CarMax 1999 Annual Report Download - page 56

1. BASIS OF PRESENTATION
On January 24, 1997, shareholders of Circuit City Stores, Inc. and
its subsidiaries approved the creation of two common stock series.
The Company’s existing common stock was subsequently redesig-
nated as Circuit City Stores, Inc.–Circuit City Group Common
Stock. In an initial public offering, which was completed February
7, 1997, the Company sold 21.86 million shares of Circuit City
Stores, Inc.–CarMax Group Common Stock.
The Circuit City Group Common Stock is intended to track
the performance of the Circuit City store-related operations, the
Company’s investment in Digital Video Express and the Group’s
retained interest in the CarMax Group. The effects of this
retained interest on the Circuit City Group’s financial statements
are identified by the term “Inter-Group.” The CarMax Group
Common Stock is intended to track the performance of the
CarMax operations. The Inter-Group Interest is not considered
outstanding CarMax Stock. Therefore, any net earnings or loss
attributed to the Inter-Group Interest is not included in the
CarMax Group’s per share calculations. The Circuit City Group
held a 76.6 percent interest in the CarMax Group at February 28,
1999, a 77.3 percent interest at February 28, 1998, and a 77.5 per-
cent interest at February 28, 1997.
The Circuit City Group financial statements give effect to
the management and allocation policies adopted by the board of
directors as described under “Corporate Activities.” The Circuit
City Group financial statements have been prepared on a basis
that management believes to be reasonable and appropriate and
include (i) the historical financial position, results of operations
and cash flows of the Circuit City Group, (ii) an allocated portion
of the Company’s cash equivalents and debt, including the related
effects upon results of operations and cash flows, (iii) an allocated
portion of the Company’s corporate general and administrative
costs and (iv) the Inter-Group Interest held by the Circuit City
Group in the CarMax Group.
Notwithstanding the attribution of the Company’s assets and
liabilities (including contingent liabilities) and stockholders’
equity between the Circuit City Group and the CarMax Group
for the purposes of preparing their respective financial statements,
holders of Circuit City Stock and holders of CarMax Stock are
shareholders of the Company and continue to be subject to all of
the risks associated with an investment in the Company and all of
its businesses, assets and liabilities. Such attribution and the
change in the equity structure of the Company does not affect
title to the assets or responsibility for the liabilities of the
Company or any of its subsidiaries. The results of operations or
financial condition of one Group could affect the results of opera-
tions or financial condition of the other Group. Accordingly, the
Circuit City Group financial statements included herein should be
read in conjunction with the Company’s consolidated financial
statements and the CarMax Group financial statements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) CASH AND CASH EQUIVALENTS: Allocated cash equivalents
of $201,379,000 at February 28, 1999, and $55,215,000 at
February 28, 1998, consist of highly liquid debt securities with
original maturities of three months or less.
(B) TRANSFERS AND SERVICING OF FINANCIAL ASSETS: The
Company adopted Statement of Financial Accounting Standards
No. 125, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities,” effective January 1,
1997. For transfers that qualify as sales, the Company recognizes
gains or losses as a component of the Company’s finance opera-
tions. For transfers of financial assets to qualify for sale accounting,
control over the assets must be surrendered at the time of sale.
Multiple estimates are used to calculate the gain or loss on sales of
receivables under SFAS No. 125. Finance charge income, default
rates and payment rates are estimated using projections developed
from the prior 12 months of operating history. These estimates are
adjusted for any industry or portfolio trends that have been
observed. The resulting cash flow projections are present valued at
a discount rate appropriate for the type of asset and risk. Retained
interests (such as residual interests in a securitization trust, cash
reserve accounts and rights to future interest from serviced assets
that exceed contractually specified servicing fees) are included in
net accounts receivable and are carried at fair value with changes in
fair value reflected in earnings. Loan receivables held for sale are
carried at the lower of cost or market, whereas loan receivables
held for investment are carried at cost less an allowance for losses.
At February 28, 1999 and 1998, cost approximates fair value.
(C) FAIR VALUE OF FINANCIAL INSTRUMENTS: The Company
enters into financial instruments on behalf of the Circuit City
Group. The carrying value of the Circuit City Group’s financial
instruments, excluding interest rate swaps held for hedging pur-
poses, approximates fair value. Credit risk is the exposure to the
potential nonperformance of another material party to an agree-
ment due to changes in economic, industry or geographic factors
and is mitigated by dealing only with counterparties that are
highly rated by several financial rating agencies. Accordingly, the
Circuit City Group does not anticipate material loss for nonper-
formance. All financial instruments are broadly diversified along
industry, product and geographic areas.
(D) MERCHANDISE INVENTORY: Inventory is stated at the lower
of cost or market. Cost is determined by the average cost method.
(E) PREPAID ROYALTIES AND EXECUTION FEES: Prepaid royal-
ties represent fixed minimum advance payments made to licensors
for digital video disc distribution rights. Divx retains a licensor’s
share of distribution revenues until the share equals the advance
paid to the licensor. Thereafter, any excess distribution revenue is
paid to the licensor. Prepaid royalties are charged to operations as
revenues are earned. Execution fees are one-time payments made
to licensors at the time the related licensing agreements are exe-
cuted and are amortized over the shorter of the initial terms of the
licensing agreements or five years. Both the prepaid royalties and
execution fees are stated at the lower of amortized cost or esti-
mated net realizable value on a license-agreement basis.
(F) PROPERTY AND EQUIPMENT: Property and equipment is
stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are calculated using the straight-
line method over the assets’ estimated useful lives.
54 CIRCUIT CITY STORES, INC. 1999 ANNUAL REPORT
NOTES TO CIRCUIT CITY GROUP FINANCIAL STATEMENTS