to these assumptions on a regular basis.
Any financial impact resulting from a change in performance is recognized in
earnings in the period in which it occurs.
Restricted cash. Restricted cash represents amounts on deposit in various
- ----------------
reserve accounts established for the benefit of the securitization investors.
The amounts on deposit in the reserve accounts are used to pay various amounts,
including principal and interest to investors, in the event that the cash
generated by the securitized receivables in a given period is insufficient to
pay those amounts. In general, each of the company's securitizations requires
that an amount equal to a specified percentage of the initial receivables
balance be deposited in a reserve account on the closing date and that any
excess cash generated by the receivables be used to fund the reserve account to
the extent necessary to maintain the required amount. If the amount on deposit
in the reserve account exceeds the required amount, an amount equal to that
excess is released through the special purpose entity to the company.
Page 10 of 30
In the public securitizations, the amount required to be on deposit in the
reserve account must equal or exceed a specified floor amount. The reserve
account remains at the floor amount until the investors are paid in full, at
which time the remaining reserve account balance is released to the company. The
amount required to be maintained in the public securitization reserve accounts
may increase depending upon the performance of the securitized receivables.
Generally, restricted cash reserves range between 2.0% and 2.5% of managed
receivables.
Required excess receivables. The warehouse facility requires that the total
- ----------------------------
value of the securitized receivables exceed, by a specified amount, the
principal amount owed to the investors. The required excess receivables balance
represents this specified amount. Any cash flows generated by the required
excess receivables are used, if needed, to make payments to the investors.
Key Assumptions Used in Measuring Retained Interests and Sensitivity Analysis.
The following table shows the key economic assumptions used in measuring the
fair value of the retained interests at May 31, 2003, and a sensitivity analysis
showing the hypothetical effect on the interest-only strip receivables if there
were unfavorable variations from the assumptions used. Key economic assumptions
at May 31, 2003, 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 interests is calculated without changing any other assumption; in
actual circumstances, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities.
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(Dollar amounts in millions) Used Adverse Change Adverse Change
- --------------------------------------------------------------------------------------------
Prepayment rate................. 1.45%-1.55% $6.0 $11.7
Cumulative default rate......... 1.85%-2.40% $3.7 $ 7.4
Annual discount rate............ 12.0% $1.8 $ 3.6
Prepayment rate. The company uses the Absolute Prepayment Model or "ABS" to
- ----------------
estimate prepayments. This model assumes a rate of prepayment each month
relative to the original number of receivables in a pool of receivables. ABS
further assumes that all the receivables are the same size and amortize at the
same rate and that each receivable in each month of its life will either be paid
as scheduled or prepaid in full. For example, in a pool of receivables
originally containing 10,000 receivables, a 1% ABS rate means that 100
receivables prepay each month.
Cumulative default rate. Cumulative default rate or "static pool" net losses are
- ------------------------
calculated by dividing the total projected future credit losses of a pool of
receivables by the original pool balance.
Continuing Involvement with Securitized Receivables. The company continues
to manage the automobile loan receivables that it securitizes. The company
receives servicing fees of approximately 1% of the outstanding principal
balance of the securitized receivables. The servicing fees specified in the
securitization agreements adequately compensate the company for servicing
the securitized receivables. Accordingly, no servicing asset or liability
has been recorded. The company is at risk for the retained interests in the
securitized receivables. If the securitized receivables do not perform as
originally projected, the value of the retained interests would be impacted
resulting in an adjustment to earnings in the period in which it occurs.
The assumptions used to value the retained interests, as well as a
sensitivity analysis, are detailed in the "Key Assumptions Used in
Measuring Retained Interests and Sensitivity Analysis" section of this
footnote. Supplemental information about the managed receivables is shown
in the following tables:
Page 11 of 30
As of May 31 As of February 28
(Amounts in millions) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------
Loans securitized................................ $ 1,960.3 $ 1,569.7 $ 1,859.1 $ 1,489.4
Loans held for sale or investment................ 32.6 20.5 19.6 13.9
------------------------------------------------------------
Ending managed receivables....................... $ 1,992.9 $ 1,590.2 $ 1,878.7 $ 1,503.3
============================================================
Accounts 31+ days past due....................... $ 28.7 $ 21.2 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables 1.44% 1.33% 1.47% 1.48%
Three Months Ended May 31
(Amounts in millions) 2003 2002
--------------------------------------------------------------------------------------------------------
Average managed receivables........................................... $1,942.5 $1,559.2
Credit losses on managed receivables.................................. 4.2 3.3
Annualized losses as a percentage of
average managed receivables...................................... 0.86% 0.85%
Selected Cash Flows from Securitized Receivables. The table below summarizes
certain cash flows received from and paid to the automobile loan
securitizations.
Three Months Ended May 31
(Amounts in millions) 2003 2002
-------------------------------------------------------------------------------------------------------------
o Proceeds from new securitizations...................................... $ 296.0 $ 221.0
o Proceeds from collections reinvested in
revolving period securitizations................................... $ 152.2 $ 134.5
o Servicing fees received................................................ $ 4.9 $ 3.9
o Other cash flows received from retained interests:
Interest-only strip receivables.................................... $ 16.8 $ 17.0
Cash reserve releases, net......................................... $ 2.4 $ 3.0
Proceeds from new securitizations. Proceeds from new securitizations represent
- ----------------------------------
receivables newly securitized through the warehouse facility during the period.
Receivables initially securitized through the warehouse facility that are
periodically sold in publicly underwritten offers are not considered new
securitizations for this table.
Proceeds from collections. Proceeds from collections reinvested in revolving
- ---------------------------
period securitizations represent principal amounts collected on receivables
securitized through the warehouse facility which are used to fund new
originations.
Servicing fees. Servicing fees received represent cash fees paid to the company
- ---------------
to service the securitized receivables.
Other cash flows received from retained interests. Other cash flows received
- --------------------------------------------------
from retained interests represent cash received by the company from securitized
receivables other than servicing fees. It includes cash collected on
interest-only strip receivables and amounts released to the company from
restricted cash accounts.
Financial Covenants and Performance Triggers. Certain securitization agreements
- ---------------------------------------------
include various financial covenants and performance tests, while other
securitization agreements such as the company's most recent public
securitization, which did not involve third-party insurance, do not include
financial covenants or performance triggers. For those agreements with financial
covenants and performance tests, the company must meet financial covenants
relating to minimum tangible net worth, maximum total liabilities to tangible
net worth ratio, minimum tangible net worth to managed assets ratio, minimum
current ratio, minimum cash balance or borrowing capacity and minimum fixed
charge coverage ratio. The securitized receivables must meet performance tests
relating to portfolio yield, default rates and delinquency rates.
Page 12 of 30
If these financial covenants and/or performance tests are not met, in addition
to other consequences, the company may be unable to continue to securitize
receivables through the warehouse facility or be terminated as servicer under
the public securitizations. At May 31, 2003, the company was in compliance with
these financial covenants and the securitized receivables were in compliance
with these performance tests.
8. Financial Derivatives
---------------------
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 in the warehouse facility. During the first quarter of
fiscal 2004, the company entered into three 40-month amortizing interest
rate swaps with initial notional amounts totaling approximately $264.5
million. The amortized notional amount of the interest rate swaps was
reduced in the first quarter of fiscal 2004 in conjunction with the
replacement of variable-rate securities in the warehouse facility with a
$507.0 million fixed-rate public securitization that was completed in May
2003. The current amortized notional amount of all outstanding swaps
related to the automobile loan receivable securitizations was approximately
$262.6 million at May 31, 2003, and $473.2 million at February 28, 2003.
The fair value of swaps included in accounts payable totaled a net
liability of $1.4 million at May 31, 2003, and $2.6 million at February 28,
2003.
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 as 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.
9. Recent Accounting Pronouncements
--------------------------------
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51." FIN No. 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated financial support
from other parties. FIN No. 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of
FIN No. 46 must be applied for the first interim or annual period beginning
after June 15, 2003. The company is currently monitoring developments with
regard to the proposed FASB Staff Position issued on the implementation of
FIN No. 46 which is currently subject to public comment. Therefore, at this
time, the company cannot determine whether the application of FIN No. 46
will affect its financial position, results of operations or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement is effective for contracts entered into
or modified after June 30, 2003, and for hedging relationships designated
after June 30, 2003. The company does not expect the application of the
provisions of SFAS No. 149 to have a material impact on its financial
position, results of operations or cash flows.
Page 13 of 30
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at
the beginning of the first interim period beginning after June 15, 2003.
The company does not expect the application of the provisions of SFAS No.
150 to have a material impact on its financial position, results of
operations or cash flows.
10. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the current
year's presentation. Prior to the third fiscal quarter ended November 30,
2002, income generated by CAF and third-party finance fee income were
recorded as reductions to selling, general and administrative expenses. The
company currently presents CAF income as a separate line item in the
consolidated statements of earnings, and third-party finance fees are
reported as a component of other sales and revenues. For the three months
ended May 31, 2002, CAF income was $19.8 million and third-party finance
fee income was $4.2 million. These reclassifications increased last year's
first quarter selling, general and administrative expenses by $24.0 million
and other sales and revenues by $4.2 million. An additional
reclassification increased selling, general and administrative expenses by
$0.4 million. The reclassifications had no impact on the company's net
earnings.
Page 14 of 30
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
OF FINANCIAL CONDITION AND RESULTS OF OPERATION
-----------------------------------------------
In this discussion, "we," "our," "CarMax," "CarMax, Inc." and "the company"
refer to CarMax, Inc. and its wholly owned subsidiaries, unless the context
requires otherwise. Amounts and percents in the tables may not total due to
rounding.
CarMax was formerly a wholly owned subsidiary of Circuit City Stores, Inc.
("Circuit City Stores"). On September 10, 2002, the Circuit City Stores
shareholders, which included Circuit City Stores, Inc.-Circuit City Group Common
Stock shareholders and Circuit City Stores, Inc.-CarMax Group Common Stock
shareholders, approved the separation of the CarMax business from Circuit City
Stores, and the Circuit City Stores board of directors authorized the redemption
of the CarMax Group Common Stock and the distribution of CarMax, Inc. common
stock to effect the separation. The separation was effective October 1, 2002.
Each outstanding share of CarMax Group Common Stock was redeemed in exchange for
one share of CarMax, Inc. common stock. In addition, each holder of Circuit City
Group Common Stock received, as a tax-free distribution, a 0.313879 share of
CarMax, Inc. common stock for each share of Circuit City Group Common Stock
owned as of September 16, 2002, the record date for the distribution. As a
result of the separation, all of the businesses, assets and liabilities of the
CarMax Group are now held in CarMax, Inc., an independent, separately traded
public company.
CRITICAL ACCOUNTING POLICIES
For a discussion of our critical accounting policies see "Critical Accounting
Policies" in Management's Discussion and Analysis included in the CarMax, Inc.
2003 Annual Report to Shareholders, filed as Exhibit 13.1 to the company's
annual report on Form 10-K for the fiscal year ended February 28, 2003. These
policies relate to the calculation of the fair value of retained interests in
securitization transactions, revenue recognition, defined benefit retirement
plans and insurance liabilities.
RESULTS OF OPERATIONS
Reclassifications. Certain prior year amounts have been reclassified to conform
to the current year's presentation. Prior to the third fiscal quarter ended
November 30, 2002, income generated by CAF and third-party finance fee income
were recorded as reductions to selling, general and administrative expenses. The
company currently presents CAF income as a separate line item in the
consolidated statements of earnings, and third-party finance fees are reported
as a component of other sales and revenues. For the three months ended May 31,
2002, CAF income was $19.8 million and third-party finance fee income was $4.2
million. These reclassifications increased last year's first quarter selling,
general and administrative expenses by $24.0 million and other sales and
revenues by $4.2 million. An additional reclassification increased selling,
general and administrative expenses by $0.4 million. The reclassifications had
no impact on the company's net earnings.
Seasonality. CarMax's operations, in common with other retailers in general, are
subject to seasonal influences. Historically, CarMax 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.
Page 15 of 30
Net Sales and Operating Revenue
- -------------------------------
Total sales for the first quarter of fiscal 2004 increased 17% to $1.17 billion
from $1.01 billion in last year's first quarter.
Three Months Ended May 31
(Amounts in millions) 2003 % 2002 %
- ------------------------------------------------------------------------------------------------------------
Used vehicle sales........................................ $ 890.1 $ 737.8
New vehicle sales......................................... 136.4 132.3
-----------------------------------------------
Total retail vehicle sales................................ 1,026.5 87.5 870.1 86.5
Wholesale vehicle sales................................... 100.7 8.6 92.5 9.2
Other sales and revenues:
Extended warranty revenue.............................. 19.9 16.7
Service department sales............................... 16.4 15.5
Appraisal purchase processing fees..................... 4.4 6.8
Third-party finance fees.............................. 4.8 4.2
-----------------------------------------------
Total other sales and revenues............................ 45.6 3.9 43.2 4.3
-----------------------------------------------
Total net sales and operating revenues.................... $ 1,172.8 100.0 $ 1,005.8 100.0
===============================================
Total Retail Vehicle Sales. Comparable store used unit sales growth is a primary
- --------------------------
driver of CarMax's profitability. For the first quarter ended May 31, 2003, the
overall increase in retail sales is attributed to the growth in comparable store
used unit sales and strong performance by the seven CarMax stores opened since
April 2002, which are not included in quarterly comparable store sales. For the
first quarter, we achieved comparable store used unit sales growth of 10%.
A CarMax store is included in comparable store retail sales after the store has
been open for a full year (in the store's fourteenth full month of operation).
Comparable store retail vehicle unit and dollar sales changes for the first
quarter of fiscal 2004 and 2003 were as follows:
Three Months Ended May 31
2003 2002
---------------------------------
Vehicle units:
Used vehicles............ 10% 12 %
New vehicles............. 3% (4)%
Total....................... 9% 10 %
Vehicle dollars:
Used vehicles............ 9% 14 %
New vehicles............. 3% (4)%
Total....................... 8% 11 %
Wholesale Vehicle Sales. Part of CarMax's operating strategy is to build
- ------------------------
customer confidence and satisfaction by offering high-quality vehicles;
therefore, fewer than half of the vehicles acquired through the appraisal
process meet CarMax standards for reconditioning and subsequent retail sale.
Those vehicles that do not meet CarMax's standards are sold at its own on-site
wholesale auctions. The increase in wholesale vehicle sales is primarily the
result of adding seven used superstores to the store base since April 2002, as
well as increased customer response to CarMax's vehicle appraisal offer.
Other Sales and Revenues. Other sales and revenues include extended warranty
- -------------------------
revenue, service department sales, appraisal purchase processing fees collected
from customers for the purchase of their vehicles and third-party finance fees.
Page 16 of 30
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 represents
commissions from the unrelated third parties. The increase in warranty revenue
is a result of the strong sales growth for used cars, which achieve a higher
extended warranty penetration rate than new cars.
Appraisal purchase processing fees collected from customers were designed to
cover some of the costs of our appraisal and wholesale operations. During the
first quarter of fiscal 2004, CarMax began testing an alternative method to
recover additional costs related to the appraisal and wholesale operations. In
these tests, instead of charging the customer an appraisal purchase processing
fee, the company adjusts the amount of its purchase offer for the customer's
vehicle to capture the total costs of the appraisal and wholesale operations.
The first quarter tests resulted in a decrease in appraisal purchase processing
fees versus last year; however, this decrease was offset by the increase in
overall wholesale gross profit margin.
Supplemental information related to vehicle sales follows:
Retail Unit Sales
-----------------
Three Months Ended May 31
2003 2002
----------------------------------
Used vehicles......................... 58,045 47,310
New vehicles.......................... 5,883 5,736
----------------------------------
Total................................. 63,928 53,046
==================================
Average Retail Selling Prices
-----------------------------
Three Months Ended May 31
2003 2002
---------------------------------
Used vehicles......................... $15,266 $15,500
New vehicles.......................... $23,063 $23,032
Total vehicles........................ $15,983 $16,314
Percent Retail Vehicle Sales
----------------------------
Three Months Ended May 31
2003 2002
---------------------------------
Vehicle units:
Used vehicles...................... 91% 89%
New vehicles....................... 9 11
---------------------------------
Total................................. 100% 100%
=================================
Vehicle dollars:
Used vehicles...................... 87% 85%
New vehicles....................... 13 15
---------------------------------
Total................................. 100% 100%
=================================
Page 17 of 30
Retail Stores. In the first quarter of fiscal 2004, CarMax opened standard
- ---------------
superstores in Henderson (Las Vegas market), Nev. and Merriam
(Kansas City market), Kan. In June 2003, CarMax added a standard superstore in
the Birmingham, Ala. market and plans to add a satellite superstore in the
Orlando, Fla. market in the second quarter of fiscal 2004.
The following table provides detail on the CarMax retail stores:
Estimate
Store Mix Feb. 28, 2004 May 31, 2003 Feb . 28, 2003 May 31, 2002
--------------------------------------------------------------------------------------------------------
Mega superstores(1)...................... 13 13 13 13
Standard superstores(2).................. 25 21 19 18
Prototype satellite stores(3)............ 11 8 8 5
Co-located new car stores................ 2 2 2 2
Stand-alone new car stores............... 0 2 2 2
--------------------------------------------------------------
Total.................................... 51 46 44 40
==============================================================
(1) 70,000 to 95,000 square feet on 20 to 35 acres
(2) 40,000 to 60,000 square feet on 10 to 25 acres
(3) 10,000 to 20,000 square feet on 4 to 7 acres
Gross Profit Margin
- -------------------
The total gross profit margin was 12.6% of sales in the first quarter of fiscal
2004 and 12.1% for the first quarter of fiscal 2003.
Three Months Ended May 31
2003 2002
%(1) $ per unit %(1) $ per unit
--------------------------------------------
Used vehicle gross profit margin................ 11.1 1,699 10.9 1,703
New vehicle gross profit margin................. 3.7 861 4.0 914
---------------------------------------------
Total retail vehicle gross profit margin........ 10.1 1,622 9.9 1,618
Wholesale vehicle gross profit margin........... 9.5 332 6.7 239
Other gross profit margin....................... 75.8 NM(2) 69.8 NM(2)
---------------------------------------------
Total gross profit margin....................... 12.6 NM(2) 12.1 NM(2)
=============================================
(1) Gross profit margin percentages are calculated as a percentage of their
respective sales or revenue
(2) Not meaningful
The new vehicle gross profit margin decline reflects an increased competitive
environment in new cars in the first quarter compared with the same period in
the prior year, requiring more aggressive pricing in order to drive sales unit
volume.
The majority of the increase in the wholesale vehicle gross profit margin
resulted from the tests of alternative methods to recover the costs of the
wholesale operations, the impact of which was an increase in wholesale vehicle
gross margins and a decrease in appraisal purchase processing fees in the first
quarter of fiscal 2004.
The increase in other gross profit margin was primarily due to the increases in
extended warranty sales and third-party finance fees as a percentage of other
sales and revenues, partially offset by the decrease in the appraisal purchase
processing fees.
CarMax Auto Finance Income
- --------------------------
CarMax Auto Finance is the company's finance operation. CAF's lending business
is limited to providing prime auto loans for CarMax's used and new car sales.
Page 18 of 30
Because the purchase of an automobile traditionally is reliant on the consumer's
ability to obtain on-the-spot financing, it is important to our business that
such financing be available to credit-worthy customers. While financing can also
be obtained from third-party sources, we are concerned that total reliance on
third parties can create an unacceptable volatility and business risk.
Furthermore, we believe that our processes and systems, the transparency of our
pricing and vehicle quality provide a unique and ideal environment in which to
procure high-quality auto loan receivables, both for CAF and for third-party
lenders. CAF provides CarMax with the opportunity to capture additional profits
and cash flows from auto loan receivables while managing the company's reliance
on third-party finance sources.
CAF income does not include any allocation of indirect costs or income. We
present this information on a direct basis to avoid making arbitrary decisions
regarding the indirect benefit or costs that could be attributed to this
operation. Examples of indirect costs not included are retail store expenses,
retail financing commissions and corporate expenses such as human resources,
administrative services, marketing, information systems, accounting, legal,
treasury and executive payroll.
For the first quarter of fiscal 2004 and 2003, CarMax Auto Finance income was as
follows:
Three Months Ended May 31
(Amounts in millions) 2003 % 2002 %
- --------------------------------------------------------------------------------------------
Gains on sales of loans(1)...................... $ 19.7 5.5 $ 15.6 5.5
------------------------------------------
Other income (2):
Servicing fee income....................... 5.1 1.1 4.1 1.1
Interest income............................ 5.1 1.1 3.6 0.9
------------------------------------------
Total other income.............................. 10.2 2.1 7.7 2.0
------------------------------------------
Direct expenses (2)
CAF payroll and fringe benefit expense..... 1.9 0.4 1.7 0.4
Other direct CAF expenses.................. 2.1 0.4 1.8 0.5
------------------------------------------
Total direct expenses........................... 4.1 0.8 3.5 0.9
------------------------------------------
CarMax Auto Finance income (3).................. $ 25.7 2.2 $ 19.8 2.0
==========================================
Loans sold...................................... $ 358.0 $ 283.1
Average managed receivables..................... $ 1,942.5 $1,559.2
Net sales and operating revenues................ $ 1,172.8 $1,005.8
Ending managed receivable balance............... $ 1,992.9 $1,590.2
Percent columns indicate:
(1) Percent of loans sold
(2) Annualized percent of averaged managed receivables
(3) Percent of net sales and operating revenues
CAF originates automobile loans to CarMax customers at competitive market rates
of interest. The majority of the profit contribution from CAF is generated by
the spread between the interest rate charged to the customer and the cost of
funds. Substantially all of the loans originated by CAF each month are sold in
securitization transactions as described in Note 7 to the company's consolidated
financial statements. A gain results from recording a receivable equal to the
present value of the expected residual cash flows generated by the securitized
receivables. The cash flows are calculated taking into account expected
prepayment and default rates.
CarMax Auto Finance income increased 30% in the first quarter of fiscal 2004 to
$25.7 million from $19.8 million for the same period last year. Gains on sale of
loans increased $4.1 million as a result of increased used vehicle sales. The
increase in other income and total direct expenses was proportionate to the
increase in the managed receivables over the same period last year.
Page 19 of 30
The company is at risk for the performance of the securitized receivables
managed to the extent that it maintains a retained interest in the receivables.
Supplemental information on our portfolio of managed receivables is shown in the
following tables:
As of May 31
As of February 28
(Amounts in millions) 2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------
Loans securitized.............................. $ 1,960.3 $ 1,569.7 $ 1,859.1 $ 1,489.4
Loans held for sale or investment.............. 32.6 20.5 19.6 13.9
-------------------------------------------------------------
Ending managed receivables..................... $ 1,992.9 $ 1,590.2 $ 1,878.7 $ 1,503.3
=============================================================
Accounts 31+ days past due..................... $ 28.7 $ 21.2 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables................ 1.44% 1.33% 1.47% 1.48%
Three Months Ended May 31
(Amounts in millions) 2003 2002
------------------------------------------------------------------------------------------------------------
Average managed receivables.................................... $1,942.5 $1,559.2
Credit losses on managed receivables........................... $ 4.2 $ 3.3
Annualized losses as a percentage of
average managed receivables............................... 0.86% 0.85%
If the managed receivables do not perform in accordance with the assumptions
used in determining the fair value of the gain receivable, earnings could be
impacted. Despite the current weak economic environment, the managed receivables
continue to perform in line with our expectations. Detail concerning the
assumptions used to value the retained interests and the valuation's sensitivity
to adverse changes in the performance of the managed receivables are included in
Note 7 to the company's consolidated financial statements.
Selling, General and Administrative Expenses
- --------------------------------------------
The selling, general and administrative expense ratio was 9.9% of sales in the
first quarter of fiscal 2004 and 9.3% of sales in the first quarter of fiscal
2003. The increase in the expense ratio for the first quarter of fiscal 2004
versus the first quarter of last fiscal year reflects the expected higher-level
operating expenses associated with being a stand-alone company following our
October 1, 2002, separation from Circuit City Stores. The incremental costs
related to being a stand-alone company were approximately $5.5 million in the
first quarter of fiscal 2004. Also as anticipated, preopening expenses increased
because we opened two stores in the first quarter of this year compared with
only one store opened in last year's first quarter.
Interest Expense
- ----------------
Interest expense increased to $0.8 million for the first quarter of fiscal 2004
from $0.7 million in the same period last year.
Income Taxes
- ------------
The effective income tax rate decreased to 38.5% for the first quarter of fiscal
2004 from 39.5% for the first quarter of fiscal 2003. In the previous fiscal
year, the effective tax rate was higher because the separation costs were not
deductible.
Net Earnings
- ------------
First quarter fiscal 2004 net earnings increased 21% to $35.3 million from $29.2
million in the first quarter of fiscal 2003. The increase in net earnings is a
result of strong sales growth and the absence of expenses related to the
separation from Circuit City Stores which was completed last fiscal year, offset
by incremental costs of being a stand-alone company.
Page 20 of 30
Operations Outlook
- ------------------
CarMax continues to demonstrate 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. In addition to the two
standard-sized superstores opened in the first quarter and the standard-sized
superstore opened in Birmingham, Ala. in June 2003, we plan to open
approximately two standard-sized used car superstores and three prototype
satellite superstores in fiscal 2004. In addition, in Los Angeles we intend to
integrate our two remaining stand-alone franchises with a new used car
superstore during the second half of fiscal 2004. We may also open a tenth store
late in the fourth quarter. In April of fiscal 2004, we sold the Jeep franchise
in Kenosha, Wis. In July of fiscal 2004, we returned the Mitsubishi new car
franchise operating in Nashville, Tenn. to the manufacturer. We still plan to
sell or return the remaining four Mitsubishi new car franchises during fiscal
2004. The sale of the Mitsubishi franchises, which are integrated with used car
superstores, will create more space for used car sales expansion, which is more
profitable for us.
Comparable store used unit sales growth is a primary driver of CarMax's
profitability. We anticipate used vehicle unit comparable growth in the range of
6% to 8% for the second quarter and net earnings per share for the second
quarter in the range of 33 cents to 35 cents. We reaffirm our belief that our
used unit comparable sales growth will be in the range of 5% to 9% in fiscal
2004 and net earnings in the range of $105 million to $116 million. This
forecast assumes the continuation of the reduced approval rates from our
nonprime loan providers experienced in the fourth quarter of fiscal 2003. The
expense leverage that we would normally expect from the comparable store used
unit growth is estimated to be more than offset by the full year of incremental
costs associated with being a stand-alone company and some additional costs
related to our geographic growth. We estimate the ongoing, annual, full-year
effect of being a stand-alone company to be approximately $20 to $22 million. In
fiscal 2003, we incurred approximately $9 million of these incremental expenses
following the October 1, 2002, separation. We expect the majority of the
incremental $11 million to $13 million to be incurred in fiscal 2004 will occur
during the first seven months fiscal 2004.
We also anticipate that our cost of funds through the second quarter of fiscal
2004 will remain roughly at first quarter levels which will again benefit CarMax
Auto Finance. In the event that interest rates remain low, we would anticipate a
more moderate reduction in yield spreads in order to maintain our competitive
consumer offer. As the spread between the cost of funds and the retail interest
rate paid by consumers ultimately returns to more normal levels, CAF's
contribution as a percent of sales is expected to decrease.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." FIN No. 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN No. 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must
be applied for the first interim or annual period beginning after June 15, 2003.
The company is currently analyzing the existing guidance and reviewing
developments with regard to the proposed FASB Staff Position issued on the
implementation of FIN No. 46 which is currently subject to public comment.
Therefore, at this time, the company cannot determine whether the application of
FIN No. 46 will affect its financial position, results of operations or cash
flows.
Page 21 of 30
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." This statement amends and clarifies financial reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The company does not expect the
application of the provisions of SFAS No. 149 to have a material impact on its
financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The company does not expect the
application of the provisions of SFAS No. 150 to have a material impact on its
financial position, results of operations or cash flows.
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
Operating Activities. For the first three months of fiscal 2004, CarMax
- ---------------------
generated cash from operating activities of $72.6 million. In the same period
last year, CarMax generated cash from operating activities of $9.1 million. The
fiscal 2004 improvement primarily resulted from an increase in net earnings, an
increase in accounts payable and accrued expenses associated with the separation
from Circuit City Stores, and a decrease in inventory, partially offset by an
increase in receivables. The increase in receivables was due to increased sales
and the quarter end falling over a weekend. In previous years, certain
liabilities such as the workers' compensation liability were recorded through
the debt from our former parent and therefore were reflected as a financing
activity. The decrease in inventory resulted from the higher mix of used to new
vehicles on our lots. New car manufacturers generally require companies to hold
approximately sixty days worth of inventory.
Investing Activities. Net cash used in investing activities was $34.9 million in
- ---------------------
the three months ended May 31, 2003. In the first three months of last fiscal
year, CarMax used $28.5 million in investing activities. The increase in capital
expenditures resulted from continued geographic growth, with six superstores
opening since May 2002, the planned opening of two superstores in the second
quarter of fiscal 2004 and the planned opening of five or six additional stores
in the second half of fiscal 2004.
Financing Activities. Net cash used in financing activities was $40.3 million in
- ---------------------
the first three months of fiscal 2004, compared with net cash generated of $77.5
million in the first three months of last fiscal year. On May 17, 2002, CarMax
entered into a $200 million credit agreement with DaimlerChrysler Services North
America, LLC and Toyota Financial Services that is secured by vehicle inventory.
During the fourth quarter of fiscal year 2003, the credit agreement was
increased from $200 million to $300 million. The credit agreement includes a
$200 million revolving loan commitment and a $100 million term loan. Principal
is due in full at maturity with interest payable monthly at a LIBOR-based rate.
The agreement is scheduled to terminate on May 17, 2005. The termination date of
the agreement will be automatically extended one year each May 17 unless CarMax
or either lender elects, prior to the next extension date, not to extend the
agreement. As of May 31, 2003, the amount outstanding under this credit
agreement was $114.5 million.
At May 31, 2003, the aggregate principal amount of securitized automobile loan
receivables totaled $1.96 billion. During the first quarter of fiscal 2004, the
company completed another public automobile loan receivables securitization.
Unlike the company's previous public securitizations, which are supported by
third-party insurance policies, this most recent transaction was the company's
first using a senior-subordinated structure. This type of structure is not
dependent on third-party insurance or other external credit support.
Additionally, the current market conditions made a senior-subordinated
arrangement more appealing to the company than another insured transaction. The
total value of automobile loan receivables securitized through this public
offering was $507.0 million. At May 31, 2003, the unused capacity of the
warehouse facility was $487.0 million. In June 2003, the warehouse facility was
renewed and now matures in June 2004. Also, the facility limit was increased to
$825.0 million from $750.0 million. 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.
Page 22 of 30
CarMax expects that proceeds from the credit agreement secured by vehicle
inventory, additional credit facilities, if needed, sale-leaseback transactions
and cash generated by operations will be sufficient to fund capital expenditures
and working capital of the CarMax business for the foreseeable future.
FORWARD-LOOKING STATEMENTS
--------------------------
This report on Form 10-Q contains "forward-looking statements" within the
meaning of Section 21E of the Securities and Exchange Act of 1934 concerning our
current expectations, assumptions, estimates and projections about the future.
These forward-looking statements are subject to risks and uncertainties that
could cause our actual results to differ materially from those indicated in the
forward-looking statements. For a discussion of risks and uncertainties that may
affect CarMax's business, see Management's Discussion and Analysis "Cautionary
Information about Forward-Looking Statements" in the company's 2003 annual
report to shareholders, filed as Exhibit 13.1 to the company's annual report on
Form 10-K for the fiscal year ended February 28, 2003.
Page 23 of 30
ITEM 3.
QUANTITATIVE AND QUALITATIVE
----------------------------
DISCLOSURES ABOUT MARKET RISK
-----------------------------
MARKET RISK
Automobile Installment Loan Receivables. At May 31, 2003, and February 28, 2003,
- ---------------------------------------
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. Generally,
changes in interest rates associated with underlying swaps will not have a
material impact on earnings. However, changes in interest rates associated with
underlying swaps may have a material impact on cash and cash flows.
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 8 to the
company's consolidated financial statements for a description of these items.
The total principal amount of ending managed receivables securitized or held for
investment or sale as of May 31, 2003, and February 28, 2003, was as follows:
(Amounts in millions) May 31 February 28
------------------------------------------------------------------------------
Fixed-rate securitizations............. $ 1,697.3 $ 1,385.1
Floating-rate securitizations
synthetically altered to fixed...... 262.6 473.2
Floating-rate securitizations.......... 0.4 0.8
Held for investment (1)................ 12.2 16.0
Held for sale (2)...................... 20.4 3.6
-------------------------------------
Total.................................. $ 1,992.9 $ 1,878.7
=====================================
(1) The majority is held by a bankruptcy-remote special purpose entity.
(2) Held by a bankruptcy-remote special purpose entity.
Interest Rate Exposure. CarMax also has interest rate risk from changing
- -----------------------
interest rates related to our outstanding debt. Substantially all of the debt is
floating rate debt based on LIBOR. A 100 basis point increase in market interest
rates would not have had a material effect on our first quarter results of
operations or cash flows.
Page 24 of 30
ITEM 4.
Controls and Procedures
-----------------------
The company maintains disclosure controls and procedures ("disclosure controls")
that are designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the U.S. Securities and Exchange
Commission's ("SEC") rules and forms. Disclosure controls are also designed to
ensure that such information is accumulated and communicated to our management,
including the chief executive officer ("CEO") and chief financial officer
("CFO"), as appropriate to allow timely decisions regarding required disclosure.
Within 90 days of the date of filing this 10-Q, the company evaluated the
effectiveness of the design and operation of its disclosure controls. This
evaluation was performed under the supervision and with the participation of
management, including our CEO and CFO. Based upon that evaluation, the CEO and
CFO concluded that the company's disclosure controls are effective. From the
date of the evaluation to the date of filing this 10-Q, there have been no
significant changes in internal controls or in other factors that could
significantly affect internal controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Page 25 of 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
CarMax is subject to various legal proceedings, claims and
liabilities that arise in the ordinary course of its business. In
the opinion of management, the amount of ultimate liability with
respect to these actions will not materially affect the financial
position or results of operations of CarMax.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of the company's shareholders was held
June 24, 2003.
(b) At the annual meeting, the shareholders of the company
elected Jeffrey E. Garten, Beth A. Stewart and William R.
Tiefel as directors for three-year terms; and W. Robert
Grafton and William S. Kellogg as directors for two-year
terms. The elections were approved by the following votes:
Directors For Withheld
-------------------------------------------------------------------------------
Jeffrey E. Garten 94,703,404 911,936
Beth A. Stewart 94,691,195 924,145
William R. Tiefel 94,702,160 913,180
W. Robert Grafton 94,664,587 950,753
William S. Kellogg 94,727,185 888,155
-------------------------------------------------------------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 CarMax, Inc. Amended and Restated Articles of
Incorporation, effective June 6, 2002, filed as
Exhibit 3.1 to CarMax's Current Report on Form
8-K, filed October 3, 2002 (File No. 1-31420), is
incorporated herein by this reference.
3.2 CarMax, Inc. Bylaws, as amended and restated June 24, 2003,
filed herewith
99.1 Certification of the Chief Executive Officer Pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith
99.2 Certification of the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith
Page 26 of 30
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.
CARMAX, INC.
By: /s/ Austin Ligon
-------------------------
Austin Ligon
President and
Chief Executive Officer
By: /s/ Keith D. Browning
-------------------------
Keith D. Browning
Executive Vice President and
Chief Financial Officer
July 14, 2003
Page 27 of 30
I, Austin Ligon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CarMax, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: July 14, 2003
/s/ Austin Ligon
-----------------------
Austin Ligon
President and
Chief Executive Officer
Page 28 of 30
I, Keith D. Browning, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CarMax, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: July 14, 2003
/s/ Keith D. Browning
-----------------------
Keith D. Browning
Executive Vice President and
Chief Financial Officer
Page 29 of 30
EXHIBIT INDEX
-------------
3.2 CarMax, Inc. Bylaws, as amended and restated June 24, 2003
99.1 Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Page 30 of 30