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CARMAX 10-K 2009 Documents found in this filing:
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
For
the fiscal year ended February 28, 2009
OR
Commission
File Number: 1-31420
CARMAX,
INC.
(Exact
name of registrant as specified in its charter)
Registrant’s
telephone number, including area code: (804) 747-0422
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes x
No ¨
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes ¨ No
x
1
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.
Yes x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes ¨ No x
The
aggregate market value of the registrant’s common stock held by non-affiliates
as of August 31, 2008, computed by reference to the closing price of the
registrant’s common stock on the New York Stock Exchange on that date, was $3.3
billion.
On March
31, 2009, there were 220,391,906 outstanding shares of CarMax, Inc. common
stock.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the CarMax, Inc. Notice of 2009 Annual Meeting of Shareholders and Proxy
Statement are incorporated by reference in Part III of this Form
10-K.
2
FORM
10-K
FOR
FISCAL YEAR ENDED FEBRUARY 28, 2009
TABLE
OF CONTENTS
3
PART
I
In this
document, “we,” “our,” “us,” “CarMax” and “the company” refer to CarMax, Inc.
and its wholly owned subsidiaries, unless the context requires
otherwise.
FORWARD-LOOKING
AND CAUTIONARY STATEMENTS
This
Annual Report on Form 10-K and, in particular, the description of our business
set forth in Item 1 and our Management’s Discussion and Analysis of Financial
Condition and Results of Operations set forth in Item 7 contain a number of
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including
statements regarding:
In
addition, any statements contained in or incorporated by reference into this
report that are not statements of historical fact should be considered
forward-looking statements. You can identify these forward-looking
statements by use of words such as “anticipate,” “believe,” “could,” “estimate,”
“expect,” “intend,” “may,” “plan,” “predict,” “should,” “will” and other similar
expressions, whether in the negative or affirmative. We cannot
guarantee that we will achieve the plans, intentions or expectations disclosed
in the forward-looking statements. There are a number of important
risks and uncertainties that could cause actual results to differ materially
from those indicated by our forward-looking statements. These risks
and uncertainties include, without limitation, those set forth in Item 1A under
the heading “Risk Factors.” We caution investors not to place undue
reliance on any forward-looking statements as these statements speak only as of
the date when made. We undertake no obligation to update any
forward-looking statements made in this report.
Item
1. Business.
BUSINESS
OVERVIEW
CarMax
Background.> CarMax, Inc. was incorporated under the laws of
the Commonwealth of Virginia in 1996. CarMax, Inc. is a holding
company and our operations are conducted through our
subsidiaries. Our home office is located at 12800 Tuckahoe Creek
Parkway, Richmond, Virginia.
Under the
ownership of Circuit City Stores, Inc. (“Circuit City”), we began operations in
1993 with the opening of our first CarMax superstore in Richmond,
Virginia. In 1997, Circuit City completed the initial public offering
of a tracking stock, Circuit City Stores, Inc.–CarMax Group common stock, which
was intended to track separately the performance of the CarMax
operations. On October 1, 2002, the CarMax business was separated
from Circuit City through a tax-free transaction, becoming an independent,
separately traded public company.
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. The CarMax
consumer offer provides customers the opportunity to shop for vehicles the same
way they shop for items at other “big-box” retailers, and it is structured
around four customer benefits: low, no-haggle prices; a broad selection; high
quality vehicles; and a customer-friendly sales process. 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.
4
We
purchase, recondition and sell used vehicles. All of the used
vehicles we retail are thoroughly reconditioned to meet high mechanical,
electrical, safety and cosmetic standards, and each vehicle must pass a
comprehensive inspection before being offered for sale. Approximately
85% of the used vehicles we retail are 1 to 6 years old with fewer than 60,000
miles. We also offer a selection of used vehicles at each superstore
that are more than 6 years old or have more than 60,000 miles, if they meet
similar quality standards.
We also
sell new vehicles at five locations under franchise agreements with four new car
manufacturers (Chrysler, General Motors, Nissan and Toyota). In
fiscal 2009, new vehicles comprised 3% of our total retail vehicle unit
sales.
We
provide customers with a full range of related products and services, including
the financing of vehicle purchases through CarMax Auto Finance (“CAF”), our own
finance operation, and third-party financing providers; the sale of extended
service plans and accessories; the appraisal and purchase of vehicles directly
from consumers; and vehicle repair service.
The
CarMax consumer offer enables customers to evaluate separately each component of
the sales process and to make informed decisions based on comprehensive
information about the options, terms and associated prices of each
component. The customer can accept or decline any individual element
of the offer without affecting the price or terms of any other component of the
offer. Our no-haggle pricing and our commission structure, which is
generally based on a fixed dollars-per-unit standard, allow sales consultants to
focus solely on meeting customer needs.
We have
separated the practice of trading in a used vehicle in conjunction with the
purchase of another vehicle into two distinct and independent
transactions. We will appraise a consumer’s vehicle and make an offer
to buy that vehicle regardless of whether the owner is purchasing a vehicle from
us. Historically, we have acquired the majority of our retail used
vehicle inventory through this unique in-store appraisal process. We
also acquire a significant portion of our used vehicle inventory through
wholesale auctions and, to a lesser extent, directly from other sources,
including wholesalers, dealers and fleet owners. Vehicles purchased
through our in-store appraisal process that do not meet our retail standards are
sold to licensed dealers through on-site wholesale auctions.
Our
inventory management and pricing system tracks each vehicle throughout the sales
process. Using the information provided by this system and applying
statistical modeling techniques, we are able to optimize our inventory mix,
anticipate future inventory needs at each store, evaluate sales consultant and
buyer performance and refine our vehicle pricing strategy. Because of
the pricing discipline afforded by the inventory management and pricing system,
more than 99% of the entire used car inventory offered at retail is sold at
retail.
Based on
industry data, there were more than 36 million used cars sold in the U.S. in
calendar year 2008, of which approximately 16 million were estimated to be
late-model, 1 to 6 year old vehicles. While we are the
largest retailer of used vehicles in the U.S., selling nearly twice as many used
vehicles as the next largest retailer in calendar 2008, we still represented
only approximately 2% of the total late-model used units sold. Over
the last several years, competition has been affected by the increasing use of
Internet-based marketing for both used vehicles and vehicle
financing. In both the used and new vehicle markets, we seek to
distinguish ourselves from traditional dealerships through our consumer offer,
sales approach and other innovative operating strategies.
We
believe that our principal competitive advantages in used vehicle retailing are
our ability to provide a high degree of customer satisfaction with the
car-buying experience; our competitively low prices; our breadth of selection of
the most popular makes and models available both on site and via our website,
carmax.com; the quality of our vehicles; our proprietary information systems;
and the locations of our retail stores. Upon request by a customer,
we will transfer virtually any used vehicle in our nationwide inventory to a
local superstore. Transfer fees may apply, depending on the distance
the vehicle needs to travel. In fiscal 2009, nearly 25% of our
vehicles sold were transferred at customer request. Our
5
Certified
Quality Inspection assures that every vehicle we offer for sale meets stringent
mechanical, electrical and safety standards. We back every vehicle
with a 5-day, money-back guarantee and at least a 30-day limited
warranty. Other competitive advantages include our ability to offer
or arrange customer financing with competitive terms and the comprehensiveness
and cost of the extended service plans we offer. We believe that we
are competitive in all of these areas and that we enjoy advantages over
competitors that employ traditional high-pressure, negotiation-oriented sales
techniques.
Our sales
consultants play a significant role in ensuring a customer-friendly sales
process. A sales consultant is paid a commission based on a fixed
dollars-per-unit standard, thereby earning the same dollar sales commission
regardless of the gross profit on the vehicle being sold. The sales
consultant normally receives no commission on the finance
process. This ensures that the sales consultant’s primary objective
is helping customers find the right vehicles for their needs at prices they can
afford. In contrast, sales and finance personnel at traditional
dealerships typically receive higher commissions for negotiating higher prices
and interest rates, and for steering customers toward vehicles with higher gross
profit.
In the
new vehicle market, we compete with other franchised
dealers. Historically, the new vehicle market has been served
primarily by dealerships employing traditional automotive selling
methods. We believe our customer-friendly, low-pressure sales methods
are points of competitive differentiation.
In our
wholesale auctions, we compete with other automotive auction
houses. We believe our principal competitive advantages include our
high vehicle sales rate, our conditional announcement and arbitration policies,
our broad geographic distribution and our dealer-friendly
practices. Because we own the cars that we auction, we generally sell
between 97% and 100% of the vehicles offered, which is substantially higher than
the sales rate at most other auto auctions. Our policy of making
conditional announcements, noting mechanical and other issues found during our
appraisal process, is also not a typical practice used at other auctions of
older, higher mileage vehicles. Together, these factors make our
auctions attractive to dealers, and they allow us to achieve a dealer-to-car
attendance ratio that is much higher than the typical auto auction.
We
continue to adjust our marketing programs in response to the evolving media
landscape. We have customized our marketing program based on
awareness levels in each market. In many markets, we have expanded
the use of Internet-based advertising while curtailing the use of newspaper
advertising. We are building awareness and driving traffic to our
stores and carmax.com by listing every retail vehicle on both AutoTrader.com and
cars.com. Through their syndicated networks, AutoTrader.com and
cars.com vehicle listings appear on sites that we believe are visited by a
majority of buyers of late-model used vehicles who use the Internet in their
shopping process. Our advertising on the Internet also includes
banner and keyword advertisements on search engines, such as Google and
Yahoo!
Our
website, carmax.com, is a marketing tool for communicating the CarMax consumer
offer in detail, a sophisticated search engine for finding the right vehicle and
a sales channel for customers who prefer to complete a part of the shopping and
sales process online. The website offers complete inventory and
pricing search capabilities. Information on each of the thousands of
cars available in our nationwide inventory is updated
daily. Carmax.com includes detailed information, such as vehicle
photos, prices, features, specifications and store locations, as well as
advanced feature-based search capabilities, and sorting and comparison tools
that allow consumers to easily compare vehicles. The site also
includes features such as detailed vehicle reviews, payment calculators and
email alerts when new inventory arrives. Virtually any used vehicle
in our nationwide inventory can be transferred at customer request to their
local superstore. Customers can contact sales consultants online via
carmax.com, by telephone or by fax. Customers can work with these
sales consultants from the comfort of home, including applying for financing,
and they need to visit the store only to sign the paperwork and pay for and pick
up their vehicle. Our survey data indicates that during fiscal 2009, more than
70% of customers who purchased a vehicle from us had visited our website
first.
6
Our used
vehicle inventory acquired directly from consumers through our appraisal process
helps provide an inventory of makes and models that reflects the tastes of each
market. In fiscal 2007, we began testing a stand-alone car-buying
center in Atlanta, Georgia. Our goal for the car-buying center was to
increase appraisal traffic and generate incremental vehicle purchases from
individual consumers. We expanded this test in fiscal 2008 and fiscal
2009, and we operated a total of five car-buying centers as of February 28,
2009.
We have
replaced the traditional “trade-in” transaction with a process in which a
CarMax-trained buyer appraises a customer’s vehicle and provides the owner with
a written, guaranteed offer that is good for seven days. An appraisal is
available to every customer free of charge, whether or not the customer
purchases a vehicle from us. Based on their age, mileage or
condition, fewer than half of the vehicles acquired through this in-store
appraisal process meet our high quality retail standards. Those
vehicles that do not meet our retail standards are sold to licensed dealers
through on-site wholesale auctions.
The
inventory purchasing function is primarily performed at the store level and is
the responsibility of the buyers, who handle both on-site appraisals and
off-site auction purchases. Our buyers evaluate all used vehicles
based on internal and external auction data and market sales, as well as
estimated reconditioning costs and, for off-site purchases, transportation
costs. Our buyers, in collaboration with our home office staff,
utilize the extensive inventory and sales trend data available through the
CarMax information system to decide which inventory to purchase at off-site
auctions. Our inventory and pricing models help the buyers tailor
inventories to the buying preferences at each superstore, recommend pricing
adjustments and optimize inventory turnover to help maintain gross profit per
unit.
Based on
consumer acceptance of the in-store appraisal process, our experience and
success to date in acquiring vehicles from auctions and other sources, and the
large size of the U.S. auction market relative to our needs, we believe that
sources of used vehicles will continue to be sufficient to meet our current and
future needs.
Products
and Services
7
We have
implemented an everyday low-price strategy under which we set no-haggle prices
on both our used and new vehicles. We believe that our pricing is
competitive with the best-negotiated prices in the market. Prices on
all vehicles are clearly displayed on each vehicle’s information sticker; on
carmax.com, AutoTrader.com and cars.com; and, where applicable, in our newspaper
advertising. We extend our no-haggle philosophy to every component of
the vehicle transaction, including vehicle appraisal offers, financing rates,
accessories, extended service plan pricing and vehicle documentation
fees.
All
CarMax used car superstores provide vehicle repair service including repairs of
vehicles covered by our extended service plans. We also provide
factory-authorized service at all new car franchises. We have
developed systems and procedures that are intended to ensure that our retail
repair service is conducted in the same customer-friendly and efficient manner
as our other operations.
We
believe that the efficiency of our reconditioning and service operations is
enhanced by our modern facilities, a technician mentoring process and our
information systems. The mentoring process and our compensation
programs are designed to increase the productivity of technicians, identify
opportunities for cost reduction and achieve high-quality
repairs. Our information systems provide the ability to track repair
history and enable trend analysis, which serves as guidance for our continuous
improvement efforts.
Customers
applying for financing provide credit information that is electronically
submitted by sales consultants through our proprietary information
system. A majority of applicants receive a response within five
minutes. The vehicle financings are retail installment contracts
secured by the vehicles financed. For the majority of the loans
arranged by the third-party providers, we are paid a fixed, prenegotiated fee
per vehicle financed. We have no recourse liability on retail
installment contracts arranged with third-party providers. Customers
are permitted to refinance or pay off their loans within three business days of
a purchase without incurring any finance or related
charges.
8
model and
the length of coverage selected. All extended service plans that we
sell (other than manufacturer programs) have been designed to our specifications
and are administered by the third parties through private-label
arrangements. We receive a commission from the administrator at the
time the extended service plan is sold. In fiscal 2009, more
than half of the customers purchasing a used vehicle from CarMax also purchased
an extended service plan.
Our
extended service plan customers have access to vehicle repair service at each
CarMax store and to the third-party administrators’ nationwide network
consisting of thousands of independent and franchised service
providers. We believe that the quality of the services provided by
this network, as well as the broad scope of our extended service plans, helps
promote customer satisfaction and loyalty, and thus increases the likelihood of
repeat and referral business.
Systems
Our
stores are supported by an advanced information system that improves the
customer experience while providing tightly integrated automation of all
operating functions. Using in-store information kiosks, customers can
search our entire vehicle inventory and print a detailed listing for any
vehicle, which includes the vehicle’s features and specifications and its
location on the display lot. Our inventory management system tracks
every vehicle through its life from purchase through reconditioning and
test-drives to ultimate sale. Bar codes are placed on each vehicle
and on each parking space on the display lot, and all vehicle bar codes are
scanned daily as a loss prevention measure. Test-drive information is
captured on every vehicle using radio frequency identification devices, linking
the specific vehicle and the sales consultant. We also capture data
on vehicles we wholesale, which helps us track market pricing. An
online finance application process and computer-assisted document preparation
ensure rapid completion of the sales transaction. Behind the scenes,
our proprietary store technology provides our management with real-time
information about every aspect of store operations, such as inventory
management, pricing, vehicle transfers, wholesale auctions and sales consultant
productivity. In addition, our store system provides a direct link to our
proprietary credit processing information system to facilitate the credit review
and approval process.
Our
inventory management and pricing system allows us to buy the mix of makes,
models, age, mileage and price points tailored to customer buying preferences at
each superstore. This system also generates recommended initial
retail price points, as well as retail price markdowns for specific vehicles
based on complex algorithms that take into account factors including sales
history, consumer interest and seasonal patterns. We believe this
systematic approach to vehicle pricing allows us to optimize inventory turns,
which minimizes the depreciation risk inherent in used cars and helps us to
achieve our targeted gross profit dollars per unit.
In
addition to inventory management, our Electronic Repair Order system (“ERO”) is
used by the service department to sequence reconditioning
procedures. ERO provides information that helps increase quality and
reduce costs, which further enhances our customer service and
profitability.
Through
our centralized systems, we are able to immediately integrate new stores into
our store network, allowing the new stores to rapidly achieve operating
efficiency. We continue to enhance and refine our information
systems, which we believe to be a core competitive advantage. The
design of our information systems incorporates off-site backups, redundant
processing and other measures to reduce the risk of significant data loss in the
event of an emergency or disaster.
Associates
On
February 28, 2009, we had a total of 13,035 associates, including 10,101
hourly and salaried associates and 2,934 sales associates, who worked on a
commission basis. Sales consultants include both full-time and
part-time employees. We employ additional associates during peak
selling seasons. As of February 28, 2009, our location general
managers averaged more than nine years of CarMax experience, in addition to
prior retail management experience. We open new stores with
experienced management teams drawn from existing stores.
We
believe we have created a unique corporate culture and maintain good employee
relations. No associate is subject to a collective bargaining agreement. We
focus on providing our associates with the information and resources they need
to offer exceptional customer service. We reward associates whose
behavior exemplifies our culture, and we believe that our favorable working
conditions and compensation programs allow us to attract and retain highly
qualified individuals. We have been recognized for the success of our
efforts by a number of external organizations.
9
We also
provide comprehensive, facilitator-led classroom training courses to sales
consultants, buyers, automotive technicians and managers. All sales
consultants receive extensive customer service training both initially and on an
ongoing basis. Buyers-in-training undergo a 6- to 18-month
apprenticeship under the supervision of experienced buyers, and they generally
will assist with the appraisal of more than 1,000 cars before making their first
independent purchase. We utilize a mix of internal and external
technical training programs in an effort to provide a stable future supply of
qualified technicians. Reconditioning and mechanical technicians
attend in-house and vendor-sponsored training programs designed to develop their
skills in performing repairs on the diverse makes and models of vehicles we
sell. Technicians at our new car franchises also attend
manufacturer-sponsored training programs to stay abreast of current diagnostic,
repair and maintenance techniques for those manufacturers’
vehicles. Additionally, our new managers attend an intensive
week-long workshop at the home office where they meet with senior leaders and
learn fundamental CarMax management skills.
Laws
and Regulations
Claims
arising out of actual or alleged violations of law could be asserted against us
by individuals or governmental authorities and could expose us to significant
damages or other penalties, including revocation or suspension of the licenses necessary to conduct business and
fines.
Our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and proxy statements on Schedule 14A, as well as any amendments to
those reports, are available without charge through our website, carmax.com, as
soon as reasonably practicable after filing or furnishing the material to the
Securities and Exchange Commission (“SEC”). The contents of our
website are not, however, part of this report.
In
addition, our Corporate Governance Guidelines and Code of Business Conduct, as
well as the charters of the Audit Committee, Nominating and Governance Committee
and Compensation and Personnel Committee, are available to shareholders and the
public through the “Corporate Governance” link on our investor information home
page at investor.carmax.com. Printed copies of these documents are
available to any shareholder, without charge, upon written request to our
corporate secretary at the address set forth on the cover page of this
report. Any changes to these documents or reportable waivers of the
Code of Business Conduct are promptly disclosed on our website.
10
Item
1A. Risk Factors.
We are
subject to various risks, including the risks described below. Our
business, results of operations and financial condition could be materially and
adversely affected by any of these risks or additional risks not presently known
or that we currently deem immaterial.
We use
and have historically relied upon a securitization program to fund substantially
all of the auto loan receivables originated by CAF. Initially, we
sell these receivables into our warehouse facility. We periodically
refinance the receivables through term securitizations. Changes in
the condition of the asset-backed securitization market have led, and could in
the future lead, us to incur higher costs to access funds in this market or we
could be required to seek alternative means to finance our loan
originations. In the event that this market ceased to exist and there
were no immediate alternative funding sources available, we might be forced to
curtail our lending practices for some period of time. The impact of
reducing or curtailing CAF’s loan originations could have a material adverse
impact on our business, sales and results of operations.
Disruptions
in the capital and credit markets could adversely affect our ability to draw on
our revolving credit facility. If our ability to secure funds from the facility
were significantly impaired, our access to working capital would be impacted,
our ability to maintain appropriate inventory levels could be affected and these
conditions could have a material adverse effect on our business, sales, results
of operations and financial condition.
11
The U.S.
Congress is considering and may adopt various forms of legislation designed to
spur automobile sales through the use of purchase vouchers, tax credits and mass
transit reimbursements. Depending on the legislation that is adopted,
if any, these incentives may only be available to consumers who purchase new
vehicles or vehicles achieving high fuel-efficiency standards. If
these incentives are limited solely to purchasers of new vehicles, or if we are
unable to maintain an inventory of vehicles achieving the mandated
fuel-efficiency standards, these conditions could have a material adverse effect
on our business, sales, results of operations and financial
condition.
Additionally,
the Financial Accounting Standards Board is currently considering various
proposed rule changes including, but not limited to, changes relating to the
accounting for securitization transactions and potential changes in accounting
for leases. The SEC is currently considering adopting rules that
would require U.S. issuers to prepare their financial statements contained in
SEC filings in accordance with International Financial Reporting Standards
(“IFRS”), as issued by the International Accounting Standards
Board. The implementation of these or other new accounting
requirements or changes to U.S. generally accepted accounting principles could
adversely affect our reported results of operations and financial
condition.
12
Other Material
Events.> The occurrence of certain material events including
acts of terrorism, the outbreak of war or other significant national or
international events could adversely affect our business, results of operations
or financial condition. 13
Item
1B. Unresolved Staff Comments.
None.
Item
2. Properties.
We
conduct our used vehicle operations in two basic retail formats – production and
non-production superstores. Production superstores are those
locations at which vehicle reconditioning is performed, while non-production
superstores do not perform vehicle reconditioning. In determining
whether to construct a production or a non-production superstore on a given
site, we take several factors into account, including the anticipated long-term
reconditioning needs and the available acreage of this and other sites in that
market. As a result, some superstores that are constructed to
accommodate reconditioning activities may initially be operated as
non-production superstores until we expand our presence in that
market. As of February 28, 2009, we operated 59 production
superstores and 41 non-production superstores. At that date, we also
operated one new car store, which was located adjacent to our used car
superstore in Laurel, Maryland. Our remaining five new car franchises
are operated as part of our used car superstores.
Production
superstores are generally 40,000 to 60,000 square feet on 10 to 25 acres, but a
few range from approximately 70,000 to 95,000 square feet on 20 to 35
acres. Non-production superstores are generally 10,000 to 25,000
square feet on 4 to 12 acres.
Used
Car Superstores as of February 28, 2009
We have
financed the majority of our stores through sale-leaseback
transactions. As of February 28, 2009, we leased 59 of our
100 used car superstores. We owned the remaining 41 stores
currently in operation and the three superstores that have been substantially
completed, but which will not be opened until market conditions
improve. We also own our home office building in Richmond, Virginia,
and land associated with planned future store openings.
14
Expansion
For the
last several years, we expanded our store base by approximately 15%
annually. In August 2008, we announced that we would temporarily slow
our store growth as a result of the weak economic and sales
environment. In December 2008, following further deterioration in
market conditions, we announced a temporary suspension in store
growth. At that time, we had four stores under construction that we
had originally planned to open in fiscal 2009, including stores in Potomac
Mills, Virginia; Augusta, Georgia; Cincinnati, Ohio; and Dayton,
Ohio. We only opened the Potomac Mills store in our well-established
Washington, D.C. market. The remaining three stores were
substantially completed at the end of fiscal 2009 and are in markets where
CarMax does not already have a presence, and given the resulting low consumer
awareness of our business model, we chose not to open these stores until market
conditions improve.
We
continue to believe that we are well positioned to succeed in the highly
competitive automotive retail industry. We have built a strong
foundation for future growth based upon our unique knowledge of the used car
market, established presence in key locations and ability to execute our
business plan in a market subject to continuous change. We continue
to refine our operating strategies and have grown to be the nation’s largest
retailer of used cars.
For
additional details on fiscal 2010, see “Operations Outlook,” included in Part
II, Item 7, of this Form 10-K.
Item 3. Legal
Proceedings.
On April
2, 2008, Mr. John Fowler filed a putative class action lawsuit against CarMax
Auto Superstores California, LLC and CarMax Auto Superstores West Coast, Inc. in
the Superior Court of California, County of Los
Angeles. Subsequently, two other lawsuits, Leena Areso et al.
v. CarMax Auto Superstores California, LLC and Justin Weaver v. CarMax Auto
Superstores California, LLC, were consolidated as part of the Fowler case. The
allegations in the consolidated case involve: (1) failure to provide meal and
rest breaks or compensation in lieu thereof; (2) failure to pay wages of
terminated or resigned employees related to meal and rest breaks and overtime;
(3) failure to pay overtime; (4) failure to comply with itemized employee wage
statement provisions; and (5) unfair competition. The putative class
consists of sales consultants, sales managers, and other hourly employees who
worked for the company in California from April 2, 2004, to the
present. The lawsuit seeks compensatory and special damages, wages,
interest, civil and statutory penalties, restitution, injunctive relief and the
recovery of attorneys’ fees. We are unable to make a reasonable
estimate of the amount or range of loss that could result from an unfavorable
outcome in this matter.
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.
No
matters were submitted to a vote of security holders during the fourth quarter
of fiscal 2009.
15
PART
II
Item
5. Market for the Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
Our
common stock is listed and traded on the New York Stock Exchange under the
ticker symbol KMX.
As of
February 28, 2009, there were approximately 7,000 CarMax shareholders of
record.
The
following table sets forth for the fiscal periods indicated, the high and low
sales prices per share for our common stock, as reported on the New York Stock
Exchange composite tape and adjusted for the effect of the 2-for-1 stock split
in March 2007.
To date,
we have not paid a cash dividend on CarMax common stock. In the near
term, we believe it is prudent to retain our net earnings for use in operations
and to maintain maximum financial flexibility and liquidity for our
business. Longer term, we intend to continue to retain our net
earnings for use in operations and, when we resume our store growth plan, for
geographic expansion. Therefore, we do not anticipate paying any cash
dividends in the foreseeable future.
During
the fourth quarter of fiscal 2009, we sold no CarMax equity securities that were
not registered under the Securities Act of 1933, as amended. In
addition, we did not repurchase any CarMax equity securities during this
period.
Performance
Graph
The
following graph compares the five-year cumulative total return among CarMax
common stock, the S&P 500 Index and the S&P 500 Retailing
Index. The graph assumes an original investment of $100 in our common
stock and in each index on February 28, 2004, and the reinvestment of dividends,
if applicable.
16
17
Item
6. Selected Financial Data.
18
Item
7. 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 consolidated financial statements and the
accompanying notes presented in Item 8, Consolidated Financial Statements and
Supplementary Data. Note references are to the notes to consolidated
financial statements included in Item 8. Amounts and percentages in
tables may not total due to rounding. Certain prior year amounts have
been reclassified to conform to the current year’s presentation. All
share and per share amounts for prior periods have been adjusted to reflect our
2-for-1 common stock split in March 2007.
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 February 28, 2009, we operated 100 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. In fiscal
2009, we sold 345,465 used cars, representing 97% of the total 356,549 vehicles
we sold at retail.
We
believe the CarMax consumer offer is distinctive within the auto 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 February 28, 2009, we conducted auctions at 49 used
car superstores. During fiscal 2009, we sold 194,081 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. As of February 28, 2009, these third parties included Bank
of America Dealer Financial Services, Capital One Auto Finance, CitiFinancial
Auto, Santander Consumer USA, Wachovia Dealer Services and Wells Fargo
Auto. 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. As of February 28, 2009, the used vehicle third-party ESP
providers were CNA National Warranty Corporation and The Warranty
Group. 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.
Over the
long term, we believe the primary driver for 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 primarily based
on the vehicle’s selling price.
19
We are
still at a relatively early stage in the national rollout of our retail concept,
and as of February 28, 2009, we had used car superstores located in markets that
comprised approximately 45% of the U.S. population. Prior to August
2008, we had planned to open used car superstores at a rate of approximately 15%
of our used car superstore base each year. In August 2008, we
announced that we would temporarily slow our store growth as a result of the
weak economic and sales environment. In December 2008, following
further deterioration in market conditions we announced a temporary suspension
in store growth. We believe this suspension will reduce our capital
needs and improve profitability.
In the
near term, our principal challenges are related to the recession, which caused a
dramatic decline in industry-wide auto sales, and the disruption of the
asset-backed securitization market, which historically has been used to provide
funding for CAF loan originations. In fiscal 2009, we experienced a
large decline in customer traffic, which led to significant reductions in our
sales and gross profits and caused the deleveraging of our selling, general and
administrative expenses. A decline in investor interest in
asset-backed securities caused us to slow CAF’s share of originations in the
second half of fiscal 2009, in an effort to slow the utilization of our
warehouse facility.
Longer
term, when economic conditions improve and we resume geographic growth, we
believe the principal challenges we face will include our ability to build our
management bench strength to support the store growth and our ability to procure
suitable real estate at reasonable costs. We staff each newly opened
store with an experienced management team. Therefore, when we are
expanding our store base, we must recruit, train and develop managers and
associates to fill the pipeline necessary to support future store
openings.
Fiscal
2009 Highlights
20
CRITICAL
ACCOUNTING POLICIES
Our
results of operations and financial condition as reflected in the consolidated
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles. Preparation of financial statements
requires management to make estimates and assumptions affecting the reported
amounts of assets, liabilities, revenues, expenses and the disclosures of
contingent assets and liabilities. We use our historical experience
and other relevant factors when developing our estimates and
assumptions. We continually evaluate these estimates and
assumptions. Note 2 includes a discussion of significant accounting
policies. The accounting policies discussed below are the ones we
consider critical to an understanding of our consolidated financial statements
because their application places the most significant demands on our
judgment. Our financial results might have been different if
different assumptions had been used or other conditions had
prevailed.
Securitization
Transactions
We use a
securitization program to fund substantially all of the auto loan receivables
originated by CAF. The securitization transactions are accounted for
as sales. A gain, recorded at the time of the securitization
transaction, results from recording a receivable equal to the present value of
the residual cash flows we expect to receive over the life of the securitized
receivables. The fair value of our retained interest in
securitization transactions includes the present value of the residual cash
flows we expect to receive over the life of the securitized receivables, reserve
accounts, an undivided ownership interest in certain receivables and retained
subordinated bonds.
The
present value of the residual cash flows we expect to receive over the life of
the securitized 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. These assumptions are derived from historical
experience and projected economic trends. Adjustments to one or more
of these assumptions could have a material impact on the fair value of the
retained interest. The fair value of the retained interest could also
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 and credit markets. Note 2(C) includes a discussion of
accounting policies related to securitizations. Note 4 includes a
discussion of securitizations and provides a sensitivity analysis showing the
hypothetical effect on the retained interest if there were variations from the
assumptions used. Note 6 includes a discussion on fair value
measurements. In addition, see the “CarMax Auto Finance Income”
section of this MD&A for a discussion of the effect of changes in our
assumptions.
Revenue
Recognition
We
recognize revenue when the earnings process is complete, generally either at the
time of sale to a customer or upon delivery to a customer. We
recognize used vehicle revenue when a sales contract has been executed and the
vehicle has been delivered, net of a reserve for returns under our 5-day,
money-back guarantee. A reserve for vehicle returns is recorded based
on historical experience and trends, and it could be affected if future vehicle
returns differ from historical averages.
We also
sell ESPs on behalf of unrelated third parties to customers who purchase a
vehicle. Because we are not the primary obligor under these service
plans, we recognize commission revenue on the ESPs at the time of sale, net of a
reserve for returns. The reserve for ESP cancellations is recorded
based on historical experience and trends, and it could be affected if future
ESP cancellations differ from historical averages.
Income
Taxes
Estimates
and judgments are used in the calculation of certain tax liabilities and in the
determination of the recoverability of certain deferred tax
assets. In the ordinary course of business, transactions occur for
which the ultimate tax outcome is uncertain at the time of the
transactions. We adjust our income tax provision in the period in
which we determine that it is probable that our actual results will differ from
our estimates. Tax law and rate changes are reflected in the income
tax provision in the period in which such changes are enacted. Note 8
includes information regarding income taxes.
We
evaluate the need to record valuation allowances that would reduce deferred tax
assets to the amount that will more likely than not be realized. When
assessing the need for valuation allowances, we consider available carrybacks,
future reversals of existing temporary differences and future taxable
income. Except for a valuation allowance recorded for a capital loss
carryforward that may not be utilized before its expiration, we believe that our
recorded deferred tax assets as of February 28, 2009, will more likely than not
be realized. However, if a change in circumstances results in a
change in our ability to realize our deferred tax assets, our tax provision
would increase in the period when the change in circumstances
occurs.
21
In
addition, the calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. We
recognize potential liabilities for anticipated tax audit issues in the U.S. and
other tax jurisdictions based on our estimate of whether, and the extent to
which, additional taxes will be due. If payments of these amounts
ultimately prove to be unnecessary, the reversal of the liabilities would result
in tax benefits being recognized in the period when we determine the liabilities
are no longer necessary. If our estimate of tax liabilities proves to
be less than the ultimate assessment, a further charge to expense would result
in the period of determination.
Defined
Benefit Retirement Plan
The plan
obligations and related assets of our defined benefit retirement plan are
presented in Note 9. Plan assets, which consist primarily of
marketable equity and debt instruments, are valued using current market
quotations. Plan obligations and the annual pension expense are
determined by independent actuaries using a number of assumptions that we
provide. Key assumptions used to measure the plan obligations include
the discount rate, the rate of compensation increases, the future return on plan
assets and the mortality rate. In determining the discount rate, we
use the current yield on high-quality, fixed-income debt instruments that have
maturities that approximate the expected timing of the anticipated benefit
payments. Compensation increase assumptions for periods prior to
December 31, 2008, were based upon our historical experience and anticipated
future board and management actions. Asset returns are estimated
based upon the anticipated average yield on the plan
assets. Effective December 31, 2008, we froze the benefits under the
plan, and no additional benefits will accrue to participants after that
date. Other than the effects of the plan freeze, we do not believe
that any significant changes in assumptions used to measure the plan obligations
are likely to occur that would have a material impact on our financial position
or results of operations.
RESULTS
OF OPERATIONS
Net
Sales and Operating Revenues
Retail
Vehicle Sales Changes
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. 22
Comparable
Store Retail Vehicle Sales Changes
Change
in Used Car Superstore Base
During
fiscal 2009, we opened 11 used car superstores, expanding our presence in 5
existing markets and opening stores in 5 new markets, including Huntsville,
Alabama; Phoenix, Arizona (2 stores opened); Colorado Springs, Colorado; Tulsa,
Oklahoma; and Charleston, South Carolina.
Used
Vehicle Sales
Fiscal 2009
Versus Fiscal 2008. Our 14% decrease in used vehicle revenues
in fiscal 2009 resulted from the combination of an 8% decline in unit sales and
a 6% decrease in average retail selling price. The decline in unit
sales reflected a 16% decrease in comparable store used units, partially offset
by sales from newer superstores not yet in the comparable store
base. The decrease in the average retail selling price was primarily
caused by a significant industry-wide drop in used car prices during the first
three quarters of the year, which reduced our inventory acquisition
costs. Early in fiscal 2009, the steep increase in the cost of
gasoline caused a temporary shift in consumer demand away from SUVs and trucks,
toward more fuel-efficient vehicles. However, in the latter half of
fiscal 2009, the combination of the decline in gasoline prices and the lower,
more affordable prices for these less fuel-efficient vehicles caused our sales
mix to return to the prior year levels.
We began
to see the initial effects of the slowdown in the automotive retail market in
the latter part of fiscal 2008. However, the weakness in the economy
and the stresses on consumer spending accelerated in fiscal 2009, causing
customer traffic to decline sharply starting in late May 2008. These
stresses included rising unemployment rates, decreases in home equity values and
personal wealth, and record low levels of consumer confidence. For
the year, the decline in customer traffic was slightly greater than the decrease
in comparable store unit sales. Despite the more difficult
environment, the solid execution by our store teams allowed us to modestly
improve our conversion rate compared with fiscal 2008. While both CAF
and our third-party providers tightened lending criteria for some higher-risk
customer segments, lack of credit availability was not a major contributor to
the reduction in sales. Our data for the year indicated that we
modestly gained market share in the late-model used vehicle market in fiscal
2009.
Fiscal 2008
Versus Fiscal 2007. The 12% increase in our used vehicle
revenues in fiscal 2008 resulted from a corresponding increase in unit
sales. The unit sales growth reflected sales from newer superstores
not yet included in the comparable store base and a 3% increase in comparable
store used units. This 3% increase in comparable store used units in
fiscal 2008 reflected the challenging comparison with the 9% increase in fiscal
2007, as well as declining consumer confidence in the latter part of fiscal
2008. Our average used vehicle selling price in fiscal 2008 was
similar to the prior year, as consumer-driven mix shifts from large and
mid-sized SUVs to smaller, more fuel-efficient vehicles in the latter half of
the year offset normal price inflation.
23
In fiscal
2008, we experienced an overall increase in consumer traffic, which we believe
was a benefit of the strength of our consumer offer, as well as a favorable
response to improvements made to carmax.com. However, compared with
fiscal 2007, our sales conversion rate declined slightly as consumers appeared
to be somewhat more hesitant in committing to big-ticket
purchases. Sales continued to be supported by the consistent
availability of credit from CAF and from third-party financing
providers. Despite the deceleration in automotive industry sales, our
data indicated that we continued to gain share within our existing markets in
fiscal 2008 in the late-model used vehicle market.
New
Vehicle Sales
Fiscal 2009
Versus Fiscal 2008. New vehicle revenues declined 29% in
fiscal 2009. The decline was the result of a 28% decrease in unit
sales and a 1% decrease in average selling price. New vehicle unit
sales primarily reflected the extremely soft new car industry sales trends, as
well as the sale of our Orlando Chrysler-Jeep-Dodge franchise in the second
quarter of fiscal 2008. For the fiscal year ended February 28, 2009,
new car manufacturers reported a 23% decline in U.S. new car unit
sales.
Fiscal 2008
Versus Fiscal 2007. The 17% decrease in new vehicle revenues
in fiscal 2008 was the result of a corresponding decrease in unit
sales. The decline in new vehicle unit sales reflected soft new car
industry sales trends, particularly for the domestic manufacturers that we
represent, and the sale of our Orlando Chrysler-Jeep-Dodge
franchise.
Wholesale
Vehicle Sales
Our
operating strategy is to build customer satisfaction by offering high-quality
vehicles. Fewer than half of the vehicles acquired from consumers
through the appraisal purchase process meet our standards for reconditioning and
subsequent retail sale. Those vehicles that do not meet our standards
are sold through on-site wholesale auctions. Our wholesale auction
prices usually reflect the trends in the general wholesale market for the types
of vehicles we sell, although they could also be affected by changes in vehicle
mix or the average age, mileage or condition of the vehicles
wholesaled.
Fiscal 2009
Versus Fiscal 2008. The 21% decrease in wholesale vehicle
revenues in fiscal 2009 resulted from a 13% decrease in wholesale unit sales
combined with a 10% decrease in average wholesale selling price. The
decline in unit sales primarily reflected a decrease in our appraisal traffic
and, to a lesser extent, a decline in our appraisal buy
rate. Industry wholesale prices for SUVs, trucks and other less fuel
efficient vehicles fell sharply in the first two quarters of fiscal 2009, and
prices for virtually all vehicle classes declined at an unprecedented rate
during the third quarter, reflecting the weak demand environment. We
believe the significant drop in wholesale market values, which resulted in
corresponding decreases in our appraisal offers, contributed to the reduction in
our buy rate. Appraisal traffic was affected by the overall slowdown
in customer traffic. The decline in average wholesale selling price
reflected the trends in the general wholesale market for the types of vehicles
we sell.
Fiscal 2008
Versus Fiscal 2007. The 7% increase in wholesale vehicle
revenues in fiscal 2008 resulted from a 6% increase in wholesale unit sales
combined with a 1% increase in average wholesale selling price. Our
wholesale unit sales benefited from an increase in appraisal traffic driven by
the combination of the expansion of our store base and our comparable store unit
sales growth. However, our appraisal buy rate declined from the prior
year level, reflecting, we believe, an increasing hesitancy of consumers to
commit to purchasing big-ticket items.
Other
Sales and Revenues
Other
sales and revenues include commissions on the sale of ESPs, service department
sales and net third-party finance fees. The fixed fees paid by
third-party finance 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 finance fee revenues received from the other third-party
providers.
Fiscal 2009
Versus Fiscal 2008. Other sales and revenues decreased 5% in
fiscal 2009. ESP revenues declined 5%. Compared with the
8% decrease in total used vehicle unit sales in fiscal 2009, ESP revenues
benefited from a slow down in the rate of ESP cancellations, which we believe
was the result of the decline in auto industry sales and
trade-ins. Third-party finance fees decreased 42% due to a
combination of factors including the reduction in retail vehicle unit sales, a
shift in mix among providers and a change in discount arrangements with certain
of the providers during fiscal 2009. Collectively, the third-party
providers financed a larger percentage of our retail unit sales in the second
half of fiscal 2009, as we chose to route more credit applications to these
providers. Doing so allowed us to slow the use of capacity
in our warehouse facility, which is used to provide initial funding for
substantially all of the auto loan receivables originated by
CAF. 24
Fiscal 2008
Versus Fiscal 2007. Other sales and
revenues increased 11% in fiscal 2008, similar to the 12% increase in used
vehicle unit sales.
Supplemental
Sales Information
Unit
Sales
Average
Selling Prices
Retail
Vehicle Sales Mix
As of
February 28, 2009, we had a total of six new car franchises representing the
Chevrolet, Chrysler, Nissan and Toyota brands. During the second
quarter of fiscal 2008, we sold our Orlando Chrysler-Jeep-Dodge
franchise.
During
fiscal 2009, we expanded our car-buying center test with the 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
centers before deciding whether to open additional ones in future
years. These test sites are part of our long-term program to increase
both appraisal traffic and retail vehicle sourcing self-sufficiency (equal to
the percentage of vehicles sold at retail that were purchased directly from
consumers).
Gross
Profit
25
Gross
Profit per Unit
Used
Vehicle Gross Profit
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 primarily based on the vehicle’s selling
price. Our ability to quickly adjust appraisal offers to be
consistent with the broader market trade-in trends and our rapid inventory turns
reduce the exposure to the inherent continual depreciation in used vehicle
values and contribute to our ability to manage gross profit dollars per
unit. We employ a volume-based strategy, and we systematically mark
down individual vehicle prices based on proprietary pricing algorithms in order
to appropriately balance sales trends, inventory turns and gross profit
achievement. When customer traffic and sales are consistently strong,
we generally take fewer pricing markdowns, which in turn benefits gross profit
dollars per unit. When the sales pace slows, we may initially take
more pricing markdowns, which could pressure gross profit dollars per
unit. However, as we are successful in reducing inventories to align
them with a slower sales pace, this may allow us to return to target levels of
gross profit per unit. Over the past several years, we have continued
to refine our car-buying strategies, which we believe has benefited used vehicle
gross profit per unit.
Fiscal 2009
Versus Fiscal 2008. Our used vehicle gross profit decreased by
$64.2 million, or 9%, to $644.4 million from $708.6 million in fiscal 2008,
primarily as a result of the 8% decline in total used unit
sales. Despite the difficult sales environment in fiscal 2009, gross
profit per unit decreased only $13 to $1,865 per unit. Several
factors adversely affected our fiscal 2009 used vehicle gross profit per unit,
including a reduction in the percent of vehicles purchased directly from
customers and the sharp decrease in wholesale industry prices. These
were largely offset, however, by our success in managing our
inventories.
During
fiscal 2009, we experienced a decline in both appraisal traffic and buy rate,
which required us to source a larger percentage of our used vehicles at
auction. Vehicles purchased at auction typically generate less gross
profit per unit compared with vehicles purchased directly from
consumers. Additionally, wholesale industry prices for mid-sized and
large SUVs and trucks declined sharply in the spring and early summer of 2008,
and this rapid decline in valuation resulted in margin pressure on this segment
of inventory in the first half of fiscal 2009.
We
believe that our ability to maintain a generally consistent level of gross
profit per unit during fiscal 2009, despite the challenging sales environment
and the unprecedented decline in wholesale market prices, was due in large part
to the effectiveness of our proprietary inventory management systems and
processes. In response to the sharp decline in traffic and sales that
began in late May 2008, we rapidly reduced our used car inventories, which
brought them back in line with the current sales rates and minimized required
pricing markdowns in the second half of the fiscal year. Compared
with inventory levels at stores open as of February 29, 2008, we had
approximately 16,500 fewer total used vehicle units in inventory as of February
28, 2009, representing a 28% reduction. Due to the severe decline in
customer traffic during fiscal 2009, we generally chose not to reduce our gross
profit targets, as we believed doing so in the current economic environment
would not have spurred a sufficient increase in sales to offset the reduction in
per-unit profitability.
Fiscal 2008
Versus Fiscal 2007. Our used vehicle gross profit increased by
$67.4 million, or 11%, to $708.6 million from $641.2 million in fiscal 2007,
primarily as a result of the 12% increase in total used unit
sales. Our used vehicle gross profit per unit declined $25 to $1,878
per unit in fiscal 2008. The gross profit per unit increased modestly
in the first half of the year before declining in the second half of the
year. As the economic environment continued to weaken in the third
quarter of fiscal 2008, we moderately reduced our gross profit targets at the
beginning of the fourth quarter in an attempt to create additional value for
customers and drive sales.
26
New
Vehicle Gross Profit
Fiscal 2009
Versus Fiscal 2008. Our new vehicle gross
profit decreased $6.4 million to $9.0 million in fiscal 2009 from $15.4 million
in fiscal 2008, reflecting the 28% reduction in total new unit sales and a $180
decline in gross profit per unit. These reductions resulted from the
sharp decline in new car industry sales and the resulting increase in
competitiveness in the new car market.
Fiscal 2008
Versus Fiscal 2007. Our new vehicle gross
profit decreased $6.3 million to $15.4 million in fiscal 2008 from $21.7 million
in fiscal 2007, reflecting the 17% drop in total new unit sales and a $175
decline in gross profit per unit. The decline in overall consumer
demand for new cars in fiscal 2008 pressured profits for many new car retailers,
including CarMax.
Wholesale
Vehicle Gross Profit
Our
wholesale vehicle gross profit per unit has steadily increased over the last
several years, reflecting the benefits realized from improvements and
refinements in our car-buying strategies, appraisal delivery processes and
in-store auction processes. We have made continuous improvements in
these processes, which we believe has allowed us to become more
efficient. Our in-store auctions have benefited from initiatives to
increase our dealer-to-car ratio, which we believe has allowed us to achieve
higher prices. In addition, the frequency of our auctions, which are
generally held weekly or bi-weekly, minimizes the depreciation risk on these
vehicles.
Fiscal 2009
Versus Fiscal 2008. Our wholesale vehicle gross profit
decreased by $14.2 million, or 8%, to $162.5 million in fiscal 2009 from $176.7
million in fiscal 2008. The reduction was driven by the 13% decline
in wholesale vehicle unit sales, partially offset by an increase in wholesale
gross profit per unit of $43, or 5%, to $837 per unit in fiscal
2009. We experienced a record dealer-to-car ratio at our auctions for
the year, with the resulting price competition among bidders contributing to the
strong wholesale gross profit per unit. Our wholesale vehicles are
predominantly comprised of older, higher mileage vehicles, and we believe the
demand for these types of vehicles remained strong from dealers who specialize
in selling to credit-challenged customers.
Fiscal 2008
Versus Fiscal 2007. Our wholesale vehicle gross profit
increased by $21.7 million, or 14%, to $176.7 million in fiscal 2008 from $155.0
million in fiscal 2007. The increase was attributable to the 6%
increase in wholesale vehicle unit sales and an increase in wholesale gross
profit per unit of $52, or 7%, to $794 per unit in fiscal 2008. We
continued to experience strong dealer attendance at our auctions throughout the
year, despite the challenging economic environment.
Other
Gross Profit
Other
gross profit includes profits related to ESP revenues, third-party finance fees
and service department sales. 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. Accordingly, changes in the
mix of ESP revenues and third-party finance fees, relative to service department
sales, can affect the composition of other gross profit.
Fiscal 2009
Versus Fiscal 2008. Other gross profit
decreased by $19.6 million, or 11%, to $152.2 million in fiscal 2009 from $171.8
million in fiscal 2008. This decrease primarily reflected the
reductions in used and new retail unit sales and the related impact on ESP
revenues and third-party finance fees and a $10 decline in other gross profit
per unit in fiscal 2009. The decline in other gross profit per unit
was primarily associated with the increase in mix of other revenues represented
by service department sales.
Fiscal 2008
Versus Fiscal 2007. Other gross profit
increased by $18.6 million, or 12%, to $171.8 million in fiscal 2008 from $153.2
million in fiscal 2007. The increase was the result of the increase
in used unit sales and the related affects on ESP sales and third-party finance
fees, and a $6 increase in other gross profit per unit in fiscal
2008. The improvement in per unit profitability was the result of an
increase in mix of other revenues represented by ESP sales and third-party
finance fees.
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 benefit the SG&A ratio and CAF income, to the extent the average
amount financed also increases.
27
In fiscal
2009, the weakness in the economy and the stresses on consumer spending
contributed to the industry-wide slowdown in the sale of new and used vehicles
and to the unprecedented decline in wholesale market prices for most vehicle
classes during the first three quarters of the year. These lower
wholesale values reduced our vehicle acquisition costs and contributed to the
decline in our used and wholesale vehicle average selling price.
CarMax
Auto Finance Income
CAF
provides financing for a portion of our used and new car retail
sales. Because the purchase of a vehicle is often 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. Generally, CAF has provided 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 Income
Percent
columns indicate:
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 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 has typically been 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 was
substantially below the low end of this range in fiscal 2009 and fiscal 2008,
primarily as a result of the more challenging economic environment and the
disruption in the global credit markets. These factors caused us to
increase the loss and discount rate assumptions that affect the gain recognized
on the sale of loans and increased our funding costs.
28
Gain
(Loss) on Loans Sold
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 term securitizations, changes in the
valuation of retained subordinated bonds and the repurchase and resale of
receivables in existing term securitizations, as applicable.
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. This option was
exercised two times in each of fiscal 2009, 2008 and 2007. In each
case, the remaining eligible receivables were subsequently resold into the
warehouse facility. These transactions did not have a material effect
on CAF income in fiscal 2009, 2008 or 2007. 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.
Beginning
in January 2008, we retained some or all of the subordinated bonds associated
with our term securitizations. These bonds were retained either
because the economics of doing so were more favorable than selling them or
because there was no market for the subordinated bonds at the applicable issue
date. The retained subordinated bonds, which had total face values of
$115 million and $44.7 million, respectively, at February 28, 2009, and February
29, 2008, are subject to mark-to-market adjustments.
Fiscal 2009
Versus Fiscal 2008. CAF income declined to $15.3 million in
fiscal 2009 from $85.9 million in fiscal 2008. In both periods, CAF
income was reduced by market-to-market write-downs and adjustments related to
loans originated in previous fiscal years. In fiscal 2009, these
adjustments totaled $81.8 million, or $0.23 per share, and they
included:
29
In fiscal
2008, the adjustments totaled $9.6 million, or $0.03 per share, for adjustments
related to loans originated and sold in previous fiscal years. In fiscal 2009,
CAF’s gain on sales of loans originated and sold declined to $46.5 million
compared with $58.1 million in fiscal 2008. This decrease was
primarily the result of the reduction in CAF loan originations, which were
adversely affected by the decreases in our used unit sales and average retail
selling price. In addition, it reflected a decrease in the percentage
of sales financed by CAF resulting from our election to slow the use of capacity
in our warehouse facility during the second half of fiscal 2009. The
gain percentage was 2.4% in both fiscal 2009 and fiscal
2008. Compared with the prior year, the effects of using higher loss
and discount rate assumptions and higher credit enhancement levels for fiscal
2009 originations were offset by the benefit of a significant drop in our
funding cost benchmark rate.
The
increases in servicing fee income and direct CAF expenses in fiscal 2009 were
proportionate to the growth in managed receivables during the
year. The interest income component of other CAF income increased to
1.2% of average managed receivables in fiscal 2009 from 0.9% in fiscal 2008,
primarily due to the increase in the discount rate assumption used to value the
retained interest. 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. Additionally, interest income
includes the interest earned on the retained subordinated
bonds. Prior to January 2008, we had not retained any subordinated
bonds.
Fiscal 2008
Versus Fiscal 2007. CAF income declined to
$85.9 million in fiscal 2008 from $132.6 million in fiscal 2007. In
fiscal 2008, CAF income was reduced by $9.6 million, or $0.03 per share, and
they included the effects of increasing the discount rate to 17% from 12%,
increasing cumulative net loss assumptions and a $2.7 million mark-to-market
write-down of subordinated bonds. In fiscal 2007, CAF income was
increased by $13.0 million, or $0.04 per share, which included the effects of
reducing cumulative net loss assumptions on loans originated and sold in
previous fiscal years.
In fiscal
2008, CAF’s gain on sales of loans originated and sold decreased to $58.1
million compared with $86.7 million in fiscal 2007. Several factors
contributed to this decrease. In the second half of fiscal 2008,
credit spreads in the asset-backed securitization market widened, resulting in a
substantial increase in CAF’s funding costs. In addition, we
increased the discount rate assumption used to calculate our gain on sales of
loans to 17% in fiscal 2008 from 12% in fiscal 2007, and we increased our
cumulative net loss assumptions on loans originated and sold during fiscal 2008
to a range of 2.7% to 3.0%, which was significantly higher than the cumulative
net loss assumptions used on loans originated in fiscal 2007. As a
result, the gain percentage declined to 2.4% in fiscal 2008 compared with 3.9%
in fiscal 2007.
The
increases in other CAF income and total direct CAF expenses in fiscal 2008 were
proportionate to the growth in managed receivables during the year.
Past
Due Account Information
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