KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2010 (First Quarter of Fiscal 2011)
Business Overview: CarMax is the largest retailer of used vehicles in the United States, operating 101 used car superstores and six new car franchises as of May 31, 2010. The company resumed store growth in fiscal 2011 after a suspension in late 2008.

Key Financial Metrics

Note: Debt figures for Q1 2010 are not directly comparable due to a major accounting change described below.

Material Changes vs. Prior Period

• Accounting Change (Critical): Effective March 1, 2010, CarMax adopted ASU Nos. 2009-16 and 2009-17. Auto loan receivables previously securitized and held off-balance sheet are now consolidated as secured borrowings. This resulted in a significant increase in reported assets (auto loan receivables of $4.1 billion) and liabilities (non-recourse notes payable of $3.8 billion) compared to the prior year.
• Revenue Growth: Net sales increased 23% year-over-year, driven by an 18% increase in used vehicle sales and an 85% surge in wholesale vehicle sales.
• Profitability: Net earnings increased 252% to $101.1 million. This was largely driven by a turnaround in CAF, which moved from a $21.6 million loss to a $57.5 million profit. The prior year loss included $40.4 million in adjustments related to funding costs and valuation changes.
• Unit Sales: Comparable store used unit sales increased 9%. Wholesale unit sales increased 52% due to higher appraisal traffic and buy rates.
• Expense Management: Selling, General, and Administrative (SG&A) expenses increased 10% to $226.7 million, but the SG&A ratio improved to 10.0% from 11.2% due to revenue leverage.

Guidance, Outlook, and Risks

• Store Growth: CarMax plans to open 3-5 stores in fiscal 2012 and 5-10 stores in fiscal 2013. Three stores were opened in fiscal 2011 (Augusta, GA; Cincinnati, OH; Dayton, OH).
• Capital Expenditures: Estimated at approximately $90 million for fiscal 2011, up from $22.4 million in fiscal 2010, reflecting real estate acquisitions and IT upgrades.
• CAF Guidance: Management provided one-time guidance on CAF income for the transition period but will not provide or update CAF guidance on a going-forward basis.
• Liquidity: The company maintains a $700 million revolving credit facility with $616.7 million available. Warehouse facility limits total $1.2 billion with $405 million unused. Management elected to reduce cash reserves to normalized levels following credit market stabilization.
• Risks: Key risks include economic conditions affecting consumer confidence, availability and cost of capital for auto loan funding, changes in wholesale vehicle pricing, and ongoing litigation (specifically a putative class action in California regarding meal/rest breaks and overtime, currently stayed pending a Supreme Court ruling).

Investor Verification Checklist

• Accounting Impact: Verify the impact of the ASU 2009-16/17 adoption on balance sheet leverage ratios and the shift from "gain-on-sale" to "interest spread" accounting for CAF income.
• CAF Performance: Confirm the sustainability of the $57.5 million CAF profit, noting it was aided by favorable loan loss provisions and high spreads, excluding the $40.4 million prior-year adjustment.
• Debt Maturity: Review the maturity schedule of the $3.82 billion in non-recourse notes payable and the $1.2 billion warehouse facility limits, noting expirations in August 2010 and February 2011.
• Inventory Levels: Assess the $894.7 million inventory balance against the 5% increase in units and rising acquisition costs to ensure turnover remains efficient.
• Litigation Exposure: Monitor the status of the California class action lawsuit, as the company cannot currently estimate the potential loss.