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 November 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-31420
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 December 31, 2003
- ----------------------------- --------------------------------
Common Stock, par value $0.50 103,742,884
An Index is included on Page 2 and a separate Exhibit Index is included on Page
28.
CARMAX, INC. AND SUBSIDIARIES
INDEX
Page
No.
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Consolidated Financial Statements:
Consolidated Statements of Earnings -
Three Months and Nine Months Ended November 30, 2003 and 2002 3
Consolidated Balance Sheets -
November 30, 2003 and February 28, 2003 4
Consolidated Statements of Cash Flows -
Nine Months Ended November 30, 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 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
- ----------
EXHIBIT INDEX 28
- -------------
Page 2 of 28
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 Nine Months Ended
November 30 November 30
------------------------------------------ ------------------------------------------
2003 %(1) 2002 %(1) 2003 %(1) 2002 %(1)
---- ---- ---- ---- ---- ---- ---- ----
Sales and operating revenues:
Used vehicle sales $ 797,752 74.4 $ 690,318 73.7 $ 2,626,620 75.5 $ 2,212,925 73.2
New vehicle sales 122,681 11.4 117,849 12.6 398,680 11.5 402,053 13.3
Wholesale vehicle sales 111,352 10.4 87,493 9.3 325,080 9.3 277,617 9.2
Other sales and revenues 39,749 3.7 41,159 4.4 130,446 3.7 130,709 4.3
---------- ---- ----------- ---- ----------- ---- ----------- ----
Net sales and operating revenues 1,071,534 100.0 936,819 100.0 3,480,826 100.0 3,023,304 100.0
Cost of sales 945,292 88.2 829,879 88.6 3,043,708 87.4 2,665,410 88.2
---------- ---- ----------- ---- ----------- ---- ----------- ----
Gross profit 126,242 11.8 106,940 11.4 437,118 12.6 357,894 11.8
CarMax Auto Finance income 17,649 1.6 19,220 2.1 66,074 1.9 61,168 2.0
(Notes 5 and 6)
Selling, general, and administrative
expenses 114,282 10.7 101,810 10.9 350,549 10.1 292,844 9.7
Gain on franchise dispositions, net 1,207 0.1 - - 746 - - -
Interest expense - - 299 - 1,137 - 1,714 0.1
Interest income 164 - 274 - 468 - 568 -
---------- ---- ----------- ---- ----------- ---- ----------- ----
Earnings before income taxes 30,980 2.9 24,325 2.6 152,720 4.4 125,072 4.1
Provision for income taxes 11,927 1.1 9,608 1.0 58,797 1.7 49,403 1.6
---------- ---- ----------- ---- ----------- ---- ----------- ----
Net earnings $ 19,053 1.8 $ 14,717 1.6 $ 93,923 2.7 $ 75,669 2.5
========== ==== =========== ==== =========== ==== =========== ====
Weighted average common
shares (Note 3):
Basic 103,647 103,047 103,428 102,973
========== =========== =========== ===========
Diluted 105,955 104,516 105,526 104,602
========== =========== =========== ===========
Net earnings per share (Note 3):
Basic $ 0.18 $ 0.14 $ 0.91 $ 0.73
========== =========== =========== ===========
Diluted $ 0.18 $ 0.14 $ 0.89 $ 0.72
========== =========== =========== ===========
(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 28
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Balance Sheets
---------------------------
(Amounts in thousands except share data)
Nov. 30, 2003 Feb. 28, 2003
------------- -------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 54,962 $ 34,615
Accounts receivable, net 60,853 56,449
Automobile loan receivables held for sale (Note 6) 18,997 3,579
Retained interests in securitized receivables (Note 6) 135,004 135,016
Inventory 449,744 466,450
Prepaid expenses and other current assets 10,328 12,636
---------- ----------
Total current assets 729,888 708,745
Property and equipment, net 239,553 187,158
Deferred income taxes 3,505 -
Other assets 20,360 21,714
---------- ----------
TOTAL ASSETS $ 993,306 $917,617
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $127,899 $ 117,587
Accrued expenses and other current liabilities 49,984 44,682
Accrued income taxes 9,355 -
Deferred income taxes 28,677 29,783
Short-term debt 6,267 56,051
---------- ----------
Total current liabilities 222,182 248,103
Long-term debt, excluding current installments 100,000 100,000
Deferred revenue and other liabilities 13,319 10,904
Deferred income taxes - 4,041
---------- ----------
TOTAL LIABILITIES 335,501 363,048
Stockholders' equity (Note 1):
Common stock, par value $0.50; authorized: 350,000,000
shares; issued and outstanding 103,727,592 shares at
November 30, 2003, and 103,083,047 shares at February 28, 2003 51,864 51,542
Capital in excess of par value 481,736 472,745
Retained earnings 124,205 30,282
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 657,805 554,569
---------- ----------
Commitments and contingent liabilities (Note 1) - -
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 993,306 $ 917,617
========== ==========
See accompanying notes to consolidated financial statements.
Page 4 of 28
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Cash Flows (Unaudited)
-------------------------------------------------
(Amounts in thousands)
Nine Months Ended November 30
2003 2002
-------- --------
Operating Activities:
- ---------------------
Net earnings $ 93,923 $ 75,669
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 12,253 11,950
Amortization of restricted stock awards 94 45
(Gain) loss on disposition of assets (588) 118
Provision for deferred income taxes (8,652) 1,227
Changes in operating assets and liabilities:
Increase in accounts receivable, net (4,404) (9,118)
Increase in automobile loan receivables held
for sale (15,418) (13,716)
Decrease (increase) in retained interests in
securitized receivables 12 (19,847)
Decrease (increase) in inventory 16,706 (2,512)
Decrease (increase) in prepaid expenses and
other current assets 2,308 (5,432)
Decrease (increase) in other assets 1,999 (847)
Increase in accounts payable, accrued
expenses and other current liabilities,
and accrued income taxes 30,390 32,820
Increase in deferred revenue and other liabilities 2,415 2,384
------------ ------------
Net cash provided by operating activities 131,038 72,741
------------ ------------
Investing Activities:
- ---------------------
Purchases of property and equipment (137,201) (71,318)
Proceeds from sales of property and equipment 72,496 37,926
------------ ------------
Net cash used in investing activities (64,705) (33,392)
------------ ------------
Financing Activities:
- ---------------------
Decrease in short-term debt, net (49,784) (5,355)
Issuance of long-term debt - 100,000
Payments on long-term debt - (77,782)
Equity issuances, net 3,798 556
Dividends paid (Note 1) - (28,400)
------------ ------------
Net cash used in financing activities (45,986) (10,981)
------------ ------------
Increase in cash and cash equivalents 20,347 28,368
Cash and cash equivalents at beginning of year 34,615 3,286
------------ ------------
Cash and cash equivalents at end of period $ 54,962 $ 31,654
------------ ------------
See accompanying notes to consolidated financial statements.
Page 5 of 28
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. Also, the CarMax board
of directors approved a one-time special dividend payment of $28.4 million to
Circuit City Stores on the separation date. 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.
At the separation date, Circuit City Stores and CarMax executed a transition
services agreement and a tax allocation agreement. In the transition services
agreement, Circuit City Stores agreed to provide to CarMax services including
human resources, payroll, benefits administration, tax services, computer center
support, and telecommunications. The agreement specified initial service periods
ranging from six to twenty four months, with varying renewal options. The tax
allocation agreement provided that the pre-separation taxes attributable to the
business of each party be borne solely by that party.
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 a portion of the
quarter and nine months ended November 30, 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 28
Reconciliations of the numerator and denominator of the basic and diluted net
earnings per share are presented below:
Three Months Ended Nine Months Ended
November 30 November 30
(Amounts in thousands except per share data) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------------------
Weighted average common shares............................. 103,647 103,047 103,428 102,973
Dilutive potential common shares:
Options................................................. 2,294 1,466 2,086 1,620
Restricted stock........................................ 14 3 12 9
--------------------------- ---------------------------
Weighted average common shares
and dilutive potential common shares.................... 105,955 104,516 105,526 104,602
=========================== ===========================
Net earnings available to common shareholders.............. $ 19,053 $ 14,717 $ 93,923 $ 75,669
Basic net earnings per share............................... $ 0.18 $ 0.14 $ 0.91 $ 0.73
Diluted net earnings per share............................. $ 0.18 $ 0.14 $ 0.89 $ 0.72
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 November 30, 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
November 30, 2002, options to purchase 1,046,510 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 exceeds the exercise price. No
stock option-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 Nine Months Ended
November 30 November 30
(Amounts in thousands except per share data) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------------
Net earnings, as reported ............................ $ 19,053 $ 14,717 $ 93,923 $ 75,669
Total stock-based compensation expenses
determined under fair value based method
for all awards, net of related tax effects .......... 1,822 1,190 5,077 3,298
------------------------ ---------------------------
Pro forma net earnings ............................... $ 17,231 $ 13,527 $ 88,846 $ 72,371
======================== ===========================
Earnings per share:
Basic, as reported.................................. $ 0.18 $ 0.14 $ 0.91 $ 0.73
Basic, pro forma.................................... $ 0.17 $ 0.13 $ 0.86 $ 0.70
Diluted, as reported................................ $ 0.18 $ 0.14 $ 0.89 $ 0.72
Diluted, pro forma.................................. $ 0.16 $ 0.13 $ 0.84 $ 0.69
Page 7 of 28
The pro forma effect on the third quarter and the first nine 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 Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------------
Gains on sales of loans..................................... $ 12.9 $ 15.9 $ 50.8 $ 49.6
--------------------- ----------------------
Other income:
Servicing fee income..................................... 5.6 4.5 16.0 12.6
Interest income.......................................... 3.4 2.3 12.4 9.6
--------------------- ----------------------
Total other income.......................................... 9.0 6.8 28.5 22.2
--------------------- ----------------------
Direct expenses:
CAF payroll and fringe benefit expense................... 2.0 1.7 6.0 5.1
Other direct CAF expenses................................ 2.1 1.8 7.2 5.5
--------------------- ----------------------
Total direct expenses....................................... 4.2 3.5 13.2 10.6
--------------------- ----------------------
CarMax Auto Finance income.................................. $ 17.6 $ 19.2 $ 66.1 $ 61.2
===================== ======================
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 company's 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
Page 8 of 28
frees up capacity in the warehouse facility. In a public securitization, a 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 refinancing receivables in a public securitization has
not been material to the operations of the company. However, because
securitization structures could change from time to time, this may not be
representative of the potential impact of future securitizations.
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 Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------------
Net loans originated.................................. $ 327.8 $ 301.2 $ 1,084.5 $ 895.3
Loans sold............................................ $ 338.0 $ 292.2 $ 1,074.4 $ 875.1
Gains on sales of loans............................... $ 12.9 $ 15.9 $ 50.8 $ 49.6
Gains on sales of loans as a
percentage of loans sold.......................... 3.8% 5.4% 4.7% 5.7%
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 and certain public securitizations, 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 November 30 As of February 28
(Amounts in millions) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------------
Interest-only strip receivables............................ $ 85.1 $ 83.1 $ 88.3 $ 74.3
Restricted cash............................................ 33.4 39.2 33.3 34.7
Required excess receivables................................ 16.5 18.2 13.4 11.7
-------------------------------------------------------
Total retained interests in securitized receivables........ $ 135.0 $ 140.5 $ 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 November
30, 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 multiplying the principal collections expected in each
future period by the number of periods until that future period, summing those
products, and dividing the sum by the initial principal balance. Supplemental
credit enhancements which consist of cash reserves and excess receivables are
generally 2% to 4% of managed receivables.
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
Page 9 of 28
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. 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 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.
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 November 30, 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 November 30, 2003, are not materially different from assumptions
used to measure the fair value of the 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% $5.3 $ 9.9
Cumulative default rate................ 2.00%-2.50% $3.9 $ 7.9
Annual discount rate................... 12.0% $2.0 $ 4.0
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.
Page 10 of 28
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. 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 November 30 As of February 28
(Amounts in millions) 2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------------------
Loans securitized.......................................... $ 2,153.9 $ 1,760.0 $1,859.1 $1,489.4
Loans held for sale or investment.......................... 36.4 34.0 19.6 13.9
--------------------------- ----------------------------
Ending managed receivables................................. $ 2,190.3 $ 1,794.0 $1,878.7 $1,503.3
=========================== =========================
Accounts 31+ days past due................................. $ 35.2 $ 25.9 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables.............................. 1.61% 1.44% 1.47% 1.48%
Three Months Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 2002 2003 2002
----------------------------------------------------------------------------------------------------------------------
Average managed receivables............................... $ 2,161.4 $ 1,748.8 $ 2,057.4 $ 1,651.7
Credit losses on managed receivables...................... 6.0 4.9 15.5 12.3
Annualized losses as a percentage
of average managed receivables......................... 1.11% 1.12% 1.00% 0.99%
Selected Cash Flows from Securitized Receivables. The table below
summarizes certain cash flows received from and paid to the automobile loan
securitizations:
Three Months Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 2002 2003 2002
---------------------------------------------------------------------------------------------------------------------
o Proceeds from new securitizations............................. $ 286.5 $ 254.0 $ 918.5 $ 741.6
o Proceeds from collections reinvested in
revolving period securitizations.......................... $ 120.5 $ 105.6 $ 400.2 $ 364.2
o Servicing fees received....................................... $ 5.5 $ 4.5 $ 15.7 $ 12.3
o Other cash flows received from retained interests:
Interest-only strip receivables........................... $ 23.8 $ 15.0 $ 59.4 $ 49.0
Cash reserve releases, net................................ $ 6.8 $ 3.0 $ 15.0 $ 13.1
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.
Page 11 of 28
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 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
triggers, 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 November 30, 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 third quarter of fiscal 2004, the company
entered into eight 40-month amortizing interest rate swaps with initial notional
amounts totaling approximately $351.5 million. The notional amount of all
outstanding swaps related to the automobile loan receivable securitizations was
approximately $285.1 million at November 30, 2003, and $473.2 million at
February 28, 2003. At November 30, 2003, the fair value of swaps was a net asset
of $0.9 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 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 application of the provisions of SFAS
No. 150 have not and are not expected to have a material impact on the company's
financial position, results of operations, or cash flows.
In December 2003, the FASB issued FASB Interpretation ("FIN") No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities." This revised
interpretation retains the original FIN No. 46 requirements for consolidating
variable interest entities by the primary beneficiary of
Page 12 of 28
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. The revised interpretation adds the requirement for
consolidating an entity where the equity investors' voting rights are not
proportionate to their economic interests and where the activities of the entity
involve or are conducted on behalf of an investor with a disproportionately
small voting interest. This revised interpretation is effective for all entities
no later than the end of the first reporting period that ends after March 15,
2004. However, for reporting periods ending after December 15, 2003, a company
must apply either the original or this revised interpretation to those entities
that are considered to be special-purpose entities. A company that has already
applied the original FIN No. 46 to an entity may continue to do so until the
effective date of the revised interpretation. The company currently is applying
the original FIN No. 46 which has not had a material impact on the company's
financial position, results of operations, or cash flows. The company has not
fully analyzed the new guidance and, therefore, cannot determine whether there
will be an impact on its financial position, results of operations, or cash
flows at this time.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This revised
statement retains the disclosures required by the original SFAS No. 132, which
standardized employers' disclosures about pensions and other postretirement
benefits, and requires additional disclosures concerning the economic resources
and obligations related to pension plans and other postretirement benefits. The
provisions of the original SFAS No. 132 remain in effect until the provisions of
this revised statement are adopted. This revised statement is effective for
fiscal years ending after December 15, 2003. The company will revise its
disclosures to meet the requirements under this revised standard in the
financial statements for the fiscal year ended February 29, 2004.
9. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
Page 13 of 28
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. Also, the CarMax board of directors approved a one-time special
dividend payment of $28.4 million to Circuit City Stores on the separation date.
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.
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 14 of 28
Net Sales and Operating Revenues
- --------------------------------
Total sales for the third quarter of fiscal 2004 increased 14% to $1.07 billion
from $936.8 million in last year's third quarter. For the nine months ended
November 30, 2003, total sales increased 15% to $3.48 billion from $3.02 billion
in last year's first nine months.
Three Months Ended November 30 Nine Months Ended November 30
(Amounts in millions) 2003 % 2002 % 2003 % 2002 %
- ------------------------------------------------------------------------------------------------------------------------
Used vehicle sales.................... $ 797.8 $690.3 $2,626.6 $2,212.9
New vehicle sales..................... 122.7 117.8 398.7 402.1
------------------------------------------------------------------------------
Total retail vehicle sales............ 920.4 85.9 808.1 86.3 3,025.3 86.9 2,615.0 86.5
------------------------------------------------------------------------------
Wholesale vehicle sales............... 111.4 10.4 87.5 9.3 325.1 9.3 277.6 9.2
------------------------------------------------------------------------------
Other sales and revenues:
Extended warranty revenue.......... 17.7 16.6 58.7 51.5
Service department sales........... 17.3 13.9 51.4 45.2
Third-party finance fees........... 4.7 3.7 15.0 12.5
Appraisal purchase processing fees - 7.0 5.3 21.5
------------------------------------------------------------------------------
Total other sales and revenues........ 39.7 3.7 41.2 4.4 130.4 3.7 130.7 4.3
------------------------------------------------------------------------------
Total net sales and operating
revenues........................... $1,071.5 100.0 $936.8 100.0 $3,480.8 100.0 $3,023.3. 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 third quarter and first
nine months of fiscal 2004 and 2003 were as follows:
Three Months Nine Months
Ended November 30 Ended November 30
2003 2002 2003 2002
---------------------------------------------------------------
Vehicle units:
Used vehicles..................... 2 % 8 % 6 % 11 %
New vehicles...................... 2 % (16)% (2)% (5)%
Total................................ 2 % 5 % 5 % 9 %
Vehicle dollars:
Used vehicles..................... 4 % 8 % 7 % 11 %
New vehicles...................... 5 % (17)% 0 % (4)%
Total................................ 4 % 3 % 6 % 9 %
The third quarter, which encompasses the new car model-year changeover period,
has historically been our most volatile and challenging quarter. Sales at the
beginning of the quarter were slower than expected. We believe that this was a
result of flatter than normal wholesale prices through mid-October, which meant
that some of our used car prices were likely less competitive with new car
closeout models than usual. We also believe there was a shift to more normal
fall seasonality in the pace of wholesale pricing declines following two
exceptionally good fall seasons in fiscal 2002 and 2003, which were driven by
sharper-than-normal wholesale pricing declines during the preceding summer
months. In response to the slower sales pace, we reduced our margin targets on
selected cars at mid-quarter in order to improve our competitive price position.
As a result, sales responded favorably, which allowed us to achieve the high end
of our revised sales expectations.
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.
Page 15 of 28
Total retail vehicle unit and dollar sales changes for the third quarter and
first nine months of fiscal 2004 and 2003 were as follows:
Three Months Nine Months
Ended November 30 Ended November 30
2003 2002 2003 2002
--------------------------------------------------------------
Vehicle units:
Used vehicles..................... 13 % 17 % 18 % 17 %
New vehicles...................... 1 % (20)% (3)% (10)%
Total................................ 12 % 12 % 16 % 14 %
Vehicle dollars:
Used vehicles..................... 16 % 17 % 19 % 18 %
New vehicles...................... 4 % (21)% (1)% (10)%
Total................................ 14 % 9 % 16 % 13 %
For the third quarter and nine months ended November 30, 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.
Wholesale Vehicle Sales. Third quarter wholesale sales growth was generated by
- ------------------------
several factors, including increased wholesale appraisal traffic resulting from
the expansion of the company's store base, increased consumer response to the
CarMax vehicle appraisal offer, and a stronger than normal wholesale pricing
environment in the first half of the quarter.
Other Sales and Revenues. Other sales and revenues include extended warranty
- -------------------------
revenue, service department sales, third-party finance fees, and up through the
second quarter of fiscal 2004 appraisal purchase processing fees collected from
customers for the purchase of their vehicles. Extended warranty revenue, service
department sales, and third-party finance fees increased due to the company's
strong retail sales growth. However, the elimination of the appraisal purchase
processing fee in the second quarter of fiscal 2004 resulted in a decrease in
total other sales and revenues.
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 these
costs. Based on the test results, during the second quarter the appraisal
purchase processing fees were discontinued across our entire store base. Under
the revised appraisal cost recovery ("ACR") 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
related costs of land on which we hold vehicles prior to being sold at the
wholesale auctions, while also making our offer more transparent to the consumer
by eliminating a fee.
Supplemental information related to vehicle sales follows:
Retail Unit Sales
-----------------
Three Months Nine Months
Ended November 30 Ended November 30
2003 2002 2003 2002
-----------------------------------------------------------------
Used vehicles................................. 51,361 45,274 169,556 143,461
New vehicles.................................. 5,079 5,051 16,804 17,276
-----------------------------------------------------------------
Total......................................... 56,440 50,325 186,360 160,737
=================================================================
Page 16 of 28
Average Retail Selling Prices
-----------------------------
Three Months Nine Months
Ended November 30 Ended November 30
2003 2002 2003 2002
-----------------------------------------------------------------
Used vehicles................................. $ 15,393 $ 15,176 $ 15,382 $ 15,354
New vehicles.................................. $ 23,968 $ 23,241 $ 23,566 $ 23,216
Weighted average.............................. $ 16,165 $ 15,985 $ 16,120 $ 16,199
Retail Vehicle Sales Composition
--------------------------------
Three Months Nine Months
Ended November 30 Ended November 30
2003 2002 2003 2002
----------------------------------------------------------------
Vehicle units:
Used vehicles............................ 91% 90% 91% 89%
New vehicles............................. 9 10 9 11
----------------------------------------------------------------
Total ........................................ 100% 100% 100% 100%
================================================================
Vehicle dollars:
Used vehicles............................ 87% 85% 87% 85%
New vehicles............................. 13 15 13 15
----------------------------------------------------------------
Total......................................... 100% 100% 100% 100%
================================================================
Retail Stores. In the third quarter of fiscal 2004, CarMax opened a standard
- --------------
superstore in Memphis, Tenn., and a satellite superstore in the Chicago market.
During the fourth quarter, CarMax plans to add a satellite superstore in the Las
Vegas market (mid fourth quarter), a standard superstore in Louisville (late
fourth quarter), and a satellite superstore in the Los Angeles market (early in
the fourth quarter) that will co-locate the company's two remaining stand-alone
new car franchises.
The following tables provide detail on the CarMax retail stores and new car
franchises:
Estimate
Store Mix Feb. 29, 2004 Nov. 30, 2003 Feb . 28, 2003 Nov. 30, 2002
-------------------------------------------------------------------------------------------------------------------------
Mega superstores(1)...................... 13 13 13 13
Standard superstores(2).................. 24 23 19 19
Satellite superstores(3)................. 12 10 8 6
Co-located new car stores................ 3 2 2 2
Stand-alone new car stores............... 0 2 2 2
-----------------------------------------------------------------------------
Total 52 50 44 42
=============================================================================
(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. 29, 2004 Nov. 30, 2003 Feb . 28, 2003 Nov. 30, 2002
-------------------------------------------------------------------------------------------------------------------------
Integrated/co-located
new car franchises.................. 9 12 15 15
Stand-alone new car franchises........... 0 2 2 2
-----------------------------------------------------------------------------
Total.................................... 9 14 17 17
=============================================================================
Page 17 of 28
Gross Profit Margin
- -------------------
The total gross profit margin was 11.8% of sales in the third quarter of fiscal
2004 and 11.4% in the third quarter of fiscal 2003. Total gross profit margin
was 12.6% of sales for the nine months ended November 30, 2003, and 11.8% for
the nine months ended November 30, 2002.
Three Months Nine Months
Ended November 30 Ended November 30
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........... 10.9 1,693 10.6 1,610 11.3 1,754 10.8 1,663
New vehicle gross profit margin............ 3.8 925 4.4 1,027 3.9 914 4.2 973
--------------------------------------- -------------------------------------
Total retail vehicle gross profit margin... 10.0 1,624 9.7 1,551 10.3 1,679 9.8 1,589
Wholesale vehicle gross profit margin...... 9.9 338 3.6 123 9.8 335 4.9 171
Other gross profit margin.................. 59.3 NM(3) 62.5 NM(3) 70.8 NM(3) 68.0 NM(3)
--------------------------------------- -------------------------------------
Total gross profit margin.................. 11.8 NM(3) 11.4 NM(3) 12.6 NM(3) 11.8 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.
Used Vehicle Gross Profit Margin. For the three months ended November 30, 2003,
- ---------------------------------
the used vehicle profit margin per unit increased compared with the prior year
as a result of the change in the ACR methodology, offset in part by declines in
used car margins before the ACR change. The decline in used car margins before
the change was due to the selected supplemental markdowns initiated in
mid-October that were taken to reestablish the price position of our used cars
and stimulate sales. For the nine month period ended November 30, 2003, used
vehicle profit margin per unit increased as a result of the change in the ACR
methodology, consistent sales performance, and better inventory management. The
ACR methodology allows us to 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 used vehicles purchased directly from consumers
decreased due to the implementation of the new appraisal cost recovery method.
Wholesale Vehicle Gross Profit Margin. For the three and nine month periods
- --------------------------------------
ended November 30, 2003, the wholesale vehicle gross profit margin per unit
increased compared with the same periods last year primarily due to the
implementation of our new ACR methodology. The acquisition cost of a wholesale
vehicle decreased resulting in higher wholesale gross margins due to the new ACR
methodology discussed previously. The increases in wholesale margins were
partially offset by corresponding decreases in other margins. Our intent is to
recover all costs related to our consumer offer to buy cars directly from
consumers, including the cost of appraisals, buying, wholesaling, and the
related land costs on which we hold vehicles prior to being sold at the
wholesale auctions. Previously, we had not been fully recovering these land
costs. The stronger than normal wholesale pricing environment in the first half
of the quarter also contributed to our increased wholesale margins, as we
received higher prices at our in-store wholesale auctions.
Other Gross Profit Margin. Third quarter other gross profit margin declined
- --------------------------
despite a year-over-year improvement in the principal component elements,
primarily due to a shift in the mix of the underlying components. Service sales,
which are the only category within other sales and revenues that do not carry
100% gross margins, became a larger percentage of the other category following
the elimination of the appraisal purchase processing fee. Compared with the
prior year, third quarter service margins improved reflecting increased service
sales and the benefits of our new electronic repair order ("ERO") system. Last
year's service sales and costs were adversely impacted by the rollout of the ERO
system. Third-party warranty commissions and third-party finance fees both
benefited from the growth in used car sales.
Page 18 of 28
CarMax Auto Finance Income
- --------------------------
CarMax Auto Finance ("CAF") 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 creditworthy 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 third quarter and first nine months of fiscal 2004 and 2003, CarMax Auto
Finance income was as follows:
Three Months Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 % 2002 % 2003 % 2002 %
- ---------------------------------------------------------------------------------------------------------------------------
Gains on sales of loans(1)............................ $ 12.9 3.8 $ 15.9 5.4 $ 50.8 4.7 $ 49.6 5.7
--------------------------------- ------------------------------
Other income:(2)
Servicing fee income.............................. 5.6 1.0 4.5 1.0 16.0 1.0 12.6 1.0
Interest income................................... 3.4 0.6 2.3 0.5 12.4 0.8 9.6 0.8
--------------------------------- ------------------------------
Total other income.................................... 9.0 1.7 6.8 1.6 28.5 1.8 22.2 1.8
--------------------------------- ------------------------------
Direct expenses:(2)
CAF payroll and fringe benefit expense............ 2.0 0.4 1.7 0.4 6.0 0.4 5.1 0.4
Other direct CAF expenses......................... 2.1 0.4 1.8 0.4 7.2 0.5 5.5 0.4
--------------------------------- ------------------------------
Total direct expenses................................. 4.2 0.8 3.5 0.8 13.2 0.9 10.6 0.9
--------------------------------- ------------------------------
CarMax Auto Finance income(3)......................... $ 17.6 1.6 $ 19.2 2.1 $ 66.1 1.9 $ 61.2 2.0
================================= ==============================
Loans sold............................................ $ 338.0 $ 292.2 $ 1,074.4 $ 875.1
Average managed receivables........................... $ 2,161.4 $ 1,748.8 $ 2,057.4 $ 1,651.7
Net sales and operating revenues...................... $ 1,071.5 $ 936.8 $ 3,480.8 $ 3,023.3
Ending managed receivables balance.................... $ 2,190.3 $ 1,794.0 $ 2,190.3 $ 1,794.0
Percent columns indicate:
(1) Percent of loans sold
(2) Annualized percent of average managed receivables
(3) Percent of net sales and operating revenues
Page 19 of 28
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 interim
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.
For the three months ended November 30, 2003, CAF income decreased 8% to $17.6
million from $19.2 million for the same period last year. Gains on sales of
loans decreased $3.0 million. The anticipated reduction in spreads resulting
from rising costs of funds generated gains on loans sold of 3.8% compared with
last year's gains on loans sold of 5.4%. The resulting 30% reduction in gains as
a percent of loans sold more than offset the benefit of the increase in loans
sold generated by increased vehicle sales. The increases in other income and in
direct expenses were proportionate to the increase in managed receivables.
For the nine months ended November 30, 2003, CAF income increased 8% to $66.1
million from $61.2 million for the same period last year. Gains on sales of
loans increased by $1.2 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 and third quarters resulted in a
decrease in gains as a percent of loans sold in these quarters compared with the
prior year. The compression of the spread was partially offset by an increase in
loans sold driven by higher sales. The increases in other income and in direct
expenses were proportionate to the increase in managed receivables.
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 November 30 As of February 28
(Amounts in millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Loans securitized.......................................... $ 2,153.9 $ 1,760.0 $ 1,859.1 $ 1,489.4
Loans held for sale or investment.......................... 36.4 34.0 19.6 13.9
-------------------------------------------------------------
Ending managed receivables................................. $ 2,190.3 $ 1,794.0 $ 1,878.7 $ 1,503.3
=============================================================
Accounts 31+ days past due................................. $ 35.2 $ 25.9 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables.............................. 1.61% 1.44% 1.47% 1.48%
Three Months Nine Months
Ended November 30 Ended November 30
(Amounts in millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Average managed receivables................................ $ 2,161.4 $ 1,748.8 $ 2,057.4 $ 1,651.7
Credit losses on managed receivables....................... $ 6.0 $ 4.9 $ 15.5 $ 12.3
Annualized losses as a percentage of
average managed receivables............................. 1.11% 1.12% 1.00% 0.99%
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. As of November 30, 2003, past due accounts as a percentage of ending
managed receivables were higher than the same period last year; however,
delinquencies were in line with expectations and were not indicative of a change
in the performance of the receivables. In the third quarter, we adjusted the
cumulative default rate assumptions for certain pools of receivables. We
increased the loss rates for two of our older pools of receivables to reflect
slightly higher losses at the end of the pools' lives. We also increased the
loss rate on current originations from 1.85% to 2.00%, reflecting current
economic conditions, including weak recovery rates that have stabilized at
historically low levels. There has been no change in the credit quality of the
receivables, which is at the high end of our historical range. The changes
resulted in no material impact on earnings or the fair value of retained
interests. Details concerning the assumptions used to value the retained
interests and the sensitivity to adverse changes in the performance of the
managed receivables are included in Note 6 to the company's interim consolidated
financial statements.
Page 20 of 28
Selling, General and Administrative Expenses
- --------------------------------------------
For the three months ended November 30, 2003, selling, general, and
administrative expenses as a percent of net sales and operating revenues were
10.7% compared with 10.9% in the same period last year. For the nine months
ended November 30, 2003, the selling, general, and administrative expense ratio
was 10.1% compared with 9.7% in the corresponding period last year. The selling,
general, and administrative expense ratio for the three months and nine months
ended November 30, 2002, included costs of $4.5 million and $7.6 million,
respectively, associated with the separation of CarMax from Circuit City Stores.
Excluding these costs, the selling, general, and administrative expense ratio
would have been 10.4% in last year's third quarter and 9.4% in the first nine
months of last year.
The current year's selling, general, and administrative expense ratio reflects
the expected higher level of operating expenses associated with being a
stand-alone company following the October 1, 2002, separation from Circuit City
Stores. Compared with last year, we estimate stand-alone costs were
approximately $1.5 million higher in the current year's quarter and
approximately $13.5 million higher in the first nine months.
As anticipated, the fiscal 2004 selling, general, and administrative expense
ratio has been adversely affected by the resumption of our store growth plan and
the increase in the number of store openings. New stores typically experience
higher selling, general, and administrative expense ratios than stores in the
comparable store base, reflecting the fact that new stores have not been open
long enough to ramp up to their expected mature sales levels. Higher total
pre-opening expenses and costs related to building our management team bench
strength to support future store growth also contributed to the higher current
year selling, general, and administrative expense ratios.
Interest Expense
- ----------------
Interest expense was zero for the third quarter of fiscal 2004 compared with
$0.3 million in the same period last year. As a result of the company's level of
capital spending, all interest incurred during the third quarter of fiscal 2004
was capitalized. For the nine months ended November 30, 2003, interest expense
was $1.1 million, compared with $1.7 million in the same period last year.
Income Taxes
- ------------
The effective income tax rate decreased to 38.5% for the third quarter and the
nine months ended November 30, 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 October 2002 separation from Circuit City Stores were not
deductible.
Net Earnings
- ------------
Third quarter fiscal 2004 net earnings increased 29% to $19.1 million from $14.7
million in the third quarter of fiscal 2003. For the nine months ended November
30, 2003, net earnings increased 24% to $93.9 million from $75.7 million. The
increases in the quarter and year-to-date net earnings were the result of strong
sales growth, increased used vehicle gross margins, and the absence of non-tax
deductible separation expenses, offset in part 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 four standard-sized
superstores and two satellite superstores opened in the first nine months of the
year, we plan to open one standard-sized used car superstore and one satellite
superstore in the fourth quarter of fiscal 2004. In addition, in Los Angeles, we
intend to co-locate our two remaining stand-alone new car franchises with a new
satellite used car superstore in the fourth quarter.
Page 21 of 28
In the first nine months of fiscal 2004, we sold our Jeep franchise in Kenosha,
Wis., and our Nissan franchise in Greenville, S.C. We also 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, this process may not be completed until the end of calendar
year 2004. In addition, we plan to sell the Ford franchise in Kenosha, Wis., and
one of our Chrysler-Jeep franchises in the Atlanta market. The sale or return of
the integrated new car franchises will create more space for used car sales
expansion, which is more profitable for us.
During the fiscal year ending February 28, 2005, the company plans to expand its
used car superstore base by approximately 20%, opening approximately 10 used car
superstores. Planned entries into new mid-sized markets include Indianapolis,
Ind.; Columbia, S.C.; Austin, Tex; and Albuquerque, N.M. Satellite superstore
additions are planned for Winston Salem, N.C.; Fayetteville, N.C.; Miami, Fla.;
and Richmond, Va. CarMax also plans to add a standard superstore and a satellite
superstore in the Los Angeles market on sites that were land-banked when the
company suspended growth in 1999.
Comparable store used unit sales growth is a primary driver of CarMax's
profitability. Assuming average winter weather, we expect fourth quarter used
unit comparable store growth in the range of 5 percent to 7 percent, bringing
the year's used unit comparable store growth expectation to the range of 6
percent or 7 percent. In addition, with third quarter funds rising faster than
consumer rates, we experienced a compression in spreads generally in line with
our projections. We expect the CAF spread to be near the mid-point of our
normalized 3.5% to 4.5% range in the fourth quarter. Based on this, we
anticipate fourth quarter net earnings per share to be in the range of 19 cents
to 22 cents, bringing the expected year to date net earnings to be in the range
of $1.08 to $1.11 per share. In addition, if the sales of our new car franchises
occur in the fourth quarter, 1 cent could be added to our fourth quarter
earnings per share.
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.
Financial Condition
Liquidity and Capital Resources
- -------------------------------
Operating Activities. For the first nine months of fiscal 2004, CarMax generated
- ---------------------
cash from operating activities of $131.0 million. In the same period last year,
CarMax generated cash from operating activities of $72.7 million. The fiscal
2004 improvement primarily resulted from an increase in net earnings, a decrease
in inventory, and a decrease in retained interests in securitized receivables.
Our inventory balance decreased because we disposed of three new car franchises
and improved inventory management at our remaining new vehicle franchise
locations. Retained interests in securitized receivables was relatively flat for
the nine months ended November 30, 2003, versus an increase of $19.8 million for
the nine months ended November 30, 2002. This change was primarily due to the
more normalized spread environment at CAF and the timing of the securitization
transactions.
Investing Activities. Net cash used in investing activities was $64.7 million in
- ---------------------
the nine months ended November 30, 2003, compared with $33.4 million in the
first nine months of last fiscal year. Capital expenditures were $137.2 million
and $71.3 million for the nine months ended November 30, 2003 and 2002,
respectively.
Page 22 of 28
The increase in capital expenditures reflects the increase in our store base
associated with the resumption of our growth plan. Additionally, some of the
increase is associated with the initial expenditures associated with our future
corporate headquarters site in Richmond, Va. Total proceeds from sales of
property and equipment were $72.5 million for the nine months ended November 30,
2003, compared with $37.9 million in the prior year period. The majority of the
sale proceeds relate to sale-leaseback transactions. In the second quarter of
fiscal 2004, the company entered into sale-leaseback transactions involving
three properties valued at approximately $25 million. The transactions were
structured as operating leases with initial lease terms of 15 years with four,
five-year renewal options. In the third quarter of fiscal 2004, the company
entered into sale-leaseback transactions involving three properties valued at
approximately $49 million. These transactions were structured as operating
leases with initial lease terms of 20 years with four, five-year renewal
options. At November 30, 2003, we owned a total of four CarMax superstores. In
December 2003, CarMax entered into sale-leaseback transactions involving three
of these properties valued at approximately $33.2 million.
Financing Activities. Net cash used in financing activities was $46.0 million in
- ---------------------
the first nine months of fiscal 2004, compared with $11.0 million in the first
nine months of last fiscal year. In the first nine months of fiscal 2004, we
used cash generated from operations to reduce total outstanding debt by $49.8
million. In the first nine months of fiscal 2003, we increased total outstanding
debt by $16.9 million and paid a one-time dividend of $28.4 million to Circuit
City in conjunction with the separation transaction.
At November 30, 2003, the aggregate principal amount of securitized automobile
loan receivables totaled $2.15 billion. During the third quarter of fiscal 2004,
the company completed a public automobile loan receivables securitization. The
total value of the automobile loan receivables securitized through this public
offering was $600.0 million. At November 30, 2003, the unused capacity of the
$825.0 million warehouse facility, which matures in June 2004, was $539.5
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 November 30, 2003, the amount outstanding under this credit facility was
$106.3 million, with the remainder fully available to the company. CarMax
expects that proceeds from securitization transactions, sale-leaseback
transactions, its credit facility, additional credit facilities if needed, 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 28
ITEM 3.
QUANTITATIVE AND QUALITATIVE
----------------------------
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Market Risk
Automobile Installment Loan Receivables. At November 30, 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 November 30, 2003, and February 28, 2003, was as
follows:
(Amounts in millions) November 30 February 28
---------------------------------------------------------------------------------------------------
Fixed-rate securitizations................................ $ 1,868.4 $ 1,385.1
Floating-rate securitizations
synthetically altered to fixed......................... 285.1 473.2
Floating-rate securitizations............................. 0.4 0.8
Held for investment (1)................................... 17.4 16.0
Held for sale (2)......................................... 19.0 3.6
-------------------------------------
Total..................................................... $ 2,190.3 $ 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 third quarter results of
operations or cash flows.
Page 24 of 28
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 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 November 30, 2003,
that has materially affected, or is reasonably likely to materially affect, the
company's internal control over financial reporting.
Page 25 of 28
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 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 as Exhibit 3.2 to
CarMax's Quarterly Report on Form 10-Q, filed
October 15, 2003 (Filed No. 1-31420),
incorporated herein by this reference.
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.
(b) Reports on Form 8-K
The company filed a report on Form 8-K pursuant to Items 5
and 7 on October 15, 2003. During the third quarter, the
company also furnished reports on Form 8-K pursuant to Item
12 on September 5, 2003, and September 22, 2003.
Page 26 of 28
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
January 13, 2004
Page 27 of 28
EXHIBIT INDEX
-------------
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 28 of 28