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| KMX > SEC Filings for KMX > Form 10-Q on 10-Jul-2008 | All Recent SEC Filings |
10-Jul-2008
Quarterly Report
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("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 our Annual Report on Form 10-K for the fiscal year ended February 29, 2008, as well as our consolidated financial statements and the accompanying notes included in this Form 10-Q.
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 tables may not total due to rounding. Certain prior year amounts have been reclassified to conform to the current presentation.
BUSINESS OVERVIEW
General
CarMax is the nation's largest retailer of used vehicles. We pioneered the used car superstore concept, opening our first store in 1993. Our strategy is to better serve the auto retailing market by addressing the major sources of customer dissatisfaction with traditional auto retailers and to maximize operating efficiencies through the use of standardized operating procedures and store formats enhanced by sophisticated, proprietary management information systems. As of May 31, 2008, we operated 95 used car superstores in 44 markets, comprised of 32 mid-sized markets, 11 large markets and 1 small market. We define mid-sized markets as those with television viewing populations generally between 600,000 and 2.5 million people. We also operated six new car franchises, all of which were integrated or co-located with our used car superstores. In fiscal 2008, we sold 377,244 used cars, representing 96% of the total 392,729 vehicles we sold at retail.
We believe the CarMax consumer offer is distinctive within the automobile retailing marketplace. Our offer provides customers the opportunity to shop for vehicles the same way they shop for items at other "big box" retailers. Our consumer offer is structured around our four customer benefits: low, no-haggle prices; a broad selection; high quality vehicles; and a customer-friendly sales process. Our website, carmax.com, is a valuable tool for communicating the CarMax consumer offer, a sophisticated search engine and an efficient channel for customers who prefer to conduct their shopping online. We generate revenues, income and cash flows primarily by retailing used vehicles and associated items including vehicle financing, extended service plans ("ESPs") and vehicle repair service.
We also generate revenues, income and cash flows from the sale of vehicles purchased through our appraisal process that do not meet our retail standards. These vehicles are sold through on-site wholesale auctions. Wholesale auctions are generally held on a weekly or bi-weekly basis, and as of May 31, 2008, we conducted auctions at 49 used car superstores. During fiscal 2008, we sold 222,406 wholesale vehicles. On average, the vehicles we wholesale are approximately 10 years old and have more than 100,000 miles. Participation in our wholesale auctions is restricted to licensed automobile dealers, the majority of whom are independent dealers and licensed wholesalers.
CarMax provides financing to qualified customers through CarMax Auto Finance ("CAF"), our finance operation, and a number of other third-party financing providers. We collect fixed, prenegotiated fees from the majority of the third-party providers, and we periodically test additional providers. CarMax has no recourse liability for the financing provided by these third parties.
We sell ESPs on behalf of unrelated third parties who are the primary obligors. We have no contractual liability to the customer under these third-party service plans. Extended service plan revenue represents commissions from the unrelated third parties.
We are still at a relatively early stage in the national rollout of our retail concept, and as of May 31, 2008, we had used car superstores located in markets that comprised approximately 45% of the U.S. population. While the impact of the current economic environment could cause us to adjust our plans on a temporary basis, in the long term, we plan to open used car superstores at a rate of approximately 15% of our used car superstore base each year, and expect comparable store used unit sales increases to average in the range of 4% to 8%. This range reflects the multi-year ramp in sales at newly opened stores as they mature, continued market share gains at stores that have reached basic maturity sales levels and the underlying industry sales growth. We estimate that our stores generally reach basic maturity sales levels in their fifth year of operation.
We believe the primary driver for future earnings growth will be vehicle unit sales growth, both from new stores and from stores included in our comparable store base. We target a dollar range of gross profit per used unit sold. The gross profit dollar target for an individual vehicle is based on a variety of factors, including its anticipated probability of sale and its mileage relative to its age; however, it is not based on the vehicle's selling price.
The principal challenges we face in expanding our store base include our ability to build our management bench strength to support store growth and our ability to procure suitable real estate at reasonable costs.
Fiscal 2009 First Quarter Highlights
††† We believe the slowdown in the economy, the dramatic rise in gasoline and food costs and the related impact on consumer spending adversely affected industry-wide sales in the automotive retail market in the first quarter.
††† Net sales and operating revenues increased 3% to $2.21 billion from $2.15 billion in the first quarter of fiscal 2008, while net earnings decreased 55% to $29.6 million, or $0.13 per share, from $65.4 million, or $0.30 per share.
††† Total used vehicle unit sales increased 10%, reflecting the combination of the growth in our store base and a 1% increase in comparable store used unit sales. Wholesale vehicle unit sales decreased 2%, reflecting a decrease in both our appraisal traffic and our appraisal buy rate (defined as appraisal purchases as a percent of vehicles appraised). New vehicle unit sales declined 26%, reflecting a combination of the softer new car industry trends and the sale of one of our new car franchises in the second quarter of fiscal 2008.
††† We opened six used car superstores in the first quarter, entering three new markets with four superstores and expanding our presence in two existing markets.
††† Our total gross profit per retail unit decreased $237 to $2,564 from $2,801 in the prior year's first quarter. The majority of the decline resulted from a $192 decrease in gross profit per used vehicle. Our used vehicle gross profit per unit was pressured by a combination of factors, including the slowing sales environment, the decline in our appraisal buy rate and the rapid decline in wholesale market values for SUVs and trucks that led us to take supplemental pricing markdowns on these vehicles.
††† CAF income decreased to $9.8 million from $37.1 million in the first quarter of fiscal 2008, reflecting the continuing effects of the disruption in global credit markets and the more challenging economic environment. CAF income for the first quarter of fiscal 2009 was reduced by $20.0 million for adjustments primarily related to increases in funding costs for loans originated during prior fiscal years, $14 million of which was anticipated.
††† Selling, general and administrative expenses as a percent of net sales and operating revenues (the "SG&A ratio") increased to 11.0% from 10.0% in the first quarter of fiscal 2008. The majority of this increase was expected, and it largely resulted from the combination of the modest level of comparable store used unit sales growth, our continued commitment to our store growth plan and the decline in the used vehicle average selling price. In addition, in the first quarter of fiscal 2009 we accrued costs related to litigation that reduced net earnings by $0.02 per share.
††† Net cash provided by operations increased to $79.4 million compared with $75.4 million in the first quarter of fiscal 2008, primarily reflecting the benefit of a decrease in inventories in fiscal 2009 partially offset by the decline in net earnings.
CRITICAL ACCOUNTING POLICIES
For a discussion of our critical accounting policies, see "Critical Accounting Policies" in MD&A included in Item 7 of the Annual Report on Form 10-K for the fiscal year ended February 29, 2008. These policies relate to securitization transactions, revenue recognition, income taxes and defined benefit retirement plan obligations.
RESULTS OF OPERATIONS
NET SALES AND OPERATING REVENUES
Three Months Ended May 31
(In millions) 2008 % 2007 %
Used vehicle sales $ 1,816.8 82.3 $ 1,708.4 79.6
New vehicle sales 82.1 3.7 112.6 5.2
Wholesale vehicle sales 242.3 11.0 261.2 12.2
Other sales and revenues:
Extended service plan revenues 36.5 1.7 33.9 1.6
Service department sales 24.5 1.1 24.1 1.1
Third-party finance fees, net 6.5 0.3 7.0 0.3
Total other sales and revenues 67.5 3.1 65.0 3.0
Total net sales and operating revenues $ 2,208.8 100.0 $ 2,147.1 100.0
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RETAIL VEHICLE SALES CHANGES
Three Months Ended May 31
2008 2007
Vehicle units:
Used vehicles 10 % 15 %
New vehicles (26 )% (5 )%
Total 9 % 14 %
Vehicle dollars:
Used vehicles 6 % 17 %
New vehicles (27 )% (5 )%
Total 4 % 15 %
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Comparable store used unit sales growth is one of the key drivers of our profitability. A store is included in comparable store retail sales in the store's fourteenth full month of operation.
COMPARABLE STORE RETAIL VEHICLE SALES CHANGES
Three Months Ended May 31
2008 2007
Vehicle units:
Used vehicles 1 % 6 %
New vehicles (18 )% (5 )%
Total 0 % 5 %
Vehicle dollars:
Used vehicles (3 )% 8 %
New vehicles (20 )% (5 )%
Total (4 )% 7 %
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CHANGE IN USED CAR SUPERSTORE BASE
Three Months Ended May 31
2008 2007
Used car superstores, beginning of
year 89 77
Superstore openings:
Production
superstores 3 1
Non-production
superstores 3 2
Total superstore
openings 6 3
Used car superstores, end of
period 95 80
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Used Vehicle Sales. Our 6% increase in used vehicle revenues in the first quarter of fiscal 2009 resulted from a 10% increase in unit sales partially offset by a 4% decrease in average retail selling price. The unit sales growth reflected sales from newer superstores not yet in the comparable store base, together with a 1% increase in comparable store used units. For the first time in more than two years, we experienced a modest decline in customer traffic in our stores. Additionally, credit availability from our third-party nonprime lenders declined slightly during the quarter. However, solid execution by our store teams resulted in a small improvement in our conversion rate, and this, together with the benefit of an extra Saturday in the quarter, contributed to the 1% increase in comparable store used unit sales. Despite the slower-than-expected sales, our data indicates that we continued to gain market share in the late-model used vehicle market. The decline in the average retail selling price primarily reflected declining market values for SUVs and trucks, as well as mix shifts away from less fuel-efficient vehicles to more fuel-efficient vehicles.
New Vehicle Sales. The 27% decline in new vehicle revenues in the first quarter of fiscal 2009 was due to a 26% decrease in unit sales and a 2% decrease in average retail selling price. New vehicle unit sales reflected the soft new car industry sales trends and the sale of our Orlando Chrysler Jeep Dodge franchise in the second quarter of fiscal 2008.
Wholesale Vehicle Sales. Vehicles acquired through the appraisal purchase process that do not meet our retail standards are sold at our on-site wholesale auctions. The 7% decrease in wholesale vehicle revenues in the first quarter of fiscal 2009 resulted from a 2% decrease in wholesale unit sales combined with a 5% decline in average wholesale selling price. The decline in the unit sales reflected a decrease in both our appraisal traffic and our appraisal buy rate. We believe the significant depreciation in the wholesale market values for SUVs, trucks and other less fuel-efficient vehicles contributed to the decrease in the buy rate. The decline in average wholesale selling prices reflects the trends in the general wholesale market for the types of vehicles we sell, although prices may also be affected by changes in the average age, miles, make, model or condition of vehicles to be wholesaled.
Other Sales and Revenues. Other sales and revenues include commissions on the sale of ESPs, service department sales and net third-party finance fees. In the first quarter of fiscal 2009, other sales and revenues increased 4%. Third-party finance fees declined 7%, primarily reflecting a slight increase in the percentage of our sales financed by the third-party subprime provider. The fixed fees paid by our third-party financing providers will vary by provider, reflecting their differing levels of credit risk exposure. We record the discount at which the subprime provider purchases loans as an offset to finance fee revenues received from the other providers.
Seasonality. Our business is seasonal. Typically, our superstores experience their strongest traffic and sales in the spring and summer quarters. Sales are typically slowest in the fall quarter, when used vehicles generally experience proportionately more of their annual depreciation. We believe this is partly the result of a decline in customer traffic, as well as discounts on model year closeouts that can pressure pricing for late-model used vehicles. Customer traffic also tends to slow in the fall as the weather changes and as customers shift their spending priorities toward holiday-related expenditures. Seasonal patterns for car buying and selling may vary in different parts of the country and, as we expand geographically, these differences could have an effect on the overall seasonal pattern of our results.
Supplemental Sales Information.
UNIT SALES
Three Months Ended May 31
2008 2007
Used vehicles 106,747 96,766
New vehicles 3,515 4,720
Wholesale vehicles 56,329 57,714
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AVERAGE SELLING PRICES
Three Months Ended May 31
2008 2007
Used vehicles $ 16,852 $ 17,480
New vehicles $ 23,211 $ 23,717
Wholesale vehicles $ 4,184 $ 4,413
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RETAIL VEHICLE SALES MIX
Three Months Ended May 31
2008 2007
Vehicle units:
Used vehicles 97 % 95 %
New vehicles 3 5
Total 100 % 100 %
Vehicle dollars:
Used vehicles 96 % 94 %
New vehicles 4 6
Total 100 % 100 %
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RETAIL STORES
Estimate
Feb. 28, 2009 May 31, 2008 Feb. 29, 2008 May 31, 2007
Production 64 60 57 54
Non-production superstores 39 35 32 26
Total used car superstores 103 95 89 80
Co-located new car stores 3 3 3 4
Total 106 98 92 84
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We opened six superstores during the first quarter of fiscal 2009. We entered the Phoenix, Arizona, market with a both a production and a non-production superstore, the Charleston, South Carolina, market with a non-production superstore and the Huntsville, Alabama, market with a production superstore. We also expanded our presence in the San Antonio, Texas, market with a non-production superstore and the Sacramento, California, market with a production superstore.
We also expanded our car-buying center test with an opening in Dallas, Texas. This represented our fourth car buying center at which we conduct appraisals and purchase, but do not sell, vehicles.
As of May 31, 2008, we had a total of six new car franchises. Two franchises are integrated within used car superstores, and the remaining four franchises are operated from three facilities that are co-located with select used car superstores.
GROSS PROFIT
Three Months Ended May 31
2008 2007
$ per unit(1) % (2) $ per unit(1) % (2)
Used vehicle gross
profit $ 1,742 10.2 $ 1,934 11.0
New vehicle gross
profit $ 860 3.7 $ 1,008 4.2
Wholesale vehicle gross
profit $ 784 18.2 $ 800 17.7
Other gross
profit $ 449 73.4 $ 455 71.0
Total gross
profit $ 2,564 12.8 $ 2,801 13.2
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(1) Calculated as category gross profit divided by its respective units sold, except the other and total categories, which are divided by total retail units sold.
(2) Calculated as a percentage of its respective sales or revenue.
Used Vehicle Gross Profit. First quarter fiscal 2009 used vehicle gross profit decreased $192 per unit compared with the prior year's first quarter. Several factors contributed to this decrease. The decline in appraisal traffic and the appraisal buy rate adversely affected our gross profit per unit. As a result of the decline in the buy rate, the percentage of our retail vehicles that were acquired through the appraisal lane was slightly below 50% of our retail unit sales compared with the prior year when this percentage was above 50%. As a result, more vehicles had to be sourced at auction, and vehicles purchased at auction typically generate less profit per unit compared with vehicles purchased directly from consumers. During the quarter, wholesale industry prices for mid-sized and large SUVs and trucks declined nearly 25%, which is approximately four times the normal depreciation expected over this period and well in excess of the depreciation normally expected over a full year. This rapid decline also resulted in significant margin pressure on this segment of our inventory, and it led us to take supplemental pricing markdowns for these vehicles, which further pressured margins. Our used vehicle gross profit per unit was also pressured by the slowing sales environment. When consumer traffic and sales decline, we generally take more pricing markdowns, which further reduces our gross profit per unit.
New Vehicle Gross Profit. First quarter fiscal 2009 new vehicle gross profit declined $148 per unit compared with the first quarter of last year. The decline in overall consumer demand for new cars pressured profits for many new car retailers, including CarMax.
Wholesale Vehicle Gross Profit. First quarter fiscal 2009 wholesale vehicle gross profit decreased $16 per unit compared with the first quarter of fiscal 2008, primarily reflecting the decline in wholesale industry prices for many classes of vehicles. The decline in profit per unit for our wholesale business was substantially less than the decline in our retail used vehicle business, however, due to the rapid pace at which we turn this inventory, with more than half of our wholesale auctions being held on a weekly basis. In addition, we continued to experience strong dealer-to-car ratios at our auctions, with the normal price competition among bidders partially offsetting the wholesale gross profit decline.
Other Gross Profit. We have no cost of sales related to either ESP revenues or third-party finance fees, as these represent commissions paid to us by the third-party providers. Our first quarter fiscal 2009 other gross profit declined $6 per unit compared with the first quarter of fiscal 2008. The change in other gross profit per unit reflected a decline in third-party finance fees, partially offset by an increase in service department margins.
Impact of Inflation. Inflation has not been a significant contributor to results. Profitability is affected by our ability to achieve targeted unit sales and gross profit dollars per vehicle rather than on average retail prices. However, increases in average vehicle selling prices will benefit the SG&A ratio and CAF income to the extent the average amount financed also increases.
CarMax Auto Finance Income. CAF provides financing for our used and new car sales. Because the purchase of a vehicle is traditionally reliant on the consumer's ability to obtain on-the-spot financing, it is important to our business that 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 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 loans, both for CAF and for the third-party financing providers. CAF provides us the opportunity to capture additional profits and cash flows from auto loan receivables while managing our reliance on third-party financing sources.
COMPONENTS OF CAF INCOME
Three Months Ended May 31
(In millions) 2008 % 2007 %
Total (loss)
gain(1) $ (2.9 ) (0.5 ) $ 27.8 4.3
Other CAF income:(2)
Servicing fee
income 10.2 1.0 8.9 1.0
Interest
income 11.1 1.1 7.8 0.9
Total other CAF
income 21.3 2.2 16.7 2.0
Direct CAF expenses:(2)
CAF payroll and fringe benefit expense 4.4 0.5 3.6 0.4
Other direct CAF
expenses 4.2 0.4 3.8 0.5
Total direct CAF
expenses 8.6 0.9 7.4 0.9
CarMax Auto Finance
income(3) $ 9.8 0.4 $ 37.1 1.7
Total loans
sold $ 626.5 $ 647.0
Average managed
receivables $ 3,940.9 $ 3,411.4
Ending managed
receivables $ 3,977.9 $ 3,475.9
Total net sales and operating revenues $ 2,208.8 $ 2,147.1
Percent columns indicate:
(1) Percent of loans sold.
(2) Annualized percent of average managed
. . .
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