UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended November 30, 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 December 31, 2004
----------------------------- --------------------------------
Common Stock, par value $0.50 104,225,630
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. Financial Statements:
Consolidated Statements of Earnings -
Three Months and Nine Months Ended November 30, 2004 and 2003 3
Consolidated Balance Sheets -
November 30, 2004, and February 29, 2004 4
Consolidated Statements of Cash Flows -
Nine Months Ended November 30, 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 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 Nine Months Ended
November 30 November 30
---------------------------------------- -----------------------------------------
2004 %(1) 2003 %(1) 2004 %(1) 2003 %(1)
------ ------- ------- ------- ------- ------- ------- -------
Sales and operating revenues:
Used vehicle sales $ 926,023 76.2 $ 797,752 74.4 $2,898,757 75.0 $2,626,620 75.5
New vehicle sales 114,199 9.4 122,681 11.4 388,480 10.1 398,680 11.5
Wholesale vehicle sales 132,669 10.9 111,352 10.4 441,658 11.4 325,080 9.3
Other sales and revenues 42,820 3.5 39,749 3.7 135,313 3.5 130,446 3.7
---------------------------------------- ----------------------------------------
Net sales and operating revenues 1,215,711 100.0 1,071,534 100.0 3,864,208 100.0 3,480,826 100.0
Cost of sales 1,070,265 88.0 945,292 88.2 3,388,332 87.7 3,043,708 87.4
---------------------------------------- ----------------------------------------
Gross profit 145,446 12.0 126,242 11.8 475,876 12.3 437,118 12.6
CarMax Auto Finance income
(Notes 3 and 4) 20,439 1.7 17,649 1.6 62,999 1.6 66,074 1.9
Selling, general, and administrative
expenses 137,170 11.3 114,282 10.7 402,584 10.4 350,549 10.1
Gain on franchise dispositions, net 692 0.1 1,207 0.1 681 -- 746 --
Interest expense -- -- -- -- 817 -- 1,137 --
Interest income 175 -- 164 -- 294 -- 468 --
---------------------------------------- ----------------------------------------
Earnings before income taxes 29,582 2.4 30,980 2.9 136,449 3.5 152,720 4.4
Provision for income taxes 11,537 0.9 11,927 1.1 53,215 1.4 58,797 1.7
---------------------------------------- ----------------------------------------
Net earnings $ 18,045 1.5 $ 19,053 1.8 $ 83,234 2.2 $ 93,923 2.7
======================================== ========================================
Weighted average common
shares (Note 7):
Basic 104,070 103,647 103,978 103,428
=========== =========== =========== ===========
Diluted 105,735 105,955 105,673 105,526
=========== =========== =========== ===========
Net earnings per share (Note 7):
Basic $ 0.17 $ 0.18 $ 0.80 $ 0.91
=========== =========== =========== ===========
Diluted $ 0.17 $ 0.18 $ 0.79 $ 0.89
=========== =========== =========== ===========
(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)
November 30, 2004 February 29, 2004
----------------- -----------------
ASSETS (unaudited)
- ------
Current assets:
Cash and cash equivalents (Note 2) $ 25,762 $ 61,643
Accounts receivable, net 63,694 72,358
Automobile loan receivables held for sale (Note 4) 3,540 18,781
Retained interests in securitized receivables (Note 4) 131,621 145,988
Inventory 503,682 466,061
Prepaid expenses and other current assets 9,248 8,650
------------ ------------
Total current assets 737,547 773,481
Property and equipment, net (Note 8) 368,203 244,064
Deferred income taxes 667 185
Other assets 18,642 19,287
------------ ------------
TOTAL ASSETS $ 1,125,059 $ 1,037,017
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 133,015 $ 145,517
Accrued expenses and other current liabilities 53,388 55,674
Accrued income taxes 4,481 4,050
Deferred income taxes 31,030 32,711
Short-term debt 6,331 4,446
------------ ------------
Total current liabilities 228,245 242,398
Long-term debt, excluding current installments (Note 8) 111,940 100,000
Deferred revenue and other liabilities 15,638 13,866
------------ ------------
TOTAL LIABILITIES 355,823 356,264
------------ ------------
Shareholders' equity:
Common stock, $0.50 par value; 350,000,000 shares authorized;
104,130,589 and 103,778,461 shares issued and outstanding
at November 30, 2004, and February 29, 2004, respectively 52,065 51,889
Capital in excess of par value 487,205 482,132
Retained earnings 229,966 146,732
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 769,236 680,753
------------ ------------
Commitments and contingent liabilities (Note 6) -- --
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,125,059 $ 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)
Nine Months Ended
November 30
2004 2003
----------- -----------
Operating Activities:
- ---------------------
Net earnings $ 83,234 $ 93,923
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 13,334 12,253
Amortization of restricted stock awards 79 94
Gain on disposition of assets (810) (588)
Provision for deferred income taxes (2,163) (8,652)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable, net 8,664 (4,404)
Decrease (increase) in automobile loan receivables held for sale 15,241 (15,418)
Decrease in retained interests in securitized receivables 14,367 12
(Increase) decrease in inventory (37,621) 16,706
(Increase) decrease in prepaid expenses and other current assets (598) 2,308
(Increase) decrease in other assets (394) 1,999
(Decrease) increase in accounts payable, accrued expenses
and other current liabilities, and accrued income taxes (11,500) 30,390
Increase in deferred revenue and other liabilities 1,772 2,415
---------- ----------
Net cash provided by operating activities 83,605 131,038
---------- ----------
Investing Activities:
- ---------------------
Purchases of property and equipment (176,341) (137,201)
Proceeds from sales of assets 52,657 72,496
---------- ----------
Net cash used in investing activities (123,684) (64,705)
----------- ----------
Financing Activities:
- ---------------------
Increase (decrease) in short-term debt, net 1,885 (49,784)
Equity issuances, net 2,313 3,798
---------- ----------
Net cash provided by (used in) financing activities 4,198 (45,986)
---------- ----------
(Decrease) increase in cash and cash equivalents (35,881) 20,347
Cash and cash equivalents at beginning of year 61,643 34,615
---------- ----------
Cash and cash equivalents at end of period $ 25,762 $ 54,962
========== ==========
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 service
plans; 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 interim
financial statements.
Cash and Cash Equivalents. Cash equivalents of $18.0 million and $48.9
million at November 30, 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 November 30, 2004,
and February 29, 2004, were restricted cash deposits of $12.0 million and
$13.0 million, respectively, which were associated with certain insurance
deductibles. Additional restricted cash related to securitized auto loan
receivables at November 30, 2004, and February 29, 2004, was $4.9 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 Nine Months Ended
November 30 November 30
(In thousands except per share data) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------------
Net earnings, as reported ...................................... $ 18,045 $ 19,053 $ 83,234 $ 93,923
Total additional stock-based compensation expenses
determined under the fair-value-based method
for all awards, net of related tax effects ................. 2,983 1,822 8,636 5,077
----------------------- ------------------------
Pro forma net earnings ......................................... $ 15,062 $ 17,231 $ 74,598 $ 88,846
======================= ========================
Earnings per share:
Basic, as reported.......................................... $ 0.17 $ 0.18 $ 0.80 $ 0.91
Basic, pro forma............................................ $ 0.14 $ 0.17 $ 0.72 $ 0.86
Diluted, as reported........................................ $ 0.17 $ 0.18 $ 0.79 $ 0.89
Diluted, pro forma.......................................... $ 0.14 $ 0.16 $ 0.71 $ 0.84
The pro forma effect on the third quarter and the first nine 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 originated by
CAF 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 Nine Months Ended
November 30 November 30
(In millions) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------------------
Gains on sales of loans................................. $ 14.3 $ 12.9 $ 44.8 $ 50.8
-------------------- ---------------------
Other income:
Servicing fee income................................. 6.2 5.6 18.3 16.0
Interest income...................................... 4.9 3.4 14.3 12.4
-------------------- ---------------------
Total other income...................................... 11.1 9.0 32.6 28.5
-------------------- ---------------------
Direct expenses:
CAF payroll and fringe benefit expense............... 2.3 2.0 6.8 6.0
Other direct CAF expenses............................ 2.7 2.1 7.6 7.2
-------------------- ---------------------
Total direct expenses................................... 5.0 4.2 14.4 13.2
-------------------- ---------------------
CarMax Auto Finance income.............................. $ 20.4 $ 17.6 $ 63.0 $ 66.1
==================== =====================
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 Nine Months
Ended November 30 Ended November 30
(In millions) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Net loans originated......................... $346.1 $327.8 $1,102.0 $1,084.5
Loans sold................................... $353.0 $338.0 $1,173.4 $1,074.4
Gains on sales of loans...................... $ 14.3 $ 12.9 $ 44.8 $ 50.8
Gains on sales of loans as a
percentage of loans sold................. 4.1% 3.8% 3.8% 4.7%
Retained Interests. The company retains various interests in the automobile
loan receivables that it securitizes. The retained interests, presented as
current assets on the company's consolidated balance sheets, serve as a
credit enhancement for the benefit of the investors in the securitized
receivables. These retained interests include the present value of the
expected residual cash flows generated by the securitized receivables, or
"interest-only strip receivables," the restricted cash on deposit in
various reserve accounts, and an undivided ownership interest in the
receivables securitized through the warehouse facility and certain public
securitizations, or "required excess receivables," as described below. The
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 $131.6 million as of November 30,
2004, and $146.0 million as of February 29, 2004. The retained interests
had a weighted average life of 1.5 years as of November 30, 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 $31.6 million as of November 30, 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 $33.6 million as of November
30, 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 November 30, 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 November 30, 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% $ 5.8 $ 11.5
Cumulative default rate................ 1.85%-2.50% $ 4.0 $ 7.9
Annual discount rate................... 12.00% $ 2.1 $ 4.2
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 November 30 As of February 29 or 28
(In millions) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Loans securitized..................................... $ 2,379.9 $ 2,153.9 $ 2,200.4 $ 1,859.1
Loans held for sale or investment..................... 39.3 36.4 48.2 19.6
------------------------------------------------------------
Ending managed receivables............................ $ 2,419.2 $ 2,190.3 $ 2,248.6 $ 1,878.7
============================================================
Accounts 31+ days past due............................ $ 38.5 $ 35.2 $ 31.4 $ 27.6
Past due accounts as a percentage of
ending managed receivables.................... 1.59% 1.61% 1.40% 1.47%
Three Months Nine Months
Ended November 30 Ended November 30
(In millions) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Average managed receivables............................ $ 2,407.2 $ 2,161.4 $ 2,357.3 $ 2,057.4
Credit losses on managed receivables................... $ 5.0 $ 6.0 $ 14.4 $ 15.5
Annualized credit losses as a percentage of
average managed receivables........................ 0.83% 1.11% 0.81% 1.00%
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 Nine Months
Ended November 30 Ended November 30
(In millions) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------------
o Proceeds from new securitizations............................ $ 294.0 $ 286.5 $ 966.5 $ 918.5
o Proceeds from collections reinvested in
revolving period securitizations......................... $ 132.3 $ 120.5 $ 443.7 $ 400.2
o Servicing fees received...................................... $ 6.2 $ 5.5 $ 18.2 $ 15.7
o Other cash flows received from retained interests:
Interest-only strip receivables.......................... $ 20.6 $ 23.8 $ 62.6 $ 59.4
Cash reserve releases, net............................... $ 3.0 $ 6.8 $ 13.9 $ 15.0
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 November 30, 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 third quarter of fiscal 2005, the
company entered into seven 40-month amortizing interest rate swaps with
initial notional amounts totaling approximately $315.5 million. The
amortized notional amount of the interest rate swaps was reduced in the
third quarter of fiscal 2005 in conjunction with the replacement of
variable-rate securities in the warehouse facility with a $550 million
fixed-rate public securitization that was completed in October 2004. The
amortized notional amount of all outstanding swaps related to the
automobile loan receivable securitizations was approximately $368.6 million
at November 30, 2004, and $551.8 million at February 29, 2004. At November
30, 2004, the fair value of swaps was a net asset of $1.8 million, which
was included in prepaid expenses and other current assets. At February 29,
2004, the fair value of swaps was a net liability of $2.0 million, which
was included in accounts payable.
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 November 30
Pension Plan Restoration Plan Total
------------ ---------------- ---------------
(In thousands) 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Service cost............................... $1,624 $1,382 $ 91 $ 58 $1,715 $1,440
Interest cost.............................. 538 420 62 31 600 451
Expected return on plan assets............. (392) (223) - - (392) (223)
Amortization of prior year
service cost........................... 9 9 12 - 21 9
Recognized actuarial loss.................. 184 162 37 13 221 175
---------------------------------------------------------------------------
Net pension expense........................ $1,963 $1,750 $ 202 $ 102 $2,165 $1,852
===========================================================================
Nine Months Ended November 30
Pension Plan Restoration Plan Total
------------ ---------------- ---------------
(In thousands) 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Service cost............................... $4,932 $4,146 $251 $174 $5,183 $4,320
Interest cost.............................. 1,614 1,260 170 94 1,784 1,354
Expected return on plan assets............. (1,130) (669) - - (1,130) (669)
Amortization of prior year
service cost........................... 27 27 12 - 39 27
Recognized actuarial loss.................. 552 486 113 39 665 525
---------------------------------------------------------------------------
Net pension expense........................ $5,995 $5,250 $546 $307 $6,541 $5,557
===========================================================================
The company contributed $6.1 million to the pension plan during the quarter
ended November 30, 2004. As of November 30, 2004, the company has
contributed $7.4 million to the pension plan during fiscal 2005 and does
not expect that any funding will be required to be made during the
remainder of this fiscal year.
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 Nine Months
Ended November 30 Ended November 30
(In thousands except per share data) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------------
Weighted average common shares.............................. 104,070 103,647 103,978 103,428
Dilutive potential common shares:
Options.................................................. 1,649 2,294 1,680 2,086
Restricted stock......................................... 16 14 15 12
---------------------------- --------------------------
Weighted average common shares
and dilutive potential common shares..................... 105,735 105,955 105,673 105,526
============================ ==========================
Net earnings available to common shareholders............... $ 18,045 $ 19,053 $ 83,234 $ 93,923
Basic net earnings per share................................ $ 0.17 $ 0.18 $ 0.80 $ 0.91
Diluted net earnings per share.............................. $ 0.17 $ 0.18 $ 0.79 $ 0.89
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 November
30, 2004, options to purchase 3,015,740 shares of common stock with
exercise prices ranging from $26.83 to $43.44 per share were outstanding
and not included in the calculation. As of November 30, 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.
8. Capital Leases
--------------
The company recorded capital leases for two superstores during the third
quarter of fiscal 2005. The related capital lease obligations of $11.9
million were recorded in long-term debt.
9. Recent Accounting Pronouncements
--------------------------------
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (revised 2004), "Share-Based Payment". This revised statement
sets forth accounting requirements for share-based compensation to
employees, including employee stock purchase plans. The revised statement
requires companies to recognize in the statement of earnings the grant-date
fair value of stock options and other equity based compensation issued to
employees. The provisions of the original SFAS No. 123 remain in effect
until the provisions of this revised statement are adopted. This revised
statement is effective for all interim or annual periods beginning after
June 15, 2005. The company is in the process of evaluating the impact of
this statement on the company's financial position, results of operations
and cash flows.
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
November 30, 2004, we operated 57 used car superstores in 27 markets, including
8 large markets and 19 mid-sized markets. We also operated 9 new car franchises,
all of which were integrated or co-located with our used car superstores. During
the twelve month period ended November 30, 2004, we sold 238,200 used cars,
representing 92% of the total 259,402 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 service plans, and vehicle repair service. A majority 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. Financing for
qualifying nonprime-rated customers is provided through three third-party
lenders, and financing for qualifying subprime-rated customers is provided
through a third-party finance provider under a program rolled out to our entire
store base in August 2004. 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. We opened a total of eight superstores during the first nine
months in fiscal 2005, representing an approximate 16% increase in our used car
superstore base.
Fiscal 2005 Third Quarter Highlights
- ------------------------------------
In the third quarter of fiscal 2005, net sales and operating revenues increased
13% to $1.22 billion from $1.07 billion in the third quarter of fiscal 2004. Net
earnings were $18.0 million, or $0.17 per share, in this year's third quarter,
compared with $19.1 million, or $0.18 per share, in the prior year's quarter.
Page 14 of 28
The 13% increase in net sales and operating revenues reflected:
* Sales from the new stores not yet included in the comparable store base,
combined with a 2% increase in comparable store used unit sales, partially
offset by a decrease in new car sales resulting from the disposal of
several new car franchises.
* A 19% 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 third quarter gross profit margin improved modestly to 12.0% from 11.8% last
year, as improvements in used and wholesale vehicle margins were partially
offset by a decrease in other gross profit margins. Margins on used and
wholesale vehicles benefited from continuing refinements to our appraisal cost
recovery methodology. The lower margin on other sales and revenues resulted from
higher service operations costs and from the subprime financing discount that
partially offsets third-party finance fee revenue. CAF income increased to $20.4
million in this year's third quarter from $17.6 million last year, reflecting
the total sales growth and a favorable adjustment in the valuation of our
retained interests in securitized receivables. Selling, general, and
administrative expenses as a percentage of sales (the "SG&A ratio") increased to
11.3% in this year's third quarter compared with 10.7% in last year's quarter.
The increase in the SG&A ratio primarily reflected the higher SG&A ratio at our
newer stores, as well as store unit bonuses that were higher than originally
expected. Newer stores that have not yet achieved mature sales rates make up a
growing proportion of our store base.
Net cash provided by operations was $83.6 million in the first nine months of
fiscal 2005 compared with $131.0 million in the same period last year. The
decline related primarily to changes in inventory. In the first nine months of
this fiscal year, inventories increased due to the increase in the store base.
In comparison, a higher-than-normal inventory balance at the beginning of fiscal
2004 contributed to a decrease in inventories by the end of the third quarter of
fiscal 2004 despite new store openings.
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.
Page 15 of 28
The net earnings of any quarter are seasonally disproportionate to net sales
since administrative and certain operating expenses remain relatively constant
during the year. Therefore, quarterly results should not be relied upon as
necessarily indicative of results for the entire fiscal year.
Net Sales and Operating Revenues
- --------------------------------
Components of net sales and operating revenues were as follows:
Three Months Nine Months
Ended November 30 Ended November 30
(In millions) 2004 % 2003 % 2004 % 2003 %
- ------------------------------------------------------------------------------------------------------------------------------
Used vehicle sales..................... $ 926.0 76.2 $ 797.8 74.4 $2,898.8 75.0 $2,626.6 75.5
New vehicle sales...................... 114.2 9.4 122.7 11.4 388.5 10.1 398.7 11.5
Wholesale vehicle sales................ 132.7 10.9 111.4 10.4 441.7 11.4 325.1 9.3
Other sales and revenues:
Extended service plan revenues...... 19.6 1.6 17.7 1.7 61.5 1.6 58.7 1.7
Service department sales............ 20.0 1.6 17.3 1.6 61.8 1.6 51.4 1.5
Third-party finance fees............ 3.2 0.3 4.7 0.4 12.0 0.3 15.0 0.4
Appraisal purchase
processing fees................. -- -- -- -- -- -- 5.3 0.2
-------------------------------------------------------------------------------------
Total other sales and revenues......... 42.8 3.5 39.7 3.7 135.3 3.5 130.4 3.7
-------------------------------------------------------------------------------------
Total net sales and operating
revenues............................... $ 1,215.7 100.0 $ 1,071.5 100.0 $3,864.2 100.0 $3,480.8 100.0
=====================================================================================
Retail vehicle unit and dollar sales changes for the third quarter and first
nine months of fiscal 2005 and 2004 were as follows:
Three Months Nine Months
Ended November 30 Ended November 30
2004 2003 2004 2003
--------------------------------------------------------
Vehicle units:
Used vehicles.......................... 15 % 13 % 8 % 18 %
New vehicles........................... (6)% 1 % (3)% (3)%
Total ...................................... 13 % 12 % 7 % 16 %
Vehicle dollars:
Used vehicles.......................... 16 % 16 % 10 % 19 %
New vehicles........................... (7)% 4 % (3)% (1)%
Total ...................................... 13 % 14 % 9 % 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 third quarter and first nine months of fiscal 2005
and 2004 were as follows:
Page 16 of 28
Three Months Nine Months
Ended November 30 Ended November 30
2004 2003 2004 2003
--------------------------------------------------------
Vehicle units:
Used vehicles.......................... 2 % 2 % (3) % 6 %
New vehicles........................... 11 % 2 % 12 % (2)%
Total ...................................... 2 % 2 % (2) % 5 %
Vehicle dollars:
Used vehicles.......................... 3 % 4 % (1)% 7 %
New vehicles........................... 9 % 5 % 11 % 0 %
Total ...................................... 4 % 4 % 0 % 6 %
Used Vehicle Sales. The increases in used vehicle sales during the third quarter
- ------------------
and first nine months of fiscal 2005 reflect the growth in our store base,
partially offset by a decline in used vehicle comparable store sales year to
date. We experienced stronger used unit sales growth in the third quarter than
in the first half of the year, including an increase in used vehicle comparable
store sales of two percent. During the quarter, used car wholesale prices fell
in line with what we generally see during the autumn model-year-changeover
period, which we believe contributed to our stronger sales performance. As we
expected, the addition of a subprime lender contributed roughly three percent to
third quarter used vehicle unit sales. This financing option was rolled out to
all of our used car superstores in August 2004.
We also believe that we recovered some of the sales lost during the second
quarter to severe weather in Florida and the southeastern United States. 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 increase in comparable store sales
during the third quarter.
New Vehicle Sales. Comparable store new vehicle sales in both the third quarter
- -----------------
and the first nine months of fiscal 2005 were robust, reflecting the strength of
the principal brands we represent - Chevrolet, DaimlerChrysler, Nissan, and
Toyota. Total new car sales declined during both periods due to the disposal of
seven new car franchises from the beginning of fiscal 2004 through this third
quarter. The Town Center Mitsubishi and Kenosha Ford new car franchises were
disposed of during the third quarter of fiscal 2005.
Wholesale Vehicle Sales. Similar to the first two quarters, the third 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 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 service plan
- ------------------------
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.
During the second quarter of fiscal 2004, the appraisal purchase processing fees
were discontinued across our entire store base and replaced with an alternative
method for recovering the costs of our appraisal and wholesale operations. The
intent of the revised ACR 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 growth is attributed to increases in extended
service plan revenues, service, and third-party nonprime finance fees. The cost
of providing subprime financing offset some of these increases. As is customary
in the industry, subprime loan contracts are purchased from the company at a
discount.
Supplemental information related to vehicle sales follows:
Page 17 or 28
Retail Unit Sales
- -----------------
Three Months Nine Months
Ended November 30 Ended November 30
2004 2003 2004 2003
-------------------------- ---------------------------
Used vehicles ............................ 58,908 51,361 183,657 169,556
New vehicles ............................ 4,765 5,079 16,365 16,804
-------------------------- ---------------------------
Total ...................................... 63,673 56,440 200,022 186,360
========================== ===========================
Average Retail Selling Prices
- -----------------------------
Three Months Nine Months
Ended November 30 Ended November 30
2004 2003 2004 2003
------------------------------ ------------------------------
Used vehicles............................... $15,591 $15,393 $15,650 $15,382
New vehicles................................ $23,804 $23,968 $23,562 $23,566
Weighted average............................ $16,205 $16,165 $16,297 $16,120
Retail Vehicle Sales Mix
- ------------------------
Three Months Nine Months
Ended November 30 Ended November 30
2004 2003 2004 2003
------------------------- --------------------------
Vehicle units:
Used vehicles......................... 93% 91% 92% 91%
New vehicles.......................... 7 9 8 9
------------------------- --------------------------
Total....................................... 100% 100% 100% 100%
========================= ==========================
Vehicle dollars:
Used vehicles......................... 89% 87% 88% 87%
New vehicles.......................... 11 13 12 13
------------------------- --------------------------
Total....................................... 100% 100% 100% 100%
========================= ==========================
Retail Stores. In the third quarter of fiscal 2005, CarMax opened two superstores,
- -------------
entering the Albuquerque, N.Mex., market with a standard superstore and adding
a satellite superstore in Richmond, Va.
The following tables provide detail on the CarMax retail stores and new car
franchises:
Estimate
Store Mix Feb. 28, 2005 Nov. 30, 2004 Feb. 29, 2004 Nov. 30, 2003
- --------------------------------------------------------------------------------------------------------------------------
Mega superstores(1).......................... 13 13 13 13
Standard superstores(2)...................... 29 29 24 23
Satellite superstores(3)..................... 16 15 12 10
Co-located new car stores.................... 3 3 3 2
Stand-alone new car stores................... 0 0 0 2
--------------------------------------------------------------------------
Total........................................ 61 60 52 50
==========================================================================
(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 or 28
Estimate
New Car Franchises Feb. 28, 2005 Nov. 30, 2004 Feb. 29, 2004 Nov. 30, 2003
- --------------------------------------------------------------------------------------------------------------------------
Integrated/co-located
new car franchises...................... 7 9 12 12
Stand-alone new car franchises............... 0 0 0 2
--------------------------------------------------------------------------
Total........................................ 7 9 12 14
==========================================================================
Gross Profit Margin
- -------------------
Gross profit margin and gross profit per unit were as follows:
Three Months Nine Months
Ended November 30 Ended November 30
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............ 11.2 1,765 10.9 1,693 11.6 1,826 11.3 1,754
New vehicle gross profit margin............. 3.7 886 3.8 925 3.7 866 3.9 914
Wholesale vehicle gross profit margin....... 11.8 440 9.9 338 11.4 428 9.8 335
Other gross profit margin................... 50.5 339 59.3 418 56.1 379 70.8 496
-------------------------------------- --------------------------------------
Total gross profit margin................... 12.0 2,284 11.8 2,237 12.3 2,379 12.6 2,346
====================================== ======================================
(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. Used vehicle gross profit dollars per unit
- --------------------------------
increased 4% in the three months and nine months ended November 30, 2004,
compared with the same periods in the prior year reflecting continuing
refinements to the appraisal cost recovery methodology.
New Vehicle Gross Profit Margin. New vehicle gross profit dollars per unit for
- -------------------------------
the three months and nine months ended November 30, 2004, decreased 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 dollars per unit for the three months
and nine months ended November 30, 2004, increased primarily as a result of the
continued refinements in the ACR methodology.
Other Gross Profit Margin. The gross profit margin on other sales and revenues
- -------------------------
for the three months and nine months ended November 30, 2004, decreased compared
with the same periods in the prior year. This decline was attributed to higher
service costs during the quarter and the impact of subprime financing discounts
that partially offset third-party finance fees.
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.
Page 19 of 28
CAF income does not include any allocation of indirect costs or income. We
present this information on a direct basis to avoid making arbitrary decisions
regarding the indirect benefit or costs that could be attributed to this
operation. Examples of indirect costs not included are retail store expenses,
retail financing commissions, and corporate expenses such as human resources,
administrative services, marketing, information systems, accounting, legal,
treasury, and executive payroll.
For the third quarter and first nine months of fiscal 2005 and 2004,
respectively, CarMax Auto Finance income was as follows:
Three Months Ended November 30 Nine Months Ended November 30
(In millions) 2004 % 2003 % 2004 % 2003 %
- ------------------------------------------------------------------------------------------------------------------------------
Gains on sales of loans(1)........................ $ 14.3 4.1 $ 12.9 3.8 $ 44.8 3.8 $ 50.8 4.7
----------------------------------- -----------------------------------
Other income: (2)
Servicing fee income......................... 6.2 1.0 5.6 1.0 18.3 1.0 16.0 1.0
Interest income.............................. 4.9 0.8 3.4 0.6 14.3 0.8 12.4 0.8
----------------------------------- -----------------------------------
Total other income................................ 11.1 1.8 9.0 1.7 32.6 1.8 28.5 1.8
----------------------------------- -----------------------------------
Direct expenses: (2)
CAF payroll and fringe benefit expense....... 2.3 0.4 2.0 0.4 6.8 0.4 6.0 0.4
Other direct CAF expenses.................... 2.7 0.4 2.1 0.4 7.6 0.4 7.2 0.5
----------------------------------- -----------------------------------
Total direct expenses............................. 5.0 0.8 4.2 0.8 14.4 0.8 13.2 0.9
----------------------------------- -----------------------------------
CarMax Auto Finance income (3).................... $ 20.4 1.7 $ 17.6 1.6 $ 63.0 1.6 $ 66.1 1.9
=================================== ===================================
Loans sold........................................ $ 353.0 $ 338.0 $ 1,173.4 $ 1,074.4
Average managed receivables....................... $ 2,407.2 $ 2,161.4 $ 2,357.3 $ 2,057.4
Net sales and operating revenues.................. $ 1,215.7 $ 1,071.5 $ 3,864.2 $ 3,480.8
Ending managed receivable balance................. $ 2,419.2 $ 2,190.3 $ 2,419.2 $ 2,190.3
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 third quarter, CAF income increased to $20.4 million from $17.6 million
in last year's third quarter. Current year results included a favorable
adjustment in the valuation of the retained interest in securitized receivables.
This adjustment reflects lower loss assumptions on certain newer pools of
securitized receivables and contributed approximately 1 cent to EPS in the
quarter. Including this valuation adjustment, gain as a percent of loans sold
was 4.1%. Excluding the impact of this adjustment, gain as a percent of loans
sold was 3.6%, which is at the lower end of the range we consider normal and
consistent with our expectations. The prior year's third quarter gain as a
percent of loans sold was 3.8%. The increase in other income and other direct
expenses, was proportionate to the increase in managed receivables.
For the first nine months, CAF income decreased to $63.0 million in fiscal 2005
from $66.1 million in fiscal 2004. Current year results included favorable
impacts from both the repurchase and subsequent sale into the warehouse facility
of the receivables related to the 2001-1 securitization, and the adjustment in
the valuation of the retained interest in securitized receivables. Excluding the
impact of both of these events, gain as a percent of loans sold was 3.7% for
fiscal 2005 compared with 4.7% for the same period in fiscal 2004. As
Page 20 of 28
anticipated, the decrease in CAF income resulted primarily from a return to more
normal gain spread levels, as CAF's cost of funds has increased more rapidly
than consumer loan rates during the first nine months of this year. The increase
in other income and direct expenses compared with the same period in the prior
year, was proportionate to the increase in managed receivables.
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 that, combined with a relatively low short-term funding cost,
resulted in an earnings benefit of approximately 1 cent to EPS when the
remaining loans were sold into the warehouse facility. This benefit was included
in the first quarter gains on loans sold.
In November 2004, a favorable adjustment in the valuation of the retained
interest in securitized receivables was recognized. This adjustment reflects
lower loss assumptions on certain newer pools of securitized receivables and
contributed approximately 1 cent to EPS during the third quarter and is included
in gains on loans sold. We believe the lower loss rates are the result of a
combination of factors including the implementation of a new credit scorecard in
the fourth quarter of 2002.
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 November 30 As of February 29 or 28
(In millions) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
Loans securitized.......................................... $ 2,379.9 $ 2,153.9 $ 2,200.4 $ 1,859.1
Loans held for sale or investment.......................... 39.3 36.4 48.2 19.6
-------------------------------------------------------------
Ending managed receivables................................. $2,419.2 $ 2,190.3 $ 2,248.6 $ 1,878.7
=============================================================
Accounts 31+ days past due................................. $ 38.5 $ 35.2 $ 31.4 $ 27.6
Past due accounts as a percentage of
ending managed receivables................................. 1.59% 1.61% 1.40% 1.47%
Three Months Nine Months
Ended November 30 Ended November 30
(In millions) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
Average managed receivables................................ $ 2,407.2 $ 2,161.4 $ 2,357.3 $ 2,057.4
Credit losses on managed receivables....................... $ 5.0 $ 6.0 $ 14.4 $ 15.5
Annualized credit losses as a percentage of
average managed receivables................................ 0.83% 1.11% 0.81% 1.00%
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 nine month periods ended November 30, 2004, compared
to the same periods in fiscal 2004. We believe the lower loss rates are the
result of a combination of factors including the implementation of a new credit
scorecard in the fourth quarter of 2002.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general, and administrative expenses as a percentage of sales and
operating revenues were 11.3% in the third quarter of fiscal 2005 compared with
10.7% in the third quarter of the prior year. The increase primarily reflected
the higher SG&A expenses at newer stores, which make up a growing portion of our
store base. The higher SG&A ratio also reflected higher than expected store unit
bonuses as sales were stronger than anticipated. At the beginning of the
quarter, store bonus targets were set in line with original expectations for the
quarter.
Page 21 of 28
For the nine months ended November 30, 2004, the SG&A ratio increased to 10.4%
from 10.1% for the same period in the prior fiscal year. This increase was
primarily due to the deleveraging impact of lower comparable store used unit
sales experienced during the first half of fiscal 2005 and the higher SG&A
expenses at newer stores.
Income Taxes
- ------------
The effective income tax rate was 39.0% in the third quarter and first nine
months of fiscal 2005 and 38.5% in the same periods of fiscal 2004. The increase
resulted from geographic expansion into states with higher income tax rates,
including having a larger percentage of stores located in unitary tax states.
Operations Outlook
- ------------------
In addition to the five standard-sized superstores and three satellite
superstores opened during the first three quarters of fiscal 2005, the company
opened a satellite superstore in the Miami, Fla., market on December 1, 2004. No
additional superstore openings are planned during the remainder of fiscal 2005.
In September 2004, we returned our Mitsubishi franchise in Atlanta, Ga., to the
manufacturer, and in November 2004, we sold our Ford franchise in Kenosha, Wis.
In December 2004, we returned 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. For the fourth quarter of fiscal 2005, we
anticipate comparable store used vehicle unit sales in the range of 2% to 7% and
net earnings per share in the range of 19 cents to 23 cents. These expectations
assume no abnormal winter weather events and take into consideration the
improved sales trends since September 2004 and the adverse calendar shifts in
the fourth quarter.
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 around the lower end of the 3.5% to 4.5% normalized range.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting pronouncements applicable to the company,
see Note 9 of the Notes to the Consolidated Financial Statements set forth
elsewhere in this report.
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
Operating Activities. For the first nine months of fiscal 2005, CarMax generated
- --------------------
cash from operating activities of $83.6 million. In the same period last year,
CarMax generated cash from operating activities of $131.0 million. This decrease
resulted primarily from changes in inventory and accounts payable, partially
offset by decreases in automobile loan receivables held for sale and retained
interests in securitized receivables.
Inventory increased $37.6 million in the first nine months of fiscal 2005,
primarily as a result of the continued growth of our store base, partially
offset by the disposition of three new car franchises. Inventory declined by
$16.7 million in the first nine 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 the disposition of three new car
franchises, partially offset by the addition of six used car superstores.
Automobile loan receivables held for sale decreased by $15.2 million in the
first nine months of fiscal 2005 compared with a $15.4 million increase in the
first nine months 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. Retained interests in securitized receivables
Page 22 of 28
decreased $14.4 million in the first nine months of fiscal 2005. The decrease
was due to a return to more normal gain spread levels, as CAF's cost of funds
has increased more rapidly than consumer loan rates during the first nine months
of this year. In the same period last year, retained interests in securitized
receivables remained relatively flat.
Investing Activities. Net cash used in investing activities was $123.7 million
- --------------------
in the nine months ended November 30, 2004, compared with $64.7 million in the
first nine months of last fiscal year. Capital expenditures were $176.3 million
and $137.2 million for the nine months ended November 30, 2004 and 2003,
respectively. The increase in capital expenditures reflects the increase in our
store base associated with our growth plan. In the nine months ended November
30, 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. Additionally, the company received $11.9 million in
lessor-financed construction funds for two properties that were accounted for as
capital leases.
Financing Activities. Net cash provided by financing activities was $4.2 million
- --------------------
in the first nine months of fiscal 2005, compared with net cash used of $46.0
million in the first nine months of last fiscal year. In the first nine months
of fiscal 2005, we increased short term debt by $1.9 million. In the first nine
months of fiscal 2004, we utilized cash generated from operations to reduce
short term debt by $49.8 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 $2.38 billion at November 30, 2004,
and $2.15 billion at November 30, 2003. At November 30, 2004, the warehouse
facility limit was $825 million and unused warehouse capacity totaled $456
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 November 30, 2004, the amount outstanding under this credit
facility was $106.3 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 November 30, 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 November 30, 2004, and February 29, 2004, was as
follows:
(In millions) November 30 February 29
- ----------------------------------------------------------------------------------------------------------------
Fixed-rate securitizations............................................. $2,010.9 $1,647.9
Floating-rate securitizations
synthetically altered to fixed.................................... 368.6 551.8
Floating-rate securitizations.......................................... 0.4 0.7
Held for investment (1)................................................ 35.8 29.4
Held for sale (2)...................................................... 3.5 18.8
---------------------------------------
Total.................................................................. $2,419.2 $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 nine months ended November 30, 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 November 30, 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 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.
3.3 CarMax, Inc. Bylaws, as amended and restated November 1,
2004, filed as Exhibit 3.1 to CarMax's Current Report on
Form 8-K, filed November 5, 2004 (File No. 1-31420),
incorporated herein by this reference.
10.1 CarMax, Inc. 2002 Stock Incentive Plan, as amended and
restated November 1, 2004, filed herewith.
10.2 CarMax, Inc. 2002 Employee Stock Purchase Plan, as amended
and restated November 1, 2004, filed herewith.
10.3 Amended and Restated Security Agreement, dated as of
February 10, 2003, as amended, among CarMax Auto
Superstores, Inc., various other debtors, and
DaimlerChrysler Services North America LLC, filed herewith.
10.4 Guaranty, dated May 17, 2002, as amended, executed by
certain CarMax, Inc. subsidiaries in favor of
DaimlerChrysler Services North America LLC, 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
January 7, 2005
Page 27 of 28
EXHIBIT INDEX
-------------
10.1 CarMax, Inc. 2002 Stock Incentive Plan, as amended and
restated November 1, 2004, filed herewith.
10.2 CarMax, Inc. 2002 Employee Stock Purchase Plan, as amended
and restated November 1, 2004, filed herewith.
10.3 Amended and Restated Security Agreement, dated as of
February 10, 2003, as amended, among CarMax Auto
Superstores, Inc., various other debtors, and
DaimlerChrysler Services North America LLC, filed herewith.
10.4 Guaranty, dated May 17, 2002, as amended, executed by
certain CarMax, Inc. subsidiaries in favor of
DaimlerChrysler Services North America LLC, 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