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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended August 31, 2004
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 X No
----- ----
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, 2004
----------------------------- ---------------------------------
Common Stock, par value $0.50 104,084,074
An Index is included on Page 2 and a separate Exhibit Index is included on Page
28.
CARMAX, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
No.
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Consolidated Financial Statements:
Consolidated Statements of Earnings -
Three Months and Six Months Ended August 31, 2004 and 2003 3
Consolidated Balance Sheets -
August 31, 2004, and February 29, 2004 4
Consolidated Statements of Cash Flows -
Six Months Ended August 31, 2004 and 2003 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 6. Exhibits 26
SIGNATURES 27
- ----------
EXHIBIT INDEX 28
- -------------
Page 2 of 28
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Earnings (Unaudited)
-----------------------------------------------
(In thousands except per share data)
Three Months Ended Six Months Ended
August 31 August 31
---------------------------------------- -----------------------------------------
2004 %(1) 2003 %(1) 2004 %(1) 2003 %(1)
------ ------- ------- ------- ------- ------- ------- -------
Sales and operating revenues:
Used vehicle sales $ 987,359 74.6 $ 938,726 75.9 $1,972,734 74.5 $1,828,868 75.9
New vehicle sales 137,516 10.4 139,600 11.3 274,281 10.4 275,999 11.5
Wholesale vehicle sales 152,118 11.5 112,995 9.1 308,989 11.7 213,728 8.9
Other sales and revenues 46,514 3.5 45,136 3.7 92,493 3.5 90,697 3.8
---------------------------------------- ----------------------------------------
Net sales and operating revenues 1,323,507 100.0 1,236,457 100.0 2,648,497 100.0 2,409,292 100.0
Cost of sales 1,160,307 87.7 1,073,352 86.8 2,318,067 87.5 2,098,416 87.1
---------------------------------------- ----------------------------------------
Gross profit 163,200 12.3 163,105 13.2 330,430 12.5 310,876 12.9
CarMax Auto Finance income
(Notes 3 and 4) 20,744 1.6 22,677 1.8 42,560 1.6 48,425 2.0
Selling, general, and administrative
expenses 134,726 10.2 120,714 9.8 265,414 10.0 236,267 9.8
Loss on franchise dispositions, net 11 -- 460 -- 11 -- 460 --
Interest expense 324 -- 383 -- 817 -- 1,137 --
Interest income 66 -- 182 -- 119 -- 304 --
---------------------------------------- ----------------------------------------
Earnings before income taxes 48,949 3.7 64,407 5.2 106,867 4.0 121,741 5.1
Provision for income taxes 19,090 1.4 24,797 2.0 41,678 1.6 46,870 1.9
---------------------------------------- ----------------------------------------
Net earnings $ 29,859 2.3 $ 39,610 3.2 $ 65,189 2.5 $ 74,871 3.1
======================================== ========================================
Weighted average common
shares (Note 7):
Basic 104,002 103,484 103,933 103,320
=========== =========== =========== ===========
Diluted 105,512 105,864 105,643 105,313
=========== =========== =========== ===========
Net earnings per share (Note 7):
Basic $ 0.29 $ 0.38 $ 0.63 $ 0.72
=========== =========== =========== ===========
Diluted $ 0.28 $ 0.37 $ 0.62 $ 0.71
=========== =========== =========== ===========
(1) Each percentage represents a ratio of the applicable amount to 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
---------------------------
(In thousands except share data)
August 31, 2004 February 29, 2004
--------------- -----------------
ASSETS (unaudited)
- ------
Current assets:
Cash and cash equivalents (Note 2) $ 56,607 $ 61,643
Accounts receivable, net 69,795 72,358
Automobile loan receivables held for sale (Note 4) 3,164 18,781
Retained interests in securitized receivables (Note 4) 139,525 145,988
Inventory 492,011 466,061
Prepaid expenses and other current assets 5,473 8,650
------------ ------------
Total current assets 766,575 773,481
Property and equipment, net 310,268 244,064
Deferred income taxes 1,635 185
Other assets 19,216 19,287
------------ ------------
TOTAL ASSETS $ 1,097,694 $ 1,037,017
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 131,495 $ 145,517
Accrued expenses and other current liabilities 59,691 55,674
Accrued income taxes 2,676 4,050
Deferred income taxes 33,556 32,711
Short-term debt 4,644 4,446
------------ ------------
Total current liabilities 232,062 242,398
Long-term debt, excluding current installments 100,000 100,000
Deferred revenue and other liabilities 15,179 13,866
------------ ------------
TOTAL LIABILITIES 347,241 356,264
------------ ------------
Shareholders' equity:
Common stock, $0.50 par value; 350,000,000 shares authorized;
104,060,497 and 103,778,461 shares issued and outstanding
at August 31, 2004, and February 29, 2004, respectively 52,030 51,889
Capital in excess of par value 486,502 482,132
Retained earnings 211,921 146,732
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 750,453 680,753
------------ ------------
Commitments and contingent liabilities (Note 6) -- --
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,097,694 $ 1,037,017
============ ============
See accompanying notes to consolidated financial statements.
Page 4 of 28
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Consolidated Statements of Cash Flows (Unaudited)
-------------------------------------------------
(In thousands)
Six Months Ended
August 31
2004 2003
----------- -----------
Operating Activities:
- ---------------------
Net earnings $ 65,189 $ 74,871
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 8,844 8,373
Amortization of restricted stock awards 51 65
(Gain) loss on disposition of assets (83) 475
Provision for deferred income taxes (605) (8,120)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable, net 2,563 (14,559)
Decrease (increase) in automobile loan receivables held for sale 15,617 (16,823)
Decrease (increase) in retained interests in securitized receivables 6,463 (13,026)
(Increase) decrease in inventory (25,950) 56,973
Decrease in prepaid expenses and other current assets 3,177 1,469
Decrease in other assets 71 772
(Decrease) increase in accounts payable, accrued expenses
and other current liabilities, and accrued income taxes (8,926) 25,480
Increase in deferred revenue and other liabilities 1,313 2,017
---------- ----------
Net cash provided by operating activities 67,724 117,967
---------- ----------
Investing Activities:
- ---------------------
Purchases of property and equipment (118,624) (82,662)
Proceeds from sales of property and equipment 43,659 24,910
---------- ----------
Net cash used in investing activities (74,965) (57,752)
---------- ----------
Financing Activities:
- ---------------------
Increase (decrease) in short-term debt, net 198 (52,698)
Equity issuances, net 2,007 3,196
---------- ----------
Net cash provided by (used in) financing activities 2,205 (49,502)
---------- ----------
(Decrease) increase in cash and cash equivalents (5,036) 10,713
Cash and cash equivalents at beginning of year 61,643 34,615
---------- ----------
Cash and cash equivalents at end of period $ 56,607 $ 45,328
========== ==========
See accompanying notes to consolidated financial statements.
Page 5 of 28
CARMAX, INC. AND SUBSIDIARIES
-----------------------------
Notes to Consolidated Financial Statements
------------------------------------------
(Unaudited)
1. Background
----------
CarMax, Inc. ("CarMax" and "the company"), including its wholly owned
subsidiaries, is the leading specialty retailer of used cars and light
trucks in the United States. CarMax was the first used vehicle retailer to
offer a large selection of quality used vehicles at low, "no-haggle" prices
using a customer-friendly sales process in an attractive, modern sales
facility. CarMax also sells new vehicles in certain locations. CarMax
provides its customers with a full range of related services, including the
financing of vehicle purchases through its own finance operation, CarMax
Auto Finance ("CAF"), and third-party lenders; the sale of extended
warranties; and vehicle repair service.
CarMax was formerly a subsidiary of Circuit City Stores, Inc. ("Circuit
City"). On October 1, 2002, the CarMax business was separated from Circuit
City through a tax-free transaction. As a result of the separation, CarMax,
Inc. became an independent, separately traded public company.
2. Accounting Policies
-------------------
Principles of Consolidation. CarMax's consolidated financial statements
conform to accounting principles generally accepted in the United States of
America. The interim period consolidated 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. All significant intercompany balances and transactions have been
eliminated.
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 29, 2004 (the "Annual
Report"). The Notes to Consolidated Financial Statements contained in the
Annual Report should be read in conjunction with these consolidated
financial statements.
Cash and Cash Equivalents. Cash equivalents of $40.3 million and $48.9
million at August 31, 2004, and February 29, 2004, respectively, consisted
of highly liquid debt securities with original maturities of three months
or less. Included in cash equivalents at August 31, 2004, and February 29,
2004, were restricted cash deposits of $13.0 million, which were associated
with certain insurance deductibles. Additional restricted cash related to
securitized auto loan receivables at August 31, 2004, and February 29,
2004, was $4.4 million and $6.4 million, respectively.
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 exercise prices equal to the market
value of the underlying common stock on the date of grant. The following
table illustrates the effect on net earnings and net earnings per share as
if the fair-value-based method of accounting had been applied to all
outstanding stock awards in each reported period:
Page 6 of 28
Three Months Ended Six Months Ended
August 31 August 31
(In thousands except per share data) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------------
Net earnings, as reported ....................................... $29,859 $39,610 $65,189 $74,871
Total additional stock-based compensation expenses
determined under the fair-value-based method
for all awards, net of related tax effects .................. 3,046 1,717 5,653 3,255
--------------------- ----------------------
Pro forma net earnings .......................................... $26,813 $37,893 $59,536 $71,616
--------------------- ----------------------
Earnings per share:
Basic, as reported.......................................... $ 0.29 $ 0.38 $ 0.63 $ 0.72
Basic, pro forma............................................ $ 0.26 $ 0.37 $ 0.57 $ 0.69
Diluted, as reported........................................ $ 0.28 $ 0.37 $ 0.62 $ 0.71
Diluted, pro forma.......................................... $ 0.25 $ 0.36 $ 0.56 $ 0.68
The pro forma effect on the second quarter and the first six months of
fiscal 2005 may not be representative of the pro forma effects on net
earnings and net earnings per share for future periods.
Reclassifications. Certain prior year amounts have been reclassified to
conform to the current year's presentation.
3. CarMax Auto Finance Income
--------------------------
The company's finance operation, CAF, originates automobile loans to
prime-rated customers at competitive market rates of interest. Throughout
each month, the company sells substantially all of the loans it originates
in securitization transactions as discussed in Note 4. The majority of the
contribution from CAF is generated by the spread between the interest rate
charged to the customer and the company's cost of funds. A gain, recorded
at the time of each securitization transaction, results from recording a
receivable approximately 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 Ended Six Months Ended
August 31 August 31
(In millions) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------------------
Gains on sales of loans................................. $ 14.9 $ 18.3 $ 30.5 $ 37.9
-------------------- --------------------
Other income:
Servicing fee income................................. 6.1 5.4 12.1 10.5
Interest income...................................... 4.4 3.9 9.4 9.1
-------------------- --------------------
Total other income...................................... 10.5 9.4 21.5 19.5
-------------------- --------------------
Direct expenses:
CAF payroll and fringe benefit expense............... 2.3 2.0 4.4 4.0
Other direct CAF expenses............................ 2.4 3.0 4.9 5.1
-------------------- --------------------
Total direct expenses................................... 4.7 5.0 9.4 9.0
-------------------- --------------------
CarMax Auto Finance income.............................. $ 20.7 $ 22.7 $ 42.6 $ 48.4
==================== ====================
Amounts in the table above may not total due to rounding.
Page 7 of 28
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.
4. Securitizations
---------------
The company uses a securitization program to fund substantially all of the
automobile loan receivables originated by CAF. 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. The company's risk is limited to
the retained interests on the company's consolidated balance sheets. 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. 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
Statement of Financial Accounting Standards ("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 3.
Three Months Six Months
Ended August 31 Ended August 31
(In millions) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Net loans originated......................... $369.8 $387.8 $755.8 $756.7
Loans sold................................... $383.4 $378.3 $820.4 $736.3
Gains on sales of loans...................... $ 14.9 $ 18.3 $ 30.5 $ 37.9
Gains on sales of loans as a
percentage of loans sold................. 3.9% 4.8% 3.7% 5.1%
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
cash reserves and required excess receivables are generally 2% to 4% of
managed receivables. The special purpose entities and the investors have no
recourse to the company's assets. The company's risk is limited to the
retained interests on the company's consolidated balance sheets. The fair
value of the retained interests may fluctuate depending on the performance
of the securitized receivables.
Page 8 of 28
The fair value of retained interests was $139.5 million as of August 31,
2004, and $146.0 million as of February 29, 2004. The retained interests
had a weighted average life of 1.5 years as of August 31, 2004, and
February 29, 2004. As defined in SFAS No. 140, the weighted average life in
periods (for example, months or years) of pre-payable 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. The following is a
detailed explanation of the components of retained interests.
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 assumptions 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
assumptions. 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. In the event that the cash generated by the securitized
receivables in a given period was insufficient to pay the interest,
principal, and other required payments, the balances on deposit in the
reserve accounts would be used 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. The amount on deposit in
restricted cash accounts was $30.8 million as of August 31, 2004, and $34.8
million as of February 29, 2004.
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. The unpaid principal balance
related to the required excess receivables was $37.0 million as of August
31, 2004, and $28.8 million as of February 29, 2004.
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, 2004, and
a sensitivity analysis showing the hypothetical effect on the retained
interests if there were unfavorable variations from the assumptions used.
Key economic assumptions at August 31, 2004, were 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.
Page 9 of 28
Impact on Fair Impact on Fair
Assumptions Value of 10% Value of 20%
(In millions) Used Adverse Change Adverse Change
---------------------------------------------------------------------------------------------------------------------
Prepayment rate........................ 1.45%-1.55% $5.6 $11.0
Cumulative default rate................ 2.00%-2.50% $4.1 $ 8.3
Annual discount rate................... 12.00% $2.2 $ 4.4
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 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 August 31 As of February 29 or 28
(In millions) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Loans securitized..................................... $2,336.5 $2,077.0 $2,200.4 $1,859.1
Loans held for sale or investment..................... 43.5 45.2 48.2 19.6
------------------------------------------------------------
Ending managed receivables............................ $2,380.0 $2,122.2 $2,248.6 $1,878.7
============================================================
Accounts 31+ days past due............................ $ 35.7 $ 32.0 $ 31.4 $ 27.6
Past due accounts as a percentage of
ending managed receivables 1.50% 1.51% 1.40% 1.47%
Three Months Six Months
Ended August 31 Ended August 31
(In millions) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Average managed receivables............................... $ 2,364.8 $ 2,068.2 $ 2,332.3 $ 2,005.3
Credit losses on managed receivables...................... $ 5.3 $ 5.3 9.3 9.5
Annualized credit losses as a percentage of
average managed receivables........................... 0.90% 1.03% 0.80% 0.95%
Page 10 of 28
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
(In millions) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------------
o Proceeds from new securitizations............................ $297.0 $336.0 $672.5 $632.0
o Proceeds from collections reinvested in
revolving period securitizations......................... $167.4 $127.6 $311.4 $279.8
o Servicing fees received...................................... $ 6.1 $ 5.3 $ 12.0 $ 10.2
o Other cash flows received from retained interests:
Interest-only strip receivables.......................... $ 18.4 $ 18.9 $ 42.0 $ 35.7
Cash reserve releases, net............................... $ 1.1 $ 5.9 $ 10.9 $ 8.2
Proceeds from new securitizations. Proceeds from new securitizations
----------------------------------
represent receivables newly securitized through the warehouse facility
during the period. Previously securitized receivables that are periodically
refinanced through the warehouse facility or 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.
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.
For such agreements, 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 securitizations. At August 31, 2004, the company was in
compliance with these financial covenants, and the securitized receivables
were in compliance with these performance triggers.
5. Financial Derivatives
---------------------
The company enters into amortizing fixed-pay interest rate swaps relating
to its automobile loan receivable securitizations. Swaps are used to better
match funding costs to the fixed-rate receivables being securitized by
converting variable-rate financing costs in the warehouse facility to
fixed-rate obligations. During the second quarter of fiscal 2005, the
company entered into seven 40-month amortizing interest rate swaps with
initial notional amounts totaling approximately $334.0 million. The
amortized notional amount of all outstanding swaps related to the
automobile loan receivable securitizations was approximately $624.3 million
at August 31, 2004, and $551.8 million at February 29, 2004. The fair value
of swaps included in accounts payable totaled a net liability of $1.6
million at August 31, 2004, and $2.0 million at February 29, 2004.
Page 11 of 28
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.
6. Retirement Plans
----------------
The company has a noncontributory defined benefit pension plan (the
"pension plan") covering the majority of full-time employees. The company
also has an unfunded nonqualified plan (the "restoration plan") that
restores retirement benefits for certain senior executives who are affected
by the Internal Revenue Code limitations on benefits provided under the
pension plan. The liabilities for these plans are included in accrued
expenses and other current liabilities in the consolidated balance sheets.
The components of net pension expense were as follows:
Three Months Ended August 31
Pension Plan Restoration Plan Total
--------------- ---------------- ---------------
(In thousands) 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Service cost............................... $1,624 $1,382 $ 80 $ 58 $1,704 $1,440
Interest cost.............................. 538 420 54 31 592 451
Expected return on plan assets............. (386) (223) - - (386) (223)
Amortization of prior year
service cost........................... 9 9 - - 9 9
Recognized actuarial loss.................. 184 162 38 13 222 175
---------------------------------------------------------------------------
Net pension expense........................ $1,969 $1,750 $172 $102 $2,141 $1,852
===========================================================================
Six Months Ended August 31
Pension Plan Restoration Plan Total
--------------- ---------------- ---------------
(In thousands) 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Service cost............................... $3,308 $2,764 $160 $116 $3,468 $2,880
Interest cost.............................. 1,076 840 108 63 1,184 903
Expected return on plan assets............. (738) (446) - - (738) (446)
Amortization of prior year
service cost........................... 18 18 - - 18 18
Recognized actuarial loss.................. 368 324 76 26 444 350
---------------------------------------------------------------------------
Net pension expense........................ $4,032 $3,500 $344 $205 $4,376 $3,705
===========================================================================
The company contributed $1.3 million to the pension plan during the quarter
ended August 31, 2004, and $3.0 million during September 2004.
Contributions for the remainder of fiscal 2005 are currently estimated to
be $3.0 million.
Page 12 of 28
7. Earnings per Share
------------------
Reconciliations of the numerator and denominator of basic and diluted
earnings per share are presented below:
Three Months Six Months
Ended August 31 Ended August 31
(In thousands except per share data) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------------
Weighted average common shares.............................. 104,002 103,484 103,933 103,320
Dilutive potential common shares:
Options.................................................. 1,495 2,367 1,695 1,983
Restricted stock......................................... 15 13 15 10
---------------------------- --------------------------
Weighted average common shares
and dilutive potential common shares..................... 105,512 105,864 105,643 105,313
============================ ==========================
Net earnings available to common shareholders............... $ 29,859 $ 39,610 $ 65,189 $ 74,871
Basic net earnings per share................................ $ 0.29 $ 0.38 $ 0.63 $ 0.72
Diluted net earnings per share.............................. $ 0.28 $ 0.37 $ 0.62 $ 0.71
Certain options were outstanding and not included in the computation of
diluted earnings per share because the options' exercise prices were
greater than the average market price of the common shares. As of August
31, 2004, options to purchase 3,090,318 shares of common stock with
exercise prices ranging from $21.49 to $43.44 per share were outstanding
and not included in the calculation. As of August 31, 2003, options to
purchase 18,364 shares with exercise prices ranging from $35.23 to $43.44
per share were outstanding and not included in the calculation.
Page 13 of 28
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------------------------
The following Management's Discussion and Analysis ("MD&A") is provided as a
supplement to, and should be read in conjunction with, our audited consolidated
financial statements, the accompanying notes, and the MD&A included in the
company's Annual Report on Form 10-K for the fiscal year ended February 29,
2004.
In this discussion, "we," "our," "us," "CarMax," "CarMax, Inc.," and "the
company" refer to CarMax, Inc. and its wholly owned subsidiaries, unless the
context requires otherwise. Amounts and percentages in the tables may not total
due to rounding.
BUSINESS OVERVIEW
CarMax is the nation's leading specialty retailer of used vehicles. As of August
31, 2004, we operated 55 used car superstores in 26 markets, including 8 large
markets and 18 mid-sized markets. We also operated 11 new car franchises, all of
which were integrated or co-located with our used car superstores. During the
twelve month period ended August 31, 2004, we sold 230,653 used cars,
representing 91% of the total 252,169 vehicles sold during that period.
Prior to October 1, 2002, CarMax was a wholly owned subsidiary of Circuit City
Stores, Inc. ("Circuit City"). On that date, CarMax was separated from Circuit
City through a tax-free transaction. As a result of the separation, CarMax, Inc.
became an independent, separately traded public company.
The CarMax consumer offer is unique in the auto retailing marketplace. It gives
consumers a way to shop for cars the same way they shop for items at other
"big-box" retailers. Our consumer offer is structured around four core equities,
including low, no-haggle prices; a broad selection; high quality; and
customer-friendly service. We generate revenues, income, and cash flows by
retailing used and new vehicles and associated items including vehicle
financing, extended warranties, and vehicle repair service. Most of the used
vehicles we sell are purchased directly from consumers. Vehicles purchased
through our appraisal process that do not meet our retail standards are sold at
on-site wholesale auctions. Vehicle financing for prime-rated customers is
provided through CarMax Auto Finance ("CAF") and Bank of America. We provide
financing for nonprime-rated customers through three third-party lenders and
financing for subprime-rated customers through a new third-party finance
provider, Drive Financial Services, LP ("Drive"). Drive was rolled out to our
entire store base during the first half of August 2004, following more than nine
months of testing in selected stores. We periodically test additional
third-party lenders.
We are still at an early stage in the national rollout of our retail concept. We
believe that the primary drivers for our earnings growth will be increased
vehicle unit sales from comparable stores and from new stores as we expand
geographically. In fiscal 2005, we plan to open nine superstores, representing
an approximate 18% increase in our store base. During the quarter ended August
31, 2004, we opened three superstores.
Fiscal 2005 Second Quarter Highlights
- -------------------------------------
In the second quarter of fiscal 2005, net sales and operating revenues increased
to $1.32 billion from $1.24 billion in the second quarter of fiscal 2004. Net
earnings were $29.9 million, or $0.28 per share, for this year's second quarter,
compared with $39.6 million, or $0.37 per share, in the prior year's quarter.
The 7% increase in net sales and operating revenues reflected:
o Sales from the eleven new stores not yet included in the comparable store
base, partially offset by a 7% decline in comparable store used unit sales.
Page 14 of 28
o A 35% increase in wholesale vehicle sales, driven largely by improvements
in the rate of appraisal purchases completed per appraisal offers made and
higher wholesale prices.
Our gross profit margin declined to 12.3% from 13.2%, as continued volatility in
the used vehicle market and slower inventory turns put downward pressure on used
vehicle margins. A change in our appraisal cost recovery ("ACR") methodology,
implemented in the second quarter of fiscal 2004, partially offset the decline
in used vehicle gross margins and provided an increase in wholesale vehicle
gross margins. Other sales and revenues margins reflect lower service margins
resulting from the slower used vehicle sales pace and the discounts associated
with the new subprime lender. CAF income declined to $20.7 million from $22.7
million due to the anticipated impact of our funding costs rising more rapidly
than rates charged to consumers. Selling, general, and administrative expenses
as a percentage of sales (the "SG&A ratio") increased to 10.2% in the second
quarter of fiscal 2005 compared with 9.8% in last year's second quarter due to
the deleveraging effect of the comparable store used unit sales decline.
Net cash provided by operations was $67.7 million in the first six months of
fiscal 2005 compared with $118.0 million in the same period last year. The
decline related primarily to changes in inventory. In the first six months of
this fiscal year, inventories increased due to the increase in the store base
and due to a shift in the timing of Labor Day weekend. Also, a
higher-than-normal inventory balance at the beginning of fiscal 2004 contributed
to a decrease in inventories by the end of the second quarter of fiscal 2004
despite new store openings. During the second quarter of fiscal 2005, we
completed the sale-leaseback of two stores for proceeds of approximately $21.1
million.
FORWARD-LOOKING STATEMENTS
The company cautions readers that the statements contained in MD&A 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 29, 2004, 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.
2004 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 29, 2004. These
policies relate to the calculation of the fair value of retained interests in
securitization transactions, revenue recognition, income taxes, the defined
benefit retirement plan, 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 15 of 28
Net Sales and Operating Revenues
- --------------------------------
Components of net sales and operating revenues were as follows:
Three Months Six Months
Ended August 31 Ended August 31
(In millions) 2004 % 2003 % 2004 % 2003 %
- ------------------------------------------------------------------------------------------------------------------------------
Used vehicle sales..................... $ 987.4 74.6 $ 938.7 75.9 $1,972.7 74.5 $1,828.9 75.9
New vehicle sales...................... 137.5 10.4 139.6 11.3 274.3 10.4 276.0 11.5
Wholesale vehicle sales................ 152.1 11.5 113.0 9.1 309.0 11.7 213.7 8.9
Other sales and revenues:
Extended warranty revenues.......... 20.7 1.6 21.0 1.7 41.8 1.6 41.0 1.7
Service department sales............ 21.4 1.6 17.7 1.4 41.8 1.6 34.1 1.4
Third-party finance fees............ 4.4 0.3 5.5 0.4 8.9 0.3 10.3 0.4
Appraisal purchase
processing fees..................... -- -- 0.9 0.1 -- -- 5.3 0.2
-------------------------------------------------------------------------------------
Total other sales and revenues......... 46.5 3.5 45.1 3.7 92.5 3.5 90.7 3.8
-------------------------------------------------------------------------------------
Total net sales and operating
revenues............................ $ 1,323.5 100.0 $ 1,236.5 100.0 $2,648.5 100.0 $2,409.3 100.0
=====================================================================================
Retail vehicle unit and dollar changes for the second quarter and first six
months of fiscal 2005 and 2004 were as follows:
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
-------------------------------------------------------
Vehicle units:
Used vehicles.......................... 4 % 18 % 6 % 20 %
New vehicles........................... (1)% (10)% (1)% (4)%
Total ...................................... 3 % 15 % 5 % 18 %
Vehicle dollars:
Used vehicles.......................... 5 % 20 % 8 % 20 %
New vehicles........................... (1)% (8)% (1)% (3)%
Total ...................................... 4 % 15 % 7 % 16 %
Comparable store used unit sales growth is one of the key drivers of our
profitability. A CarMax store is included in comparable store retail sales in
the store's fourteenth full month of operation. Comparable store retail unit and
dollar sales changes for the second quarter and first six months of fiscal 2005
and 2004 were as follows:
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
-------------------------------------------------------
Vehicle units:
Used vehicles.......................... (7)% 6 % (5)% 8 %
New vehicles........................... 13 % (9)% 12 % (4)%
Total ...................................... (5)% 4 % (3)% 7 %
Vehicle dollars:
Used vehicles.......................... (6)% 7 % (3)% 8 %
New vehicles........................... 13 % (8)% 12 % (3)%
Total ...................................... (4)% 5 % (1)% 6 %
Page 16 of 28
Used Vehicle Sales. The increases in used vehicle sales for the second quarter
- -------------------
and first six months of fiscal 2005 reflect the growth in our store base,
partially offset by a decline in used vehicle comparable store sales. The
widespread volatility and softness in our used car business that began in April
2004 continued throughout the second quarter of fiscal 2005. We believe these
effects occurred broadly across the late model used car market. We believe
current economic factors, such as higher gas prices, have contributed to the
softer market environment. In addition, we believe the unusually intense and
volatile competition among new car manufacturers led to unpredictable incentive
behavior throughout the peak summer selling season, which made it difficult for
the wholesale used car market to be as efficient as normal in adjusting to
changes in new car pricing.
Our sales softness in the second quarter was aggravated by the severe weather
experienced in the southeastern United States in August. A calendar shift that
moved the Saturday and Sunday of the traditionally strong Labor Day weekend from
the second quarter in fiscal 2004 to the third quarter in fiscal 2005 may have
also contributed to our decline in comparable store sales. Despite the sales
softness, we believe that we are maintaining or gaining used car market share.
New Vehicle Sales. We reported strong growth in comparable store new vehicle
- ------------------
sales in both the second quarter and the first six months of fiscal 2005,
reflecting the strength of the principal brands we represent - DaimlerChrysler,
Nissan, and Toyota. Total new car sales declined modestly, however, as the
comparable store sales increases were more than offset by the impact of having
disposed of four new car franchises during fiscal 2004 and the Laurel Mitsubishi
new car franchise during the second quarter of fiscal 2005.
Wholesale Vehicle Sales. Similar to the first quarter, the second quarter
- ------------------------
increase in wholesale vehicle sales was due in large part to enhancements to our
systems support for buyers and the processes that our sales consultants use to
deliver appraisals to customers. We believe that these enhancements have
contributed to the continuing increase in our rate of appraisal purchases
completed per appraisal offers made. Additionally, the expansion of the
company's store base and higher average wholesale prices added to the wholesale
vehicle sales increase.
Other Sales and Revenues. Other sales and revenues include extended warranty
- -------------------------
revenues, service department sales, third-party finance fees, and, through the
second quarter of fiscal 2004, appraisal purchase processing fees collected from
customers on the purchase of their vehicles.
Appraisal purchase processing fees were designed to cover some of the costs of
our appraisal and wholesale operations. During the first quarter of fiscal 2004,
we tested an alternative method for recovering these costs, and during the
second quarter of fiscal 2004, the appraisal purchase processing fees were
discontinued across our entire store base. Under the revised ACR method, instead
of charging the customer the appraisal purchase processing fee, we adjust the
price of our purchase offer to allow for full recovery of our costs, thereby
reducing the acquisition costs of used and wholesale vehicles and increasing
used vehicle and wholesale vehicle gross margins. The intent of changing to this
method is to recover all costs, including the related costs of land where we
hold vehicles before their sale at the wholesale auctions.
Overall, other sales and revenues were relatively flat as growth in service
revenues was offset by a decrease in third-party finance fees and by the
elimination of the appraisal purchase processing fee in the second quarter of
fiscal 2004. Service revenues and third-party finance fees benefited from the
growth in the store base. However, third-party finance fees were reduced by
discounts associated with a new subprime lender, which was rolled out to all of
the used car superstores in August 2004. As is customary in the industry,
subprime loan contracts are purchased from the company at a discount.
Page 17 of 28
Supplemental information related to vehicle sales follows:
Retail Unit Sales
- -----------------
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
--------------------------- ----------------------------
Used vehicles............................... 62,396 60,150 124,749 118,195
New vehicles................................ 5,756 5,842 11,600 11,725
--------------------------- ----------------------------
Total ...................................... 68,152 65,992 136,349 129,920
=========================== ============================
Average Retail Selling Prices
- -----------------------------
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
------------------------------ ------------------------------
Used vehicles............................... $15,693 $15,484 $15,678 $15,377
New vehicles................................ $23,706 $23,723 $23,463 $23,392
Weighted average............................ $16,370 $16,214 $16,340 $16,100
Retail Vehicle Sales Mix
- ------------------------
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
--------------------------- -----------------------------
Vehicle units:
Used vehicles......................... 92% 91% 91% 91%
New vehicles.......................... 8 9 9 9
--------------------------- ----------------------------
Total....................................... 100% 100% 100% 100%
=========================== ============================
Vehicle dollars:
Used vehicles......................... 88% 87% 88% 87%
New vehicles.......................... 12 13 12 13
--------------------------- ----------------------------
Total....................................... 100% 100% 100% 100%
=========================== ============================
Retail Stores. In the second quarter of fiscal 2005, CarMax opened three superstores, entering the Austin, Tex.,
- --------------
market with a standard superstore and adding satellite superstores in Winston-Salem, N.C., in the Greensboro market,
and in Fayetteville, N.C., in the Raleigh market.
The following tables provide detail on the CarMax retail stores and new car
franchises:
Estimate
Store Mix Feb. 28, 2005 August 31, 2004 Feb. 29, 2004 August 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------
Mega superstores(1).......................... 13 13 13 13
Standard superstores(2)...................... 29 28 24 22
Satellite superstores(3)..................... 16 14 12 9
Co-located new car stores.................... 3 3 3 2
Stand-alone new car stores................... 0 0 0 2
---------------------------------------------------------------------------
Total........................................ 61 58 52 48
===========================================================================
(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
Page 18 of 28
Estimate
New Car Franchises Feb. 28, 2005 August 31, 2004 Feb. 29, 2004 August 31, 2003
- -----------------------------------------------------------------------------------------------------------------------------
Integrated/co-located
new car franchises...................... 7 11 12 13
Stand-alone new car franchises............... 0 0 0 2
-----------------------------------------------------------------------------
Total........................................ 7 11 12 15
=============================================================================
Gross Profit Margin
- -------------------
Gross profit margin and gross profit per unit were as follows:
Three Months Six Months
Ended August 31 Ended August 31
2004 2003 2004 2003
%(1) $ per unit(2) %(1) $ per unit(2) %(1) $ per unit(2) %(1) $ per unit(2)
--------------------------------------- ---------------------------------------
Used vehicle gross profit margin............ 11.7 1,846 11.9 1,860 11.7 1,855 11.5 1,781
New vehicle gross profit margin............. 3.7 890 4.0 959 3.6 859 3.9 909
Wholesale vehicle gross profit margin....... 11.0 406 10.0 334 11.3 423 9.8 333
Other gross profit margin................... 56.3 385 76.0 520 58.7 398 75.9 530
-------------------------------------- ---------------------------------------
Total gross profit margin................... 12.3 2,395 13.2 2,472 12.5 2,423 12.9 2,393
====================================== =======================================
(1) Calculated as a percentage of its respective sales or revenue.
(2) Calculated as category gross profit dollars divided by the respective units
sold, except the other and total categories, which are divided by total retail
units sold.
Used Vehicle Gross Profit Margin. The modest decline in the used vehicle gross
- ---------------------------------
profit per unit in the second quarter of fiscal 2005 compared with the same
period in the prior year resulted from the generally slower sales environment,
partially offset by the change in the ACR methodology made in the second quarter
of fiscal 2004. During June and July 2004, we maintained inventory at a level
higher than the sales pace in order to be able to take advantage of a potential
upturn in sales during the peak sales months of the summer. The higher inventory
levels reduced our inventory turns and pressured gross margin. For the six
months ended August 31, 2004, compared with the prior year, used vehicle gross
profit per unit increased as the effect of the new ACR methodology more than
offset the impact of the soft sales environment.
New Vehicle Gross Profit Margin. New vehicle gross profit per unit for the three
- --------------------------------
months and six months ended August 31, 2004, decreased slightly, compared with
the same periods in the prior year, as a result of the heightened competitive
market with strong manufacturers' incentives.
Wholesale Vehicle Gross Profit Margin. As compared with the same periods last
- --------------------------------------
year, the wholesale vehicle gross profit per unit for the three and six month
periods ended August 31, 2004, increased primarily as a result of the
implementation of our new ACR methodology.
Other Gross Profit Margin. The lower gross margin on other sales and revenues
- --------------------------
for the three and six month periods ended August 31, 2004, as compared with the
same periods last year, resulted primarily from lower service margins and the
effect of the subprime lender's discount on third-party finance fee revenue. The
decrease in service margins reflects the slower sales pace and the associated
deleveraging of service and reconditioning overhead.
Page 19 of 28
CarMax Auto Finance Income
- --------------------------
CAF's lending business is limited to providing prime auto loans for our 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 believe 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 our 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 us the opportunity to capture additional
profits and cash flows from auto loan receivables while managing our 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 second quarter and first six months of fiscal 2005 and 2004,
respectively, CarMax Auto Finance income was as follows:
Three Months Ended August 31 Six Months Ended August 31
(In millions) 2004 % 2003 % 2004 % 2003 %
- ------------------------------------------------------------------------------------------------------------------------------
Gains on sales of loans(1)........................ $ 14.9 3.9 $ 18.3 4.8 $ 30.5 3.7 $ 37.9 5.1
----------------------------------- ------------------------------------
Other income: (2)
Servicing fee income......................... 6.1 1.0 5.4 1.0 12.1 1.0 10.5 1.0
Interest income.............................. 4.4 0.7 3.9 0.8 9.4 0.8 9.1 0.9
----------------------------------- ------------------------------------
Total other income................................ 10.5 1.8 9.4 1.8 21.5 1.8 19.5 1.9
----------------------------------- ------------------------------------
Direct expenses: (2)
CAF payroll and fringe benefit expense....... 2.3 0.4 2.0 0.4 4.4 0.4 4.0 0.4
Other direct CAF expenses.................... 2.4 0.4 3.0 0.6 4.9 0.4 5.1 0.5
----------------------------------- ------------------------------------
Total direct expenses............................. 4.7 0.8 5.0 1.0 9.4 0.8 9.0 0.9
----------------------------------- ------------------------------------
CarMax Auto Finance income (3).................... $ 20.7 1.6 $ 22.7 1.8 $ 42.6 1.6 $ 48.4 2.0
=================================== ====================================
Loans sold........................................ $ 383.4 $ 378.3 $ 820.4 $ 736.3
Average managed receivables....................... $ 2,364.8 $ 2,068.2 $ 2,332.3 $ 2,005.3
Net sales and operating revenues.................. $ 1,323.5 $ 1,236.5 $ 2,648.5 $ 2,409.3
Ending managed receivable balance................. $ 2,380.0 $ 2,122.2 $ 2,380.0 $ 2,122.2
Percent columns indicate:
(1) Percent of loans sold
(2) Annualized percent of averaged managed receivables
(3) Percent of net sales and operating revenues
CAF originates automobile loans to CarMax customers at competitive market rates
of interest. The majority of the 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 4 of the Notes to Consolidated
Financial Statements. A gain, recorded at the time of the securitization
transaction, results from recording a receivable approximately 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 second quarter, CAF income decreased to $20.7 million from $22.7 million
in last year's second quarter. For the first six months, CAF income decreased to
$42.6 million in fiscal 2005 from $48.4 million in fiscal 2004. As anticipated,
these decreases in CarMax Auto Finance income resulted primarily from a return
Page 20 of 28
to more normal gain spread levels, as CAF's cost of funds has increased more
rapidly than consumer loan rates during the first half of this year. For the
three and six month periods, the gain as a percent of loans sold was 3.9% and
3.7%, respectively, in fiscal 2005 compared with 4.8% and 5.1%, respectively, in
fiscal 2004. On a normalized basis, we expect the gains as a percent of loans
sold in the range of 3.5% to 4.5%. The decrease in the gain on sales of loans
was partially offset by an increase in other income, which includes servicing
fee income and interest income, in both the second quarter and the first six
months of fiscal 2005. The increase in other income was proportionate to the
increase in managed receivable for both periods. The decrease in other direct
expenses during the second quarter of fiscal 2005 reflects expenses incurred in
the second quarter of the prior year related to establishing a shelf
registration of asset-backed securities for public securitization.
For the second quarter, CAF income was also adversely affected by a decline in
CAF loans originated as a percent of total used vehicle sales. We believe this
resulted from a lower mix of prime-rated customers in our traffic flow, as high
new car incentives may have diverted some of these customers.
In May 2004, CAF exercised its option to repurchase the remaining balance
outstanding related to the 2001-1 securitization and sold the underlying
receivables into the warehouse facility. These loans carried relatively high
interest rates as they were originated over three years ago when interest rates
were higher than they are today. The high interest rates combined with a
relatively low short-term funding cost resulted in an earnings benefit of
approximately 1 cent per share when the remaining loans were sold into the
warehouse facility. This benefit was included in the first quarter gains on
loans sold.
We are at risk for the performance of the managed securitized receivables to the
extent that we maintain 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 29 or 28
(In millions) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
Loans securitized.......................................... $2,336.5 $2,077.0 $2,200.4 $1,859.1
Loans held for sale or investment.......................... 43.5 45.2 48.2 19.6
------------------------------------------------------------
Ending managed receivables................................. $2,380.0 $2,122.2 $2,248.6 $1,878.7
=============================================================
Accounts 31+ days past due................................. $ 35.7 $ 32.0 $ 31.4 $ 27.6
Past due accounts as a percentage of
ending managed receivables.............................. 1.50% 1.51% 1.40% 1.47%
Three Months Six Months
Ended August 31 Ended August 31
(In millions) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
Average managed receivables................................ $2,364.8 $2,068.2 $2,332.3 $2,005.3
Credit losses on managed receivables....................... $ 5.3 $ 5.3 $ 9.3 $ 9.5
Annualized credit losses as a percentage of
average managed receivables............................. 0.90% 1.03% 0.80% 0.95%
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. Annualized losses as a percentage of average managed receivables
decreased for the three and six month periods ended August 31, 2004, compared to
the same periods in fiscal 2004. This change reflects both a decrease in the
rate of defaults as well as an increase in recovery rates.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general, and administrative expenses as a percentage of sales and
operating revenues were 10.2% in the second quarter of fiscal 2005 compared with
9.8% in the second quarter of the prior year. For the six months ended August
31, 2004, the SG&A ratio increased to 10.0% from 9.8% for the same period in the
Page 21 of 28
prior fiscal year. These increases were due to the deleveraging impact of lower
comparable store used unit sales experienced during the first two quarters of
fiscal 2005.
Income Taxes
- ------------
The effective income tax rate was 39.0% in the second quarter and first six
months of fiscal 2005 and 38.5% in the same periods of fiscal 2004. The increase
resulted from geographic expansion into states with higher tax rates, including
having a larger percentage of stores located in unitary tax states.
Operations Outlook
- ------------------
In addition to the four standard-sized superstores and two satellite superstore
opened thus far in fiscal 2005, we plan to open one standard superstore and two
satellite superstores during the balance of the fiscal year, bringing total
fiscal 2005 store openings to nine.
In September 2004, we returned our Mitsubishi franchise in Atlanta, Ga., to the
manufacturer. During the last half of fiscal 2005, we plan to sell our Ford
franchise in Kenosha, Wis., and we plan to sell or return our remaining two
Mitsubishi new car franchises. The sale or return of integrated new car
franchises creates more space for used car sales expansion, which is more
profitable for us.
We continue to believe that comparable store used unit sales growth is a primary
driver of CarMax's profitability. We anticipate comparable store used vehicle
unit sales in the range of -8% to -2% for the third quarter and net earnings per
share for the third quarter in the range of 12 cents to 17 cents. We have chosen
to provide significantly wider ranges for the third quarter's comparable store
unit performance and earnings per share expectations due to the amount of sales
volatility we may continue to experience, compounded by the always challenging
new car model year changeover period. We have also chosen not to provide our
outlook for the fourth quarter until we see a more consistent trend that would
allow us to issue an updated forecast.
CAF's income will continue to be affected by changes in the interest rate
environment. For the balance of the year, we expect that CAF gain spreads will
be at the lower end of the 3.5% to 4.5% normalized range.
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
Operating Activities. For the first six months of fiscal 2005, CarMax generated
- ---------------------
cash from operating activities of $67.7 million. In the same period last year,
CarMax generated cash from operating activities of $118.0 million. The decline
in cash provided by operating activities resulted primarily from changes in
inventory, partially offset by a decrease in automobile loan receivables held
for sale.
Inventory increased $26.0 million in the first half of fiscal 2005, primarily as
a result of the opening of six stores since the beginning of the year. Inventory
declined by $57.0 million in the first six months of fiscal 2004, reflecting a
higher-than-normal inventory balance at the start of that year resulting from
weather-impeded sales in February 2003 and a return to more normal levels by the
end of the second quarter, as well as the disposition of two new car franchises.
The shift in the timing of the Labor Day weekend from the second quarter in
fiscal 2004 to the third quarter in fiscal 2005, also contributed to the current
year increase in inventory, as the August 31, 2004, inventory balance included
an amount projected to support the upcoming Labor Day weekend sales. We target
having our lowest inventory position of the year during the week following Labor
Day, in order to minimize the inherent inventory risk associated with the new
car model year changeover in the fall. Inventory was at target levels at the end
of the second quarter.
Page 22 of 28
Automobile loan receivables held for sale decreased by $15.6 million in the
first half of fiscal 2005 compared with a $16.8 million increase in the first
half of fiscal 2004. The amount of receivables held for sale is highly dependent
on the timing of the quarter-end relative to the dates of the securitization
transactions.
Investing Activities. Net cash used in investing activities was $75.0 million in
- ---------------------
the six months ended August 31, 2004, compared with $57.8 million in the first
six months of last fiscal year. Capital expenditures were $118.6 million and
$82.7 million for the six months ended August 31, 2004 and 2003, respectively.
The increase in capital expenditures reflects the increase in our store base
associated with our growth plan. In the six months ended August 31, 2004, the
company received proceeds of approximately $40 million associated with the
sale-leaseback of three properties. These transactions were structured as
operating leases with initial lease terms of 20 years with four, five-year
renewal options.
Financing Activities. Net cash provided by financing activities was $2.2 million
- ---------------------
in the first six months of fiscal 2005, compared with net cash used of $49.5
million in the first six months of last fiscal year. In the first six months of
fiscal 2005, we increased total outstanding debt by $0.2 million. In the first
six months of fiscal 2004, we utilized cash generated from operations to reduce
total outstanding debt by $52.7 million.
The aggregate principal amount of automobile loan receivables funded through
securitizations, which are discussed in Notes 3 and 4 of the Notes to
Consolidated Financial Statements, totaled $2.34 billion at August 31, 2004, and
$2.08 billion at August 31, 2003. At August 31, 2004, the warehouse facility
limit was $825 million and unused warehouse capacity totaled $200 million. In
June 2004, the warehouse facility was renewed and the expiration date was
extended to June 2005. In October 2004, the company completed a public
securitization of automobile loan receivables. The total value of the automobile
loan receivables securitized through this public offering was $550 million. We
anticipate that we will be able to renew, expand, or enter into new
securitization arrangements to meet the future needs of the automobile loan
finance operation.
The company maintains a $300 million credit facility secured by vehicle
inventory. As of August 31, 2004, the amount outstanding under this credit
facility was $104.6 million, with the remainder fully available to the company.
This facility expires in May 2006.
We expect that proceeds from securitization transactions; sale-leaseback
transactions; current and, if needed, additional credit facilities; and cash
generated by operations will be sufficient to fund capital expenditures and
working capital for the foreseeable future.
Page 23 of 28
ITEM 3.
QUANTITATIVE AND QUALITATIVE
----------------------------
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Market Risk
Automobile Installment Loan Receivables. At August 31, 2004, and February 29,
- ----------------------------------------
2004, 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 5 of the
Notes to 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, 2004, and February 29, 2004, was as follows:
(In millions) August 31 February 29
- ----------------------------------------------------------------------------------------------------------------
Fixed-rate securitizations............................................ $1,711.5 $1,647.9
Floating-rate securitizations
synthetically altered to fixed................................... 624.3 551.8
Floating-rate securitizations......................................... 0.7 0.7
Held for investment (1)............................................... 40.3 29.4
Held for sale (2)..................................................... 3.2 18.8
-------------------------------------
Total................................................................. $2,380.0 $2,248.6
=====================================
(1) The majority is held by a bankruptcy-remote special purpose entity.
(2) Held by a bankruptcy-remote special purpose entity.
Interest Rate Exposure. We also are exposed to 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 results of operations or cash
flows for the three months and six months ended August 31, 2004.
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 Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the 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 the 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
end of such period. There was no change in the company's internal control over
financial reporting that occurred during the quarter ended August 31, 2004, 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 4. Submission of Matters to a Vote of Security Holders
The company held an annual meeting of shareholders on June 29,
2004. Information on the matters voted upon and the votes cast
with respect to each matter was previously reported in the
company's Quarterly Report on Form 10-Q for the quarter ended May
31, 2004.
Item 6. 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. Articles of Amendment to the Amended and
Restated Articles of Incorporation, effective June 6, 2002,
filed as Exhibit 3.2 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 June 29, 2004,
filed as Exhibit 3.3 to CarMax's Quarterly Report on Form
10-Q, filed July 12, 2004 (File No. 1-31420), incorporated
herein by this reference.
10.1 Form of Employment Agreement between CarMax, Inc. and
certain executive officers including Austin Ligon,
Thomas J. Folliard, Keith D. Browning, Michael K. Dolan, and
Joseph S. Kunkel, 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 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
October 8, 2004
Page 27 of 28
EXHIBIT INDEX
-------------
10.1 Form of Employment Agreement between CarMax, Inc. and
certain executive officers including Austin Ligon,
Thomas J. Folliard, Keith D. Browning, Michael K. Dolan,
and Joseph S. Kunkel, 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 28 of 28