UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended August 31, 2001
Commission File Number 1-5767
CIRCUIT CITY STORES, INC.
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-0493875
-------- ----------
(State of Incorporation) (I.R.S. Employer
Identification No.)
9950 MAYLAND DRIVE, RICHMOND, VIRGINIA 23233
(Address of Principal Executive Offices and Zip Code)
(804) 527-4000
(Registrant's Telephone Number, Including Area Code)
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 the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 30, 2001
----------------------------------------------------------------------------- ---------------------------------
Circuit City Stores, Inc. - Circuit City Group Common Stock, par value $0.50 36,271,561
Circuit City Stores, Inc. - CarMax Group Common Stock, par value $0.50 208,317,708
An Index is included on Page 2 and a separate Index for Exhibits is included on
Page 43.
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
INDEX
Page
No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Financial Statements:
Consolidated Balance Sheets -
August 31, 2001, and February 28, 2001 4
Consolidated Statements of Earnings -
Three Months and Six Months Ended August 31, 2001, and 2000 5
Consolidated Statements of Cash Flows -
Six Months Ended August 31, 2001, and 2000 6
Notes to Consolidated Financial Statements 7
Circuit City Group Financial Statements:
Circuit City Group Balance Sheets -
August 31, 2001, and February 28, 2001 21
Circuit City Group Statements of Earnings -
Three Months and Six Months Ended August 31, 2001, and 2000 22
Circuit City Group Statements of Cash Flows -
Six Months Ended August 31, 2001, and 2000 23
Notes to Circuit City Group Financial Statements 24
CarMax Group Financial Statements:
CarMax Group Balance Sheets -
August 31, 2001, and February 28, 2001 33
CarMax Group Statements of Earnings -
Three Months and Six Months Ended August 31, 2001, and 2000 34
CarMax Group Statements of Cash Flows -
Six Months Ended August 31, 2001, and 2000 35
Notes to CarMax Group Financial Statements 36
Item 2. Management's Discussion and Analysis:
-------------------------------------
Circuit City Stores, Inc. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Circuit City Group Management's Discussion and Analysis
of Financial Condition and Results of Operations 29
CarMax Group Management's Discussion and Analysis
of Financial Condition and Results of Operations 39
Page 2 of 44
Item 3. Quantitative and Qualitative Disclosures About Market Risk:
-----------------------------------------------------------
Circuit City Stores, Inc. Quantitative and Qualitative Disclosures 20
About Market Risk
Circuit City Group Quantitative and Qualitative Disclosures 32
About Market Risk
CarMax Group Quantitative and Qualitative Disclosures 42
About Market Risk
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 43
Page 3 of 44
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Amounts in thousands except share data)
Aug. 31, 2001 Feb. 28, 2001
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 823,654 $ 446,131
Net accounts receivable 600,600 585,761
Inventory 1,560,461 1,757,664
Prepaid expenses and other current assets 41,692 57,623
-------------- -------------
Total current assets 3,026,407 2,847,179
Property and equipment, net 898,222 988,947
Other assets 34,251 35,207
-------------- -------------
TOTAL ASSETS $ 3,958,880 $ 3,871,333
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 102,441 $ 132,388
Accounts payable 947,405 902,560
Short-term debt 1,570 1,200
Accrued expenses and other current liabilities 153,670 162,972
Deferred income taxes 103,017 92,479
-------------- -------------
Total current liabilities 1,308,103 1,291,599
Long-term debt, excluding current installments 15,528 116,137
Deferred revenue and other liabilities 85,880 92,165
Deferred income taxes 11,649 14,949
-------------- -------------
TOTAL LIABILITIES 1,421,160 1,514,850
-------------- -------------
Stockholders' equity:
Circuit City Group common stock, $0.50 par value;
350,000,000 shares authorized; 208,260,121 shares
issued and outstanding as of August 31, 2001 104,130 103,510
CarMax Group common stock, $0.50 par value;
175,000,000 shares authorized; 36,255,730 shares
issued and outstanding as of August 31, 2001 18,128 12,820
Capital in excess of par value 793,590 642,838
Retained earnings 1,621,872 1,597,315
-------------- -------------
TOTAL STOCKHOLDERS' EQUITY 2,537,720 2,356,483
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,958,880 $ 3,871,333
============== =============
See accompanying notes to consolidated financial statements.
Page 4 of 44
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings (Unaudited)
(Amounts in thousands except per share data)
Three Months Ended Six Months Ended
August 31, August 31,
2001 2000 2001 2000
-------------- -------------- ------------- --------------
Net sales and operating revenues $ 2,887,915 $ 3,179,781 $ 5,566,389 $ 6,254,632
Cost of sales, buying and warehousing 2,282,845 2,477,990 4,394,966 4,869,579
Appliance exit costs - 28,326 - 28,326
-------------- -------------- ------------- --------------
Gross profit 605,070 673,465 1,171,423 1,356,727
-------------- -------------- ------------- --------------
Selling, general and administrative expenses 579,465 572,298 1,115,459 1,151,504
Appliance exit costs - 1,670 - 1,670
Interest expense 1,654 3,583 4,646 9,804
-------------- -------------- ------------- --------------
Total expenses 581,119 577,551 1,120,105 1,162,978
-------------- -------------- ------------- --------------
Earnings before income taxes 23,951 95,914 51,318 193,749
Provision for income taxes 9,101 36,447 19,501 73,624
-------------- -------------- ------------- --------------
Net earnings $ 14,850 $ 59,467 $ 31,817 $ 120,125
============== ============== ============= ==============
Net earnings attributed to:
Circuit City Group common stock $ 6,822 $ 55,341 $ 16,957 $ 112,464
CarMax Group common stock 8,028 4,126 14,860 7,661
-------------- -------------- ------------- --------------
$ 14,850 $ 59,467 $ 31,817 $ 120,125
============== ============== ============= ==============
Weighted average common shares:
Circuit City Group:
Basic 205,329 203,770 205,133 203,318
============== ============== ============= ==============
Diluted 206,924 205,494 206,208 205,686
============== ============== ============= ==============
CarMax Group:
Basic 29,877 25,550 27,905 25,534
============== ============== ============= ==============
Diluted 32,025 26,956 29,864 26,937
============== ============== ============= ==============
Net earnings per share attributed to:
Circuit City Group common stock:
Basic $ 0.03 $ 0.27 $ 0.08 $ 0.55
============== ============== ============= ==============
Diluted $ 0.03 $ 0.27 $ 0.08 $ 0.55
============== ============== ============= ==============
CarMax Group common stock:
Basic $ 0.27 $ 0.16 $ 0.53 $ 0.30
============== ============== ============= ==============
Diluted $ 0.25 $ 0.15 $ 0.50 $ 0.28
============== ============== ============= ==============
Dividends paid per share:
Circuit City Group common stock $ 0.0175 $ 0.0175 $ 0.0350 $ 0.0350
============== ============== ============= ==============
CarMax Group common stock $ - $ - $ - $ -
============== ============== ============= ==============
See accompanying notes to consolidated financial statements.
Page 5 of 44
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Six Months Ended
August 31,
2001 2000
------------- ------------
Operating Activities:
Net earnings $ 31,817 $ 120,125
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities of
continuing operations:
Depreciation and amortization 77,682 66,957
(Gain) loss on sales of property and equipment (4,742) 898
Deferred income taxes 7,238 (6,389)
Changes in operating assets and liabilities:
Increase in net accounts receivable (14,835) (21,250)
Decrease (increase) in inventory 197,203 (156,740)
Decrease (increase) in prepaid expenses and other
current assets 15,936 (21,944)
(Increase) decrease in other assets (488) 346
Increase in accounts payable, accrued expenses and
other current liabilities 46,318 15,643
Increase (decrease) in deferred revenue and other liabilities 4,215 (3,818)
------------- ------------
Net cash provided by (used in) operating activities of
continuing operations 360,344 (6,172)
------------- ------------
Investing Activities:
Cash used in business acquisitions - (1,325)
Purchases of property and equipment (91,468) (97,475)
Proceeds from sales of property and equipment 110,644 41,068
------------- ------------
Net cash provided by (used in) investing activities of
continuing operations 19,176 (57,732)
------------- ------------
Financing Activities:
Proceeds from issuance of (payments on) short-term debt, net 370 (535)
Principal payments on long-term debt (130,556) (175,874)
Issuances of Circuit City Group common stock, net 13,916 49,731
Issuances of CarMax Group common stock, net 500 1,168
Proceeds from CarMax Group stock offering, net 139,685 -
Dividends paid on Circuit City Group common stock (7,260) (7,156)
-------------- ------------
Net cash provided by (used in) financing activities
of continuing operations 16,655 (132,666)
------------- ------------
Cash used in discontinued operations (18,652) (14,663)
------------- ------------
Increase (decrease) in cash and cash equivalents 377,523 (211,233)
Cash and cash equivalents at beginning of year 446,131 643,933
------------- ------------
Cash and cash equivalents at end of period $ 823,654 $ 432,700
============= ============
See accompanying notes to consolidated financial statements.
Page 6 of 44
CIRCUIT CITY STORES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. (the "Company") consists of
two common stock series that are intended to reflect the performance of the
Company's two businesses. The Circuit City Group stock is intended to
reflect the performance of the Circuit City store-related operations, the
shares of CarMax Group stock reserved for the Circuit City Group or for
issuance to holders of Circuit City Group stock and the Company's
investment in Digital Video Express, which has been discontinued (see Note
8). The CarMax Group stock is intended to reflect the performance of the
CarMax Group's operations. The reserved CarMax Group shares are not
outstanding CarMax Group common stock. Any net earnings attributed to the
reserved CarMax Group shares are not included in the CarMax Group's
earnings per share calculations. As of August 31, 2001, 66,052,258 shares
of CarMax Group stock were reserved for the Circuit City Group or for
issuance to holders of Circuit City Group stock. The reserved CarMax Group
shares represented 64.6 percent of the total outstanding and reserved
shares, excluding shares reserved for CarMax employees' stock incentive
plans, of CarMax Group stock at August 31, 2001, and 74.6 percent at both
February 28, 2001, and August 31, 2000. The Company allocates to the
Circuit City Group the portion of the net earnings of the CarMax Group
attributed to the reserved CarMax Group shares. The terms of each series of
common stock are discussed in detail in the Company's Form 8-A registration
statement on file with the Securities and Exchange Commission.
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 the
financial statements, holders of Circuit City Group stock and holders of
CarMax Group 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
equity structure of the Company do not affect title to the assets or
responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of CarMax Group stock nor shares of Circuit
City Group stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one group could affect the results of operations or financial
condition of the other group. Net losses of either group and dividends or
distributions on, or repurchases of, Circuit City Group stock or CarMax
Group stock will reduce funds legally available for dividends on, or
repurchases of, both stocks. Accordingly, the Company's consolidated
financial statements included in this report should be read in conjunction
with the financial statements of each group and the Company's SEC filings.
2. Accounting Policies
The consolidated financial statements of the Company conform to accounting
principles generally accepted in the United States of America. The interim
period financial statements are unaudited; however, in the opinion of
management, all adjustments, which consist only of normal, recurring
adjustments, necessary for a fair presentation of the interim consolidated
financial statements have been included. The fiscal year-end balance sheet
data was derived from the audited financial statements included in the
Company's fiscal 2001 Annual Report on Form 10-K.
Page 7 of 44
3. Net Earnings per Share
Reconciliations of the numerator and denominator of the basic and diluted
net earnings per share calculations are presented below.
Three Months Ended Six Months Ended
(Amounts in thousands August 31, August 31,
except per share data) 2001 2000 2001 2000
--------------------------------------------------------------------------------------------------------------------------
Circuit City Group:
Weighted average shares.................................... 205,329 203,770 205,133 203,318
Dilutive potential shares:
Options................................................. 824 1,033 469 1,618
Restricted stock........................................ 771 691 606 750
--------------------------- ---------------------------
Weighted average shares and
dilutive potential shares............................... 206,924 205,494 206,208 205,686
=========================== ===========================
Net earnings available to shareholders..................... $ 6,822 $ 55,341 $ 16,957 $ 112,464
Basic net earnings per share .............................. $ 0.03 $ 0.27 $ 0.08 $ 0.55
Diluted net earnings per share ............................ $ 0.03 $ 0.27 $ 0.08 $ 0.55
CarMax Group:
Weighted average shares.................................... 29,877 25,550 27,905 25,534
Dilutive potential shares:
Options................................................. 2,121 1,344 1,917 1,278
Restricted stock........................................ 27 62 42 125
--------------------------- ---------------------------
Weighted average shares and
dilutive potential shares............................... 32,025 26,956 29,864 26,937
=========================== ===========================
Net earnings available to shareholders..................... $ 8,028 $ 4,126 $ 14,860 $ 7,661
Basic net earnings per share............................... $ 0.27 $ 0.16 $ 0.53 $ 0.30
Diluted net earnings per share............................. $ 0.25 $ 0.15 $ 0.50 $ 0.28
In a public offering completed during the second quarter, Circuit City
Stores, Inc. sold 9,516,800 CarMax Group shares that had previously been
reserved for the Circuit City Group. Because both the earnings allocation
and the outstanding CarMax shares were adjusted to reflect the impact of
the sale, net earnings per CarMax Group share were not diluted by the sale.
With the impact of the offering, 70.7 percent of the CarMax Group's second
quarter earnings and 72.5 percent of the CarMax Group's first-half earnings
were allocated to the Circuit City Group. For the same periods last year,
74.6 percent of the CarMax Group's earnings were allocated to the Circuit
City Group. At the end of the second quarter, the reserved CarMax Group
shares represented 64.6 percent of the total outstanding and reserved
shares, excluding shares reserved for CarMax employees' stock incentive
plans, of CarMax Group stock.
Certain options were outstanding and not included in the computation of
diluted net earnings per share because the options' exercise prices were
greater than the average market price of the common shares. For the
three-month period ended August 31, 2001, options to purchase 6,798,996
shares of Circuit City Group stock at prices ranging from $17.25 to $43.03
per share were outstanding and not included in the calculation. For the
three-month period ended August 31, 2000, options to purchase 5,614,789
shares of Circuit City Group stock at prices ranging from $34.84 to $47.53
per share were outstanding and not included in the calculation.
For the three-month period ended August 31, 2001, options to purchase 7,899
shares of CarMax Group stock at $16.31 per share were outstanding and not
included in the calculation. For the three-month period
Page 8 of 44
ended August 31, 2000, options to purchase 1,458,326 shares of CarMax Group
stock at prices ranging from $3.91 to $16.31 per share were outstanding and
not included in the calculation.
4. Securitizations
(A) Credit Card Securitizations:
The Company enters into securitization transactions, which allow for the
sale of credit card receivables to unrelated entities, to finance the
consumer revolving credit receivables generated by Circuit City's finance
operation. For transfers of receivables that qualify as sales, the Company
recognizes gains or losses as a component of Circuit City's finance
operation. In these securitizations, the Company retains servicing rights
and subordinated interests. Provisions under the bankcard receivables
master trust agreement provide recourse to the Company for any cash flow
deficiencies on $105 million of the receivables sold. The Company believes
as of August 31, 2001, no liability existed under the recourse provisions.
As of August 31, 2001, the private-label master trust agreement had no
recourse provisions.
At August 31, 2001, the total principal amount of loans managed was $2,584
million. Of the total loans, the principal amount of loans securitized was
$2,564 million, and the principal amount of loans held for sale was $20
million. The aggregate amount of loans that were 31 days or more delinquent
was $187.2 million at August 31, 2001. The principal amount of losses net
of recoveries amounted to $62.3 million for the three months ended August
31, 2001, and $131.9 million for the six-month period ended August 31,
2001.
The Company receives annual servicing compensation approximating 2 percent
of the outstanding principal loan balance of the receivables and retains
the rights to future cash flows arising after the investors in the
securitization trusts have received the return for which they contracted.
The servicing fees specified in the credit card securitization agreements
adequately compensate the finance operation for servicing the securitized
assets. Accordingly, no servicing asset or liability has been recorded.
The table below summarizes certain cash flows received from and paid to
securitization trusts:
Three Months Ended Six Months Ended
(Amounts in thousands) August 31, 2001 August 31, 2001
-------------------------------------------------------------------------------------------------------
Proceeds from new securitizations........................... $ 204,000 $ 378,200
Proceeds from collections reinvested
in previous credit card securitizations................... $ 457,482 $ 817,039
Servicing fees received..................................... $ 12,581 $ 25,907
Other cash flows received on retained interests*............ $ 49,721 $ 93,936
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
In determining the fair value of retained interests, the Company estimates
future cash flows using management's best estimates of key assumptions such
as finance charge income, default rates, payment rates, forward yield
curves and discount rates. The Company employs a risk-based pricing
strategy that increases the stated annual percentage rate for accounts that
have a higher predicted risk of default. Accounts with a lower risk profile
may qualify for promotional financing.
Rights recorded for future finance income from serviced assets that exceed
the contractually specified servicing fees are carried at fair value,
amounted to $132.1 million at August 31, 2001, and are included in net
accounts receivable. Gains of $42.2 million on sales were recorded for the
three-month period ended August 31, 2001; gains of $79.3 million on sales
were recorded for the six-month period ended August 31, 2001.
The fair value of retained interests at August 31, 2001, was $292.5
million, with a weighted-average life ranging from 0.17 years to 2.25
years. The following table shows the key economic assumptions used in
measuring the fair value of retained interests at August 31, 2001, and a
sensitivity analysis showing the
Page 9 of 44
hypothetical effect on the fair value of those interests when there are
unfavorable variations from the assumptions used. Key economic assumptions
at August 31, 2001, are not materially different from assumptions used to
measure the fair value of retained interests at the time of securitization.
These sensitivities are hypothetical and should be used with caution. In
this table, the effect of a variation in a particular assumption on the
fair value of the retained interest is calculated without changing any
other assumption; in reality, changes in one factor may result in changes
in another, which might magnify or counteract the sensitivities.
Impact on Fair Impact on Fair
Assumptions Used Value of 10% Value of 20%
(Dollar amounts in thousands) (Annual) Adverse Change Adverse Change
--------------------------------------------------------------------------------------------------------
Payment rate........................... 6.9%-10.8% $ 8,798 $ 16,626
Default rate........................... 9.1%-19.4% $ 25,196 $ 50,392
Discount rate.......................... 9.0%-15.0% $ 2,542 $ 5,048
(B) Automobile Loan Securitizations:
The Company also has asset securitization programs, operated through
special purpose subsidiaries on behalf of the CarMax Group, to finance the
consumer installment credit receivables generated by CarMax's automobile
loan finance operation. For transfers of receivables that qualify as sales,
the Company recognizes gains or losses as a component of CarMax's finance
operation. In these securitizations, the Company retains servicing rights
and subordinated interests.
At August 31, 2001, the total principal amount of loans managed was $1,434
million. Of the total loans, the principal amount of loans securitized was
$1,412 million, and the principal amount of loans held for sale or
investment was $22 million. The principal amount of loans that were 31 days
or more delinquent was $18.8 million at August 31, 2001. The principal
amount of losses net of recoveries amounted to $2.7 million for the three
months ended August 31, 2001, and $4.6 million for the six-month period
ended August 31, 2001.
The Company receives annual servicing fees approximating 1 percent of the
outstanding principal balance of the securitized automobile loans and
retains the rights to future cash flows arising after the investors in the
securitization trusts have received the return for which they contracted.
The servicing fees specified in the automobile loan securitization
agreements adequately compensate the finance operation for servicing the
accounts. Accordingly, no servicing asset or liability has been recorded.
The table below summarizes certain cash flows received from and paid to
securitization trusts:
Three Months Ended Six Months Ended
(Amounts in thousands) August 31, 2001 August 31, 2001
--------------------------------------------------------------------------------------------------------
Proceeds from new securitizations........................... $ 181,000 $ 376,000
Proceeds from collections reinvested
in previous automobile loan securitizations............... $ 126,929 $ 218,394
Servicing fees received..................................... $ 3,485 $ 6,737
Other cash flows received on retained interests*............ $ 17,186 $ 30,572
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
In determining the fair value of retained interests, the Company estimates
future cash flows using management's best estimates of key assumptions such
as finance charge income, default rates, prepayment rates and discount
rates. The Company employs a risk-based pricing strategy that increases the
stated annual percentage rate for accounts that have a higher predicted
risk of default. Accounts with a lower risk profile may qualify for
promotional financing.
Page 10 of 44
Rights recorded for future finance income from serviced assets that exceed
the contractually specified servicing fees are carried at fair value,
amounted to $61.2 million at August 31, 2001, and are included in net
accounts receivable. Gains of $14.7 million on sales were recorded for the
three-month period ended August 31, 2001; gains of $27.8 million on sales
were recorded for the six-month period ended August 31, 2001
The fair value of retained interests at August 31, 2001, was $91.3 million,
with a weighted-average life ranging from 0.88 years to 1.63 years. The
following table shows the key economic assumptions used in measuring the
fair value of retained interests at August 31, 2001, and a sensitivity
analysis showing the hypothetical effect on the fair value of those
interests when there are unfavorable variations from the assumptions used.
Key economic assumptions at August 31, 2001, are not materially different
from assumptions used to measure the fair value of retained interests at
the time of securitization. These sensitivities are hypothetical and should
be used with caution. In this table, the effect of a variation in a
particular assumption on the fair value of the retained interest is
calculated without changing any other assumption; in reality, changes in
one factor may result in changes in another, which might magnify or
counteract the sensitivities.
Impact on Fair Impact on Fair
Assumptions Used Value of 10% Value of 20%
(Dollar amounts in thousands) (Annual) Adverse Change Adverse Change
------------------------------------------------------------------------------------------------------
Prepayment speed........................ 1.5%-1.6% $ 3,133 $ 6,490
Default rate............................ 1.0%-1.2% $ 1,759 $ 3,517
Discount rate........................... 12.0% $ 1,248 $ 2,468
5. Financial Derivatives
On behalf of the Circuit City Group, the Company enters into interest rate
cap agreements to meet the requirements of the credit card receivable
securitization transactions. In the second quarter of fiscal 2002, the
Company did not enter into any new interest rate caps. At August 31, 2001,
the total notional amount of interest rate caps outstanding was $839
million. Purchased interest rate caps are included in net accounts
receivable and had a fair value of $5.9 million as of August 31, 2001.
Written interest rate caps are included in accounts payable and had a fair
value of $5.9 million as of August 31, 2001.
On behalf of the CarMax Group, the Company, in the second quarter of fiscal
2002, entered into three 40-month amortizing interest rate swaps related to
auto loan receivable securitizations. These swaps had an initial notional
amount of approximately $215 million. The total notional amount of all
swaps related to the automobile loan receivable securitizations was $675
million at August 31, 2001, and $299 million at February 28, 2001. These
swaps are used to better match funding costs and are recorded at fair
value. At August 31, 2001, these swaps totaled a net liability of $10.3
million and are included in accounts payable.
The market and credit risks associated with interest rate caps and interest
rate swaps are similar to those relating to other types of financial
instruments. Market risk is the exposure created by potential fluctuations
in interest rates and is directly related to the product type, agreement
terms and transaction volume. The Company has entered into offsetting
interest rate cap positions, and therefore, does not anticipate significant
market risk arising from interest rate caps. The Company does not
anticipate significant market risk from swaps, because their use is to
match funding costs to the use of the funding. Credit risk is the exposure
to nonperformance of another party to an agreement. The Company mitigates
credit risk by dealing with highly rated counterparties.
6. Appliance Exit Costs
On July 25, 2000, the Company announced plans to exit the major appliance
category and expand its selection of key consumer electronics and home
office products in all Circuit City Superstores. A product profitability
analysis had indicated that the appliance category produced below-average
profits. This analysis, combined with declining sales, expected increases
in appliance competition and the Company's profit expectations for the
consumer electronics and home office categories led to the decision to exit
the
Page 11 of 44
major appliance category. To exit the appliance business, the Company
closed six distribution centers and seven service centers in fiscal 2001,
one service center in August 2001 and one distribution center in September
2001 and expects to close one distribution center by the end of October
2001. The majority of these closed properties are leased. While the Company
has entered into contracts to sublease some of these properties, it
continues the process of preparing and marketing its remaining properties
to be subleased. The Company maintains control over Circuit City's in-home
major appliance repair business, although repairs are subcontracted to an
unrelated third party. In the second quarter of fiscal 2001, the Company
recorded appliance exit costs of $30 million. These expenses are reported
separately on the fiscal 2001 statement of earnings.
Approximately 890 employees have been terminated and approximately 60
employees will be terminated as a result of the exit from the appliance
business. These reductions are mainly in the service, distribution and
merchandising functions. Because severance is being paid to employees on a
bi-weekly schedule based on years of service, cash payments lag job
eliminations. The composition of the appliance exit cost accrual and the
remaining liability at August 31, 2001, are presented below. The
fixed-asset write-downs include appliance build-to-order kiosks in stores
as well as non-salvageable fixed assets and leasehold improvements at the
locations closed as part of the exit from the appliance business.
Expenses Liability at
Total Paid or Assets August 31,
(Amounts in millions) Exit Costs Written Off 2001
-----------------------------------------------------------------------------------------------
Lease termination costs................... $17.8 $ 4.2 $13.6
Fixed asset write-downs, net.............. 5.0 5.0 -
Employee termination benefits............. 4.4 3.9 0.5
Other..................................... 2.8 2.8 -
------------------------------------------------
Appliance exit costs...................... $30.0 $ 15.9 $14.1
================================================
7. Operating Segment Information
The Company conducts business in two operating segments: Circuit City and
CarMax. These segments are identified and managed by the Company based on
the different products and services offered by each. Circuit City refers to
the retail operations bearing the Circuit City name and to all related
operations such as Circuit City's finance operation. This segment is
engaged in the business of selling brand-name consumer electronics,
information technology and entertainment software. CarMax refers to the
used- and new-car retail locations bearing the CarMax name and to all
related operations, such as CarMax's finance operation. Financial
information for these segments for the three- and six-month periods ended
August 31, 2001, and 2000, is presented below.
Three Months Ended August 31, 2001
Total Operating
(Amounts in thousands) Circuit City CarMax Segments
------------------------------------------------------------------------------------------------------------
Revenues from external customers............... $ 2,036,552 $ 851,363 $ 2,887,915
Interest (income) expense...................... (432) 2,086 1,654
Depreciation and amortization.................. 33,888 4,612 38,500
(Loss) earnings before income taxes............ (20,227) 44,178 23,951
Income tax (benefit) provision................. (7,686) 16,787 9,101
Net (loss) earnings............................ (12,541) 27,391 14,850
Total assets................................... $ 3,264,090 $ 694,453 $ 3,958,543
Page 12 of 44
Three Months Ended August 31, 2000
Total Operating
(Amounts in thousands) Circuit City CarMax Segments
----------------------------------------------------------------------------------------------------------
Revenues from external customers............... $ 2,506,220 $ 673,561 $ 3,179,781
Interest expense............................... 625 2,958 3,583
Depreciation and amortization.................. 27,819 4,570 32,389
Earnings before income taxes................... 69,671 26,243 95,914
Provision for income taxes..................... 26,475 9,972 36,447
Net earnings................................... 43,196 16,271 59,467
Total assets................................... $ 3,289,201 $ 643,793 $ 3,932,994
Six Months Ended August 31, 2001
Total Operating
(Amounts in thousands) Circuit City CarMax Segments
----------------------------------------------------------------------------------------------------------
Revenues from external customers............... $ 3,918,206 $ 1,648,183 $ 5,566,389
Interest expense............................... 9 4,637 4,646
Depreciation and amortization.................. 68,377 9,305 77,682
(Loss) earnings before income taxes............ (35,719) 87,037 51,318
Income tax (benefit) provision................. (13,573) 33,074 19,501
Net (loss) earnings............................ (22,146) 53,963 31,817
Total assets................................... $ 3,264,090 $ 694,453 $ 3,958,543
Six Months Ended August 31, 2000
Total Operating
(Amounts in thousands) Circuit City CarMax Segments
----------------------------------------------------------------------------------------------------------
Revenues from external customers............... $ 4,955,330 $ 1,299,302 $ 6,254,632
Interest expense............................... 3,318 6,486 9,804
Depreciation and amortization.................. 57,811 9,146 66,957
Earnings before income taxes................... 145,016 48,733 193,749
Provision for income taxes..................... 55,106 18,518 73,624
Net earnings................................... 89,910 30,215 120,125
Total assets................................... $ 3,289,201 $ 643,793 $ 3,932,994
Net (loss) earnings and total assets for Circuit City on the above tables
exclude the reserved CarMax shares and the discontinued Divx operations,
which are discussed in Note 8.
8. Discontinued Operations
On June 16, 1999, Digital Video Express announced that it would cease
marketing the Divx home video system and discontinue operations, but that
existing, registered customers would be able to view discs during a
two-year phase-out period. Discontinued operations have been segregated on
the consolidated statements of cash flows. However, Divx is not segregated
on the consolidated balance sheets.
The loss on the disposal includes a provision for operating losses to be
incurred during the phase-out period. It also includes provisions for
commitments under licensing agreements with motion picture distributors,
the write-down of assets to net realizable value, lease termination costs,
employee severance and benefit costs and other contractual commitments. For
the quarters and six-month periods ended August 31, 2001, and 2000, the
discontinued Divx operations had no impact on the earnings of Circuit City
Stores, Inc.
Page 13 of 44
The net liabilities of the discontinued Divx operations, reflected in the
accompanying consolidated balance sheets as of August 31, 2001, and
February 28, 2001, are comprised of the following:
(Amounts in thousands) Aug. 31, 2001 Feb. 28, 2001
---------------------------------------------------------------------------------------------
Current assets........................................ $ 66 $ 8
Property and equipment, net........................... - -
Other assets.......................................... 271 324
Current liabilities................................... (19,326) (27,522)
Other liabilities..................................... (3,582) (14,082)
-----------------------------------
Net liabilities of discontinued operations............ $ (22,571) $ (41,272)
===================================
9. Recent Accounting Pronouncements
In July 2000, the Financial Accounting Standards Board issued Emerging
Issues Task Force No. 00-14, "Accounting for Certain Sales Incentives,"
which is effective for fiscal quarters beginning after December 15, 2001.
The issue provides that sales incentives, such as mail-in rebates, offered
to customers should be classified as a reduction of revenue. The Company
offers certain mail-in rebates that are currently recorded in cost of
sales, buying and warehousing. However, the Company expects to reclassify
these rebate expenses from cost of sales, buying and warehousing to net
sales and operating revenues to be in compliance with EITF No. 00-14. For
the quarter ended August 31, 2001, this reclassification would have
increased the gross profit margin by 0.10 percent and the expense ratio by
0.09 percent. For the six-month period ended August 31, 2001, the
reclassification would have increased both the gross profit margin and the
expense ratio by 0.09 percent. The Company does not expect the adoption of
EITF No. 00-14 to have a material impact on its financial position, results
of operations or cash flows.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations," effective for business combinations
initiated after June 30, 2001, and SFAS No. 142, "Goodwill and Other
Intangible Assets," effective for fiscal years beginning after December 15,
2001. Under SFAS No. 141, the pooling of interests method of accounting for
business combinations is eliminated, requiring that all business
combinations initiated after the effective date be accounted for using the
purchase method. Also under SFAS No. 141, identified intangible assets
acquired in a purchase business combination must be separately valued and
recognized on the balance sheet if they meet certain requirements. Under
the provisions of SFAS No. 142, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized but will be subject to
annual impairment tests in accordance with the pronouncements. Other
intangible assets that are identified to have finite useful lives will
continue to be amortized in a manner that reflects the estimated decline in
the economic value of the intangible asset and will be subject to review
when events or circumstances arise which indicate impairment. Application
of the nonamortization provisions of SFAS No. 142 in fiscal 2003 is not
expected to have a material impact on the financial position, results of
operations or cash flows of the Company. During fiscal 2003, the Company
will perform the first of the required impairment tests of goodwill and
indefinite-lived intangible assets, as outlined within the new
pronouncements. Based on preliminary estimates as well as ongoing periodic
assessments of goodwill, the Company does not expect to recognize any
material impairment losses from these tests.
10. Reclassifications
Certain previously reported amounts have been reclassified to conform with
current-year presentation.
Page 14 of 44
ITEM 2.
CIRCUIT CITY STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "Circuit City business" and "Circuit City" refer to the retail
operations bearing the Circuit City name and to all related operations such as
product service and Circuit City's finance operation. "Circuit City Group"
refers to the Circuit City business and the reserved CarMax Group shares.
"CarMax business," "CarMax" and "CarMax Group" refer to retail locations bearing
the CarMax name and to all related operations such as CarMax's finance
operation.
Net Sales and Operating Revenues and General Comments
Total sales for the second quarter of fiscal 2002 were $2.89 billion, a decrease
of 9 percent from $3.18 billion for the same period last year. For the six
months ended August 31, 2001, total sales were $5.57 billion, an 11 percent
decrease from $6.25 billion for the same period last year. We experienced solid
comparable store sales increases in digital and advanced technologies, such as
digital televisions, and in new and expanded categories, such as digital
imaging, video game hardware and software, DVD software and personal computer
software, accessories and peripherals, added in the former appliance space.
These increases were offset by the absence of major appliances, continued
industry-wide weakness in personal computer sales and declines in sales of
analog products and older technologies, caused in part by lower average retail
sales. In the second quarter of fiscal 2002, our CarMax business continued a
strong sales trend begun in fiscal 2001, with sales increasing 26 percent over
the same period last year. Higher-than-anticipated sales were led by used-car
sales growth driven by strong store traffic, better in-store execution and
increases in average retails.
Comparable store sales changes for the second quarters of fiscal years 2002 and
2001 were as follows:
===================== =========================================
2nd Quarter Six Months
--------------------- -------------------
FY02 FY01 FY02 FY01
===================== ========== ========== ========= =========
===================== ========== ========== ========= =========
Circuit City Group (21%) 0% (23%) 4%
--------------------- ---------- ---------- --------- ---------
--------------------- ---------- ---------- --------- ---------
CarMax Group 27% 18% 27% 16%
===================== ========== ========== ========= =========
For Circuit City, comparable store sales declined 21 percent in the second
quarter of fiscal 2002 and 23 percent for the six-month period ended August 31,
2001. Excluding the appliance category, from which we completed our exit in the
third quarter of fiscal 2001, comparable store sales declined 9 percent in the
second quarter of fiscal 2002 and 11 percent for the six-month period ended
August 31, 2001. CarMax's comparable store sales increased 27 percent in the
second quarter after an 18 percent increase in the same prior year period.
CarMax's comparable store sales increased 27 percent for the six-month period
ended August 31, 2001, after a 16 percent increase for the same period last
year.
We plan to open 12 Circuit City Superstores and relocate nine Circuit City
Superstores in the current fiscal year. In the first quarter of fiscal 2002, we
opened one Circuit City Superstore in the Las Vegas, Nev., market and relocated
one store in the Los Angeles, Calif., market. In the second quarter of fiscal
2002, we opened four Circuit City Superstores, in Boca Raton, Fla.; Dallas,
Texas; St. Louis, Mo.; and Tampa, Fla., and relocated two stores in Louisville,
Ky. and Tampa, Fla. Our remodels for fiscal 2002 include 24 Circuit City
Superstores in which we are testing two different remodel designs. A more
extensive approach is being conducted in 10 stores in the Chicago market and two
stores in Virginia and a second, less costly version is being tested in 12
stores in the Washington, D.C., and Baltimore, Md., markets. The majority of the
remodeling activities were completed by the end of the second quarter.
We expect CarMax's geographic growth over the next five years to primarily
include the addition of superstores in new mid-sized markets that can be served
effectively with one CarMax superstore and
Page 15 of 44
additional satellite stores in existing multi-store markets. Mid-sized markets
are those with populations of approximately 1 million to 2.5 million people. In
late fiscal 2002, we plan to open two CarMax superstores in the mid-sized
markets of Sacramento, Calif., and Greensboro, N.C. In fiscal 2003, we plan to
open four to six stores, and in fiscal years 2004 through 2006, we plan to open
six to eight stores per year.
For Circuit City, gross dollar sales from all extended warranty programs were
5.6 percent of sales in the second quarter of fiscal 2002 and 5.2 percent of
sales in the second quarter of fiscal 2001. Third-party warranty revenue was 4.4
percent of sales in this year's second quarter and 4.1 percent in the same
period last year. The total extended warranty revenue that is reported in total
sales was 4.3 percent of sales in the second quarter of both fiscal 2002 and
2001.
For CarMax, gross dollar sales from all extended warranty programs were 3.9
percent of sales in the second quarters of fiscal 2002 and fiscal 2001.
Third-party warranty revenue was 1.7 percent of sales, and the total extended
warranty revenue that is reported in total sales was 1.7 percent of sales in the
second quarter of both years.
Our operations, in common with other retailers in general, are subject to
seasonal influences. Historically, the Circuit City business has realized more
of its net sales and net earnings in the fourth quarter, which includes the
December holiday selling season, than in any other fiscal quarter. The CarMax
business, however, has experienced more of its net sales in the first half of
the fiscal year. The net earnings of any interim quarter are seasonally
disproportionate to net sales since administrative and certain operating
expenses remain relatively constant during the year. Therefore, interim results
should not be relied upon as necessarily indicative of results for the entire
fiscal year.
Cost of Sales, Buying and Warehousing
Our gross profit margin was 21.0 percent of sales in the second quarter of
fiscal 2002, compared with 21.2 percent in the same period last year. For the
six months ended August 31, 2001, our gross profit margin was 21.0 percent
compared with 21.7 percent in the same period last year.
For Circuit City, the gross profit margin increased to 24.4 percent of sales in
the second quarter from 23.3 percent in the same period last year. Excluding
appliance merchandise markdowns of $7.0 million and one-time exit costs in last
year's second quarter, last year's second quarter gross profit margin was 24.7
percent. The reduction in gross profit margin, when the appliance impact is
excluded, in part reflects a brief supply constraint as we made a transition in
DIRECTV inventory during the quarter as well as slower wireless communications
sales early in the quarter. The DIRECTV supply issues have since been resolved
and both of these high-margin service businesses were performing well as the
quarter ended. For the six months ended August 31, 2001, the gross profit margin
was 24.5 percent compared with 23.8 percent in the same period last year.
Excluding the impact of the appliance exit in the first half of last year, the
gross profit margin for the six-month period of last year was 24.5 percent.
For CarMax, the gross profit margin was 12.7 percent of sales in the second
quarter of fiscal 2002 versus 13.4 percent for the same period last year. For
the six months ended August 31, 2001, the gross profit margin was 12.9 percent,
compared with 13.5 percent in the same period last year. We achieved our gross
profit margin dollar targets per vehicle; however, higher average retails
generated a decline in the gross profit margin on a percentage basis.
Selling, General and Administrative Expenses
Our selling, general and administrative expense ratio was 20.7 percent in the
second quarter of fiscal 2002, compared with 18.1 percent for the same period
last year. For the six-month period ended August 31, 2001, the Company's
selling, general, and administrative expense ratio was 20.0 percent compared
with 18.4 percent for the same period last year.
For Circuit City, the selling, general and administrative expense ratio was 25.4
percent of sales in the second quarter of fiscal 2002, compared with 20.5
percent for the same period last year. The prior year's second
Page 16 of 44
quarter expense ratio includes $1.7 million of one-time appliance exit costs.
Excluding these costs, the second quarter expense ratio for fiscal 2001 was 20.4
percent. The increased expense ratio in fiscal 2002 is primarily a function of
lower comparable store sales. In addition, remodeling costs were higher in the
second quarter of fiscal 2002, as most of the costs associated with last year's
full remodels in Florida were incurred in the third quarter of fiscal 2001.
Although advertising expense was higher in this year's second quarter, it did
not increase for the first six months of fiscal 2002, reflecting a shift in the
timing of our spending. Partially offsetting these factors, the funding cost of
Circuit City's finance operation declined more rapidly than yields during both
the first and second quarters. For the six-month period ended August 31, 2001,
the Company's selling, general, and administrative expense ratio was 25.4
percent compared with 20.8 percent for the same period last year.
CarMax's selling, general and administrative expense ratio decreased to 7.3
percent of sales in the second quarter of fiscal 2002 from 9.1 percent of sales
for the same period last year. For the six-month period ended August 31, 2001,
the ratio was 7.3 percent of sales compared with 9.3 percent for the same period
last year. Similar to the first quarter of this year, the expense ratio
improvement reflects the significant expense leverage generated by comparable
store sales growth. CarMax's finance operation also contributed to the improved
ratio as lower funding costs generated higher spreads.
Net Earnings
Net earnings for the Company decreased to $14.9 million in the second quarter of
fiscal 2002 from $59.5 million in last year's second quarter. For the six-month
period ended August 31, 2001, net earnings for the Company decreased to $31.8
million from $120.1 million for the same period last year. These decreases
reflect lower earnings for the Circuit City business, partly offset by earnings
increases achieved by the CarMax business.
In a public offering completed during the second quarter, the Company sold 9.5
million CarMax Group shares that had previously been reserved for the Circuit
City Group. Because both the earnings allocation and the outstanding CarMax
shares were adjusted to reflect the impact of the sale, net earnings per CarMax
Group share were not diluted by the sale. With the impact of the offering, 70.7
percent of the CarMax Group's second quarter earnings and 72.5 percent of the
CarMax Group's first-half earnings were allocated to the Circuit City Group. For
the same periods last year, 74.6 percent of the CarMax Group's earnings were
allocated to the Circuit City Group. At the end of the second quarter, the
reserved CarMax Group shares represented 64.6 percent of the total outstanding
and reserved shares, excluding shares reserved for CarMax employees' stock
incentive plans, of CarMax Group stock.
For the Circuit City business, the loss before income attributed to the reserved
CarMax Group shares was $12.5 million, or 6 cents per share, in the second
quarter of fiscal 2002 compared with earnings of $43.2 million, or 21 cents per
share, in last year's second quarter. For the first half of the year, the
Circuit City business had a loss of $22.1 million, or 11 cents per share, in
fiscal 2002 compared with earnings of $89.9 million, or 44 cents per share, in
fiscal 2001. Excluding the fiscal 2001 non-recurring costs associated with the
exit from the appliance business, earnings before income attributed to the
reserved CarMax Group shares were $66.1 million, or 32 cents per share in the
second quarter of last year and $112.8 million, or 55 cents per share, in the
first six months of last year.
The net earnings attributed to the reserved CarMax Group shares were $19.4
million in the second quarter of this year compared with $12.1 million in last
year's second quarter, and $39.1 million in the first half of this year compared
with $22.6 million in last year's first half.
Net earnings of the Circuit City Group were $6.8 million, or 3 cents per share,
in the second quarter of fiscal 2002 versus $55.3 million, or 27 cents per
share, in the second quarter of fiscal 2001. For the first half of the year, net
earnings of the Circuit City Group were $17.0 million, or 8 cents per share, in
the current fiscal year compared with $112.5 million, or 55 cents per share,
last year.
For the CarMax business, net earnings were $27.4 million in the second quarter
of fiscal 2002 compared with net earnings of $16.3 million in last year's second
quarter. For the first half of the year, the CarMax business had net earnings of
$54.0 million in fiscal 2002 compared with $30.2 million in fiscal 2001.
Page 17 of 44
Net earnings attributed to the CarMax Group common stock were $8.0 million, or
25 cents per share, in the second quarter of fiscal 2002 compared with $4.1
million, or 15 cents per share, in the second quarter of last year. For the
first half of the year, net earnings attributed to the CarMax Group common stock
were $14.9 million, or 50 cents per share, in the current year compared with
$7.7 million, or 28 cents per share, last year.
For the quarter and the six months, net earnings attributed to the CarMax Group
stock grew faster than total net earnings and net earnings per CarMax Group
share because of the impact of the sale of CarMax Group stock by the Company
during the quarter.
Liquidity and Capital Resources
Net fixed assets decreased $90.7 million primarily as a result of the CarMax
sale-leaseback transaction in this year's second quarter. The inventory decrease
of $197.2 million reflects an increased focus on inventory management in our
Circuit City business, as well as the decline in Circuit City comparable store
sales for the first half of this fiscal year. This decrease is partially offset
by an increase in the CarMax Group's inventory in an effort to hold new-car
inventories higher over the summer to assure the availability of competitively
priced current model-year vehicles during the fall model changeover period.
Accounts payable has increased $44.8 million from the end of fiscal 2001 as we
extended vendor payment terms in our Circuit City business. As scheduled, we
used existing working capital to repay a term loan totaling $130 million in June
2001. At August 31, 2001, we maintained a $150 million unsecured revolving
credit facility and $195 million in committed seasonal lines of credit that are
renewed annually with various banks.
Circuit City's finance operation has a master trust securitization facility that
allows the transfer of its private-label credit card receivables through private
placement and the public market. As of August 31, 2001, the master trust program
had a total program capacity of $1.29 billion. Circuit City's finance operation
also has a master trust securitization facility related to its bankcard program.
As of August 31, 2001, the bankcard master trust program had a total program
capacity of $2.15 billion. These master trust vehicles permit further expansion
of the securitization programs in both the public and private markets.
We also have an asset securitization program operated through a special purpose
subsidiary on behalf of CarMax, through which we sell automobile loan
receivables. This program had a capacity of $800 million as of August 31, 2001.
On behalf of CarMax, we also have two public asset securitization programs under
which we originally securitized $1.30 billion of auto loan receivables. As of
August 31, 2001, the two public asset securitization programs had a capacity of
$736 million. We anticipate that we will be able to expand or enter into new
arrangements comparable to these securitization programs to meet future needs.
During the second quarter, we completed the public offering of 9,516,800 shares,
including the underwriters' over-allotment option of 666,800 shares, of CarMax
Group stock. The shares sold in the offering are shares of CarMax Group stock
that previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group stock. We allocated the net proceeds of $139.7
million from this offering to the Circuit City Group to be used for general
purposes of the Circuit City business, including the remodeling of Circuit City
Superstores.
In August 2001, CarMax entered into a sale-leaseback transaction with Capital
Automotive Real Estate Investment Trust covering nine superstore properties
valued at $102.4 million. This transaction was the first sale-leaseback for
CarMax without Circuit City guarantees. It was entered into at competitive rates
and structured with an initial lease term of 15 years with two 10-year renewal
options.
We believe fiscal 2002 capital expenditures will continue to be funded through a
combination of internally generated cash, sale-leaseback transactions, operating
leases, floor plan financing of CarMax inventory or proceeds from the public
stock offering discussed above and that securitization transactions will finance
any growth in receivables.
Page 18 of 44
Forward-Looking Statements
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties. Additional discussion of factors that could
cause actual results to differ materially from management's projections,
forecasts, estimates and expectations is contained in our SEC filings, including
our report on Form 10-Q for the quarter ended May 31, 2001.
Page 19 of 44
ITEM 3.
Circuit City Stores, Inc. Quantitative and Qualitative
Disclosures About Market Risk
We centrally manage the market risk associated with the private-label and
bankcard revolving loan portfolios of Circuit City's finance operation and the
automobile installment loan portfolio of CarMax's finance operation. Portions of
these portfolios are securitized and, therefore, are not presented on the
consolidated balance sheets. Interest rate exposure relating to these
receivables represents a market risk exposure that we manage with matched
funding and interest rate swaps.
As of August 31, 2001, the composition of the Circuit City finance operation's
private-label and bankcard portfolios had not changed significantly since
February 28, 2001. However, as a result of CarMax's growth and the amortization
of loans funded through public securitizations, the composition of the
automobile installment loan portfolio has changed significantly.
Total principal outstanding for fixed-rate automobile loans at August 31 and
February 28, 2001, was as follows:
(Amounts in millions) August 31 February 28
----------------------------------------------------------------------------
Fixed-rate............................... $1,434 $1,296
Financing for these automobile receivables is achieved through asset
securitization programs that, in turn, issue both fixed- and floating-rate
securities. Receivables held by Circuit City Stores for investment or sale are
financed with working capital. Financings at August 31 and February 28, 2001,
were as follows:
(Amounts in millions) August 31 February 28
----------------------------------------------------------------------------
Fixed-rate securitizations............... $ 736 $ 984
Floating-rate securitizations
synthetically altered to fixed........ 675 299
Floating-rate securitizations............ 1 1
Held by the Company:
For investment*....................... 19 9
For sale.............................. 3 3
--------------------------------
Total ................................... $ 1,434 $ 1,296
================================
* Held by a bankruptcy remote special purpose company.
Because programs are in place to manage interest rate exposure relating to the
installment loan portfolios, we expect to experience relatively little impact as
interest rates fluctuate.
Page 20 of 44
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Balance Sheets
(Amounts in thousands)
Aug. 31, 2001 Feb. 28, 2001
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 799,097 $ 437,329
Net accounts receivable 439,976 451,099
Merchandise inventory 1,173,558 1,410,527
Prepaid expenses and other current assets 39,734 55,317
-------------- -------------
Total current assets 2,452,365 2,354,272
Property and equipment, net 801,592 796,789
Reserved CarMax Group shares 290,241 292,179
Other assets 10,470 9,319
-------------- -------------
TOTAL ASSETS $ 3,554,668 $ 3,452,559
============== =============
LIABILITIES AND GROUP EQUITY
Current liabilities:
Current installments of long-term debt $ 14,659 $ 24,237
Accounts payable 848,229 820,077
Short-term debt 211 213
Accrued expenses and other current liabilities 129,220 146,818
Deferred income taxes 81,666 74,317
-------------- -------------
Total current liabilities 1,073,985 1,065,662
Long-term debt, excluding current installments 14,702 33,080
Deferred revenue and other liabilities 78,909 85,329
Deferred income taxes 8,122 11,329
-------------- -------------
TOTAL LIABILITIES 1,175,718 1,195,400
GROUP EQUITY 2,378,950 2,257,159
-------------- -------------
TOTAL LIABILITIES AND GROUP EQUITY $ 3,554,668 $ 3,452,559
============== =============
See accompanying notes to group financial statements.
Page 21 of 44
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Statements of Earnings (Unaudited)
(Amounts in thousands)
Three Months Ended Six Months Ended
August 31, August 31,
2001 2000 2001 2000
-------------- -------------- ------------- --------------
Net sales and operating revenues $ 2,036,552 $ 2,506,220 $ 3,918,206 $ 4,955,330
Cost of sales, buying and warehousing 1,540,008 1,894,978 2,959,269 3,746,288
Appliance exit costs - 28,326 - 28,326
-------------- -------------- ------------- --------------
Gross profit 496,544 582,916 958,937 1,180,716
-------------- -------------- ------------- --------------
Selling, general and administrative expenses 517,203 510,950 994,647 1,030,712
Appliance exit costs - 1,670 - 1,670
Interest (income) expense (432) 625 9 3,318
-------------- -------------- ------------- --------------
Total expenses 516,771 513,245 994,656 1,035,700
-------------- -------------- ------------- --------------
(Loss) earnings before income taxes and
income attributed to the reserved
CarMax Group shares (20,227) 69,671 (35,719) 145,016
Income tax (benefit) provision (7,686) 26,475 (13,573) 55,106
-------------- -------------- ------------- --------------
(Loss) earnings before income attributed to
the reserved CarMax Group shares (12,541) 43,196 (22,146) 89,910
Net earnings attributed to the reserved
CarMax Group shares 19,363 12,145 39,103 22,554
-------------- -------------- ------------- --------------
Net earnings $ 6,822 $ 55,341 $ 16,957 $ 112,464
============== ============== ============= ==============
See accompanying notes to group financial statements.
Page 22 of 44
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Six Months Ended
August 31,
2001 2000
------------- ------------
Operating Activities:
Net earnings $ 16,957 $ 112,464
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities of continuing operations:
Net earnings attributed to the reserved CarMax Group shares (39,103) (22,554)
Depreciation and amortization 68,377 57,811
(Gain) loss on sales of property and equipment (4,742) 725
Deferred income taxes 4,142 (10,218)
Changes in operating assets and liabilities:
Decrease (increase) in net accounts receivable 11,127 (39,770)
Decrease (increase) in merchandise inventory 236,969 (153,529)
Decrease (increase) in prepaid expenses and other current assets 15,588 (21,769)
(Increase) decrease in other assets (1,204) 346
Increase in accounts payable, accrued expenses
and other current liabilities 18,284 14,150
Increase (decrease) in deferred revenue and other liabilities 4,080 (3,666)
------------- ------------
Net cash provided by (used in) operating activities
of continuing operations 330,475 (66,010)
------------- ------------
Investing Activities:
Purchases of property and equipment (82,738) (90,922)
Proceeds from sales of property and equipment 14,300 29,032
------------- ------------
Net cash used in investing activities of continuing operations (68,438) (61,890)
------------- ------------
Financing Activities:
Decrease in allocated short-term debt, net (2) (496)
Decrease in allocated long-term debt, net (27,956) (107,658)
Issuances of group equity, net 13,916 49,731
Allocated proceeds from CarMax Group stock offering, net 139,685 -
Dividends paid (7,260) (7,156)
------------- ------------
Net cash provided by (used in) financing activities
of continuing operations 118,383 (65,579)
------------- ------------
Cash used in discontinued operations (18,652) (14,663)
------------- ------------
Increase (decrease) in cash and cash equivalents 361,768 (208,142)
Cash and cash equivalents at beginning of year 437,329 633,952
------------- ------------
Cash and cash equivalents at end of period $ 799,097 $ 425,810
============= ============
See accompanying notes to group financial statements.
Page 23 of 44
CIRCUIT CITY STORES, INC. - CIRCUIT CITY GROUP
Notes to Group Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. (the "Company") consists of
two common stock series that are intended to reflect the performance of the
Company's two businesses. The Circuit City Group stock is intended to
reflect the performance of the Circuit City store-related operations, the
shares of CarMax Group stock reserved for the Circuit City Group or for
issuance to holders of Circuit City Group stock and the Company's
investment in Digital Video Express, which has been discontinued (see Note
6). The CarMax Group stock is intended to reflect the performance of the
CarMax Group's operations. The reserved CarMax Group shares represented
64.6 percent of the total outstanding and reserved shares, excluding shares
reserved for CarMax employees' stock incentive plans, of CarMax Group stock
at August 31, 2001, and 74.6 percent at both February 28, 2001, and August
31, 2000. The Company allocates to the Circuit City Group the portion of
net earnings of the CarMax Group attributed to the reserved CarMax Group
shares. The terms of each series of common stock are discussed in detail in
the Company's Form 8-A registration statement on file with the Securities
and Exchange Commission.
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 the
financial statements, holders of Circuit City Group stock and holders of
CarMax Group 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
equity structure of the Company do not affect title to the assets or
responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of CarMax Group stock nor shares of Circuit
City Group stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one group could affect the results of operations or financial
condition of the other group. Net losses of either group and dividends or
distributions on, or repurchases of, Circuit City Group stock or CarMax
Group stock will reduce funds legally available for dividends on, or
repurchases of, both stocks. Accordingly, the Circuit City Group financial
statements included in this report should be read in conjunction with the
Company's consolidated financial statements, the CarMax Group financial
statements and the Company's SEC filings.
2. Accounting Policies
The Circuit City Group has accounted for the reserved CarMax Group shares
in a manner similar to the equity method of accounting. Accounting
principles generally accepted in the United States of America require that
the CarMax Group be consolidated with the Circuit City Group. Except for
the effects of not consolidating the CarMax Group with the Circuit City
Group, the financial statements of the Circuit City Group conform to
accounting principles generally accepted in the United States of America.
The interim period financial statements are unaudited; however, in the
opinion of management, all adjustments, which consist only of normal,
recurring adjustments, necessary for a fair presentation of the interim
group financial statements have been included. The fiscal year-end balance
sheet data was derived from the audited financial statements included in
the Company's fiscal 2001 Annual Report on Form 10-K.
3. Securitizations
The Company enters into securitization transactions, which allow for the
sale of credit card receivables to unrelated entities, to finance the
consumer revolving credit receivables generated by Circuit City's finance
operation. For transfers of receivables that qualify as sales, the Company
recognizes gains or losses as a component of Circuit City's finance
operation. In these securitizations, the Company retains servicing rights
and subordinated interests. Provisions under the bankcard receivables
master trust agreement provide
Page 24 of 44
recourse to the Company for any cash flow deficiencies on $105 million of
the receivables sold. The Company believes as of August 31, 2001, no
liability existed under the recourse provisions. As of August 31, 2001, the
private-label master trust agreement had no recourse provisions.
At August 31, 2001, the total principal amount of loans managed was $2,584
million. Of the total loans, the principal amount of loans securitized was
$2,564 million, and the principal amount of loans held for sale was $20
million. The aggregate amount of loans that were 31 days or more delinquent
was $187.2 million at August 31, 2001. The principal amount of losses net
of recoveries amounted to $62.3 million for the three months ended August
31, 2001, and $131.9 million for the six-month period ended August 31,
2001.
The Company receives annual servicing compensation approximating 2 percent
of the outstanding principal loan balance of the receivables and retains
the rights to future cash flows arising after the investors in the
securitization trusts have received the return for which they contracted.
The servicing fees specified in the credit card securitization agreements
adequately compensate the finance operation for servicing the securitized
assets. Accordingly, no servicing asset or liability has been recorded.
The table below summarizes certain cash flows received from and paid to
securitization trusts:
Three Months Ended Six Months Ended
(Amounts in thousands) August 31, 2001 August 31, 2001
------------------------------------------------------------------------------------------------
Proceeds from new securitizations...................... $ 204,000 $ 378,200
Proceeds from collections reinvested
in previous credit card securitizations.............. $ 457,482 $ 817,039
Servicing fees received................................ $ 12,581 $ 25,907
Other cash flows received on retained interests*....... $ 49,721 $ 93,936
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
In determining the fair value of retained interests, the Company estimates
future cash flows using management's best estimates of key assumptions such
as finance charge income, default rates, payment rates, forward yield
curves and discount rates. The Company employs a risk-based pricing
strategy that increases the stated annual percentage rate for accounts that
have a higher predicted risk of default. Accounts with a lower risk profile
may qualify for promotional financing.
Rights recorded for future finance income from serviced assets that exceed
the contractually specified servicing fees are carried at fair value,
amounted to $132.1 million at August 31, 2001, and are included in net
accounts receivable. Gains of $42.2 million on sales were recorded for the
three-month period ended August 31, 2001; gains of $79.3 million on sales
were recorded for the six-month period ended August 31, 2001.
The fair value of retained interests at August 31, 2001, was $292.5
million, with a weighted-average life ranging from 0.17 years to 2.25
years. The following table shows the key economic assumptions used in
measuring the fair value of retained interests at August 31, 2001, and a
sensitivity analysis showing the hypothetical effect on the fair value of
those interests when there are unfavorable variations from the assumptions
used. Key economic assumptions at August 31, 2001, are not materially
different from assumptions used to measure the fair value of retained
interests at the time of securitization. These sensitivities are
hypothetical and should be used with caution. In this table, the effect of
a variation in a particular assumption on the fair value of the retained
interest is calculated without changing any other assumption; in reality,
changes in one factor may result in changes in another, which might magnify
or counteract the sensitivities.
Page 25 of 44
Impact on Fair Impact on Fair
Assumptions Used Value of 10% Value of 20%
(Dollar amounts in thousands) (Annual) Adverse Change Adverse Change
-----------------------------------------------------------------------------------------------------
Payment rate....................... 6.9%-10.8% $ 8,798 $ 16,626
Default rate....................... 9.1%-19.4% $ 25,196 $ 50,392
Discount rate...................... 9.0%-15.0% $ 2,542 $ 5,048
4. Financial Derivatives
On behalf of the Circuit City Group, the Company enters into interest rate
cap agreements to meet the requirements of the credit card receivable
securitization transactions. In the second quarter of fiscal 2002, the
Company did not enter into any new interest rate caps. At August 31, 2001,
the total notional amount of interest rate caps outstanding was $839
million. Purchased interest rate caps are included in net accounts
receivable and had a fair value of $5.9 million as of August 31, 2001.
Written interest rate caps are included in accounts payable and had a fair
value of $5.9 million as of August 31, 2001.
The market and credit risks associated with interest rate caps are similar
to those relating to other types of financial instruments. Market risk is
the exposure created by potential fluctuations in interest rates and is
directly related to the product type, agreement terms and transaction
volume. The Company has entered into offsetting interest rate cap
positions, and therefore, does not anticipate significant market risk
arising from interest rate caps. Credit risk is the exposure to
nonperformance of another party to an agreement. The Company mitigates
credit risk by dealing with highly rated counterparties.
5. Appliance Exit Costs
On July 25, 2000, the Company announced plans to exit the major appliance
category and expand its selection of key consumer electronics and home
office products in all Circuit City Superstores. A product profitability
analysis had indicated that the appliance category produced below-average
profits. This analysis, combined with declining sales, expected increases
in appliance competition and the Company's profit expectations for the
consumer electronics and home office categories led to the decision to exit
the major appliance category. To exit the appliance business, the Company
closed six distribution centers and seven service centers in fiscal 2001,
one service center in August 2001 and one distribution center in September
2001 and expects to close one distribution center by the end of October
2001. The majority of these closed properties are leased. While the Company
has entered into contracts to sublease some of these properties, it
continues the process of preparing and marketing its remaining properties
to be subleased. The Company maintains control over Circuit City's in-home
major appliance repair business, although repairs are subcontracted to an
unrelated third party. In the second quarter of fiscal 2001, the Company
recorded appliance exit costs of $30 million. These expenses are reported
separately on the fiscal 2001 statements of earnings.
Approximately 890 employees have been terminated and approximately 60
employees will be terminated as a result of the exit from the appliance
business. These reductions are mainly in the service, distribution and
merchandising functions. Because severance is being paid to employees on a
bi-weekly schedule based on years of service, cash payments lag job
eliminations. The composition of the appliance exit cost accrual and the
remaining liability at August 31, 2001, are presented below. The
fixed-asset write downs include appliance build-to-order kiosks in stores
as well as non-salvageable fixed assets and leasehold improvements at the
locations closed as part of the exit from the appliance business.
Page 26 of 44
Expenses Liability at
Total Paid or Assets August 31,
(Amounts in millions) Exit Costs Written Off 2001
----------------------------------------------------------------------------------------------
Lease termination costs................... $17.8 $ 4.2 $13.6
Fixed asset write-downs, net.............. 5.0 5.0 -
Employee termination benefits............. 4.4 3.9 0.5
Other..................................... 2.8 2.8 -
-----------------------------------------------
Appliance exit costs...................... $30.0 $ 15.9 $14.1
===============================================
6. Discontinued Operations
On June 16, 1999, Digital Video Express announced that it would cease
marketing the Divx home video system and discontinue operations, but that
existing, registered customers would be able to view discs during a
two-year phase-out period. Discontinued operations have been segregated on
the Circuit City Group statements of cash flows. However, Divx is not
segregated on the Circuit City Group balance sheets.
The loss on the disposal includes a provision for operating losses to be
incurred during the phase-out period. It also includes provisions for
commitments under licensing agreements with motion picture distributors,
the write-down of assets to net realizable value, lease termination costs,
employee severance and benefit costs and other contractual commitments. For
the quarters and six-month periods ended August 31, 2001, and 2000, the
discontinued Divx operations had no impact on the earnings of the Circuit
City Group.
The net liabilities of the discontinued Divx operations, reflected in the
accompanying group balance sheets as of August 31, 2001, and February 28,
2001, are comprised of the following:
(Amounts in thousands) Aug. 31, 2001 Feb. 28, 2001
---------------------------------------------------------------------------------------------
Current assets........................................ $ 66 $ 8
Property and equipment, net........................... - -
Other assets.......................................... 271 324
Current liabilities................................... (19,326) (27,522)
Other liabilities..................................... (3,582) (14,082)
-----------------------------------
Net liabilities of discontinued operations............ $ (22,571) $ (41,272)
===================================
7. Recent Accounting Pronouncements
In July 2000, the Financial Accounting Standards Board issued Emerging
Issues Task Force No. 00-14, "Accounting for Certain Sales Incentives,"
which is effective for fiscal quarters beginning after December 15, 2001.
The issue provides that sales incentives, such as mail-in rebates, offered
to customers should be classified as a reduction of revenue. The Company
offers certain mail-in rebates that are currently recorded in cost of
sales, buying and warehousing. However, the Company expects to reclassify
these rebate expenses from cost of sales, buying and warehousing to net
sales and operating revenues to be in compliance with EITF No. 00-14. For
the quarter ended August 31, 2001, this reclassification would have
increased the gross profit margin by 0.16 percent and the expense ratio by
0.17 percent. For the six-month period ended August 31, 2001, the
reclassification would have increased the gross profit margin by 0.15
percent and the expense ratio by 0.16 percent. The Company does not expect
the adoption of EITF No. 00-14 to have a material impact on the Circuit
City Group's financial position, results of operations or cash flows.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations," effective for business combinations
initiated after June 30, 2001, and SFAS No. 142, "Goodwill and Other
Intangible Assets," effective for fiscal years beginning after December 15,
2001. Under SFAS No. 141, the pooling of interests method of accounting for
business combinations is eliminated, requiring that all business
combinations initiated after the effective date be accounted for using
Page 27 of 44
the purchase method. Also under SFAS No. 141, identified intangible assets
acquired in a purchase business combination must be separately valued and
recognized on the balance sheet if they meet certain requirements. Under
the provisions of SFAS No. 142, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized but will be subject to
annual impairment tests in accordance with the pronouncements. Other
intangible assets that are identified to have finite useful lives will
continue to be amortized in a manner that reflects the estimated decline in
the economic value of the intangible asset and will be subject to review
when events or circumstances arise which indicate impairment. Application
of the nonamortization provisions of SFAS No. 142 in fiscal 2003 will not
have a material impact on the financial position, results of operations or
cash flows of the Company.
8. Reclassifications
Certain previously reported amounts have been reclassified to conform with
current-year presentation.
Page 28 of 44
ITEM 2.
CIRCUIT CITY GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "Circuit City business" and "Circuit City" refer to the retail
operations bearing the Circuit City name and to all related operations such as
product service and Circuit City's finance operation. "Circuit City Group"
refers to the Circuit City business and the reserved CarMax Group shares.
"CarMax business," "CarMax" and "CarMax Group" refer to retail locations bearing
the CarMax name and to all related operations such as CarMax's finance
operation.
Net Sales and Operating Revenues and General Comments
Total sales for the second quarter of fiscal 2002 were $2.04 billion, a decrease
of 19 percent from $2.51 billion for the same period last year. For the six
months ended August 31, 2001, total sales were $3.92 billion, a decrease of 21
percent from $4.96 billion in the same period last year. We experienced solid
comparable store sales increases in digital and advanced technologies, such as
digital televisions, and in new and expanded categories, such as digital
imaging, video game hardware and software, DVD software and personal computer
software, accessories and peripherals, added in the former appliance space.
These increases were offset by the absence of major appliances, continued
industry-wide weakness in personal computer sales and declines in sales of
analog products and older technologies, caused in part by lower average retail
sales. Comparable store sales declined 21 percent in the second quarter of
fiscal 2002 and 23 percent for the six-month period ended August 31, 2001.
Excluding the appliance category, from which we completed our exit in the third
quarter of fiscal 2001, comparable store sales declined 9 percent in the second
quarter of fiscal 2002 and 11 percent for the six-month period ended August 31,
2001.
We plan to open 12 Circuit City Superstores and relocate nine Circuit City
Superstores in the current fiscal year. In the first quarter of fiscal 2002, we
opened one Circuit City Superstore in the Las Vegas, Nev., market and relocated
one store in the Los Angeles, Calif., market. In the second quarter of fiscal
2002, we opened four Circuit City Superstores, in Boca Raton, Fla.; Dallas,
Texas; St. Louis, Mo.; and Tampa, Fla., and relocated two stores in Louisville,
Ky. and Tampa, Fla. Our remodels for fiscal 2002 include 24 Circuit City
Superstores in which we are testing two different remodel designs. A more
extensive approach is being conducted in 10 stores in the Chicago market and two
stores in Virginia and a second, less costly version is being tested in 12
stores in the Washington, D.C., and Baltimore, Md., markets. The majority of the
remodeling activities were completed by the end of the second quarter.
The table below details Circuit City retail units:
===================================================================================================
Estimate
Store Mix Aug. 31, 2001 Aug. 31, 2000 Feb. 28, 2002 Feb. 28, 2001
===================================================================================================
Superstores 598 574 604 594
---------------------------------------------------------------------------------------------------
Circuit City Express 29 41 20 35
===================================================================================================
TOTAL 627 615 624 629
===================================================================================================
Gross dollar sales from all extended warranty programs were 5.6 percent of sales
in the second quarter of fiscal 2002 and 5.2 percent of sales in the second
quarter of fiscal 2001. Third-party warranty revenue was 4.4 percent of sales in
this year's second quarter and 4.1 percent in the same period last year. The
total extended warranty revenue that is reported in total sales was 4.3 percent
of sales in the second quarter of both fiscal 2002 and 2001.
Page 29 of 44
The percentage of merchandise sales represented by each category is listed
below:
========================= ==================================== =====================================
2nd Quarter Six Months
------------------------------------ -------------------------------------
Fiscal 2002 Fiscal 2001 Fiscal 2002 Fiscal 2001
========================= ================== ================= ================== ==================
Video 38% 32% 38% 32%
------------------------- ------------------ ----------------- ------------------ ------------------
Audio 16 15 16 15
------------------------- ------------------ ----------------- ------------------ ------------------
Information Technology 36 34 36 34
------------------------- ------------------ ----------------- ------------------ ------------------
Entertainment 10 5 10 5
------------------------- ------------------ ----------------- ------------------ ------------------
Appliances - 14 - 14
========================= ================== ================= ================== ==================
TOTAL 100% 100% 100% 100%
========================= ================== ================= ================== ==================
Circuit City's operations, in common with other retailers in general, are
subject to seasonal influences. Historically, Circuit City has realized more of
its net sales and net earnings in the fourth quarter, which includes the
December holiday selling season, than in any other fiscal quarter. The net
earnings of any interim quarter are seasonally disproportionate to net sales
since administrative and certain operating expenses remain relatively constant
during the year. Therefore, interim results should not be relied upon as
necessarily indicative of results for the entire fiscal year.
Cost of Sales, Buying and Warehousing
For the quarter ended August 31, 2001, Circuit City's gross profit margin
increased to 24.4 percent of sales from 23.3 percent in the same period last
year. Excluding appliance merchandise markdowns of $7.0 million and one-time
exit costs in last year's second quarter, last year's second quarter gross
profit margin was 24.7 percent. The reduction in gross profit margin, when the
appliance impact is excluded, in part reflects a brief supply constraint as we
made a transition in DIRECTV inventory during the quarter as well as slower
wireless communications sales early in the quarter. The DIRECTV supply issues
have since been resolved and both of these high-margin service businesses were
performing well as the quarter ended. For the six months ended August 31, 2001,
the gross profit margin was 24.5 percent compared with 23.8 percent in the same
period last year. Excluding the impact of the appliance exit in the first half
of last year, the gross profit margin for the six-month period of last year was
24.5 percent.
Selling, General and Administrative Expenses
Circuit City's selling, general and administrative expense ratio was 25.4
percent of sales in the second quarter of fiscal 2002, compared with 20.5
percent for the same period last year. The prior year's second quarter expense
ratio includes $1.7 million of one-time appliance exit costs. Excluding these
costs, the second quarter expense ratio for fiscal 2001 was 20.4 percent. The
increased expense ratio in fiscal 2002 is primarily a function of lower
comparable store sales. In addition, remodeling costs were higher in the second
quarter of fiscal 2002, as most of the costs associated with last year's full
remodels in Florida were incurred in the third quarter of fiscal 2001. Although
advertising expense was higher in this year's second quarter, it did not
increase for the first six months of fiscal 2002, reflecting a shift in the
timing of our spending. Partially offsetting these factors, the funding cost of
Circuit City's finance operation declined more rapidly than yields during both
the first and second quarters. For the six-month period ended August 31, 2001,
the Company's selling, general, and administrative expense ratio was 25.4
percent compared with 20.8 percent for the same period last year.
(Loss) Earnings Before Income Attributed to the Reserved CarMax Group Shares
Excluding the income attributed to the reserved CarMax Group shares, Circuit
City incurred a loss for the second quarter of $12.5 million compared with
earnings of $43.2 million for the same period last year. For the six-month
period ended August 31, 2001, excluding the income attributed to the reserved
CarMax Group shares, Circuit City incurred a loss of $22.1 million compared with
earnings of $89.9 million for the same period last year.
Page 30 of 44
Net Earnings Attributed to the Reserved CarMax Group Shares
During the second quarter of fiscal 2002, the net earnings attributed to the
reserved CarMax Group shares rose 59 percent to $19.3 million compared with
$12.1 million for the same period last year. For the first six months of fiscal
2002, net earnings attributed to the reserved CarMax Group shares rose 73
percent to $39.1 million compared with $22.6 million for the same period last
year.
Net Earnings
Net earnings for the Circuit City Group for the quarter ended August 31, 2001,
were $6.8 million compared with $55.3 million in the same period last year. For
the six-month period ended August 31, 2001, net earnings for the Circuit City
Group were $17.0 million compared with $112.5 million for the same period last
year.
Liquidity and Capital Resources
Merchandise inventory decreased $237.0 million reflecting an increased focus on
inventory management as well as the decline in comparable store sales for the
first half of this fiscal year. Accounts payable has increased $28.2 million
since the end of fiscal 2001 as we extended vendor payment terms. As scheduled,
we used existing working capital to repay a term loan totaling $130 million in
June 2001. Payment of corporate debt will not necessarily reduce Circuit City
Group allocated debt. At August 31, 2001, we maintained a $150 million unsecured
revolving credit facility and $195 million in committed seasonal lines of credit
that are renewed annually with various banks.
Circuit City's finance operation has a master trust securitization facility that
allows the transfer of its private-label credit card receivables through private
placement and the public market. As of August 31, 2001, the master trust program
had a total program capacity of $1.29 billion. Circuit City's finance operation
also has a master trust securitization facility related to its bankcard program.
As of August 31, 2001, the bankcard master trust program had a total program
capacity of $2.15 billion. These master trust vehicles permit further expansion
of the securitization programs in both the public and private markets.
Circuit City relies on the external debt we allocate to the Circuit City Group
to provide working capital needed to fund net assets not otherwise financed
through sale-leasebacks or receivable securitizations. We manage all significant
financial activities of the Circuit City business on a centralized basis.
Circuit City's significant financial activities are dependent on our financial
condition as a whole and include the investment of surplus cash, issuance and
repayment of debt, securitization of receivables and sale-leasebacks of real
estate.
During the second quarter, we completed the public offering of 9,516,800 shares,
including the underwriters' over-allotment option of 666,800 shares, of CarMax
Group stock. The shares sold in the offering are shares of CarMax Group stock
that previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group stock. We allocated the net proceeds of $139.7
million from this offering to the Circuit City Group to be used for general
purposes of the Circuit City business, including the remodeling of Circuit City
Superstores.
We believe that proceeds from sales of property and equipment and receivables,
future increases in the Circuit City Stores' debt allocated to the Circuit City
Group, cash generated by operations and proceeds from the public stock offering
discussed above will be sufficient to fund the capital expenditures and
operations of the Circuit City business.
Forward-Looking Statements
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties. Additional discussion of factors that could
cause actual results to differ materially from management's projections,
forecasts, estimates and expectations is contained in our SEC filings, including
our report on Form 10-Q for the quarter ended May 31, 2001.
Page 31 of 44
ITEM 3.
CIRCUIT CITY GROUP QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
We centrally manage the market risk associated with the private-label and
bankcard revolving loan portfolios of Circuit City's finance operation. Portions
of these portfolios are securitized and, therefore, are not presented on the
Circuit City Group's balance sheets. Interest rate exposure relating to these
receivables represents a market risk exposure that we manage with matched
funding; therefore, we expect to experience relatively little impact as interest
rates fluctuate.
As of August 31, 2001, the composition of the Circuit City finance operation's
private-label and bankcard portfolios had not changed significantly since
February 28, 2001.
Page 32 of 44
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Balance Sheets
(Amounts in thousands)
Aug. 31, 2001 Feb. 28, 2001
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 24,557 $ 8,802
Net accounts receivable 160,624 134,662
Inventory 386,903 347,137
Prepaid expenses and other current assets 1,958 2,306
------------ -----------
Total current assets 574,042 492,907
Property and equipment, net 96,630 192,158
Other assets 23,781 25,888
------------ -----------
TOTAL ASSETS $ 694,453 $ 710,953
============ ===========
LIABILITIES AND GROUP EQUITY
Current liabilities:
Current installments of long-term debt $ 87,782 $ 108,151
Accounts payable 99,176 82,483
Short-term debt 1,359 987
Accrued expenses and other current liabilities 24,450 16,154
Deferred income taxes 21,351 18,162
------------ -----------
Total current liabilities 234,118 225,937
Long-term debt, excluding current installments 826 83,057
Deferred revenue and other liabilities 6,971 6,836
Deferred income taxes 3,527 3,620
------------ -----------
TOTAL LIABILITIES 245,442 319,450
GROUP EQUITY 449,011 391,503
------------ -----------
TOTAL LIABILITIES AND GROUP EQUITY $ 694,453 $ 710,953
============ ===========
See accompanying notes to group financial statements.
Page 33 of 44
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Statements of Earnings (Unaudited)
(Amounts in thousands)
Three Months Ended Six Months Ended
August 31, August 31,
2001 2000 2001 2000
------------ ----------- ------------- -------------
Net sales and operating revenues $ 851,363 $ 673,561 $ 1,648,183 $ 1,299,302
Cost of sales 742,837 583,012 1,435,697 1,123,291
------------ ----------- ------------- -------------
Gross profit 108,526 90,549 212,486 176,011
------------ ----------- ------------- -------------
Selling, general and administrative expenses 62,262 61,348 120,812 120,792
Interest expense 2,086 2,958 4,637 6,486
------------ ----------- ------------- -------------
Total expenses 64,348 64,306 125,449 127,278
------------ ----------- ------------- -------------
Earnings before income taxes 44,178 26,243 87,037 48,733
Provision for income taxes 16,787 9,972 33,074 18,518
------------ ----------- ------------- -------------
Net earnings $ 27,391 $ 16,271 $ 53,963 $ 30,215
============ =========== ============= =============
Net earnings attributed to:
Circuit City Group common stock $ 19,363 $ 12,145 $ 39,103 $ 22,554
CarMax Group common stock 8,028 4,126 14,860 7,661
------------ ----------- ------------- -------------
$ 27,391 $ 16,271 $ 53,963 $ 30,215
============ =========== ============= =============
See accompanying notes to group financial statements.
Page 34 of 44
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Statements of Cash Flows (Unaudited)
(Amounts in thousands)
Six Months Ended
August 31,
2001 2000
------------ -----------
Operating Activities:
Net earnings $ 53,963 $ 30,215
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 9,305 9,146
Loss on sales of property and equipment - 173
Deferred income taxes 3,096 3,829
Changes in operating assets and liabilities:
(Increase) decrease in net accounts receivable (25,962) 18,520
Increase in inventory (39,766) (3,211)
Decrease (increase) in prepaid expenses and other current assets 348 (175)
Decrease in other assets 716 -
Increase in accounts payable, accrued expenses and other
current liabilities 28,034 1,493
Increase (decrease) in deferred revenue and other liabilities 135 (152)
------------ -----------
Net cash provided by operating activities 29,869 59,838
------------ -----------
Investing Activities:
Cash used in business acquisitions - (1,325)
Proceeds from sales of property and equipment 96,344 12,036
Purchases of property and equipment (8,730) (6,553)
------------ -----------
Net cash provided by investing activities 87,614 4,158
------------ -----------
Financing Activities:
Increase (decrease) in allocated short-term debt, net 372 (39)
Decrease in allocated long-term debt, net (102,600) (68,216)
Issuances of group equity, net 500 1,168
------------ -----------
Net cash used in financing activities (101,728) (67,087)
------------ -----------
Increase (decrease) in cash and cash equivalents 15,755 (3,091)
Cash and cash equivalents at beginning of year 8,802 9,981
------------ -----------
Cash and cash equivalents at end of period $ 24,557 $ 6,890
============ ===========
See accompanying notes to group financial statements.
Page 35 of 44
CIRCUIT CITY STORES, INC. - CARMAX GROUP
Notes to Group Financial Statements
(Unaudited)
1. Basis of Presentation
The common stock of Circuit City Stores, Inc. (the "Company") consists of
two common stock series that are intended to reflect the performance of the
Company's two businesses. The Circuit City Group stock is intended to
reflect the performance of the Circuit City store-related operations, the
shares of CarMax Group stock reserved for the Circuit City Group or for
issuance to holders of Circuit City Group stock and the Company's
investment in Digital Video Express, which has been discontinued. The
CarMax Group stock is intended to reflect the performance of the CarMax
Group's operations. The reserved CarMax Group shares represented 64.6
percent of the total outstanding and reserved shares, excluding shares
reserved for CarMax employees' stock incentive plans, of CarMax Group stock
at August 31, 2001, and 74.6 percent at both February 28, 2001, and August
31, 2000. The Company allocates to the Circuit City Group the portion of
net earnings of the CarMax Group attributed to the reserved CarMax Group
shares. The terms of each series of common stock are discussed in detail in
the Company's Form 8-A registration statement on file with the Securities
and Exchange Commission.
Notwithstanding the attribution of the Company's assets and liabilities,
including contingent liabilities, and stockholders' equity between the
CarMax Group and the Circuit City Group for the purposes of preparing the
financial statements, holders of CarMax Group stock and holders of Circuit
City Group 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 equity
structure of the Company do not affect title to the assets or
responsibility for the liabilities of the Company or any of its
subsidiaries. Neither shares of CarMax Group stock nor shares of Circuit
City Group stock represent a direct equity or legal interest solely in the
assets and liabilities allocated to a particular group. Instead, those
shares represent direct equity and legal interests in the assets and
liabilities of the Company. The results of operations or financial
condition of one group could affect the results of operations or financial
condition of the other group. Net losses of either group and dividends or
distributions on, or repurchases of, Circuit City Group stock or CarMax
Group stock will reduce funds legally available for dividends on, or
repurchases of, both stocks. Accordingly, the CarMax Group financial
statements included in this report should be read in conjunction with the
Company's consolidated financial statements, the Circuit City Group
financial statements and the Company's SEC filings.
2. Accounting Policies
The financial statements of the CarMax Group conform to accounting
principles generally accepted in the United States of America. The interim
period financial statements are unaudited; however, in the opinion of
management, all adjustments, which consist only of normal, recurring
adjustments, necessary for a fair presentation of the interim group
financial statements have been included. The fiscal year-end balance sheet
data was derived from the audited financial statements included in the
Company's fiscal 2001 Annual Report on Form 10-K.
3. Securitizations
The Company has asset securitization programs, operated through special
purpose subsidiaries on behalf of the CarMax Group, to finance the consumer
installment credit receivables generated by CarMax's automobile loan
finance operation. For transfers of receivables that qualify as sales, the
Company recognizes gains or losses as a component of CarMax's finance
operation. In these securitizations, the Company retains servicing rights
and subordinated interests.
At August 31, 2001, the total principal amount of loans managed was $1,434
million. Of the total loans, the principal amount of loans securitized was
$1,412 million, and the principal amount of loans held for sale or
Page 36 of 44
investment was $22 million. The principal amount of loans that were 31 days
or more delinquent was $18.8 million at August 31, 2001. The principal
amount of losses net of recoveries amounted to $2.7 million for the three
months ended August 31, 2001, and $4.6 million for the six-month period
ended August 31, 2001.
The Company receives annual servicing fees approximating 1 percent of the
outstanding principal balance of the securitized automobile loans and
retains the rights to future cash flows arising after the investors in the
securitization trusts have received the return for which they contracted.
The servicing fees specified in the automobile loan securitization
agreements adequately compensate the finance operation for servicing the
accounts. Accordingly, no servicing asset or liability has been recorded.
The table below summarizes certain cash flows received from and paid to
securitization trusts:
Three Months Ended Six Months Ended
(Amounts in thousands) August 31, 2001 August 31, 2001
--------------------------------------------------------------------------------------------
Proceeds from new securitizations................... $ 181,000 $ 376,000
Proceeds from collections reinvested
in previous automobile loan securitizations....... $ 126,929 $ 218,394
Servicing fees received............................. $ 3,485 $ 6,737
Other cash flows received on retained interests*.... $ 17,186 $ 30,572
*This amount represents cash flows received from retained interests by the
transferor other than servicing fees, including cash flows from
interest-only strips and cash above the minimum required level in cash
collateral accounts.
In determining the fair value of retained interests, the Company estimates
future cash flows using management's best estimates of key assumptions such
as finance charge income, default rates, prepayment rates and discount
rates. The Company employs a risk-based pricing strategy that increases the
stated annual percentage rate for accounts that have a higher predicted
risk of default. Accounts with a lower risk profile may qualify for
promotional financing.
Rights recorded for future finance income from serviced assets that exceed
the contractually specified servicing fees are carried at fair value,
amounted to $61.2 million at August 31, 2001, and are included in net
accounts receivable. Gains of $14.7 million on sales were recorded for the
three-month period ended August 31, 2001; gains of $27.8 million on sales
were recorded for the six-month period ended August 31, 2001.
The fair value of retained interests at August 31, 2001, was $91.3 million,
with a weighted-average life ranging from 0.88 years to 1.63 years. The
following table shows the key economic assumptions used in measuring the
fair value of retained interests at August 31, 2001, and a sensitivity
analysis showing the hypothetical effect on the fair value of those
interests when there are unfavorable variations from the assumptions used.
Key economic assumptions at August 31, 2001, are not materially different
from assumptions used to measure the fair value of retained interests at
the time of securitization. These sensitivities are hypothetical and should
be used with caution. In this table, the effect of a variation in a
particular assumption on the fair value of the retained interest is
calculated without changing any other assumption; in reality, changes in
one factor may result in changes in another, which might magnify or
counteract the sensitivities.
Impact on Fair Impact on Fair
Assumptions Used Value of 10% Value of 20%
(Dollar amounts in thousands) (Annual) Adverse Change Adverse Change
--------------------------------------------------------------------------------------------
Prepayment speed................ 1.5%-1.6% $ 3,133 $ 6,490
Default rate.................... 1.0%-1.2% $ 1,759 $ 3,517
Discount rate................... 12.0% $ 1,248 $ 2,468
Page 37 of 44
4. Financial Derivatives
On behalf of the CarMax Group, the Company, in the second quarter of fiscal
2002, entered into three 40-month amortizing interest rate swaps related to
auto loan receivable securitizations. These swaps had an initial notional
amount of approximately $215 million. The total notional amount of all
swaps related to the automobile loan receivable securitizations was $675
million at August 31, 2001, and $299 million at February 28, 2001. These
swaps are used to better match funding costs and are recorded at fair
value. At August 31, 2001, these swaps totaled a net liability of $10.3
million and are included in accounts payable.
The market and credit risks associated with interest rate swaps are similar
to those relating to other types of financial instruments. Market risk is
the exposure created by potential fluctuations in interest rates and is
directly related to the product type, agreement terms and transaction
volume. The Company does not anticipate significant market risk from swaps,
because their use is to match funding costs to the use of the funding.
Credit risk is the exposure to nonperformance of another party to an
agreement. The Company mitigates credit risk by dealing with highly rated
counterparties.
5. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations," effective
for business combinations initiated after June 30, 2001, and SFAS No. 142,
"Goodwill and Other Intangible Assets," effective for fiscal years
beginning after December 15, 2001. Under SFAS No. 141, the pooling of
interests method of accounting for business combinations is eliminated,
requiring that all business combinations initiated after the effective date
be accounted for using the purchase method. Also under SFAS No. 141,
identified intangible assets acquired in a purchase business combination
must be separately valued and recognized on the balance sheet if they meet
certain requirements. Under the provisions of SFAS No. 142, goodwill and
intangible assets deemed to have indefinite lives will no longer be
amortized but will be subject to annual impairment tests in accordance with
the pronouncements. Other intangible assets that are identified to have
finite useful lives will continue to be amortized in a manner that reflects
the estimated decline in the economic value of the intangible asset and
will be subject to review when events or circumstances arise which indicate
impairment. Application of the nonamortization provisions of SFAS No. 142
in fiscal 2003 is not expected to have a material impact on the financial
position, results of operations or cash flows of the Company. During fiscal
2003, the Company will perform the first of the required impairment tests
of goodwill and indefinite-lived intangible assets, as outlined within the
new pronouncements. Based on preliminary estimates as well as ongoing
periodic assessments of goodwill, the Company does not expect to recognize
any material impairment losses from these tests.
6. Reclassifications
Certain previously reported amounts have been reclassified to conform with
current-year presentation.
Page 38 of 44
ITEM 2.
CARMAX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this discussion, "we," "our" and "Circuit City Stores" refer to Circuit City
Stores, Inc. and our wholly owned subsidiaries, unless the context requires
otherwise. "CarMax business," "CarMax" and "CarMax Group" refer to retail
locations bearing the CarMax name and to all related operations such as CarMax's
finance operation.
Net Sales and Operating Revenues and General Comments
Total sales rose 26 percent for the quarter ended August 31, 2001, to $851.4
million from $673.6 million in last year's second quarter. For the six months
ended August 31, 2001, total sales were $1.65 billion, an increase of 27 percent
from $1.30 billion in the same period last year. Our CarMax business continued a
strong sales trend begun in fiscal 2001. Higher-than-anticipated sales were led
by used-car sales growth driven by strong store traffic, better in-store
execution and increases in average retails. Comparable store sales increased 27
percent in this year's second quarter after an 18 percent increase in the same
prior year period. Comparable store sales increased 27 percent for the six-month
period ended August 31, 2001, after a 16 percent increase for the same period
last year.
We expect CarMax's geographic growth over the next five years to primarily
include the addition of superstores in new mid-sized markets that can be served
effectively with one CarMax superstore and additional satellite stores in
existing multi-store markets. Mid-sized markets are those with populations of
approximately 1 million to 2.5 million people. In late fiscal 2002, CarMax plans
to open two superstores in the mid-sized markets of Sacramento, Calif., and
Greensboro, N.C. In fiscal 2003, we plan to open four to six stores, and in
fiscal years 2004 through 2006, we plan to open six to eight stores per year.
The table below details CarMax retail units:
===========================================================================================================
Estimate
Stores Open Aug. 31, 2001 Aug. 31, 2000 Feb. 28, 2002 Feb. 28, 2001
===========================================================================================================
"C" and "B" Stores 14 14 14 14
-----------------------------------------------------------------------------------------------------------
"A" Stores 17 17 19 17
-----------------------------------------------------------------------------------------------------------
Prototype Satellite Stores 4 4 4 4
-----------------------------------------------------------------------------------------------------------
Stand-Alone New-Car Stores 5 5 5 5
===========================================================================================================
TOTAL 40 40 42 40
===========================================================================================================
Gross dollar sales from all extended warranty programs were 3.9 percent of sales
in the second quarters of fiscal 2002 and fiscal 2001. Third-party warranty
revenue was 1.7 percent of sales, and the total extended warranty revenue that
is reported in total sales was 1.7 percent of sales in the second quarter of
both years.
Page 39 of 44
The percentages of sales dollars and sales units represented by used and new
vehicles for the second quarter and six-month periods are listed below:
=======================================================================
Three Months Ended Six Months Ended
August 31, August 31,
------------------------------------------------
2001 2000 2001 2000
=======================================================================
Vehicle Dollars:
-----------------------------------------------------------------------
Used Vehicles 81% 79% 81% 80%
-----------------------------------------------------------------------
New Vehicles 19% 21% 19% 20%
=======================================================================
Vehicle Units:
-----------------------------------------------------------------------
Used Vehicles 87% 86% 87% 86%
-----------------------------------------------------------------------
New Vehicles 13% 14% 13% 14%
=======================================================================
CarMax's operations, in common with other retailers in general, are subject to
seasonal influences. Historically, CarMax has experienced more of its net sales
in the first half of the fiscal year. The net earnings of any interim quarter
are seasonally disproportionate to net sales since administrative and certain
operating expenses remain relatively constant during the year. Therefore,
interim results should not be relied upon as necessarily indicative of results
for the entire fiscal year.
Cost of Sales
The gross profit margin was 12.7 percent of sales in the second quarter of
fiscal 2002 versus 13.4 percent for the same period last year. For the six-month
period ended August 31, 2001, the gross profit margin was 12.9 percent compared
with 13.5 percent for the same period last year. We achieved our gross profit
margin dollar targets per vehicle; however, higher average retails generated a
decline in the gross profit margin on a percentage basis.
Selling, General and Administrative Expenses
The selling, general and administrative expense ratio decreased to 7.3 percent
of sales in the second quarter of fiscal 2002 from 9.1 percent of sales for the
same period last year. For the six months ended August 31, 2001, the ratio was
7.3 percent of sales, compared with 9.3 percent in the same period last year.
Similar to the first quarter of this year, the expense ratio improvement
reflects the significant expense leverage generated by the comparable store
sales growth. CarMax's finance operation also contributed to the improved ratio
as lower funding costs generated higher spreads.
Net Earnings
During the second quarter, CarMax's net earnings increased 68 percent to $27.4
million from $16.3 million in the same period last year. The net earnings
attributed to the CarMax Group stock were $8.0 million in the second quarter of
fiscal 2002, compared with $4.1 million in the same period last year. The net
earnings in the six-month period ended August 31, 2001, were $54.0 million
compared with $30.2 million in the same period last year. In the six-month
period ended August 31, 2001, the net earnings attributed to the CarMax Group
stock were $14.9 million compared with $7.7 million in the same period last
year.
Liquidity and Capital Resources
Net fixed assets decreased $95.5 million as a result of the sale-leaseback
transaction in this year's second quarter. Inventory increased $39.8 million in
an effort to hold new-car inventories higher over the summer to assure
availability of competitively priced current model-year vehicles during the fall
model changeover period.
Page 40 of 44
Net accounts receivable increased by $26.0 million, reflecting an increase in
auto loans generated by higher sales volume. As scheduled, we used existing
working capital to repay a term loan totaling $130 million in June 2001. Payment
of corporate debt will not necessarily reduce CarMax Group allocated debt. At
August 31, 2001, we maintained a $150 million unsecured revolving credit
facility and $195 million in committed seasonal lines of credit that are renewed
annually with various banks.
We also have an asset securitization program operated through a special purpose
subsidiary on behalf of CarMax, through which we sell automobile loan
receivables. This program had a capacity of $800 million as of August 31, 2001.
On behalf of CarMax, we also have two public asset securitization programs under
which we originally securitized $1.30 billion of auto loan receivables. As of
August 31, 2001, the two public asset securitization programs had a capacity of
$736 million. We anticipate that we will be able to expand or enter into new
arrangements comparable to these securitization programs to meet future needs.
CarMax relies on the external debt we allocate to the CarMax Group to provide
working capital needed to fund net assets not otherwise financed through
sale-leasebacks or receivable securitizations. We manage most of the significant
financial activities of the CarMax business on a centralized basis. CarMax's
significant financial activities are dependent on our financial condition as a
whole and include the investment of surplus cash, issuance and repayment of
debt, securitization of receivables and sale-leasebacks of real estate.
During the second quarter, we completed the public offering of 9,516,800 shares,
including the underwriters' over-allotment option of 666,800 shares, of CarMax
Group stock. The shares sold in the offering were shares of CarMax Group stock
that previously had been reserved for the Circuit City Group or for issuance to
holders of Circuit City Group stock. We allocated the net proceeds of $139.7
million from this offering to the Circuit City Group to be used for general
purposes of the Circuit City business, including the remodeling of Circuit City
Superstores.
In August 2001, CarMax entered into a sale-leaseback transaction with Capital
Automotive Real Estate Investment Trust covering nine superstore properties
valued at $102.4 million. This transaction was the first sale-leaseback for
CarMax without Circuit City guarantees. It was entered into at competitive rates
and structured with an initial lease term of 15 years with two 10-year renewal
options.
We believe that proceeds from sales of property and equipment and receivables,
future increases in Circuit City Stores' debt allocated to the CarMax Group,
inter-group loans, floor plan financing and cash generated by operations will be
sufficient to fund the capital expenditures and operations of the CarMax
business.
Forward-Looking Statements
This report on Form 10-Q contains "forward-looking statements," which are
subject to risks and uncertainties. Additional discussion of factors that could
cause actual results to differ materially from management's projections,
forecasts, estimates and expectations is contained in our SEC filings, including
our report on Form 10-Q for the quarter ended May 31, 2001.
Page 41 of 44
ITEM 3.
CARMAX GROUP QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
We centrally manage the market risk associated with the automobile installment
loan portfolio of CarMax's finance operation. A portion of this portfolio is
securitized and, therefore, is not presented on the CarMax Group's balance
sheets. Interest rate exposure relating to these receivables represents a market
risk exposure that we manage with matched funding and interest rate swaps.
Total principal outstanding for fixed-rate automobile loans at August 31 and
February 28, 2001, was as follows:
(Amounts in millions) August 31 February 28
-------------------------------------------------------------------------
Fixed-rate................................. $1,434 $1,296
Financing for these receivables is achieved through asset securitization
programs that, in turn, issue both fixed- and floating-rate securities.
Receivables held by Circuit City Stores for investment or sale are financed with
working capital. Financings at August 31 and February 28, 2001, were as follows:
(Amounts in millions) August 31 February 28
-------------------------------------------------------------------------
Fixed-rate securitizations................. $ 736 $ 984
Floating-rate securitizations
synthetically altered to fixed......... 675 299
Floating-rate securitizations.............. 1 1
Held by the Company:
For investment*........................ 19 9
For sale............................... 3 3
--------------------------
Total...................................... $1,434 $1,296
==========================
* Held by a bankruptcy remote special purpose company.
Because programs are in place to manage interest rate exposure relating to the
installment loan portfolio, we expect to experience relatively little impact as
interest rates fluctuate.
Page 42 of 44
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(4) Second Amended and Restated Rights Agreement dated as
of July 10, 2001 between Circuit City Stores, Inc.
and Wells Fargo Bank Minnesota, N.A. (incorporated by
reference to Exhibit 1 to Circuit City Stores, Inc.
Form 8A/A filed July 20, 2001 (File No. 001-05767)).
(b) Reports on Form 8-K
None.
Page 43 of 44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CIRCUIT CITY STORES, INC.
By: s/ W. Alan McCollough
------------------------------------
W. Alan McCollough
President and
Chief Executive Officer
By: s/ Michael T. Chalifoux
------------------------------------
Michael T. Chalifoux
Executive Vice President,
Chief Financial Officer and
Corporate Secretary
By: s/ Philip J. Dunn
------------------------------------
Philip J. Dunn
Senior Vice President, Treasurer,
Corporate Controller and
Chief Accounting Officer
October 11, 2001
Page 44 of 44