Business context and reporting period
CarMax, Inc. filed this unaudited Form 10-Q for the quarter and six months ended August 31, 2016, the second quarter of fiscal 2017. The company operates used-vehicle retail and related services, alongside CarMax Auto Finance (CAF), which finances CarMax retail customers. At quarter-end, CarMax operated 163 used-car stores in 82 U.S. markets.
Financial performance
| Metric | Three months ended Aug. 31, 2016 | Year-over-year | Six months ended Aug. 31, 2016 | Year-over-year |
|---|---|---|---|---|
| Net sales and operating revenues | $3.997 billion | +2.9% | $8.124 billion | +2.8% |
| Gross profit / gross margin | $545.4 million / 13.6% | +$24.0 million; 13.4% prior year | $1.118 billion / 13.8% | +$52.8 million; 13.5% prior year |
| CAF income | $96.0 million | -2.4% | $196.7 million | -5.1% |
| Net earnings | $162.4 million | -5.7% | $337.7 million | -4.7% |
| Diluted earnings per share | $0.84 | +$0.02; +2.4% | $1.74 | +$0.06; +3.6% |
For the quarter, used-unit sales rose 7.0% (comparable-store units +3.1%); used-vehicle gross profit increased 6.7%, while gross profit per unit was broadly steady at $2,160. Wholesale gross profit fell 9.7%, including an 8.5% decline in gross profit per unit to $870. SG&A rose 10.7% to $366.1 million, or 9.2% of revenue versus 8.5%; interest expense increased to $13.9 million from $7.5 million. The effective tax rate was 38.0%, versus 38.5%.
Cash flow, balance sheet and financing
- For the six months, operating cash flow was a use of $39.8 million, compared with a use of $84.7 million a year earlier. Management’s non-GAAP adjusted operating cash flow, adding net non-recourse note issuances, was $697.0 million versus $597.8 million.
- Investing cash outflow was $262.2 million, including $214.6 million of capital expenditures. Financing cash inflow was $580.6 million. Cash and cash equivalents ended at $316.0 million, versus $37.4 million at fiscal year-end.
- At August 31, total debt was $11.51 billion, including $10.26 billion of non-recourse notes payable; total debt was $10.66 billion at February 29. The $10.13 billion of net auto-loan receivables was principally financed by securitizations and warehouse facilities.
- The $1.20 billion revolving credit facility was nearly unused, with $1.200 billion available. Warehouse facilities had $1.10 billion of unused capacity against a $2.80 billion limit. The company reported compliance with financial covenants and securitization performance triggers.
- Inventory was $1.92 billion, down 0.7% from fiscal year-end. Share repurchases totaled $266.0 million during the first half; $1.89 billion remained authorized at quarter-end.
Material changes and management commentary
- CAF’s average managed receivables grew 11.7% in the quarter, but income declined as the interest margin rate fell to 5.9% from 6.2% and loan-loss provision rose to $35.7 million from $25.6 million. Annualized net credit losses were 1.20% versus 0.96%; past-due accounts were 3.24% versus 3.00%, and recovery rates declined to 48.4% from 51.8%.
- Management attributed lower store traffic partly to tighter lending standards at a third-party Tier 3 provider and fewer applicants in that credit tier. Comparable-store used-unit growth was stronger among non-Tier 3 customers.
- Quarterly results included $10.9 million of pretax share-based compensation expense from modifying former CEO Thomas J. Folliard’s awards upon retirement. Prior-year quarterly results included a $10.4 million favorable service-department gross-profit adjustment from a change in reconditioning-overhead timing. Management estimated these items affected net earnings by -$6.8 million ($0.04 per diluted share) and +$6.4 million ($0.03 per share), respectively.
- Management planned 15 store openings in fiscal 2017, including five already opened in the first half, and 13–16 openings in fiscal 2018. Fiscal 2017 capital expenditures were expected to be approximately $450 million, compared with $332 million in fiscal 2016. Long term, management identified vehicle-unit growth as the primary earnings-growth driver and said it expects to leverage SG&A when comparable-store used-unit growth reaches the mid-single-digit range.
- Management cautioned that a projected influx of off-lease vehicles could increase auction supply, affecting wholesale prices, acquisition costs and CAF recovery rates. Funding renewals may also become more costly or constrained by credit-market conditions; several warehouse facilities were due to expire in February or August 2017.
Risks, contingencies and unusual items
CAF’s loss outlook, funding costs and securitization access are sensitive to credit performance, interest rates, recovery values and capital-market conditions. Other cited risks include competition, used-vehicle price and inventory changes, consumer-credit availability, store expansion and real-estate access, seasonality, systems and data security, regulation, and litigation. The company disclosed additional California wage-and-hour proceedings for which it could not reasonably estimate potential losses; earlier Fowler and Areso claims were settled for immaterial amounts. Management said other ordinary-course proceedings were not expected to have a material adverse effect. The filing reported no material change in market-risk disclosures or risk factors and stated disclosure controls were effective.
Important facts for investors to verify
- Whether CAF delinquency, charge-off and recovery-rate trends continue to worsen, and how they affect provisions and earnings.
- Whether CAF interest-margin compression and any increase in funding costs persist.
- Renewal terms, capacity and pricing for warehouse facilities expiring in 2017, and continued access to securitization markets.
- Progress against store-opening and capital-expenditure plans, and whether comparable-store sales growth supports operating leverage.
- Potential effects of increased off-lease supply on wholesale pricing, vehicle acquisition economics and CAF collateral recoveries.
- Any material developments in the California wage-and-hour cases and other contingencies.