Business context and reporting period
CarMax, Inc. filed this unaudited Form 10-Q for the quarter and six months ended August 31, 2018 (the second quarter and first half of fiscal 2019). The company operates used-car retail, wholesale, service and related-product businesses, plus CarMax Auto Finance (CAF), which finances retail customers.
Financial performance and position
| Metric | Three months ended August 31, 2018 | Six months ended August 31, 2018 |
|---|---|---|
| Net sales and operating revenues | $4.766 billion, up 8.6% | $9.559 billion, up 7.1% |
| Gross profit and margin | $650.6 million; 13.7% (13.8% prior year) | $1.312 billion; 13.7% (14.0% prior year) |
| Earnings before taxes | $289.5 million; 6.1% margin | $609.2 million; 6.4% margin |
| Net earnings | $220.9 million, up 21.8%; 4.6% margin | $459.5 million, up 16.9%; 4.8% margin |
| Diluted earnings per share | $1.24, versus $0.98 | $2.57, versus $2.12 |
| Operating cash flow | $110.9 million for the six months, versus $81.1 million; adjusted operating cash flow, a non-GAAP measure, was $718.4 million versus $642.2 million |
Quarterly used-vehicle revenue grew 7.6%, wholesale revenue 14.6%, and other revenue 12.4%. Used units rose 5.8%, including 2.1% comparable-store growth; wholesale units rose 14.6%. SG&A increased 12.0% to $453.6 million, faster than revenue. Quarterly CAF income was $109.7 million, up 1.6%.
At August 31, total assets were $18.18 billion and shareholders’ equity was $3.48 billion. Cash and cash equivalents were $37.1 million, with $447.6 million of restricted cash from auto-loan collections. Total debt was $13.61 billion, including $12.25 billion of non-recourse notes tied to auto-loan receivables and $515.7 million of finance and capital lease obligations. The company had $1.15 billion of available capacity under its $1.20 billion revolving credit facility and $1.03 billion of unused warehouse-facility capacity. It reported compliance with financial covenants and funding-vehicle performance triggers.
Material changes versus prior comparable periods
- Net earnings grew faster than revenue, primarily because the effective tax rate fell to 23.7% from 37.5% in the quarter, reflecting the 2017 Tax Act and, in part, share-based awards. The first-half rate was 24.6% versus 37.4%.
- Gross profit increased 7.7% in the quarter, but gross margin declined 0.1 percentage point. For the first half, gross profit rose 4.7% and gross margin declined 0.3 percentage point.
- CAF’s total interest margin declined to 5.7% from 5.8% in both the quarter and first half. Quarterly loan-loss provision rose to $40.0 million from $32.9 million; annualized net credit losses were 1.20% versus 1.19%.
- First-half capital expenditures were $171.1 million versus $155.1 million. Share repurchases totaled $381.3 million versus $344.8 million; 5.6 million shares were repurchased in the first half.
- Revenue-recognition adoption increased quarterly and first-half other revenue by $4.4 million and $8.4 million, respectively, and increased opening retained earnings by $12.9 million after tax.
Outlook, commentary, risks and contingencies
Management planned 15 store openings in fiscal 2019, including nine during the remainder of that fiscal year, and 13–16 openings in fiscal 2020. Estimated fiscal 2019 capital expenditures were approximately $340 million. CarMax planned to introduce an omni-channel experience in a major market later in the fiscal year. Management said lower tax rates were expected to benefit results and cash flows, with 70%–85% of the benefit expected to affect net earnings after planned investments. It said SG&A leverage over the long term was expected when comparable-store used-unit growth reached the mid-single-digit range, likely toward the higher end in the near term while strategic investment remained elevated. No specific earnings or revenue guidance was provided.
Management highlighted the possibility that increased off-lease vehicle supply could affect wholesale prices, vehicle acquisition costs and CAF recovery rates. Other risks include credit losses, interest-rate and funding-cost pressures, availability and cost of securitization and warehouse financing, competition, inventory sourcing, consumer financing availability, seasonality, and execution of store growth and technology initiatives. Some warehouse facilities were due to expire in February and August 2019; management cautioned that renewal terms, costs and capacity could change with market conditions.
Four California wage-and-hour putative class actions and an informal inquiry by California municipal district attorneys concerning hazardous-waste handling, storage and disposal remained outstanding. The company said it could not reasonably estimate potential losses in these matters. Management believed other ordinary-course legal proceedings would not materially adversely affect the company. The filing also reports a $7.3 million liability for its 30-day limited vehicle warranty. A new lease accounting standard was expected to increase assets and liabilities by an estimated $400–$430 million at adoption on March 1, 2019, without a material effect on expense recognition. The company said its disclosure controls were effective and there had been no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether used-unit growth, especially comparable-store growth, can strengthen while store expansion and digital initiatives raise SG&A.
- Whether CAF credit losses and funding-cost pressure remain manageable as its managed receivables portfolio grows; review delinquencies, allowance levels and interest margins.
- Availability, renewal terms and cost of warehouse and securitization funding, including upcoming facility expirations.
- How much reported earnings growth reflects the lower tax rate versus underlying operating performance, and the effect of share repurchases on per-share results.
- Developments in the California litigation and hazardous-waste inquiry, for which potential loss estimates were not available.