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 August 31, 2008
OR
[ ] 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
|
(I.R.S.
Employer
|
incorporation
or organization)
|
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.
(A) Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definition of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act. (Check one):
(B)
Large
accelerated filer X
|
Accelerated
filer _
|
|
Non-accelerated
filer _
|
Smaller
reporting company _
|
|
(C) Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the 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 as of
September 30, 2008
|
Common
Stock, par value $0.50
|
|
220,429,817
|
|
|
|
A Table
of Contents is included on Page 2 and a separate Exhibit Index is included on
Page 42.
CARMAX, INC. AND
SUBSIDIARIES
TABLE OF
CONTENTS
|
Page
No.
|
PART
I.
|
FINANCIAL
INFORMATION
|
|
|
|
|
|
|
Item
1. Financial Statements:
|
|
|
|
Consolidated
Statements of Earnings -
Three
Months and Six Months Ended August 31, 2008 and 2007
|
3
|
|
|
Consolidated
Balance Sheets -
August
31, 2008, and February 29, 2008
|
4
|
|
|
Consolidated
Statements of Cash Flows -
Six
Months Ended August 31, 2008 and 2007
|
5
|
|
|
Notes
to Consolidated Financial Statements
|
6
|
|
|
|
|
|
Item
2. Management's Discussion and Analysis of
Financial Condition and Results
of Operations
|
21
|
|
|
|
|
Item
3. Quantitative and Qualitative Disclosures About
Market Risk
|
37
|
|
|
|
|
Item
4. Controls and Procedures
|
38
|
|
|
|
PART
II.
|
OTHER
INFORMATION
|
|
|
|
|
|
Item
1. Legal Proceedings
|
39
|
|
|
|
|
Item
1A. Risk Factors
|
39
|
|
|
|
|
Item
4. Submission of Matters to a Vote of Security
Holders
|
39
|
|
|
|
|
Item
6. Exhibits
|
40
|
|
|
|
|
|
|
SIGNATURES
|
41
|
|
|
|
EXHIBIT
INDEX
|
42
|
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 August 31
|
|
|
Six
Months Ended August 31
|
|
|
|
2008
|
|
|
|
% |
(1) |
|
2007
|
|
|
|
% |
(1) |
|
2008
|
|
|
|
% |
(1) |
|
2007
|
|
|
|
% |
(1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and operating revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicle
sales
|
|
$ |
1,476,317 |
|
|
|
80.3 |
|
|
$ |
1,687,142 |
|
|
|
79.5 |
|
|
$ |
3,293,165 |
|
|
|
81.4 |
|
|
$ |
3,395,533 |
|
|
|
79.5 |
|
New
vehicle sales
|
|
|
77,818 |
|
|
|
4.2 |
|
|
|
104,779 |
|
|
|
4.9 |
|
|
|
159,888 |
|
|
|
3.9 |
|
|
|
217,394 |
|
|
|
5.1 |
|
Wholesale
vehicle
sales
|
|
|
223,269 |
|
|
|
12.1 |
|
|
|
265,282 |
|
|
|
12.5 |
|
|
|
465,596 |
|
|
|
11.5 |
|
|
|
526,434 |
|
|
|
12.3 |
|
Other
sales and
revenues
|
|
|
61,650 |
|
|
|
3.4 |
|
|
|
65,327 |
|
|
|
3.1 |
|
|
|
129,168 |
|
|
|
3.2 |
|
|
|
130,303 |
|
|
|
3.1 |
|
Net
sales and operating revenues
|
|
|
1,839,054 |
|
|
|
100.0 |
|
|
|
2,122,530 |
|
|
|
100.0 |
|
|
|
4,047,817 |
|
|
|
100.0 |
|
|
|
4,269,664 |
|
|
|
100.0 |
|
Cost
of sales
|
|
|
1,583,141 |
|
|
|
86.1 |
|
|
|
1,834,336 |
|
|
|
86.4 |
|
|
|
3,509,190 |
|
|
|
86.7 |
|
|
|
3,697,249 |
|
|
|
86.6 |
|
Gross
profit
|
|
|
255,913 |
|
|
|
13.9 |
|
|
|
288,194 |
|
|
|
13.6 |
|
|
|
538,627 |
|
|
|
13.3 |
|
|
|
572,415 |
|
|
|
13.4 |
|
CarMax
Auto Finance (loss) income
|
|
|
(7,141 |
) |
|
|
(0.4 |
) |
|
|
33,412 |
|
|
|
1.6 |
|
|
|
2,678 |
|
|
|
0.1 |
|
|
|
70,480 |
|
|
|
1.7 |
|
Selling,
general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
225,148 |
|
|
|
12.2 |
|
|
|
214,196 |
|
|
|
10.1 |
|
|
|
468,132 |
|
|
|
11.6 |
|
|
|
428,010 |
|
|
|
10.0 |
|
Gain
on franchise
disposition
|
|
|
― |
|
|
|
― |
|
|
|
740 |
|
|
|
― |
|
|
|
― |
|
|
|
― |
|
|
|
740 |
|
|
|
― |
|
Interest
expense
|
|
|
1,477 |
|
|
|
0.1 |
|
|
|
950 |
|
|
|
― |
|
|
|
3,535 |
|
|
|
0.1 |
|
|
|
2,966 |
|
|
|
0.1 |
|
Interest
income
|
|
|
354 |
|
|
|
― |
|
|
|
245 |
|
|
|
― |
|
|
|
618 |
|
|
|
― |
|
|
|
623 |
|
|
|
― |
|
Earnings
before income
taxes
|
|
|
22,501 |
|
|
|
1.2 |
|
|
|
107,445 |
|
|
|
5.1 |
|
|
|
70,256 |
|
|
|
1.7 |
|
|
|
213,282 |
|
|
|
5.0 |
|
Provision
for income
taxes
|
|
|
8,495 |
|
|
|
0.5 |
|
|
|
42,450 |
|
|
|
2.0 |
|
|
|
26,692 |
|
|
|
0.7 |
|
|
|
82,932 |
|
|
|
1.9 |
|
Net
earnings
|
|
$ |
14,006 |
|
|
|
0.8 |
|
|
$ |
64,995 |
|
|
|
3.1 |
|
|
$ |
43,564 |
|
|
|
1.1 |
|
|
$ |
130,350 |
|
|
|
3.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
217,600 |
|
|
|
|
|
|
|
215,891 |
|
|
|
|
|
|
|
217,347 |
|
|
|
|
|
|
|
215,592 |
|
|
|
|
|
Diluted
|
|
|
220,944 |
|
|
|
|
|
|
|
220,580 |
|
|
|
|
|
|
|
221,145 |
|
|
|
|
|
|
|
220,355 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.06 |
|
|
|
|
|
|
$ |
0.30 |
|
|
|
|
|
|
$ |
0.20 |
|
|
|
|
|
|
$ |
0.60 |
|
|
|
|
|
Diluted
|
|
$ |
0.06 |
|
|
|
|
|
|
$ |
0.29 |
|
|
|
|
|
|
$ |
0.20 |
|
|
|
|
|
|
$ |
0.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)(1)Percents
are calculated as a percentage of net sales and operating revenues and may
not equal totals due to rounding.
|
|
|
|
See
accompanying notes to consolidated financial statements.
CARMAX, INC. AND
SUBSIDIARIES
Consolidated Balance
Sheets
(Unaudited)
(In
thousands except share data)
|
|
August
31, 2008
|
|
|
February
29, 2008
|
|
ASSETS
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash
equivalents
|
|
$ |
10,917 |
|
|
$ |
12,965 |
|
Accounts
receivable,
net
|
|
|
59,149 |
|
|
|
73,228 |
|
Auto
loan receivables held for
sale
|
|
|
31,037 |
|
|
|
4,984 |
|
Retained
interest in securitized
receivables
|
|
|
311,027 |
|
|
|
270,761 |
|
Inventory
|
|
|
736,131 |
|
|
|
975,777 |
|
Prepaid
expenses and other current
assets
|
|
|
15,050 |
|
|
|
19,210 |
|
|
|
|
|
|
|
|
|
|
Total
current
assets
|
|
|
1,163,311 |
|
|
|
1,356,925 |
|
|
|
|
|
|
|
|
|
|
Property
and equipment,
net
|
|
|
960,524 |
|
|
|
862,497 |
|
Deferred
income
taxes
|
|
|
89,420 |
|
|
|
67,066 |
|
Other
assets
|
|
|
50,897 |
|
|
|
46,673 |
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$ |
2,264,152 |
|
|
$ |
2,333,161 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
228,578 |
|
|
$ |
306,013 |
|
Accrued
expenses and other current
liabilities
|
|
|
62,038 |
|
|
|
58,054 |
|
Accrued
income
taxes
|
|
|
23,380 |
|
|
|
7,569 |
|
Deferred
income
taxes
|
|
|
17,468 |
|
|
|
17,710 |
|
Short-term
debt
|
|
|
12,600 |
|
|
|
21,017 |
|
Current
portion of long-term
debt
|
|
|
48,229 |
|
|
|
79,661 |
|
|
|
|
|
|
|
|
|
|
Total
current
liabilities
|
|
|
392,293 |
|
|
|
490,024 |
|
|
|
|
|
|
|
|
|
|
Long-term
debt, excluding current
portion
|
|
|
176,864 |
|
|
|
227,153 |
|
Deferred
revenue and other
liabilities
|
|
|
134,049 |
|
|
|
127,058 |
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES
|
|
|
703,206 |
|
|
|
844,235 |
|
|
|
|
|
|
|
|
|
|
Commitments
and contingent
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
|
Common
stock, $0.50 par value; 350,000,000 shares authorized; 220,379,416
and 218,616,069 shares issued and outstanding
|
|
|
|
|
|
|
|
|
as
of August 31, 2008, and February 29, 2008, respectively
|
|
|
110,190 |
|
|
|
109,308 |
|
Capital
in excess of par
value
|
|
|
668,959 |
|
|
|
641,766 |
|
Accumulated
other comprehensive
loss
|
|
|
(16,347 |
) |
|
|
(16,728 |
) |
Retained
earnings
|
|
|
798,144 |
|
|
|
754,580 |
|
|
|
|
|
|
|
|
|
|
TOTAL
SHAREHOLDERS’
EQUITY
|
|
|
1,560,946 |
|
|
|
1,488,926 |
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
$ |
2,264,152 |
|
|
$ |
2,333,161 |
|
See
accompanying notes to consolidated financial statements.
|
|
CARMAX, INC. AND
SUBSIDIARIES
Consolidated Statements of
Cash Flows
(Unaudited)
(In
thousands)
|
|
Six
Months Ended August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Operating
Activities:
|
|
|
|
|
|
|
Net
earnings
|
|
$ |
43,564 |
|
|
$ |
130,350 |
|
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and
amortization
|
|
|
27,494 |
|
|
|
22,026 |
|
Share-based
compensation
expense
|
|
|
19,095 |
|
|
|
17,744 |
|
Loss
(gain) on disposition of
assets
|
|
|
1,547 |
|
|
|
(28 |
) |
Deferred
income tax
benefit
|
|
|
(22,777 |
) |
|
|
(1,324 |
) |
Net
decrease (increase) in:
|
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
14,079 |
|
|
|
15,248 |
|
Auto
loan receivables held for sale, net
|
|
|
(26,053 |
) |
|
|
1,698 |
|
Retained
interest in securitized receivables
|
|
|
(40,266 |
) |
|
|
(22,032 |
) |
Inventory
|
|
|
239,646 |
|
|
|
15,945 |
|
Prepaid
expenses and other current assets
|
|
|
4,152 |
|
|
|
(4,925 |
) |
Other
assets
|
|
|
(215 |
) |
|
|
702 |
|
Net
(decrease) increase in:
|
|
|
|
|
|
|
|
|
Accounts
payable, accrued expenses and other current liabilities and accrued income
taxes
|
|
|
(48,356 |
) |
|
|
(26,695 |
) |
Deferred
revenue and other liabilities
|
|
|
6,991 |
|
|
|
24,316 |
|
Net
cash provided by operating
activities
|
|
|
218,901 |
|
|
|
173,025 |
|
|
|
|
|
|
|
|
|
|
Investing
Activities:
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(137,519 |
) |
|
|
(132,092 |
) |
Proceeds
from sales of
assets
|
|
|
1,254 |
|
|
|
1,272 |
|
Purchases
of money market
securities
|
|
|
(4,009 |
) |
|
|
(1,000 |
) |
Purchases
of investments
available-for-sale
|
|
|
– |
|
|
|
(4,000 |
) |
Net
cash used in investing
activities
|
|
|
(140,274 |
) |
|
|
(135,820 |
) |
|
|
|
|
|
|
|
|
|
Financing
Activities:
|
|
|
|
|
|
|
|
|
Decrease
in short-term debt,
net
|
|
|
(8,417 |
) |
|
|
(618 |
) |
Issuances
of long-term
debt
|
|
|
278,200 |
|
|
|
448,600 |
|
Payments
on long-term
debt
|
|
|
(359,921 |
) |
|
|
(510,607 |
) |
Equity
issuances,
net
|
|
|
9,100 |
|
|
|
9,947 |
|
Excess
tax benefits from share-based payment arrangements
|
|
|
363 |
|
|
|
3,607 |
|
Net
cash used in financing
activities
|
|
|
(80,675 |
) |
|
|
(49,071 |
) |
|
|
|
|
|
|
|
|
|
Decrease
in cash and cash
equivalents
|
|
|
(2,048 |
) |
|
|
(11,866 |
) |
Cash
and cash equivalents at beginning of
period
|
|
|
12,965 |
|
|
|
19,455 |
|
Cash
and cash equivalents at end of
period
|
|
$ |
10,917 |
|
|
$ |
7,589 |
|
See
accompanying notes to consolidated financial statements.
|
|
CARMAX, INC. AND
SUBSIDIARIES
Notes to Consolidated
Financial Statements
(Unaudited)
CarMax,
Inc. (“we”, “our”, “us”, “CarMax” and “the company”), including its
wholly owned subsidiaries, is the largest retailer of used vehicles in the
United States. We were the first used vehicle retailer to offer a
large selection of high quality used vehicles at competitively low, no-haggle
prices using a customer-friendly sales process in an attractive, modern sales
facility. We also sell new vehicles under various franchise
agreements at select locations. We provide customers with a full
range of related products and services, including the financing of vehicle
purchases through our own finance operation, CarMax Auto Finance (“CAF”), and
third-party lenders; the sale of extended service plans and accessories; the
appraisal and purchase of vehicles directly from consumers; and vehicle repair
service. Vehicles purchased through the appraisal process that do not
meet our retail standards are sold to licensed dealers through on-site wholesale
auctions.
Basis of Presentation and Use of
Estimates. The accompanying interim unaudited consolidated
financial statements include the accounts
of CarMax and our wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation. The preparation of financial statements in conformity
with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and the disclosure of contingent assets and
liabilities. Actual results could differ from those
estimates. Amounts and percentages in tables may not total due to
rounding. Certain previously reported amounts have been reclassified
to conform to the current period presentation.
These
consolidated financial statements have been prepared in conformity 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 our Annual Report on Form 10-K for the fiscal year ended
February 29, 2008.
Cash and Cash
Equivalents. Cash equivalents of $0.1 million as of August 31,
2008, and $2.0 million as of February 29, 2008, consisted of highly liquid
investments with original maturities of three months or less.
3.
|
CarMax Auto Finance
(Loss) Income
|
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Gain
on sales of loans originated and sold (1)
|
|
$ |
9.4 |
|
|
$ |
24.7 |
|
|
$ |
23.6 |
|
|
$ |
52.0 |
|
Other
(losses) gains (1)
|
|
|
(28.2 |
) |
|
|
0.3 |
|
|
|
(45.2 |
) |
|
|
0.7 |
|
Total
(loss)
gain
|
|
|
(18.8 |
) |
|
|
25.0 |
|
|
|
(21.6 |
) |
|
|
52.8 |
|
Other
CAF income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing
fee
income
|
|
|
10.4 |
|
|
|
9.2 |
|
|
|
20.6 |
|
|
|
18.1 |
|
Interest
income
|
|
|
11.2 |
|
|
|
7.8 |
|
|
|
22.2 |
|
|
|
15.6 |
|
Total
other CAF
income
|
|
|
21.6 |
|
|
|
17.0 |
|
|
|
42.9 |
|
|
|
33.7 |
|
Direct
CAF expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAF
payroll and fringe benefit expense
|
|
|
4.7 |
|
|
|
3.8 |
|
|
|
9.2 |
|
|
|
7.4 |
|
Other
direct CAF expenses
|
|
|
5.2 |
|
|
|
4.7 |
|
|
|
9.4 |
|
|
|
8.5 |
|
Total
direct CAF expenses
|
|
|
10.0 |
|
|
|
8.5 |
|
|
|
18.6 |
|
|
|
16.0 |
|
CarMax
Auto Finance (loss) income
|
|
$ |
(7.1 |
) |
|
$ |
33.4 |
|
|
$ |
2.7 |
|
|
$ |
70.5 |
|
(1)To
the extent we recognize valuation or other adjustments related to loans
originated in previous quarters of the same fiscal year, the sum of
amounts reported for the individual quarters may not equal the
year-to-date total.
|
|
CAF
provides financing for qualified customers at competitive market rates of
interest. Throughout each month, we sell substantially all of the
loans originated by CAF in securitization transactions as discussed in Note
4. The majority of CAF income is typically 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, losses and
funding costs.
The gain
on sales of loans originated and sold includes both the gain income recorded at
the time of securitization and the effect of any subsequent changes in valuation
assumptions or funding costs that are incurred in the same fiscal period that
the loans were originated. Other losses or gains include the effects
of changes in valuation assumptions or funding costs related to loans originated
and sold during previous fiscal periods. In addition, other losses or
gains could include the effects of new securitizations, changes in the valuation
of retained subordinated bonds and the resale of receivables in existing
securitizations, as applicable.
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 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.
We use a
securitization program to fund substantially all of the auto loan receivables
originated by CAF. We sell the auto 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 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 return requirements of
investors in asset-backed commercial paper may fluctuate significantly depending
on market conditions. In addition, the warehouse facility renews on
an annual basis. At renewal both the cost and structure of the
facility could change. These changes could have a significant impact
on our funding costs.
We
routinely use term securitizations to refinance the receivables previously
securitized through the warehouse facility. In these transactions, a
pool of auto 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 transaction structure and market
conditions, refinancing receivables in a term securitization could have a
significant impact on our results of operations. The impact of
refinancing activity will depend upon the securitization structure and market
conditions at the refinancing date.
The
special purpose entity and investors have no recourse to our
assets. Our risk is limited to the retained interest. All
transfers of receivables are accounted for as sales. When the
receivables are securitized, we recognize a gain or loss on the sale of the
receivables as described in Note 3.
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
loans
originated
|
|
$ |
547.9 |
|
|
$ |
620.9 |
|
|
$ |
1,179.5 |
|
|
$ |
1,263.2 |
|
Total
loans
sold
|
|
$ |
575.3 |
|
|
$ |
668.5 |
|
|
$ |
1,201.8 |
|
|
$ |
1,315.5 |
|
Total
(loss)
gain
|
|
$ |
(18.8 |
) |
|
$ |
25.0 |
|
|
$ |
(21.6 |
) |
|
$ |
52.8 |
|
Total
(loss) gain as a percentage of total loans sold
|
|
|
(3.3 |
)% |
|
|
3.7 |
% |
|
|
(1.8 |
)% |
|
|
4.0 |
% |
Retained
Interest. We retain an interest in the auto loan receivables
that we securitize. 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, required excess
receivables and retained subordinated bonds, as described below. As
of August 31, 2008, on a combined basis, the reserve accounts and required
excess receivables were 3% of managed receivables. The interest-only
strip receivables, reserve accounts and required excess receivables serve as a
credit enhancement for the benefit of the investors in the securitized
receivables.
The fair
value of the retained interest was $311.0 million as of August 31, 2008, and
$270.8 million as of February 29, 2008. Additional information on
fair value measurements is included in Note 6. The receivables
underlying the retained interest had a weighted average life of 1.5 years as of
August 31, 2008, and February 29, 2008. 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 we expect
to receive over the life of the securitized receivables. The value of
these receivables is determined by estimating the future cash flows using our
assumptions of key factors, such as finance charge income, loss rates,
prepayment rates, funding costs 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. We evaluate 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. We are 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 our 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 term 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 $41.0 million as of August 31, 2008, and $37.0 million as
of February 29, 2008.
Required excess
receivables. The total value of the securitized receivables
must exceed the principal amount owed to the investors by a specified
amount. 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 $93.6 million as of August 31, 2008, and $63.0 million as of
February 29, 2008.
Retained subordinated
bonds. In
fiscal 2009 and 2008, we retained subordinated bonds issued by securitization
trusts. We receive interest payments on the bonds. The
bonds are carried at fair value and changes in fair value are included in
earnings as a component of CAF income. We base our valuation on
observable market prices of the same or similar instruments when available;
however, observable market prices are not currently available for these assets
due to illiquidity in the credit markets. Our current valuations are
primarily based on an average of three non-binding, current market spread quotes
from third party investment banks. By applying these average spreads to current
bond benchmarks, as determined through the use of a widely accepted third-party
bond pricing model, we have measured a current fair value. The value
of retained subordinated bonds was $105.9 million as of August 31, 2008, and
$43.1 million as of February 29, 2008.
Key Assumptions Used in Measuring the
Fair Value of the Retained Interest and Sensitivity
Analysis. The following table shows the key economic
assumptions used in measuring the fair value of the retained interest as of
August 31, 2008, and a sensitivity analysis showing the hypothetical effect on
the retained interest if there were unfavorable variations from the assumptions
used. These sensitivity analyses 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
|
|
|
1.37%
- 1.50 |
% |
|
$ |
7.3 |
|
|
$ |
14.0
|
|
Cumulative
loss
rate
|
|
|
1.30%
- 3.50 |
% |
|
$ |
9.8 |
|
|
$ |
19.4
|
|
Annual
discount
rate
|
|
|
19.00 |
% |
|
$ |
4.7 |
|
|
$ |
9.3
|
|
Warehouse
facility costs (1)
|
|
|
2.05 |
% |
|
$ |
2.0 |
|
|
$ |
3.9
|
|
(1)Expressed
as a spread above appropriate benchmark rates. Applies only to
retained interest in receivables securitized through the warehouse
facility. As of
August
31, 2008, there were $600.0 million receivables in the warehouse
facility.
|
|
Prepayment
rate. We use 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 loss
rate. The cumulative loss 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.
Annual discount
rate. The discount rate is the interest rate used for
computing the present value of future cash flows and is determined based on the
perceived market risk of the underlying auto loan receivables and current market
conditions.
Warehouse facility
costs. While receivables are securitized in the warehouse
facility, our retained interest is exposed to changes in credit spreads and
other variable funding costs. The warehouse facility costs are
expressed as a spread above appropriate benchmark rates.
Continuing Involvement with
Securitized Receivables. We continue to manage the auto loan
receivables that we securitize. We receive servicing fees of
approximately 1% of the outstanding principal balance of the securitized
receivables. We believe that the servicing fees specified in the
securitization agreements adequately compensate us for servicing the securitized
receivables. No servicing asset or liability has been
recorded. We are 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 August 31
|
|
|
As
of February 29 or 28
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Accounts
31+ days past
due
|
|
$ |
117.7 |
|
|
$ |
75.7 |
|
|
$ |
86.1 |
|
|
$ |
56.9 |
|
Ending
managed
receivables
|
|
$ |
4,061.4 |
|
|
$ |
3,596.0 |
|
|
$ |
3,838.5 |
|
|
$ |
3,311.0 |
|
Past
due accounts as a percentage of ending managed receivables
|
|
|
2.90 |
% |
|
|
2.10 |
% |
|
|
2.24 |
% |
|
|
1.72 |
% |
CREDIT
LOSS INFORMATION
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
credit losses on managed receivables
|
|
$ |
16.7 |
|
|
$ |
9.2 |
|
|
$ |
27.0 |
|
|
$ |
14.7 |
|
Average
managed
receivables
|
|
$ |
4,039.9 |
|
|
$ |
3,550.6 |
|
|
$ |
3,990.4 |
|
|
$ |
3,481.0 |
|
Annualized
net credit losses as a percentage of average managed
receivables
|
|
|
1.65 |
% |
|
|
1.04 |
% |
|
|
1.35 |
% |
|
|
0.85 |
% |
Recovery
rate
|
|
|
43.8 |
% |
|
|
51.4 |
% |
|
|
45.4 |
% |
|
|
52.1 |
% |
SELECTED
CASH FLOWS FROM SECURITIZED RECEIVABLES
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Proceeds
from new securitizations
|
|
$ |
477.8 |
|
|
$ |
542.5 |
|
|
$ |
1,007.8 |
|
|
$ |
1,031.5 |
|
Proceeds
from collections
|
|
$ |
211.7 |
|
|
$ |
289.5 |
|
|
$ |
488.2 |
|
|
$ |
593.1 |
|
Servicing
fees received
|
|
$ |
10.4 |
|
|
$ |
9.1 |
|
|
$ |
20.4 |
|
|
$ |
17.8 |
|
Other
cash flows received from the retained interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-only
strip receivables
|
|
$ |
25.2 |
|
|
$ |
25.7 |
|
|
$ |
56.4 |
|
|
$ |
47.5 |
|
Reserve
account releases
|
|
$ |
2.9 |
|
|
$ |
5.5 |
|
|
$ |
3.1 |
|
|
$ |
5.8 |
|
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 term securitizations that were refinanced through the
warehouse facility totaled $48.4 million in the second quarter and first half of
fiscal 2009 and $50.7 million in the second quarter and first half of fiscal
2008. Proceeds received when we refinance receivables from the
warehouse facility are excluded from this table as they are not considered new
securitizations.
Proceeds from
collections. Proceeds from collections 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
us to service the securitized receivables.
Other cash flows received
from the retained interest. Other cash flows received from the
retained interest represents cash that we receive from the securitized
receivables other than servicing fees. It includes cash collected on
interest-only strip receivables and amounts released to us from reserve
accounts.
Financial Covenants and Performance
Triggers. The securitization agreement related to the
warehouse facility includes various financial covenants and performance
triggers. This agreement requires us to meet financial covenants
related to a maximum total liabilities to tangible net worth ratio and a minimum
fixed charge coverage ratio. Performance triggers require that the
pool of securitized receivables in the warehouse facility achieve specified
thresholds related to portfolio yield, loss rate and delinquency
rate. If these financial covenants and/or thresholds are not met, we
could be unable to continue to securitize receivables through the warehouse
facility. In addition, the warehouse facility investors could have us
replaced as servicer and charge us a higher rate of
interest. Further, we could be forced to deposit collections on the
securitized receivables with the warehouse agent on a daily basis, deliver
executed lockbox agreements to the warehouse facility agent and obtain a
replacement counterparty for the interest rate cap agreement related to the
warehouse facility. As of August 31, 2008, we were in
compliance with the financial covenants and the securitized receivables were in
compliance with the performance triggers.
We
utilize interest rate swaps relating to our auto loan receivable securitizations
and our investment in retained subordinated bonds. Swaps are used to
better match funding costs to the interest on the fixed-rate receivables being
securitized and the retained subordinated bonds and to minimize the funding
costs related to certain of our securitizations trusts. During
the second quarter of fiscal 2009, we entered into 25 interest rate swaps with
initial notional amounts totaling $548.0 million and terms ranging from 17 to 45
months. The notional amount of outstanding swaps was $719.4
million as of August 31, 2008, and $898.7 million as of
February 29, 2008. The fair value of swaps included in
accounts payable totaled a net liability of $3.0 million as of
August 31, 2008, and $15.1 million as of
February 29, 2008. Additional information on fair value
measurements is included in Note 6.
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. We do
not anticipate significant market risk from swaps as they are predominantly used
to match funding costs to the use of the funding. However,
disruptions in the credit markets could impact the effectiveness of our hedging
strategies. Credit risk is the exposure to nonperformance of another
party to an agreement. We mitigate credit risk by dealing with highly
rated bank counterparties.
6.
|
Fair Value
Measurements
|
We
adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair
Value Measurements” ("SFAS 157"), on March
1, 2008. SFAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value
measurements. SFAS 157 defines “fair value” as the price that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the principal market, or if none
exists, the most advantageous market, for the specific asset or liability at the
measurement date (referred to as the “exit price”). The fair value
should be based on assumptions that market participants would use, including a
consideration of nonperformance risk.
We assess
the inputs used to measure fair value using the three-tier hierarchy in
accordance with SFAS 157 and as disclosed in the tables below. The
hierarchy indicates the extent to which inputs used in measuring fair value are
observable in the market.
|
Level 1
|
Inputs
include unadjusted quoted prices in active markets for identical assets or
liabilities that we can access at the measurement
date.
|
|
Level 2
|
Inputs
other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly, including quoted
prices for similar assets in active markets and observable inputs such as
interest rates and yield curves.
|
|
Level 3
|
Inputs
that are significant to the measurement that are not observable in the
market and include management's judgments about the assumptions market
participants would use in pricing the asset or liability (including
assumptions about
risk).
|
Our fair
value processes include controls that are designed to ensure that fair values
are appropriate. Such controls include model validation, review of
key model inputs, analysis of period-over-period fluctuations and reviews by
senior management.
VALUATION
METHODOLOGIES
Money market
securities. Money market securities
are cash equivalents, which are included in either cash and cash equivalents or
other assets, and consist of highly liquid investments with original maturities
of three months or less. We use quoted market prices for identical
assets to measure fair value. Therefore, all money market securities
are classified as Level 1.
Retained interest in
securitized receivables. We retain an interest in the auto
loan receivables that we securitize, including interest-only strip receivables,
various reserve accounts, required excess receivables and retained subordinated
bonds. Excluding the retained subordinated bonds, we estimate the
fair value of the retained interest using internal valuation models. These
models include a combination of market inputs and our own assumptions as
described in Note 4. As the valuation models include significant
unobservable inputs, we classified the retained interest as Level
3.
For the
retained subordinated bonds, we base our valuation on observable market prices
for similar assets when available. Otherwise, our valuations are
based on input from independent third parties and internal valuation models, as
described in Note 4. As the key assumption is currently based on
unobservable inputs, we classified the retained subordinated bonds as Level
3.
Financial
derivatives. Financial derivatives are included in either
prepaid expenses and other current assets or accounts payable. As part of our
risk management strategy, we utilize interest rate swaps relating to our auto
loan receivable securitizations and our investment in retained subordinated
bonds. Swaps are used to better match funding costs to the interest
on the fixed-rate receivables being securitized and the retained subordinated
bonds and to minimize the funding costs related to certain of our securitization
trusts. Our derivatives are not exchange-traded and are
over-the-counter customized derivative instruments. All of our
derivative exposures are with highly rated bank counterparties.
We
measure derivative fair values assuming that the unit of account is an
individual derivative instrument and that derivatives are sold or transferred on
a stand-alone basis. We estimate the fair value of our derivatives
using quotes determined by the swap counterparties. We validate these
quotes using our own internal model. Both our internal model and
quotes received from bank counterparties project future cash flows and discount
the future amounts to a present value using market-based expectations for
interest rates and the contractual terms of the derivative instruments.
Because
model inputs can typically be observed in the liquid market and the models do
not require significant judgment, these derivatives are classified as Level
2.
Our
derivative fair value measurements consider assumptions about counterparty and
our own nonperformance risk. We monitor counterparty and our own
nonperformance risk and, in the event that we determine that a party is unlikely
to perform under terms of the contract, we would adjust the derivative fair
value to reflect the nonperformance risk.
ITEMS
MEASURED AT FAIR VALUE ON A RECURRING BASIS
|
|
As
of August 31, 2008
|
|
(In
millions)
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
Money
market securities
|
|
$ |
28.6 |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
28.6 |
|
Retained
interest in securitized
receivables
|
|
|
– |
|
|
|
– |
|
|
|
311.0 |
|
|
|
311.0 |
|
Total
assets at fair value
|
|
$ |
28.6 |
|
|
$ |
– |
|
|
$ |
311.0 |
|
|
$ |
339.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent
of total assets at fair value
|
|
|
8.4 |
% |
|
|
– |
% |
|
|
91.6 |
% |
|
|
100.0 |
% |
Percent
of total assets
|
|
|
1.3 |
% |
|
|
– |
% |
|
|
13.7 |
% |
|
|
15.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
derivatives
|
|
$ |
– |
|
|
$ |
3.0 |
|
|
$ |
– |
|
|
$ |
3.0 |
|
Total
liabilities at fair value
|
|
$ |
– |
|
|
$ |
3.0 |
|
|
$ |
– |
|
|
$ |
3.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent
of total liabilities
|
|
|
– |
% |
|
|
0.4 |
% |
|
|
– |
% |
|
|
0.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CHANGES
IN THE LEVEL 3 ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS
(In
millions)
|
|
Retained
interest in securitized receivables
|
|
Balance
as of March 1, 2008
|
|
$ |
270.8 |
|
Total
realized/unrealized losses
|
|
|
(37.1 |
) |
Purchases,
sales, issuances and settlements
|
|
|
77.3 |
|
Balance
as of August 31, 2008
|
|
$ |
311.0 |
|
|
|
|
|
|
Change
in unrealized losses on assets still held (1)
|
|
$ |
(24.2 |
) |
(1) Reported
in CarMax Auto Finance income on the consolidated statements of
earnings.
|
|
We had
$25.4 million of gross unrecognized tax benefits as of
August 31, 2008, and $32.7 million as of
February 29, 2008. During the first and second quarters of
fiscal 2009, we settled federal and state liabilities of $7.7 million related to
the Internal Revenue Service audit of fiscal years 2003 and
2004. There were no other significant changes to the unrecognized tax
benefits as reported for the year ended February 29, 2008, during the second
quarter, as all other activity was related to positions taken on tax returns
filed or intended to be filed in the current fiscal year.
We have a
noncontributory defined benefit pension plan (the “pension plan”) covering the
majority of full-time employees. We also have an unfunded
nonqualified plan (the “restoration plan”) that restores retirement benefits for
certain senior executives who are affected by Internal Revenue Code limitations
on benefits provided under the pension plan. We use a fiscal year end
measurement date for both the pension plan and the restoration
plan.
COMPONENTS
OF NET PENSION EXPENSE
|
|
Three
Months Ended August 31
|
|
|
|
Pension
Plan
|
|
|
Restoration
Plan
|
|
|
Total
|
|
(In
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Service
cost
|
|
$ |
3,231 |
|
|
$ |
4,173 |
|
|
$ |
214 |
|
|
$ |
201 |
|
|
$ |
3,445 |
|
|
$ |
4,374 |
|
Interest
cost
|
|
|
1,764 |
|
|
|
1,639 |
|
|
|
208 |
|
|
|
101 |
|
|
|
1,972 |
|
|
|
1,740 |
|
Expected
return on plan assets
|
|
|
(1,515 |
) |
|
|
(1,108 |
) |
|
|
– |
|
|
|
– |
|
|
|
(1,515 |
) |
|
|
(1,108 |
) |
Amortization
of prior service cost
|
|
|
9 |
|
|
|
9 |
|
|
|
30 |
|
|
|
6 |
|
|
|
39 |
|
|
|
15 |
|
Recognized
actuarial loss
|
|
|
159 |
|
|
|
964 |
|
|
|
99 |
|
|
|
46 |
|
|
|
258 |
|
|
|
1,010 |
|
Net
pension expense
|
|
$ |
3,648 |
|
|
$ |
5,677 |
|
|
$ |
551 |
|
|
$ |
354 |
|
|
$ |
4,199 |
|
|
$ |
6,031 |
|
|
|
Six
Months Ended August 31
|
|
|
|
Pension
Plan
|
|
|
Restoration
Plan
|
|
|
Total
|
|
(In
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Service
cost
|
|
$ |
6,884 |
|
|
$ |
7,836 |
|
|
$ |
428 |
|
|
$ |
294 |
|
|
$ |
7,312 |
|
|
$ |
8,130 |
|
Interest
cost
|
|
|
3,530 |
|
|
|
2,998 |
|
|
|
416 |
|
|
|
204 |
|
|
|
3,946 |
|
|
|
3,202 |
|
Expected
return on plan assets
|
|
|
(2,690 |
) |
|
|
(1,998 |
) |
|
|
– |
|
|
|
– |
|
|
|
(2,690 |
) |
|
|
(1,998 |
) |
Amortization
of prior service cost
|
|
|
18 |
|
|
|
18 |
|
|
|
60 |
|
|
|
12 |
|
|
|
78 |
|
|
|
30 |
|
Recognized
actuarial loss
|
|
|
288 |
|
|
|
1,486 |
|
|
|
198 |
|
|
|
92 |
|
|
|
486 |
|
|
|
1,578 |
|
Net
pension expense
|
|
$ |
8,030 |
|
|
$ |
10,340 |
|
|
$ |
1,102 |
|
|
$ |
602 |
|
|
$ |
9,132 |
|
|
$ |
10,942 |
|
We made
contributions to the pension plan totaling $2.8 million during the second
quarter of fiscal 2009. We will contribute $15.6 million to the
pension plan in fiscal 2009.
Effective
December 31, 2008, we will freeze the pension plan and the restoration plan, and
no additional benefits will accrue under these plans after that date. On January
1, 2009, we will implement significant enhancements to our 401(k) plan,
including both an increased matching component and a company-funded
contribution made regardless of associate participation. We will also
establish a new non-qualified retirement plan for certain senior executives who
are affected by Internal Revenue Code limitations on benefits provided under the
401(k) plan.
During
the second quarter of fiscal 2009, we increased the aggregate borrowing limit
under our revolving credit facility by $200 million to a total of $700 million.
The credit facility expires in December 2011 and is secured by vehicle
inventory. Borrowings under this credit facility are subject to
limitation based on a specified percentage of qualifying inventory, and they are
available for working capital and general corporate purposes. As of
August 31, 2008, $210.3 million was outstanding under the credit facility and
$359.5 million of the remaining borrowing limit was available to
us. The outstanding balance included $12.6 million classified as
short-term debt, $47.7 million classified as current portion of long-term debt
and $150.0 million classified as long-term debt. We classified $47.7
million of the outstanding balance as of August 31, 2008, as current
portion of long-term debt based on our expectation that this balance will not
remain outstanding for more than one year.
Obligations
under capital leases as of August 31, 2008, consisted of $0.5 million
classified as current portion of long-term debt and $26.9 million classified as
long-term debt.
10.
|
Share-Based
Compensation
|
We
maintain long-term incentive plans for management, key employees and the
non-employee members of our 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. To date, we have
awarded no incentive stock options.
Stock
options are awards that allow the recipient to purchase shares of our stock at a
fixed price. Stock options are granted at an exercise price equal to
the volume-weighted average fair market value of our stock on the grant
date. Substantially all of the stock options vest annually in equal
amounts over periods of three to four years. These options expire no
later than ten years after the date of the grant. Restricted stock
awards are subject to specified restrictions and a risk of
forfeiture. The restrictions typically lapse three years from the
grant date.
COMPOSITION
OF SHARE-BASED COMPENSATION EXPENSE
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Cost
of sales
|
|
$ |
528 |
|
|
$ |
467 |
|
|
$ |
1,003 |
|
|
$ |
924 |
|
CarMax
Auto Finance income
|
|
|
271 |
|
|
|
296 |
|
|
|
429 |
|
|
|
597 |
|
Selling,
general and administrative expenses
|
|
|
8,979 |
|
|
|
7,960 |
|
|
|
18,267 |
|
|
|
16,876 |
|
Share-based
compensation expense, before income taxes
|
|
$ |
9,778 |
|
|
$ |
8,723 |
|
|
$ |
19,699 |
|
|
$ |
18,397 |
|
We
measure share-based compensation expense at the grant date, based on the
estimated fair value of the award and the number of awards expected to
vest. We recognize compensation expense for stock options and
restricted stock on a straight-line basis (net of estimated forfeitures) over
the requisite service period, which is generally the vesting period of the
award. Our employee stock purchase plan is considered a
liability-classified compensatory plan; the associated costs of $0.6 million in
the first half of fiscal 2009 and $0.7 million in the first half of 2008 are
included in share-based compensation expense. There were no
capitalized share-based compensation costs as of August 31, 2008 and
2007.
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, 2008
|
|
|
13,648 |
|
|
$ |
14.55 |
|
|
|
|
|
|
|
Options
granted
|
|
|
2,220 |
|
|
$ |
19.56 |
|
|
|
|
|
|
|
Options
exercised
|
|
|
(709 |
) |
|
$ |
12.84 |
|
|
|
|
|
|
|
Options
forfeited or expired
|
|
|
(83 |
) |
|
$ |
17.41 |
|
|
|
|
|
|
|
Outstanding
as of August 31, 2008
|
|
|
15,076 |
|
|
$ |
15.36 |
|
|
|
5.4 |
|
|
$ |
23,926 |
|
Exercisable
as of August 31, 2008
|
|
|
9,625 |
|
|
$ |
13.13 |
|
|
|
5.0 |
|
|
$ |
22,402 |
|
For the
six months ended August 31, 2008 and 2007, we granted nonqualified options to
purchase 2,219,857 and 1,775,253 shares of common stock,
respectively. The total cash received as a result of stock option
exercises was $9.1 million in the first half of fiscal 2009 and $9.9 million in
the first half of fiscal 2008. We settle stock option exercises with
authorized but unissued shares of CarMax common stock. The total
intrinsic value of options exercised was $5.3 million for the first six months
of fiscal 2009 and $15.2 million for the first six months of fiscal
2008. We realized related tax benefits of $2.1 million in the first
half of fiscal 2009 and $5.6 million in the first half of fiscal
2008.
OUTSTANDING
STOCK OPTIONS
As
of August 31, 2008
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6.62
to $9.30 |
|
|
|
2,229 |
|
|
|
4.5 |
|
|
$ |
7.16 |
|
|
|
2,229 |
|
|
$ |
7.16 |
|
$ |
10.74
to $13.42 |
|
|
|
4,290 |
|
|
|
5.4 |
|
|
$ |
13.20 |
|
|
|
3,321 |
|
|
$ |
13.20 |
|
$ |
14.13
to $15.72 |
|
|
|
2,872 |
|
|
|
5.6 |
|
|
$ |
14.71 |
|
|
|
2,754 |
|
|
$ |
14.70 |
|
$ |
16.33
to $22.29 |
|
|
|
3,994 |
|
|
|
5.7 |
|
|
$ |
18.61 |
|
|
|
888 |
|
|
$ |
17.13 |
|
$ |
24.99
to $25.79 |
|
|
|
1,691 |
|
|
|
5.6 |
|
|
$ |
25.04 |
|
|
|
433 |
|
|
$ |
25.06 |
|
Total
|
|
|
|
15,076 |
|
|
|
5.4 |
|
|
$ |
15.36 |
|
|
|
9,625 |
|
|
$ |
13.13 |
|
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, such as 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 this reason, we believe 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 prior to fiscal 2009, we
used the Black-Scholes model to estimate the fair value of stock option
awards. Beginning in fiscal 2009, we used the binomial
model. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by the recipients of share-based
awards.
The
weighted average fair values at the date of grant for options granted during the
six month periods ended August 31, 2008 and 2007, was $7.16 and $8.58 per share,
respectively. The unrecognized compensation costs related to
nonvested options totaled $26.7 million as of
August 31, 2008. These costs are expected to be recognized
over a weighted average period of 2.4 years.
ASSUMPTIONS
USED TO ESTIMATE OPTION VALUES
|
|
Six
Months Ended August 31
|
|
|
|
2008
|
|
|
2007
|
|
Dividend
yield
|
|
|
0.0 |
% |
|
|
0.0 |
% |
Expected
volatility factor (1)
|
|
|
34.8%
- 60.9 |
% |
|
|
28.0%
- 54.0 |
% |
Weighted
average expected volatility
|
|
|
44.1 |
% |
|
|
38.8 |
% |
Risk-free
interest rate (2)
|
|
|
1.5%
- 3.7 |
% |
|
|
4.6%
- 5.0 |
% |
Expected
term (in years) (3)
|
|
|
4.8
– 5.2 |
|
|
|
4.2
- 4.4 |
|
(1)Measured
using historical daily price changes of our stock for a period
corresponding to the term of the option and the implied volatility derived
from the market prices of traded options on our stock.
(2)Based
on the U.S. Treasury yield curve in effect at the time of
grant.
(3)Represents
the estimated number of years 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, 2008
|
|
|
1,721 |
|
|
$ |
21.04 |
|
Restricted
stock granted
|
|
|
1,079 |
|
|
$ |
19.82 |
|
Restricted
stock vested or cancelled
|
|
|
(65 |
) |
|
$ |
21.04 |
|
Outstanding
as of August 31, 2008
|
|
|
2,735 |
|
|
$ |
20.56 |
|
For the
six months ended August 31, 2008 and 2007, we granted 1,078,580 and 903,815
shares of restricted stock, respectively. The fair value of a
restricted stock award is determined and fixed based on the volume-weighted
average fair market value of our stock on the grant date. The
unrecognized compensation costs related to nonvested restricted stock awards
totaled $28.2 million as of August 31, 2008. These costs
are expected to be recognized over a weighted average period of 1.7
years.
11.
|
Net Earnings per
Share
|
BASIC
AND DILUTIVE NET EARNINGS PER SHARE RECONCILIATIONS
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
(In thousands except per share
data)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
earnings available to common shareholders
|
|
$ |
14,006 |
|
|
$ |
64,995 |
|
|
$ |
43,564 |
|
|
$ |
130,350 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
217,600 |
|
|
|
215,891 |
|
|
|
217,347 |
|
|
|
215,592 |
|
Dilutive
potential common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
2,356 |
|
|
|
4,161 |
|
|
|
2,873 |
|
|
|
4,288 |
|
Restricted
stock
|
|
|
988 |
|
|
|
529 |
|
|
|
925 |
|
|
|
475 |
|
Weighted
average common shares and dilutive potential common shares
|
|
|
220,944 |
|
|
|
220,580 |
|
|
|
221,145 |
|
|
|
220,355 |
|
Basic
net earnings per share
|
|
$ |
0.06 |
|
|
$ |
0.30 |
|
|
$ |
0.20 |
|
|
$ |
0.60 |
|
Diluted
net earnings per share
|
|
$ |
0.06 |
|
|
$ |
0.29 |
|
|
$ |
0.20 |
|
|
$ |
0.59 |
|
As of
August 31, 2008, options to purchase 5,819,022 shares of common stock
were outstanding and not included in the calculation of diluted net earnings per
share because their inclusion would be antidilutive. As of August
31, 2007, options to purchase 1,740,453 shares of common stock were
outstanding and not included in the calculation.
12.
|
Accumulated Other
Comprehensive Loss
|
(In
thousands, net of income taxes)
|
|
Unrecognized
Actuarial Losses
|
|
|
Unrecognized
Prior Service Cost
|
|
|
Total
Accumulated Other Comprehensive Loss
|
|
Balance
as of February 29, 2008
|
|
$ |
15,926 |
|
|
$ |
802 |
|
|
$ |
16,728 |
|
Amortization
expense
|
|
|
(328 |
) |
|
|
(53 |
) |
|
|
(381 |
) |
Balance
as of August 31, 2008
|
|
$ |
15,598 |
|
|
$ |
749 |
|
|
$ |
16,347 |
|
The
cumulative balances are net of deferred tax of $9.6 million as of August 31,
2008, and $9.8 million as of February 29, 2008.
13.
|
Contingent
Liabilities
|
On June
12, 2007, Ms. Regina Hankins filed a putative class action lawsuit against
CarMax, Inc., in Baltimore County Circuit Court, Maryland. We operate
five stores in the state of Maryland. The plaintiff alleges that,
since May 25, 2004, CarMax has not properly disclosed its vehicles’ prior rental
history, if any. The plaintiff seeks compensatory damages, punitive
damages, injunctive relief and the recovery of attorneys’ fees. We
have settled this matter, pending judicial approval.
We are
involved in various other legal proceedings in the normal course of
business. Based upon our evaluation of information currently available, we
believe that the ultimate resolution of any such proceedings will not have a
material adverse effect, either individually or in the aggregate, on our
financial condition or results of operations.
14.
|
Recent Accounting
Pronouncements
|
SFAS No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities –
Including an amendment of FASB Statement No. 115” (“SFAS 159”) was effective for
our fiscal year beginning March 1, 2008. SFAS 159 permits
entities to measure certain financial assets and liabilities at fair
value. The fair value option may be elected on an
instrument-by-instrument basis and is irrevocable. Unrealized gains
and losses on items for which the fair value option has been elected are
recognized in earnings at each subsequent reporting date. We did not
elect to apply the fair value option to any of our financial assets or
liabilities not already within the scope of SFAS 157.
In
December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 141(R), “Business Combinations (revised 2007)” (“SFAS
141(R)”). SFAS 141(R) replaces SFAS No. 141, “Business
Combinations” (“SFAS 141”), but retains the requirement that the purchase method
of accounting for acquisitions be used for all business
combinations. SFAS 141(R) expands on the disclosures previously
required by SFAS 141, better defines the acquirer and the acquisition date in a
business combination and establishes principles for recognizing and measuring
the assets acquired (including goodwill), the liabilities assumed and any
noncontrolling interests in the acquired business. SFAS 141(R) also
requires an acquirer to record an adjustment to income tax expense for changes
in valuation allowances or uncertain tax positions related to acquired
businesses. SFAS 141(R) is effective for all business combinations
with an acquisition date in the first annual period following December 15,
2008; early adoption is not permitted. We will apply the provisions
of SFAS 141(R) when applicable.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS
160”). SFAS 160 requires that noncontrolling (or minority) interests
in subsidiaries be reported in the equity section of our balance sheet, rather
than in a mezzanine section of the balance sheet between liabilities and
equity. SFAS 160 also changes the manner in which the net income of
the subsidiary is reported and disclosed in the controlling company's income
statement. SFAS 160 also establishes guidelines for accounting for
changes in ownership percentages and for deconsolidation. SFAS 160 is
effective for financial statements for fiscal years beginning on or after
December 1, 2008, and interim periods within those years. As of
August 31, 2008, we did not hold any noncontrolling interests in
subsidiaries.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”),
which expands the disclosure requirements about an entity’s derivative
instruments and hedging activities. SFAS 161 requires that objectives
for using derivative instruments and related hedged activities be disclosed in
terms of the underlying risk that the entity is intending to manage and in terms
of accounting designation. The fair values of derivative instruments
and related hedged activities and their gains are to be disclosed in tabular
format showing both the derivative positions existing at period end and the
effect of using derivatives during the reporting period. Any
credit-risk-related contingent features are to be disclosed and are to include
information on the potential effect on an entity’s liquidity from
using
derivatives. Finally,
SFAS 161 requires cross-referencing within the notes to enable users of
financial statements to better locate information about derivative
instruments. These expanded disclosure requirements are required for
every annual and interim reporting period for which a balance sheet and
statement of earnings are presented. SFAS 161 is effective for any
reporting period (annual or quarterly interim) beginning after November 15,
2008, with early application encouraged. We will be adopting SFAS 161
effective as of the start of the fourth quarter of fiscal 2009.
In April
2008, the FASB issued FASB Staff Position Financial Accounting Standard 142-3,
“Determination of the Useful Life of Intangible Assets” (“FSP FAS
142-3”). FSP FAS 142-3 amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under SFAS No. 142, “Goodwill and Other
Intangible Assets” (“SFAS 142”). In developing assumptions about
renewal or extension, FSP FAS 142-3 requires an entity to consider its own
historical experience (or, if no experience, market participant assumptions)
adjusted for the entity-specific factors in paragraph 11 of SFAS
142. FSP FAS 142-3 expands the disclosure requirements of SFAS 142
and is effective for financial statements issued for fiscal years beginning
after December 15, 2008, with early adoption prohibited. The guidance
for determining the useful life of a recognized intangible asset shall be
applied prospectively to intangible assets acquired after the effective
date. The disclosure requirements shall be applied prospectively to
all intangible assets recognized as of, and subsequent to, the effective
date. We believe the adoption of FSP FAS 142-3 will have no material
impact on our results of operations, financial condition or cash
flows.
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources
of accounting principles and the framework for selecting the principles to be
used in the preparation of financial statements of nongovernmental entities that
are presented in conformity with generally accepted accounting principles
(“GAAP”) in the United States (“the GAAP hierarchy”). SFAS 162 makes
the GAAP hierarchy explicitly and directly applicable to preparers of financial
statements, a step that recognizes preparers’ responsibilities for selecting the
accounting principles for their financial statements, and sets the stage for
making the framework of FASB Concept Statements fully
authoritative. The effective date for SFAS 162 is 60 days following
the SEC’s approval of the Public Company Accounting Oversight Board’s related
amendments to remove the GAAP hierarchy from auditing standards, where it has
resided for some time. The adoption of SFAS 162 will have no impact
on our results of operations, financial condition or cash flows.
In June
2008, the FASB issued FASB Staff Position Emerging Issues Task Force
No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment
Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP
EITF 03-6-1 addresses whether instruments granted in share-based payment
transactions are participating securities prior to vesting, and therefore need
to be included in the earnings allocation in computing earnings per share under
the two-class method as described in SFAS No. 128, “Earnings per
Share.” Under the guidance of FSP EITF 03-6-1, unvested
share-based payment awards that contain nonforfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are participating securities and
shall be included in the computation of earnings per share pursuant to the
two-class method. Our restricted stock awards are considered “participating
securities” because they contain nonforfeitable rights to dividends. FSP
EITF 03-6-1 is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and all prior-period earnings per share
data presented shall be adjusted retrospectively. Early application is not
permitted. We are currently evaluating the impact of FSP EITF 03-6-1 on our
consolidated financial statements and will adopt FSP EITF 03-6-1 effective March
1, 2009.
In
September 2008, the FASB issued exposure drafts that eliminate
qualifying special purpose entities from the guidance of SFAS No. 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities,” and FASB Interpretation 46 (revised December 2003),
“Consolidation of Variable Interest Entities - an interpretation of ARB No. 51,”
as well as other modifications. While the proposed revised
pronouncements have not been finalized and the proposals are subject to further
public comment,
the
changes could have a significant impact on our consolidated financial statements
as we could potentially be precluded from using sales accounting treatment for
our securitization transactions, which would change the timing of the
recognition of CAF income. In addition, the changes could result in the
consolidation of the financial assets and liabilities transferred to our
qualified special purpose entities. The changes would be effective
March 1, 2010, on a prospective basis.
On
October 1, 2008, we announced a workforce reduction of more than 600 service
operations associates. The reductions were made in a majority of our production
superstores, where vehicles are reconditioned. About a third of the reductions
were made in response to our lower sales rate. The remaining reductions
represented a restructuring of our cosmetic operations, and they were part of
our long-term initiative to decrease costs in the reconditioning area. In
connection with these reductions, we estimate that we will incur approximately
$7.0 million of severance costs, which will be included in selling, general and
administrative expenses in the third quarter ending November 30,
2008.
ITEM
2.
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 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 our Annual Report on Form 10-K
for the fiscal year ended February 29, 2008, 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. Certain prior year amounts have been reclassified to
conform to the current presentation.
BUSINESS
OVERVIEW
General
CarMax is
the nation’s largest retailer of used vehicles. We pioneered the used
car superstore concept, opening our first store in 1993. Our strategy
is to better serve the auto retailing market by addressing the major sources of
customer dissatisfaction with traditional auto retailers and to maximize
operating efficiencies through the use of standardized operating procedures and
store formats enhanced by sophisticated, proprietary management information
systems. As of August 31, 2008, we operated 98 used car superstores
in 46 markets, comprised of 34 mid-sized markets, 11 large markets and 1 small
market. We define mid-sized markets as those with television viewing
populations generally between 600,000 and 2.5 million people. We also
operated six new car franchises, all of which were integrated or co-located with
our used car superstores. In fiscal 2008, we sold 377,244 used cars,
representing 96% of the total 392,729 vehicles we sold at retail.
We
believe the CarMax consumer offer is distinctive within the automobile retailing
marketplace. Our offer provides customers the opportunity to shop for
vehicles the same way they shop for items at other “big box”
retailers. Our consumer offer is structured around our four customer
benefits: low, no-haggle prices; a broad selection; high quality vehicles; and a
customer-friendly sales process. Our website, carmax.com, is a
valuable tool for communicating the CarMax consumer offer, a sophisticated
search engine and an efficient channel for customers who prefer to conduct their
shopping online. We generate revenues, income and cash flows
primarily by retailing used vehicles and associated items including vehicle
financing, extended service plans (“ESPs”) and vehicle repair
service.
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 through on-site wholesale
auctions. Wholesale auctions are generally held on a weekly or
bi-weekly basis, and as of August 31, 2008, we conducted auctions at 49
used car superstores. During fiscal 2008, we sold 222,406 wholesale
vehicles. 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 financing to qualified retail customers through CarMax Auto Finance
(“CAF”), our finance operation, and a number of third-party financing
providers. We collect fixed, prenegotiated fees from the majority of
the third-party providers, and we periodically test additional
providers. CarMax has no recourse liability for the financing
provided by these third parties.
We sell
ESPs 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,
and as of August 31, 2008, we had used car superstores located in markets that
comprised approximately 45% of the U.S. population. In response to
the challenging economic environment and the unprecedented decline in our
comparable store sales during the second quarter of fiscal 2009, in August 2008,
we announced our decision to temporarily slow our store growth. We
believe slowing growth will both aid profitability and reduce our capital needs
in the near term. Previously, we had planned to open used car
superstores at a rate of approximately 15% of our used car superstore base each
year. In fiscal 2009, we now plan to open a total of 10 stores (down
from our original plan of 14 store openings), and in fiscal 2010, we plan to
open between 5 and 10 stores.
We
believe the primary driver for future earnings growth will be vehicle unit sales
growth, both from new stores and from stores included in our comparable store
base. We target a dollar range of gross profit per used unit
sold. The gross profit dollar target for an individual vehicle is
based on a variety of factors, including its anticipated probability of sale and
its mileage relative to its age; however, it is not based on the vehicle’s
selling price.
Fiscal 2009 Second Quarter
Highlights
§
|
We
believe the slowdown in the economy and reductions in consumer spending
power resulting from higher gasoline and food costs continued to adversely
affect industry-wide sales in the automotive retail market in the second
quarter.
|
§
|
Net
sales and operating revenues decreased 13% to $1.84 billion from $2.12
billion in the second quarter of fiscal 2008, while net earnings declined
to $14.0 million, or $0.06 per share, from $65.0 million, or $0.29 per
share.
|
§
|
Total
used vehicle unit sales decreased 7%, reflecting the combination of a 17%
decrease in comparable store used unit sales partially offset by the
growth in our store base. Wholesale vehicle unit sales
decreased 9%, reflecting a decrease in both our appraisal traffic and our
appraisal buy rate (defined as the number of appraisal purchases as a
percent of vehicles appraised). New vehicle unit sales declined
24%, primarily reflecting the soft new car industry trends, as well as the
sale of one of our new car franchises in the second quarter of fiscal
2008.
|
§
|
We
opened three used car superstores in the second quarter, entering two new
markets and expanding our presence in one existing
market.
|
§
|
Our
total gross profit per retail unit decreased $116 to $2,753 from $2,869 in
the prior year’s second quarter. The majority of the decline
resulted from a $112 decrease in gross profit per used
vehicle. Our used vehicle gross profit per unit was pressured
by a combination of factors, including the sharply slower sales and the
decline in our appraisal buy rate.
|
§
|
CAF
reported a pretax loss of $7.1 million compared with income of $33.4
million in the second quarter of fiscal 2008. CAF results for
the second quarter of fiscal 2009 were reduced by $28.2 million for
adjustments primarily related to loans originated in prior fiscal
periods. In addition, CAF’s gain on loans originated and sold
as a percentage of loans originated and sold decreased to 1.8% from 4.0%
in the second quarter of fiscal 2008. This decline was due to
the combination of higher funding costs, higher loss and discount rate
assumptions and increased credit enhancement requirements in the warehouse
facility in fiscal 2009, as well as a decline in origination
volume.
|
§
|
Selling,
general and administrative expenses as a percent of net sales and
operating revenues (the “SG&A ratio”) increased to 12.2% from 10.1% in
the second quarter of fiscal 2008. The increase in the SG&A
ratio was the result of the significant decline in comparable store used
unit sales and average selling price. The increase in the ratio
was partially offset by a reduction of variable
costs.
|
§
|
For
the first half of the fiscal year, net cash provided by operations
increased to $218.9 million compared with $173.0 million in fiscal 2008,
primarily reflecting the benefit of a large reduction in used vehicle
inventories in fiscal 2009, partially offset by the decrease in net
earnings.
|
CRITICAL
ACCOUNTING POLICIES
For a
discussion of our critical accounting policies, see “Critical Accounting
Policies” in MD&A included in Item 7 of the Annual Report on Form 10-K for
the fiscal year ended February 29, 2008. These policies relate to
securitization transactions, revenue recognition, income taxes and defined
benefit retirement plan obligations.
RESULTS
OF OPERATIONS
NET
SALES AND OPERATING REVENUES
|
|
Three
Months Ended August 31
|
|
|
Six
Months Ended August 31
|
|
(In
millions)
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
Used
vehicle sales
|
|
$ |
1,476.3 |
|
|
|
80.3 |
|
|
$ |
1,687.1 |
|
|
|
79.5 |
|
|
$ |
3,293.2 |
|
|
|
81.4 |
|
|
$ |
3,395.5 |
|
|
|
79.5 |
|
New
vehicle sales
|
|
|
77.8 |
|
|
|
4.2 |
|
|
|
104.8 |
|
|
|
4.9 |
|
|
|
159.9 |
|
|
|
3.9 |
|
|
|
217.4 |
|
|
|
5.1 |
|
Wholesale
vehicle sales
|
|
|
223.3 |
|
|
|
12.1 |
|
|
|
265.3 |
|
|
|
12.5 |
|
|
|
465.6 |
|
|
|
11.5 |
|
|
|
526.4 |
|
|
|
12.3 |
|
Other
sales and revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Extended
service plan revenues
|
|
|
31.7 |
|
|
|
1.7 |
|
|
|
33.2 |
|
|
|
1.6 |
|
|
|
68.3 |
|
|
|
1.7 |
|
|
|
67.1 |
|
|
|
1.6 |
|
Service
department sales
|
|
|
26.5 |
|
|
|
1.4 |
|
|
|
25.2 |
|
|
|
1.2 |
|
|
|
51.0 |
|
|
|
1.3 |
|
|
|
49.4 |
|
|
|
1.2 |
|
Third-party
finance fees, net
|
|
|
3.4 |
|
|
|
0.2 |
|
|
|
6.9 |
|
|
|
0.3 |
|
|
|
9.9 |
|
|
|
0.2 |
|
|
|
13.8 |
|
|
|
0.3 |
|
Total
other sales and revenues
|
|
|
61.7 |
|
|
|
3.4 |
|
|
|
65.3 |
|
|
|
3.1 |
|
|
|
129.2 |
|
|
|
3.2 |
|
|
|
130.3 |
|
|
|
3.1 |
|
Total
net sales and operating revenues
|
|
$ |
1,839.1 |
|
|
|
100.0 |
|
|
$ |
2,122.5 |
|
|
|
100.0 |
|
|
$ |
4,047.8 |
|
|
|
100.0 |
|
|
$ |
4,269.7 |
|
|
|
100.0 |
|
RETAIL
VEHICLE SALES CHANGES
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
(7 |
)% |
|
|
11 |
% |
|
|
2 |
% |
|
|
13 |
% |
New
vehicles
|
|
|
(24 |
)% |
|
|
(15 |
)% |
|
|
(25 |
)% |
|
|
(10 |
)% |
Total
|
|
|
(7 |
)% |
|
|
9 |
% |
|
|
1 |
% |
|
|
11 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
(12 |
)% |
|
|
11 |
% |
|
|
(3 |
)% |
|
|
14 |
% |
New
vehicles
|
|
|
(26 |
)% |
|
|
(14 |
)% |
|
|
(26 |
)% |
|
|
(9 |
)% |
Total
|
|
|
(13 |
)% |
|
|
9 |
% |
|
|
(4 |
)% |
|
|
12 |
% |
Comparable
store used unit sales growth is one of the key drivers of our
profitability. A store is included in comparable store retail sales
in the store’s fourteenth full month of operation.
COMPARABLE
STORE RETAIL VEHICLE SALES CHANGES
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
(17 |
)% |
|
|
3 |
% |
|
|
(8 |
)% |
|
|
5 |
% |
New
vehicles
|
|
|
(20 |
)% |
|
|
(13 |
)% |
|
|
(19 |
)% |
|
|
(9 |
)% |
Total
|
|
|
(17 |
)% |
|
|
2 |
% |
|
|
(8 |
)% |
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
(22 |
)% |
|
|
3 |
% |
|
|
(12 |
)% |
|
|
5 |
% |
New
vehicles
|
|
|
(21 |
)% |
|
|
(11 |
)% |
|
|
(20 |
)% |
|
|
(8 |
)% |
Total
|
|
|
(22 |
)% |
|
|
2 |
% |
|
|
(13 |
)% |
|
|
4 |
% |
CHANGE
IN USED CAR SUPERSTORE BASE
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Used
car superstores, beginning of period
|
|
|
95 |
|
|
|
80 |
|
|
|
89 |
|
|
|
77 |
|
Superstore
openings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production
superstores
|
|
|
1 |
|
|
|
― |
|
|
|
4 |
|
|
|
1 |
|
Non-production
superstores
|
|
|
2 |
|
|
|
1 |
|
|
|
5 |
|
|
|
3 |
|
Total
superstore openings
|
|
|
3 |
|
|
|
1 |
|
|
|
9 |
|
|
|
4 |
|
Used
car superstores, end of period
|
|
|
98 |
|
|
|
81 |
|
|
|
98 |
|
|
|
81 |
|
Used
Vehicle Sales. Our 12% decrease
in used vehicle revenues in the second quarter of fiscal 2009 resulted from the
combination of a 7% decrease in unit sales and a 6% decrease in average retail
selling price. The decline in unit sales reflected a 17% decrease in
comparable store used units, partially offset by sales from newer superstores
not yet in the comparable store base. Starting in late May 2008,
customer traffic in our stores declined sharply, and the decrease in traffic for
the second quarter was similar to the 17% decrease in comparable store used unit
sales. Despite the more difficult business environment, the solid
execution by our store teams resulted in a conversion rate that was only
marginally below the rate in the prior year’s second quarter. The
decrease in the average retail selling price was primarily caused by the
industry-wide drop in used car prices, which reduced our inventory acquisition
costs. Our data indicated that our market share in the late-model
used vehicle market fell slightly in the second quarter of fiscal
2009.
Our 3%
decrease in used vehicle revenues in the first half of fiscal 2009 resulted from
a 2% increase in unit sales offset by a 5% decrease in average retail selling
price. The unit sales growth reflected sales from newer superstores
not yet in the comparable store base, offset by an 8% decrease in comparable
store used units. Similar to the second quarter, the decline in
comparable store used units was primarily the result of the decline in customer
traffic, and the decline in average retail selling price reflected our reduced
vehicle acquisition costs.
New
Vehicle Sales. Compared with the
corresponding prior year periods, new vehicle revenues decreased 26% in both the
second quarter and the first half of fiscal 2009. The declines were
substantially the result of decreases in unit sales, which fell 24% in the
second quarter and 25% in the first half of the year. New vehicle
unit sales reflected the soft new car industry sales trends, particularly for
the domestic manufacturers that we represent, and the sale of our Orlando
Chrysler-Jeep-Dodge franchise in the second quarter of fiscal 2008.
Wholesale
Vehicle Sales. Vehicles acquired
through the appraisal purchase process that do not meet our retail standards are
sold at our on-site wholesale auctions. The 16% decrease in wholesale
vehicle revenues in the second quarter of fiscal 2009 resulted from a 9%
decrease in wholesale unit sales combined with an 8% decline in average
wholesale selling price. The decline in the unit sales reflected a
decrease in both our appraisal traffic and our appraisal buy
rate. This was similar to our experience in the first quarter of
fiscal 2009, which we believe was partly due to the significant year-over-year
decline in wholesale market values for SUVs, trucks and other less
fuel-efficient vehicles. The decline in average wholesale selling
price reflected the trends in the general wholesale market for the types of
vehicles we sell.
The 12%
decrease in wholesale vehicle revenues in the first half of fiscal 2009 resulted
from a 6% decrease in wholesale unit sales combined with a 7% decline in average
wholesale selling price. The factors that contributed to these
declines in the second quarter were also the cause of the declines for the first
half of the year.
Other
Sales and Revenues. Other sales and
revenues include commissions on the sale of ESPs, service department sales and
net third-party finance fees. In the second quarter of fiscal 2009,
other sales and revenues decreased 6%. ESP sales declined 5%, as the
decrease in used vehicle sales was partly offset by an improvement in the ESP
attachment rate. Service department sales increased
5%. Third-party finance fees declined 51% due to the reduction in
vehicle sales combined with a shift in mix among, and discount arrangements
with, our third-party finance providers. The fixed fees paid by our
third-party financing providers vary by provider, reflecting their differing
levels of credit risk exposure. Providers who purchase the highest
risk loans purchase these loans at a discount, which is reflected as an offset
to the finance fee revenues received from the other third-party
providers.
For the
first half of the year, other sales and revenues decreased 1% in fiscal
2009. Modest increases in ESP and service department sales in the
first half of fiscal 2009 were more than offset by a decrease in third-party
finance fees.
Seasonality. Our business is
seasonal. Typically, our superstores experience their strongest
traffic and sales in the spring and summer quarters. Sales are
typically slowest in the fall quarter, when used vehicles generally experience
proportionately more of their annual depreciation. We believe this is
partly the result of a decline in customer traffic, as well as discounts on
model year closeouts that can pressure pricing for late-model used
vehicles. Customer traffic also tends to slow in the fall as the
weather changes 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 we expand
geographically, these differences could have an effect on the overall seasonal
pattern of our results.
Supplemental Sales
Information.
UNIT
SALES
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Used
vehicles
|
|
|
89,664 |
|
|
|
96,102 |
|
|
|
196,411 |
|
|
|
192,868 |
|
New
vehicles
|
|
|
3,300 |
|
|
|
4,365 |
|
|
|
6,815 |
|
|
|
9,085 |
|
Wholesale
vehicles
|
|
|
55,124 |
|
|
|
60,476 |
|
|
|
111,453 |
|
|
|
118,190 |
|
AVERAGE
SELLING PRICES
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Used
vehicles
|
|
$ |
16,278 |
|
|
$ |
17,388 |
|
|
$ |
16,590 |
|
|
$ |
17,434 |
|
New
vehicles
|
|
$ |
23,434 |
|
|
$ |
23,863 |
|
|
$ |
23,319 |
|
|
$ |
23,787 |
|
Wholesale
vehicles
|
|
$ |
3,935 |
|
|
$ |
4,278 |
|
|
$ |
4,061 |
|
|
$ |
4,344 |
|
RETAIL
VEHICLE SALES MIX
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Vehicle
units:
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
96 |
% |
|
|
96 |
% |
|
|
97 |
% |
|
|
96 |
% |
New
vehicles
|
|
|
4 |
|
|
|
4 |
|
|
|
3 |
|
|
|
4 |
|
Total
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vehicle
dollars:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Used
vehicles
|
|
|
95 |
% |
|
|
94 |
% |
|
|
95 |
% |
|
|
94 |
% |
New
vehicles
|
|
|
5 |
|
|
|
6 |
|
|
|
5 |
|
|
|
6 |
|
Total
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
RETAIL
STORES
|
|
Estimate
Feb.
28, 2009(1)
|
|
|
August
31, 2008
|
|
|
Feb.
29, 2008
|
|
|
August
31, 2007
|
|
Production(2)
|
|
|
59 |
|
|
|
60 |
|
|
|
56 |
|
|
|
53 |
|
Non-production
superstores(2)
|
|
|
40 |
|
|
|
38 |
|
|
|
33 |
|
|
|
28 |
|
Total
used car superstores
|
|
|
99 |
|
|
|
98 |
|
|
|
89 |
|
|
|
81 |
|
Co-located
new car stores
|
|
|
3 |
|
|
|
3 |
|
|
|
3 |
|
|
|
3 |
|
Total
|
|
|
102 |
|
|
|
101 |
|
|
|
92 |
|
|
|
84 |
|
(1)Effective
October 1, 2008, we converted the superstore in Tucson, Arizona, from a
production to a non-production store.
(2)The
Clearwater, Florida, superstore has been reclassified from a production to
a non-production superstore.
|
|
We opened
three superstores during the second quarter of fiscal 2009. We
entered Colorado Springs, Colorado, with a production superstore; we entered
Tulsa, Oklahoma, with a non-production superstore; and we expanded our presence
in Los Angeles market with a non-production superstore in Costa Mesa,
California.
During
the first half of the year, we opened nine superstores. In addition
to the stores opened in the second quarter, we entered Phoenix, Arizona, with a
both a production and a non-production superstore,
Charleston,
South Carolina, with a non-production superstore and Huntsville, Alabama, with a
production superstore. We also expanded our presence in San Antonio,
Texas, with a non-production superstore and Sacramento, California, with a
production superstore.
During
the first half of fiscal 2009, we also expanded our car-buying center test with
openings in Dallas, Texas, and Baltimore, Maryland. We now have a
total of five car-buying centers at which we conduct appraisals and purchase,
but do not sell, vehicles. We will continue to evaluate the
performance of these five test centers before deciding whether to open
additional centers in future years. These test stores are part of our
long-term program to increase both appraisal traffic and retail vehicle sourcing
self-sufficiency, which is the number of vehicles sold at retail that we
purchased from consumers.
As of
August 31, 2008, we had a total of six new car franchises. Two
franchises are integrated within used car superstores, and the remaining four
franchises are operated from three facilities that are co-located with select
used car superstores. During the second quarter of fiscal 2008, we
sold a Chrysler-Jeep-Dodge franchise.
GROSS
PROFIT
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
$
per unit (1)
|
|
|
|
% |
(2) |
|
$
per unit (1)
|
|
|
|
% |
(2) |
|
$
per unit (1)
|
|
|
|
% |
(2) |
|
$
per unit (1)
|
|
|
|
% |
(2) |
Used
vehicle gross profit
|
|
$ |
1,870 |
|
|
|
11.4 |
|
|
$ |
1,982 |
|
|
|
11.3 |
|
|
$ |
1,800 |
|
|
|
10.7 |
|
|
$ |
1,958 |
|
|
|
11.1 |
|
New
vehicle gross profit
|
|
$ |
909 |
|
|
|
3.9 |
|
|
$ |
1,072 |
|
|
|
4.5 |
|
|
$ |
883 |
|
|
|
3.8 |
|
|
$ |
1,039 |
|
|
|
4.3 |
|
Wholesale
vehicle gross profit
|
|
$ |
897 |
|
|
|
22.2 |
|
|
$ |
796 |
|
|
|
18.1 |
|
|
$ |
840 |
|
|
|
20.1 |
|
|
$ |
798 |
|
|
|
17.9 |
|
Other
gross profit
|
|
$ |
385 |
|
|
|
58.0 |
|
|
$ |
447 |
|
|
|
68.8 |
|
|
$ |
420 |
|
|
|
66.1 |
|
|
$ |
451 |
|
|
|
69.9 |
|
Total
gross profit
|
|
$ |
2,753 |
|
|
|
13.9 |
|
|
$ |
2,869 |
|
|
|
13.6 |
|
|
$ |
2,650 |
|
|
|
13.3 |
|
|
$ |
2,834 |
|
|
|
13.4 |
|
(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.
|
|
In the
second quarter, total gross profit declined by $32.3 million to $255.9 million
versus $288.2 million in the prior year primarily because of the decrease in
used unit sales, as well as the reduction in total gross profit per
unit. Lower-than-targeted profitability earlier in the year
contributed to a compression in our margins leading into the second quarter. For
the first half of the year, total gross profit declined by $33.8 million to
$538.6 million from $572.4 million in the prior year mainly because of the
reduction in total gross profit per unit.
Used
Vehicle Gross Profit. Second quarter
fiscal 2009 used vehicle gross profit per unit decreased $112 to $1,870 compared
with $1,982 in the prior year’s second quarter. Several factors
contributed to this decrease. Similar to the first quarter of fiscal
2009, the decline in appraisal traffic and the appraisal buy rate required us to
source a larger percentage of our used vehicles at auction, which had an adverse
effect our gross profit per used unit. In the second quarter of
fiscal 2009, the percentage of our used vehicles acquired through the appraisal
lane was slightly below 50% of our total used unit sales, while in the prior
year’s quarter this percentage was above 50%. Vehicles purchased at
auction typically generate less profit per unit compared with vehicles purchased
directly from consumers. Additionally, our second quarter average
gross profit per unit for mid-sized and large SUVs and trucks was lower in the
current fiscal year due to the rapid decline in consumer demand and wholesale
values for these types of vehicles from spring to mid-summer of
2008.
In
response to the sharp decline in traffic and sales in the second quarter of
fiscal 2009, we rapidly reduced our used car inventories, which brought them
back in line with current sales rates and minimized required pricing
markdowns. Compared with inventory levels at stores open as of May
31, 2008, during the second quarter we reduced used vehicle inventory by more
than 13,300 units, representing a reduction in excess of $200
million. These corresponded to reductions of more than
20%.
For the
first half of fiscal 2009, used vehicle gross profit per unit declined $158 to
$1,800 compared with $1,958 in the first half of fiscal 2008. We had
lower appraisal traffic and a lower buy rate in the first half of fiscal 2009,
which adversely affected our gross profit per unit. Additionally,
wholesale industry prices for mid-sized and large SUVs and trucks declined by
23% during the first half of fiscal 2009, which was more than twice the
depreciation normally expected over this period. This rapid decline in valuation
resulted in significant margin pressure on this segment of our inventory in the
first half of the fiscal year. During the latter part of the second
quarter, however, wholesale values for SUVs and trucks rebounded modestly off of
the lows experienced earlier in the quarter. Our used vehicle gross
profit per unit was also pressured by the slowing sales
environment.
New
Vehicle Gross Profit. Compared with the
corresponding prior year periods, new vehicle gross profit per unit decreased
$163 in the second quarter and $156 in the first half of fiscal
2009. The decline in overall consumer demand for new cars pressured
profits for many new car retailers, including CarMax.
Wholesale
Vehicle Gross Profit. Compared with the
corresponding prior year periods, wholesale vehicle gross profit per unit
increased $101 in the second quarter and $42 in the first half of fiscal
2009. Throughout the first half of fiscal 2009, we continued to
experience strong dealer attendance at our auctions, with the normal price
competition among bidders contributing to the strong wholesale gross profit
performance. With an average selling price of roughly $4,000, the
majority of our wholesale units are older, higher mileage
vehicles. We believe the demand for these types of vehicles from the
dealers who specialize in selling to credit-challenged customers has been
particularly strong in fiscal 2009. Additionally, with more than half
of our wholesale auctions held on a weekly basis, the rapid pace at which we
turn our wholesale inventory minimizes our exposure to changes in market
valuations for these vehicles.
Other
Gross Profit. We have no cost
of sales related to either ESP revenues or third-party finance fees, as these
represent commissions paid to us by the third-party providers. Compared with the
corresponding prior year periods, other gross profit per unit declined $62 in
the second quarter and $31 in the first half of fiscal 2009. For both
periods, the decrease in other gross profit per unit reflected a decline in
third-party finance fees and a drop in service department
profits. The decline in service department profits reflected the
slower used vehicle sales pace and the associated deleveraging of service and
reconditioning overhead costs.
Impact of
Inflation. Historically,
inflation has not been a significant contributor to
results. Profitability is primarily affected by our ability to
achieve targeted unit sales and gross profit dollars per vehicle rather than on
average retail prices. However, increases in average vehicle selling
prices will benefit CAF income, to the extent the average amount financed also
increases, and they will also benefit the SG&A ratio.
In the
first half of fiscal 2009, steep increases in the price of gasoline, food and
other consumer staples adversely affected consumer spending, contributing to an
industry-wide slowdown in the sale of new and used vehicles. The
increase in fuel costs caused a particularly sharp decline in consumer demand
for SUVs, trucks and other less fuel-efficient vehicles, resulting in a
decline in the wholesale value of these types of used vehicles. These
lower wholesale values reduced our vehicle acquisition costs and they
contributed to the decline in our used vehicle average retail selling
price.
CarMax
Auto Finance (Loss) Income. CAF provides
financing for our used and new car sales. Because the purchase of a
vehicle is traditionally reliant on the consumer’s ability to obtain on-the-spot
financing, it is important to our business that 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 auto loans, both for CAF and for the third-party financing
providers. CAF provides us the opportunity to capture additional
profits and cash flows from auto loan receivables while managing our reliance on
third-party financing sources.
COMPONENTS
OF CAF (LOSS) INCOME
|
|
Three
Months Ended
August
31
|
|
|
Six
Months Ended
August
31
|
|
(In
millions)
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
Total
(loss) gain (1)
|
|
$ |
(18.8 |
) |
|
|
(3.3 |
) |
|
$ |
25.0 |
|
|
|
3.7 |
|
|
$ |
(21.6 |
) |
|
|
(1.8 |
) |
|
$ |
52.8 |
|
|
|
4.0 |
|
Other
CAF income: (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing
fee income
|
|
|
10.4 |
|
|
|
1.0 |
|
|
|
9.2 |
|
|
|
1.0 |
|
|
|
20.6 |
|
|
|
1.0 |
|
|
|
18.1 |
|
|
|
1.0 |
|
Interest
income
|
|
|
11.2 |
|
|
|
1.1 |
|
|
|
7.8 |
|
|
|
0.9 |
|
|
|
22.2 |
|
|
|
1.1 |
|
|
|
15.6 |
|
|
|
0.9 |
|
Total
other CAF income
|
|
|
21.6 |
|
|
|
2.1 |
|
|
|
17.0 |
|
|
|
1.9 |
|
|
|
42.9 |
|
|
|
2.1 |
|
|
|
33.7 |
|
|
|
1.9 |
|
Direct
CAF expenses: (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAF
payroll and fringe benefit expense
|
|
|
4.7 |
|
|
|
0.5 |
|
|
|
3.8 |
|
|
|
0.4 |
|
|
|
9.2 |
|
|
|
0.5 |
|
|
|
7.4 |
|
|
|
0.4 |
|
Other
direct CAF expenses
|
|
|
5.2 |
|
|
|
0.5 |
|
|
|
4.7 |
|
|
|
0.5 |
|
|
|
9.4 |
|
|
|
0.5 |
|
|
|
8.5 |
|
|
|
0.5 |
|
Total
direct CAF expenses
|
|
|
10.0 |
|
|
|
1.0 |
|
|
|
8.5 |
|
|
|
1.0 |
|
|
|
18.6 |
|
|
|
0.9 |
|
|
|
16.0 |
|
|
|
0.9 |
|
CAF
(loss) income (3)
|
|
$ |
(7.1 |
) |
|
|
(0.4 |
) |
|
$ |
33.4 |
|
|
|
1.6 |
|
|
$ |
2.7 |
|
|
|
0.1 |
|
|
$ |
70.5 |
|
|
|
1.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans sold
|
|
$ |
575.3 |
|
|
|
|
|
|
$ |
668.5 |
|
|
|
|
|
|
$ |
1,201.8 |
|
|
|
|
|
|
$ |
1,315.5 |
|
|
|
|
|
Average
managed receivables
|
|
$ |
4,039.9 |
|
|
|
|
|
|
$ |
3,550.6 |
|
|
|
|
|
|
$ |
3,990.4 |
|
|
|
|
|
|
$ |
3,481.0 |
|
|
|
|
|
Ending
managed receivables
|
|
$ |
4,061.4 |
|
|
|
|
|
|
$ |
3,596.0 |
|
|
|
|
|
|
$ |
4,061.4 |
|
|
|
|
|
|
$ |
3,596.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales and operating revenues
|
|
$ |
1,839.1 |
|
|
|
|
|
|
$ |
2,122.5 |
|
|
|
|
|
|
$ |
4,047.8 |
|
|
|
|
|
|
$ |
4,269.7 |
|
|
|
|
|
Percent
columns indicate:
(1)
Percent of total loans sold.
(2)
Annualized percent of average managed receivables.
(3)
Percent of total net sales and operating revenues.
|
|
CAF
income or loss 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 benefits 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.
CAF
originates auto loans to qualified customers at competitive market rates of
interest. The majority of CAF income is typically 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. Historically, the gain on loans originated and sold as a percent of
loans originated and sold (the “gain percentage”) has generally been in the
range of 3.5% to 4.5%. However, the gain percentage has
been substantially below the low end of this range in recent quarters, primarily
as a result of the disruption in the global credit markets and the more
challenging economic environment, which have increased CAF funding costs and
caused us to increase the discount rate and loss rate assumptions that affect
the gain recognized on the sale of loans.
(LOSS)
GAIN AND LOANS SOLD
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Gain
on sales of loans originated and sold (1)
|
|
$ |
9.4 |
|
|
$ |
24.7 |
|
|
$ |
23.6 |
|
|
$ |
52.0 |
|
Other
(losses) gains (1)
|
|
|
(28.2 |
) |
|
|
0.3 |
|
|
|
(45.2 |
) |
|
|
0.7 |
|
Total
(loss) gain
|
|
$ |
(18.8 |
) |
|
$ |
25.0 |
|
|
$ |
(21.6 |
) |
|
$ |
52.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
originated and sold
|
|
$ |
526.9 |
|
|
$ |
617.8 |
|
|
$ |
1,153.4 |
|
|
$ |
1,264.9 |
|
Receivables
repurchased from term securitizations and
resold
|
|
|
48.4 |
|
|
|
50.7 |
|
|
|
48.4 |
|
|
|
50.7 |
|
Total
loans sold
|
|
$ |
575.3 |
|
|
$ |
668.5 |
|
|
$ |
1,201.8 |
|
|
$ |
1,315.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
percentage on loans originated and sold
|
|
|
1.8 |
% |
|
|
4.0 |
% |
|
|
2.0 |
% |
|
|
4.1 |
% |
Total
(loss) gain as a percentage of total loans sold
|
|
|
(3.3 |
)% |
|
|
3.7 |
% |
|
|
(1.8 |
)% |
|
|
4.0 |
% |
(1)To
the extent we recognize valuation or other adjustments related to loans
originated in previous quarters of the same fiscal year, the sum of
amounts reported for the individual quarters may not equal the
year-to-date total.
|
|
The gain
on sales of loans originated and sold includes both the gain income recorded at
the time of securitization and the effect of any subsequent changes in valuation
assumptions or funding costs that are incurred in the same fiscal period that
the loans were originated. Other losses or gains include the effects
of changes in valuation assumptions or funding costs related to loans originated
and sold during previous fiscal periods. In addition, other losses or
gains could include the effects of new securitizations, changes in the valuation
of retained subordinated bonds and the resale of receivables in existing
securitizations, as applicable.
In the
second quarter of fiscal 2009, CAF reported a pretax loss of $7.1 million
compared with income of $33.4 million in the prior year’s second
quarter. CAF results for the second quarter of fiscal 2009 were
reduced by $28.2 million for adjustments primarily related to loans originated
in prior fiscal years. These adjustments included:
·
|
$15.7
million related to increases in loss rate assumptions, mainly for loans
originated in fiscal 2006, 2007 and 2008. The upper end of our
cumulative loss rate assumption range increased to 3.5% from
3.0%.
|
·
|
$7.7
million for a mark-to-market reduction in the carrying value of
subordinated bonds that we hold. These bonds have a face value
of $115 million, and they were part of three term securitizations
completed earlier in calendar year
2008.
|
·
|
$4.1
million related to increasing the discount rate used to value our retained
interest in securitized receivables to 19% from 17% used at the start of
fiscal 2009.
|
The
adjustments related to reducing the fair value of the retained subordinated
bonds and increasing the discount rate are non-cash charges that primarily
affect the timing of the recognition of CAF income. If current
conditions continue, these adjustments should result in positive contributions
to CAF earnings in future periods.
The gain
recognized on loans originated and sold in the second quarter of fiscal 2009 was
also adversely affected by the disruption in the credit markets and worsening
economic conditions. The gain percentage decreased to 1.8% in the
second quarter of fiscal 2009 from 4.0% in the corresponding prior year
period. This decrease resulted from a combination of factors,
including higher funding costs in the warehouse facility, which we have been
unable to offset through higher consumer rates; the increase in the discount
rate assumption used to calculate the gain on the sale of loans to 19% from 12%
used in the second quarter of last year; the use of a higher loss assumption on
current quarter originations compared with the assumption used in the prior
year’s quarter; and an increase in the credit enhancement requirements in the
warehouse facility. In addition, CAF’s origination volume was
negatively affected by the slowdown in unit sales, the decrease in average
retail prices and a small decline in the percentage of sales financed by
CAF.
For the
first half of the year, CAF income declined to $2.7 million in fiscal 2009 from
$70.5 million in fiscal 2008. CAF results for the first half of
fiscal 2009 were reduced by $45.2 million for adjustments primarily related to
loans originated during prior fiscal years. Of the $28.2 million in
adjustments in the second quarter, $2.9 million related to loans originated and
sold during the first quarter of fiscal 2009. In addition, CAF first quarter
results were also reduced by $20.0 million primarily related to increases in
funding costs for loans that had been originated in prior fiscal
years. These funding cost increases occurred in connection with the
$750 million term securitization completed in May 2008 and the renewal of the
warehouse facility agreement in July 2008.
The gain
percentage for the first half of the year decreased to 2.0% in fiscal 2009 from
4.1% in fiscal 2008. Many of the factors that contributed to the
decline in the gain percentage in the second quarter of fiscal 2009 were also
factors contributing to the decline in the gain percentage for the first six
months of the year.
Our term
securitizations typically contain an option to repurchase the securitized
receivables when the outstanding balance in the pool of auto loan receivables
falls below 10% of the original pool balance. In the second quarter
of fiscal 2009, we exercised this repurchase option and $48.4 million of
previously securitized receivables were resold into the warehouse
facility. In the second quarter of fiscal 2008, we exercised this
repurchase option and $50.7 million of previously securitized receivables were
resold into the warehouse facility. Neither of these transactions had
a material effect on total gain income. In future periods, the
effects of refinancing, repurchase or resale activity could be favorable or
unfavorable, depending on the securitization structure and the market conditions
at the transaction date.
The
increases in servicing fee income and direct CAF expenses in the second quarter
of fiscal 2009 were proportionate to the growth in managed
receivables. The interest income component of other CAF income
increased to an annualized 1.1% of average managed receivables in the second
quarter of fiscal 2009 from 0.9% in the prior year quarter, primarily due to the
increase in the discount rate assumption used to value the retained interest to
19% from 12%. The use of a higher discount rate reduces the gain
recognized at the time the loans are sold, but increases the interest income
recognized in subsequent periods. In addition, interest income
included the interest earned on the retained subordinated
bonds. Prior to January 2008, we had not retained any subordinated
bonds.
PAST
DUE ACCOUNT INFORMATION
|
|
As
of
August
31
|
|
|
As
of
February
29 or 28
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Loans
securitized
|
|
$ |
3,931.6 |
|
|
$ |
3,524.6 |
|
|
$ |
3,764.5 |
|
|
$ |
3,242.1 |
|
Loans
held for sale or
investment
|
|
|
129.8 |
|
|
|
71.4 |
|
|
|
74.0 |
|
|
|
68.9 |
|
Ending
managed
receivables
|
|
$ |
4,061.4 |
|
|
$ |
3,596.0 |
|
|
$ |
3,838.5 |
|
|
$ |
3,311.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
31+ days past
due
|
|
$ |
117.7 |
|
|
$ |
75.7 |
|
|
$ |
86.1 |
|
|
$ |
56.9 |
|
Past
due accounts as a percentage of ending managed receivables
|
|
|
2.90 |
% |
|
|
2.10 |
% |
|
|
2.24 |
% |
|
|
1.72 |
% |
CREDIT
LOSS INFORMATION
|
|
Three
Months
Ended
August 31
|
|
|
Six
Months
Ended
August 31
|
|
(In
millions)
|
|
2008
|
2007
|
|
|
2008
|
|
2007
|
|
Net
credit losses on managed receivables
|
|
$ |
16.7 |
|
|
$ |
9.2 |
|
|
$ |
27.0 |
|
|
$ |
14.7 |
|
Average
managed receivables
|
|
$ |
4,039.9 |
|
|
$ |
3,550.6 |
|
|
$ |
3,990.4 |
|
|
$ |
3,481.0 |
|
Annualized
net credit losses as a percentage of average
managed receivables
|
|
|
1.65 |
% |
|
|
1.04 |
% |
|
|
1.35 |
% |
|
|
0.85 |
% |
Recovery
rate
|
|
|
43.8 |
% |
|
|
51.4 |
% |
|
|
45.4 |
% |
|
|
52.1 |
% |
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, earnings could be affected. Our
retained interest in securitized receivables was $311.0 million as of August 31,
2008, compared with $270.8 million as of February 29, 2008, and $224.3 million
as of August 31, 2007. Compared with both prior periods, our
retained interest increased primarily as a result of our holding the retained
subordinated bonds and an increase in the required excess receivables, partially
offset by a decrease in the interest-only strip receivables. We
retained subordinated bonds in the term securitizations completed in January,
May and July 2008.
Compared
with the prior year periods, we experienced increases in both past due
accounts as a percentage of ending managed receivables and annualized net credit
losses as a percentage of average managed receivables in the second quarter and
in the first half of fiscal 2009. We believe these increases were
primarily the result of the less favorable general economic and industry trends
for losses and delinquencies.
We
continually strive to refine CAF’s origination strategy in order to optimize
profitability and sales while managing risk. Historically, we
originated pools of loans targeted to have cumulative net loss rates in the
range of 2.0% to 2.5%. Receivables originated in calendar years 2003,
2004 and early 2005 experienced loss rates well below both CAF’s historical
averages and these targeted loss rates. We believe this favorability
was due, in part, to the credit scorecard we implemented in late
2002. As it became evident that the scorecard was resulting in
lower-than-expected loss rates, CAF gradually expanded its credit offers
beginning in late 2004. As a result, receivables originated in late
2005 and periods thereafter have been experiencing higher delinquency and loss
rates compared with the receivables originated in these earlier
years. While the delinquency and projected loss rates on the more
recent originations were higher than our initial expectations, we believe this
was primarily related to the worsening economic
climate. Consequently, we have increased our cumulative net loss
assumptions on several more recent securitizations, and we have continued to
incorporate similar economic stress into the projections for our most recent
originations. In addition, we have tightened CAF’s lending criteria
for applicants whose credit profile indicates a higher-than-average
risk.
The
recovery rate represents the average percentage of the outstanding principal
balance we receive when a vehicle is repossessed and liquidated at wholesale
auction. Historically, the annual recovery rate has ranged from a low
of 42% to a high of 51%, and it is primarily affected by changes in the
wholesale market pricing environment.
Selling,
General and Administrative Expenses. The SG&A
ratio increased to 12.2% in the second quarter of fiscal 2009 compared with
10.1% in the second quarter of the prior year. For the six months
ended August 31, 2008, the SG&A ratio increased to 11.6% compared with 10.0%
in the first six months of the prior year. The increases in the
SG&A ratio in fiscal 2009 were mainly the result of the declines in
comparable store used unit sales and average selling price. In
addition, in the first quarter of fiscal 2009, we accrued costs related to
litigation that reduced net earnings by $0.02 per share. The
increases in the SG&A ratio were partially offset by our success in reducing
costs in the second quarter of fiscal 2009. In the current market
environment, we are focusing on reducing variable costs in an effort to control
expenses. In our stores, in the second quarter we adjusted associate
scheduling resulting in a reduction in hours worked, and we allowed the natural
attrition in the workforce to reduce variable store staffing
levels. In addition, we implemented a hiring freeze at the home
office and are carefully monitoring expenses at CAF.
Income
Taxes. The effective
income tax rate was 37.8% in the second quarter of fiscal 2009 compared with
39.5% in the second quarter of fiscal 2008. For the first half of the
year, the effective tax rate was 38.0% in fiscal 2009 compared with 38.9% in
fiscal 2008. The lower effective tax rate in fiscal 2009 is primarily
due to the establishment of a valuation allowance against certain deferred tax
assets during the second quarter of fiscal 2008.
OPERATIONS
OUTLOOK
Store
Openings and Capital Expenditures. During the second half
of fiscal 2009, we plan to open one additional used car superstore, and in
fiscal 2010, we plan to open between five and ten superstores.
PLANNED
SUPERSTORE OPENINGS – TWELVE MONTHS ENDING AUGUST 31, 2009
Location
|
Television
Market
|
Market
Status
|
Production
Superstores
|
Non-Production
Superstores
|
FY09
Second Half:
|
|
|
|
|
Hickory, North Carolina (1)
|
Charlotte
|
Existing
|
-
|
1
|
|
|
|
|
|
FY10
First Half:
|
|
|
|
|
Potomac Mills,
Virginia
|
D.C.
/ Baltimore
|
Existing
|
-
|
1
|
Augusta, Georgia
|
Augusta
|
New
|
-
|
1
|
Cincinnati, Ohio
|
Cincinnati
|
New
|
1
|
-
|
(1)Opened
in September 2008.
|
Normal
construction, permitting or other scheduling delays could shift opening dates of
any of these stores into a later period.
We
currently estimate gross capital expenditures will total between $200 million
and $225 million in fiscal 2009. Prior to deciding to slow our store
growth rate, we had expected gross capital expenditures would total
approximately $350 million in fiscal 2009. Planned expenditures
primarily relate to new store construction and land purchases associated with
future year store openings.
Fiscal
2009 Comparable
Store Sales and Earnings Per Share Expectations. As a result of
the unprecedented near-term declines in traffic and sales and the current
volatility in the asset-backed credit markets, we are not yet able to make a
meaningful projection of fiscal 2009 comparable store sales or
earnings.
Other
Items. As
described in Note 8, effective December 31, 2008, we will freeze the pension
plan and the restoration plan, and no additional benefits will accrue under
these plans after that date. On January 1, 2009, we will implement
significant enhancements to our 401(k) plan, and we will establish a new
non-qualified retirement plan for certain senior executives who are affected by
Internal Revenue Code limitations on benefits provided under the 401(k)
plan. We believe our revised retirement program will be easier to
understand and give associates more control over their retirement savings while
also allowing us to control escalating and unpredictable pension
expenses.
FINANCIAL
CONDITION
Liquidity and Capital
Resources.
Operating
Activities. Net cash from
operating activities increased to $218.9 million in the first half of fiscal
2009 from $173.0 million in the first half of fiscal 2008, primarily reflecting
the benefit of the significant decrease in inventory in fiscal 2009 partially
offset by the decline in net earnings. We reduced inventory by $239.6
million in the first half of fiscal 2009 compared with a decrease of $15.9
million in the prior-year
period. In
fiscal 2009, we dramatically reduced our used vehicle inventory levels to bring
them in line with the lower sales rate. The fiscal 2009 inventory
reduction also reflects the decrease in vehicle acquisition costs for several
vehicle categories. In fiscal 2008, the decrease in inventory was
largely the result of the sale of a new car franchise, which reduced inventory
by $13 million.
The
aggregate principal amount of outstanding auto loan receivables funded through
securitizations, which are discussed in Notes 3 and 4 to our consolidated
financial statements, totaled $3.93 billion as of August 31, 2008, and
$3.52 billion as of August 31, 2007. During the first
half of fiscal 2009, we completed two term securitizations of auto loan
receivables. In July 2008, we completed a term securitization of $525
million of auto loan receivables, and in May 2008 we completed a term
securitization of $750 million of auto loan receivables. We retained
a total of $70.3 million face value of subordinated bonds in these two
securitizations.
During
the second quarter of fiscal 2009, we increased the capacity of the warehouse
facility, which expires in July 2009, by $400 million to a total of $1.4
billion. As of August 31, 2008, $600 million of auto
loan receivables were securitized through the warehouse facility and unused
warehouse capacity totaled $800 million. We intend to enter into new, or
renew or expand existing funding arrangements to meet CAF’s future funding
needs. However, based on conditions in the credit markets, the cost
for these arrangements could be materially higher than historic costs and the
timing of these transactions could be dictated by market availability rather
than our requirements.
Investing
Activities. Net cash used in
investing activities was $140.3 million in the first half of fiscal 2009,
compared with $135.8 million in the first half of the prior
year. Cash used in investing activities consists almost entirely of
capital expenditures, which primarily includes 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.
Historically,
capital expenditures have been funded with internally generated funds, short-
and long-term debt and sale-leaseback transactions. As of August 31,
2008, we owned 41 superstores currently in operation, as well as our home office
in Richmond, Virginia. In addition, five superstores were accounted
for as capital leases.
Financing
Activities. Net cash used in
financing activities was $80.7 million in the first half of fiscal 2009 compared
with $49.1 million in the first half of fiscal 2008. In
the first half of fiscal 2009, we used cash generated from operations to reduce
total debt by $90.1 million compared with a $62.6 million reduction in the first
half of fiscal 2008.
During the second quarter of fiscal
2009, we increased the aggregate borrowing limit under our revolving credit
facility by $200 million to a total of $700 million. The credit
facility expires in December 2011 and is secured by our vehicle inventory.
Borrowings under this credit facility are subject to limitation based on a
specified percentage of qualifying inventory, and they are available for working
capital and general corporate purposes. As of August 31, 2008, $210.3
million was outstanding under the credit facility and $359.5 million of the
remaining balance was available to us. The outstanding balance
included $12.6 million classified as short-term debt, $47.7 million classified
as current portion of long-term debt and $150.0 million classified as long-term
debt. We classified $47.7 million of the outstanding balance as of
August 31, 2008, as current portion of long-term debt based on our expectation
that this balance will not remain outstanding for more than one
year.
We expect
that cash generated by operations and proceeds from securitization transactions
or other funding arrangements, sale-leaseback transactions and borrowings under
existing or expanded credit facilities will be sufficient to fund capital
expenditures and working capital for the foreseeable future.
Fair
Value Measurements. On March 1, 2008,
we adopted Statement of Financial Accounting Standards No. 157, “Fair Value
Measurements” ("SFAS
157"). SFAS 157 defines fair value and is applied in any situation
where an asset or liability is measured at fair value under existing U.S.
generally accepted accounting principles. In accordance with SFAS
157, we
reported
money market securities, retained interest in securitized receivables and
financial derivatives at fair value. As these financial assets were already
reported at fair value, the implementation of SFAS 157 did not have a material
impact on our results of operations, liquidity or financial
condition. See Note 6 for more information on the adoption and
application of this standard.
Retained
interest in securitized receivables was valued at $311.0 million as of August
31, 2008 and $270.8 million as of February 29, 2008. Included in the
retained interest were interest-only strip receivables, various reserve accounts
and required excess receivables totaling $205.1 million and $227.7 million as of
August 31, 2008, and February 29, 2008, respectively. In addition,
the retained interest included retained subordinated bonds totaling $105.9
million and $43.1 million as of August 31, 2008, and February 29, 2008,
respectively.
As
described in Note 4, we use discounted cash flow models to measure the fair
value of retained interest, excluding retained subordinated bonds. In
addition to funding costs and prepayment rates, the estimates of future cash
flows are based on certain key assumptions, such as loss rates and discount
rates appropriate for the type of asset and risk, both of which are significant
unobservable inputs. Changes in these inputs could have a material
impact on our financial condition or results of operations, as they have had in
the past.
In
measuring the fair value of the retained subordinated bonds, we use a widely
accepted third-party bond pricing model. Our key assumption is
determined based on current market spread quotes from third-party investment
banks and is currently a significant unobservable input. Changes in
this input could have a material impact on our financial condition or results of
operations.
During
the second quarter of fiscal 2009, changes were made to certain key assumptions
used in measuring the fair value of retained interest. For a
discussion of the effects of these changes, see the “(Loss) Gain and Loans Sold”
section of CarMax Auto Finance Income in MD&A starting on page
30.
As the
key assumptions used in measuring the fair value of the retained interest
(including the retained subordinated bonds) are significant unobservable inputs,
retained interest is classified as a Level 3 asset in accordance with the SFAS
157 hierarchy. Retained interest represents 91.6% of the total assets
measured at fair value, as disclosed in Note 6.
FORWARD-LOOKING
STATEMENTS
We
caution readers that the statements contained in this report about our 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. We disclaim 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 general U.S. or regional U.S. economic
conditions.
|
§
|
Changes
in the availability or cost of capital and working capital financing,
including the availability and cost of long-term financing to support our
geographic expansion and the availability and cost of financing auto loans
receivable.
|
§
|
Changes
in consumer credit availability related to our third-party financing
providers.
|
§
|
Changes
in the competitive landscape within our
industry.
|
§
|
Significant
changes in retail prices for used and new
vehicles.
|
§
|
A
reduction in the availability or access to sources of
inventory.
|
§
|
Factors
related to the regulatory environment in which we
operate.
|
§
|
The
loss of key employees from our store, region and corporate management
teams.
|
§
|
The
failure of key information systems.
|
§
|
The
effect of new accounting requirements or changes to U.S. generally
accepted accounting principles.
|
§
|
Security
breaches or other events that result in the misappropriation, loss or
other unauthorized disclosure of confidential customer
information.
|
§
|
The
effect of various litigation
matters.
|
§
|
Our
inability to acquire or lease suitable real estate at favorable
terms.
|
§
|
The
occurrence of severe weather
events.
|
§
|
Factors
related to seasonal fluctuations in our
business.
|
§
|
Factors
related to the geographic concentration of our
superstores.
|
§
|
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 39 of this report, our Annual Report on Form 10-K for the
fiscal year ended February 29, 2008, and our quarterly or current reports as
filed with or furnished to the Securities and Exchange
Commission. Our filings are publicly available on our investor
information home page at investor.carmax.com. Requests for
information may also be made to our Investor Relations Department by email to
[email protected] or by calling 1-804-747-0422, ext.
4489.
ITEM
3.
QUANTITATIVE AND
QUALITATIVE
DISCLOSURES ABOUT
MARKET
RISK
Auto Loan
Receivables. As
of August 31, 2008, and February 29, 2008, all loans in our
portfolio of auto loan receivables were fixed-rate installment
loans. Financing for these auto loan receivables was achieved through
asset securitization programs that, in turn, issue both fixed- and floating-rate
securities. We manage the interest rate exposure relating to
floating-rate securitizations through the use of interest rate
swaps. Disruptions in the credit markets could impact the
effectiveness of our hedging strategies. 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, they could have a material impact on cash and cash
flows.
Credit
risk is the exposure to nonperformance of another party to an
agreement. We mitigate credit risk 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. Notes 5 and 6 provide additional information on
financial derivatives.
COMPOSITION
OF AUTO LOAN RECEIVABLES
(In
millions)
|
|
August
31, 2008
|
|
|
February
29, 2008
|
|
Principal
amount of:
|
|
|
|
|
|
|
Fixed-rate
securitizations
|
|
$ |
2,866.7 |
|
|
$ |
2,533.4 |
|
Floating-rate
securitizations synthetically altered
to fixed (1)
|
|
|
1,064.5 |
|
|
|
1,230.6 |
|
Floating-rate
securitizations
|
|
|
0.4 |
|
|
|
0.5 |
|
Loans
held for investment (2)
|
|
|
98.8 |
|
|
|
69.0 |
|
Loans
held for sale (3)
|
|
|
31.0 |
|
|
|
5.0 |
|
Total
|
|
$ |
4,061.4 |
|
|
$ |
3,838.5 |
|
(1)Includes
$464.8 million of variable-rate securities issued in connection with
certain term securitizations that were synthetically altered to fixed at
the bankruptcy-remote special purpose entity.
(2)The
majority is held by a bankruptcy-remote special purpose
entity.
(3)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 our 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
six months ended August 31, 2008.
ITEM
4.
CONTROLS AND
PROCEDURES
We
maintain 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 this information is accumulated and communicated to
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, we evaluated the effectiveness of the
design and operation of our disclosure controls. This evaluation was
performed under the supervision and with the participation of management,
including the CEO and CFO. Based upon that evaluation, the CEO and
CFO concluded that our disclosure controls were effective as of the end of the
period. There was no change in our internal control over financial
reporting that occurred during the quarter ended August 31, 2008, that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART
II. OTHER INFORMATION
Item
1.
|
Legal
Proceedings
|
On June
12, 2007, Ms. Regina Hankins filed a putative class action lawsuit against
CarMax, Inc., in Baltimore County Circuit Court, Maryland. We operate
five stores in the state of Maryland. The plaintiff alleges that,
since May 25, 2004, CarMax has not properly disclosed its vehicles’ prior rental
history, if any. The plaintiff seeks compensatory damages, punitive
damages, injunctive relief and the recovery of attorneys’ fees. We
have settled this matter, pending judicial approval.
On August
6, 2008, Mr. Peter Rangos filed a putative class action lawsuit against CarMax
Inc., certain CarMax officers and a CarMax director in the United States
District Court for the Eastern District of Virginia (Alexandria
Division). The plaintiff primarily alleges that the defendants
violated federal securities laws through the dissemination or approval of false
and misleading statements. The plaintiff seeks compensatory damages
and the recovery of attorneys’ fees.
We are
involved in various other legal proceedings in the normal course of
business. Based upon our evaluation of information currently available, we
believe that the ultimate resolution of any such proceedings will not have a
material adverse effect, either individually or in the aggregate, on our
financial condition or results of operations.
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 29, 2008,
should be considered. Additionally, we are subject to the risk set forth
below:
Third-Party
Financing Providers. CarMax provides financing to qualified customers
through CAF and a number of third-party financing providers. In the event that
one or more of these third-party providers could no longer provide financing to
our customers, could only provide financing to a reduced segment of our
customers or could no longer provide financing at competitive rates of interest,
it could have a material impact on our business, sales and results of
operations. Additionally, if we were unable to replace current
third-party financing providers upon the occurrence of one or more of the
foregoing events, it could also have a material impact on our business, sales
and results of operations.
The risks
included in the Form 10-K and as set forth above could materially and adversely
affect our business, financial condition, and results of
operations.
Other
than as set forth above, there have been no material changes to the factors
discussed in our Form 10-K.
Item
4.
|
Submission
of Matters to a Vote of Security
Holders
|
The
annual meeting of the company’s shareholders was held June 24,
2008. Information on the matters voted upon and the votes cast with
respect to each matter was previously reported in our Quarterly Report on Form
10-Q for the quarter ended May 31, 2008.
|
10.1
|
Amendment
No. 2 to the Credit Agreement and Joinder Agreement, dated July 17, 2008,
by and among CarMax, Inc., CarMax Auto Superstores, Inc., various
subsidiaries of CarMax, various Lenders named therein, and Bank of America
N.A., as Administrative Agent, filed as Exhibit 10.1 to CarMax’s Current
Report on Form 8-K, filed July 22, 2008 (File No. 1-1420), is incorporated
by this reference.
|
|
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.
|
SIGNATURES
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
|
October
9, 2008
EXHIBIT
INDEX
|
10.1
|
Amendment
No. 2 to the Credit Agreement and Joinder Agreement, dated July 17, 2008,
by and among CarMax, Inc., CarMax Auto Superstores, Inc., various
subsidiaries of CarMax, various Lenders named therein, and Bank of America
N.A., as Administrative Agent, filed as Exhibit 10.1 to CarMax’s Current
Report on Form 8-K, filed July 22, 2008 (File No. 1-1420), is incorporated
by this reference.
|
|
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 42 of
42