CarMax 2004 Annual Report Download - page 19

The following Management’s Discussion and Analysis
(“MD&A”) is intended to help the reader understand
CarMax, Inc. MD&A is presented in nine sections: Business
Overview; Critical Accounting Policies; Results of Operations;
Operations Outlook; Recent Accounting Pronouncements;
Financial Condition; Contractual Obligations; Market Risk;
and Cautionary Information About Forward-Looking
Statements. MD&A is provided as a supplement to, and
should be read in conjunction with, our consolidated financial
statements and the accompanying notes contained elsewhere
in this annual report.
In MD&A, “we,” “our,” “us,” “CarMax,” and “the
company” refer to CarMax, Inc. and its wholly owned
subsidiaries, unless the context requires otherwise. Amounts
and percents in tables may not total due to rounding.
BUSINESS OVERVIEW
General
CarMax was formerly a subsidiary of Circuit City Stores, Inc.
(“Circuit City”). On October 1, 2002, the CarMax business was
separated from Circuit City through a tax-free transaction and
became an independent, separately traded public company. We
pioneered the used car superstore concept, opening our first store
in 1993. Over the next six years, we opened an additional 32
used car superstores before suspending new store development to
focus on improving profitability. After a period of concept
refinement and execution improvement, we resumed used car
superstore growth in fiscal 2002, adding two stores late in the
fiscal year, five stores in fiscal 2003, and nine stores in fiscal 2004.
At the end of fiscal 2004, we had 49 used car superstores in 23
markets, including 8 large markets and 15 mid-sized markets.
CarMax is the nation’s leading specialty retailer of used
vehicles. The CarMax consumer offer is unique in the auto
retailing marketplace. It gives consumers a way to shop for cars
the same way they shop for items at other “big-box” retailers.
Our consumer offer is structured around four core equities,
including low, no-haggle prices; a broad selection; high
quality; and customer-friendly service. We generate revenues,
income, and cash flows by retailing used and new vehicles and
associated items including vehicle financing, extended
warranties, and vehicle repair service. In addition, vehicles
purchased through our appraisal process that do not meet our
retail standards are wholesaled at on-site auctions.
Sales of new vehicles represented a decreasing percentage of
our total revenues over the last three years as we divested new
car franchises and added used car superstores. While further
franchise disposals are planned, we expect to keep a small
number of core new car franchises in order to maintain long-
term strategic relationships with automotive manufacturers.
We provide prime financing for customers through CarMax
Auto Finance (“CAF”) and Bank of America. We also provide
financing for non-prime customers through three third-party
lenders. We continue to test additional non-prime lenders, as
well as lenders for sub-prime financing. Having our own
finance operation allows us to limit the risk of reliance on
third-party finance sources, while also allowing us to capture
additional profit and cash flows. The majority of CAF’s profit
contribution is generated from the spread between the interest
rate charged the customer and our cost of funds. We collect
fixed, pre-negotiated fees from most of the third-party lenders
for each CarMax customer loan they finance.
We sell extended warranties on behalf of unrelated third
parties who are the primary obligors. Under these third-party
warranty programs, we have no contractual liability to the
customer. Extended warranty revenue represents commissions
from the unrelated third parties.
We are still at an early stage in the national rollout of our
retail concept. The primary drivers for future earnings growth
will be vehicle unit growth from geographic expansion and
comparable store sales increases, and the related expense
leverage. We target a roughly similar fixed dollar amount of
gross profit per used unit, regardless of price, making unit
growth our primary focus. During the next two-to-three years,
we plan to focus our store growth primarily on adding standard
superstores to new mid-sized markets, which we define as those
with television viewing audiences between 1 million and 2.5
million people, and satellite fill-in superstores in established
markets. In addition, in fiscal 2005 we plan to open two stores
in Los Angeles on sites that were purchased prior to suspending
growth in 1999. Following these openings, we will have four
stores in Los Angeles, which will provide a foundation for
future expansion in this market. In fiscal 2006 or 2007, we
expect to once again begin entering additional larger, multi-
store markets. Over the three-year period, we plan to open used
car superstores at a rate of 15% to 20% of our store base each
year. We also expect used unit comparable store sales increases
in the range of 4% to 8%, reflecting the multi-year ramp in
sales of newly opened stores as they mature and continued
market share gains at stores that have reached mature sales
levels. On a combined basis, we expect that new store openings
and comparable store used unit increases will drive total used
unit growth of approximately 20% annually.
The principal challenges we face in expanding our store
base and meeting our total unit growth targets include:
■Our ability to procure suitable real estate at reasonable
costs. Real estate acquisition will be an increasing challenge
as we enter large, multi-store markets.
■Our ability to build our management bench strength to
support the store growth.
We staff each newly opened store with an experienced
management team, including the location general manager,
operations manager, purchasing manager, and business office
manager, as well as a number of experienced sales managers
and buyers. We must therefore be continually recruiting,
training, and developing managers and associates to fill the
pipeline necessary to support future store openings. If at any
time we believe that the rate of store growth is causing our
performance to falter, we will slow the growth rate.
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MANAGEMENT’S DISCUSSION AND ANALYSIS