Form 10-Q
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the Quarterly Period Ended November 30, 2006
OR
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
Commission
File Number: 1-31420
CARMAX,
INC.
(Exact
name of registrant as specified in its charter)
VIRGINIA
|
|
54-1821055
|
(State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification No.)
|
12800
TUCKAHOE CREEK PARKWAY, RICHMOND, VIRGINIA
|
|
23238
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
(804)
747-0422
(Registrant's
telephone number, including area code)
N/A
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required
to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was
required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer x
|
Accelerated
filer o
|
Non-accelerated
filer o
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule
12b-2 of the Exchange Act).
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
Class
|
|
Outstanding
at December 31, 2006
|
Common
Stock, par value $0.50
|
|
107,444,503
|
CARMAX,
INC. AND SUBSIDIARIES
TABLE
OF CONTENTS
|
|
Page
No.
|
|
|
|
PART
I.
|
|
|
|
|
|
Item
1.
|
|
|
|
|
|
|
|
|
3
|
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|
4
|
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|
5
|
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6
|
|
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|
Item
2.
|
|
14
|
|
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|
Item
3.
|
|
25
|
|
|
|
Item
4.
|
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26
|
|
|
|
|
|
|
PART
II.
|
|
|
|
|
|
Item
1.
|
|
27
|
|
|
|
Item
1A.
|
|
27
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|
Item
6.
|
|
28
|
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29
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|
30
|
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
CARMAX,
INC. AND SUBSIDIARIES
Consolidated
Statements of Earnings
(Unaudited)
(In
thousands except per share data)
|
|
Three
Months Ended November 30
|
|
Nine
Months Ended November 30
|
|
|
|
2006
|
|
%(1)
|
|
2005
|
|
%(1)
|
|
2006
|
|
%(1)
|
|
2005
|
|
%(1)
|
|
|
|
|
|
|
|
Restated(2)
|
|
|
|
|
|
|
Restated(2)
|
|
|
Sales
and operating revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used vehicle sales
|
|
$
|
1,377,551
|
|
|
77.9
|
|
$
|
1,087,097
|
|
|
76.3
|
|
$
|
4,365,409
|
|
|
78.2
|
|
$
|
3,527,416
|
|
|
76.1
|
|
New vehicle sales
|
|
|
109,940
|
|
|
6.2
|
|
|
113,299
|
|
|
8.0
|
|
|
349,579
|
|
|
6.3 |
|
|
399,314
|
|
|
8.6
|
|
Wholesale vehicle sales
|
|
|
226,363
|
|
|
12.8
|
|
|
174,235
|
|
|
12.2
|
|
|
695,958
|
|
|
12.5 |
|
|
554,510
|
|
|
12.0
|
|
Other sales and revenues
|
|
|
54,293
|
|
|
3.1
|
|
|
49,349
|
|
|
3.5
|
|
|
171,882
|
|
|
3.1
|
|
|
154,953
|
|
|
3.3
|
|
Net
sales and operating revenues
|
|
|
1,768,147
|
|
|
100.0
|
|
|
1,423,980
|
|
|
100.0
|
|
|
5,582,828
|
|
|
100.0
|
|
|
4,636,193
|
|
|
100.0
|
|
Cost
of sales
|
|
|
1,539,538
|
|
|
87.1
|
|
|
1,246,807
|
|
|
87.6
|
|
|
4,852,599
|
|
|
86.9
|
|
|
4,052,677
|
|
|
87.4
|
|
Gross
profit
|
|
|
228,609
|
|
|
12.9
|
|
|
177,173
|
|
|
12.4
|
|
|
730,229
|
|
|
13.1
|
|
|
583,516
|
|
|
12.6
|
|
CarMax
Auto Finance income
|
|
|
31,974
|
|
|
1.8
|
|
|
27,971
|
|
|
2.0
|
|
|
100,880
|
|
|
1.8
|
|
|
78,866
|
|
|
1.7
|
|
Selling,
general, and administrative expenses
|
|
|
187,318
|
|
|
10.6
|
|
|
167,351
|
|
|
11.8
|
|
|
574,333
|
|
|
10.3
|
|
|
502,517
|
|
|
10.8
|
|
Interest
expense
|
|
|
167
|
|
|
|
|
|
|
|
|
-
|
|
|
4,449
|
|
|
0.1
|
|
|
1,999
|
|
|
-
|
|
Interest
income
|
|
|
406
|
|
|
-
|
|
|
262
|
|
|
-
|
|
|
973
|
|
|
-
|
|
|
588
|
|
|
-
|
|
Earnings
before income taxes
|
|
|
73,504
|
|
|
4.2
|
|
|
37,625
|
|
|
2.6
|
|
|
253,300
|
|
|
4.5 |
|
|
158,454
|
|
|
3.4
|
|
Provision
for income taxes
|
|
|
28,085
|
|
|
1.6
|
|
|
14,694
|
|
|
1.0
|
|
|
96,841
|
|
|
1.7
|
|
|
60,907
|
|
|
1.3
|
|
Net
earnings
|
|
$
|
45,419
|
|
|
2.6
|
|
$
|
22,931
|
|
|
1.6
|
|
$
|
156,459
|
|
|
2.8
|
|
$
|
97,547
|
|
|
2.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
106,511
|
|
|
|
|
|
104,727
|
|
|
|
|
|
105,895
|
|
|
|
|
|
104,547
|
|
|
|
|
Diluted
|
|
|
108,883
|
|
|
|
|
|
106,507
|
|
|
|
|
|
107,861
|
|
|
|
|
|
106,343
|
|
|
|
|
|
|
|
|
|
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|
|
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|
|
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|
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|
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|
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|
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|
|
Net
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.43
|
|
|
|
|
$
|
0.22
|
|
|
|
|
$
|
1.48
|
|
|
|
|
$
|
0.93
|
|
|
|
|
Diluted
|
|
$
|
0.42
|
|
|
|
|
$
|
0.22
|
|
|
|
|
$
|
1.45
|
|
|
|
|
$
|
0.92
|
|
|
|
|
(1)
|
Percents
are calculated as a percentage of net sales and operating revenues
and may
not equal totals due to
rounding.
|
(2)
|
Prior
period amounts have been restated to reflect the impact of share-based
compensation expense, as permitted by SFAS 123(R). See Notes 2
and 7 for
additional information.
|
See
accompanying notes to consolidated financial
statements.
CARMAX,
INC. AND SUBSIDIARIES
Consolidated
Balance Sheets
(Unaudited)
(In
thousands except share data)
|
|
November
30,
|
|
February
28,
|
|
|
2006
|
|
2006
|
|
|
|
|
Restated(1)
|
ASSETS |
|
|
|
|
|
|
|
Current
assets: |
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
12,352
|
|
$
|
21,759
|
|
Accounts
receivable, net
|
|
|
53,092
|
|
|
76,621
|
|
Automobile
loan receivables held for sale
|
|
|
3,145
|
|
|
4,139
|
|
Retained
interest in securitized receivables
|
|
|
202,594
|
|
|
158,308
|
|
Inventory
|
|
|
760,816
|
|
|
669,700
|
|
Prepaid
expenses and other current assets
|
|
|
13,955 |
|
|
11,211
|
|
Total
current assets
|
|
|
1,045,954
|
|
|
941,738
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
585,109
|
|
|
499,298
|
|
Deferred
income taxes
|
|
|
25,788
|
|
|
24,576
|
|
Other
assets
|
|
|
47,817
|
|
|
44,000
|
|
TOTAL
ASSETS
|
|
$
|
1,704,668
|
|
$
|
1,509,612
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
222,205
|
|
$
|
188,614
|
|
Accrued
expenses and other current liabilities
|
|
|
83,623
|
|
|
85,316
|
|
Accrued
income taxes
|
|
|
33,275
|
|
|
5,598
|
|
Deferred
income taxes
|
|
|
10,151
|
|
|
23,562
|
|
Short-term
debt
|
|
|
2,984
|
|
|
463
|
|
Current
portion of long-term debt
|
|
|
84,422
|
|
|
59,762
|
|
Total
current liabilities
|
|
|
436,660
|
|
|
363,315
|
|
|
|
|
|
|
|
|
|
Long-term
debt, excluding current portion
|
|
|
34,012
|
|
|
134,787
|
|
Deferred
revenue and other liabilities
|
|
|
35,090
|
|
|
31,407
|
|
TOTAL
LIABILITIES
|
|
|
505,762
|
|
|
529,509
|
|
|
|
|
|
|
|
|
|
Commitments
and contingent liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, $0.50 par value; 350,000,000 shares authorized; 107,229,646
and
104,954,983 shares issued and outstanding at November 30, 2006,
and
February 28, 2006, respectively
|
|
|
53,615
|
|
|
52,477
|
|
Capital
in excess of par value
|
|
|
615,282
|
|
|
554,076
|
|
Retained
earnings
|
|
|
530,009
|
|
|
373,550
|
|
TOTAL
SHAREHOLDERS’ EQUITY
|
|
|
1,198,906
|
|
|
980,103
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
$
|
1,704,668
|
|
$
|
1,509,612
|
|
(1)
|
Prior
period amounts have been restated to reflect the impact of share-based
compensation expense, as permitted by SFAS 123(R). See Notes 2 and
7 for
additional information.
|
See
accompanying notes to consolidated financial statements.
CARMAX,
INC. AND SUBSIDIARIES
Consolidated
Statements of Cash Flows
(Unaudited)
(In
thousands)
|
|
Nine
Months Ended
November
30
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
Restated(1)
|
Operating
Activities:
|
|
|
|
|
|
Net
earnings
|
|
$
|
156,459 |
|
$
|
97,547
|
|
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
25,177 |
|
|
19,193
|
|
Share-based
compensation expense
|
|
|
25,548 |
|
|
15,713
|
|
Loss
(gain) on disposition of assets
|
|
|
259 |
|
|
(777
|
)
|
Deferred
income tax benefit
|
|
|
(14,623 |
) |
|
(22,603
|
)
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Decrease in
accounts receivable, net
|
|
|
23,529 |
|
|
20,551
|
|
Decrease
in automobile loan receivables held for sale, net
|
|
|
994 |
|
|
20,625
|
|
Increase
in retained interest in securitized receivables
|
|
|
(44,286 |
) |
|
(10,967
|
)
|
Increase
in inventory
|
|
|
(91,116 |
) |
|
(29,799
|
)
|
(Increase)
decrease in prepaid expenses and other current assets
|
|
|
(2,744 |
) |
|
1,627
|
|
Increase in
other assets
|
|
|
(3,817 |
) |
|
(6,184
|
)
|
Increase
in accounts payable, accrued expenses and other current liabilities,
and
accrued income taxes
|
|
|
58,502 |
|
|
33,371
|
|
Increase
in deferred revenue and other liabilities
|
|
|
3,683 |
|
|
800
|
|
Net
cash provided by operating activities
|
|
|
137,565 |
|
|
139,097
|
|
|
|
|
|
|
|
|
|
Investing
Activities:
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(114,719 |
) |
|
(153,490
|
)
|
Proceeds
from sales of assets
|
|
|
3,472 |
|
|
78,217
|
|
Net
cash used in investing activities
|
|
|
(111,247 |
) |
|
(75,273
|
)
|
|
|
|
|
|
|
|
|
Financing
Activities:
|
|
|
|
|
|
|
|
Increase
(decrease) in short-term debt, net
|
|
|
2,521 |
|
|
(60,490
|
)
|
Issuance
of long-term debt |
|
|
– |
|
|
105,229
|
|
Payments
on long-term debt
|
|
|
(76,115
|
) |
|
(116,764 |
) |
Equity
issuances, net
|
|
|
27,449
|
|
|
5,108
|
|
Excess
tax benefits from share-based payment arrangements
|
|
|
10,420
|
|
|
3,221
|
|
Net
cash used in financing activities
|
|
|
(35,725
|
) |
|
(63,696
|
)
|
|
|
|
|
|
|
|
|
(Decrease)
increase in cash and cash equivalents
|
|
|
(9,407
|
) |
|
128
|
|
Cash
and cash equivalents at beginning of year
|
|
|
21,759
|
|
|
17,124
|
|
Cash
and cash equivalents at end of period
|
|
$
|
12,352 |
|
$
|
17,252
|
|
(1)
|
Prior
period amounts have been restated to reflect the impact of share-based
compensation expense, as permitted by SFAS 123(R). See Notes 2 and
7 for
additional information.
|
See
accompanying notes to consolidated financial statements.
CARMAX,
INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
(Unaudited)
CarMax,
Inc. (“CarMax” and the “company”), including its wholly owned subsidiaries, is
the largest retailer of used vehicles in the United States. CarMax was the
first
used vehicle retailer to offer a large selection of quality used vehicles at
low, “no-haggle” prices using a customer-friendly sales process in an
attractive, modern sales facility. CarMax also sells new vehicles under various
franchise agreements. CarMax provides its customers with a full range of related
services, including the financing of vehicle purchases through its own finance
operation, CarMax Auto Finance (“CAF”), and third-party lenders; the sale of
extended service plans; the appraisal and purchase of vehicles directly from
consumers; and vehicle repair service. Vehicles purchased through the company’s
appraisal process that do not meet its retail standards are sold at on-site
wholesale auctions.
Basis
of Presentation. The
accompanying interim unaudited consolidated financial statements include
the accounts
of CarMax and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. Certain
previously reported amounts have been reclassified to conform with the current
period presentation, including restricted cash deposits associated with certain
insurance deductibles, which were reclassified from cash and cash
equivalents to other assets.
The
company adopted Statement of Financial Accounting Standards (“SFAS”) No.
123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”), effective March 1,
2006, applying the modified retrospective method. As a result, prior period
amounts have been restated to reflect the adoption of this standard. The impact
of the adoption of SFAS 123(R) on net income for the third quarter and
first nine months of fiscal 2006 is consistent with the pro forma amounts
previously disclosed in the company’s quarterly reports.
These
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by U.S. generally accepted accounting principles for complete financial
statements. In the opinion of management, such interim consolidated financial
statements reflect all normal recurring adjustments considered necessary to
present fairly the financial position and the results of operations and cash
flows for the interim periods presented. The results of operations for the
interim periods are not necessarily indicative of the results to be expected
for
the full fiscal year. These consolidated financial statements should be read
in
conjunction with the audited consolidated financial statements and footnotes
included in the company’s Annual Report on Form 10-K for the fiscal year
ended February 28, 2006.
Cash
and Cash Equivalents. Cash equivalents of $4.0 million at November 30,
2006, and $6.0 million at February 28, 2006, consisted of highly liquid
investments with original maturities of three months or less.
3.
|
CarMax
Auto Finance Income
|
The
company’s finance operation, CAF, originates prime-rated financing for qualified
customers at competitive market rates of interest. Throughout each month, the
company sells substantially all of the loans originated by CAF in securitization
transactions as discussed in Note 4. The majority of CAF income is generated
by
the spread between the interest rates charged to customers and the related
cost
of funds. A gain, recorded at the time of securitization, results from recording
a receivable approximately equal to the present value of the expected residual
cash flows generated by the securitized receivables. The cash flows are
calculated taking into account expected prepayments and defaults.
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
|
November
30
|
(In
millions)
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Total
gain income
|
|
$
|
23.7 |
|
$
|
20.9
|
|
$
|
77.4 |
|
$
|
58.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
CAF income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing fee income
|
|
|
8.2
|
|
|
7.0 |
|
|
23.5
|
|
|
20.5
|
|
Interest income
|
|
|
6.8
|
|
|
5.6 |
|
|
19.2
|
|
|
15.7
|
|
Total
other CAF income
|
|
|
15.0
|
|
|
12.6 |
|
|
42.7 |
|
|
36.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
CAF expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAF payroll and fringe benefit expense
|
|
|
3.1
|
|
|
2.7 |
|
|
8.8
|
|
|
7.6
|
|
Other direct CAF expenses
|
|
|
3.6
|
|
|
2.9 |
|
|
10.4
|
|
|
8.4
|
|
Total
direct CAF expenses
|
|
|
6.7
|
|
|
5.6 |
|
|
19.2
|
|
|
16.0
|
|
CarMax
Auto Finance income
|
|
$
|
32.0 |
|
$
|
28.0 |
|
$
|
100.9 |
|
$
|
78.9
|
|
CarMax
Auto Finance income does not include any allocation of indirect costs or income.
The company presents this information on a direct basis to avoid making
arbitrary decisions regarding the indirect benefit or costs that could be
attributed to CAF. Examples of indirect costs not included are retail store
expenses and corporate expenses such as human resources, administrative
services, marketing, information systems, accounting, legal, treasury, and
executive payroll.
The
company uses a securitization program to fund substantially all of the
automobile loan receivables originated by CAF. The company sells the automobile
loan receivables to a wholly owned, bankruptcy-remote, special purpose entity
that transfers an undivided interest in the receivables to a group of
third-party investors. The special purpose entity and investors have no recourse
to the company’s assets. The company’s risk is limited to the retained interest
on the company’s consolidated balance sheets. The investors issue commercial
paper supported by the transferred receivables, and the proceeds from the sale
of the commercial paper are used to pay for the securitized receivables. This
program is referred to as the warehouse facility.
The
company routinely uses public securitizations to refinance the receivables
previously securitized through the warehouse facility. In a public
securitization, a pool of automobile loan receivables is sold to a
bankruptcy-remote, special purpose entity that in turn transfers the receivables
to a special purpose securitization trust. The securitization trust issues
asset-backed securities, secured or otherwise supported by the transferred
receivables, and the proceeds from the sale of the securities are used to pay
for the securitized receivables. Depending on the securitization structure
and
market conditions, refinancing receivables in a public securitization may or
may
not have a significant impact on the company’s results.
All
transfers of receivables are accounted for as sales in accordance with SFAS
No.
140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.” When the receivables are securitized, the
company recognizes a gain or loss on the sale of the receivables as described
in
Note 3.
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
(In
millions)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
loans originated
|
|
$ |
537.9 |
|
$ |
415.7 |
|
$ |
1,686.6 |
|
$ |
1,333.8
|
|
Total
loans sold
|
|
$ |
538.7 |
|
$
|
416.6
|
|
$ |
1,728.7 |
|
$ |
1,405.9
|
|
Total
gain income(1)
|
|
$ |
23.7 |
|
$
|
20.9
|
|
$ |
77.4 |
|
$ |
58.7
|
|
Total
gain income as a percentage of total loans sold
(1)
|
|
|
4.4 |
% |
|
5.0
|
%
|
|
4.5 |
% |
|
4.2
|
%
|
|
(1)
|
Includes
the effects of valuation adjustments, new public securitizations,
and the
repurchase and resale of receivables in existing public securitizations,
as applicable.
|
Retained
Interest. The company retains an interest in the automobile loan
receivables that it securitizes. The retained interest, presented as a current
asset on the company’s consolidated balance sheets, serves as a credit
enhancement for the benefit of the investors in the securitized receivables.
The
retained interest includes the present value of the expected residual cash
flows
generated by the securitized receivables, or “interest-only strip receivables,”
various reserve accounts, and an undivided ownership interest in the securitized
receivables, or “required excess receivables,” as described below. On a combined
basis, the reserve accounts and required excess receivables are generally 2%
to
4% of managed receivables. The special purpose entities and the investors have
no recourse to the company’s assets.
The
fair
value of the retained interest was $202.6 million as of November 30, 2006,
and
$158.3 million as of February 28, 2006. The retained interest had a weighted
average life of 1.5 years as of November 30, 2006, and February 28, 2006.
As defined in SFAS No. 140, the weighted average life in periods (for example,
months or years) of prepayable assets is calculated by multiplying the principal
collections expected in each future period by the number of periods until that
future period, summing those products, and dividing the sum by the initial
principal balance.
Interest-only
strip receivables. Interest-only
strip receivables represent the present value of residual cash flows the company
expects to receive over the life of the securitized receivables. The value
of
these receivables is determined by estimating the future cash flows using
management’s assumptions of key factors, such as finance charge income, default
rates, prepayment rates, and discount rates appropriate for the type of asset
and risk. The value of interest-only strip receivables may be affected by
external factors, such as changes in the behavior patterns of customers, changes
in the strength of the economy, and developments in the interest rate markets;
therefore, actual performance may differ from these assumptions. Management
evaluates the performance of the receivables relative to these assumptions
on a
regular basis. Any financial impact resulting from a change in performance
is
recognized in earnings in the period in which it occurs.
Reserve
accounts.
The
company is required to fund various reserve accounts established for the benefit
of the securitization investors. In the event that the cash generated by the
securitized receivables in a given period was insufficient to pay the interest,
principal, and other required payments, the balances on deposit in the reserve
accounts would be used to pay those amounts. In general, each of the company’s
securitizations requires that an amount equal to a specified percentage of
the
original balance of the securitized receivables be deposited in a reserve
account on the closing date and that any excess cash generated by the
receivables be used to fund the reserve account to the extent necessary to
maintain the required amount. If the amount on deposit in the reserve account
exceeds the required amount, the excess is released through the special purpose
entity to the company. In the public securitizations, the amount required to
be
on deposit in the reserve account must equal or exceed a specified floor amount.
The reserve account remains funded until the investors are paid in full, at
which time the remaining balance is released through the special purpose entity
to the company. The amount on deposit in reserve accounts was $30.4 million
as
of November 30, 2006, and $29.0 million as of February 28,
2006.
Required
excess receivables.
The
total value of the securitized receivables must exceed, by a specified
amount, the principal amount owed to the investors. The required excess
receivables balance represents this specified amount. Any cash flows generated
by the required excess receivables are used, if needed, to make payments to
the
investors. Any remaining cash flows from the required excess receivables are
released through the special purpose entity to the company. The unpaid principal
balance related to the required excess receivables was $64.8 million as of
November 30, 2006, and $52.2 million as of February 28, 2006.
Key
Assumptions Used in Measuring the Retained Interest and Sensitivity
Analysis. The
following table shows the key economic assumptions used in measuring the fair
value of the retained interest at November 30, 2006, and a sensitivity analysis
showing the hypothetical effect on the retained interest if there were
unfavorable variations from the assumptions used. These sensitivities are
hypothetical and should be used with caution. In this table, the effect of
a
variation in a particular assumption on the fair value of the retained interest
is calculated without changing any other assumption; in actual circumstances,
changes in one factor may result in changes in another, which might magnify
or
counteract the sensitivities.
KEY
ASSUMPTIONS
(In
millions)
|
|
Assumptions
Used
|
|
Impact
on Fair Value of 10% Adverse Change
|
|
Impact
on Fair Value of 20% Adverse Change
|
Prepayment
rate
|
|
|
1.35%-1.52%
|
|
|
$
|
6.8
|
|
|
$
|
13.5
|
|
Cumulative
default rate
|
|
|
1.25%-2.30%
|
|
|
$
|
5.5
|
|
|
$
|
10.9
|
|
Annual
discount rate
|
|
|
12.0%
|
|
|
$
|
2.9
|
|
|
$
|
5.8
|
|
Prepayment
rate.
The
company uses the Absolute Prepayment Model or “ABS” to estimate prepayments.
This model assumes a rate of prepayment each month relative to the original
number of receivables in a pool of receivables. ABS further assumes that all
the
receivables are the same size and amortize at the same rate and that each
receivable in each month of its life will either be paid as scheduled or prepaid
in full. For example, in a pool of receivables originally containing 10,000
receivables, a 1% ABS rate means that 100 receivables prepay each
month.
Cumulative
default rate.
The
cumulative default rate, or “static pool” net losses, is calculated by dividing
the total projected credit losses of a pool of receivables by the original
pool
balance. Projected credit losses are estimated using the losses experienced
to
date, the credit quality of the receivables, economic factors, and the
performance history of similar receivables.
Continuing
Involvement with Securitized Receivables.
The
company continues to manage the automobile loan receivables that it securitizes.
The company receives servicing fees of approximately 1% of the outstanding
principal balance of the securitized receivables. The servicing fees specified
in the securitization agreements adequately compensate the company for servicing
the securitized receivables. No servicing asset or liability has been recorded.
The company is at risk for the retained interest in the securitized receivables
and, if the securitized receivables do not perform as originally projected,
the
value of the retained interest would be impacted.
PAST
DUE ACCOUNT INFORMATION
|
|
As
of November 30
|
|
As
of February 28
|
|
(In
millions)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Accounts
31+ days past due
|
|
$
|
61.2
|
|
$
|
43.3
|
|
$
|
37.4
|
|
$
|
31.1
|
|
Ending
managed receivables
|
|
$
|
3,180.8
|
|
$
|
2,710.7
|
|
$
|
2,772.5
|
|
$
|
2,494.9
|
|
Past
due accounts as a percentage of ending managed receivables
|
|
|
1.93
|
%
|
|
1.60
|
%
|
|
1.35
|
%
|
|
1.24
|
%
|
CREDIT
LOSS INFORMATION
|
|
Three
Months Ended
November
30
|
|
Nine
Months Ended
November
30
|
|
(In
millions)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
credit losses on managed receivables
|
|
$ |
6.7 |
|
$
|
5.3
|
|
$ |
13.7 |
|
$
|
13.4 |
|
Average
managed receivables
|
|
$ |
3,147.9 |
|
|
2,705.9
|
|
$ |
3,006.4 |
|
$
|
2,626.6
|
|
Annualized
net credit losses as a percentage of average managed
receivables
|
|
|
0.85 |
% |
|
0.78
|
%
|
|
0.61 |
% |
|
0.68
|
%
|
Recovery
rate
|
|
|
49.2 |
%
|
|
48.5 |
% |
|
50.6 |
%
|
|
49.3 |
%
|
SELECTED
CASH FLOWS FROM SECURITIZED RECEIVABLES
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
(In
millions)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Proceeds
from new securitizations
|
|
$ |
445.5 |
|
$
|
327.0
|
|
$ |
1,386.5 |
|
$ |
1,118.5 |
|
Proceeds
from collections reinvested in revolving period
securitizations
|
|
$ |
264.6 |
|
$
|
185.7
|
|
$ |
777.1 |
|
$ |
573.9 |
|
Servicing
fees received
|
|
$ |
8.1 |
|
$
|
7.0
|
|
$ |
23.1 |
|
$ |
20.3 |
|
Other
cash flows received from the retained interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-only strip receivables
|
|
$ |
22.0 |
|
$
|
20.1
|
|
$ |
65.8 |
|
$ |
62.2 |
|
Reserve account releases
|
|
$ |
1.8 |
|
$
|
3.2
|
|
$ |
10.2 |
|
$ |
12.3 |
|
Proceeds
from new securitizations.
Proceeds
from new securitizations include proceeds from receivables that are newly
securitized in or refinanced through the warehouse facility during the indicated
period. Balances previously outstanding in public securitizations that were
refinanced through the warehouse facility totaled $41.0 million in the first
nine months of fiscal 2007 and $51.5 million in the first nine months of
fiscal 2006. There were no balances previously outstanding in public
securitizations that were refinanced through the warehouse facility in the
third
quarter of fiscal 2007 or fiscal 2006. Proceeds received when the company
refinances receivables in public securitizations are excluded from this table
as
they are not considered new securitizations.
Proceeds
from collections.
Proceeds
from collections reinvested in revolving period securitizations represent
principal amounts collected on receivables securitized through the warehouse
facility that are used to fund new originations.
Servicing
fees.
Servicing fees received represent cash fees paid
to
the company to service the securitized receivables.
Other
cash flows received from the retained interest.
Other
cash flows received from the retained interest represent cash received by the
company from securitized receivables other than servicing fees. It includes
cash
collected on interest-only strip receivables and amounts released to the company
from reserve accounts.
Financial
Covenants and Performance Triggers.
Certain
of the securitization agreements include various financial covenants and
performance triggers. These agreements require the company to meet financial
covenants related to maintaining minimum tangible net worth, maximum total
liabilities to tangible net worth ratio, minimum current ratio, and
minimum fixed charge coverage ratio. Performance triggers require certain pools
of securitized receivables to achieve specified thresholds related to portfolio
yields, default rates, and delinquency rates. If these financial covenants
and/or thresholds are not met, in addition to other consequences, the company
may be unable to continue to securitize receivables through the warehouse
facility. At November 30, 2006, the company was in compliance with the financial
covenants, and the securitized receivables were in compliance with the
performance triggers.
The
company enters into amortizing fixed-pay interest rate swaps relating to its
automobile loan receivable securitizations. Swaps are used to better match
funding costs to the fixed-rate receivables being securitized by converting
variable-rate financing costs in the warehouse facility to fixed-rate
obligations. During
the third quarter of fiscal 2007, the company entered into ten
40-month amortizing interest rate swaps with initial notional amounts
totaling $480.5 million. The amortized notional amount of all outstanding swaps
related to the automobile loan receivable securitizations was $704.6 million
at
November 30, 2006, and $584.0 million at February 28, 2006. At November
30, 2006, the fair value of swaps totaled a net liability of
$2.6 million and was included in accounts payable. At February 28,
2006, the fair value of swaps totaled a net asset of $1.6 million and was
included in prepaid expenses and other current assets.
The
market and credit risks associated with interest rate swaps are similar to
those
relating to other types of financial instruments. Market risk is the exposure
created by potential fluctuations in interest rates. The company does not
anticipate significant market risk from swaps as they are used on a monthly
basis to match funding costs to the use of the funding. Credit risk is the
exposure to nonperformance
of another party to an agreement. The company mitigates credit risk by dealing
with highly rated bank counterparties.
The
company has a noncontributory defined benefit pension plan (the “pension plan”)
covering the majority of full-time employees. The company also has an unfunded
nonqualified plan (the “restoration plan”) that restores retirement benefits for
certain senior executives who are affected by the Internal Revenue Code
limitations on benefits provided under the pension plan. The company uses a
fiscal year end measurement date for both the pension plan and the restoration
plan.
COMPONENTS
OF NET PENSION EXPENSE
|
|
Three
Months Ended November
30
|
|
|
|
Pension
Plan
|
|
Restoration
Plan
|
|
Total
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Service
cost
|
|
$
|
3,012
|
|
$
|
2,332
|
|
$
|
103
|
|
$
|
172
|
|
$
|
3,115
|
|
$
|
2,504
|
|
Interest
cost
|
|
|
1,024
|
|
|
698
|
|
|
98
|
|
|
64
|
|
|
1,122
|
|
|
762
|
|
Expected
return on plan assets
|
|
|
(737
|
)
|
|
(567
|
)
|
|
–
|
|
|
–
|
|
|
(737
|
)
|
|
(567
|
)
|
Amortization
of prior service cost
|
|
|
9
|
|
|
10
|
|
|
6 |
|
|
6
|
|
|
15
|
|
|
16
|
|
Recognized
actuarial loss
|
|
|
439
|
|
|
241
|
|
|
62
|
|
|
34
|
|
|
501
|
|
|
275
|
|
Net
pension expense
|
|
$
|
3,747
|
|
$
|
2,714
|
|
$
|
269
|
|
$
|
276
|
|
$
|
4,016
|
|
$
|
2,990
|
|
|
|
Nine
Months Ended November
30
|
|
|
|
Pension
Plan
|
|
Restoration
Plan
|
|
Total
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Service
cost
|
|
$
|
9,036 |
|
$
|
6,584
|
|
$ |
309 |
|
$
|
360
|
|
$ |
9,345 |
|
$
|
6,944
|
|
Interest
cost
|
|
|
3,072 |
|
|
2,096
|
|
|
294 |
|
|
194
|
|
|
3,366 |
|
|
2,290
|
|
Expected
return on plan assets
|
|
|
(2,211 |
) |
|
(1,553
|
)
|
|
– |
|
|
–
|
|
|
(2,211 |
) |
|
(1,553
|
)
|
Amortization
of prior service cost
|
|
|
27 |
|
|
28
|
|
|
18 |
|
|
18
|
|
|
45 |
|
|
46
|
|
Recognized
actuarial loss
|
|
|
1,317 |
|
|
721
|
|
|
186 |
|
|
102
|
|
|
1,503 |
|
|
823
|
|
Net
pension expense
|
|
$
|
11,241 |
|
$
|
7,876
|
|
$ |
807 |
|
$
|
674
|
|
$ |
12,048 |
|
$
|
8,550
|
|
The
company contributed $7.5 million to the pension plan in the third quarter
of
fiscal 2007 bringing contributions for the first nine months of fiscal 2007
to
$10.7 million. The company does not anticipate making a contribution to the
pension plan in the fourth quarter of fiscal 2007.
7.
|
Share-Based
Compensation
|
Effective
March 1, 2006, the company adopted the provisions of SFAS 123(R), which
establishes accounting for share-based awards exchanged for employee services.
Under the provisions of SFAS 123(R), share-based compensation cost is measured
at the grant date, based on the estimated fair value of the award, and is
recognized as an expense over the requisite service period (generally the
vesting period of the equity grant). Prior to March 1, 2006,
the company applied Accounting Principles Board (APB) Opinion
No. 25, “Accounting for Stock Issued to Employees,” and related
interpretations for share-based awards, and provided the pro forma disclosures
required by SFAS No. 123, “Accounting for Stock-Based Compensation.” The
company elected to apply the modified retrospective application method as
provided by SFAS 123(R), and, accordingly, financial statement amounts for
the
prior periods presented in this Form 10-Q have been restated to reflect the
fair
value method of expensing share-based compensation on a basis consistent with
the pro forma disclosures required for those periods by SFAS 123.
In
accordance with SFAS 123(R), the company is required to base initial
compensation cost on the estimated number of awards expected to vest.
Historically, and as permitted under SFAS 123, the company chose to reduce
pro
forma compensation expense in the periods the awards were forfeited. The
cumulative effect on prior periods of the change to an estimated number of
awards expected to vest was a $0.6 million reduction of selling, general, and
administrative expenses recorded in the first quarter of fiscal
2007.
COMPOSITION
OF SHARE-BASED COMPENSATION EXPENSE
|
|
Three
Months Ended
November
30
|
|
Nine
Months Ended
November
30
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
Restated
|
|
|
|
Restated
|
|
Cost
of sales
|
|
$
|
327 |
|
$
|
– |
|
$
|
1,048
|
|
$
|
– |
|
CarMax
Auto Finance income
|
|
|
210 |
|
|
– |
|
|
682 |
|
|
– |
|
Selling,
general, and administrative expenses
|
|
|
5,582 |
|
|
5,633 |
|
|
24,467 |
|
|
16,334 |
|
Share-based
compensation expense, before income taxes
|
|
$ |
6,119 |
|
$
|
5,633 |
|
$
|
26,197
|
|
$
|
16,334 |
|
For
periods prior to fiscal 2007, all share-based compensation expense has been
presented in selling, general, and administrative expenses, as amounts that
would have been presented in cost of sales and CarMax Auto Finance income were
immaterial. Consistent with the provisions of SFAS 123, the company’s employee
stock purchase plan is considered compensatory under SFAS 123(R), and the
associated costs of $0.6 million in the first nine months of fiscal 2007 and
fiscal 2006 are included in share-based compensation expense. There
were no capitalized share-based compensation costs at November 30, 2006 and
2005.
IMPACT
OF SFAS 123(R) ON FISCAL 2006 CONSOLIDATED FINANCIAL
STATEMENTS
|
|
Three
Months Ended
November
30, 2005
|
|
Nine
Months Ended
November
30, 2005
|
|
(In
thousands, except per share data)
|
|
As
Restated
|
|
Previously
Reported
|
|
As
Restated
|
|
Previously
Reported
|
|
Selling,
general, and administrative
expenses(1)
|
|
$
|
167,351 |
|
|
$
|
161,727
|
|
|
$ |
502,517 |
|
|
$
|
486,236
|
|
|
Earnings
before income taxes
|
|
$
|
37,625 |
|
|
$
|
43,249
|
|
|
$ |
158,454 |
|
|
$
|
174,735
|
|
|
Net
earnings
|
|
$ |
22,931 |
|
|
$
|
26,412
|
|
|
$ |
97,547 |
|
|
$
|
107,652
|
|
|
Basic
earnings per share
|
|
$ |
0.22 |
|
|
$
|
0.25
|
|
|
$ |
0.93 |
|
|
$
|
1.03
|
|
|
Diluted
earnings per share
|
|
$ |
0.22 |
|
|
$
|
0.25
|
|
|
$ |
0.92 |
|
|
$
|
1.01
|
|
|
Net
cash provided by operating
activities(2)
|
|
$ |
N/A |
|
|
$
|
N/A
|
|
|
$ |
139,097 |
|
|
$
|
148,689
|
|
|
Net
cash used in financing activities
|
|
$ |
N/A |
|
|
$
|
N/A
|
|
|
$ |
63,696 |
|
|
$
|
67,538
|
|
|
(1)
Amount previously reported included expenses relating to the amortization
of restricted stock of $9 in the third quarter of fiscal 2006 and $53 for
the
first nine months of fiscal 2006.
(2)
As
restated amount for the nine
months ended November 30, 2005, also includes restricted cash
deposits. See Note 2.
|
|
As
of February 28, 2006
|
|
|
(In
thousands) |
|
As
Restated
|
|
Previously
Reported
|
|
Deferred
income taxes
|
|
$
|
24,576
|
|
|
$
|
4,211
|
|
|
Total
assets
|
|
$
|
1,509,612
|
|
|
$
|
1,489,247
|
|
|
Capital
in excess of par value
|
|
$
|
554,076
|
|
|
$
|
499,546
|
|
|
Retained
earnings
|
|
$
|
373,550
|
|
|
$
|
407,715
|
|
|
Total
shareholders’ equity
|
|
$
|
980,103
|
|
|
$
|
959,738
|
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
1,509,612
|
|
|
$
|
1,489,247
|
|
|
The
company maintains long-term incentive plans for management, key employees,
and
the nonemployee members of the board of directors. The plans allow for the
grant
of equity-based compensation awards, including nonqualified stock options,
incentive stock options, stock appreciation rights, restricted stock awards,
stock grants, or a combination of awards.
In
fiscal
2006 and prior years, the company primarily awarded stock options to employees
that received share-based compensation. Beginning in fiscal 2007, the
substantial majority of employees receiving awards now receive restricted stock
instead of stock options. Senior management continues to receive awards of
nonqualified stock options. Nonemployee directors continue to receive awards
of
nonqualified stock options and stock grants.
Stock
options are awards that allow the recipient to purchase shares of the company’s
stock at a fixed price. Stock options are granted at an exercise price equal
to
the fair market value of the company's stock price on the grant date.
Substantially all of the awards vest annually in equal amounts over periods
of
three years to four years. These options generally expire no later than ten
years after the date of the grant. Restricted stock awards are stock awards
that
are subject to specified restrictions and a risk of forfeiture. The restrictions
typically lapse three years from the grant date. The fair value of a restricted
stock award is determined and fixed based on the company’s stock price on the
grant date. The company recognizes compensation expense for stock options and
restricted stock on a straight-line basis over the requisite service
period.
STOCK
OPTION ACTIVITY
(Shares
and intrinsic value in thousands)
|
|
Number
of Shares
|
|
Weighted
Average Exercise Price
|
|
Weighted
Average Remaining Contractual Life (Years)
|
|
Aggregate
Intrinsic Value
|
|
Outstanding
as of March 1, 2006
|
|
|
8,769
|
|
|
|
$
|
20.55
|
|
|
|
|
|
|
|
|
|
|
|
Options
granted
|
|
|
953
|
|
|
|
$
|
34.28
|
|
|
|
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
(1,847
|
) |
|
|
$
|
15.73
|
|
|
|
|
|
|
|
|
|
|
|
Options
expired or terminated
|
|
|
(163
|
)
|
|
|
$
|
26.39
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
as of November 30, 2006
|
|
|
7,712
|
|
|
|
$
|
23.28
|
|
|
|
6.1 |
|
|
|
$
|
174,806
|
|
|
Exercisable
as of November 30, 2006
|
|
|
3,940
|
|
|
|
$
|
18.97
|
|
|
|
4.8 |
|
|
|
$
|
106,283
|
|
|
The
total
cash received from employees as a result of employee stock option exercises
was
$41.8 million in the first nine months of fiscal 2007 and
$8.9 million in the first nine months of fiscal 2006. The company
settles employee stock option exercises with authorized but unissued shares
of
CarMax common stock. The total intrinsic value of options exercised was
$39.3 million for the first nine months of fiscal 2007 and
$10.7 million for the first nine months of fiscal 2006. The related
tax benefits realized by the company were $15.2 million for the nine-month
period ended November 30, 2006, and $4.2 million for the nine-month
period ended November 30, 2005.
OUTSTANDING
STOCK OPTIONS
As
of November 30, 2006
|
|
Options
Outstanding
|
|
Options
Exercisable
|
|
(Shares
in thousands)
Range
of Exercise Prices
|
|
Number
of Shares
|
|
Weighted
Average Remaining Contractual Life (Years)
|
|
Weighted
Average Exercise Price
|
|
Number
of Shares
|
|
Weighted
Average Exercise Price
|
|
$1.63
to $3.31
|
|
|
259
|
|
|
|
0.3
|
|
|
$
|
1.95
|
|
|
|
259
|
|
|
|
$
|
1.95
|
|
|
$4.89
|
|
|
630
|
|
|
|
1.3
|
|
|
$
|
4.89
|
|
|
|
630
|
|
|
|
$
|
4.89
|
|
|
$13.25
to $18.60
|
|
|
1,419
|
|
|
|
6.3
|
|
|
$
|
14.32
|
|
|
|
1,022
|
|
|
|
$
|
14.33
|
|
|
$20.00
to $26.83
|
|
|
2,732
|
|
|
|
6.9
|
|
|
$
|
26.42
|
|
|
|
1,128
|
|
|
|
$
|
26.54
|
|
|
$28.26
to $31.43
|
|
|
1,712
|
|
|
|
7.3
|
|
|
$
|
29.43
|
|
|
|
885
|
|
|
|
$
|
29.26
|
|
|
$32.67
to $44.57
|
|
|
960
|
|
|
|
6.4
|
|
|
$
|
34.40 |
|
|
|
16
|
|
|
|
$
|
41.84
|
|
|
Total
|
|
|
7,712
|
|
|
|
6.1 |
|
|
$
|
23.28
|
|
|
|
3,940
|
|
|
|
$
|
18.97
|
|
|
For
all
stock options granted prior to March 1, 2006, the fair value was estimated
as of the date of grant using a Black-Scholes option-pricing model. For stock
options granted to employees on or after March 1, 2006, the fair value of
each award is estimated as of the date of grant using a binomial valuation
model. In computing the value of the option, the binomial model considers
characteristics of fair value option pricing that are not available for
consideration under the Black-Scholes model. Similar to the Black-Scholes model,
the binomial model takes into account variables such as expected volatility,
dividend yield, and risk-free interest rate. However, in addition, the binomial
model considers the contractual term of the option, the probability that the
option will be exercised prior to the end of its contractual life, and the
probability of termination or retirement of the option holder. For these
reasons, the company believes that the binomial model provides a fair value
that
is more representative of actual experience and future expected experience
than
the value calculated using the Black-Scholes model. For grants to nonemployee
directors, the company will continue to use the Black-Scholes model to estimate
the fair value of stock option awards due to the comparatively small population
of recipients of these awards. Estimates of fair value are not intended to
predict actual future events or the value ultimately realized by the recipients
of share-based awards.
For
the
nine months ended November 30, 2006, the company granted nonqualified options
to
purchase 918,600 shares of common stock to its employees and nonqualified
options to purchase 34,020 shares of common stock to its nonemployee
directors. There were nonqualified options to purchase 2,428,566
shares of common stock granted during the nine months ended November 30,
2005. The weighted average fair values at the date of grant for options
granted during the nine month periods ended November 30, 2006, and November
30, 2005, were $14.16 and $12.18 per share, respectively. The unrecognized
compensation costs related to all nonvested options totaled $35.6 million at
November 30, 2006. These costs are expected to be recognized over a
weighted average period of 2.2 years.
ASSUMPTIONS
USED TO ESTIMATE OPTION VALUES
|
Nine
Months Ended
November
30, 2006
|
Nine
Months Ended
November
30, 2005
|
Dividend
yield
|
0.0%
|
0.0%
|
Expected
volatility factor(1)
|
29.8%-63.4%
|
51.3%
|
Weighted
average expected volatility
|
47.4%
|
51.3%
|
Risk-free
interest rate(2)
|
4.5%-5.1%
|
3.7%
|
Expected
term (in years)(3)
|
4.5-4.6
|
4.5
|
|
(1)
|
Measured
using historical daily price changes of the company’s stock over the
respective term of the option.
|
|
(2)
|
The
risk-free interest rate for periods within the contractual term of
the
share option is based on the U.S. Treasury yield curve in effect
at the
time of grant.
|
|
(3)
|
The
expected term is the number of years that the company estimates,
based
primarily on historical experience, that options will be outstanding
prior
to exercise.
|
RESTRICTED
STOCK ACTIVITY
(In
thousands)
|
|
Number
of Shares
|
|
Weighted
Average Grant Date
Fair Value
|
Outstanding
as of March 1, 2006
|
|
|
–
|
|
|
|
$
|
–
|
|
|
Restricted
stock granted
|
|
|
492
|
|
|
|
$
|
34.40
|
|
|
Restricted
stock vested or cancelled
|
|
|
(23
|
) |
|
|
$
|
34.39
|
|
|
Outstanding
as of November 30, 2006
|
|
|
469
|
|
|
|
$
|
34.40
|
|
|
The
unrecognized compensation costs related to nonvested restricted stock awards
totaled $11.7 million at November 30, 2006. These costs are expected to be
recognized over a weighted average period of 2.4 years.
8.
|
Net
Earnings per Share
|
BASIC
AND DILUTIVE NET EARNINGS PER SHARE RECONCILIATIONS
|
|
Three
Months Ended
November
30
|
|
Nine
Months Ended
November
30
|
|
(In
thousands except per share data)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Net
earnings available to common shareholders
|
|
$ |
45,419 |
|
$
|
22,931
|
|
$
|
156,459 |
|
$
|
97,547
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
106,511 |
|
|
104,727
|
|
|
105,895 |
|
|
104,547
|
|
Dilutive
potential common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
2,246 |
|
|
1,772
|
|
|
1,910 |
|
|
1,782
|
|
Restricted
stock
|
|
|
126 |
|
|
8
|
|
|
56 |
|
|
14
|
|
Weighted
average common shares and dilutive potential common shares
|
|
|
108,883 |
|
|
106,507
|
|
|
107,861 |
|
|
106,343
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net earnings per share
|
|
$ |
0.43 |
|
$
|
0.22
|
|
$
|
1.48 |
|
$
|
0.93
|
|
Diluted
net earnings per share
|
|
$ |
0.42 |
|
$
|
0.22
|
|
$
|
1.45 |
|
$
|
0.92
|
|
Certain
options were determined to be anti-dilutive and were excluded from the
calculation of diluted earnings per share. As of November 30, 2006,
options to purchase 796,584 shares of common stock with exercise prices ranging
from $29.61 to $44.57 per share were outstanding and not included in the
calculation. As of November 30, 2005, options to purchase 4,326,697 shares
with
exercise prices ranging from $14.21 to $43.44 per share were outstanding
and not included in the calculation.
As
of
November 30, 2006, $86.4 million was outstanding under the company’s revolving
credit facility, with the remainder fully available to the company. The
outstanding balance included $3.0 million of swing line loans classified as
short-term debt and $83.4 million classified as current portion of
long-term debt. The outstanding balance has been classified as current at
November 30, 2006, as management expects the outstanding balance to
fluctuate and to be fully paid off at times during the next 12 months.
The
company's revolving credit facility was amended in December 2006. The term
of
the agreement was extended from August 2009 to December 2011
and aggregate borrowings available under the agreement were increased from
$450 million to $500 million.
As
of
November 30, 2006, obligations under capital leases consisted of $34.0 million
classified as long-term debt and $1.0 million classified as current portion
of
long-term debt.
On
August
29, 2006, Heather Herron, et al. filed a putative class action lawsuit against
51 South Carolina automobile dealers, including CarMax Auto Superstores,
Inc.,
in the Court of Common Pleas in Aiken County, South Carolina. As of November
30,
2006, there were over 300 automobile dealers named as defendants in the
lawsuit. The company operated two of its 73 used car superstores in the
state of South Carolina. The plaintiffs allege that the defendants are violating
South Carolina’s Regulation of Manufacturers, Distributors and Dealers Act by
(a) presenting their respective processing fees in a manner that gives consumers
the impression that charging the processing fees is required by law and (b)
excluding their respective processing fees from the advertised prices of
their
vehicles. The plaintiffs seek compensatory damages equal to two times actual
damages and punitive damages equal to three times actual damages. The complaint,
however, does not specify a dollar amount of damages. The plaintiffs
alternatively seek equitable relief in the form of a permanent injunction
to
prevent the defendants from deceptively charging future consumers such
processing fees and the disgorgement of all such processing fees collected
since
August 29, 2002. The plaintiffs also seek to recover their attorneys’
fees.
At
this
time, the lawsuit is in its initial stages and the company is evaluating
the
allegations and intends to defend itself vigorously. The company is unable
to make an estimate of the amount or range of loss that could result from
an
unfavorable outcome.
11.
|
Recent
Accounting
Pronouncements
|
In July 2006,
the Financial Accounting Standards Board ("FASB") issued FASB Interpretation
("FIN") 48, "Accounting for Uncertainty in Income Taxes," which establishes
a consistent framework to use to determine the appropriate level of
tax reserves
to maintain for "uncertain tax positions." This interpretation of SFAS
No. 109,
"Accounting
for Income Taxes," uses a two-step approach wherein a tax benefit is
recognized
if a position is more likely than not to be sustained. The amount of
the benefit
is
then
measured as the highest tax benefit that is greater than fifty percent
likely to
be realized. FIN 48 also establishes new disclosure requirements related
to an
entity's tax
reserves. The company will be required to adopt FIN 48 as of March
1, 2007. The
company is currently evaluating the impact of adopting FIN 48 on its
financial
position, results of operations, and cash flows.
In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
which
defines fair value, establishes a framework for measuring fair value
in
generally accepted accounting principles, and expands disclosures about
fair
value measurements. The statement does not require new fair value measurements,
but is applied to the extent that other accounting pronouncements require
or
permit fair value measurements. The statement emphasizes that fair
value is a
market-based measurement that should be determined based on the assumptions
that
market participants would use in pricing an asset or liability. Companies
will
be required to disclose the extent to which fair value is used to measure
assets
and liabilities, the inputs used to develop the measurements, and the
effect of
certain of the measurements on earnings (or changes in net assets)
for the
period. CarMax will be required to adopt SFAS No. 157 as of March 1,
2008. The
company is currently evaluating the impact of adopting SFAS No. 157
on its
financial position, results of operations, and cash flows.
In
September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." This statement requires the
company to fully recognize the over-funded or under-funded status of
its
postretirement benefit plans as an asset or liability in its financial
statements. In addition, the statement eliminates the use of a measurement
date that is different than the date of the company's year-end financial
statements. The standard is effective for CarMax's current fiscal
year ending February 28, 2007. The company is currently evaluating the
impact of
adopting SFAS No. 158 on its financial position, results of operations,
and cash
flows.
In
September 2006, the SEC staff published Staff
Accounting Bulletin (SAB) No. 108, "Considering the Effects of Prior
Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements." The bulletin addresses quantifying the financial statement
effects of misstatements, specifically, how the effects of prior year
uncorrected errors must be considered in quantifying misstatements in
the
current year financial statements. The bulletin offers a special
"one-time" transition provision for correcting certain prior year misstatements
that were uncorrected as of the beginning of the fiscal year of adooption.
SAB No. 108 is effective for CarMax's current fiscal year ending February
28,
2007. The adoption of this statement is not expected to have a material
impact on the company's financial position, results of operations, and
cash
flows.
MANAGEMENT'S
DISCUSSION AND ANALYSIS
OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations (“MD&A”) is intended to help the reader understand the
financial performance of CarMax, Inc. MD&A is provided as a supplement to,
and should be read in conjunction with, our audited consolidated financial
statements, the accompanying notes, and the MD&A included in the company's
Annual Report on Form 10-K for the fiscal year ended February 28, 2006, as
well
as our consolidated financial statements and the accompanying notes included
in
this Form 10-Q.
In
this
discussion, “we,” “our,” “us,” “CarMax,” “CarMax, Inc.,” and the “company” refer
to CarMax, Inc. and its wholly owned subsidiaries, unless the context requires
otherwise. Amounts and percentages in tables may not total due to
rounding.
The
company adopted Statement of Financial Accounting Standards No. 123 (Revised
2004), “Share-Based Payment” (“SFAS 123(R)”), effective March 1, 2006, applying
the modified retrospective method. As a result, prior period amounts have
been
restated to reflect the adoption of this standard. The impact of the adoption
of
SFAS 123(R) on net income for the third quarter and first nine months of
fiscal
2006 is consistent with the pro forma amounts previously disclosed in the
company’s quarterly reports.
BUSINESS
OVERVIEW
General
CarMax
is
the nation’s largest retailer of used vehicles. As of November 30, 2006, we
operated 73 used car superstores in 34 markets, including 26 mid-sized markets
and 8 large markets. We define mid-sized markets as those with television
viewing populations generally between 600,000 and 2.5 million people. We
also
operated seven new car franchises, all of which were integrated or co-located
with our used car superstores. During the twelve-month period ended November
30,
2006, we sold 323,570 used cars, representing 94% of the total
342,482 vehicles we sold at retail.
We
believe the CarMax consumer offer is unique in the automobile retailing
marketplace. Our offer gives consumers a way to shop for cars in the same
manner
that they shop for items at other “big box” retailers. Our consumer offer is
structured around four core equities: low, no-haggle prices; a broad selection;
high quality; and customer-friendly service. Our website, www.carmax.com,
is a
valuable tool for communicating the CarMax consumer offer, a sophisticated
search engine, and an efficient sales channel for customers who prefer to
complete part of the shopping and sales process online. We generate revenues,
income, and cash flows primarily by retailing used vehicles and associated
items
including vehicle financing, extended service plans, and vehicle repair service.
A majority of the used vehicles we sell at retail is purchased directly from
consumers.
We
also
generate revenues, income, and cash flows from the sale of vehicles purchased
through our appraisal process that do not meet our retail standards. These
vehicles are sold at our on-site wholesale auctions. Wholesale auctions are
conducted at the majority of our superstores and are held on a weekly,
bi-weekly, or monthly basis. On average, the vehicles we wholesale are
approximately 10 years old and have more than 100,000 miles. Participation
in
our wholesale auctions is restricted to licensed automobile dealers, the
majority of whom are independent dealers, and licensed wholesalers.
CarMax
provides prime-rated financing to qualified customers through CarMax Auto
Finance (“CAF”), the company’s finance operation, and Bank of America. Nonprime
financing is provided through several third-party lenders. Subprime financing,
also provided by a third-party lender, is available in CarMax stores in several
states. We periodically test additional third-party lenders. We collect fixed,
prenegotiated fees from the third parties that finance prime- and nonprime-rated
customers. As is customary in the subprime finance industry, the subprime
lender
purchases the loans at a discount. CarMax has no recourse liability for loans
provided by third-party lenders.
We
sell
extended service plans on behalf of unrelated third parties who are the primary
obligors. We have no contractual liability to the customer under these
third-party service plans. Extended service plan revenue represents commissions
from the unrelated third parties.
We
are
still at a relatively early stage in the national rollout of our retail concept.
We believe the primary driver for future earnings growth will be vehicle
unit
sales growth from comparable store sales increases and from geographic
expansion. We target a similar dollar amount of gross profit per used unit,
regardless of retail price. Used unit sales growth is our primary focus.
We plan
to open used car superstores at a rate of approximately 15% to 20% of our
used
car superstore base each year. In fiscal 2007, we plan to open ten superstores,
representing an approximate 15% increase in our store base. The fiscal 2007
store openings are primarily comprised of standard superstores in new mid-sized
markets and satellite fill-in superstores in established markets. In the
fiscal year ending February 28, 2008, we currently expect to open 13 used
car
superstores, expanding our superstore base by approximately 17%. For
the foreseeable future, we expect used unit comparable store sales increases
to
average in the range of 4% to 8% per year, reflecting the multi-year ramp
in
sales at newly opened stores as they mature, continued market share gains
at
stores that have reached basic maturity sales levels, which generally occurs
in
a store’s fifth year of operation, and underlying industry sales
growth.
The
principal challenges we face in expanding our store base include our ability
to
build our management bench strength to support store growth and our ability
to
procure suitable real estate at reasonable costs.
Fiscal
2007 Third Quarter Highlights
|
§
|
Net
sales and operating revenues increased 24% to $1.77 billion from
$1.42
billion in the third quarter of fiscal 2006, while net earnings increased
98% to $45.4 million, or $0.42 per share, from $22.9 million, or
$0.22 per
share.
|
|
§
|
Total
used vehicle unit sales increased 18%, reflecting the combination
of a 13%
increase in comparable store used unit sales and the growth in our
store
base.
|
|
§
|
Two used car superstores were
opened late in the third quarter.
|
|
§
|
Our
total gross profit per unit increased to $2,736 from $2,483 in the
prior
year's third quarter. We realized improvements in gross profit per
unit in
all major categories, including used vehicles, new vehicles, wholesale
vehicles, and other. We believe used vehicle gross profit benefited
from
our strong, consistent sales performance, which resulted in fewer
pricing
markdowns being made, as well as a more stable underlying
environment.
|
|
§
|
CAF
income increased 14% to $32.0 million from $28.0 million in the third
quarter of fiscal 2006 despite the inclusion of $6.1 million of favorable
items in last year's quarter. The improvement reflected growth in
retail vehicle sales and managed receivables, an improvement in the
gain on loans originated and sold, and an increase in the
average amount financed.
|
|
§
|
Selling,
general, and administrative expenses as a percent of net sales and
operating revenues (the "SG&A ratio") decreased to 10.6% from 11.8% in
the third quarter of fiscal 2006. We benefited from the leverage
of fixed
expenses generated by our strong comparable store sales
growth.
|
|
§
|
As
a result of adopting SFAS 123(R) in fiscal 2007, we recognized share-based
compensation expense of $0.03 per share in both the third quarter
of
fiscal 2007 and the third quarter of fiscal 2006, as
restated.
|
|
§
|
Net
cash provided by operations for the nine months ended November
30, 2006, was $137.6 million compared with $139.1 million in the
first
nine months of fiscal 2006.
|
CRITICAL
ACCOUNTING POLICIES
For
a
discussion of our critical accounting policies, see “Critical Accounting
Policies” in MD&A included in the CarMax, Inc. 2006 Annual Report to
Shareholders, which is included as Exhibit 13.1 to the Annual Report on Form
10-K for the fiscal year ended February 28, 2006. These policies relate to
securitization transactions, revenue recognition, income taxes, and the defined
benefit retirement plan.
RESULTS
OF OPERATIONS
Certain
prior year amounts have been reclassified to conform to the current year’s
presentation.
NET
SALES AND OPERATING REVENUES
|
|
Three
Months Ended November 30
|
|
Nine
Months Ended November 30
|
|
(In
millions)
|
|
2006
|
|
%
|
|
2005
|
|
%
|
|
2006
|
|
%
|
|
2005
|
|
%
|
|
Used
vehicle sales
|
|
$
|
1,377.6
|
|
|
77.9
|
|
$
|
1,087.1
|
|
|
76.3
|
|
$ |
4,365.4 |
|
|
78.2
|
|
$
|
3,527.4
|
|
|
76.1
|
|
New
vehicle sales
|
|
|
109.9
|
|
|
6.2
|
|
|
113.3
|
|
|
8.0
|
|
|
349.6
|
|
|
6.3
|
|
|
399.3
|
|
|
8.6
|
|
Wholesale
vehicle sales
|
|
|
226.4
|
|
|
12.8
|
|
|
174.2
|
|
|
12.2
|
|
|
696.0
|
|
|
12.5
|
|
|
554.5
|
|
|
12.0
|
|
Other
sales and revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Extended
service plan revenues
|
|
|
27.1
|
|
|
1.5
|
|
|
22.6
|
|
|
1.6
|
|
|
85.1
|
|
|
1.5
|
|
|
72.7
|
|
|
1.6
|
|
Service
department sales
|
|
|
21.6
|
|
|
1.2
|
|
|
23.0
|
|
|
1.6
|
|
|
68.6
|
|
|
1.2
|
|
|
70.4
|
|
|
1.5
|
|
Third-party
finance fees, net
|
|
|
5.6
|
|
|
0.3
|
|
|
3.8
|
|
|
0.3
|
|
|
18.2
|
|
|
0.3
|
|
|
11.8
|
|
|
0.3
|
|
Total
other sales and revenues
|
|
|
54.3
|
|
|
3.1
|
|
|
49.3
|
|
|
3.5
|
|
|
171.9
|
|
|
3.1
|
|
|
155.0
|
|
|
3.3
|
|
Total
net sales and operating revenues
|
|
$
|
1,768.1 |
|
|
100.0 |
|
$
|
1,424.0
|
|
|
100.0
|
|
$ |
5,582.8 |
|
|
100.0 |
|
$
|
4,636.2
|
|
|
100.0
|
|
RETAIL
VEHICLE SALES CHANGES
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
18
|
%
|
|
13
|
%
|
|
16 |
% |
|
18
|
%
|
New
vehicles
|
|
|
(3 |
)% |
|
(2
|
)%
|
|
(12 |
)% |
|
1
|
%
|
Total
|
|
|
17 |
% |
|
12
|
%
|
|
14 |
% |
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
27 |
% |
|
17
|
%
|
|
24 |
% |
|
22
|
%
|
New
vehicles
|
|
|
(3 |
)% |
|
(1
|
)%
|
|
(12 |
)% |
|
3
|
%
|
Total
|
|
|
24 |
% |
|
15
|
%
|
|
20 |
% |
|
19
|
%
|
COMPARABLE
STORE RETAIL VEHICLE SALES CHANGES
Comparable
store used unit sales growth is one of the key drivers of our profitability.
A
CarMax store is included in comparable store sales beginning in the store’s
fourteenth full month of operation.
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
13
|
%
|
|
3
|
%
|
|
8 |
% |
|
7
|
%
|
New
vehicles
|
|
|
(3 |
)% |
|
(6
|
)%
|
|
(12 |
)% |
|
2
|
%
|
Total
|
|
|
12 |
% |
|
3
|
%
|
|
7 |
% |
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
21 |
% |
|
7
|
%
|
|
16 |
% |
|
10
|
%
|
New
vehicles
|
|
|
(3 |
)% |
|
(5
|
)%
|
|
(13 |
)% |
|
3
|
%
|
Total
|
|
|
19 |
% |
|
6
|
%
|
|
13 |
% |
|
9
|
%
|
Used
Vehicle Sales.
The
27% increase in used vehicle dollar sales in the third quarter of fiscal
2007
resulted from an 18% increase in unit sales and a 7% increase in average
retail
selling price. The unit sales growth reflected the combination of a 13% increase
in comparable store used unit sales, together with sales from newer superstores
not yet in the comparable store base. Our comparable store used unit growth
benefited from strong store and Internet traffic and continued strong execution
by our store teams. We believe many factors contributed to the strong customer
traffic, including among others, our increased Internet visibility resulting
from recent improvements to our www.carmax.com website and the expansion
of our
Internet classified advertising. The increase in average retail selling price
was primarily the result of a shift in vehicle mix, as we continued to
experience a resurgence in the sales of SUVs and trucks, which we believe
were
adversely affected in the prior year by consumer reaction to higher gas prices.
Sales of luxury vehicles also continued to comprise an increased percentage
of
our sales.
As
anticipated, the curtailment of subprime sales in CarMax stores located
in
certain states beginning in the second half of fiscal 2006 had a slightly
adverse effect on third quarter used unit sales compared with the prior
year's
quarter. This adverse effect was largely offset by incremental sales financed
by
two new third-party nonprime finance providers added in the second half
of
fiscal 2006.
The
24%
increase in used vehicle dollar sales in the first nine months of fiscal
2007
resulted from a 16% increase in unit sales and a 7% increase in average
retail
selling price. The unit sales growth reflected an 8% increase in comparable
store used unit sales, together with sales from newer superstores not
yet in the
comparable store base. Our comparable store used unit growth benefited
from
strong store and Internet traffic and continued strong execution by our
store
teams. Similar to our experience in the third quarter, the increase in
average
retail selling price for the nine-month period reflected a return to
a more
normalized mix of SUV and truck sales compared with the prior year when
sales of
these types of vehicles were adversely affected by rising gasoline prices.
The
increase in average retail selling price also reflected the growing percentage
of luxury vehicles in our sales mix.
New
Vehicle Sales.
Compared
with the corresponding prior year periods, new vehicle dollar sales declined
by
3% in the third quarter of fiscal 2007 and 12% in the first nine months of
fiscal 2007. The declines were substantially the result of decreases in unit
sales, and in part they reflect our strategic decision in fiscal 2007 to
increase targeted gross profit dollars per unit on new vehicles. We had
anticipated that this decision would result in some reduction in new vehicle
unit sales. The decline in unit sales in the first nine months of fiscal
2007
also reflected the challenging comparison with the prior year period, which
benefited from unusually large new car sales generated by the domestic new
car
manufacturers’ employee pricing programs in the summer of fiscal 2006.
Wholesale
Vehicle Sales.
The
30%
increase in wholesale vehicle dollar sales in the third quarter of fiscal
2007
was principally the result of an increase in wholesale unit sales. Our wholesale
unit sales benefited from a substantial increase in appraisal traffic, in
part
spurred by our strong increase in third quarter used vehicle sales, together
with the growth in our store base. Vehicles acquired through the appraisal
process that do not meet our retail standards are sold at our on-site wholesale
auctions.
The
26%
increase in wholesale vehicle dollar sales in the first nine months of
fiscal
2007 reflected a 20% increase in wholesale unit sales and a 4% increase
in
average wholesale selling price. Similar to the third quarter, wholesale
sales
for the first nine months of the year benefited from increases in our
appraisal
traffic and from the expansion in our store base.
Other
Sales and Revenues.
Other
sales and revenues include commissions on the sale of extended service
plans,
service department sales, and third-party finance fees. Compared with
the
corresponding prior year periods, other sales and revenues increased
10% in the
third quarter of fiscal 2007 and 11% in the first nine months of fiscal
2007.
The increases were primarily the result of increased sales of extended
service
plans and an increase in third-party finance fees. Extended service
plan sales
benefited from the growth in used unit sales, and third-party finance
fees
benefited from the decline in subprime-financed sales. We record the
discount at
which the subprime lender purchases these sales as an offset to third-party
finance fee revenues.
Impact
of Inflation.
Inflation has not been a significant contributor to results. Profitability
is
based on achieving targeted unit sales and gross profit dollars per vehicle
rather than on average retail prices.
Seasonality.
Most
of
our superstores experience their strongest traffic and sales in the spring
and
summer fiscal quarters. Sales are typically lowest in the fall quarter,
which
coincides with the new vehicle model-year-changeover period. In the fall
quarter, the new model year introductions and discounts on model year closeouts
generally can cause rapid depreciation in used car pricing, particularly
for
late-model used cars. Customer
traffic also tends to slow in the fall as the weather gets colder and as
customers shift their spending priorities toward holiday-related expenditures.
Seasonal patterns for car buying and selling may vary in different
parts
of the country and, as CarMax expands geographically, these differences
could
have an effect on the overall seasonal pattern of the company’s
results.
Supplemental
Sales Information.
UNIT
SALES
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Used
vehicles
|
|
|
79,009
|
|
|
66,680
|
|
|
250,121 |
|
|
216,439 |
|
New
vehicles
|
|
|
4,532 |
|
|
4,675
|
|
|
14,610 |
|
|
16,599 |
|
Wholesale
vehicles
|
|
|
51,833 |
|
|
40,228 |
|
|
158,267 |
|
|
132,357 |
|
AVERAGE
SELLING PRICES
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Used
vehicles
|
|
|
17,247
|
|
$
|
16,147 |
|
$
|
17,273 |
|
$
|
16,157 |
|
New
vehicles
|
|
$
|
24,118
|
|
$
|
24,081 |
|
$
|
23,779 |
|
$
|
23,896 |
|
Wholesale
vehicles
|
|
$
|
4,258
|
|
$
|
4,247 |
|
$
|
4,288 |
|
$
|
4,105 |
|
RETAIL
VEHICLE SALES MIX
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
November
30
|
|
November
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
95
|
%
|
|
93
|
%
|
|
94 |
% |
|
93 |
% |
New
vehicles
|
|
|
5 |
|
|
7
|
|
|
6 |
|
|
7 |
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
93 |
% |
|
91
|
%
|
|
93 |
% |
|
90
|
% |
New
vehicles
|
|
|
7 |
|
|
9
|
%
|
|
7 |
|
|
10 |
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Retail
Stores.
We
opened
two superstores late in the third quarter of fiscal 2007, including a satellite
superstore in the Los Angeles market, and a standard superstore in
Fredericksburg, Va., which is part of the Washington, D.C., market. In the
first
half of the year, we entered the Hartford, Conn., market with a standard
superstore; the Columbus, Ohio, market with a standard and a satellite
superstore; and the Oklahoma City, Okla., market with a standard superstore.
The
opening in Hartford represented our first superstore in the Northeast. We
plan
to open four additional superstores in the fourth quarter, including our
first
small market format store in Charlottesville, Va., which opened in
December, bringing total superstore openings in fiscal 2007 to ten.
Late
in
the first quarter of fiscal 2007, we opened our first CarMax Car Buying Center,
which focuses on appraisals and vehicle purchases. This test site in the
Atlanta
market is part of a long-term effort to increase appraisal traffic and retail
vehicle sourcing self-sufficiency.
RETAIL
STORES
|
|
Estimate February
28, 2007
|
November
30,
2006
|
February 28,
2006
|
November
30,
2005
|
February
28,
2005
|
Mega
superstores(1) |
|
|
13
|
|
|
13
|
|
|
13
|
|
|
13
|
|
|
13
|
|
Standard
superstores(2) (4) |
|
|
40
|
|
|
39
|
|
|
35
|
|
|
35
|
|
|
30
|
|
Satellite
superstores(3)
(4) |
|
|
24
|
|
|
21
|
|
|
19
|
|
|
19
|
|
|
15
|
|
Total
used car superstores |
|
|
77
|
|
|
73
|
|
|
67
|
|
|
67
|
|
|
58
|
|
Co-located
new car stores |
|
|
4
|
|
|
4
|
|
|
4
|
|
|
4
|
|
|
3
|
|
Total
|
|
|
81
|
|
|
77
|
|
|
71
|
|
|
71
|
|
|
61
|
|
|
(1)
|
Generally
70,000 to 95,000 square feet on 20 to 35
acres.
|
|
(2)
|
Generally
40,000 to 60,000 square feet on 10 to 25
acres.
|
|
(3)
|
Generally
10,000 to 20,000 square feet on 4 to 10
acres.
|
|
(4) |
The
Kenosha, Wisc. superstore has been reclassified from a satellite
to a
standard superstore. |
We
have a
total of seven new car franchises, and we expect to maintain long-term
relationships with the automotive manufacturers that we currently represent.
Two
franchises are integrated within used car superstores, and the remaining
five
franchises are operated from four facilities that are co-located with select
used car superstores.
GROSS
PROFIT
|
|
Three
Months Ended November 30
|
|
Nine
Months Ended November 30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
$
per unit (1)
|
%(2)
|
$ per
unit(1)
|
%(2)
|
$
per unit(1)
|
|
%(2)
|
$
per unit(1)
|
|
%(2)
|
Used
vehicle
|
|
|
1,898
|
|
|
|
10.9 |
|
|
1,758
|
|
|
|
10.8
|
|
|
1,929 |
|
|
|
11.1 |
|
|
1,807
|
|
|
|
11.1
|
|
New
vehicle
|
|
|
1,108 |
|
|
|
4.6 |
|
|
866
|
|
|
|
3.6
|
|
|
1,168 |
|
|
|
4.9 |
|
|
943
|
|
|
|
3.9
|
|
Wholesale
vehicle
|
|
|
742 |
|
|
|
17.0 |
|
|
726
|
|
|
|
16.8
|
|
|
721 |
|
|
|
16.4 |
|
|
641
|
|
|
|
15.3
|
|
Other
|
|
|
421 |
|
|
|
64.8 |
|
|
374
|
|
|
|
54.0
|
|
|
440 |
|
|
|
67.8 |
|
|
395
|
|
|
|
59.3
|
|
Total
|
|
|
2,736 |
|
|
|
12.9 |
|
|
2,483
|
|
|
|
12.4
|
|
|
2,758 |
|
|
|
13.1 |
|
|
2,504
|
|
|
|
12.6
|
|
(1)
|
Calculated
as category gross profit divided by its respective units sold,
except the
other and total categories, which are divided by
total retail units sold.
|
(2)
|
Calculated
as a percentage of its respective sales or
revenue.
|
Used
Vehicle Gross Profit. We target a similar dollar amount of gross
profit per used unit, regardless of retail price. Our ability to quickly
adjust
appraisal offers to stay in line with the broader market trade-in trends
and our
rapid inventory turns, which reduce our exposure to the inherent continual
depreciation in used vehicle values, contribute to our ability to manage
our
gross profit dollars per unit. In addition, over the past few years, we have
continued to refine our car-buying strategies, which we believe has benefited
our used vehicle gross profits.
Compared
with the third quarter and the first nine months of fiscal 2006, our fiscal
2007
used vehicle gross profit increased $140 per unit and $122 per unit,
respectively. These increases reflected the benefit of our strong, consistent
sales performance throughout the first nine months of fiscal 2007. We believe
several external factors contributed to sales volatility in prior
years, including significant changes in gasoline prices, new vehicle
incentives, interest rates, and consumer confidence. We did not experience
significant changes in these factors in fiscal 2007, which we believe
contributed to a more stable environment. We employ a volume-based
strategy, and we systematically markdown individual vehicle prices based
on our
proprietary pricing algorithms in order to appropriately balance sales
growth,
inventory turns, and gross profit achievement. When customer traffic and
our
sales pace are consistently strong, we generally take fewer pricing markdowns,
which in turn maximizes our gross profit dollars. In addition, gross profit
in
the prior year’s periods was adversely affected by slowing demand for
gas-guzzling SUVs and trucks, which resulted in higher pricing markdowns
for
these vehicles.
New
Vehicle Gross Profit.
Compared
with the third quarter and first nine months of last year, our fiscal 2007
new
vehicle gross profit increased $242 per unit and $225 per unit, respectively.
These increases primarily reflected our strategic decision to increase targeted
new vehicle gross profit dollars per unit. While this decision contributed
to
the decline in new vehicle unit sales, it resulted in an increase in the
total
gross profit contribution from new vehicles in the first nine
months of fiscal 2007.
Wholesale
Vehicle Gross Profit.
Compared
with the third quarter and first nine months of fiscal 2006, our fiscal 2007
wholesale gross profit increased $16 per unit and $80 per unit, respectively.
Wholesale vehicle profitability has steadily increased over the last several
years, reflecting the combined benefits of improvements and refinements in
our
car-buying strategies, our appraisal delivery processes, and our in-store
auction processes. We have made continuous improvements in these processes,
which we believe have allowed us to become more efficient. Our in-store auctions
have benefited from our initiatives to increase average dealer attendance,
which
we believe has allowed us to achieve better price realizations.
For
the
third quarter, we had anticipated that our wholesale gross profit per unit
would
decline compared with the unusually high level achieved in fiscal 2006.
In the
prior year’s third quarter, we believe our wholesale gross profit per unit
benefited from a temporary shortfall in supply and an unusually strong
demand
for older and higher mileage vehicles occurring in the aftermath of Hurricane
Katrina. These older, higher mileage vehicles comprise the majority of
our
wholesale units and, as a result, we experienced a record level of attendance
at
our auctions in the prior year. In the current year’s third quarter, we believe
the combination of our process improvements and a more-moderate-than-normal
seasonal decline in wholesale market prices benefited our
results.
Other
Gross Profit.
Compared
with the corresponding prior year periods, other gross profit per unit
increased
$47 per unit in the third quarter and $45 per unit in the first nine months
of
fiscal 2007. The improvements were primarily the result of the growth in
third-party finance fees and an improvement in our extended service plan
revenues and service margin. The service department, which is the only
category within other sales and revenues that has an associated cost of
sales,
reported higher profits, reflecting the greater overhead expense absorption
provided by the increased vehicle sales and reconditioning volumes.
CarMax
Auto Finance Income.
CAF
provides prime automobile financing for our used and new car sales. Because
the
purchase of an automobile is traditionally reliant on the consumer’s ability to
obtain on-the-spot financing, it is important to our business that such
financing be available to creditworthy customers. While financing can also
be
obtained from third-party sources, we believe that total reliance on third
parties can create unacceptable volatility and business risk. Furthermore,
we
believe that our processes and systems, the transparency of our pricing,
and our
vehicle quality provide a unique and ideal environment in which to procure
high-quality automobile loan receivables, both for CAF and for third-party
lenders. CAF provides us the opportunity to capture additional profits
and cash
flows from automobile loan receivables while managing our reliance on
third-party finance sources.
|
|
Three
Months Ended
November
30
|
|
Nine
Months Ended
November
30
|
|
(In
millions)
|
|
2006
|
|
%
|
|
2005
|
|
%
|
|
2006
|
|
%
|
|
2005
|
|
%
|
|
Total
gain income(1)
|
|
$ |
23.7 |
|
|
4.4
|
|
$
|
20.9
|
|
|
5.0
|
|
$ |
77.4 |
|
|
4.5
|
|
$
|
58.7
|
|
|
4.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
CAF income: (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing
fee income
|
|
|
8.2 |
|
|
1.0 |
|
|
7.0
|
|
|
1.0
|
|
|
23.5 |
|
|
1.0 |
|
|
20.5
|
|
|
1.0
|
|
Interest
income
|
|
|
6.8
|
|
|
0.9 |
|
|
5.6
|
|
|
0.8
|
|
|
19.2 |
|
|
0.9 |
|
|
15.7
|
|
|
0.8
|
|
Total
other CAF income
|
|
|
15.0 |
|
|
1.9 |
|
|
12.6
|
|
|
1.9
|
|
|
42.7 |
|
|
1.9 |
|
|
36.2
|
|
|
1.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
CAF expenses: (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAF
payroll and fringe benefit expense
|
|
|
3.1 |
|
|
0.4 |
|
|
2.7
|
|
|
0.4
|
|
|
8.8 |
|
|
0.4 |
|
|
7.6
|
|
|
0.4
|
|
Other
direct CAF expenses
|
|
|
3.6 |
|
|
0.5 |
|
|
2.9
|
|
|
0.4
|
|
|
10.4 |
|
|
0.5 |
|
|
8.4
|
|
|
0.4
|
|
Total
direct CAF expenses
|
|
|
6.7 |
|
|
0.9 |
|
|
5.6
|
|
|
0.8
|
|
|
19.2 |
|
|
0.9 |
|
|
16.0
|
|
|
0.8
|
|
CarMax
Auto Finance income (3)
|
|
$ |
32.0 |
|
|
1.8 |
|
$
|
28.0
|
|
|
2.0
|
|
$ |
100.9 |
|
|
1.8 |
|
$
|
78.9
|
|
|
1.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans sold
|
|
$ |
538.7 |
|
|
|
|
$
|
416.6
|
|
|
|
|
$ |
1,728.7 |
|
|
|
|
$
|
1,405.9
|
|
|
|
|
Average
managed receivables
|
|
$ |
3,147.9 |
|
|
|
|
$
|
2,705.9
|
|
|
|
|
$ |
3,006.4 |
|
|
|
|
$
|
2,626.6
|
|
|
|
|
Ending
managed receivables
|
|
$ |
3,180.8 |
|
|
|
|
$
|
2,710.7
|
|
|
|
|
$ |
3,180.8 |
|
|
|
|
$
|
2,710.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales and operating revenues
|
|
$ |
1,768.1 |
|
|
|
|
$
|
1,424.0
|
|
|
|
|
$ |
5,582.8 |
|
|
|
|
$
|
4,636.2
|
|
|
|
|
Percent
columns indicate:
|
(1)
|
Percent
of loans sold.
|
|
(2)
|
Annualized
percent of average managed
receivables.
|
|
(3)
|
Percent
of total net sales and operating
revenues.
|
CAF
income does not include any allocation of indirect costs or income. We present
this information on a direct basis to avoid making arbitrary decisions regarding
the indirect benefit or costs that could be attributed to this operation.
Examples of indirect costs not included are retail store expenses and
corporate expenses such as human resources, administrative services, marketing,
information systems, accounting, legal, treasury, and executive payroll.
CAF
originates automobile loans to qualified customers at competitive market rates
of interest. The majority of the profit contribution from CAF is generated
by
the spread between the interest rates charged to customers and the related
cost
of funds. Substantially all of the loans originated by CAF are sold in
securitization transactions. A gain, recorded at the time of securitization,
results from recording a receivable approximately equal to the present value
of
the expected residual cash flows generated by the securitized receivables.
In a
normalized environment, we expect the gains on loans originated and sold as
a
percent of loans originated and sold (the “gain spread”) to be in the range of
3.5% to 4.5%.
Total
gain income in fiscal 2007 and fiscal 2006 also included the effects of retained
interest valuation adjustments. In addition, total gain income in fiscal
2006
included a benefit related to the repurchase and resale of receivables in
existing public securitizations. The following table provides information
on the
aggregate effect of these items on gain income, loans sold, and gain
spread.
GAIN
INCOME AND LOANS SOLD
|
|
Three
Months Ended
|
Nine
Months Ended
|
|
|
November
30
|
November
30
|
(In
millions)
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Gain
on sales of loans originated and sold
|
|
$
|
23.0
|
|
$
|
14.9
|
|
$
|
64.7
|
|
$
|
46.2
|
|
Other
gain income
|
|
|
0.7
|
|
|
6.1
|
|
|
12.8
|
|
|
12.5
|
|
Total
gain income
|
|
$
|
23.7
|
|
$
|
20.9
|
|
$
|
77.4
|
|
$
|
58.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
originated and sold
|
|
$
|
538.7
|
|
$
|
416.6
|
|
[$
|
1,687.6
|
] |
$
|
1,354.4
|
|
Receivables
repurchased from public securitizations and resold
|
|
|
–
|
|
|
–
|
|
|
[41.0
|
] |
|
51.5
|
|
Total
loans sold
|
|
$
|
538.7
|
|
$
|
416.6
|
|
[ $
|
1,728.7
|
] |
$
|
1,405.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
percentage on loans originated and sold
|
|
|
4.3
|
% |
|
3.6
|
% |
|
3.8
|
% |
|
3.4
|
% |
Total
gain income as a percentage of total loans sold
|
|
|
4.4
|
% |
|
5.0
|
% |
|
4.5
|
% |
|
4.2
|
% |
In
the
third quarter of fiscal 2007, CAF income increased 14% to $32.0 million from
$28.0 million in the prior year's third quarter, despite the challenging
comparison with last year's quarter that included $6.1 million of favorable
items. Excluding favorable items in both years, CAF income increased $9.4
million or 43%. CAF income benefited from the growth in retail vehicle
unit sales, an increase in the gain spread, an increase in the average
amount financed, and an increase in managed receivables. The third quarter
gain spread increased to 4.3% in fiscal 2007 compared with 3.6% in fiscal
2006,
reflecting changes in the interest rate environment. In fiscal 2006, our
funding costs were rising faster than consumer rates resulting in a lower
gain
spread. In fiscal 2007, relative stability in our funding cost allowed us
to achieve a higher gain spread.
In
the
third quarter of last year, we recognized $6.1 million, or $0.03 per share,
of
other gain income, principally comprised of favorable valuation adjustments
resulting from lowering the loss rate assumptions on pools of previously
securitized receivables. We believe these pools of receivables experienced
lower-than-expected loss rates as a result of a combination of factors,
including better-than-expected performance of our credit scorecard, favorable
economic conditions, and an improved recovery rate. In the third quarter
of
fiscal 2007, other gain income was $0.7 million, or less than $0.01 per share,
as the effect of modestly higher-than-anticipated loss experience on our
most
recent securitizations was offset by the effect of favorable loss experience
on
older securitizations.
For
the
nine months ended November 30, 2006, CAF income increased 28% to $100.9 million
from $78.9 million in the first nine months of the prior year. CAF income
benefited from the growth in retail vehicle unit sales, an increase in the
gain
spread, an increase in the average amount financed, an increase in CAF’s
penetration rate, and an increase in managed receivables. For the nine-month
period, the gain spread increased to 3.8% in fiscal 2007 from 3.4% in fiscal
2006, as relative stability in the interest rate market allowed us to achieve
a
higher gain spread.
We
recognized other gain income of $12.8 million, or $0.07 per share, in the
first
nine months of fiscal 2007 compared with $12.5 million, or $0.07 per share,
in
the corresponding period in the prior year. Other gain income in the fiscal
2007
period was primarily comprised of favorable valuation adjustments. Other
gain
income in the fiscal 2006 period included approximately $0.04 per share of
favorable valuation adjustments, $0.02 per share of favorable effects from
new
public securitizations, and $0.01 per share of favorable effect from the
repurchase and resale of receivables in existing public securitizations.
The
favorable valuation adjustments in the fiscal 2007 and the fiscal 2006 periods
primarily resulted from lowering loss rate assumptions on pools of previously
securitized receivables.
The
company’s securitizations typically contain an option to repurchase the
securitized receivables when the outstanding balance in a pool of automobile
loan receivables falls below 10% of the original pool balance. This option
was
exercised on the 2002-2 securitization in the second quarter of fiscal 2007,
and
it was exercised on the 2001-2 securitization in the first quarter of fiscal
2006. In each case, all remaining eligible receivables were subsequently resold
into the warehouse facility. In the fiscal 2006 transaction, the remaining
receivables carried interest rates that were higher than the then-current
funding cost in the warehouse facility, resulting in the earnings benefit
of $0.01 per share.
In
future
periods, the effects of refinancing, repurchase, and resale activity could
be
either favorable or unfavorable depending on the securitization structure and
market conditions at the transaction date.
PAST
DUE ACCOUNT INFORMATION
|
|
|
As
of November 30
|
|
|
As
of February 28
|
|
(In
millions)
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Loans
securitized
|
|
|
$
|
3,108.5
|
|
|
$
|
2,654.6
|
|
|
$
|
2,710.4
|
|
|
$
|
2,427.2
|
|
Loans
held for sale or investment
|
|
|
|
72.3
|
|
|
|
56.1
|
|
|
|
62.0
|
|
|
|
67.7
|
|
Ending
managed receivables
|
|
|
$
|
3,180.8
|
|
|
$
|
2,710.7
|
|
|
$
|
2,772.5
|
|
|
$
|
2,494.9
|
|
Accounts
31+ days past due
|
|
|
$
|
61.2
|
|
|
$
|
43.3
|
|
|
$
|
37.4
|
|
|
$
|
31.1
|
|
Past
due accounts as a percentage of ending managed receivables
|
|
|
|
1.93
|
%
|
|
|
1.60
|
%
|
|
|
1.35
|
%
|
|
|
1.24
|
%
|
CREDIT
LOSS INFORMATION
|
|
Three
Months Ended
November
30
|
|
Nine Months
Ended
November
30
|
|
(In
millions)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
credit losses on managed receivables
|
|
$ |
6.7 |
|
$
|
5.3
|
|
$ |
13.7 |
|
$
|
13.4 |
|
Average
managed receivables
|
|
$ |
3,147.9 |
|
|
2,705.9
|
|
$ |
3,006.4 |
|
$
|
2,626.6
|
|
Annualized
net credit losses as a percentage of average managed
receivables
|
|
|
0.85 |
% |
|
0.78
|
%
|
|
0.61 |
% |
|
0.68
|
%
|
Recovery
rate
|
|
|
49.2 |
%
|
|
48.5 |
% |
|
50.6 |
%
|
|
49.3 |
%
|
We
are at
risk for the performance of the managed securitized receivables to the extent
of
our retained interest in the receivables. If the managed receivables do not
perform in accordance with the assumptions used in determining the fair value
of
the retained interest, our earnings could be impacted. For the three
months ended November 30, 2006, both past due accounts as a percentage of ending
managed receivables and annualized net credit losses as a percentage of average
managed receivables increased moderately. We believe the increases were
the result of a combination of factors including a gradual shift in credit
mix
of the portfolio as well as less favorable general economic and industry
trends. Receivables originated in calendar years 2003, 2004, and early
2005 have experienced loss rates well below CAF's historical averages and
targeted loss rates. We believe this favorability was due, in part, to the
credit scorecard implemented in late 2002. As it became evident that the
scorecard was resulting in lower than expected loss rates, CAF gradually
expanded its credit offer beginning in late 2004. As a
result, receivables originated in late 2005 and 2006 are experiencing
higher loss and delinquency rates than receivables originated in 2003, 2004,
and
early 2005. Despite the unfavorable variance to prior year, loss rates for
the quarter were in line with our expectations and year-to-date loss rates
were
lower than expected.
Selling,
General, and Administrative Expenses. The
SG&A ratio declined 120 basis points to 10.6% in the third quarter of fiscal
2007 compared with 11.8% in the third quarter of the prior year. The decline
primarily reflects the substantial fixed overhead leverage generated by our
strong comparable store sales growth. The SG&A ratio also benefited modestly
from a shift in the timing of approximately $2 million to $3 million of planned
spending from the third quarter to the fourth quarter. In connection with the
adoption of SFAS 123(R), we recognized $6.1 million, or $0.03 per share, of
share-based compensation cost in the third quarter of fiscal 2007, including
$5.6 million reflected in SG&A, compared with $5.6 million, or $0.03 per
share, in last year’s third quarter, all of which was included in SG&A.
For
the
nine months ended November 30, 2006, the SG&A ratio declined 50 basis points
to 10.3% compared with 10.8% in the corresponding period of last year.
The leverage of fixed expenses associated with our strong comparable store
sales growth in the first nine months of fiscal 2007 was partially offset
by a
10 basis point increase related to higher share-based compensation costs.
The
increase in share-based compensation costs was driven, in large part, by
the
accelerated vesting of stock options upon the retirement of our former
chief
executive officer in the second quarter of fiscal 2007. We recognized $26.2
million, or $0.15 per share, of share-based compensation costs in the first
nine
months of fiscal 2007, including $24.5 million reflected in SG&A, compared
with $16.3 million, or $0.09 per share, in the first nine months of last
year,
all of which was included in SG&A.
Income
Taxes. The
effective income tax rate was 38.2% in the third quarter of fiscal 2007,
compared with 39.1% in the third quarter of fiscal 2006. For
the
first nine months of the fiscal year, the effective tax rate was 38.2%
in
fiscal 2007 and 38.4% in fiscal 2006.
Operations
Outlook.
Fiscal
2007 Comparable Store Sales and Earnings Per Share
Expectations.
Given
our stronger-than-expected performance in the third quarter of fiscal
2007, we have increased our comparable store used unit
growth and our earnings per share expectations for the current fiscal
year. We now expect annual comparable store used unit growth for fiscal
2007 in the range of 8% to 9%, versus our previous expectations of 6% to
8%.
We
now
expect fiscal 2007 earnings per share in the range of $1.75 to $1.85,
representing an increase of 39% to 47% compared with the $1.26 reported in
fiscal 2006 after restatement for SFAS 123(R). We previously expected fiscal
2007 earnings per share in the range of $1.55 to $1.65. The revised fiscal
2007
expectations include an estimated $0.19 or $0.20 per share of share-based
compensation expense resulting from the adoption of SFAS 123(R), compared with
$0.13 per share included in the restated fiscal 2006 results. The
revised fiscal 2007 expectations also include the $0.07 per share of CAF
favorable items reported in the first nine months of fiscal 2007, while the
fiscal 2006 full year results included $0.09 per share of CAF favorable items.
As
is
standard, our expectations are not adjusted for the possibility of unusual
winter weather, which could adversely affect our fourth quarter results.
In the
fourth quarter, we expect the opportunity for SG&A leverage will be limited
by the combination of higher store preopening costs in this year’s quarter, the
shift in timing of certain spending from the third quarter to the fourth
quarter, and the challenging comparison with last year’s fourth quarter when we
benefited from unexpectedly favorable healthcare and property tax costs.
PLANNED
SUPERSTORE OPENINGS
Location
|
Television
Market
|
Market
Status
|
Standard
Superstores
|
Satellite
Superstores
|
Fiscal
2007 - fourth quarter:
|
|
|
|
|
|
|
|
|
|
Charlottesville,
Va.
|
Charlottesville
|
New
market
|
-
|
1
|
New
Haven, Conn.
|
Hartford
/ New Haven
|
Existing
market
|
-
|
1
|
Fresno,
Calif.
|
Fresno
|
New
market
|
1
|
-
|
Austin,
Tex.
|
Austin
|
Existing
market
|
-
|
1
|
Total
|
|
|
1
|
3
|
|
|
|
|
|
Fiscal
2008:
|
|
|
|
|
|
|
|
|
|
Tucson,
Ariz.
|
Tucson
|
New
market
|
1
|
-
|
Milwaukee,
Wis.
|
Milwaukee
|
New
market
|
-
|
2
|
Gastonia,
N.C.
|
Charlotte
|
Existing
market
|
1
|
-
|
Torrance,
Calif.
|
Los
Angeles
|
Exisiting
market
|
-
|
1
|
Roswell,
Ga.
|
Atlanta
|
Existing
market
|
-
|
1
|
Newport
News, Va.
|
Norfolk
/ Va. Beach
|
Exisiting
market
|
-
|
1
|
Ellicott
City, Md.
|
DC
/ Baltimore
|
Existing
market
|
-
|
1
|
San
Diego, Calif.
|
San
Diego
|
New
market
|
-
|
1
|
Modesto,
Calif.
|
Sacramento
|
Existing
market
|
1
|
-
|
Omaha,
Neb.
|
Omaha
|
New
market
|
1
|
-
|
Riverside,
Calif.
|
Los
Angeles
|
Existing
market
|
-
|
1
|
Jackson,
Miss.
|
Jackson
|
New
market
|
1
|
-
|
Total
|
|
|
5
|
8
|
We
plan
to open one standard superstore and three satellite superstores during the
fourth quarter, bringing total fiscal 2007 store openings to ten. Given
their timing, we expect little, if any, contribution to fiscal 2007 sales
and
profits from stores opened in the fourth quarter. In addition, normal
construction or other scheduling delays could shift the opening dates of
stores
into fiscal 2008.
During
the fiscal year ending February 28, 2008, we expect to open 13 used car
superstores, including 5 standard superstores and 8 satellite superstores.
These store openings will expand our used car superstore base by approximately
17%, consistent with our target for used car superstore annual growth in
the
range of 15% to 20%. We
will
enter five new markets and expand our presence in six existing markets,
geographically dispersed across the country. The opening plan also contains
a
mix of market sizes, ranging from San Diego, which is our first new large
market
in several years, to markets such as Omaha and Jackson. We currently
expect that five of the superstores will be opened in the first half of the
year
and the remaining eight in the second half of the year. As is generally
the case, normal construction, permitting, or other scheduling delays could
shift opening dates of stores into the following fiscal
year.
We
now
expect capital expenditures in fiscal 2007 to be approximately $190 million,
compared with our previous expectation of approximately $215 million. The
decrease in expected capital spending primarily reflects changes in the
anticipated timing of construction of superstores we plan to open in
future years.
FINANCIAL
CONDITION
Liquidity
and Capital Resources.
Operating
Activities.
Net cash
from operations decreased slightly to $137.6 million in the first nine months
of
fiscal 2007 from $139.1 million in the first nine months of fiscal 2006,
primarily reflecting an increase in working capital, substantially offset
by
higher fiscal 2007 net earnings. Inventory
increased by $91.1 million in the first nine months of fiscal 2007, compared
with a $29.8 million increase in last year’s first nine months. The increase
reflected inventory purchases to support sales and new store openings, as
well
as a higher average inventory cost in the first nine months of fiscal
2007. Our retained interests in securitized receivables increased by $44.3
million in the first nine months of fiscal 2007 compared with an $11.0 million
increase in the prior year period. The increase primarily reflected the growth
in the carrying value of the interest-only strip receivable in fiscal 2007
resulting from the improvement in the gain spread. Accounts payable, accrued
expenses and other current liabilities, and accrued income taxes increased
by
$58.5 million in the first nine months of fiscal 2007, compared with a $33.4
million increase in last year’s first nine months. The $25.1
million increase in the year-over-year growth in these current liabilities
included $12.9 million related to purchases of inventory and $7.3 million
related to accrued income taxes.
The
aggregate principal amount of outstanding automobile loan receivables funded
through securitizations, discussed in Notes 3 and 4 to the company’s
consolidated financial statements, totaled $3.11 billion at November 30,
2006,
and $2.65 billion at November 30, 2005. At November 30, 2006, the warehouse
facility limit was $825.0 million and unused warehouse capacity totaled $119.5
million. The warehouse facility matures in July 2007. We anticipate that we
will be able to renew, expand, or enter into new securitization arrangements
to
meet the future needs of the automobile finance operation.
Investing
Activities.
Net cash
used in investing activities was $111.2 million in the first nine months
of
fiscal 2007, compared with $75.3 million in the first nine months of the
prior
year. Capital expenditures were $114.7 million in the first nine months of
fiscal 2007, compared with $153.5 million in the first nine months of fiscal
2006. Capital expenditures primarily include store construction costs and
the
cost of land acquired for future year store openings. These expenditures
will
vary from quarter to quarter based on the timing of store openings and land
acquisitions. Higher capital expenditures in fiscal 2006 also reflected
the costs associated with the completion of our new home office in October
2005.
Capital
expenditures are funded through internally generated funds, short- and long-term
debt, and sale-leaseback transactions. There were no sale-leaseback transactions
in the first nine months of fiscal 2007. In the first nine
months of fiscal 2006, we generated $78.2 million of proceeds from the sales
of
assets, principally from sale-leaseback transactions involving five
superstores. At November 30, 2006, we owned 16 superstores currently
in operation, as well as the company’s home office in Richmond, Virginia. In
addition, six store facilities were accounted for as capital
leases.
Financing
Activities.
Net cash
used in financing activities was $35.7 million in the first nine months of
fiscal 2007, compared with $63.7 million in the first nine months of fiscal
2006.
In
the
first nine months of fiscal 2007, we used cash generated from operations
to
reduce total debt by $73.6 million compared with a $72.0 million net reduction
in the first nine months of fiscal 2006.
As
of
November 30, 2006, $86.4 million was outstanding under our revolving credit
facility, with the remainder fully available to the company. The outstanding
balance included $3.0 million of swing line loans classified as short-term
debt
and $83.4 million classified as current portion of long-term debt. The
outstanding balance was classified as current at November 30, 2006,
as management expects the outstanding balance to fluctuate and to be fully
paid off at times during the next 12 months.
The company's revolving credit
facility was amended in December 2006. The
term of the agreement was extended from August 2009 to
December 2011 and aggregate borrowings available under the agreement were
increased from $450 million to $500 million.
We
expect
that cash generated by operations, proceeds from securitization transactions,
and, if needed, additional debt and sale-leaseback transactions will be
sufficient to fund capital expenditures and working capital for the foreseeable
future.
FORWARD-LOOKING
STATEMENTS
The
company cautions readers that the statements contained in this report about
the
company’s future business plans,
operations, opportunities, or prospects, including without limitation any
statements or factors regarding expected sales, margins, or earnings, are
forward-looking statements made pursuant to the safe harbor provisions of
the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements are based upon management’s current knowledge and assumptions about
future events and involve risks and uncertainties that could cause actual
results to differ materially from anticipated results. The company disclaims
any
intent or obligation to update these statements. Among the factors that
could cause actual results and outcomes to differ materially from those
contained in the forward-looking statements are the following:
§ |
Changes
in the general U.S. or regional U.S. economy. |
§ |
Intense
competition within the company's industry. |
§ |
Significant
changes in retail prices for used and new vehicles. |
§ |
A
reduction in the availability or the company’s access to sources of
inventory. |
§ |
The
significant loss of key employees from the company’s store, regional, or
corporate management teams. |
§ |
The
efficient operation of the company’s information systems. |
§ |
Changes
in the availability or cost of capital and working capital
financing. |
§ |
The
company’s ability to acquire suitable real estate.
|
§ |
The
occurrence of adverse weather events. |
§ |
Seasonal
fluctuations in the company’s business.
|
§ |
The
geographic concentration of the company’s superstores.
|
§ |
The
regulatory environment in which the company operates.
|
§ |
The
effect of various litigation matters.
|
§ |
The
effect of new accounting requirements or changes to U.S. generally
accepted accounting principles.
|
§ |
The
occurrence of certain other material
events. |
For
more
details on factors that could affect expectations, see Part II, Item 1A.
“Risk
Factors” on page 26
of this
report, the company's Annual Report on Form 10-K for the fiscal year ended
February 28, 2006, and its quarterly and current reports as filed with or
furnished to the Securities and Exchange Commission. The company's filings
are
publicly available on our investor information home page at
http://investor.carmax.com. Requests for information may also be made to
the Investor Relations department by email to [email protected]
or
by calling 1-804-747-0422 extension 4489.
QUANTITATIVE
AND QUALITATIVE
DISCLOSURES
ABOUT MARKET
RISK
Automobile
Installment Loan Receivables. At
November 30, 2006, and February 28, 2006, all loans in the portfolio of
automobile loan receivables were fixed-rate installment loans. Financing
for
these automobile loan receivables is achieved through asset securitization
programs that, in turn, issue both fixed- and floating-rate securities. Interest
rate exposure relating to floating-rate securitizations is managed through
the
use of interest rate swaps. Receivables held for investment or sale are financed
with working capital. Generally, changes in interest rates associated with
underlying swaps will not have a material impact on earnings. However, changes
in interest rates associated with underlying swaps may have a material impact
on
cash and the timing of cash flows.
Credit
risk is the exposure to nonperformance of another party to an agreement.
Credit
risk is mitigated by dealing with highly rated bank counterparties. The market
and credit risks associated with financial derivatives are similar to those
relating to other types of financial instruments.
COMPOSITION
OF AUTOMOBILE LOAN RECEIVABLES
(In
millions)
|
|
November
30, 2006
|
February
28, 2006
|
|
|
|
|
|
|
Principal
amount of:
|
|
|
|
|
|
Fixed-rate
securitizations
|
|
|
$ |
2,403.0
|
|
$
|
2,126.4
|
|
|
Floating-rate
securitizations synthetically altered to fixed
|
|
|
|
704.6
|
|
|
584.0
|
|
|
Floating-rate
securitizations
|
|
|
|
0.9
|
|
|
–
|
|
|
Held
for investment (1)
|
|
|
|
69.2 |
|
|
57.9
|
|
|
Held
for sale (2)
|
|
|
|
3.1
|
|
|
4.1
|
|
|
Total
|
|
|
$
|
3,180.8
|
|
$
|
2,772.5
|
|
|
|
(1)
|
The
majority is held by a bankruptcy-remote special purpose
entity.
|
|
(2)
|
Held
by a bankruptcy-remote special purpose
entity.
|
Interest
Rate Exposure. We
also
have interest rate risk from changing interest rates related to our outstanding
debt. Substantially all of the debt is floating-rate debt based on LIBOR.
A
100-basis point increase in market interest rates would have decreased our
net
earnings per share by less than $0.01 for the three months and the nine months
ended November 30, 2006.
CONTROLS
AND PROCEDURES
The
company maintains disclosure controls and procedures (“disclosure controls”)
that are designed to ensure that information required to be disclosed in our
reports filed under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the U.S.
Securities and Exchange Commission’s rules and forms. Disclosure controls are
also designed to ensure that such information is accumulated and communicated
to
our management, including the chief executive officer (“CEO”) and the chief
financial officer (“CFO”), as appropriate, to allow timely decisions regarding
required disclosure.
As
of the
end of the period covered by this report, the company evaluated the
effectiveness of the design and operation of its disclosure controls. This
evaluation was performed under the supervision and with the participation of
management, including our CEO and CFO. Based upon that evaluation, the CEO
and
CFO concluded that the company’s disclosure controls were effective as of the
end of such period. There was no change in the company’s internal control over
financial reporting that occurred during the quarter ended November 30,
2006, that has materially affected, or is reasonably likely to materially
affect, the company’s internal control over financial reporting.
PART
II. OTHER INFORMATION
On
August
29, 2006, Heather Herron, et al. filed a putative class action lawsuit against
51 South Carolina automobile dealers, including CarMax Auto Superstores, Inc.,
in the Court of Common Pleas in Aiken County, South Carolina.
As of November 30, 2006, there were over 300 automobile dealers named as
defendants in the lawsuit. At
this
time, the lawsuit is in its initial stages and the company is evaluating the
allegations and intends to defend itself vigorously. The company is unable
to make an estimate of the amount or range of loss that could result from an
unfavorable outcome. Additional information regarding this
lawsuit can be found in Part I, Item 1, Note 10 of this Form
10-Q.
CarMax
is
subject to various other legal proceedings, claims, and liabilities that arise
in the ordinary course of its business. In the opinion of management, the amount
of ultimate liability with respect to these other actions will not materially
affect the financial position or results of operations of CarMax.
In
connection with information set forth in this Form 10-Q, the factors discussed
under “Risk Factors” in our Form 10-K for fiscal year ended February 28, 2006,
should be considered. These risks could materially and adversely affect
our business, financial condition, and results of operations. There have
been no material changes to the factors discussed in our Form
10-K.
|
31.1
|
Certification
of the Chief Executive Officer Pursuant to Rule 13a-14(a), filed
herewith.
|
|
31.2
|
Certification
of the Chief Financial Officer Pursuant to Rule 13a-14(a), filed
herewith.
|
|
32.1
|
Certification
of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,
filed
herewith.
|
|
32.2
|
Certification
of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
filed
herewith.
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
CARMAX,
INC. |
|
|
|
|
|
|
|
By:
|
/s/
Thomas J. Folliard
|
|
|
|
Thomas
J. Folliard
|
|
|
President
and
|
|
|
Chief
Executive Officer
|
|
|
|
|
|
|
|
By:
|
/s/
Keith D. Browning
|
|
|
|
Keith
D. Browning
|
|
|
Executive
Vice President and
|
|
|
Chief
Financial Officer
|
January
8, 2007
31.1
|
Certification
of the Chief Executive Officer Pursuant to Rule 13a-14(a), filed
herewith.
|
31.2
|
Certification
of the Chief Financial Officer Pursuant to Rule 13a-14(a), filed
herewith.
|
32.1
|
Certification
of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,
filed
herewith.
|
32.2
|
Certification
of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
filed
herewith.
|
Page
30 of
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