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10-K
CARMAX INC filed this Form 10-K on 04/26/2013
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

x        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended February 28, 2013

 

OR

 

¨               TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to             

 

Commission File Number: 1-31420

 

CARMAX, INC.

(Exact name of registrant as specified in its charter)

 

VIRGINIA

(State or other jurisdiction of

incorporation or organization)

54-1821055

(I.R.S. Employer

Identification No.)

 

 

12800 TUCKAHOE CREEK PARKWAY, RICHMOND, VIRGINIA

(Address of principal executive offices)

23238

(Zip Code)

 

 

Registrant’s telephone number, including area code: (804) 747-0422

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

 

 

 

Title of each class

Common Stock, par value $0.50

Rights to Purchase Series A Preferred Stock,

par value $20.00

Name of each exchange on which registered

New York Stock Exchange

New York Stock Exchange

 

 

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

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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 x             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):

Large accelerated filer x                                                                                    Accelerated filer ¨

Non-accelerated filer ¨ (do not check if a smaller reporting company)                        Smaller reporting company ¨

 

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, 2012, computed by reference to the closing price of the registrant’s common stock on the New York Stock Exchange on that date, was $6,988,118,233.

On March 31, 2013, there were 224,488,682 outstanding shares of CarMax, Inc. common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the CarMax, Inc. Notice of 2013 Annual Meeting of Shareholders and Proxy Statement are incorporated by reference in Part III of this Form 10-K.

 

 

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CARMAX, INC.

FORM 10-K

FOR FISCAL YEAR ENDED FEBRUARY 28, 2013

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

   

Page No.

 

 

 

 

 

PART I

 

 

 

 

 

Item 1.

 

Business

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

12 

 

 

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

15 

 

 

 

 

 

Item 2.

 

Properties

 

16 

 

 

 

 

 

Item 3.

 

Legal Proceedings

 

17 

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

17 

 

 

 

 

 

PART II

 

 

 

 

 

Item 5.

 

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases

of Equity Securities

 

18 

 

 

 

 

 

Item 6.

 

Selected Financial Data

 

20 

 

 

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21 

 

 

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

 

36 

 

 

 

 

 

Item 8.

 

Consolidated Financial Statements and Supplementary Data

 

37 

 

 

 

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

72 

 

 

 

 

 

Item 9A.

 

Controls and Procedures

 

72 

 

 

 

 

 

Item 9B.

 

Other Information

 

72 

 

 

 

 

 

PART III

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

72 

 

 

 

 

 

Item 11.

 

Executive Compensation

 

73 

 

 

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder

Matters

 

73 

 

 

 

 

 

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

 

74 

 

 

 

 

 

Item 14.

 

Principal Accountant Fees and Services

 

74 

 

 

 

 

 

PART IV

 

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

74

 

 

 

 

 

 

 

Signatures

 

75 

 

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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 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:

 

·

Our projected future sales growth, comparable store unit sales growth, margins, earnings, CarMax Auto Finance income and earnings per share.

 

·

Our expectations of factors that could affect CarMax Auto Finance income.

 

·

Our expected future expenditures, cash needs and financing sources.

 

·

The projected number, timing and cost of new store openings.

 

·

Our sales and marketing plans.

 

·

Our assessment of the potential outcome and financial impact of litigation and the potential impact of unasserted claims.

 

·

Our assessment of competitors and potential competitors.

 

·

Our assessment of the effect of recent legislation and accounting pronouncements.

 

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,” “outlook,” “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 that 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, publicly traded company.

CarMax Business.    We operate in two reportable segments:  CarMax Sales Operations and CarMax Auto Finance (“CAF”).  Our CarMax Sales Operations segment consists of all aspects of our auto merchandising and service operations, excluding financing provided by CAF.  Our CAF segment consists solely of our own finance operation that provides vehicle financing through CarMax superstores.

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CarMax Sales Operations:  We are the nation’s largest retailer of used cars, based on the 447,728 used vehicles we retailed during the fiscal year ended February 28, 2013.  As of the end of fiscal 2013, we operated 118 used car superstores in 58 metropolitan markets.  In addition, we are one of the nation’s largest wholesale vehicle auction operators, based on the 324,779 wholesale vehicles we sold through our on-site auctions in fiscal 2013.    

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.  Our consumer offer allows customers to shop for vehicles the same way they shop for items at other “big-box” retailers.  We provide low, no-haggle prices; a broad selection of CarMax Quality Certified vehicles; and superior customer service.  Our strategy is to revolutionize 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.

Our 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.

All of the used vehicles we retail are thoroughly reconditioned to meet our high standards, and each vehicle must pass a comprehensive inspection before being offered for sale.  In fiscal 2013, 87% of the used vehicles we retailed were 0 to 6 years old. 

Vehicles purchased through our in-store appraisal process that do not meet our retail standards are sold to licensed dealers through our on-site wholesale auctions.  Unlike many other auto auctions, we own all the vehicles that we sell in our auctions, which allows us to maintain a high auction sales rate.  This high sales rate, combined with dealer-friendly practices, makes our auctions an attractive source of vehicles for independent used car dealers.  As of February 28, 2013, we conducted weekly or bi-weekly auctions at 57 of our 118 used car superstores.

In addition, we sell new vehicles at four locations under franchise agreements with three new car manufacturers.  In fiscal 2013, new vehicles comprised only 2% of our total retail vehicle unit sales. 

Our finance program provides customers financing alternatives through CAF, our own finance operation, and third-party financing providers.  This program provides access to credit for customers across a wide range of the credit spectrum.  We believe the company’s processes and systems, transparency of pricing, vehicle quality and the integrity of the information collected at the time the customer applies for credit provide a unique and ideal environment in which to originate and procure high quality auto loans.  CAF focuses solely on originating loans through CarMax stores, customizing its offers to meet the customer’s risk profile and ensuring credit availability to support CarMax retail vehicle unit sales.  All of the finance offers by CAF and our third-party providers are backed by a 3‑day payoff offer whereby a customer can refinance their loan within three business days at no charge.

We provide customers with a full range of other related products and services, including the appraisal and purchase of vehicles directly from consumers; the sale of extended service plans (“ESP”), guaranteed asset protection (“GAP”) and accessories; and vehicle repair service.

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.  We acquire a significant percentage of our retail used vehicle inventory through our in-store appraisal process.  We also acquire a large portion of our used vehicle inventory through wholesale auctions and, to a lesser extent, directly from other sources, including wholesalers, dealers and fleet owners.

Our proprietary 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, generally more than 99% of the entire used car inventory offered at retail is sold at retail.

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CarMax Auto Finance:  CAF provides financing to qualified customers purchasing vehicles at CarMax.  Because the purchase of a vehicle is generally 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.  CAF offers financing solely to customers purchasing vehicles at CarMax, and offers qualifying customers an array of competitive rates and terms, allowing them to choose the one that best fits their needs.  We believe CAF enables us to capture additional sales, profits and cash flows while managing our reliance on third-party finance sources.  After the effect of 3-day payoffs and vehicle returns, CAF financed 39% of our retail vehicle unit sales in fiscal 2013.  As of February 28, 2013, CAF serviced approximately 459,000 customer accounts in its $5.93 billion portfolio of managed receivables.

Industry and Competition.    CarMax Sales Operations:    The U.S. used car marketplace is highly fragmented and competitive.  According to industry sources, as of December 31, 2012, there were approximately 17,800 franchised automotive dealerships, which sell both new and used vehicles.  In addition, used vehicles were sold by approximately 37,900 independent used vehicle dealers, as well as millions of private individuals.  Our primary retail competitors are the franchised auto dealers, who sell the majority of late-model used vehicles.  Independent used car dealers predominantly sell older, higher mileage cars than we do.  The number of franchised and independent auto dealers has gradually declined over the last decade, in large part due to manufacturers’ franchise and brand terminations, as well as dealership closures caused by the stress of the recession.  Despite this reduction in the number of dealers, the automotive retail environment remains highly fragmented.

Based on industry data, there were approximately 38 million used cars sold in the U.S. in calendar year 2012, of which approximately 13 million were estimated to be late-model, 0- to 6-year old vehicles and approximately 21 million were 0- to 10-year old vehicles.  While we are the largest retailer of used vehicles in the U.S., selling more than two times as many used vehicles as the next largest retailer in calendar 2012, we represented approximately 3% 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.  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 include our ability to provide a high degree of customer satisfaction with the car-buying experience by virtue of our competitively low, no-haggle prices and our customer-friendly sales process; 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; CAF; and the locations of our retail stores.  In addition, we believe our willingness to appraise and purchase a customer’s vehicle, whether or not the customer is buying a car from us, provides us a competitive sourcing advantage for retail vehicles.  Our large volume of appraisal purchases supplies not only a large portion of our retail inventory, but also provides the scale that enables us to conduct our own wholesale auctions to dispose of vehicles that don’t meet our retail standards.  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 2013,  approximately 30% of our vehicles sold were transferred at customer request.  Our CarMax Quality Inspection assures that every vehicle we offer for sale meets our stringent standards.  We back every vehicle with a 5-day, money-back guarantee and at least a 30-day limited warranty.  We maintain an ability to offer or arrange customer financing with competitive terms, and all financing is backed by our 3‑day payoff offer.  Additionally, we offer comprehensive and competitively priced ESP and GAP products.    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, generally 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.  In addition, sales consultants do not receive commissions based on the number of credit approvals or the amount a customer finances.  This pay structure aligns our sales associates’ interests with those of our customers, in contrast to other dealerships where sales and finance personnel may receive higher commissions for negotiating higher prices and interest rates or steering customers to vehicles with higher gross profits.

In our wholesale auctions, we compete with other automotive auction houses.  In contrast with the highly fragmented used vehicle market, the automotive auction market has two primary competitors, Manheim, a subsidiary of Cox Enterprises, and KAR Auction Services, Inc., representing an estimated 70% of the U.S. whole car auction market.  These competitors auction vehicles of all ages, while CarMax predominantly  sells older, higher mileage vehicles.    We believe the principal competitive advantages of our wholesale auctions include our high vehicle sales rate, our vehicle condition disclosures and arbitration policies, our broad geographic distribution and

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our dealer-friendly practices.  Because we own the cars that we auction, we generally sell more than 95% of the vehicles offered, which is substantially higher than the sales rate at most other auto auctions.  Our policy of making vehicle condition disclosures, 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, resulting in a  high dealer-to-car attendance ratio.

CarMax Auto Finance:  CAF operates in the auto finance sector of the consumer finance market.  This sector is primarily comprised of banks, captive finance divisions of new car manufacturers, credit unions and independent finance companies.  This sector represented approximately $800 billion in outstanding receivables as of December 31, 2012 according to industry data.  As of February 28, 2013, CAF had $5.93 billion in managed receivables, having originated $3.45 billion in loans during the fiscal year.  For loans originated during the calendar quarter ended December 31, 2012, CAF ranked 20th in market share for all vehicle loans and 9th in market share for used vehicle loans.

CAF’s competitive advantage is its strategic position as the primary finance source in CarMax stores.    We believe the company’s processes and systems, transparency of pricing, vehicle quality and the integrity of the information collected at the time the customer applies for credit provide a unique and ideal environment in which to procure high quality auto loans.  CAF utilizes proprietary scoring models based upon the credit history of the customer along with CAF’s historical experience to predict the likelihood of customer repayment.  Because CAF offers financing solely through CarMax stores, scoring models are optimized for the CarMax channel.

CAF’s primary competitors are banks and credit unions that offer direct financing to customers purchasing cars from dealers.  Some of our customers have already obtained financing prior to shopping for a vehicle and do not apply for financing in the store.  We also offer customers the ability to pay off their loans within three days without penalty.  The percentage of customers exercising this option can be an indication of the competitiveness of our rates.

Marketing and Advertising.  Our marketing strategies are focused on developing awareness of the advantages of shopping at our stores and on carmax.com and on attracting customers who are already considering buying or selling a vehicle.  Our marketing strategies are implemented primarily through television and radio broadcasts, carmax.com, Internet search engines and online classified listings.  We also reach out to customers and potential customers to build awareness and loyalty through Facebook, Twitter and other social media.  Television and radio advertisements are designed to build consumer awareness of the CarMax name, carmax.com and key components of the CarMax offer.  Broadcast and Internet advertisements are designed to drive customers to our stores and to carmax.com.

We strive 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.  We have transitioned a portion of our television and radio advertising to national cable network and national radio programming and we will continue to seek to optimize our media mix between local and national distribution.  In addition to providing cost savings, this transition allows us to build awareness of CarMax prior to our entrance into new markets.  We are also building awareness and driving traffic to our stores and carmax.com by listing retail vehicles on online classified sites.  Our advertising on the Internet also includes advertisements on search engines, such as Google and Yahoo!, as well as online properties such as Pandora and Hulu.

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 several times per day.  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 in a variety of ways, including online via carmax.com.  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 complete the final steps of the transaction, such as signing the paperwork and picking up their vehicle.  We also have a mobile website and mobile apps that allow customers to search for and view cars on their smartphones and other mobile devices.  Our survey data indicates that during fiscal 2013, approximately 80% of customers who purchased a vehicle from us had first visited us online.

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We also maintain a website, carmaxauctions.com, that supports our wholesale auctions.  This website, which is accessible only by authorized dealers, provides listings of all vehicles that will be available in upcoming auctions.  It also has many features similar to our retail website, including vehicle photos, free vehicle history reports and vehicle search and alert capabilities.

Suppliers for Used Vehicles.  We acquire used vehicle inventory directly from consumers through our appraisal process, as well as through other sources, including local, regional and online auctions, wholesalers, franchised and independent dealers and fleet owners, such as leasing companies and rental companies.  The supply of used vehicles is influenced by a variety of factors, including the total number of vehicles in operation; the rate of new vehicle sales, which in turn generate used-car trade-ins; and the number of used vehicles sold or remarketed through retail channels, wholesale transactions and at automotive auctions. 

According to industry data, as of December 31, 2012, there were approximately 247 million light vehicles in operation in the U.S., including approximately 78 million vehicles that were 0 to 6 years old.  Prior to the recession, generally 16 million to 17 million new vehicles and 40 million to 45 million used vehicles were sold annually in the U.S.  In addition, approximately 9 million to 10 million used vehicles were remarketed annually in wholesale auctions.  During the recession, retail vehicle sales dropped sharply, with calendar year 2009 new car sales falling to 10 million and used car sales to 35 million.  New car sales have gradually improved since 2009, but they remain below pre-recession levels.  The resulting decline in the total supply of 0-6 year old vehicles, combined with a reduction in trade-in activity and fewer off-lease vehicles has resulted in a tighter supply of late-model used vehicles in recent years.  While we have maintained steady access to inventory during this period, the used car supply constraints have resulted in strong wholesale valuations, which have increased our acquisition costs and average selling prices for used vehicles. 

Our used vehicle inventory acquired directly from consumers through our appraisal process helps provide an inventory of makes and models that reflects the consumer preferences in each market.  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 our 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 costsOur 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 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.

Suppliers for New Vehicles.  Our new car operations are governed by the terms of the sales, service and dealer agreements.  Among other things, these agreements generally impose operating requirements and restrictions, including inventory levels, working capital, monthly financial reporting, signage and cooperation with marketing strategies. 

Seasonality.    Historically, our business has been 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 generally tends to slow in the fall as the weather changes and as customers shift their spending priorities.  We typically experience an increase in subprime traffic and sales in February and March, coincident with tax refund season.

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Products and Services

Merchandising.  We offer customers a broad selection of makes and models of used vehicles, including both domestic and imported vehicles, at competitive prices.  Our used car selection covers popular brands from manufacturers such as Chrysler, Ford, General Motors, Honda, Hyundai, Kia, Mazda, Nissan, Toyota and Volkswagen and luxury brands such as Acura, BMW, Infiniti, Lexus and Mercedes-Benz.  Our primary focus is vehicles that are 0 to 6 years old and generally range in price from $12,000 to $34,000.  For the more cost-conscious consumer, we also offer used cars that are more than 6 years old.  The mix of our used vehicle inventory by make, model and age will vary from time to time, depending on consumer preferences.

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.  Prices on all vehicles are clearly displayed on each vehicle’s information sticker, on carmax.com and on applicable online classified sites on which they are listed.  We extend our no-haggle philosophy to every component of the vehicle transaction, including vehicle appraisal offers, financing rates, accessories, and ESP and GAP pricing.

Wholesale Auctions.    Vehicles purchased through our in-store appraisal process that do not meet our retail standards are sold through on-site wholesale auctions.  As of February 28, 2013, wholesale auctions were conducted at 57 of our 118 superstores and were generally held on a weekly or bi-weekly basis.  Auction frequency at a given superstore is determined by the number of vehicles to be auctioned, which depends on the number of stores in that market and the consumer awareness of CarMax and our in-store appraisal offer.  The typical wholesale vehicle is approximately 10 years old and has more than 100,000 miles.  Participants in CarMax auctions must be licensed automobile dealers and are required to register with our centralized auction support group.  The majority of the participants are independent automobile dealers.  We provide condition disclosures on each vehicle, including those for vehicles with major mechanical issues, possible frame or flood damage, branded titles, salvage history and unknown true mileage.  Professional, licensed auctioneers conduct our auctions.  The average auction sales rate was 97% in fiscal 2013.  Dealers pay a fee to us based on the sales price of the vehicles they purchase.

 

Extended Service Plans and Guaranteed Asset Protection.  At the time of the sale, we offer the customer an ESP.  We sell these plans on behalf of unrelated third parties that are the primary obligors.  Under the third-party service plan programs, we have no contractual liability to the customer.  The ESPs we offer on all used vehicles provide coverage up to 72 months (subject to mileage limitations) and include multiple mileage and deductible options, depending on the vehicle odometer reading, make and model.  We offer ESPs at competitive, fixed prices, which are based primarily on the historical repair record of the vehicle make and model, the mileage option selected and the deductible chosen.  All ESPs 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 of sale.    In fiscal 2013,  more than 60% of the customers who purchased a used vehicle also purchased an ESP. 

Our ESP customers have access to vehicle repair service at each CarMax store and at 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 ESPs, helps promote customer satisfaction and loyalty, and thus increases the likelihood of repeat and referral business.

We also offer GAP at the time of the sale.  GAP is a product that will pay the difference between the customer’s insurance settlement and the finance contract payoff amount on their vehicle in the case of a total loss or unrecovered theft.  We sell this product on behalf of an unrelated third party that is the primary obligor, and we have no contractual liability to the customer.  GAP has been designed to our specifications and is administered by the third party through a private-label arrangement.  We receive a commission from the administrator at the time of sale.  In fiscal 2013, more than 20% of customers who purchased a used vehicle also purchased GAP.

Reconditioning and Service.    An integral part of our used car consumer offer is the renewal process used to make sure every car meets our high standards before it can become a CarMax Quality Certified (CQC) vehicle.  This process includes a comprehensive CarMax Quality Inspection of the engine and all major systems, including cooling, fuel, drivetrain, transmission, electronics, suspension, brakes, steering, air conditioning and other equipment, as well as the interior and exterior of the vehicle.  Based on this quality inspection, we determine the reconditioning necessary to bring the vehicle up to our quality standards.  We perform most routine mechanical and minor body repairs in-house; however, for some reconditioning services, we engage third parties specializing in those services.  Many superstores depend upon nearby, typically larger, superstores for reconditioning, which increases efficiency and reduces overhead.

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All CarMax used car superstores provide vehicle repair service, including repairs of vehicles covered by our ESPs.  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, our information systems and our technician training and development process.  The training and development process and our compensation programs are designed to increase the productivity of technicians, identify opportunities for waste reduction and achieve high-quality repairs.  Our information systems allow us to track repair history and enable trend analysis, which guides our continuous improvement efforts.

Customer Credit.  We offer financing alternatives for retail customers across a wide range of the credit spectrum through CAF and our arrangements with several industry-leading financial institutions.  We believe our program enables us to capture additional sales and enhances the CarMax consumer offer.  Credit applications are initially reviewed by CAF.  Customers who are not approved by CAF may be evaluated by the other financial institutions.   Having an array of finance sources increases discrete approvals,  expands finance opportunities for our customers and mitigates risk to CarMaxIn fiscal 2013, 90% of our applicants received an approval from one or more of our sources.  We  periodically test additional third-party providers.

Retail 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.  Vehicles are financed using retail installment contracts secured by the vehicles.  Customers are permitted to refinance or pay off their contract within three business days of a purchase without incurring any finance or related charges.  Depending on the credit profile of the customer, third-party finance providers generally either pay us or are paid a fixed, pre-negotiated fee per contract.  The fee amount is independent of any finance term offered to the customer; it does not vary based on the amount financed, the term of the loan, the interest rate or the loan-to-value ratio.  We refer to the providers who pay us a fee as prime and nonprime providers, and we refer to the providers to whom we pay a fee as subprime providers.  We have no recourse liability on retail installment contracts arranged with third-party providers.

We do not offer financing to dealers purchasing vehicles at our wholesale auctions.  However, we have made arrangements to have third-party financing available to our auction customers.

Systems

Our stores are supported by an advanced, proprietary information system that improves the customer experience, while providing tightly integrated automation of all operating functions.  Customers can search our entire vehicle inventory through our website, carmax.com, and our mobile apps.  They can also print a detailed listing for any vehicle, which includes the vehicle’s features and specifications and its location on the display lot.  We also have a mobile website and mobile apps that allow customers to search for and view cars on their smartphones and other mobile devices.  Our integrated inventory management system tracks every vehicle through its life from purchase through reconditioning and test-drives to ultimate sale.  Using radio frequency identification (“RFID”) tags and bar codes, all vehicles are scanned and tracked daily as a loss prevention measure.  Test-drive information is captured using RFID tags, linking the specific vehicle and the sales consultant.  We also capture data on vehicles we wholesale, which helps us track market pricing.  A computerized 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 many aspects 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 of CAF and third party providers.

Our proprietary inventory management and pricing system is centralized and allows us to buy the mix of makes, models, age, mileage and price points tailored to customer buying preferences at each CarMax location.  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.

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Our Electronic Repair Order system (“ERO”) is used 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 quickly integrate new stores into our store network.  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, 2013, we had a total of 18,111 full- and part-time associates, including 13,705 hourly and salaried associates and 4,406 sales associates, who worked on a commission basis.  We employ additional associates during peak selling seasons.  As of February  28, 2013, our location general managers averaged 10 years of CarMax experience, in addition to prior retail management experience.  We staff each newly opened store with associates who have extensive CarMax training.

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.

Training.  To further support our emphasis on attracting, developing and retaining qualified associates, we have made a commitment to providing exceptional training programs.  Store associates receive many hours of structured, self-paced training that introduces them to company policies and their specific job responsibilities through KMX University (“KMXU”) – our intranet-based, on-premises learning management system.  KMXU is comprised of customized applications hosted within a learning management system that allow us to author, deliver and track training events and to measure associate competency after training.  KMXU also provides a variety of learning activities and collaborative discussions delivered through an integrated virtual classroom system.  Most new store associates are also assigned mentors who provide on-the-job guidance and support.

We also provide comprehensive, facilitator-led classroom training courses at the associate and manager levels.  All new sales consultants go through an on-boarding process in which they are partnered with a mentor; combining self-paced online training with shadowing and role-playing.  Our professional selling principles (“PSPs”) provide all sales associates the opportunity to learn and practice customer-oriented selling techniques.  This online training program contains modules on a variety of skill sets, including building confidence, connecting with the customer, and listening and persuasion techniques.  KMXU also provides access to hundreds of short video-based learning modules that provide focused behavioral examples supporting the PSPs.  We also have a call recording and review program to provide constructive feedback to associates on how to improve their interactions with customers. 

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.  Business office associates undergo a 3‑ to 6‑month, on-the-job certification process in order to be fully cross-trained in all functional areas of the business office.  All business office associates and managers also receive regular training through facilitated competency-based training courses.  Reconditioning and service 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 and service.  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.  New managers complete intensive training where they meet with senior leaders, participate in hands-on activities and learn fundamental CarMax leadership skills.

Laws and Regulations

Vehicle Dealer and Other Laws and Regulations.    We operate in a highly regulated industry.  In every state in which we operate, we must obtain various licenses and permits in order to conduct business, including dealer, service, sales and finance licenses issued by state and local regulatory authorities.  A wide range of federal, state and local laws and regulations govern the manner in which we conduct business, including advertising, sales, financing and employment practices.  These laws include consumer protection laws, privacy laws and state franchise laws, as well as other laws and regulations applicable to new and used motor vehicle dealers.  These laws also include federal and state wage-hour, anti-discrimination and other employment practices laws.  Our financing activities with

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customers are subject to federal truth-in-lending, consumer leasing, equal credit opportunity and fair credit reporting laws and regulations, all of which are subject to enforcement by the federal Consumer Financial Protection Bureau or Federal Trade Commission, as well as state and local motor vehicle finance, collection, repossession and installment finance laws.

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.

Environmental Laws and Regulations.    We are subject to a variety of federal, state and local laws and regulations that pertain to the environment.  Our business involves the use, handling and disposal of hazardous materials and wastes, including motor oil, gasoline, solvents, lubricants, paints and other substances.  We are subject to compliance with regulations concerning the operation of underground and above-ground gasoline storage tanks, gasoline dispensing equipment, above-ground oil tanks and automotive paint booths.

AVAILABILITY OF REPORTS AND OTHER INFORMATION

The following items are available free of charge through the “Corporate Governance” link on our investor information home page at investor.carmax.com, shortly after we file them with, or furnish them to, the Securities and Exchange Commission (the “SEC”): annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements on Schedule 14A, and any amendments to those reports.  The following documents are also available free of charge on our website: Corporate Governance Guidelines, Code of Business Conduct, and the charters of the Audit Committee, Nominating and Governance Committee, and Compensation and Personnel Committee.  We publish any changes to these documents on our website.  We also promptly disclose reportable waivers of the Code of Business Conduct on our website.  The contents of our website are not, however, part of this report.

Printed copies of these documents are also 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.

Item 1A.  Risk Factors.

We are subject to a variety of risks, the most significant of which are described below.  Our business, sales, results of operations and financial condition could be materially adversely affected by any of these risks.

Economic Conditions.  We are subject to changes in general or regional U.S. economic conditions, including, but not limited to, consumer credit availability, consumer credit delinquency and loss rates, interest rates, gasoline prices, inflation, personal discretionary spending levels, unemployment levels, the state of the housing market,  and consumer sentiment about the economy in general.  The difficult U.S. economic environment over the past several years has adversely affected the automotive retail industry in general, including CarMax.  Any significant change or further deterioration in economic conditions could adversely affect consumer demand or increase costs and have a material adverse effect on our business, sales, results of operations and financial condition.

Competition.    Automotive retailing is a highly competitive and highly fragmented business.  Our competition includes publicly and privately owned new and used car dealers, as well as millions of private individuals.  Since we sell vehicles that do not meet our retail standards through on-site wholesale auctions, our competition also includes automotive wholesalers.  Competitors buy and sell the same or similar makes of vehicles that we offer in the same or similar markets at competitive prices.  In addition, competitors who have franchise relationships with automotive manufacturers brand certain used cars as “certified pre-owned,” which could provide those competitors with an advantage over CarMax.  New entrants to the automotive retail market, or new automotive wholesalers, could result in increased acquisition costs for used vehicles and lower-than-expected retail and wholesale sales and margins. 

The increasing use of the Internet to market, buy and sell used vehicles and to provide vehicle financing could have a material adverse effect on our sales and results of operations.  The increasing on-line availability of used vehicle information, including pricing information, could make it more difficult for us to differentiate our customer offering from competitors’ offerings, could result in lower-than-expected retail margins, and could have a material adverse effect on our business, sales and results of operations.  In addition, our competitive standing is affected by companies, including search engines such as Google, Bing and Yahoo! and online classified sites such as AutoTrader.com and cars.com, that are not direct competitors but that may direct on-line traffic to the websites of competing automotive retailers.  The increasing activities of these companies could make it more difficult for

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carmax.com to attract traffic and could have a material adverse effect on our business, sales and results of operations.

CAF and our third-party financing providers are subject to competition from various financial institutions. If we were unable to continue providing competitive finance offers to our customers through CAF and our third-party financing providers, it could have a material adverse effect on our business, sales and results of operations.  In addition, we believe that CAF allows us to capture additional sales, profits and cash flows.  Accordingly, if CAF was unable to continue making competitive finance offers to our customers, it could have a material adverse effect on our business, sales and results of operations.

Capital.  Changes in the availability or cost of capital and working capital financing, including the long-term financing to support the origination of auto loan receivables through CAF and our geographic expansion, could adversely affect sales, operating strategies and store growth.  Further, our current credit facility and certain securitization and sale-leaseback agreements contain covenants and/or performance triggers.  Any failure to comply with these covenants or performance triggers could have a material adverse effect on our business, results of operations and financial condition.

We use a securitization program to fund substantially all of the auto loan receivables originated by CAF.  Initially, we sell these receivables into our warehouse facilities.  We periodically refinance the receivables through term securitizations.  Changes in the condition of the asset-backed securitization market could lead us to incur higher costs to access funds in this market or require us to seek alternative means to finance CAF’s 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 effect 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.

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, or choose not to, 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 adverse effect on our business, sales and results of operations.  Additionally, if we were unable to replace the current third-party providers upon the occurrence of one or more of the foregoing events, it could also have a material adverse effect on our business, sales and results of operations.

Retail Prices.    Any significant changes in retail prices for new and used vehicles could have a material adverse effect on our sales and results of operations.  If prices for used vehicles rise significantly due to supply constraints this could adversely affect consumer demand for vehicles.  If retail prices for used vehicles rise relative to retail prices for new vehicles, it could make buying a new vehicle more attractive to our customers than buying a used vehicle, which could have a material adverse effect on our business, sales and results of operations.

Inventory.  A reduction in the availability of or access to sources of inventory could have a material adverse effect on our business.  A failure to adjust appraisal offers to stay in line with broader market trade-in offer trends, or a failure to recognize those trends, could adversely affect our ability to acquire inventory.  Should we develop excess inventory, the inability to liquidate the excess inventory at prices that allow us to meet margin targets or to recover our costs could have a material adverse effect on our results of operations.

Regulatory and Legislative Environment.  We are subject to a wide range of federal, state and local laws and regulations, such as licensing requirements and laws regarding advertising, vehicle sales, financing and employment practices.  Our facilities and business operations are also subject to laws and regulations relating to environmental protection and health and safety.  The violation of these laws or regulations could result in administrative, civil or criminal penalties or in a cease-and-desist order against business operations.  As a result, we have incurred and will continue to incur capital and operating expenses and other costs to comply with these laws and regulations.  Further, private plaintiffs and federal, state and local regulatory and law enforcement authorities continue to scrutinize advertising, sales, financing and insurance activities in the sale and leasing of motor vehicles.  If, as a result, other automotive retailers adopt more transparent, consumer-oriented business practices, our differentiation versus those retailers could be reduced.

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Recent federal legislative and regulatory initiatives and reforms may result in an increase in expenses or a decrease in revenues.  For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) regulates, among other things, the provision of consumer financing.  The Dodd-Frank Act established a new consumer financial protection agency, the Consumer Financial Protection Bureau (“CFPB”), with broad regulatory powers.  The CFPB is responsible for administering and enforcing laws and regulations related to consumer financial products and services.  The evolving regulatory environment in the wake of the Dodd-Frank Act and the creation of the CFPB may increase the cost of regulatory compliance or result in changes to business practices that could have a material adverse effect on our results of operations.  The Patient Protection and Affordable Care Act of 2010, as it is phased in over time, significantly affects the provision of health care services and may impact the cost of providing our associates with health coverage.  Current federal labor policy could lead to increased unionization efforts, which could increase labor costs, disrupt store operations, and have a material adverse effect on our results of operations.

Reputation.  Our reputation as a company that is founded on the fundamental principle of integrity is critical to our success.  Our reputation as a retailer offering a broad selection of CarMax Quality Certified vehicles at competitive, no-haggle prices with a customer-friendly sales process in attractive, modern facilities is also critical to our success.  If we fail to maintain the high standards on which this reputation is built, or if an event occurs that damages this reputation, it could adversely affect consumer demand and have a material adverse effect on our business, sales and results of operations.  Even the perception of a decrease in the quality of our brand could impact results.  Accordingly, if we fail to correct or mitigate misinformation or negative information, including information spread through social media or traditional media channels, about the vehicles we offer, our customer experience, or any aspect of our brand, it could have a material adverse effect on our business, sales and results of operations.

Confidential Customer and Associate Information.    In the normal course of business, we collect, process and retain sensitive and confidential customer and associate information and may share that information with our third-party service providers.  Despite the security measures we have in place and the assurances we have from our third-party providers, our facilities and systems, and those of third-party service providers, could be vulnerable to external or internal security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events.  Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer or associate information, whether experienced by us or by our third-party service providers, and whether due to an external cyber-security incident, a programming error, or other cause, could damage our reputation, expose us to mitigation costs and the risks of private litigation and government enforcement, disrupt our business, or otherwise have a material adverse effect on our sales and results of operations.

Growth.  The expansion of our store base places significant demands on our management team, our associates and our systems.  If we fail to effectively or efficiently manage our growth, it could have a material adverse effect on our business, sales and results of operations.    In addition, our inability to acquire or lease suitable real estate at favorable terms could limit our expansion and could have a material adverse effect on our business and results of operations.    

Management and Workforce.  Our success depends upon the continued contributions of our store, region and corporate management teams.  Consequently, the loss of the services of key employees could have a material adverse effect on our business.  In addition, an inability to build our management bench strength to support store growth could have a material adverse effect on our business.  Our ability to meet our staffing needs while controlling related costs is subject to numerous external and internal factors, including unemployment levels, prevailing wage rates, changes in employment legislation, competition for qualified employees in the industry and regions in which we operate, and associate relations.  An inability to retain qualified associates or a significant increase in labor costs could have a material adverse effect on our business, sales and results of operations.

Information Systems.  Our business is dependent upon the integrity and efficient operation of our information systems.  In particular, we rely on our information systems to effectively manage sales, inventory, carmax.com, consumer financing and customer information.  The failure of these systems to perform as designed could disrupt our business operations and have a material adverse effect on our sales and results of operations.  In addition, despite our ongoing efforts to maintain and enhance the integrity and security of these systems, we could be subjected to attacks by hackers, including denial-of-service attacks directed at our websites or other system breaches or malfunctions due to associate error or misconduct or other disruptions.  Such incidents could disrupt our business and have a material adverse effect on sales and results of operations.

Litigation.  We are subject to various litigation matters from time to time, which could have a material adverse effect on our business and results of operations.  Claims arising out of actual or alleged violations of law could be asserted against us by individuals, either individually or through class actions, or by governmental entities in civil or

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criminal investigations and proceedings.  These actions could expose us to adverse publicity and to substantial monetary damages and legal defense costs, injunctive relief and criminal and civil fines and penalties, including suspension or revocation of licenses to conduct business.

Automotive Manufacturers.  Adverse conditions affecting one or more automotive manufacturers could have a material adverse effect on our results of operationsManufacturer recalls could also adversely affect used vehicle sales or valuations and could expose us to litigation and adverse publicity related to the sale of a recalled vehicle, which could have a material adverse effect on our business, sales and results of operations.

Weather.  The occurrence of severe weather events, such as rain, snow, wind, storms, hurricanes or other natural disasters, could cause store closures, adversely affecting consumer traffic, and could have a material adverse effect on our sales and results of operations in a given period.

Seasonal Fluctuations.  Our business is subject to seasonal fluctuations.  We generally realize a higher proportion of revenue and operating profit during the first and second fiscal quarters.  If conditions arise that impair vehicle sales during the first or second fiscal quarters, these conditions could have a disproportionately large adverse effect on our annual results of operations.

Geographic Concentration.  Our performance is subject to local economic, competitive and other conditions prevailing in geographic areas where we operate.  Since a large portion of our sales is generated in the Southeastern U.S., including Florida, and in Texas, Southern California and Washington, D.C./Baltimore, our results of operations depend substantially on general economic conditions and consumer spending habits in these markets.  In the event that any of these geographic areas experienced a downturn in economic conditions, it could have a material adverse effect on our business, sales and results of operations.

Accounting Policies and Matters.    We have identified several accounting policies as being “critical” to the fair presentation of our financial condition and results of operations because they involve major aspects of our business and require management to make judgments about matters that are inherently uncertain.  These policies are described in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the notes to consolidated financial statements included in Item 8.  Materially different amounts could be recorded under different conditions or using different assumptions.  In addition, the implementation of new accounting requirements or other changes to U.S. generally accepted accounting principles could have a material adverse effect on our reported results of operations and financial condition.

Other Material Events.  The occurrence of acts of terrorism, the outbreak of war or other significant national or international events could have a material adverse effect on our business, sales, results of operations or financial condition.

 

Item 1B.  Unresolved Staff Comments.

None.

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Item 2.  Properties.

We conduct our retail vehicle operations in two basic formats – production and non-production superstores.  Production superstores are those locations at which vehicle reconditioning is performed.  Production superstores have more service bays and require additional space for work-in-process inventory and, therefore, are generally larger than non-production stores.  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 regional reconditioning needs and the available acreage of the 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, 2013, we operated 68 production superstores and 50 non-production superstores. 

As of February 28, 2013, we operated 57 wholesale auctions, most of which were located at production superstores.  Stores at which auctions are conducted generally have additional space to store wholesale inventory.  As of February 28, 2013, we also operated one new car store, which was located adjacent to our used car superstore in Laurel, Maryland.  Our remaining three 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 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, 2013

 

 

 

 

 

 

 

Total

 

Alabama

 

Arizona

 

California

16 

 

Colorado

 

Connecticut

 

Florida

13 

 

Georgia

 

Illinois

 

Iowa

 

Indiana

 

Kansas

 

Kentucky

 

Louisiana

 

Maryland

 

Massachusetts

 

Mississippi

 

Missouri

 

Nebraska

 

Nevada

 

New Mexico

 

North Carolina

 

Ohio

 

Oklahoma

 

Pennsylvania

 

South Carolina

 

Tennessee

 

Texas

12 

 

Utah

 

Virginia

 

Wisconsin

 

Total

118 

 

 

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As of February 28, 2013, we leased 58 of our 118 used car superstores, our new car store and our CAF office building in Atlanta, Georgia.  We owned the remaining 60 stores currently in operation.  We also owned our home office building in Richmond, Virginia, and land associated with planned future store openings. 

Expansion

Since opening our first used car superstore in 1993, we have grown organically, through the construction and opening of company-operated stores.  We do not franchise our operations.  As of February 28, 2013, we operated 118 used car superstores in 58 U.S. markets, which represented approximately 53% of the U.S. population.  We believe that further geographic expansion and additional fill-in opportunities in existing markets will provide a foundation for future sales and earnings growth.

In December 2008, we temporarily suspended store growth due to the weak economic and sales environment.  We resumed store growth in fiscal 2011, opening 3 superstores that year, 5 superstores in fiscal 2012 and 10 superstores in fiscal 2013.  We currently plan to open 13 superstores in fiscal 2014 and between 10 and 15 in each of the following 2 fiscal years.

For additional details on our future expansion plans, see “Fiscal 2013 Planned Superstore Openings,” 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 involved: (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; (5) unfair competition; and (6) California’s Labor Code Private Attorney General Act.  The putative class consisted of sales consultants, sales managers, and other hourly employees who worked for the company in California from April 2, 2004, to the present.  On May 12, 2009, the court dismissed all of the class claims with respect to the sales manager putative class.  On June 16, 2009, the court dismissed all claims related to the failure to comply with the itemized employee wage statement provisions.  The court also granted CarMax's motion for summary adjudication with regard to CarMax's alleged failure to pay overtime to the sales consultant putative class.  The plaintiffs appealed the court's ruling regarding the sales consultant overtime claim.  On May 20, 2011, the California Court of Appeal affirmed the ruling in favor of CarMax.  The plaintiffs filed a Petition of Review with the California Supreme Court, which was denied.  As a result, the plaintiffs’ overtime claims are no longer a part of the lawsuit.

The claims currently remaining in the lawsuit regarding the sales consultant putative class are: (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; (3) unfair competition; and (4) California’s Labor Code Private Attorney General Act.  On June 16, 2009, the court entered a stay of these claims pending the outcome of a California Supreme Court case involving unrelated third parties but related legal issues.  Subsequently, CarMax moved to lift the stay and compel the plaintiffs’ remaining claims into arbitration on an individual basis, which the court granted on November 21, 2011.  The plaintiffs appealed the court’s ruling to the California Court of Appeal.  On March 26, 2013, the California Court of Appeal reversed the trial court's order granting CarMax's motion to compel arbitration.  CarMax intends to pursue an appeal of this decision.  The Fowler 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 these matters.

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, results of operations or cash flows.

Item 4.  Mine Safety Disclosures.

None.

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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.  We are authorized to issue up to 350,000,000 shares of common stock and up to 20,000,000 shares of preferred stock.  As of February 28, 2013, there were 225,906,108 shares of CarMax common stock outstanding and we had approximately 4,300 shareholders of record.  As of that date, there were no preferred shares outstanding.

The following table presents the quarterly high and low sales prices per share for our common stock for each quarter during the last two fiscal years, as reported on the New York Stock Exchange composite tape.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Quarter

 

2nd Quarter

 

3rd Quarter

 

4th Quarter

 

 

Fiscal 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

High

 

$

35.17 

 

$

30.68 

 

$

36.55 

 

$

40.22 

 

 

Low

 

$

27.28 

 

$

24.83 

 

$

28.04 

 

$

34.21 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

High

 

$

35.98 

 

$

34.81 

 

$

31.73 

 

$

33.48 

 

 

Low

 

$

28.39 

 

$

25.18 

 

$

22.77 

 

$

28.44 

 

 

 

To date, we have not paid a cash dividend on CarMax common stock.

During the fourth quarter of fiscal 2013, we sold no CarMax equity securities that were not registered under the Securities Act of 1933, as amended.

Issuer Purchases of Equity Securities

The following table provides information relating to the company’s repurchase of common stock during the fourth quarter of fiscal 2013.  The table does not include transactions related to employee equity awards or the exercises of employee stock options.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Approximate

 

 

 

 

 

 

Dollar Value

 

 

 

 

Total Number

 

of Shares that

 

Total Number

Average

of Shares Purchased

 

May Yet Be

 

of Shares

Price Paid

as Part of Publicly

 

Purchased Under

Period

Purchased

per Share

Announced Programs

 

 

the Programs (1) 

 

 

 

 

 

 

 

 

December 1-31, 2012

1,508,000 

$

36.03 
1,508,000 

 

$

185,428,374 

January 1-31, 2013

1,157,100 

$

38.16 
1,157,100 

 

$

641,276,583 

February 1-28, 2013

1,352,600 

$

39.31 
1,352,600 

 

$

588,108,852 

Total

4,017,700 

 

 

4,017,700 

 

 

 

 

(1)

On October 17, 2012, our board of directors authorized the repurchase of up to $300 million of our common stock.  This $300 million authorization expires on December 31, 2013.  On January 29, 2013, our board of directors authorized an additional $500 million for the repurchase of our common stock.  This $500 million authorization expires on December 31, 2014.  Purchases may be made in the open market or privately negotiated transactions at management’s discretion and the timing and amount of repurchases are determined based on share price, market conditions, legal requirements and other factors.  Shares repurchased are deemed authorized but unissued shares of common stock.

18


 

 

Performance Graph

The following graph compares the cumulative total shareholder return (stock price appreciation plus dividends, as applicable) on our common stock for the last five fiscal years with the cumulative total return of the S&P 500 Index and the S&P 500 Retailing Index.  The graph assumes an original investment of $100 in CarMax common stock and in each index on February 29, 2008, and the reinvestment of all dividends, as applicable.

Picture 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of February 28 or 29

 

 

 

2008

 

 

2009

 

 

2010

 

 

2011

 

 

2012

 

 

2013

 

 

CarMax

 

 

$     100.00

 

 

$       51.37

 

 

$     109.98

 

 

$     192.65

 

 

$     167.18

 

 

$     209.24

 

 

S&P 500 Index

 

 

$     100.00

 

 

$       56.67

 

 

$       87.05

 

 

$     106.69

 

 

$     112.15

 

 

$     127.23

 

 

S&P 500 Retailing Index

 

 

$     100.00

 

 

$       66.56

 

 

$     113.28

 

 

$     139.64

 

 

$     160.30

 

 

$     197.13

 

 

 

 

 

19


 

 

Item 6.  Selected Financial Data.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars and shares in millions, except per share)

 

FY13

 

FY12

 

FY11 (1)

 

FY10

 

FY09

 

FY08

Income statement information

 

 

 

 

 

 

 

 

 

 

 

 

Used vehicle sales

$

8,747.0 

$

7,826.9 

$

7,210.0 

$

6,192.3 

$

5,690.7 

$

6,589.3 

New vehicle sales

 

207.7 

 

200.6 

 

198.5 

 

186.5 

 

261.9 

 

370.6 

Wholesale vehicle sales

 

1,759.6 

 

1,721.6 

 

1,301.7 

 

844.9 

 

779.8 

 

985.0 

Other sales and revenues

 

248.6 

 

254.5 

 

265.3 

 

246.6 

 

241.6 

 

254.6 

Net sales and operating revenues

 

10,962.8 

 

10,003.6 

 

8,975.6 

 

7,470.2 

 

6,974.0 

 

8,199.6 

Gross profit

 

1,464.4 

 

1,378.8 

 

1,301.2 

 

1,098.9 

 

968.2 

 

1,072.4 

CarMax Auto Finance income

 

299.3 

 

262.2 

 

220.0 

 

175.2 

 

15.3 

 

85.9 

SG&A 

 

1,031.0 

 

940.8 

 

878.8 

 

792.2 

 

856.1 

 

832.4 

Interest expense

 

32.4 

 

33.7 

 

34.7 

 

36.0 

 

38.6 

 

38.0 

Earnings before income taxes

 

701.4 

 

666.9 

 

608.2 

 

446.5 

 

90.5 

 

289.9 

Income tax provision

 

267.1 

 

253.1 

 

230.7 

 

168.6 

 

35.2 

 

112.5 

Net earnings

 

434.3 

 

413.8 

 

377.5 

 

277.8 

 

55.2 

 

177.5 

Share and per share information

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic shares outstanding

 

228.1 

 

226.3 

 

223.4 

 

219.5 

 

217.5 

 

216.0 

Weighted average diluted shares outstanding

 

231.8 

 

230.7 

 

227.6 

 

222.2 

 

219.4 

 

220.0 

Basic net earnings per share

$

1.90 

$

1.83 

$

1.68 

$

1.25 

$

0.25 

$

0.82 

Diluted net earnings per share

$

1.87 

$

1.79 

$

1.65 

$

1.24 

$

0.25 

$

0.80 

Balance sheet information

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

$

2,310.1 

$

1,853.4 

$

1,410.1 

$

1,556.4 

$

1,287.8 

$

1,356.9 

Auto loan receivables, net

 

5,895.9 

 

4,959.8 

 

4,320.6 

 

 ―

 

 ―

 

 ―

Total assets

 

9,888.6 

 

8,331.5 

 

7,125.5 

 

2,856.4 

 

2,693.6 

 

2,646.0 

Total current liabilities

 

684.2 

 

646.3 

 

522.7 

 

490.5 

 

502.7 

 

500.7 

Short-term debt and current portion:

 

 

 

 

 

 

 

 

 

 

 

 

Non-recourse notes payable

 

182.9 

 

174.3 

 

132.5 

 

 ―

 

 ―

 

 ―

Other

 

16.5 

 

15.1 

 

13.6 

 

133.6 

 

168.2 

 

108.6 

Non-current debt:

 

 

 

 

 

 

 

 

 

 

 

 

Non-recourse notes payable

 

5,672.2 

 

4,509.8 

 

3,881.1 

 

 ―

 

 ―

 

 ―

Other

 

337.5 

 

353.6 

 

367.6 

 

378.5 

 

539.6 

 

581.3 

Total shareholders’ equity

 

3,019.2 

 

2,673.1 

 

2,239.2 

 

1,884.6 

 

1,547.9 

 

1,447.7 

Unit sales information

 

 

 

 

 

 

 

 

 

 

 

 

Used vehicle units sold

 

447,728 

 

408,080 

 

396,181 

 

357,129 

 

345,465 

 

377,244 

Wholesale vehicle units sold

 

324,779 

 

316,649 

 

263,061 

 

197,382 

 

194,081 

 

222,406 

Percent changes in

 

 

 

 

 

 

 

 

 

 

 

 

Comparable store used vehicle unit sales

 

 

 

10 

 

 

(16)

 

Total used vehicle unit sales

 

10 

 

 

11 

 

 

(8)

 

12 

Wholesale vehicle unit sales

 

 

20 

 

33 

 

 

(13)

 

Net sales and operating revenues

 

10 

 

11 

 

20 

 

 

(15)

 

10 

Net earnings

 

 

10 

 

36 

 

403 

 

(69)

 

(8)

Diluted net earnings per share

 

 

 

33 

 

396 

 

(69)

 

(10)

Other year-end information

 

 

 

 

 

 

 

 

 

 

 

 

Used car superstores

 

118 

 

108 

 

103 

 

100 

 

100 

 

89 

Associates

 

18,111 

 

16,460 

 

15,565 

 

13,439 

 

13,035 

 

15,637 

 

 (1)    Reflects the adoption in fiscal 2011 of ASU Nos. 2009-16 and 2009-17 effective March 1, 2010, to recognize the transfers of auto loan receivables and the related non-recourse notes payable on our consolidated balance sheets.

 

 

 

 

20


 

 

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 audited 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.  Certain prior year amounts have been reclassified to conform to the current year’s presentation.  All references to net earnings per share are to diluted net earnings per share.  Amounts and percentages may not total due to rounding.

BUSINESS OVERVIEW

General

CarMax is the nation’s largest retailer of used vehicles.  We operate in two reportable segments:  CarMax Sales Operations and CarMax Auto Finance (“CAF”).  Our CarMax Sales Operations segment consists of all aspects of our auto merchandising and service operations, excluding financing provided by CAF.  Our CAF segment consists solely of our own finance operation that provides vehicle financing through CarMax superstores.

We pioneered the used car superstore concept, opening our first store in 1993.  Our strategy is to revolutionize 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, 2013, we operated 118 used car superstores in 58 markets, comprising 45 mid-sized markets, 12 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 four new car franchises.  During fiscal 2013, we sold 447,728 used cars, representing 98% of the total 455,583  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 features low, no-haggle prices; a broad selection of CarMax Quality Certified used vehicles; and superior customer service.  Our website, carmax.com, is a valuable tool for communicating the CarMax consumer offer, as well as a sophisticated search engine and efficient channel for customers who prefer to commence their shopping online.  Our financial results are driven by retailing used vehicles and associated items including vehicle financing, extended service plans (“ESPs”), a guaranteed asset protection (“GAP”) product and vehicle repair service.  GAP is designed to cover the unpaid balance on an auto loan in the event of a total loss of the vehicle or unrecovered theft.

Our financial results also reflect 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, 2013, we conducted auctions at 57 used car superstores.  During fiscal 2013, we sold 324,779 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.

We sell ESPs and GAP on behalf of unrelated third parties who are the primary obligors.  As of February 28, 2013, the used vehicle third-party ESP providers were CNA National Warranty Corporation and The Warranty Group, and the third-party GAP provider was Safe-Guard Products International, LLC.  We have no contractual liability to the customer under these third-party plans.  ESP revenue represents commissions earned on the sale of ESPs and GAP from the unrelated third parties.

We provide financing to qualified retail customers through CAF, our finance operation, and our arrangements with several industry-leading financial institutions.  As of February 28, 2013, these third parties included Capital One Auto Finance, Santander Consumer USA, Wells Fargo Dealer Services and American Credit Acceptance.  Depending on the credit profile of the customer, the third-party finance providers generally either pay us or are paid a fixed, pre-negotiated fee per contract.  The fee amount is independent of any finance term offered to the customer; it does not vary based on the amount financed, the term of the loan, the interest rate or the loan-to-value ratio.  We refer to the providers who pay us a fee as prime and nonprime providers, and we refer to the providers to whom we pay a fee as subprime providers.  We  periodically test additional third-party providers.    We have no recourse liability on retail installment contracts arranged with third-party providers.

21


 

 

We offer financing through CAF to qualified customers purchasing vehicles at CarMax.  CAF utilizes proprietary customized scoring models based upon the credit history of the customer, along with CAF’s historical experience, to predict the likelihood of customer repayment.  CAF offers customers an array of competitive rates and terms, allowing them to choose the ones that best fit their needs.  In addition, customers are permitted to refinance or pay off their contract with CAF or a third-party provider within three business days of a purchase without incurring any finance or related charges.  We randomly test different credit offers and closely monitor acceptance rates and 3-day payoffs to assess market competitiveness.  After the effect of 3-day payoffs and vehicle returns, CAF financed 39% of our retail vehicle unit sales in fiscal 2013.  As of February 28, 2013, CAF serviced approximately 459,000 customer accounts in its $5.93 billion portfolio of managed receivables.

Over the long term, we believe the primary driver for earnings growth will be vehicle unit sales growth from both new stores and stores included in our comparable store base.  Increased vehicle unit sales should also drive increased sales of wholesale vehicles and ancillary products and CAF income.  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 probability of sale and its mileage relative to its age; however, it is not primarily based on the vehicle’s selling price

In December 2008, we temporarily suspended store growth due to the weak economic and sales environment.  We opened 3 superstores in fiscal 2011, 5 superstores in fiscal 2012 and 10 superstores in fiscal 2013.  We currently plan to open 13 superstores in fiscal 2014 and between 10 and 15 superstores in each of the following 2 fiscal yearsWhile we currently have more than 100 superstores, we are still in the midst of the national rollout of our retail concept, and as of February 28, 2013, we had used car superstores located in markets that comprised approximately 53% of the U.S. population.

The principal challenges we face in expanding our store base include our ability to build our management bench strength to support our store growth and our ability to procure suitable real estate at favorable terms.  We staff each newly opened store with associates who have extensive CarMax trainingTherefore, we must recruit, train and develop managers and associates to fill the pipeline necessary to support future store openings.

Fiscal 2013 Highlights

·

Net sales and operating revenues increased 10% to $10.96 billion from $10.00 billion in fiscal 2012.  Net earnings grew 5% to $434.3 million, or $1.87 per share, from $413.8 million, or $1.79 per share.

·

Total used vehicle revenues increased 12% to $8.75 billion versus $7.83 billion in fiscal 2012.  Total used vehicle unit sales rose 10%, reflecting the combination of a 5% increase in comparable store used unit sales together with sales from newer stores not yet included in the comparable store base. 

·

Total wholesale vehicle revenues increased 2% to $1.76 billion versus $1.72 billion in fiscal 2012.  Wholesale vehicle unit sales increased 3%, reflecting the combined effects of the growth in our store base, higher appraisal traffic and a lower appraisal buy rate.  The modest growth in wholesale unit sales also reflected the challenging comparisons with fiscal 2012 and fiscal 2011, when wholesale unit sales grew 20% and 33%, respectively.

·

Total other sales and revenues declined 2% to $248.6 million from $254.5 million in fiscal 2012, as a 13% increase in ESP revenues was more than offset by a reduction in net third-party finance fees. 

·

Total gross profit increased 6% to $1.46 billion compared with $1.38 billion in fiscal 2012, primarily reflecting the increases in used and wholesale vehicle unit sales. 

·

Selling, general and administrative (“SG&A”) expenses rose 10% to $1.03 billion from $940.8 million in fiscal 2012.  The increase reflected the combination of the 9% expansion in our store base during fiscal 2013 (representing the addition of 10 stores), higher variable selling costs resulting from the 5% increase in comparable store used unit sales and higher growth-related costs.  SG&A per retail unit was consistent at $2,263 in both fiscal 2013 and fiscal 2012.

·

CAF income increased 14% to $299.3 million compared with $262.2 million in fiscal 2012.  The improvement in CAF income was largely attributable to the 16% increase in average managed receivables.  The allowance for loan losses increased moderately to 1.0% of managed receivables as of February 28, 2013, compared with 0.9% as of February 29, 2012.

·

Net cash used in operating activities totaled $778.4 million in fiscal 2013 compared with $62.2 million in fiscal 2012.  These amounts included increases in auto loan receivables of $992.2 million and $675.7 million, respectively.  The majority of the increases in auto loan receivables are accompanied by increases in non-recourse notes payable, which are reflected as cash provided by financing activities.  In fiscal 2013, net cash used in operating activities also included a $425.2 million increase in inventory.  We had 35% more used vehicles in inventory as of February 28, 2013, compared with a year earlier, reflecting the additional used vehicle units to support the 10 stores opened during fiscal 2013 and our comparable store sales growth.  In

22


 

 

addition, during the second half of fiscal 2013 we built inventories at a higher rate than in recent years to better position ourselves for seasonal sales opportunities.

 

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.

Financing and Securitization Transactions

We maintain a revolving securitization program composed of two warehouse facilities (“warehouse facilities”) that we use to fund auto loan receivables originated by CAF until they are funded through a term securitization or alternative funding arrangement.  We recognize transfers of auto loan receivables into the warehouse facilities and term securitizations as secured borrowings, which result in recording the auto loan receivables and the related non-recourse notes payable on our consolidated balance sheets.  CAF income included in the consolidated statements of earnings primarily reflects the interest and fee income generated by the auto loan receivables less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct CAF expenses.

Auto loan receivables include amounts due from customers related to retail vehicle sales financed through CAF.  The receivables are presented net of an allowance for estimated loan losses.  The allowance for loan losses represents an estimate of the amount of net losses inherent in our portfolio of managed receivables as of the applicable reporting date and anticipated to occur during the following 12 months.  The allowance is primarily based on the credit quality of the underlying receivables, historical loss trends and forecasted forward loss curves.  We also take into account recent trends in delinquencies and losses, recovery rates and the economic environment.  The provision for loan losses is the periodic expense of maintaining an adequate allowance.

See Notes 2(F), 2(I) and 4 for additional information on securitizations and auto loan receivables.

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.  As part of our customer service strategy, we guarantee the retail vehicles we sell with a 5‑day, money-back guarantee.  We record a reserve for estimated returns based on historical experience and trends, and results could be affected if future vehicle returns differ from historical averages.

We also sell ESPs and GAP on behalf of unrelated third parties to customers who purchase a vehicle.  The ESPs we offer on all used vehicles provide coverage up to 72 months (subject to mileage limitations), while GAP covers the customer for the term of their finance contract.  Because we are not the primary obligor under these plans, we recognize commission revenue at the time of sale, net of a reserve for estimated customer cancellations.  The reserve for cancellations is based on historical experience and trends, and results could be affected if future cancellations differ from historical averages.

Customers applying for financing who are not approved by CAF may be evaluated by other financial institutions.  Depending on the credit profile of the customer, third-party finance providers generally either pay us or are paid a fixed, pre-negotiated fee per contract.  We recognize these fees at the time of sale.

We collect sales taxes and other taxes from customers on behalf of governmental authorities at the time of sale.  These taxes are accounted for on a net basis and are not included in net sales and operating revenues or cost of sales.

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 enactedSee Note 8 for additional information on income taxes.

23


 

 

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 capital loss carryforwards that may not be utilized before their expiration, we believe that our recorded deferred tax assets as of February 28, 2013, 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 be affected in the period when the change in circumstances occurs.

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.

 

RESULTS OF OPERATIONSCARMAX SALES OPERATIONS

 

Net Sales and Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

(In millions)

 

2013

Change

2012

Change

2011

Used vehicle sales

 

$

8,747.0 

 

11.8 

%

$

7,826.9 

 

8.6 

%

$

7,210.0 

 

New vehicle sales

 

 

207.7 

 

3.6 

%

 

200.6 

 

1.0 

%

 

198.5 

 

Wholesale vehicle sales

 

 

1,759.6 

 

2.2 

%

 

1,721.6 

 

32.3 

%

 

1,301.7 

 

Other sales and revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Extended service plan revenues

 

 

202.9 

 

13.0 

%

 

179.6 

 

3.3 

%

 

173.8 

 

Service department sales

 

 

101.8 

 

3.2 

%

 

98.6 

 

(2.0)

%

 

100.6 

 

Third-party finance fees, net

 

 

(56.1)

 

(136.0)

%

 

(23.8)

 

(160.1)

%

 

(9.1)

 

Total other sales and revenues

 

 

248.6 

 

(2.3)

%

 

254.5 

 

(4.1)

%

 

265.3 

 

Total net sales and operating revenues

 

$

10,962.8 

 

9.6 

%

$

10,003.6 

 

11.5 

%

$

8,975.6 

 

 

Unit Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

2013

2012

2011

Used vehicles

 

 

447,728 

 

 

408,080 

 

 

396,181 

 

New vehicles

 

 

7,855 

 

 

7,679 

 

 

8,231 

 

Wholesale vehicles

 

 

324,779 

 

 

316,649 

 

 

263,061 

 

 

Average Selling Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

2013

2012

2011

Used vehicles

 

$

19,351 

 

$

18,995 

 

$

18,019 

 

New vehicles

 

$

26,316 

 

$

25,986 

 

$

23,989 

 

Wholesale vehicles

 

$

5,268 

 

$

5,291 

 

$

4,816 

 

 

Used Vehicle Sales Changes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

 

2013

2012

2011

Used vehicle units

 

 

 

10 

%

 

%

 

11 

%

Used vehicle dollars

 

 

 

12 

%

 

%

 

16 

%

 

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.

24


 

 

Comparable Store Used Vehicle Sales Changes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

 

2013

2012

2011

Used vehicle units

 

 

 

%

 

%

 

10 

%

Used vehicle dollars

 

 

 

%

 

%

 

15 

%

 

Wholesale Vehicle Sales Changes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

 

2013

2012

2011

Wholesale vehicle units

 

 

 

%

 

20 

%

 

33 

%

Wholesale vehicle dollars

 

 

 

%

 

32 

%

 

54 

%

 

Change in Used Car Superstore Base

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

 

 

2013

2012

2011

Used car superstores, beginning of period

 

 

 

108 

 

 

103 

 

 

100 

 

Superstore openings

 

 

 

10 

 

 

 

 

 

Used car superstores, end of period

 

 

 

118 

 

 

108 

 

 

103 

 

 

Used Vehicle Sales

Fiscal 2013 Versus Fiscal 2012.  The 12% increase in used vehicle revenues in fiscal 2013 resulted from a 10% increase in used unit sales and a 2% increase in average retail selling price.  The increase in used unit sales included a 5% increase in comparable store used unit sales, together with sales from newer stores not yet included in the comparable store base.  The comparable store unit growth was driven by improved conversion, which we believe benefited from a variety of factors, including more compelling credit offers from third-party finance providers and CAF, increased inventory selection and continued strong in-store execution. 

The increase in average retail selling price primarily reflected changes in our sales mix by vehicle age, with an increased mix of ages 0-2 vehicles and a reduced mix of ages 3-4 vehicles, which corresponds to the model years in shortest supply.  The overall supply of late-model used vehicles being remarketed has remained constrained following four years of new car industry sales at rates significantly below pre-recession levels.  During much of the period from 2009 through 2011, wholesale vehicle industry values rose, which increased our vehicle acquisition costs and average selling prices compared with pre-recession periods.  We believe the constrained supply of late-model used vehicles and the resulting increase in selling prices has had an adverse effect on our used vehicle sales in recent years.  As new car industry sales return to historical levels, the supply of late-model used vehicles should gradually improve, which we believe will benefit our business.

Our data indicated that we increased our share of the late-model (0- to 6-year old) used vehicle market by approximately 4% in fiscal 2013.  This data also indicated that our share of the broader, 0- to 10-year old used vehicle market grew approximately 7%, reflecting shifts in our inventory mix in recent years in response to changing consumer preferences.  We believe our ability to grow market share year after year is a reflection of the strength of our consumer offer, the skill of our associates and the preference for our brand.

Fiscal 2012 Versus Fiscal 2011.  The 9% increase in used vehicle revenues in fiscal 2012 resulted from a 5% increase in average retail selling price and a 3% increase in unit sales.  The growth in the average retail selling price primarily reflected increases in our acquisition costs, which resulted from the year-over-year increase in used vehicle wholesale industry values.  A shift in our sales mix moderated the effect of higher acquisition costs on our average retail selling price.  During fiscal 2012, 5- to 10-year old vehicles, which generally have lower selling prices than later-model vehicles, represented an increased portion of our sales mix.

The 3% increase in used unit sales included a 1% increase in comparable store used unit sales, together with sales from superstores not yet included in the comparable store base.  We believe the modest rate of comparable store used unit sales growth reflected both a challenging sales comparison with fiscal 2011, when comparable store used unit sales increased 10%, and the continuation of weak economic conditions and low consumer confidence for much of fiscal 2012.  While customer traffic at comparable stores was higher than in the prior year, a larger portion of the fiscal 2012 traffic represented customers who only obtained vehicle appraisals, which contributed to a decline in sales conversion. 

25


 

 

Our data indicated that we increased our share of the late model used vehicle market by approximately 3% in fiscal 2012.  We achieved market share growth despite a shift within the market for 0‑ to 6‑year old vehicles towards older used vehicles and having fewer immature stores (those less than five years old) in our store base due to our temporary suspension of store growth.  Historically, market share gains are strongest among immature stores.

Wholesale Vehicle Sales

We seek 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 can also be affected by changes in vehicle mix or the average age, mileage or condition of the vehicles sold.

Fiscal 2013 Versus Fiscal 2012.  The 2% increase in wholesale vehicle revenues in fiscal 2013 resulted from a 3% increase in wholesale unit sales offset by a slight reduction in average wholesale vehicle selling price.  The wholesale unit growth included the combined effects of the growth in our store base and higher appraisal traffic, offset by a lower appraisal buy rate.  The modest growth in wholesale unit sales also reflected the challenging comparisons with fiscal 2012 and fiscal 2011, when wholesale unit sales grew 20% and 33%, respectively. 

Fiscal 2012 Versus Fiscal 2011.  The 32% increase in wholesale vehicle revenues in fiscal 2012 resulted from a 20% increase in wholesale unit sales combined with a 10% increase in average wholesale vehicle selling price.  The increase in unit sales primarily reflected a significant increase in appraisal traffic.  While the appraisal buy rate remained high relative to historical averages, it declined modestly from the prior year.  Our appraisal traffic benefited from the increase in customer traffic in our stores and from the lift in new car industry sales and related used vehicle trade-in activity in fiscal 2012. 

Other Sales and Revenues

Other sales and revenues include commissions on the sale of ESPs and GAP (reported in ESP revenues), service department sales and net third-party finance fees.  The fixed, per-vehicle fees paid to us by prime and nonprime third-party finance providers may vary, reflecting the providers’ differing levels of credit risk exposure.  The fixed, per-vehicle fees that we pay to the subprime providers are reflected as an offset to finance fee revenues received from prime and nonprime providers.

Fiscal 2013 Versus Fiscal 2012.  Other sales and revenues declined 2% in fiscal 2013, as an increase in ESP revenues was more than offset by a decrease in net third-party finance fees.  ESP revenues increased 13%, primarily reflecting the growth in our retail vehicle unit sales and an increase in ESP penetration.  The decrease in net third-party finance fees was driven by a mix shift among providers, including an increase in the percentage of our retail unit sales financed by the subprime providers to 15% in fiscal 2013 versus 10% in fiscal 2012.  The growth in the subprime sales mix primarily resulted from more compelling credit offers being made by the subprime providers. 

Fiscal 2012 Versus Fiscal 2011.  Other sales and revenues declined 4% in fiscal 2012, as a 3% increase in ESP revenues was more than offset by a decrease in net third-party finance fees resulting from a mix change among providers.  Subprime providers financed 10% of our retail vehicle unit sales in fiscal 2012 compared with 8% in fiscal 2011.  The reduction in net third-party finance fees also reflected the decision by CAF to retain an increased portion of the loans that third-party providers had been purchasing following CAF’s tightening of lending standards beginning in fiscal 2010.  As CAF retained an increased portion of these loans, the fees previously received from third parties declined.

 

Gross Profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

(In millions)

2013

 

Change

2012

Change

2011

Used vehicle gross profit

 

$

971.5 

 

9.3 

%

$

888.6 

 

4.0 

%

$

854.0 

 

New vehicle gross profit

 

 

5.0 

 

(23.8)

%

 

6.5 

 

19.9 

%

 

5.4 

 

Wholesale vehicle gross profit

 

 

308.1 

 

2.1 

%

 

301.8 

 

26.4 

%

 

238.8 

 

Other gross profit

 

 

179.8 

 

(1.2)

%

 

181.9 

 

(10.4)

%

 

203.0 

 

Total

 

$

1,464.4 

 

6.2 

%

$

1,378.8 

 

6.0 

%

$

1,301.2 

 

 

26


 

 

Gross Profit per Unit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

 

2013

 

2012

 

2011

 

$ per unit (1)

%(2)

 

$ per unit (1)

%(2)

 

$ per unit (1)

%(2)

Used vehicle gross profit

$

2,170 

 

11.1 

 

$

2,177 

 

11.4 

 

$

2,156 

 

11.8 

New vehicle gross profit

$

630 

 

2.4 

 

$

847 

 

3.2 

 

$

659 

 

2.7 

Wholesale vehicle gross profit

$

949 

 

17.5 

 

$

953 

 

17.5 

 

$

908 

 

18.3 

Other gross profit

$

395 

 

72.3 

 

$

438 

 

71.5 

 

$

502 

 

76.5 

Total gross profit

$

3,214 

 

13.4 

 

$

3,316 

 

13.8 

 

$

3,218 

 

14.5 

 

 (1)    Calculated as category gross profit divided by its respective units sold, except the other and total categories, which are divided by total retail units sold.

(2)  Calculated as a percentage of its respective sales or revenue.

 

Used Vehicle Gross Profit

We target a 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 our exposure to the inherent continual fluctuation 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.    Other factors that may influence gross profit include changes in our vehicle reconditioning costs, changes in the percentage of vehicles sourced directly from consumers through our appraisal process and changes in the wholesale pricing environment.  Vehicles purchased directly from consumers typically generate more gross profit per unit compared with vehicles purchased at auction.  Over the past several years, we have successfully managed to generate a used vehicle gross profit per unit within a fairly narrow range. 

Fiscal 2013 Versus Fiscal 2012.  Used vehicle gross profit increased 9% in fiscal 2013, driven primarily by the 10% increase in used unit sales.  Used vehicles gross profit per unit was only marginally lower, averaging $2,170 in fiscal 2013 versus $2,177 in fiscal 2012.

Fiscal 2012 Versus Fiscal 2011.  Used vehicle gross profit increased 4% in fiscal 2011, reflecting the combination of the 3% increase in used unit sales and a 1% improvement in gross profit per unit.  Used vehicle gross profit per unit increased $21 to $2,177 per unit compared with $2,156 per unit in fiscal 2011.  Our shift to selling an increased mix of 5- to 10-year old vehicles in fiscal 2012 increased our average reconditioning cost per unit, as older vehicles typically require more reconditioning effort.  However, the older vehicles we sold were generally no less profitable than newer models.

Wholesale Vehicle Gross Profit

The strength of our wholesale gross profit per unit in recent years reflects the strong demand for older, higher mileage vehicles, which are the mainstay of our auctions, as well as the continued strong dealer attendance and resulting high dealer-to-car ratios at our auctions.  The frequency of our auctions, which are generally held weekly or bi-weekly, minimizes the depreciation risk on these vehicles.

Fiscal 2013 Versus Fiscal 2012.  Wholesale vehicle gross profit increased 2% in fiscal 2013, driven by the 3% increase in wholesale unit sales.  Wholesale gross profit per unit was relatively stable, declining only $4 per unit.

Fiscal 2012 Versus Fiscal 2011.  Wholesale vehicle gross profit increased 26% in fiscal 2012.  The improvement reflected the 20% increase in wholesale unit sales combined with a 5% rise in wholesale vehicle gross profit per unit, to $953 per unit from $908 per unit in fiscal 2011.  The year-over-year increase in industry pricing and strong dealer demand contributed to the improved wholesale gross profit per unit. 

Other Gross Profit

Other gross profit includes profits related to ESP and GAP revenues, net third-party finance fees and the service department.  We have no cost of sales related to ESP and GAP revenues or net third-party finance fees, as these represent commissions paid to us by certain third-party providers, net of the fees we pay to third-party subprime

27


 

 

finance providers.  Accordingly, changes in the relative mix of the other gross profit components can affect the composition and amount of other gross profit.

Fiscal 2013 Versus Fiscal 2012.    Other gross profit declined 1% in fiscal 2013, as improved ESP and service department profits were more than offset by the lower net third-party finance fees.

Fiscal 2012 Versus Fiscal 2011.  Other gross profit fell 10% in fiscal 2012, as the 3% growth in ESP profits was more than offset by the lower net third-party finance fees and service department profits.  Service department gross profit declined $12.2 million primarily due to the deleverage associated with increased service overhead costs, the modest retail unit sales growth and lower service retail sales.

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 by changes in average retail prices.  However, increases in average vehicle selling prices benefit CAF income, to the extent the average amount financed also increases.

During fiscal 2012 and fiscal 2011, we experienced a period of appreciation in used vehicle wholesale pricing.  We believe the appreciation resulted, in part, from the reduced supply of late-model used vehicles in the market that was caused by the dramatic decline in new car industry sales and the associated slow down in used vehicle trade-in activity, compared with pre-recession periods.  The higher wholesale values increased both our vehicle acquisition costs and our average selling prices for used and wholesale vehicles.  In fiscal 2013 and fiscal 2012, we also experienced inflationary increases in key reconditioning costs.

 

Selling, General and Administrative Expenses

Components of SG&A Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended February 28 or 29

(In millions except per unit data)

 

2013

Change

 

2012

Change

 

2011

Compensation and benefits (1)

 

$

581.9 

 

11.7 

%

 

$

521.0 

 

6.8 

%

 

$

487.8 

 

Store occupancy costs

 

 

199.9 

 

6.5 

%

 

 

187.6 

 

3.3 

%

 

 

181.6 

 

Advertising expense

 

 

106.3 

 

7.2 

%

 

 

99.1 

 

3.8 

%

 

 

95.5 

 

Other overhead costs (2)

 

 

142.9 

 

7.5 

%

 

 

133.1 

 

16.7 

%

 

 

113.9 

 

Total SG&A expenses

 

$

1,031.0 

 

9.6 

%

 

$

940.8 

 

7.1 

%

 

$

878.8 

 

 

 (1)    Excludes compensation and benefits related to reconditioning and vehicle repair service, which is included in cost of sales.

(2)  Includes IT expenses, insurance, bad debt, travel, preopening and relocation costs, charitable contributions and other administrative expenses.

 

Fiscal 2013 Versus Fiscal 2012.  SG&A expenses increased 10% in fiscal 2013.  The increase primarily reflected the combination of the 9% expansion in our store base during fiscal 2013 (representing the addition of 10 stores), higher variable selling costs resulting from the 5% increase in comparable store used unit sales, and higher growth-related costs.  Growth-related costs include store pre-opening expenses, relocation expenses, and the costs of maintaining store management bench strength to support future growth.  These costs were affected by the increase in the rate of our store openings, from 5 stores in fiscal 2012 to 10 stores in fiscal 2013.  SG&A per retail unit was consistent at $2,263 in both fiscal 2013 and fiscal 2012.

Fiscal 2012 Versus Fiscal 2011.  SG&A expenses increased 7% in fiscal 2012.  The increase was driven by the 5% expansion of our store base in fiscal 2012 (representing the addition of five stores), higher growth-related costs, and increases in variable selling costs.  SG&A per retail unit rose 4% to $2,263 from $2,173 in fiscal 2011.

Income Taxes

The effective income tax rate was 38.1% in fiscal 2013, 38.0% in fiscal 2012 and 37.9% in fiscal 2011.

 

 

28


 

 

RESULTS OF OPERATIONSCARMAX AUTO FINANCE

CAF provides financing to qualified customers purchasing vehicles at CarMax.  Because the purchase of a vehicle is generally 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 the company’s processes and systems, transparency of pricing, vehicle quality and the integrity of the information collected at the time the customer applies for credit provide a unique and ideal environment in which to procure high quality auto loans, both for CAF and for the third-party finance providers.

We believe CAF enables us to capture additional sales, profits and cash flows while managing our reliance on third- party finance sources.    Management regularly analyzes CAF's operating results by assessing profitability, the performance of the auto loan receivables including trends in credit losses and delinquencies, and CAF direct expenses.

CAF income primarily reflects the interest and fee income generated by the auto loan receivables less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct CAF expenses.    CAF income does not include any allocation of indirect costs.  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 allocated to CAF include retail store expenses and corporate expenses such as human resources, administrative services, marketing, information systems, accounting, legal, treasury and executive payroll.

 

Components of CAF Income