KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-K (Annual Report)
Period Ended: February 28, 2007
Business Overview: CarMax is the nation's largest retailer of used vehicles, operating 77 used car superstores in 36 metropolitan markets as of the fiscal year-end. The company utilizes a "no-haggle" pricing model, selling reconditioned used vehicles, new vehicles (via franchise), and wholesale vehicles through on-site auctions. It also provides financing through CarMax Auto Finance (CAF) and sells extended service plans.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 19% year-over-year, driven by a 16% increase in total used vehicle unit sales and a 6% increase in average retail selling prices.
• Profitability: Net earnings surged 48% to $198.6 million. Gross profit per unit increased to $2,731 from $2,544, attributed to stable economic conditions and fewer pricing markdowns.
• Store Expansion: The company opened 10 new used car superstores (5 standard, 5 satellite) during the fiscal year, bringing the total to 77.
• CAF Performance: CAF income rose 27%, benefiting from increased retail sales, higher average amounts financed, and a gain percentage increase to 3.9% (from 3.5%).
• Expense Management: Selling, General, and Administrative (SG&A) expenses as a percentage of revenue declined to 10.4% from 10.8%, leveraging fixed costs against strong sales growth.
• Accounting Changes: The company adopted SFAS 123(R) for share-based compensation, resulting in a $32.7 million expense (including $0.02 per share related to the former CEO's retirement).

Guidance, Outlook, and Risks

Outlook for Fiscal 2008

• Store Openings: Plans to open approximately 13 new superstores (5 standard, 8 satellite), expanding the base by 17%.
• Sales Growth: Anticipates comparable store used unit growth of 3% to 9% and total revenue growth of 14% to 20%.
• Earnings: Projects diluted EPS in the range of $1.03 to $1.14 (12% to 24% growth).
• Capital Expenditures: Estimates gross capital expenditures of approximately $300 million.

Risks and Contingencies

• Economic Sensitivity: Results are subject to consumer credit availability, interest rates, gasoline prices, and general economic conditions.
• Competition: Highly competitive market with franchised dealers and independent dealers; price competition could reduce margins.
• Inventory Risk: Exposure to depreciation of used vehicle inventory and potential inability to liquidate excess inventory at target margins.
• Financing Covenants: Securitization agreements contain financial covenants and performance triggers related to loss rates and delinquency rates.
• Legal Proceedings: A putative class action lawsuit in South Carolina was settled; management believes other ongoing proceedings will not have a material adverse effect.

Investor Verification Checklist

• Inventory Turnover: Verify the impact of the $166.4 million increase in inventory on future cash flows and depreciation risks.
• CAF Credit Quality: Monitor the 1.72% past due rate (31+ days) and net credit loss rate of 0.67% to assess the stability of the finance arm.
• Share-Based Compensation: Review the impact of the $32.7 million share-based compensation expense on future earnings, particularly regarding the shift to restricted stock awards.
• Debt Structure: Confirm the status of the $500 million revolving credit facility and the maturity of the warehouse facility (July 2007).
• Comparable Store Sales: Validate the 9% comparable store unit sales growth against industry trends to ensure sustainability.