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| KMX > SEC Filings for KMX > Form 10-Q on 15-Jul-2003 | All Recent SEC Filings |
15-Jul-2003
Quarterly Report
In this discussion, "we," "our," "CarMax," "CarMax, Inc." and "the company" refer to CarMax, Inc. and its wholly owned subsidiaries, unless the context requires otherwise. Amounts and percents in the tables may not total due to rounding.
CarMax was formerly a wholly owned subsidiary of Circuit City Stores, Inc. ("Circuit City Stores"). On September 10, 2002, the Circuit City Stores shareholders, which included Circuit City Stores, Inc.-Circuit City Group Common Stock shareholders and Circuit City Stores, Inc.-CarMax Group Common Stock shareholders, approved the separation of the CarMax business from Circuit City Stores, and the Circuit City Stores board of directors authorized the redemption of the CarMax Group Common Stock and the distribution of CarMax, Inc. common stock to effect the separation. The separation was effective October 1, 2002. Each outstanding share of CarMax Group Common Stock was redeemed in exchange for one share of CarMax, Inc. common stock. In addition, each holder of Circuit City Group Common Stock received, as a tax-free distribution, a 0.313879 share of CarMax, Inc. common stock for each share of Circuit City Group Common Stock owned as of September 16, 2002, the record date for the distribution. As a result of the separation, all of the businesses, assets and liabilities of the CarMax Group are now held in CarMax, Inc., an independent, separately traded public company.
CRITICAL ACCOUNTING POLICIES
For a discussion of our critical accounting policies see "Critical Accounting Policies" in Management's Discussion and Analysis included in the CarMax, Inc. 2003 Annual Report to Shareholders, filed as Exhibit 13.1 to the company's annual report on Form 10-K for the fiscal year ended February 28, 2003. These policies relate to the calculation of the fair value of retained interests in securitization transactions, revenue recognition, defined benefit retirement plans and insurance liabilities.
RESULTS OF OPERATIONS
Reclassifications. Certain prior year amounts have been reclassified to conform to the current year's presentation. Prior to the third fiscal quarter ended November 30, 2002, income generated by CAF and third-party finance fee income were recorded as reductions to selling, general and administrative expenses. The company currently presents CAF income as a separate line item in the consolidated statements of earnings, and third-party finance fees are reported as a component of other sales and revenues. For the three months ended May 31, 2002, CAF income was $19.8 million and third-party finance fee income was $4.2 million. These reclassifications increased last year's first quarter selling, general and administrative expenses by $24.0 million and other sales and revenues by $4.2 million. An additional reclassification increased selling, general and administrative expenses by $0.4 million. The reclassifications had no impact on the company's net earnings.
Seasonality. CarMax's operations, in common with other retailers in general, are subject to seasonal influences. Historically, CarMax has experienced more of its net sales in the first half of the fiscal year. The net earnings of any quarter are seasonally disproportionate to net sales since administrative and certain operating expenses remain relatively constant during the year. Therefore, quarterly results should not be relied upon as necessarily indicative of results for the entire fiscal year.
Net Sales and Operating Revenue -
Total sales for the first quarter of fiscal 2004 increased 17% to $1.17 billion from $1.01 billion in last year's first quarter.
Three Months Ended May 31
(Amounts in millions) 2003 % 2002 %
------------------------------------------------------------------------------------------------------------
Used vehicle sales........................................ $ 890.1 $ 737.8
New vehicle sales......................................... 136.4 132.3
-----------------------------------------------
Total retail vehicle sales................................ 1,026.5 87.5 870.1 86.5
Wholesale vehicle sales................................... 100.7 8.6 92.5 9.2Other sales and revenues:
Extended warranty revenue.............................. 19.9 16.7
Service department sales............................... 16.4 15.5
Appraisal purchase processing fees..................... 4.4 6.8
Third-party finance fees.............................. 4.8 4.2
-----------------------------------------------
Total other sales and revenues............................ 45.6 3.9 43.2 4.3
-----------------------------------------------
Total net sales and operating revenues.................... $ 1,172.8 100.0 $ 1,005.8 100.0
===============================================
Total Retail Vehicle Sales. Comparable store used unit sales growth is a primary driver of CarMax's profitability. For the first quarter ended May 31, 2003, the overall increase in retail sales is attributed to the growth in comparable store used unit sales and strong performance by the seven CarMax stores opened since April 2002, which are not included in quarterly comparable store sales. For the first quarter, we achieved comparable store used unit sales growth of 10%.
A CarMax store is included in comparable store retail sales after the store has been open for a full year (in the store's fourteenth full month of operation). Comparable store retail vehicle unit and dollar sales changes for the first quarter of fiscal 2004 and 2003 were as follows:
Three Months Ended May 31
2003 2002
---------------------------------
Vehicle units:
Used vehicles............ 10% 12 %
New vehicles............. 3% (4)%
Total....................... 9% 10 %
Vehicle dollars:
Used vehicles............ 9% 14 %
New vehicles............. 3% (4)%
Total....................... 8% 11 %
Wholesale Vehicle Sales. Part of CarMax's operating strategy is to build customer confidence and satisfaction by offering high-quality vehicles; therefore, fewer than half of the vehicles acquired through the appraisal process meet CarMax standards for reconditioning and subsequent retail sale. Those vehicles that do not meet CarMax's standards are sold at its own on-site wholesale auctions. The increase in wholesale vehicle sales is primarily the result of adding seven used superstores to the store base since April 2002, as well as increased customer response to CarMax's vehicle appraisal offer.
Other Sales and Revenues. Other sales and revenues include extended warranty - revenue, service department sales, appraisal purchase processing fees collected from customers for the purchase of their vehicles and third-party finance fees.
CarMax sells extended warranties on behalf of unrelated third parties who are the primary obligors. Under these third-party warranty programs, CarMax has no contractual liability to the customer. Extended warranty revenue represents commissions from the unrelated third parties. The increase in warranty revenue is a result of the strong sales growth for used cars, which achieve a higher extended warranty penetration rate than new cars.
Appraisal purchase processing fees collected from customers were designed to cover some of the costs of our appraisal and wholesale operations. During the first quarter of fiscal 2004, CarMax began testing an alternative method to recover additional costs related to the appraisal and wholesale operations. In these tests, instead of charging the customer an appraisal purchase processing fee, the company adjusts the amount of its purchase offer for the customer's vehicle to capture the total costs of the appraisal and wholesale operations. The first quarter tests resulted in a decrease in appraisal purchase processing fees versus last year; however, this decrease was offset by the increase in overall wholesale gross profit margin.
Supplemental information related to vehicle sales follows:
Retail Unit Sales -
Three Months Ended May 31
2003 2002
----------------------------------
Used vehicles......................... 58,045 47,310
New vehicles.......................... 5,883 5,736
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Total................................. 63,928 53,046
==================================
Average Retail Selling Prices
-
Three Months Ended May 31
2003 2002
---------------------------------
Used vehicles......................... $15,266 $15,500
New vehicles.......................... $23,063 $23,032
Total vehicles........................ $15,983 $16,314
Percent Retail Vehicle Sales
Three Months Ended May 31
2003 2002
---------------------------------
Vehicle units:
Used vehicles...................... 91% 89%
New vehicles....................... 9 11
---------------------------------
Total................................. 100% 100%
=================================
Vehicle dollars:
Used vehicles...................... 87% 85%
New vehicles....................... 13 15
---------------------------------
Total................................. 100% 100%
=================================
Retail Stores. In the first quarter of fiscal 2004, CarMax opened standard - superstores in Henderson (Las Vegas market), Nev. and Merriam (Kansas City market), Kan. In June 2003, CarMax added a standard superstore in the Birmingham, Ala. market and plans to add a satellite superstore in the Orlando, Fla. market in the second quarter of fiscal 2004.
The following table provides detail on the CarMax retail stores:
Estimate
Store Mix Feb. 28, 2004 May 31, 2003 Feb . 28, 2003 May 31, 2002
--------------------------------------------------------------------------------------------------------
Mega superstores(1)...................... 13 13 13 13
Standard superstores(2).................. 25 21 19 18
Prototype satellite stores(3)............ 11 8 8 5
Co-located new car stores................ 2 2 2 2
Stand-alone new car stores............... 0 2 2 2
--------------------------------------------------------------
Total.................................... 51 46 44 40
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(1) 70,000 to 95,000 square feet on 20 to 35 acres
(2) 40,000 to 60,000 square feet on 10 to 25 acres
(3) 10,000 to 20,000 square feet on 4 to 7 acres
Gross Profit Margin -
The total gross profit margin was 12.6% of sales in the first quarter of fiscal 2004 and 12.1% for the first quarter of fiscal 2003.
Three Months Ended May 31
2003 2002
%(1) $ per unit %(1) $ per unit
--------------------------------------------
Used vehicle gross profit margin................ 11.1 1,699 10.9 1,703
New vehicle gross profit margin................. 3.7 861 4.0 914
---------------------------------------------
Total retail vehicle gross profit margin........ 10.1 1,622 9.9 1,618
Wholesale vehicle gross profit margin........... 9.5 332 6.7 239
Other gross profit margin....................... 75.8 NM(2) 69.8 NM(2)
---------------------------------------------
Total gross profit margin....................... 12.6 NM(2) 12.1 NM(2)
=============================================
(1) Gross profit margin percentages are calculated as a percentage of their
respective sales or revenue
(2) Not meaningful
The new vehicle gross profit margin decline reflects an increased competitive environment in new cars in the first quarter compared with the same period in the prior year, requiring more aggressive pricing in order to drive sales unit volume.
The majority of the increase in the wholesale vehicle gross profit margin resulted from the tests of alternative methods to recover the costs of the wholesale operations, the impact of which was an increase in wholesale vehicle gross margins and a decrease in appraisal purchase processing fees in the first quarter of fiscal 2004.
The increase in other gross profit margin was primarily due to the increases in extended warranty sales and third-party finance fees as a percentage of other sales and revenues, partially offset by the decrease in the appraisal purchase processing fees.
CarMax Auto Finance Income
CarMax Auto Finance is the company's finance operation. CAF's lending business is limited to providing prime auto loans for CarMax's used and new car sales.
Because the purchase of an automobile traditionally is reliant on the consumer's ability to obtain on-the-spot financing, it is important to our business that such financing be available to credit-worthy customers. While financing can also be obtained from third-party sources, we are concerned that total reliance on third parties can create an unacceptable volatility and business risk. Furthermore, we believe that our processes and systems, the transparency of our pricing and vehicle quality provide a unique and ideal environment in which to procure high-quality auto loan receivables, both for CAF and for third-party lenders. CAF provides CarMax with the opportunity to capture additional profits and cash flows from auto loan receivables while managing the company's reliance on third-party finance sources.
CAF income does not include any allocation of indirect costs or income. We present this information on a direct basis to avoid making arbitrary decisions regarding the indirect benefit or costs that could be attributed to this operation. Examples of indirect costs not included are retail store expenses, retail financing commissions and corporate expenses such as human resources, administrative services, marketing, information systems, accounting, legal, treasury and executive payroll.
For the first quarter of fiscal 2004 and 2003, CarMax Auto Finance income was as follows:
Three Months Ended May 31 (Amounts in millions) 2003 % 2002 % --------------------------------------------------------------------------------------------
Gains on sales of loans(1)...................... $ 19.7 5.5 $ 15.6 5.5
------------------------------------------
Other income (2):
Servicing fee income....................... 5.1 1.1 4.1 1.1
Interest income............................ 5.1 1.1 3.6 0.9
------------------------------------------
Total other income.............................. 10.2 2.1 7.7 2.0
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Direct expenses (2)
CAF payroll and fringe benefit expense..... 1.9 0.4 1.7 0.4
Other direct CAF expenses.................. 2.1 0.4 1.8 0.5
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Total direct expenses........................... 4.1 0.8 3.5 0.9
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CarMax Auto Finance income (3).................. $ 25.7 2.2 $ 19.8 2.0
==========================================
Loans sold...................................... $ 358.0 $ 283.1
Average managed receivables..................... $ 1,942.5 $1,559.2
Net sales and operating revenues................ $ 1,172.8 $1,005.8
Ending managed receivable balance............... $ 1,992.9 $1,590.2
Percent columns indicate: (1) Percent of loans sold (2) Annualized percent of averaged managed receivables (3) Percent of net sales and operating revenues
CAF originates automobile loans to CarMax customers at competitive market rates of interest. The majority of the profit contribution from CAF is generated by the spread between the interest rate charged to the customer and the cost of funds. Substantially all of the loans originated by CAF each month are sold in securitization transactions as described in Note 7 to the company's consolidated financial statements. A gain results from recording a receivable equal to the present value of the expected residual cash flows generated by the securitized receivables. The cash flows are calculated taking into account expected prepayment and default rates.
CarMax Auto Finance income increased 30% in the first quarter of fiscal 2004 to $25.7 million from $19.8 million for the same period last year. Gains on sale of loans increased $4.1 million as a result of increased used vehicle sales. The increase in other income and total direct expenses was proportionate to the increase in the managed receivables over the same period last year.
The company is at risk for the performance of the securitized receivables managed to the extent that it maintains a retained interest in the receivables. Supplemental information on our portfolio of managed receivables is shown in the following tables:
As of May 31
As of February 28
(Amounts in millions) 2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------
Loans securitized.............................. $ 1,960.3 $ 1,569.7 $ 1,859.1 $ 1,489.4
Loans held for sale or investment.............. 32.6 20.5 19.6 13.9
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Ending managed receivables..................... $ 1,992.9 $ 1,590.2 $ 1,878.7 $ 1,503.3
=============================================================
Accounts 31+ days past due..................... $ 28.7 $ 21.2 $ 27.6 $ 22.3
Past due accounts as a percentage of
ending managed receivables................ 1.44% 1.33% 1.47% 1.48%
Three Months Ended May 31
(Amounts in millions) 2003 2002
------------------------------------------------------------------------------------------------------------
Average managed receivables.................................... $1,942.5 $1,559.2
Credit losses on managed receivables........................... $ 4.2 $ 3.3
Annualized losses as a percentage of
average managed receivables............................... 0.86% 0.85%
If the managed receivables do not perform in accordance with the assumptions used in determining the fair value of the gain receivable, earnings could be impacted. Despite the current weak economic environment, the managed receivables continue to perform in line with our expectations. Detail concerning the assumptions used to value the retained interests and the valuation's sensitivity to adverse changes in the performance of the managed receivables are included in Note 7 to the company's consolidated financial statements.
Selling, General and Administrative Expenses
The selling, general and administrative expense ratio was 9.9% of sales in the first quarter of fiscal 2004 and 9.3% of sales in the first quarter of fiscal 2003. The increase in the expense ratio for the first quarter of fiscal 2004 versus the first quarter of last fiscal year reflects the expected higher-level operating expenses associated with being a stand-alone company following our October 1, 2002, separation from Circuit City Stores. The incremental costs related to being a stand-alone company were approximately $5.5 million in the first quarter of fiscal 2004. Also as anticipated, preopening expenses increased because we opened two stores in the first quarter of this year compared with only one store opened in last year's first quarter.
Interest Expense
Interest expense increased to $0.8 million for the first quarter of fiscal 2004 from $0.7 million in the same period last year.
Income Taxes
The effective income tax rate decreased to 38.5% for the first quarter of fiscal 2004 from 39.5% for the first quarter of fiscal 2003. In the previous fiscal year, the effective tax rate was higher because the separation costs were not deductible.
Net Earnings
First quarter fiscal 2004 net earnings increased 21% to $35.3 million from $29.2 million in the first quarter of fiscal 2003. The increase in net earnings is a result of strong sales growth and the absence of expenses related to the separation from Circuit City Stores which was completed last fiscal year, offset by incremental costs of being a stand-alone company.
Operations Outlook
CarMax continues to demonstrate that its consumer offer and business model can produce strong sales and earnings growth. At the beginning of fiscal 2002, CarMax announced that it would resume geographic growth. In addition to the two standard-sized superstores opened in the first quarter and the standard-sized superstore opened in Birmingham, Ala. in June 2003, we plan to open approximately two standard-sized used car superstores and three prototype satellite superstores in fiscal 2004. In addition, in Los Angeles we intend to integrate our two remaining stand-alone franchises with a new used car superstore during the second half of fiscal 2004. We may also open a tenth store late in the fourth quarter. In April of fiscal 2004, we sold the Jeep franchise in Kenosha, Wis. In July of fiscal 2004, we returned the Mitsubishi new car franchise operating in Nashville, Tenn. to the manufacturer. We still plan to sell or return the remaining four Mitsubishi new car franchises during fiscal 2004. The sale of the Mitsubishi franchises, which are integrated with used car superstores, will create more space for used car sales expansion, which is more profitable for us.
Comparable store used unit sales growth is a primary driver of CarMax's profitability. We anticipate used vehicle unit comparable growth in the range of 6% to 8% for the second quarter and net earnings per share for the second quarter in the range of 33 cents to 35 cents. We reaffirm our belief that our used unit comparable sales growth will be in the range of 5% to 9% in fiscal 2004 and net earnings in the range of $105 million to $116 million. This forecast assumes the continuation of the reduced approval rates from our nonprime loan providers experienced in the fourth quarter of fiscal 2003. The expense leverage that we would normally expect from the comparable store used unit growth is estimated to be more than offset by the full year of incremental costs associated with being a stand-alone company and some additional costs related to our geographic growth. We estimate the ongoing, annual, full-year effect of being a stand-alone company to be approximately $20 to $22 million. In fiscal 2003, we incurred approximately $9 million of these incremental expenses following the October 1, 2002, separation. We expect the majority of the incremental $11 million to $13 million to be incurred in fiscal 2004 will occur during the first seven months fiscal 2004.
We also anticipate that our cost of funds through the second quarter of fiscal 2004 will remain roughly at first quarter levels which will again benefit CarMax Auto Finance. In the event that interest rates remain low, we would anticipate a more moderate reduction in yield spreads in order to maintain our competitive consumer offer. As the spread between the cost of funds and the retail interest rate paid by consumers ultimately returns to more normal levels, CAF's contribution as a percent of sales is expected to decrease.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must be applied for the first interim or annual period beginning after June 15, 2003. The company is currently analyzing the existing guidance and reviewing developments with regard to the proposed FASB Staff Position issued on the implementation of FIN No. 46 which is currently subject to public comment. Therefore, at this time, the company cannot determine whether the application of FIN No. 46 will affect its financial position, results of operations or cash flows.
In April 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies financial reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The company does not expect the application of the provisions of SFAS No. 149 to have a material impact on its financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The company does not expect the application of the provisions of SFAS No. 150 to have a material impact on its financial position, results of operations or cash flows.
FINANCIAL CONDITION
Liquidity and Capital Resources -
Operating Activities. For the first three months of fiscal 2004, CarMax - generated cash from operating activities of $72.6 million. In the same period last year, CarMax generated cash from operating activities of $9.1 million. The fiscal 2004 improvement primarily resulted from an increase in net earnings, an increase in accounts payable and accrued expenses associated with the separation from Circuit City Stores, and a decrease in inventory, partially offset by an increase in receivables. The increase in receivables was due to increased sales and the quarter end falling over a weekend. In previous years, certain liabilities such as the workers' compensation liability were recorded through the debt from our former parent and therefore were reflected as a financing activity. The decrease in inventory resulted from the higher mix of used to new vehicles on our lots. New car manufacturers generally require companies to hold approximately sixty days worth of inventory.
Investing Activities. Net cash used in investing activities was $34.9 million in - the three months ended May 31, 2003. In the first three months of last fiscal year, CarMax used $28.5 million in investing activities. The increase in capital expenditures resulted from continued geographic growth, with six superstores opening since May 2002, the planned opening of two superstores in the second quarter of fiscal 2004 and the planned opening of five or six additional stores in the second half of fiscal 2004.
Financing Activities. Net cash used in financing activities was $40.3 million in - the first three months of fiscal 2004, compared with net cash generated of $77.5 million in the first three months of last fiscal year. On May 17, 2002, CarMax entered into a $200 million credit agreement with DaimlerChrysler Services North America, LLC and Toyota Financial Services that is secured by vehicle inventory. During the fourth quarter of fiscal year 2003, the credit agreement was increased from $200 million to $300 million. The credit agreement includes a $200 million revolving loan commitment and a $100 million term loan. Principal is due in full at maturity with interest payable monthly at a LIBOR-based rate. The agreement is scheduled to terminate on May 17, 2005. The termination date of the agreement will be automatically extended one year each May 17 unless CarMax or either lender elects, prior to the next extension date, not to extend the agreement. As of May 31, 2003, the amount outstanding under this credit agreement was $114.5 million.
At May 31, 2003, the aggregate principal amount of securitized automobile loan receivables totaled $1.96 billion. During the first quarter of fiscal 2004, the company completed another public automobile loan receivables securitization. Unlike the company's previous public securitizations, which are supported by third-party insurance policies, this most recent transaction was the company's first using a senior-subordinated structure. This type of structure is not dependent on third-party insurance or other external credit support. Additionally, the current market conditions made a senior-subordinated arrangement more appealing to the company than another insured transaction. The total value of automobile loan receivables securitized through this public offering was $507.0 million. At May 31, 2003, the unused capacity of the warehouse facility was $487.0 million. In June 2003, the warehouse facility was renewed and now matures in June 2004. Also, the facility limit was increased to $825.0 million from $750.0 million. CarMax anticipates that it will be able to expand or enter into new securitization arrangements to meet the future needs of the automobile loan finance operation.
CarMax expects that proceeds from the credit agreement secured by vehicle inventory, additional credit facilities, if needed, sale-leaseback transactions and cash generated by operations will be sufficient to fund capital expenditures and working capital of the CarMax business for the foreseeable future.
FORWARD-LOOKING STATEMENTS
--------------------------
This report on Form 10-Q contains "forward-looking statements" within the
meaning of Section 21E of the Securities and Exchange Act of 1934 concerning our
current expectations, assumptions, estimates and projections about the future.
These forward-looking statements are subject to risks and uncertainties that
could cause our actual results to differ materially from those indicated in the
forward-looking statements. For a discussion of risks and uncertainties that may
affect CarMax's business, see Management's Discussion and Analysis "Cautionary
Information about Forward-Looking Statements" in the company's 2003 annual
report to shareholders, filed as Exhibit 13.1 to the company's annual report on
Form 10-K for the fiscal year ended February 28, 2003.
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