KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 30, 2008 (Third Quarter of Fiscal 2009)
Business Overview: CarMax is the largest retailer of used vehicles in the United States, operating 99 used car superstores and six new car franchises as of November 30, 2008. The company also operates CarMax Auto Finance (CAF) to provide financing for vehicle purchases.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 23% in the quarter and 11% year-to-date compared to the prior year, driven by a 17% drop in used vehicle unit sales and a 26% drop in new vehicle unit sales.
• Profitability Shift: The company reported a net loss of $21.9 million for the quarter, a reversal from the $29.8 million net earnings in the prior year quarter. Year-to-date earnings dropped significantly to $21.7 million from $160.2 million.
• CAF Performance: CarMax Auto Finance (CAF) swung from a profit of $16.3 million to a loss of $15.4 million in the quarter. This was primarily due to a $39.8 million adjustment related to loans originated in previous periods, including a $23.8 million mark-to-market write-down on retained subordinated bonds due to credit market illiquidity.
• Inventory Reduction: Management aggressively reduced used vehicle inventory by approximately 18,500 units ($340 million) compared to the prior year to align with lower sales rates, contributing to a $374.3 million cash inflow from operating activities year-to-date.
• SG&A Ratio: The SG&A ratio increased to 14.9% from 11.2% in the prior year quarter due to lower sales volumes, though variable costs were reduced through staffing adjustments.

Guidance, Outlook, and Risks

• Store Growth Suspension: CarMax has temporarily suspended store growth due to the weak economic environment. While three stores are under construction, they will not open until market conditions improve. Only one non-production store is planned for late fiscal 2009 or early fiscal 2010.
• Capital Expenditures: Gross capital expenditures for fiscal 2009 are now estimated between $175 million and $190 million, significantly reduced from the original $350 million estimate.
• Outlook: Management stated it cannot make a meaningful projection of fiscal 2009 comparable store sales or earnings due to unprecedented declines in traffic and volatility in asset-backed credit markets.
• Key Risks:
  • Credit Markets: Disruptions in credit markets have increased funding costs and reduced the gain percentage on securitized loans. The company is relying more on third-party financing providers.
  • Delinquency Rates: Past due accounts (31+ days) increased to 3.38% of managed receivables from 2.51% in the prior year. Annualized net credit losses rose to 2.11% from 1.12%.
  • Legal Proceedings: A putative class action lawsuit in California regarding meal/rest breaks and overtime pay is ongoing; the company cannot estimate the potential loss.
  • Automotive Manufacturers: Adverse conditions affecting domestic manufacturers pose a risk to profitability.

Investor Verification Checklist

• CAF Valuation Assumptions: Verify the impact of the increased discount rate (19%) and cumulative loss rate assumptions (up to 3.9%) on future CAF earnings and retained interest fair value.
• Liquidity Position: Confirm the availability of the $225.4 million remaining borrowing capacity under the revolving credit facility and the status of the warehouse facility renewal (expires July 2009).
• Inventory Turnover: Monitor the effectiveness of inventory management systems in maintaining gross profit per unit amidst falling wholesale vehicle prices.
• Legal Exposure: Track developments in the California class action lawsuit regarding potential financial impact.
• Store Economics: Assess the financial impact of the suspended store growth strategy on long-term market share and revenue potential.