Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended August 31, 2002, for CarMax, Inc. The financial statements are presented on a pro forma basis as if CarMax had been a separate entity from its former parent, Circuit City Stores, Inc., for the periods presented. The separation was approved by shareholders on September 10, 2002, and became effective on October 1, 2002, making CarMax an independent, publicly traded company.
Key Financial Metrics
Revenue and Profit (Three Months Ended Aug 31, 2002):
- Net Sales: $1,076.1 million (up 15% from prior year).
- Gross Profit: $124.2 million (Gross Margin: 11.5%).
- Net Earnings: $31.7 million.
- Diluted EPS: $0.30.
Revenue and Profit (Six Months Ended Aug 31, 2002):
- Net Sales: $2,077.6 million (up 14% from prior year).
- Gross Profit: $242.1 million (Gross Margin: 11.7%).
- Net Earnings: $61.0 million.
- Diluted EPS: $0.58.
Cash Flow and Liquidity (Six Months Ended Aug 31, 2002):
- Cash from Operating Activities: $93.1 million (compared to $29.9 million in prior year).
- Cash from Investing Activities: $(40.1) million (primarily capital expenditures for store expansion).
- Cash from Financing Activities: $18.3 million.
- Cash and Cash Equivalents (Aug 31, 2002): $74.7 million.
Debt and Capital Structure:
- Total Debt Outstanding: Approximately $105.2 million under a new $200 million credit agreement (secured by inventory) entered in May 2002.
- Securitization Capacity: $361.0 million unused capacity in the automobile loan variable funding program.
- Securitized Receivables: $1.72 billion principal amount managed.
Material Changes vs. Prior Period
- Revenue Growth: Driven by a 15% increase in retail vehicle sales, with used vehicle sales up 18% and new vehicle sales up 1% for the quarter. Wholesale sales also increased to $97.7 million.
- Margin Pressure: Retail vehicle gross profit margin declined slightly to 9.8% (from 9.9%) due to selective markdowns on used vehicles in response to zero-percent financing incentives on new cars.
- Expense Management: Selling, general, and administrative (SG&A) expenses as a percentage of sales remained stable at 6.6%. This stability was aided by strong finance income ($26.7 million for the quarter), which is recorded as a reduction to SG&A.
- Capital Expenditures: Significantly increased to $40.1 million for the six-month period (vs. $8.7 million prior year) to fund the resumption of geographic expansion with new superstore openings.
- One-Time Costs: Net earnings included $1.3 million in non-tax-deductible separation costs for the quarter and $3.1 million for the six-month period.
Guidance, Outlook, and Risks
Outlook and Guidance:
- Fiscal 2003 EPS: Management anticipates pro forma net earnings of $0.95 to $1.00 per share, excluding approximately $0.08 per share of one-time separation costs.
- Store Expansion: Plans to open five superstores in fiscal 2003 (three in the second half). Future plans include 4-6 stores in fiscal 2004 and 6-8 stores annually through fiscal 2006.
- Comparable Store Growth: Expects mid- to high-single digit growth in used-unit comparable store sales for the second half of the fiscal year.
Risks and Contingencies:
- Separation Costs: Fiscal 2003 is a transition year with increased expenses related to the separation from Circuit City (e.g., benefits, insurance, management bench development) which may offset expense leverage from sales growth.
- Interest Rate Environment: While the company anticipated rising interest rates reducing yield spreads, the current low-rate environment may sustain higher finance operation yields.
- Market Risk: Exposure to interest rate fluctuations is managed via amortizing swaps to match funding costs to receivables. Credit risk is mitigated by dealing with highly rated bank counterparties.
- Accounting Changes: Pending adoption of SFAS No. 143 (Asset Retirement Obligations) and SFAS No. 146 (Exit/Disposal Activities), though impacts are not yet determined.
Investor Verification Checklist
- Verify the pro forma nature of the financial statements, as they reflect a capital structure effective only after the October 1, 2002 separation.
- Confirm the impact of the $3.1 million one-time separation costs on net earnings and the adjusted earnings growth rate (19% excluding costs).
- Review the details of the $200 million credit agreement and the $1.72 billion securitization program to assess liquidity and leverage.
- Monitor the execution of the store expansion plan and the associated capital expenditure burn rate ($40.1 million in six months).
- Assess the sensitivity of finance operation income to changes in default rates and prepayment speeds, as detailed in the retained interest fair value analysis.