KMX

Business Context and Reporting Period

Company: CARMAX, INC.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three months ended May 31, 2004 (First Quarter of Fiscal 2005)
Business Overview: CarMax is the leading specialty retailer of used cars and light trucks in the United States, operating 52 used car superstores and 12 new car franchises as of May 31, 2004. The company utilizes a "no-haggle" pricing model and provides financing through its subsidiary, CarMax Auto Finance (CAF).

Key Financial Metrics

Note: Short-term debt increased to $28,182 from $4,446; Long-term debt remained at $100,000.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 13% to $1.32 billion, driven by a 56% surge in wholesale vehicle sales and contributions from approximately ten new stores. However, comparable store used vehicle unit sales declined 3%.
• CAF Income Decline: CarMax Auto Finance income dropped 15% to $21.8 million. This was attributed to funding costs rising more rapidly than consumer loan rates, narrowing the spread.
• Operating Cash Flow: Net cash from operations fell significantly to $2.6 million from $72.6 million. The primary driver was a $57.6 million increase in inventory due to slower-than-expected sales and seasonal buildup, contrasting with a decrease in inventory in the prior year.
• Margin Stability: Gross profit margin remained stable at 12.6%. Improvements in used and wholesale vehicle margins (due to a change in appraisal cost recovery methodology) offset declines in new vehicle and other margins.

Guidance, Outlook, and Risks

Outlook and Guidance

• Store Expansion: CarMax plans to open approximately 9 to 10 superstores in Fiscal 2005 (3 opened in Q1).
• Q2 Forecast: Management anticipates comparable store used unit sales growth in the range of -5% to +1% for the second quarter. Diluted EPS is expected to range from $0.30 to $0.35.
• Franchise Strategy: The company plans to sell its Ford franchise in Kenosha, WI, and sell or return four Mitsubishi franchises to free up space for more profitable used car sales.

Risks and Contingencies

• Market Volatility: Sales volatility was noted due to higher gasoline prices, rising mortgage rates, and manufacturer incentives. Management stated forecasting is difficult due to this volatility.
• Securitization Risk: The company retains interests in securitized receivables. If these receivables do not perform as projected (e.g., higher default or prepayment rates), earnings could be impacted. As of May 31, 2004, accounts 31+ days past due were 1.51% of managed receivables.
• Interest Rate Risk: Substantially all debt is floating-rate based on LIBOR. The company uses interest rate swaps to manage exposure, though changes in rates could materially impact cash flows.

Investor Verification Checklist

• Inventory Levels: Verify the $523.7 million inventory balance and the rationale for the $57.6 million increase, given the decline in comparable store sales.
• CAF Spreads: Monitor the spread between consumer loan rates and funding costs, as this drove the 15% decline in CAF income.
• Wholesale Sales Sustainability: Assess whether the 56% increase in wholesale sales is sustainable or a one-time benefit from improved appraisal processes and pricing.
• Securitization Covenants: Confirm continued compliance with financial covenants (tangible net worth, current ratio) required by securitization agreements.
• Q2 Execution: Watch for Q2 results to see if the wide guidance range (-5% to +1% unit sales) narrows as market conditions stabilize.