KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 31, 2005 (Second Quarter of Fiscal 2006)
Business Overview: CarMax is the largest retailer of used cars and light trucks in the United States, operating 63 used car superstores and 7 new car franchises as of the period end. The company utilizes a "no-haggle" pricing model and provides financing through its subsidiary, CarMax Auto Finance (CAF).

Key Financial Metrics

Note: Debt figures represent the sum of current portion of long-term debt ($106.2M) and long-term debt excluding current portion ($35.3M) as of August 31, 2005. Short-term debt was $0 at period end.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 23% year-over-year for the quarter, driven by a 21% increase in used vehicle unit sales and a 10% increase in comparable store used unit sales.
• Profitability: Net earnings rose 39% to $41.4 million. Gross profit per unit increased to $2,546 from $2,395 in the prior year quarter.
• CAF Performance: CAF income increased 15% to $23.8 million. While loan volume grew 31%, the gain spread on loans sold decreased to 3.3% from 3.8%.
• Expense Management: Selling, General, and Administrative (SG&A) expenses as a percentage of revenue declined slightly to 10.1% from 10.2%, despite increased advertising spend in Los Angeles and a higher proportion of newer, less mature stores.
• Liquidity: Cash and cash equivalents increased from $29.1 million at the prior fiscal year-end to $53.8 million. Net cash provided by operating activities for the six-month period more than doubled to $118.9 million.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Q3 Fiscal 2006 Guidance: Management anticipates comparable store used vehicle unit growth of 2% to 8% and diluted net earnings per share in the range of $0.19 to $0.25.
• Expansion Plans: The company plans to open nine superstores in Fiscal 2006 (five opened in the first half, four planned for the second half). Future expansion includes entering markets such as Columbus, Hartford, Oklahoma City, and Fresno in Fiscal 2007.
• CAF Outlook: Expected gains on sales of loans for the third quarter are approximately 3.5%, slightly higher than the 3.3% realized in the second quarter.

Risks and Contingencies

• Market Conditions: Management notes uncertainty in market conditions, specifically price declines for SUVs and light trucks due to rising gasoline costs, which may cause incremental margin pressure.
• Weather Events: Hurricane Rita caused temporary closures of four Houston stores; management expects to recover lost sales in subsequent months but does not anticipate a sales benefit from replacement purchases.
• Securitization Risk: The company retains an interest in securitized receivables ($157.8 million). Earnings could be impacted if these receivables do not perform according to assumptions regarding prepayment and default rates.
• Accounting Changes: The company will be required to adopt SFAS No. 123R (Share-Based Payment) effective March 1, 2006, though the specific financial impact has not yet been determined.

Investor Verification Checklist

• Inventory Valuation: Verify the impact of supplemental markdowns on SUV and light truck inventory due to falling wholesale prices and rising gas costs.
• CAF Gain Spreads: Monitor the trend of gain spreads on loans sold, which compressed to 3.3% in Q2, against the normalized range of 3.5% to 4.5%.
• Debt Structure: Confirm the classification of the $105.2 million outstanding under the new credit facility as current debt and the company's intent/ability to refinance or repay within one year.
• Store Maturity: Assess the impact of the growing percentage of "newer" stores (46% of the base) on SG&A ratios and overall profitability.
• Securitization Covenants: Review compliance with financial covenants and performance triggers related to the $2.6 billion in managed receivables.