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 August 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 or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4900 COX ROAD, GLEN ALLEN, VIRGINIA 23060
(Address of principal executive offices) (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
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 30, 2003
- ----------------------------- ---------------------------------
Common Stock, par value $0.50 103,631,814
An Index is included on Page 2 and a separate Exhibit Index is included on Page
29.
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
INDEX
-----
Page
No.
----
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Consolidated Financial Statements:
Consolidated Statements of Earnings -
Three Months and Six Months Ended August 31, 2003 and 2002 3
Consolidated Balance Sheets -
August 31, 2003, and February 28, 2003 4
Consolidated Statements of Cash Flows -
Six Months Ended August 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 14
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 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 28
- ----------
EXHIBIT INDEX 29
- -------------
Page 2 of 29
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Earnings (Unaudited)
-----------------------------------------------
(Amounts in thousands except per share data)
Three Months Ended Six Months Ended
August 31 August 31
-------------------------------------- --------------------------------------
2003 %(1) 2002 %(1) 2003 %(1) 2002 %(1)
---- ---- ---- ---- ---- ---- ---- ----
Sales and operating revenues:
Used vehicle sales $ 938,726 75.9 $ 784,826 72.6 $ 1,828,868 75.9 $ 1,522,607 73.0
New vehicle sales 139,600 11.3 151,861 14.1 275,999 11.5 284,204 13.6
Wholesale vehicle sales 112,995 9.1 97,671 9.0 213,728 8.9 190,124 9.1
Other sales and revenues 45,136 3.7 46,324 4.3 90,697 3.8 89,550 4.3
------ --- ------ --- ------ --- ------ ---
Net sales and operating revenues 1,236,457 100.0 1,080,682 100.0 2,409,292 100.0 2,086,485 100.0
Cost of sales 1,073,352 86.8 951,870 88.1 2,098,416 87.1 1,835,531 88.0
--------- ---- ------- ---- --------- ---- --------- ----
Gross profit 163,105 13.2 128,812 11.9 310,876 12.9 250,954 12.0
CarMax Auto Finance income 22,677 1.8 22,110 2.0 48,425 2.0 41,948 2.0
(Notes 5 and 6)
Selling, general and administrative
expenses 121,174 9.8 97,997 9.1 236,727 9.8 191,034 9.2
Interest expense 383 - 721 0.1 1,137 - 1,415 0.1
Interest income 182 - 216 - 304 - 294 -
------- --- ------ --- ------- --- ------- ---
Earnings before income taxes 64,407 5.2 52,420 4.9 121,741 5.1 100,747 4.8
Provision for income taxes 24,797 2.0 20,706 1.9 46,870 1.9 39,795 1.9
------ --- ------ --- ------ --- ------ ---
Net earnings $ 39,610 3.2 $ 31,714 2.9 $ 74,871 3.1 $ 60,952 2.9
=========== === =========== === =========== === =========== ===
Weighted average common
shares (Note 3):
Basic 103,484 102,988 103,320 102,936
======= ======= ======= =======
Diluted 105,864 104,542 105,313 104,647
======= ======= ======= =======
Net earnings per share (Note 3):
Basic $ 0.38 $ 0.31 $ 0.72 $ 0.59
=========== =========== =========== ===========
Diluted $ 0.37 $ 0.30 $ 0.71 $ 0.58
=========== =========== =========== ===========
(1) Percentages are calculated as a percentage of net sales and operating
revenues. Percentages may not total due to rounding.
See accompanying notes to consolidated financial statements.
Page 3 of 29
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Balance Sheets
---------------------------
(Amounts in thousands except share data)
Aug.31,2003 Feb.28,2003
----------- -----------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 45,328 $ 34,615
Accounts receivable, net 71,008 56,449
Automobile loan receivables held for sale (Note 6) 20,402 3,579
Retained interests in securitized receivables (Note 6) 148,042 135,016
Inventory 409,477 466,450
Prepaid expenses and other current assets 11,167 12,636
------- -------
Total current assets 705,424 708,745
Property and equipment, net 236,606 187,158
Deferred income taxes 3,208 -
Other assets 20,398 21,714
------- -------
TOTAL ASSETS $965,636 $917,617
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $115,366 $117,587
Accrued expenses and other current liabilities 59,331 44,682
Accrued income taxes 8,736 -
Deferred income taxes 28,912 29,783
Short-term debt 3,353 56,051
-------- --------
Total current liabilities 215,698 248,103
Long-term debt, excluding current installments 100,000 100,000
Deferred revenue and other liabilities 12,921 10,904
Deferred income taxes - 4,041
------- -------
TOTAL LIABILITIES 328,619 363,048
Stockholders' equity (Note 1):
Common stock, par value $0.50; authorized: 350,000,000
shares; issued and outstanding 103,623,076 shares at
August 31, 2003, and 103,083,047 shares at February 28, 2003 51,812 51,542
Capital in excess of par value 480,052 472,745
Retained earnings 105,153 30,282
------- -------
TOTAL STOCKHOLDERS' EQUITY 637,017 554,569
------- -------
Commitments and contingent liabilities (Note 1) - -
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $965,636 $917,617
======== ========
See accompanying notes to consolidated financial statements.
Page 4 of 29
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Cash Flows (Unaudited)
-------------------------------------------------
(Amounts in thousands)
Six Months Ended August 31
2003 2002
---- ----
Operating Activities:
- ---------------------
Net earnings $ 74,871 $ 60,952
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 8,373 8,424
Amortization of restricted stock awards 65 23
Loss on disposition of property and equipment 15 68
Provision for deferred income taxes (8,120) (86)
Changes in operating assets and liabilities:
Increase in accounts receivable, net (14,559) (16,267)
Increase in automobile loan receivables held
for sale (16,823) (11,922)
Increase in retained interests in securitized
receivables (13,026) (10,438)
Decrease in inventory 56,973 38,238
Decrease (increase) in prepaid expenses and
other current assets 1,469 (1,498)
Decrease (increase) in other assets 1,232 (845)
Increase in accounts payable, accrued
expenses and other current liabilities
and accrued income taxes 25,480 24,613
Increase in deferred revenue and other liabilities 2,017 1,870
-------- --------
Net cash provided by operating activities 117,967 93,132
-------- --------
Investing Activities:
- ---------------------
Purchases of property and equipment (82,662) (40,062)
Proceeds from sales of property and equipment 24,910 6
-------- ---------
Net cash used in investing activities (57,752) (40,056)
-------- ---------
Financing Activities:
- ---------------------
Decrease in short-term debt, net (52,698) (4,634)
Issuance of long-term debt - 100,000
Payments on long-term debt - (77,782)
Equity issuances, net 3,196 744
-------- --------
Net cash (used in) provided by financing activities (49,502) 18,328
-------- --------
Increase in cash and cash equivalents 10,713 71,404
Cash and cash equivalents at beginning of year 34,615 3,286
-------- --------
Cash and cash equivalents at end of period $ 45,328 $ 74,690
======== ========
See accompanying notes to consolidated financial statements.
Page 5 of 29
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Notes to Consolidated Financial Statements
------------------------------------------
(Unaudited)
1. Basis of Presentation
---------------------
Prior to October 1, 2002, CarMax, Inc. ("CarMax" and "the company") was a
wholly owned subsidiary of Circuit City Stores, Inc. ("Circuit City
Stores".) On that date, CarMax was separated from Circuit City Stores
through a transaction in which each share of Circuit City Stores, Inc. --
CarMax Group Common Stock was redeemed in exchange for one share of CarMax,
Inc. common stock. In addition, each holder of Circuit City Stores, Inc. --
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. As a result of the separation, all of the businesses,
assets and liabilities of the CarMax Group are now held in CarMax, Inc.,
which is an independent, separately traded public company. CarMax's assets
and liabilities are accounted for at the historical values carried by
Circuit City Stores prior to the separation. 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 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 original 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.
3. Net Earnings per Share
----------------------
CarMax was a wholly owned subsidiary of Circuit City Stores for the quarter
and six months ended August 31, 2002. Earnings per share for these periods
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.
Page 6 of 29
Reconciliations of the numerator and denominator of the basic and diluted net
earnings per share are presented below:
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in thousands except per share data) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------
Weighted average common shares.................. 103,484 102,988 103,320 102,936
Dilutive potential common shares:
Options...................................... 2,367 1,549 1,983 1,699
Restricted stock............................. 13 5 10 12
--------------------------- ---------------------------
Weighted average common shares
and dilutive potential common shares......... 105,864 104,542 105,313 104,647
=========================== ===========================
Net earnings available to common shareholders... $ 39,610 $ 31,714 $ 74,871 $ 60,952
Basic net earnings per share.................... $ 0.38 $ 0.31 $ 0.72 $ 0.59
Diluted net earnings per share.................. $ 0.37 $ 0.30 $ 0.71 $ 0.58
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. As of August
31, 2003, options to purchase 18,364 shares of common stock at prices
ranging from $35.23 to $43.44 per share were outstanding and not included
in the calculation. As of August 31, 2002, options to purchase 1,056,496
shares at prices ranging from $19.16 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. Under this opinion and related interpretations,
compensation expense is recorded on the date of grant and amortized over
the period of service only if the market value of the underlying stock on
the grant date 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. 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:
Three Months Ended Six Months Ended
August 31 August 31
(Amounts in thousands except per share data) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------
Net earnings, as reported .............................. $ 39,610 $ 31,714 $ 74,871 $ 60,952
Total stock-based compensation expenses
determined under fair value based method
for all awards, net of related tax effects .......... 1,717 1,030 3,255 2,108
---------------------- -----------------------
Pro forma net earnings ................................ $ 37,893 $ 30,684 $ 71,616 $ 58,844
====================== =======================
Earnings per share:
Basic, as reported ................................. $ 0.38 $ 0.31 $ 0.72 $ 0.59
Basic, pro forma ................................... $ 0.37 $ 0.30 $ 0.69 $ 0.57
Diluted, as reported ............................... $ 0.37 $ 0.30 $ 0.71 $ 0.58
Diluted, pro forma ................................. $ 0.36 $ 0.29 $ 0.68 $ 0.56
Page 7 of 29
The pro forma effect on the second quarter and the first six months of
fiscal 2004 may not be representative of the pro forma effects on net
earnings for future periods.
5. 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 6. 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.
CarMax Auto Finance income was as follows:
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------
Gains on sales of loans........................ $18.3 $18.1 $37.9 $33.7
------------------ ------------------
Other income:
Servicing fee income........................ 5.4 4.0 10.5 8.0
Interest income............................. 3.9 3.7 9.1 7.3
------------------ ------------------
Total other income............................. 9.4 7.7 19.5 15.4
------------------ ------------------
Direct expenses:
CAF payroll and fringe benefit expense...... 2.0 1.7 4.0 3.4
Other direct CAF expenses................... 3.0 2.0 5.1 3.7
------------------ ------------------
Total direct expenses.......................... 5.0 3.6 9.0 7.1
------------------ ------------------
CarMax Auto Finance income..................... $22.7 $22.1 $48.4 $41.9
================== ==================
Amounts in the table above 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.
6. 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
Page 8 of 29
pool of automobile loan receivables is sold to a bankruptcy-remote, 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 5.
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
Net loans originated........................... $ 387.8 $ 304.3 $ 756.7 $ 594.1
Loans sold..................................... $ 378.3 $ 299.8 $ 736.3 $ 582.9
Gains on sales of loans........................ $ 18.3 $ 18.1 $ 37.9 $ 33.7
Gains on sales of loans as a
percentage of loans sold................... 4.8% 6.0% 5.1% 5.8%
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 August 31 As of February 28
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
Interest-only strip receivables............................ $ 89.4 $ 84.2 $ 88.3 $ 74.3
Restricted cash............................................ 35.2 35.9 33.3 34.7
Required excess receivables................................ 23.5 11.0 13.4 11.7
-----------------------------------------
Total retained interests in securitized receivables........ $ 148.0 $ 131.1 $ 135.0 $ 120.7
=========================================
Amounts in the table above may not total due to rounding.
The retained interests had a weighted average life of 1.5 years as of
August 31, 2003, and 1.6 years as of February 28, 2003. 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.
Page 9 of 29
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. 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 through the
qualified special purpose entity 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 are less than 2.5% of managed receivables.
Required excess receivables. The warehouse facility and certain public
---------------------------
securitizations require 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 August 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 August 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% $5.6 $10.9
Cumulative default rate.............. 1.85%-2.40% $3.8 $ 7.7
Annual discount rate................. 12.0% $2.1 $ 4.1
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.
Page 10 of 29
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. 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:
As of August 31 As of February 28
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
Loans securitized......................... $2,077.0 $1,664.0 $1,859.1 $1,489.4
Loans held for sale or investment......... 45.2 25.1 19.6 13.9
---------------------------- ---------------------------
Ending managed receivables................ $2,122.2 $1,689.1 $1,878.7 $1,503.3
============================ ========================
Accounts 31+ days past due................ $ 32.0 $ 26.1 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables............. 1.51% 1.55% 1.47% 1.48%
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
Average managed receivables................. $2,068.2 $1,647.2 $2,005.3 $1,603.2
Credit losses on managed receivables........ 5.3 4.1 9.5 7.3
Annualized losses as a percentage
of average managed receivables........... 1.03% 1.00% 0.95% 0.91%
Selected Cash Flows from Securitized Receivables. The table below
summarizes certain cash flows received from and paid to the automobile loan
securitizations:
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------
o Proceeds from new securitizations...................... $336.0 $266.6 $632.0 $487.6
o Proceeds from collections reinvested in
revolving period securitizations................... $127.6 $124.1 $279.8 $258.6
o Servicing fees received................................ $ 5.3 $ 3.9 $ 10.2 $ 7.8
o Other cash flows received from retained interests:
Interest-only strip receivables.................... $ 18.9 $ 17.0 $ 35.7 $ 34.0
Cash reserve releases, net......................... $ 5.9 $ 7.1 $ 8.2 $ 10.1
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 refinanced in public securitizations 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.
Page 11 of 29
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 triggers,
while other securitization agreements, such as a public securitization with
a senior-subordinated structure 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. Certain securitized receivables must meet performance tests
relating to portfolio yield, default rates and delinquency rates. 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 it may be terminated as
servicer under the public securitizations. At August 31, 2003, the company
was in compliance with these financial covenants and the securitized
receivables were in compliance with these performance triggers.
7. 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 second quarter of
fiscal 2004, the company entered into five 40-month amortizing interest
rate swaps with initial notional amounts totaling approximately $307.0
million. The notional amount of all outstanding swaps related to the
automobile loan receivable securitizations was approximately $548.7 million
at August 31, 2003, and $473.2 million at February 28, 2003. At August 31,
2003, the fair value of swaps was a net asset of $3.3 million, which was
included in accounts receivable. At February 28, 2003, the fair value of
swaps was a net liability of $2.6 million, which was 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 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.
8. 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 does not expect the provisions of FIN No.
46 to have a material impact on 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
Page 12 of 29
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement is effective for contracts entered
into, modified 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.
9. 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 August 31, 2002, CAF income was $22.1 million and third-party finance
fee income was $4.6 million. These reclassifications increased last year's
second quarter selling, general and administrative expenses by $26.7
million and other sales and revenues by $4.6 million. For the six months
ended August 31, 2002, CAF income was $41.9 million and third-party finance
fee income was $8.8 million. These reclassifications increased the first
six months of last year's selling, general and administrative expenses by
$50.7 million and other sales and revenues by $8.8 million. The
reclassifications had no impact on the company's net earnings.
Page 13 of 29
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------------------------
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.
Prior to October 1, 2002, CarMax was a wholly owned subsidiary of Circuit City
Stores, Inc. ("Circuit City Stores".) On that date, CarMax was separated from
Circuit City Stores through a transaction in which each share of Circuit City
Stores, Inc. - CarMax Group Common Stock was redeemed in exchange for one share
of CarMax, Inc. common stock. In addition, each holder of Circuit City Stores,
Inc. - 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. As a result of the separation, all of the businesses, assets and
liabilities of the CarMax Group are now held in CarMax, Inc., which is an
independent, separately traded public company.
FORWARD-LOOKING STATEMENTS
The company cautions readers that the statements contained in Management's
Discussion and Analysis of Financial Condition and Results of Operations
regarding the company's future business plans, operations, opportunities or
prospects, including without limitation any statements or factors regarding
expected sales, margins or earnings are forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based upon management's current
knowledge and assumptions about future events and involve risks and
uncertainties that could cause actual results to differ materially from
anticipated results. For more details on factors that could affect expectations,
see the company's Annual Report on Form 10-K for the fiscal year ended February
28, 2003, and its quarterly and current reports as filed with or furnished to
the Securities and Exchange Commission.
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, which is included as Exhibit 13.1 to the
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 CarMax Auto Finance ("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 August 31, 2002, CAF income was $22.1 million and third-party
finance fee income was $4.6 million. These reclassifications increased last
year's second quarter selling, general and administrative expenses by $26.7
million and other sales and revenues by $4.6 million. For the six months ended
August 31, 2002, CAF income was $41.9 million and third-party finance fee income
was $8.8 million. These reclassifications increased the first six months of last
year's selling, general and administrative expenses by $50.7 million and other
sales and revenues by $8.8 million. The reclassifications had no impact on the
company's net earnings.
Page 14 of 29
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.
Net Sales and Operating Revenues
- --------------------------------
Total sales for the second quarter of fiscal 2004 increased 14% to $1.24 billion
from $1.08 billion in last year's second quarter. For the six months ended
August 31, 2003, total sales increased 15% to $2.41 billion from $2.09 billion
in last year's first six months.
Three Months Ended August 31 Six Months Ended August 31
(Amounts in millions) 2003 % 2002 % 2003 % 2002 %
- -------------------------------------------------------------------------------------------------------------------------
Used vehicle sales.................... $ 938.7 $ 784.8 $1,828.9 $1,522.6
New vehicle sales..................... 139.6 151.9 276.0 284.2
-------------------------------------------------------------------------------
Total retail vehicle sales............ 1,078.3 87.2 936.7 86.7 2,104.9 87.4 1,806.8 86.6
-------------------------------------------------------------------------------
Wholesale vehicle sales............... 113.0 9.1 97.7 9.0 213.7 8.9 190.1 9.1
-------------------------------------------------------------------------------
Other sales and revenues:
Extended warranty revenue.......... 21.0 18.1 41.0 34.8
Service department sales........... 17.7 15.9 34.1 31.4
Third-party finance fees........... 5.5 4.6 10.3 8.8
Appraisal purchase processing fees 0.9 7.7 5.3 14.5
-------------------------------------------------------------------------------
Total other sales and revenues........ 45.1 3.7 46.3 4.3 90.7 3.8 89.6 4.3
-------------------------------------------------------------------------------
Total net sales and operating
revenues.............................. $1,236.5 100.0 $1,080.7 100.0 $2,409.3 100.0 $2,086.5 100.0
===============================================================================
Total Retail Vehicle Sales. Comparable store used unit sales growth is a primary
- --------------------------
driver of CarMax's profitability. A CarMax store is included in comparable store
retail sales in the store's fourteenth full month of operation. Comparable store
retail vehicle unit and dollar sales changes for the second quarter and first
six months of fiscal 2004 and 2003 were as follows:
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
---------------------------------------------------
Vehicle units:
Used vehicles........... 6 % 12% 8 % 12%
New vehicles............ (9)% 5% (4)% 1%
Total...................... 4 % 11% 7 % 10%
Vehicle dollars:
Used vehicles........... 7 % 12% 8 % 13%
New vehicles............ (8)% 8% (3)% 2%
Total...................... 5 % 11% 6 % 11%
Comparable store sales growth was driven by continuing improvement in store
execution, with strong sales growth experienced broadly across the company's
store base. Second quarter comparable store sales reflect the adverse impacts of
an estimated 1% to 2% of cannibalization and one fewer Saturday and one
additional Sunday in this year's second quarter compared with last year. The
slightly higher than expected sales cannibalization resulted from the addition
of four satellite stores in existing mid-sized markets in the last year, which
are not yet included in the comparable store base. The company has chosen to add
satellite stores to existing markets, despite some anticipated sales
cannibalization, based on the attractive economics of this store format. The
economics are based upon driving higher market share with a lower cost
structure. Satellite stores share the cost of the purchasing and reconditioning
operations of a nearby hub store, with little or no incremental advertising
expenditures. Consequently, satellite store economics drive attractive returns
on the net incremental sales added to a market. As long as the total market
Page 15 of 29
sales goals are achieved, the economic returns are neutral as to whether there
is more or less cannibalization than originally anticipated.
The company's new car sales performance was generally in line with industry
performance for the brands we sell. The reported new car comparable sales and
units were reduced by both the April 2003 sale of the Kenosha, Wis., Jeep
franchise and the July 2002 sale of the Kenosha Nissan franchise. Because the
company has multiple new car franchises within the Kenosha auto mall, we have
not adjusted our comparable sales base for the impact of disposing of any one
franchise within this location.
Total retail vehicle unit and dollar sales changes for the second quarter and
first six months of fiscal 2004 and 2003 were as follows:
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
-------------------------------------------------
Vehicle units:
Used vehicles............... 18 % 18 % 20 % 18 %
New vehicles................ (10)% (2)% (4)% (5)%
Total.......................... 15 % 15 % 18 % 15 %
Vehicle dollars:
Used vehicles............... 20 % 18 % 20 % 19 %
New vehicles................ (8)% 1 % (3)% (4)%
Total.......................... 15 % 15 % 16 % 15 %
For the second quarter and six months ended August 31, 2003, the overall
increase in retail sales reflects growth in comparable store used unit sales as
well as growth in new stores not yet included in the comparable store base.
Other Sales and Revenues. Other sales and revenues include extended warranty
- ------------------------
revenue, service department sales, third-party finance fees and appraisal
purchase processing fees collected from customers for the purchase of their
vehicles.
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 increases in warranty revenue
for the three and six month periods ended August 31, 2003, are 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 the costs of our appraisal and wholesale operations. During the first
quarter of fiscal 2004, CarMax tested an alternative method for recovering the
costs. Based on the test results, during the second quarter the appraisal
purchase processing fees were discontinued across our entire store base
resulting in a decrease in appraisal purchase processing fees for the three and
six month periods ended August 31, 2003 compared to the same periods last year.
Under the appraisal cost recovery method, instead of charging the customer the
appraisal purchase processing fee, the company adjusts the price of its purchase
offer thereby reducing the acquisition cost of used and wholesale vehicles and
increasing used vehicle and wholesale vehicle gross profit margins. The intent
of changing to this method is to recover all costs, including the expense of
land on which we hold vehicles prior to being sold at the wholesale auctions
while also improving the consumers experience by eliminating a fee.
Page 16 of 29
Supplemental information related to vehicle sales follows:
Retail Unit Sales
-----------------
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
-----------------------------------------------------------------
Used vehicles......................... 60,150 50,877 118,195 98,187
New vehicles.......................... 5,842 6,489 11,725 12,225
-----------------------------------------------------------------
Total................................. 65,992 57,366 129,920 110,412
=================================================================
Average Retail Selling Prices
-----------------------------
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
-----------------------------------------------------------------
Used vehicles......................... $ 15,484 $ 15,378 $ 15,377 $ 15,437
New vehicles.......................... $ 23,723 $ 23,361 $ 23,392 $ 23,206
Weighted average...................... $ 16,214 $ 16,281 $ 16,100 $ 16,297
Retail Vehicle Sales Composition
--------------------------------
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
-----------------------------------------------------------------
Vehicle units:
Used vehicles.................... 91% 89% 91% 89%
New vehicles..................... 9 11 9 11
-----------------------------------------------------------------
Total ................................ 100% 100% 100% 100%
=================================================================
Vehicle dollars:
Used vehicles.................... 87% 84% 87% 84%
New vehicles..................... 13 16 13 16
-----------------------------------------------------------------
Total................................. 100% 100% 100% 100%
=================================================================
Retail Stores. In the second quarter of fiscal 2004, CarMax opened a standard
- -------------
superstore in Hoover, (Birmingham market), Ala., and a satellite superstore in
Sanford, (Orlando market), Fla. During the third quarter, CarMax plans to add a
standard superstore in the Memphis, Tenn., market (middle of the third quarter),
a satellite superstore in the Chicago market (late third quarter) and a standard
superstore in the Los Angeles market (middle of the third quarter) that will
integrate the company's two remaining stand-alone new car franchises.
Page 17 of 29
The following tables provide detail on the CarMax retail stores and new car
franchises:
Estimate
Store Mix Feb. 28, 2004 August 31, 2003 Feb. 28, 2003 August 31, 2002
-----------------------------------------------------------------------------------------------------------------
Mega superstores(1)................ 13 13 13 13
Standard superstores(2)............ 25 22 19 18
Satellite stores(3)................ 11 9 8 5
Co-located new car stores.......... 2 2 2 2
Stand-alone new car stores......... 0 2 2 2
---------------------------------------------------------------------------
Total.............................. 51 48 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.
Estimate
Feb. 28, 2004 August 31, 2003 Feb. 28, 2003 August 31, 2002
-----------------------------------------------------------------------------------------------------------------
Integrated/co-located
new car franchises............ 8 13 15 15
Stand-alone new car franchises..... 0 2 2 2
---------------------------------------------------------------------------
Total.............................. 8 15 17 17
===========================================================================
Gross Profit Margin
- -------------------
The total gross profit margin was 13.2% of sales in the second quarter of fiscal
2004 and 11.9% for the second quarter of fiscal 2003. Total gross profit margin
was 12.9% of sales for the six months ended August 31, 2003 and 12.0% for the
six months ended August 31, 2002.
Three Months Six Months
Ended August 31 Ended August 31
2003 2002 2003 2002
%(1) $ per unit(2) %(1) $ per unit(2) %(1) $ per unit(2) %(1) $ per unit(2)
-------------------------------------- --------------------------------------
Used vehicle gross profit margin.......... 11.9 1,860 10.9 1,675 11.5 1,781 10.9 1,688
New vehicle gross profit margin........... 4.0 959 4.2 982 3.9 909 4.1 950
------------------------------------- ------------------------------------
Total retail vehicle gross profit margin.. 10.9 1,780 9.8 1,596 10.5 1,702 9.8 1,607
Wholesale vehicle gross profit margin..... 10.0 334 4.4 153 9.8 333 5.5 194
Other gross profit margin................. 76.0 NM(3) 71.2 NM(3) 75.9 NM(3) 70.5 NM(3)
------------------------------------- ------------------------------------
Total gross profit margin................. 13.2 NM(3) 11.9 NM(3) 12.9 NM(3) 12.0 NM(3)
===================================== ====================================
(1) Gross profit margin percentages are calculated as a percentage of its respective sales or revenue.
(2) Dollars per unit are calculated as gross profit margin dollars divided by its respective unit sales.
(3) Not meaningful.
As compared with the same periods last year, the used vehicle profit margin per
used vehicle sold for the three and six month periods ended August 31, 2003,
increased as a result of the change in the appraisal cost recovery methodology,
consistent sales performance during both the first and second quarters and
better inventory management. We now recover the expense of our appraisal, buying
and wholesale operating processes by factoring those costs into the purchase
offers we make. The acquisition cost of a used vehicle decreased due to the
implementation of the new appraisal cost recovery method.
The wholesale vehicle gross profit margin per wholesale vehicle sold for the
three and six month periods ended August 31, 2003, as compared with the same
periods last year increased, also due to the implementation of our new appraisal
Page 18 of 29
cost recovery method. The acquisition cost of a wholesale vehicle decreased due
to the new appraisal cost recovery method implemented. The expense of the
appraisal, buying and wholesaling processes are recovered by factoring those
costs in the purchase offers we make. Our intent is to recover all costs,
including the expense of the land on which we hold vehicles prior to being sold
at the wholesale auctions. Previously, we had not been fully recovering these
land costs.
The increase in other gross profit margin was primarily due to the increase in
service margins resulting from increased service sales and the benefits of our
new electronic repair order system (ERO). Last year's service sales and costs
were adversely affected as we began the ERO rollout. Other gross profit margin
also benefited from 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.
Because the purchase of an automobile is traditionally 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.
Page 19 of 29
For the second quarter and first six months of fiscal 2004 and 2003, CarMax Auto
Finance income was as follows:
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 % 2002 % 2003 % 2002 %
- -------------------------------------------------------------------------------------------------------------------------
Gains on sales of loans(1)....................... $ 18.3 4.8 $ 18.1 6.0 $ 37.9 5.1 $ 33.7 5.8
--------------------------------- ---------------------------------
Other income:(2)
Servicing fee income......................... 5.4 1.0 4.0 1.0 10.5 1.0 8.0 1.0
Interest income.............................. 3.9 0.8 3.7 0.9 9.1 0.9 7.3 0.9
--------------------------------- ---------------------------------
Total other income............................... 9.4 1.8 7.7 1.9 19.5 1.9 15.4 1.9
--------------------------------- ---------------------------------
Direct expenses:(2)
CAF payroll and fringe benefit expense....... 2.0 0.4 1.7 0.4 4.0 0.4 3.4 0.4
Other direct CAF expenses.................... 3.0 0.6 2.0 0.5 5.1 0.5 3.7 0.5
--------------------------------- ---------------------------------
Total direct expenses............................ 5.0 1.0 3.6 0.9 9.0 0.9 7.1 0.9
--------------------------------- ---------------------------------
CarMax Auto Finance income(3).................... $ 22.7 1.8 $ 22.1 2.0 $ 48.4 2.0 $ 41.9 2.0
================================= =================================
Loans sold....................................... $ 378.3 $ 299.8 $ 736.3 $ 582.9
Average managed receivables...................... $ 2,068.2 $ 1,647.2 $ 2,005.3 $ 1,603.2
Net sales and operating revenues................. $ 1,236.5 $ 1,080.7 $ 2,409.3 $ 2,086.5
Ending managed receivables balance............... $ 2,122.2 $ 1,689.1 $ 2,122.2 $ 1,689.1
Percent columns indicate:
(1) Percent of loans sold
(2) Annualized percent of average 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 6 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 3% in the second quarter of fiscal 2004 to
$22.7 million from $22.1 million for the same period last year. Gains on sales
of loans increased $0.2 million. The increase in loans sold driven by higher
sales was substantially offset by an anticipated compression of spreads due to
rising interest rates. The increase in other income was proportionate to the
increase in the managed receivables. Direct expenses were slightly higher
compared with the prior year as a result of certain start-up costs related to a
shelf registration of asset-backed securities with the Securities and Exchange
Commission for public securitizations.
For the six months ended August 31, 2003, CarMax Auto Finance income increased
15% to $48.4 million from $41.9 million for the same period last year. Gains on
sales of loans increased by $4.2 million with the majority of the increase
occurring in the first quarter of fiscal 2004 when spreads remained at
abnormally high levels. Spread compression in the second quarter resulted in a
decrease in gains as a percent of loans sold. The compression of the spread was
partially offset by an increase in loans sold driven by higher sales. The
increase in other income and direct expenses was proportionate to the increase
in managed receivables.
Page 20 of 29
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 August 31 As of February 28
(Amounts in millions) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------
Loans securitized............................ $ 2,077.0 $ 1,664.0 $ 1,859.1 $ 1,489.4
Loans held for sale or investment............ 45.2 25.1 19.6 13.9
------------------------------------------------------------
Ending managed receivables................... $ 2,122.2 $ 1,689.1 $ 1,878.7 $ 1,503.3
============================================================
Accounts 31+ days past due................... $ 32.0 $ 26.1 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables................... 1.51% 1.55% 1.47% 1.48%
Three Months Six Months
Ended August 31 Ended August 31
(Amounts in millions) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------
Average managed receivables.................. $ 2,068.2 $ 1,647.2 $ 2,005.3 $ 1,603.2
Credit losses on managed receivables......... $ 5.3 $ 4.1 $ 9.5 $ 7.3
Annualized losses as a percentage of
average managed receivables.................. 1.03% 1.00% 0.95% 0.91%
If the managed receivables do not perform in accordance with the assumptions
used in determining the fair value of the retained interests, 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 6 to the company's consolidated financial statements.
Selling, General and Administrative Expenses
- --------------------------------------------
The selling, general and administrative expense ratio was 9.8% of net sales and
operating revenues for the three and six month periods ended August 31, 2003,
and 9.1% and 9.2%, respectively, for the same periods last year. The increase in
the expense ratio reflects the expected higher level of 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 $6.5 million in the second quarter and
$12.0 million for the six months ended August 31, 2003. Also as anticipated, our
new stores have experienced higher expense ratios than stores in the comparable
store base due to the fact that these newer stores have not been open long
enough to ramp up to their expected mature sales levels. In addition, preopening
expenses increased because we opened four stores in the first half of this year
compared with one store opened in last year's first half.
Interest Expense
- ----------------
Interest expense decreased to $0.4 million for the second quarter of fiscal 2004
from $0.7 million in the same period last year. For the six months ended August
31, 2003, interest expense was $1.1 million, compared with $1.4 million in the
same period last year.
Income Taxes
- ------------
The effective income tax rate decreased to 38.5% for the second quarter and the
six months ended August 31, 2003, from 39.5% for the same periods last year. In
the previous fiscal year, the effective tax rate was higher because the costs
related to the separation from Circuit City Stores completed last fiscal year
were not deductible.
Page 21 of 29
Net Earnings
- ------------
Second quarter fiscal 2004 net earnings increased 25% to $39.6 million from
$31.7 million in the second quarter of fiscal 2003. For the six months ended
August 31, 2003, net earnings increased 23% to $74.9 million from $61.0 million.
The increase in net earnings is a result of strong sales growth, increased used
vehicle gross margins and the absence of non-tax deductible separation expenses,
which were more than offset by the incremental costs of being a stand-alone
company.
Operations Outlook
- ------------------
CarMax continues to demonstrate that its consumer offer and business model can
produce strong sales and earnings growth. In addition to the three
standard-sized superstores and one satellite superstore opened in the first half
of the year, we plan to open approximately two standard-sized used car
superstores and two satellite superstores in the second half of fiscal 2004. In
addition, in Los Angeles, we intend to integrate our two remaining stand-alone
new car franchises with a new used car superstore in the third quarter. In the
first half of fiscal 2004, we sold our Jeep franchise in Kenosha, Wis., and
returned the Mitsubishi new car franchise operation in Nashville, Tenn., to the
manufacturer. We still plan to sell or return the remaining four Mitsubishi new
car franchises; however, completion of this process may not be until the end of
calendar year 2004. In addition, we plan to sell the Ford franchise in Kenosha,
Wis. The sale or return of these 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 have lowered our third quarter used unit comparable store
sales growth expectations to a range of 0% to 2%. The third quarter net earnings
per share have also been revised downward to a range of 16 cents to 18 cents. We
believe that the reduction in comparable sales expectations for the third
quarter is temporary and is caused by wholesale vehicle prices adjusting more
slowly and later in the fall model-year transition period than we have
historically seen. Consequently, we believe retail used car prices are likely
less competitive with new car closeout models than usual. We believe that these
seasonal transition issues will have been largely resolved by the beginning of
the fourth quarter. As a result of the change in expectations for the third
quarter, we are modifying our full year fiscal 2004 comparable used unit
expectations to a range of 5% to 7% and now believe that our net earnings will
be in a range of $114 million to $120 million. The expense leverage that we
would normally expect from the comparable store used unit growth is estimated to
be more than offset by the combined effects of a full year of incremental costs
associated with being a stand-alone company and the higher selling, general and
administrative expense ratios experienced by our newer stores which have not
been open long enough to ramp up to their expected mature sales levels.
We also anticipate that our cost of funds through the third quarter of fiscal
2004 will remain roughly at the average of the second quarter levels. As long as
the spread between the average of the cost of funds and retail interest rate
paid by consumers stabilizes at levels experienced at the end of the second
quarter, we would expect CAF to contribute at a similar level as a percent of
net sales and operating revenues for the third quarter as the second quarter.
However, if our cost of funds continues to increase, CAF's contribution is
likely to decrease.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting pronouncements applicable to the company,
see Note 8 of the Notes to the Consolidated Financial Statements set forth
elsewhere in this report.
Page 22 of 29
Financial Condition
Liquidity and Capital Resources
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Operating Activities. For the first six months of fiscal 2004, CarMax generated
- --------------------
cash from operating activities of $118.0 million. In the same period last year,
CarMax generated cash from operating activities of $93.1 million. The fiscal
2004 improvement primarily resulted from an increase in net earnings and a
decrease in inventory. The decrease in our inventory balance is attributed to
reducing new vehicle inventory through the disposition of two new car
franchises, improving inventory management at our new vehicle locations and
improving our used vehicle inventory turns.
Investing Activities. Net cash used in investing activities was $57.8 million in
- --------------------
the six months ended August 31, 2003 compared with $40.1 million in the first
six months of last fiscal year. Capital expenditures were $82.7 million and
$40.1 million for the six months ended August 31, 2003 and 2002, respectively.
The increase in capital expenditures is primarily attributed to the increase in
our store base associated with our growth plan. Additionally, some of the
increase is associated with the initial expenditures associated with the
development of our future corporate headquarters site in Richmond, Va. In the
second quarter of fiscal 2004, the company received proceeds of approximately
$25 million associated with the sale-leaseback transaction of three properties.
The transaction was structured as an operating lease with an initial lease term
of 15 years with four five-year renewal options. At August 31, 2003, a total of
five CarMax superstores were owned, pending completion of sale-leaseback
transactions in the third quarter of fiscal 2004.
Financing Activities. Net cash used in financing activities was $49.5 million in
- --------------------
the first six months of fiscal 2004, compared with net cash generated of $18.3
million in the first six months of last fiscal year. The increase in net cash
used is attributed to the paying down of the revolving loan balance with excess
cash.
At August 31, 2003, the aggregate principal amount of securitized automobile
loan receivables totaled $2.08 billion. At August 31, 2003, the unused capacity
of the warehouse facility was $226.0 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.
CarMax maintains a $300 million credit facility secured by vehicle inventory. As
of August 31, 2003, the amount outstanding under this credit facility was $103.4
million, with the remainder fully available to the company. CarMax expects that
proceeds from its credit facility, 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 company for the
foreseeable future.
Page 23 of 29
ITEM 3.
QUANTITATIVE AND QUALITATIVE
----------------------------
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Market Risk
Automobile Installment Loan Receivables. At August 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 7 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 August 31, 2003, and February 28, 2003, was as follows:
(Amounts in millions) August 31 February 28
------------------------------------------------------------------------------------
Fixed-rate securitizations................. $ 1,478.0 $ 1,385.1
Floating-rate securitizations
synthetically altered to fixed.......... 548.7 473.2
Floating-rate securitizations............. 50.3 0.8
Held for investment (1)................... 24.8 16.0
Held for sale (2)......................... 20.4 3.6
-------------------------------------
Total..................................... $ 2,122.2 $ 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 second quarter results of
operations or cash flows.
Page 24 of 29
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.
As of the end of the period covered by this report, 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 were effective as of the
evaluation date. There was no change in the company's internal control over
financial reporting that occurred during the quarter ended August 31, 2003 that
has materially affected, or is reasonably likely to materially affect, the
company's internal control over financial reporting.
Page 25 of 29
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
The company held an annual meeting of shareholders on June 24,
2003. Information on the matters voted upon and the votes cast
with respect to each matter was previously disclosed in the
company's Quarterly Report on Form 10-Q for the quarter ended May
31, 2003.
Item 5. Other Information
Effective July 28, 2003, James F. Clingman was elected to serve as
a director of the company for a term that will expire at the
annual meeting of shareholders to be held in 2004.
Effective September 23, 2003, Thomas G. Stemberg was elected to
serve as a director of the company for a term that will expire at
the annual meeting of shareholders to be held in 2004.
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),
incorporated herein by this reference.
3.2 CarMax, Inc. Bylaws, as amended and restated
September 23, 2003, filed herewith.
10 Amendment No.1 to Transition Services Agreement
("Agreement") dated as of August 21, 2003,
between Circuit City Stores, Inc. and
CarMax, Inc., filed herewith.
31.1 Certification of the Chief Executive Officer
Pursuant to Rule 13a-14(a), filed herewith.
31.2 Certification of the Chief Financial Officer
Pursuant to Rule 13a-14(a), filed herewith.
32.1 Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, filed
herewith.
32.2 Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, filed
herewith.
Page 26 of 29
(b) Reports on Form 8-K
The company did not file any reports on Form 8-K during
the period covered by this report; however, during the
quarter the company furnished a report on Form 8-K
pursuant to Items 7 and 9 (reporting information required
by Item 12) on June 5, 2003, and furnished one report on
Form 8-K pursuant to Item 9 on July 11, 2003.
Page 27 of 29
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant 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
October 15, 2003
Page 28 of 29
EXHIBIT INDEX
-------------
3.2 CarMax, Inc. Bylaws, as amended and restated
September 23, 2003, filed herewith
10 Amendment No. 1 to Transition Services Agreement
("Agreement") dated as of August 21, 2003, between
Circuit City Stores, Inc. and CarMax, Inc, filed herewith
31.1 Certification of the Chief Executive Officer Pursuant to
Rule 13a-14(a), filed herewith
31.2 Certification of the Chief Financial Officer Pursuant to
Rule 13a-14(a), filed herewith
32.1 Certification of the Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, filed herewith
32.2 Certification of the Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, filed herewith
Page 29 of 29