KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2005 (First Quarter of Fiscal 2006)
Business Overview: CarMax is the largest retailer of used cars and light trucks in the United States, operating 62 used car superstores and seven new car franchises as of May 31, 2005. The company utilizes a "no-haggle" pricing model and provides financing through its subsidiary, CarMax Auto Finance (CAF).

Key Financial Metrics

Note: Total Debt for Q1 2006 calculated as Short-term debt ($41,428) + Current installments of long-term debt ($100,351) + Long-term debt ($28,315) = $170,094. However, the balance sheet lists "Short-term debt" and "Current installments of long-term debt" separately. The sum of all debt obligations listed is $170,094.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 19% to $1.58 billion, driven by a 19% increase in used vehicle unit sales and a 21% increase in wholesale vehicle sales.
• Profitability: Net earnings rose 13% to $39.8 million. CAF income increased 24% to $27.1 million, aided by a favorable valuation adjustment of retained interest and a new public securitization.
• Cash Flow: Operating cash flow surged to $64.9 million from $2.6 million in the prior year. This improvement was primarily due to a decision to maintain inventory levels consistent with sales pace, contrasting with the prior year's $57.6 million inventory buildup.
• Store Expansion: The company opened four new superstores in the quarter, including two in the Los Angeles market.
• Market Conditions: Used vehicle sales momentum softened in April and May due to rising wholesale auction prices and higher gas prices. Management adjusted appraisal offers to remain competitive.

Guidance, Outlook, and Risks

Outlook and Guidance

• Q2 2006 Forecast: Management anticipates comparable store used vehicle unit growth of 3% to 9%. Diluted EPS is expected to range from $0.29 to $0.34.
• CAF Performance: The gain on loans sold is expected to be below the normalized range of 3.5% to 4.5% as funding costs rise faster than consumer rates.
• Expansion: Plans to open nine superstores in Fiscal 2006 (four already opened). No full-year outlook provided due to market volatility.

Risks and Contingencies

• Market Volatility: The used car market environment remains volatile, with rising wholesale prices and consumer sensitivity to gas prices.
• Securitization Risk: The company retains an interest in securitized receivables ($144.4 million). Earnings could be impacted if these receivables do not perform according to assumptions regarding prepayment and default rates.
• Interest Rate Risk: Substantially all debt is floating-rate based on LIBOR. The company uses interest rate swaps to manage exposure, though cash flows may be materially impacted by rate changes.
• Accounting Changes: Adoption of SFAS No. 123R (Share-Based Payment) is required effective March 1, 2006, with the impact on financial position yet to be determined.

Investor Verification Checklist

• Inventory Management: Verify the sustainability of the improved operating cash flow given the shift in inventory strategy compared to the prior year.
• CAF Valuation Adjustments: Review the specific assumptions used for the favorable valuation adjustment of retained interest in securitized receivables, as this significantly boosted Q1 income.
• Wholesale Price Trends: Monitor the trend of wholesale auction prices and their impact on used vehicle gross profit margins in upcoming quarters.
• Debt Maturity: Confirm the renewal status of the $825 million warehouse facility maturing in August 2005 and the $300 million inventory credit facility maturing in May 2006.
• Comparable Store Growth: Track the 3% to 9% comparable store unit growth guidance against actual results in Q2 to gauge market resilience.