車美仕 (KMX) 2002 Q3 法說會逐字稿

Welcome to the CarMax Inc Q3 Earnings Conference Call.

This call is being recorded.

Following management's discussion this morning, the conference call will be open for questions.

During the question and answer session, you may press *1 to ask a question.

You will be announced prior by your name and company name.

Please indicate when your question is answered so we may move on to the next.

I will now turn the call over to Dandy Barrett, CarMax's director of Investor Relations, who will introduce the senior management.

Ms Barrett, you may begin.

Good morning.

With us on the call today are Austin Ligon, President and Chief Executive Officer of CarMax, and Keith Browning, Executive Vice President and Chief Financial Officer.

Before we begin, let me remind you that today's discussion is likely to include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from management's projections, forecasts, estimates and expectations.

These risk factors are set forth in more detail in CarMax's SEC filings, including the August 7, 2002 proxy prospectus related to CarMax's separation from Circuit City Stores Inc.

Now I'm pleased to introduce Austin Ligon.

Good morning.

Thanks for joining us today.

I regret to say that if you're looking for more of the gloom and doom that we've been hearing from most of the retail sector, you're tuned to the wrong channel.

We just had a great quarter.

We're real happy with it, and we expect to have another pretty good quarter coming up.

So, the news I have to give you today is good.

First, I want to call your attention this morning to the new presentation of our earnings statement.

As most of you will know, this is the first time we've presented an earnings statement as a separate, independent company.

The earnings statement that you see today more accurately reflects the structure of our business and the contribution of each of our businesses' elements.

There are four revenue lines: Used Vehicle Sales, New Vehicle Sales, Wholesale Sales, Other Sales and Revenue, which now includes third-party lender fees, as well as fees from extended warrantee sales, service departments sales and processing fees from consumers who sell vehicles to us.

Following the gross profit line, we now present CarMax's Auto Finance income.

This income has only the direct cost of operating the CarMax Auto Finance Group itself.

It does not reflect any of the finance sales commissions costs, nor retail store costs of any kind, nor does it reflect any corporate overhead costs of human resources, MIS, marketing, accounting and the like.

Consequently, this income line should be compared with the gross profit line produced by our sales and revenue lines.

Our SG&A now reflects the true cost of operating our stores and corporate operations without any revenue offsets.

That's followed by interest expense and interest income.

The normal earnings and EPS lines then complete the statement.

We think this is a much cleaner and more easily understood P&L that will help you most effectively understand our business.

Now let's talk about the quarter.

As far as sales go, we were very pleased with the 8% growth in our used unit comps, which was at the higher end of our range, especially when you compare it to the exceptional 29% growth we experienced last year in the third quarter.

I'll remind you that, while we had a strong 21% comp trend in the first half of last year, the 29% performance in the third quarter of last year was driven largely by a 0% financing surge, which drove extraordinary traffic into the marketplace, as well as the effectiveness of our appraisal offer during the chaos of the post 9-11 period.

So, the 29% last year was unusual.

We feel great about the 8% in comparison to that.

I'm also very pleased with the performance of our five new stores: Greensborough, Merrillville, Roseville, Charlotte and Knoxville.

As we've said, these stores are now consistently outperforming our original expectations.

Our inventory management and pricing systems also helped us once again to adjust quickly to market pricing changes, as we move through a challenging model year changeover period.

This protected our margins, even though our used vehicle pricing has fallen at a slightly greater rate during the year's model year changeover than in prior year ... than the prior recent years.

As far as earnings go, our earnings per share have been presented reflecting the CarMax Inc capital structure, following the October 1 separation from Circuit City.

Historically, the dilutive effect of options on restricted stock is spread over all the 104.5 million CarMax Inc shares outstanding, rather than only the roughly 37 million CarMax Group shares, as it was historically presented.

Consequently, we have presented pro forma historical EPS numbers to reflect the accretive effect on historical numbers.

As we expected, our EPS this quarter was flat to last year's third quarter, at $0.18 versus $0.18, after excluding the one-time cost of separation.

Gross margin improved slightly, quarter over quarter, reflecting the higher mix of more profitable used vehicles, and a higher penetration of extended warrantees, compared with last year's third quarter.

CarMax Auto Finance income was up 7%.

This more moderate growth reflects our keeping interest rates competitive for CarMax customers with the marketplace.

Also, our loans, [originated by cap], continue to perform in line with our expectations on both default rates and pre-payment speeds.

As far as 3Q SG&A, it was reported as 10.9% of sales.

Excluding the $4.5m in one-time separation costs, the SG&A ratio was 10.4%, versus 9.7% last year.

This 10.4% reflects the ramp-up that we've done this year due to geographic growth, which brings both pre-opening expense, training, recruiting and development of management [bench] expenses, as well as higher welfare benefit costs, as we've separated from Circuit City.

We have a much smaller pool of [indecipherable] than we did when we were part of Circuit City, and our [indecipherable] on average is older and has a larger family size.

As far as fourth quarter expectations, our used unit comp growth is once again in the mid to upper-mid -- if you will -- range, 4% to 7%.

This is a-- We have 23% comp growth in last year's fourth quarter.

If you look back in history, a 19% comp growth in the fourth quarter before that.

So, this is the first time that we've come up against two consecutive, very strong quarters in a row.

We also lose 1% roughly of comps, compared to the trend of this quarter because we lose a Saturday in the fourth quarter this year.

So, overall, the run rate that we expect in the fourth quarter is roughly the same as the run rate we had in the third quarter, and the yield of used unit comps what that will give us is about 4% to 7%.

Our EPS expectation is $0.18 to $0.20 per share, reflecting a continuation of our stepped-up expenses from both growth and the independence from Circuit City.

We'll see that until the one-year anniversary of our accelerated growth sometime in the middle of next year.

So, with that, I'd be happy to take your questions.

Thank you.

At this time, they're ready to begin the question and answer session.

If you'd like to ask a question, you may press *1.

To withdraw your question, you may press *2.

Once again, to ask a question, you may press *1.

One moment please.

Am Rubinson from Bank of America, you may ask your question.

Three quick [indecipherable] questions.

New stores, you said, are consistently ahead of plan.

I assume you were referring to sales there.

Can you comment about the profitability of those new stores, or costs of those new stores, I guess?

Costs, I'd say, are consistent with plans, and profitability would be consistent with what we'd expect, given moderate over-performance to reasonable expectations.

So, profits are up about in line with what we'd expect them to be for sales.

Okay.

The Wholesale gross margin showed an up-tick there.

I'm curious if I'm reading that properly.

Does that reflect the fact that you guys are therefore, at the margin, buying your cars better than the competition?

It really reflects last year when we had the post 9-11 events, and the Wholesale market collapsed.

We did comment that we actually did make less money on our cars during that period.

So, it's really going against an easier comparison that they were actually in line with our expectations for the quarter.

But on a nine-month, year to date basis, you're still at 4.9% versus 4.5%.

So, the trend has been there prior as well.

I think that Wholesale impact of the third quarter is really-- I mean it started post 9-11 and lasted for the balance of the year.

I don't think that there's anything meaningful to derive from those numbers.

Okay.

Can you give us a sense on the SG&A-- We know the one-time separation cost, but how much in basis points, roughly, you're being impacted by some of these other kind of ramp costs from being independent?

Well, we've gone from 9.7% to 10.4%, so that's 70 basis points.

Probably a little more than half of that's coming from the growth [perspective] that we [cost] on a year over year basis.

The rest of it is coming from the stand-alone expenses, which will continue to have that challenge going on until next year at this time.

Okay.

Good luck, guys.

Thanks.

Let me just mention to those of you who don't recognize his voice that the other voice on the line is Keith Browning, our EVP and CFO.

Our next question comes from Joe Jolson of JFP.

Congratulations on hitting your numbers in a tough environment.

I just had a couple of questions.

You said that in the Auto Finance business, you provided competitive rates.

Would that be competitive with the 0% financings that we see?

Or is that competitive with the used car market?

Can you kind of give a breakout of that?

No, we don't do 0% financing.

I understand that.

The good news is we don't have a lot of inventory that we've manufactured that we have to get rid of when they're not competitive in the marketplace.

The answer is, what we've done is stayed competitive with Bank of America and the other prime lenders in the marketplace.

Including Internet sites.

So, for instance, what would have been your average contract yield in the quarter?

I'll give you an example.

Our rate to our best customer is now 5.9%, where earlier in the year it was closer to 6.5% to 6.9%.

So, we've dropped our rates.

Are those the contracts that you sell?

Or are those the ones that you securitize?

We securitize-- That's for [indecipherable] finance, which is what we're focused on.

We securitize all of our loans every month.

Okay.

Is it still about half your loans that you do through that?

Or is that--?

About half of the customers that come through the door that choose financing still finance with CarMax Auto Finance.

And all of those loans are securitized.

Right.

Okay.

So, the loans on your balance sheet at the end of the month, is that just the day's worth of volume, or--?

That's really the last few days of each month, depending on how the month falls.

This month, it happens to include a Saturday.

Okay.

The other thing is, since you're reporting as an independent company now, the comparisons are going to-- Like this quarter compared now against $0.18, what's the appropriate comparison for operating earnings next quarter?

Hold on just a second.

Let me come back, and I'll answer that.

We'll take another question, but I'll come back and answer what that comparison is.

It's 18% on a pro forma diluted basis.

So, the guidance you're giving is 18% to 20%, versus 18%?

Yes.

And does the 18% from last year include anything unusual in that?

No, but if you look at the 18% to 20% for guidance that we're giving, we're using an effective tax rate that is 39.5% because of the separation costs that occur throughout this year.

That's comparing it to a 38% effective tax rate for the fourth quarter of last year.

Is the 39.5% what it's going to be going forward?

No.

We would expect that, starting next fiscal year, to go back to approximately 38%.

We'll give guidance on that as soon as we give guidance for next year's earnings.

The reason it's 39.5% is because the one-time costs are not tax-deductible.

That makes your effective tax rate higher.

Because we use that tax rate for the entire year that's what will be used for the fourth quarter.

Right.

But the effective will be roughly 38%.

So, pre-tax, it will be a little bit better than 18% versus 18%, if it is indeed 18%?

That's the point, yes.

And a final thing on that, now last year's $0.18 didn't include any other non-recurring kind of write-offs or anything?

I don't think so.

Nothing comes to mind.

Certainly, there was nothing material.

We didn't announce anything. [Inaudible].

Thank you.

Congratulations, again.

Bret Freeman from CFN Capital, you may ask your question.

Just a quick question on the third-party loan origination fees being down.

Can you give us a little bit of color in terms of what's going on there?

Sure.

A large part of that is really related to new car third-party fees that we would normally get.

But new car sales were obviously up substantially in the third quarter of last year.

And as you saw, we had negative comps there, and that is a large part of -- or a substantial part anyway -- of the third-party fees we get.

And then the other thing is that the CarMax Auto Finance, in adjusting their rates, did get a little bit of share there, so that's adding marginally to the contribution -- or reducing that contribution -- as they got more competitive in the marketplace.

Okay.

And is that a number that on a going forward basis you'll be providing each quarter, what those third-party registration fees were.

Yes.

Okay.

Thank you.

David Campbell from the Danfour Company, you may ask your question.

Thank you.

I was wondering if you could comment on what your expectations are for the new car business in the fourth quarter?

And then also comment on the condition of your inventories?

And where you expect your CAPEX to be for the full year?

As far as car expectations from new cars, the good news I can give you is it doesn't really matter to our business what happens to new cars, because it's such a small portion of our business and is almost an inconsequential portion of our profitability, that we're not really very affected by that.

And the honest truth is I expect the all-out price war that's in the marketplace to continue.

As far as where consumer demand is going to be, to be very honest, for new cars, I don't have a clue.

The good news is it doesn't matter to our business, to a large extent.

I expect it to continue to stay very competitive.

It may slow down a bit, but I wouldn't be surprised if the domestic manufacturers, because of their need to keep their factories running and sell inventory, put more incentives behind them.

So, as far as the condition of our inventory, our inventory is right where we want it to be.

This is a great time of the year, because we've been through the turbulence -- if you will -- that we incur every fall as we go through model year change-over.

This is typically when car prices bottom out during the month of December because of seasonality factors and demand factors.

So, this is actually-- We have already reached the bottom of our inventory cycle, and we typically are adding a little bit of inventory for the sales pick-up in January and February.

So, we're pretty much exactly in line with where we want to be.

I'll let Keith answer the question on CAPEX.

We gave earlier guidance of $175m for the year.

It doesn't look like our real estate department's doing a good job of controlling property without us having to actually buy it until a later point.

So, we could actually come at it slightly favorable of that.

But I'd say somewhere between $150m and $175m is still a reasonable expectation.

And remember that's gross CAPEX.

We'll recover the vast majority of that as we sell and lease-back these properties.

And how are your new store opening plans going forward for your upcoming stores?

Well, we have two more stores -- actually three more stores -- this year.

Two of them are satellite stores: one at [Lidia] Springs, which is on the west side of Atlanta, and the other Okalon, which is on 95th Street on the [T Auto] area in south Chicago.

The third is Las Vegas, which technically will open a couple of weeks into the next fiscal year.

But we're treating it as part of this year's opening package, if you will.

Then for next year, what we told people is six to eight stores.

We have all the real estate we need, and we're in good shape to be sure that we'll be within that range.

We haven't decided yet where we'll be within that range, but probably-- We'll certainly be at the six level, probably at least at seven.

But we'll decide that over the next 90 days or so how many stores we really want to open for next year.

But we've got the real estate to open even at the high end of that, if we want to.

Great.

Thanks.

Gary Blacks from Raymond James, you may ask your question.

Good morning.

I'm just wondering, do you guys break out what the third-party lenders' fees were for the fiscal's first and second quarter?

Because, from a modeling standpoint, we're going to be kind of comparing apples and oranges with our SG&A numbers.

We'll go back and provide that.

We'll go back for each quarter and give you the new disclosures in the very near future.

We're currently working on putting that together, and we'll release that to everyone so that they have that to model from.

Okay.

But that's why our models will be showing a lower SG&A than the 70 basis points that you guys indicated?

I assume that was fiscal third quarter versus fiscal second quarter?

No.

That was third quarter to third quarter.

Okay.

And it was 70 basis points.

Any idea in terms of how it compared to second quarter?

It's certainly up because of the separation cost, the operation of a stand-alone company basis, plus a lower overall sales volume.

Seasonally, we're always going to see SG&A higher in third and the fourth quarters because our sales volume is at a seasonal low.

Our SG&A is always higher in those two quarters anyway.

I understand.

I'm just saying-- I mean, you know, based on the historical data that we have for the fiscal second quarter, I'm showing like 6.7%, and then all of a sudden we're looking at--

The answer is, if you want to go back and model that, you'd have to wait until we give you some pro forma numbers back in time.

Yes.

And I think it was up marginally, related to the growth aspects, because we didn't have the other costs hitting us in the second quarter.

But we'll provide that.

Okay.

And the other thing, I guess, GM earlier this week was kind of hinting in a media call that they're going to do huge incentives.

And I realize that you guys have done a great job, in terms of preserving your gross profits.

But I think it's kind of like the fiscal second quarter-- You guys indicated that, initially, you lowered your comp guidance kind of mid-way through because there was like a sudden burst of incentive that you were able to adjust real fast and get double-digit comp growth.

I mean, do you actually see that being an issue as we go into the first quarter, if GM or somebody comes out with some sort of--?

I don't know what they have left, -5% financing.

What was very unusual in July was that July is not normally the time that domestic manufacturers start burning the furniture when it comes to incentives, because normally that's when demand is at its peak.

And as you know, they over-produce; they have too much.

So, that incentive was a little bit unusual in its timing, not necessarily in its amount.

Whereas at this time of year, big incentives, particularly on 2002 models, is still expected, and those are out there.

Given that the 2003 model launch hadn't gotten off to that strong a start, and they've already had 0% out there, I'd expect them to continue to put as big an incentive as they can figure out a way to put on the table.

So, I think that's the normal environment.

I don't think there's anything unusual about that, and that's not unusual for this time of year.

As you saw last summer, although our comp sales rate got a little bit of downward pressure in July because of the quick adjustment in the Wholesale market, and because of our adjustment of both our pricing and our inventory.

We were able to get virtually all of that back in August.

So, we don't think anything is coming down the pipe that we shouldn't be able to handle, on our experience.

You know we can only draw off that.

But I think the manufacturers are throwing everything they can into this, and I expect they'll continue to do so because they have no choice, because the alternative -- which is having new car sales fall -- is too ugly to contemplate in Detroit.

I expect that to be the environment.

That's the environment we've been in for the last four years, and we expect that to continue.

Right.

I guess the difference in terms of the fiscal second quarter was that kind of timing.

Yes. [Indecipherable] is the effect on earnings.

It just had a modest effect on when the sales came.

Okay.

Thanks a lot.

David Revere from Geneson, you may ask your question.

Hi, guys.

A question on just the comp store sales guidance.

Does the 4% to 7% range imply a mild deceleration in the two-year comps?

Or are you really trying to signal that the environment might be a little bit softer in the next quarter?

Or are you just trying to not change your guidance for the year at this point, with what's going on with the economy and the environment out there?

Yes.

Here's what we're doing.

What we're doing is protecting our run rate.

The way we actually forecast sales is we estimate seasonality based on our history, by store, and then we look at the run rate trend by store.

Then we aggregate that up.

The run rate that we've been seeing would, in the last quarter, would get us about in the 4% to 7% comp range.

About 1% of that difference is due to the fact that we lose a Saturday in the fourth quarter.

Saturdays are big days in the car business.

You normally sell twice as much as you do on a weekday.

So, losing one for a quarter costs you about 1% of comps.

Beyond that, we're predisposed certainly not to over-estimate.

If anything, we want to be more at the conservative end than the aggressive end.

But we think this is the most realistic range, based on our current run rate.

We don't really see that implying a deceleration.

As you say, you don't want to take 1% or 2% to mean very much, I think, in a given quarter, given that comps are always partly a reflection of all the things that happened last year and the year before.

So, from a run rate point of view we expect the run rate this quarter to be about the same that it was last quarter.

Okay.

And actually this is a follow-up on the CarMax Auto Finance.

You said that it continues to perform in line with expectations on that default rates and pre-payment speeds.

Can you give any more elaboration on that, how it's tracking against prior tranches and things like that, just to get some more comfort around that?

I can tell you that we clearly look at each pool of performance, because the public market-- The public securitizations are out there.

So, we look at it on a deal-by-deal basis, and an aggregate basis.

You have expected losses based on the seasoning of a given portfolio.

We're currently working on trying to put together more information because we understand people want to learn more about what the expected loss rates are for CarMax Auto Finance.

It's hard to give you really a flavor without really sharing static pools, on a pole-by-pole basis, so that you can look at it for yourself, and then we can talk to those-- That's part of what we're going to be working towards.

Okay.

But when you give that-- [indecipherable] make sure you're kind of looking at the static pool, and stuff like that.

You don't see any adverse history?

We're looking at static pools.

We're looking at delinquencies, bankruptcies, recoveries -- all elements of what we're doing -- to try to make sure that we're comfortable that we're within our expectations.

I can tell you, in every pool and in aggregate, we're absolutely comfortable.

Okay.

Thank you.

Brian Blade from Maverick Capital, you may ask your question.

As a follow-up to the previous question, there was an article on thestreet.com, I believe yesterday, that drew conclusions about the performance of the credit business, based on material from the OwerTrust filed monthly.

Can you just help us understand how we can use those trusts, if at all, to determine the performance of the credit business?

Yes.

I got a copy of that this morning.

I think drawing conclusions based on data would be a mis-statement, because that would imply a more logical process than was indicated here.

But I'll let Keith respond.

I was going to say, you can draw conclusions, or use the public data, especially when looking at static pools.

The key is that it's difficult, just looking at that data on an absolute basis, because one of the things that particular article references is the difference between the 1999-1 pool and 2001-1 pool.

There was a substantial difference seasoning between those two pools.

The 99-1 was 15 months average seasoning; the next one was seven months average seasoning.

What that means is that, if you're looking at cumulative losses for pools, that first pool really was missing a lot of losses that normally would have been incurred between month 7 and month 15.

Therefore, it would naturally be expected to have a much lower cumulative loss rate.

And that's obviously considered as we look at the aging.

Another element of that particular article literally took out of context one of Moody's comments.

Moody's basically indicated that there was a slightly-- In July, there was a report saying that Moody's said that there was a slightly lower weighted average credit bureau score.

What they were doing was comparing the 2001-1 public securitization to 1999-1.

That article goes on to talk about, for the next public securitization, that the average weighted bureau score is back up.

And I can tell that on the two public securitizations we've gotten this fiscal year, they are also up higher than they've been before.

So, part of the article alleges that CarMax is driving its sales by changing its underwriting criteria.

Our average weighted [cycle] score is actually up for each of the two public securitizations we've done this year.

In our latest public securitization, the one that just closed this month, the enhancement level required by both the rating agencies and the insurer was reduced by 25 basis points because of the ongoing consistency of performance and the stability of how our portfolio is performing in the current economic environment.

So all of that would lead me to believe that the debt market thoroughly understands the consistency of performance.

There is certainly an agenda with that article that you read yesterday that is trying to drive something that isn't true.

I would characterize the article as the other conclusion and ending with looked for - pieces of information out of context that he could use to support that conclusion - mostly either old data or facts taken out of context or as Keith stated, as far as quote unquote, slightly lower weighted average credit [Euro] scores.

Even during the period of time which was historical, where that was true, it was so small that it was inconsequential.

But in fact we actually put the different loss rate for that particular fall of securitization that reflected our expectations there, and they are performing within those expectations.

The other thing in context of that article, basically it says that static pull losses and punitive losses are increasing.

That by its very nature has to be true.

That is a truism of what is in the business that accumulatal losses will continue to increase until they are finally at the end of their life.

So as to point to that I think what they are trying to do is to take that out of context, something that Investor Relations was explaining about seasonality of delinquencies and losses instead of really trying to focus on the true results of our credit portfolio, which are very consistent.

Okay.

Thanks a lot.

As far as you can tell, our general view is there was nothing of substance in the article that was either correct or useful.

Our next question comes from Mike Voss of J.P.

Morgan Fleming.

Thanks.

Just two questions.

The auto finance income [inaudible] I might have missed it in your comments in the call.

Did you break out the gain on sale versus the servicing fee, or do we have to wait for the 10Q to get the gain on sale?

It will be in the Q.

So you don't have it at your fingertips?

No.

I know you did make a comment on the average interest rate, I think I missed that.

Would you just be able to repeat that?

Well I indicated that we got more aggressive on our average charge to consumers because the market place has changed, and in order to remain competitive we had to lower our rates.

We didn't change our underwriting standards.

What we did was pass on the [inaudible] lower cost to firms in order to make sure that we are providing a competitive market rate to the consumers.

We haven't quantified that exact amount.

What I did give is an example that for our best customers, the impact could have been as much as 100 basis point change.

OK.

The last question is looking at the new car operations, is there any reason for you to look at it as perhaps a non-core business that might at some point, or in the near future, not be relevant to the mix?

Or is there some relevancy there that I am missing?

Well, in terms of relevance to profitability it is at the very margin already.

So it is non-core in that sense.

Our view as we have stated, of the new car business is that we don't intend new car assets.

We may in fact shed a few more franchises as we have over the last several years.

Our goal with new cars is to keep a core group of assets and a core group of relationships with manufacturers.

We think that is beneficial on both the relationship side and our understanding of the overall business.

We want to keep open the potential to grow new cars sometime in the future.

I don't mean in the near future.

I mean in the distant future.

If and when we think the conditions are such that that would be a good use of our management and shareholder profits.

I think it may be some day.

So abandoning the business completely would, I think, give up all of the learning and relationships we have built.

But you should expect it to become a smaller and stronger portion of our sales.

It already is really almost inconsequential to our earnings.

And just quickly, when is the Q expected to be filed?

Or is it already filed?

No, it will be in mid-January.

Mid-January, oh I see.

Okay.

Thank you.

Ari Stand from Janus Capital, you may ask your question.

Gentlemen.

Could you compare average used car prices this last quarter to last year?

Average used car prices this quarter to last year - they were essentially flat.

They were $15,200 this year versus $15,100 last year.

Okay.

And that would account for the gross margin in used vehicle sales being up 20 points.

They must have had a little bit...

No.

Most of it was due to improved terms.

Right.

Lower mark downs?

Because the faster we turn our inventory the earlier in its life, it sells and as you know, we used a mark down model that is time sensitive.

It is not just time sensitive, but the sooner we sell a car in its life, the higher average margin we will get.

Okay and just one last question on this.

In your earlier comments Austin, you used the word of falling, talking about the used car prices during this transitional period of the year.

They were falling at a quicker rate than typical, more than a year ago?

I am talking about our own data, that they fell a little bit quicker in terms of average car price fell a little bit quicker than in prior years.

Okay.

In your earlier comments you used the present tense falling and you just said they fell - I was just curious...

I am sorry, I am talking about the third quarter.

Okay.

They level out now?

They typically do.

But the other thing I can tell you is - and I don't want to be flip here - I really mean this.

We don't really care much whether they fall or not.

I mean they fall and rise according to a whole combination of mix and market factors and our experience has been that doesn't have a big impact on our ability to realize our margin for each season of the year, as long as the speed is manageable.

It is really not even the speed.

The thing that presents us with a challenge, which we demonstrated, that we handle better than anybody else in the market place, is if there is a step function change of $1,000 or more in the pricing of a specific group of vehicles, which usually means a dramatic change in incentives on a large commodity type car, like a Taurus or an Explorer of $1,000 or more.

We will have to adjust to that.

But as we demonstrated in the summer even that hasn't been something that has been anything that we couldn't adjust to enough in a quarter that largely it had no impact on us.

Okay.

Thank you very much.

Our next question comes from Arnie Bullen from Arnhold and Bleichroeder.

Hello.

Good Quarter.

Thanks a lot.

Just one detail.

The SG&A costs you said slightly more than half is based on growth.

I presume that pre-opening costs of this quarter were about 15 basis points versus very little a year ago?

That's a reasonable guess.

That's the CFO talking.

My other question is looking at the fact that your inventory turnover has been increasing and the satellite stores seem to be doing well, does this change anything about the size of store that you want to build - the ability to re-supply the store fast?

Some of these stores look to me like we are running out of space.

And you and I did talk about that before.

There are some stores like Roseville, Merrillville where we are out of space.

If you were to visit that store you would find that as soon as a space becomes empty, something fills it.

But most of our stores - the first generation of satellite store if we were doing it again, and that's the first three we built, we would build a little bit bigger showrooms.

In fact that is what you would see if you go to our satellite stores that are now coming out of the ground.

The showrooms are a little bit bigger so that they can accommodate more upside.

As far as the selling lot, we try to leave ourselves some flexibility to expand when it is available.

It really depends on real estate.

But our other experience is that even when we run into a limit as far as the ability to add inventory, that does not cap our sales.

We have found that what that does is that it means that inventory turn increases.

Now we may in theory be giving up some sales that we could get if we raised inventory even more and we certainly try to test and understand that.

But largely I would say that in the entire system including both satellite and full-size stores, there are probably only three to five stores where we are really running up against a size limitation.

If we go forward, we think the size store that we will be building will give us plenty of room to capture all the upside that we can capture without unreasonably overbuilding.

So we certainly noted the good news, which is that things are going well and that we need to have enough flexibility that we can capture the upside.

But we also want to make sure that we don't overbuild and burden ourselves with excess rent.

You seem to have been picking up considerable markets here against the new car dealer, used car operations, which I think are going to be down 10% or something in the quarter we are in right now versus you are up 8%.

How do you see this going for the future?

Do you think that differentials can be maintained?

What do you think is really happening?

What is it really based on other than consumers liking your concept?

Yes.

I mean this is what fundamentally our business is.

There are I guess some of the guys who tracked the new car business.

Occasionally we refer to the new car guys as our peers, which they clearly are not, because they are in a different business.

We have a consumer concept that is built around a fixed price offer and a consumer offer that the consumer clearly prefers dramatically to anything else out there.

Our concept is premised on share gain.

Share gain from the people who sell late model new cars who are new car dealers.

So the new car guys who happen to be publicly traded are really a benchmark or sub-sample if you will, of the entirety of new car dealers and our expectation is that we will continue to gain share from those guys as long as we are in business.

Because that really is the business we are in.

We are in the business of gaining share from the new car dealers who sell late model used cars now.

It is now and has been from the beginning our consumer concept that drives that.

As you know, we sell over 5,000 units per location and that makes us a little more than three times as big as the average new car dealer if you include both his used and new cars and make this eight to ten times as big as those guys in terms of their used car sales.

That's not true just because we build reasonably large stores.

It is mainly true because we have a better concept.

So we expect to continue to gain market share going forward.

Now the particular set of guys who are publicly traded and who report their [inaudible] aren't necessarily competing in the same markets with us.

They are each different.

They have different strategies.

So I can't tell you that that benchmark will always be a good sample of the rest of new car dealers.

In theory, if they are adding value by being public companies, they should evolve in some way that would make them a little better than average.

So in theory if they can find the way to do that, you might expect that our relative advantage compared to them might go down some.

We have not seen that so far because our experience so far is they pretty much run their stores the way everybody else does.

I am not criticizing their business model and say 'if that's the business you want to invest in, don't invest in it, that's up to you'.

But it is a different business and it is not the business we are in.

We are in the business of gaining used car market share from that market place and the question I always pose to people is we have all our best people on the used car business and show me anybody else who will make that statement.

Ask anybody else 'are all your best guys working on the used car side?'

If the answer is 'no', it is probably hardly surprising that we might be gaining a little market share.

Right.

Definitely not the case for most people.

Thanks.

Okay.

Sharon Zackfia from William Blair, you may ask your question.

Hi.

Good quarter.

I came on the call late so I apologize if you already went over this.

I guess in summer I was a little perplexed by the guidance that was given for the fourth quarter specifically in terms of used unit comps.

Can you go over what your thought process is on for the---

I did go over it, but I will go over it again for you.

Basically we base our sales projections off of run rate.

Our run rate is based on calculating the seasonality of each [inaudible] that we are in.

Projecting the trend of sales off of that.

Then we look at what comps does that yield.

So the run rate that we are projecting for the fourth quarter is essentially the same run rate that we have seen in the third quarter.

So we are not saying that sales will slow down, we are just saying that same run rate will actually produce slightly lower comps.

One reason for that is we lose a Saturday in the fourth quarter this year and that accounts for about 1% comp loss, just by losing a Saturday in a quarter.

The other is we are now going up against two strong comp quarters in a row and as you know, comps are not an absolute measure of sales trend, they are really a relative measure to what happened in prior years.

So those are the main factors.

But in terms of are we signaling a slow down in sales?

No we are not.

The sales run rate we expect in the fourth quarter is the same one as we saw in the third.

When you go through the numbers and go through the markets, it just results in slightly lower comps.

All right.

Thanks a lot.

Aram Rubinson from Bank of America, you may ask your question.

I am sorry, I just had a follow up question.

I guess that's a good sign you are coming to the end.

The charge that you gave of $4.5m, I just wanted to reconcile that.

That was a pre-tax.

Do you have the after tax number there?

$4.5m.

So that was completely non-deductible.

Yes that's completely non-deductible.

Okay.

That was it.

Okay.

Thank you.

That was easy.

Mark Short from J and L Advisors, you may ask your question.

Congratulations on the quarter guys.

Just looking at the balance sheet retained interest in securitized receivables.

Year by year I guess it looks like it is up $24m and about $10m from last quarter.

I am just wondering what the reasons are there.

Do you want to explain Keith?

I think it is really just related to the combination of just the growth in the overall portfolio allowance and therefore the gain receivable related through the IO strip.

As we mentioned because we did get a little sharper with our pencil in the third quarter, we did take a little bit of share, so that would have accelerated a little bit of the gain receivable for the third quarter versus second quarter.

So it is from the growth in the receivables rather than writing up the IO.

No, we haven't made any adjustment in the IO one way or the other.

Our gain assumptions have been consistent over time.

It is really a result of the IO will be [inaudible] by market to market adjustment on [inaudible] but it is really related to the overall portfolio [inaudible] which will gain recognition.

So the [inaudible] portfolio gross to lending.

Sounds good.

Thanks.

Sandy Braun, Gilder Gagman, you may ask your question.

Hi.

I know we are getting to the end here.

Do you notice any change in the percent of customers that come to you who are qualifying for prime loans?

Maybe perhaps more are falling to the sub-prime category.

The first thing is, I will tell you is very dramatically by market and by store.

If you were to go to our highest demographic market, the people who qualify for prime loans - the highest demographic market we service is Dulles, Northern Virginia.

The people qualify for prime loans there would be twice or more the percentage that would qualify in our store with the lowest qualification rate.

So that is the main variation.

In terms of any qualification rate trends---

There is no major change in the trends of [inaudible] coming through.

There is always a little seasonality related to that.

The credit scores on the average creditworthiness of people coming in the spring were a little bit higher than the following winter.

But it is marginal and that's just the seasonal pattern.

But we see no shift versus the buyer year.

Okay.

Can you talk about the bottom line stats on the new stores?

Can you say quantitatively so word of mouth, how people are coming in, what the trends are like in the new versus the existing source?

You say quantitatively in terms of the quantitatively?

Got me.

A little more detail [indecipherable]

I am not going to give you the terms yet on the new stores.

But here is what I would say.

Uniformly all of the stores have opened very successfully and we are very happy with the performance in the new stores so far.

The oldest of those stores are now coming around.

They opened in February of last year so they are now coming around.

Maryville and Greensborough nine years old.

The most recent opening was Knoxville a little over a month ago.

Two things please us.

One it is pretty clear that we have improved our skills at grand opening stores in terms of being able to impact the market, get people aware of CarMax, get people coming in the door from day one.

We have improved our executional skills in terms of our ability to take advantage of that customer flow and turn it into sales.

We are very comfortable based on the five stores that we have now opened and the processes that we have put back in place that we are going to be able to manage the rate of growth that we have projected going forward.

As far as the stores themselves, all I can say is that they are performing pretty much operationally like we would expect them to perform for the sales level they are achieving which is ahead of the sales level that we originally projected when we set them out.

So as I said at the beginning of the call, as far as I can see there is nothing but good news there and we are really happy with how it is going so far.

So very successful, as you just said now, you said moderate over performance before, is there any difference between those two terms?

It is very successful as a store opening.

In other words to be able to outperform what we set out as our expectations.

It is not that our expectations are low.

Our expectations day one are usually higher than anybody else in the market might already be selling.

So in many cases that means we have to become number one market share the first month or two we are in place.

So to outdo that I consider a very successful opening.

Okay.

Do you think that new cars are almost inconsequential to the business right now?

Do you try and steer people when they come for a new car towards a used car?

No.

That's a fundamental premise of CarMax from day one, we don't steer people period.

We have got the cars on the lot and it is what people like about us is you can buy what you want to buy.

Now one comment I will make about new cars.

I mean because new cars are a commodity and because we use fixed prices and those prices are on the Internet, we are competitive with the best prices out there, which means our new car prices are normally screaming bargains compared to what you typically find elsewhere.

New cars typically do very well in our environment.

One of the things that we have done in a couple of brands over the years, is we have become less aggressive than we might have been a couple of years ago, when we were really trying to drive sales slightly.

But that's what I would say not really comparable.

Keith has another comment.

The only thing that I would point out is that our sales consultants aren't compensated any differently whether you are buying a new car or a used car.

Their goal is to find and it doesn't matter whether it is a [mark-up] on either car, their goal is to find you the car because they make the same commission regardless of what type of car you buy from CarMax.

A general comment I would make Sandy is, if we have a store where we feel like we don't want to sell new cars and we would want to steer people away from them then that is a store where we are going to eliminate the franchise because we don't want to be selling something that we are not perfectly comfortable letting the customer make their own decision.

Okay.

Last question.

You talk about six to eight new stores.

Are they mostly going to be still ends or new market, can you give us a little more?

It will be about a 50:50 mix.

Roughly over the next four years I would expect our satellite versus new market mix to be 60% new markets, 40% satellite.

But [inaudible] right now will be 50:50.

But from an earnings impact point of view it is pretty neutral because although the new markets on average will do a little more sales, they have higher costs, whereas the satellites have more leverage.

So I don't think if you are trying to model the business it makes much difference.

But it will roughly be 50:50.

Thank you very much.

This will be our last question.

Our final question comes from Jeff Kitchell from Traflin and Company

Hi.

Congratulations on a good quarter.

With respect to the decrease in the rate you charge your best customers, obviously the CarMax Autofinance commission for vehicles decreases as well.

Can you give your expectations or assumptions for that figure going forward, and assuming no change in rates in the near future, would you expect that to further contract from these levels from you main competitors?

When you said Autofinance commission.

When you look at CarMax Autofinance income, that combines both the commission which we would earn if it were third party plus the finance earnings that we make by running the finance company.

So those are combined, they are not separated.

But I will let Keith answer as far as going forward.

Well the answer is that if there is no change in the cost of funds then I think over time if the market adjusts downward, we will continue to adjust to be competitive with that market place.

It really just depends on what is going on.

We have an ability to monitor that in very short time because we have an offer of that we will finance your car for three days for free so that if you want to go and shop for rates.

We use that as a barometer of our competitors in the market place as well as going and doing the research of what other offers are out there.

The answer is that if the market timbers fall, we will adjust our rates accordingly.

And if you look at what we have said for a couple of years, we have been getting a windfall gain over the fact that wholesale prices of money have gone down faster than the retail prices to the consumer.

With the competitiveness in the market place that gap has closed a little bit and we have said that we expect that gap to close.

Historically we would expect CarMax Autofinance to be 11%-12% of all of the gross margins we generate if you combine the gross margins plus CarMax Autofinance income.

It has been running at closer to 14%.

So over time we expect competitive process to make that go away.

That can come partly from retail prices to consumers coming down or it could come the other way with wholesale prices to us going up in terms of interest rate.

I would think we would expect the wholesale price increases to be the driving factor of the majority of that change in the future.

Particularly once the economy begins to show any positive upward trend.

I want to thank you very much for joining us this morning.

We appreciate your participation in the first official CarMax Inc.

Earnings Call of independent companies and thanks very much for your support and I look forward to talking to you again.

Goodbye.