車美仕 (KMX) 2002 Q4 法說會逐字稿

Good morning.

Welcome to the CarMax Incorporated conference call being held in conjunction with the company's release of the fourth quarter and fiscal 2003 earnings.

This call is being recorded.

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

At that time, you may press star 1 to ask a question.

You will be announced by your name and firm name.

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

I shall now turn the call over to Dandy Barrett, CarMax’s Director of Investor Relations

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 the CarMax SEC filings.

Now, I'm pleased to introduce Austin Ligon

Good morning.

I'm glad to have you join us.

Let me talk, first, about the earnings for the year.

We're very happy with the performance in fiscal 2003.

We met the earnings expectation range we forecast last April.

Our earnings including the $0.07 of separation costs were $0.91 a share and excluding the one-time separation cost were $0.98 a share, well within forecast range of $0.95 to $1.00 that we put out last year.

We met the target in a challenging year.

We had good use unit comps of 8%, but this was coming up against an exceptional year the year before of 24% unit comps.

We also hit our targets for average gross margin dollars per vehicle despite larger than normal wholesale price declines and used unit comp shortfalls during the year.

We absorbed roughly $9m in additional expenses associated with being an independent company, and we absorbed the expense of ramping up growth, opening 6 stores in fiscal 2003 if you include Las Vegas, which opened March the 12th, compared to 2 at the end of fiscal year 2002.

The reasons for this strong and solid performance were first and foremost, continuing solid sales execution in our comp stores.

This really illustrates the strong consumer preference for the CarMax consumer offer and our continuing market share gains.

Perhaps the best contrast is the fact that we achieved 8% used unit comp growth positively this year, which was about 16% higher than our nearest comp as far as used car sales goes, which are the publicly traded new car dealers, which had negative 8% comps estimated for 2002.

This continuing strong execution also illustrates that the annual growth pace we set ourselves for 15% to 20% of our store base can be accomplished without losing productivity in our existing stores.

A second important reason for our profit achievement for the year was, really, excellent results from all our new stores.

We did this partly through staffing the new stores with experienced management in all major positions, and it further confirms, really, our focus of opening mid-size markets and satellite markets.

The mid-size markets are those with 1m to 2.5m people in the DMA where we can build consumer awareness quickly and the satellite stores are stores in existing markets where we already have high consumer awareness and little if any incremental advertising costs.

Both of those allow us to build stores that ramp up quickly and perform at or above what our expectations have been.

A third reason for the strong performance is the continuing strength of CarMax Auto Finance.

Importantly, we have a competitive advantage in finance originations.

There are three risks in originating an auto finance contract; the risk of the consumer, the risk of the car, and the risk of the intermediary.

We still bear the risk of the consumer, which everyone has, but we greatly reduced the risk of the car because all CarMax cars are high quality, reconditioned to a high standard, have a five-day guarantee of 30-day bumper to bumper warranty, and the majority of our customers actually purchase an extended warranty to go with this.

Then the third risk, the risk of the intermediary, we eliminate completely.

There is no F&I manager of the CarMax who stands between the finance organization whether it is CarMax or a third-party organization and the customer.

Therefore, consumer credit information on the vehicle is accurate and fully described, and all lenders receive the same transparent information.

This transparent loan environment and more accurate information on both the consumer and the vehicle permit better loan decision making with greater predictability of loan performance, and therefore, better portfolio performance.

Cap again benefited from the exceptionally low cost of funds as well.

Though market rates to used car customers came down some during the year, cost of funds reached an all-time low for CarMax auto finance.

The result was that [inaudible] continued to yield profit above that which we would expect at a more normalized rate environment.

Cap’s portfolio of managed receivables continues to perform inline with our expectations.

While we announced that certain [inaudible] may exceed the high end of our previously published loss assumptions, some [inaudible] are experiencing lower than expected pre-payment rates.

Consequently, we have adjusted to both our loss and pre-payment assumptions.

Loss assumptions now range from 1.85% to 2.40%, while pre-payment assumptions range from 1.45% to 1.55%.

These offsetting adjustments had no material impact on earnings or the fair value of retained interest.

As far as the fourth quarter goes, as we had forecast, we had $0.18 a share, at the higher end of the range we forecast a month ago, despite, primarily, weather related used unit comp growth shortfall in the quarter, we achieved our earnings forecast for the same reasons that we achieved forecast for the year.

That is, strong performance of our comp store base, excellent above expectation performance by the new stores and a continuing strong contribution from CarMax Auto Finance.

As far fiscal year 2004 expectations, for the year, we expect comp store used unit growth rate in the 5% to 9% range that we have projected as our medium to long-term comp growth range.

While we have no idea what affect a prolonged war in Iraq will have on the U.S. economy, so far we have not seen any significant impact on our business.

The comp growth assumption that we're making does assume, however, a continuation of the reduced approval rates from our sub prime or nonprime third-party lenders that we began to experience late in the fourth quarter last year,.

We expect earnings per share in the range of $1.00 to $1.10.

In fiscal 2004 we will still be absorbing the incremental costs associated with being a stand alone company.

These are not the one time costs, these are the incremental ongoing costs.

We estimate the full year effect of these expenses to be approximately $20m to $22m over a full 12-month period.

As I noted before, we absorbed roughly $9m from October the 1st to the end of the fiscal year but will have about $20m to $22m in total this year.

There are three main areas that these costs come in.

Higher employee benefits and benefits of the administration costs are more than half of this amount.

Then we also have additional necessary staff such as legal and treasury and the expense of independent activity, being an independent company, New York Stock Exchange expenses, SEC filings, insurance, et cetera.

We also project a lower yield at CarMax Auto Finance as the year progresses.

Even if our cost of funds do not rise, we would expect to see some compression in spreads as the market lowers rates to consumers.

And finally,, we project a 38.5% tax rate which reflects our expansion into states with higher tax rates.

Last year’s 39.5% tax rate was caused be the non-deductibility of the roughly $8m in one-time expenses we paid in separating from Circuit City.

For the quarter coming up, the first quarter of fiscal 2004, we expect comp store used unit growth to be in the range of 7% to 9% as compares with 12% in last year’s first quarter and we expect earnings per share in the range of $0.29 to $0.31, compared with first quarter earnings of, roughly, $0.28 per share last year or $0.30 per share after excluding the $0.02 in separation cost that were in the quarterly earnings a year ago.

Finally, a special note I’ll make, we're posting on our website today quarterly earnings statements of fiscal years 2001, 2002, and 2003 that are consistent with our current presentation.

You should find this information on the home page of our investor website.

Go to CarMax.com, click on investor information.

On the first page, look for historical consolidated statements earnings in the current information section at the top of the page.

That will give you a handy reference for our current statement.

So with that, let me conclude and answer some questions.

Thank you.

At this time, we are ready to begin the question-and-answer session.

If you would like to ask a question, please press star 1.

You will be announced prior to asking your question.

To withdraw your question, please press star 2.

Once again, to ask a question, please press star 1.

One moment, please.

Sharon Zackfia of William Blair, you may ask your question

Hi.

Good to see that the first quarter is off to a great sales start.

Thank you

I had a question on the sub prime lending availability.

You had seemed pretty optimistic.

The sales [inaudible] rebound a little bit.

You said that your projecting the same sort of drag going forward.

Have you seen any indication that that might come back a little bit and you might be being conservative?

I'll let Keith answer that

Early Indications are we saw a slight up tick.

It has been, basically, stable.

The good news is that AmeriCredit (ph), which is the one we saw the biggest change from, actually did do a transaction that, basically, originated a $1b in cash flow or additional capital for them, which we think makes their likelihood of being around and continued interest in our business, you know, very positive outlook for us.

That was our biggest anxiety, quite honestly.

Okay.

Secondly, this is probably a question for Keith as well.

On the anticipated spread for the finance unit for fiscal '04, you mentioned perhaps higher funding rates or more competitive loan rates.

How much of that is a function of your new gain on sales assumptions?

Does it affect that at all?

It doesn't affect that at all.

It really isn't a matter of what happens to our cost [inaudible] over the year and what happens in the marketplace as far as interest rates to consumers in order to make sure that we have a competitive offer.

If you remember, we assumed that the spread would come down some this last year.

It just never did.

Right.

I think all of us believe that everything that goes up must eventually come down and these spreads can't maintain themselves.

On the new prepayment rate that you're using, are you trending in line with that rate, or is that a pretty conservative rate, the 1.45% to 1.55%?

Obviously, it is our best estimate.

We were, probably, too conservative as we looked at the changes in the environment over the last couple of years, and, you know, we've been reassured, having taken a look at our cash flows, that the changes in the overall interest rate environment, mortgage refinancings, the zero percent financings of new cars hasn't had as big of an impact as we anticipated.

That's why we made the adjustment downward.

We feel after this much time and this environment that they’ve been tested as severity as they can be.

The new Las Vegas store, how has that opened?

Overall, what we're going to do this year is the same thing we did last year.

We're going to wait until we're a bit into the year before we start giving you information on the new stores.

If you remember, we didn't start talking about new stores until we had several months under our belt.

Same thing we'll do this year.

One observation I will make about Las Vegas is with regard to Las Vegas specifically, we probably won't really give you guidance on whether we think Las Vegas is under or over performing until next fall sometime.

The reason is Las Vegas is a unique market for us in the following sense.

As you know, we're opening two stores there.

It is a mid-size market but we’re opening two stores in the first year.

One, a standard size store and the second a satellite store.

The one we opened first is the standard size store, but it is in the smaller of the two trade areas.

Quite frankly, we've never done that before.

We don't have any experience with opening a mid-size market where our first store is in the smaller trade area.

The particular circumstance in Las Vegas was that there was a Auto Nation store we could buy that was there, and the only land we could get on West Sahara was a satellite store.

This is a market where we would actually expect the satellite store to outperform the full-size store.

I've talked about that possibility before.

So we're certainly happy with the way the store opened.

Any comment beyond that, as far as Las Vegas goes, I'll wait until the fall.

We won't know until we get both stores open, how has the whole thing has sorted out and how we feel about it.

Thanks so much

Thanks.

Tom Gainer (ph) of Maple Gainer Asset Management,, you may ask your question.

Good morning, how are you?

I have a couple questions.

I was trying to do some quick calculations in terms of the average price per unit of used cars that you sold and look for 2003, if my math is right, something on the order of about 15.3.

Is that correct?

What's the trend there?

That sounds about right.

What was the trend, slightly up.

Really slightly.

I think that's fantastic.

The average selling price per used car was up a little bit?

You know, Tom, that as we've said, although it is clearly interesting that we were able to do that in a year where prices, on average, were falling, our view is it's not particularly important.

As we've said before, what matters is how many units we sell, not the average price.

It is interesting we were able to go against the trend.

Would you expect to hold on to a similar kind of average selling price for the coming year, or are you going to work against deflation?

My honest answer to that -- I'm not being flip here -- we don't care.

The reality is, what matters is, what will sell the most cars because the dollar profit spread we make per car sold is largely independent of the average price point.

All our profitability is driven by units, not average price points.

If the way the market turns out, if it allows us to continue to sell at about the same price point, that will be fine.

It is not a big focus for us because it doesn't have much impact, doesn't have, as far as I can tell, any impact on profitability.

The second question is what expectations do you have about your ability to get expense leverage in this year, in the SGA&A line, advertising you spoke of with having satellite stores, public companies expenses coming down, things of that nature.

The SG&A did creep up from $10.3m to $10.5m.

Would you expect to make that go in a different direction this year?

I think the projection for this year is negative SG&A leverage.

There are components to this.

Our corporate overhead should remain roughly flat this year, as a percent of sales, which, actually, we think is a huge accomplishment since most of those incremental costs we just talked about are related to overhead and not store-related costs.

What that implies is, if you look at our continuing leverage on corporate overhead, excluding those costs of being a stand alone company, we're, in fact, continuing to leverage the other components of corporate overhead at about the same rate we have been.

It is all being washed away by the full year cost of being separate.

As far as other areas of SG&A, the reality is when you open new stores, new stores will have lower leverage than existing stores.

So our efforts there have been to keep that reasonably flat in terms of the growth rate and the de-leveraging that comes from new stores would roughly even out against the leverage that comes from comps.

The one negative impact is medical benefits are the one portion of those stand alone costs that will be impacting the store level.

We get a double whammy.

Not only are we negotiating as an 7,000 base of people with an average older associate with more children, which, is not surprisingly, since you're associated with an insurance company you know those things lead to higher costs.

We’re not only smaller scale with an older and more child friendly, if you will, employment group, but we also are suffering from the same cost increase that everybody is.

We get a double whammy there.

I guess my net answer is, the underlying dynamic is good in terms of continued leverage.

We are getting the same leverage off of comps that we expect to get at the comp stores and we’re getting continued leverage on the corporate overhead.

This year it is being offset by the other costs.

Finally, would you expect that next year would be a year where the total SG&A line would come down because you anniversaried the cost of being a public companies and you have new stores open in satellite market and your advertising is spilling over from one market to another?

It sure better.

If it doesn't, you should have some hard questions to ask us why not.

I'll be here.

I hope I don't have to ask the questions.

I think we expect it to.

Thank you.

Rick Frayton (ph) of CMF Capital, you may ask your question

On the first quarter comp expectation of 7% to 9%, that is the toughest comparisons of the year.

Yet, you're using a higher guidance there than for the full year.

Can you give us perspective?

I suspect you're off to a good start.

Why do you expect things to tail off from there?

You know, let's put it this way.

March is consistent with that expectation.

We are off to a decent start.

The other thing I would say is, it's always easier to forecast the next 90 days than it is the rest of the year, particularly with all the volatility.

We could still be wrong, but we feel that we're close enough to this that we have a pretty good handle on it, and, you know, it's our best guess at this point.

It is probably a little bit at the higher end of the range.

It also has to do with just the particular dynamics.

You probably remember that we forecast each store on a store by store basis based on seasonal sales trends.

Then we roll them up and that's where we get our comps.

We don't pick a comp number out of the air.

All of those factors put together is what get us to this forecast.

It is true that so far March at least is off to a start that's consistent with this.

Okay.

Then with regard to the sub prime lending and lower approval rates, is there much reason or any reason for hope that we might be able to sign up some additional sub prime lending partners to improve the rates going forward?

I'll let Keith talk about that.

We currently are in discussions with other lenders.

However, part of the challenge is that because of the demands we put on our lenders to be online in connectivity with our systems, open all of our store hours, in order to make sure they get a satisfactory return, they have to have a reasonable amount of bookings for what they see.

They see more with us than what they do a traditional dealer because we force them to look at, basically, all of the declines from CarMax Auto Finance and Bank of America, who are the two prime lenders.

It is a delicate balancing act to make sure we have a long-term relationship with them and can provide enough positive approvals and bookings versus the other competitors we have online.

The answer is, yes, we'll continue to look, but we have to keep in mind that those relationships are long-term relationships and we try to strategically align ourselves with the best providers in the industry.

I suppose the good news is there are people out there to talk to.

At least we have some conversation

Okay.

Thank you

Thank you.

David Campbell of Davenport, you may ask your question

Hi.

Good morning.

Congratulations on a nice quarter and a good year.

Thank you

I was wondering if you could update us on how your electronic repair order system has performed since you implemented it.

Are there training issues that are continuing?

Also, have you seen the service revenues stabilize since February?

Yeah.

I think as far as service revenues, we have seen them come back after the snow was cleared.

The big problem we had, as you know, being here in Richmond, particularly in the Mid-Atlantic area, nobody could even get out of their driveway to get their car serviced.

So there's just a period of time where we lost, virtually, all service revenue.

That has come back.

As far as the impact of ERO, the major impact of the electronic repair order system will be on the cycle time, on the production side of our shop.

What it really does is it gives us a system that allows us to control who does what operation next so that when our process engineers come up with an optimal process for moving cars through the shop, the system will allocate those cars to technicians in a way that drives doing the optimal thing next, which is not necessarily intuitive.

It is like our own version of the Toyota production planning system.

And I believe that all of the training-related issues that we went through on that are now past us.

The training related issues are pretty simple.

Every tech in every store had to spend about a week doing nothing but learning how to use the system because it is a completely new system.

None have used it before.

It really had a pretty significant impact on how they do their work, and the good news is we were able to accomplish that in about a week per store.

We saved the biggest store for last.

We should be through all of that now.

You know, with the early signs, we should see some benefit on the cycle time from that, and it really puts the tool in place.

We will continue to expand this tool, but now that the basic training is in, we shouldn't have training issues going forward.

We will continue to expand the tool to our benefit in both reconditioning and service operations.

The upfront cost of putting it in place in terms of people time was pretty substantial.

Okay.

Great.

Then a question on CarMax Auto Finance.

Where do you expect the yields to stabilize over that on a longer term basis, I suppose?

Anywhere between 3.75 and 4.25 over long-term.

What were your loss and prepayment assumptions previously, Keith?

The prepay assumptions used to be 1.5% to 1.6%.

The loss assumptions used to be 1.8% to 2.1%.

Great.

Thank you very much

Certainly.

Aram Rubinson of Bank of America Securities, you may ask your question

Hi, guys.

A couple things.

The other revenue line item was up about 10%.

You mentioned that service was pretty lousy, I guess, based upon the ERO implementation and the weather.

We know the third-party financing fees were even.

Does that say something about the warranty business?

Are you doing anything to drive the warranty business?

The attachment rates looked good.

Sure.

The warranty business was up and positive.

In addition, because our purchases of vehicles, we have a fee that's associated with that transaction.

It also goes there.

The purchase rate was higher than it was the prior year and has been.

So both of those are positive.

And the other question is on the finance business, the prime market.

Do you expect, as you say, that yields might come down?

Do you expect that you'll be leading that, or will be responding to that?

How do you expect the market share of the loans in the prime business to look in the fourth quarter and going forward?

Given costs of funds, we've taken a fairly aggressive posture.

We've been monitoring our three-day pay-offs and what we can kind on internet source providers as far as competitor alternatives.

We'll be aggressive in order to make sure we're, basically, making the consumer a great offer at all times.

Obviously, our ability to be aggressive will diminish as cost of funds accelerate.

Right now, you'll see us probably leading, I guess would be the best description.

I'll make a point that, by and large, when we do that, where the consumer is price sensitive is at the top end, the A and A-Plus credit.

It is people who have a lot of alternatives are very sharply price credit.

Being aggressive on that may cut our spread some, but it is not something that deteriorates your portfolio.

It is not going after low quality business.

If anything, it creates a broader band of the highest quality business because these are the people who get the best rate who have the most ability and desire to shop around.

The last question which is kind of intertwined, can you give us a sense to how cap performed versus the original plans for the quarter in terms of profits?

I think cap was a penny ahead what our expectations were for the quarter.

Thanks.

Good luck

Once again, to ask a question, press star 1.

Jerry Marks (ph) of Raymond James, you may ask your question

Good morning

Hi, Jerry

Just a couple quick questions.

Regarding the FY `04 guidance, the average selling price doesn't matter.

Was there a mix shift in the quarter?

More SUVs might have affected that selling price?

The honest truth is I don't know.

When I tell you we don't spend a lot of time on this, that's exactly true.

The answer is, of necessity, there must have been some mix shift because wholesale prices went down, retail prices went down.

It implies some mix shift.

I haven't spent time looking at where the mix shift was, more SUVs, luxury cars, slightly newer cars.

It is certainly some combination of all of those and away from all the things that would be a little lower price.

But you know how our model works and what our model is continuously doing is looking for what's optimal in the market and looking to match up what we buy and sell best with that, and we let the price fall where it may because it doesn't affect our profitability.

Yeah.

In terms of wholesale, I presume that there was a biggest loss in the quarter?

No.

I mean, wholesale contributed positively.

It was lower than the prior year just for the simple reason the prior year continued to have some of the pent up demand that was post 9/11.

We actually are buying more cars as a percentage of the cars we see, and, you know, felt very good about the outcome of the quarter.

Yeah.

Actually, the quarter came out right on line or slightly where we expected it to at the beginning of the year.

December, January, February last year, we were in a uniquely advantage position relative to the rest of the market because after 9/11, really, as you know, all of the traditional guys quit buying cars.

We found ourselves in a very positive position for buying.

As you got later into that and they got back in and started buying cars again, we ended up making some money there without intending to.

Okay.

So last year in the quarter, you made a profit on the wholesale and this year that profit was reduced?

You're still breaking even?

You indicated your goal is to make a dollar on the wholesale?

Our goal is to make a dollar after fully recovering our costs.

The way the accounting is done, you see a margin for wholesale.

That includes the fee we charge which covers the cost of our appraisal team and cost of our auctions.

You see a gross margin there.

That's roughly equal to our costs.

We're, in fact, adding slightly to that margin this year to recover for the real estate we have to use to hold these wholesale cars.

We have hundreds of acres holding wholesale inventory.

The answer is yes.

We're very much in line with the slightly, slightly positive $1.00 to $3.00 per car goal we set after fully loaded costs.

The other element is there is seasonality to the wholesale business.

We expect to make money in the fourth quarter but lose money in the third quarter when the model changeover happens and there is price reductions coming in the marketplace.

Typically, in the third quarter you are buying and selling into a falling seasonal environment.

In the fourth quarter you're buying and selling into a rising environment.

I get it.

I’m still a little confused.

It must have been a big profit you made in the fourth quarter if you're gross margins declined by 80 basis points and keeping your average dollar per vehicle and your average selling price doesn't change much.

That is the difference in terms 80 basis point differential is just the profit on the wholesale.

The 80 basis point differential, you’re talking about which one?

For the gross margin line.

Total gross margin?

For the quarter.

50 basis points Basically, a tenth of that did come out of used cars.

We met our targets this year.

Last year we had exceptional strong comps.

We over performed the year before.

Another tenth is related to new cars and another tenth or more to what we just talked about wholesale over performing the year before.

It is really a little bit everywhere that brought down the margins from versus the prior year.

The way to look at it is, what was unusual was last year.

Last year in the fourth quarter we over performed on almost everything because of the residual impact of 9/11, just as we did in comps.

Okay.

Thanks

Thanks very much

William Armstrong (ph) of CLK Associates, you may ask your question.

Good morning.

Just looking longer term.

Are there any states or regions of the country where either market conditions or other factors would prevent you or inhibit you from expanding into?

In other words, ultimately, can CarMax be, you know, in 40 or more states and have a truly nationwide presence?

Yeah.

Ultimately, I think we ought to be in 50 states.

I've spent a fair amount of time in Wyoming.

Towns are small there.

The answer is, certainly, we expect to go to all markets.

The toughest one will be New York because costs are high, real estate is hard to get.

The guys who have real estate see you coming.

To pay the cost of television, you know, you have to buy all 15mNew York consumers day one you start advertising.

That's why most retailers wait until they have national advertising scale so they can buy network advertising before taking on New York.

But even New York we think we'll eventually get into.

We think this is a nationwide concept.

Having said that, certainly for the next several years, we're getting growth going again.

We want to make sure the wind is fully behind our backs.

We're leaning towards those markets that are most profitable, lowest risk to get started.

It is the mid-size markets and satellite stores and existing markets.

There's nothing that we've seen so far that says we won't be successful in any market.

Okay.

Now, you had some problems a few years back in some of the larger markets with the real huge stores.

How would you attack a larger market going forward?

Chicago is a great example.

When we opened Chicago, we were using what I have referred to as the Ikea (ph) concept, fewer bigger stores, trying to have 800 to 1,000 cars in inventory, build 100,000 square foot store and draw people from a bigger trade area.

That worked two times, once in Washington and once in Atlanta and never worked again.

Each one of those stores, we said, has some peculiar characteristics.

If we were doing Chicago again, instead of opening with four stores, we would open with at least seven, would be my guess.

Right now, we now have seven and we're in the process of building an eighth store in Chicago.

If you look at where we're putting satellites, our first full-size stores in Chicago were Naperville, Hillside on the Eisenhower Expressway, Tinley Park on the far South Side of Chicago and Schaumburg, the number one auto roll in Chicago.

We're filling in with Merrillville, the far South Eastern suburb with Oaklawn in South Central Chicago with Kenosha at the far North End and with Glencoe (ph).

That will bring us up to eight.

I would say with the exception of Kenosha, if we were doing Chicago again from scratch, we would do it with the seven of those eight stores I just talked about with some mix of regular size 50,000 square foot 10 to 15 acre stores and satellite stores.

We have gotten more efficient in the reconditioning operation.

We now have learned how to hire people and get folks to work on a 24-hour schedule for reconditioning that we can produce out of a standard store a lot more cars than we could five or six or seven years ago.

We're able to support one satellite store out of every standard store.

Our approach would be, compared to what we were doing five years ago, we would be building roughly twice as many stores to start with, with an average size of slightly less than half the size we built before by getting ourselves much better market coverage.

One of the reasons we're not taking on any big new markets yet is we want to let the satellite stores mature a little bit.

We also want to do some of the experiments like we've done in Charlotte where we added a satellite store to a mid-size market or like in Las Vegas where we open a mid-size market with two stores to begin with to give us a better sense of how closely can we pack stores, how high can the market share go?

What are the dynamics of that?

So when we go to Los Angeles or go to another big market like Philadelphia, we really have the best possible idea of, you know, what your entry level store is how many do you add.

All of us would like to do what Kohl’s did in LA.

They opened 24 stores in the same day so you get immediate leverage.

We have to work our way up to that.

Opening 24 car stores on the same day may not be possible.

We have to factor in the inventory.

I think that description of Chicago is probably the best indication.

Okay.

Conversely, is the CarMax concept down scalable to smaller markets, again, looking down the road a bit?

We think so.

The answer is we haven't put a lot of effort into that.

The smallest market we've opened is Knoxville, Tennessee.

It is off to a very good start and we're very happy with that.

That tells us that we can build a standard-sized store in the small end of mid-size markets.

We know from operating satellite stores we can have a store that breaks even at 150 cars a month or substantially less than that even.

The question is when you get to a Charlottesville, Virginia, with 100,000 people, do we have a store that can work there.

We think we can develop one.

Quite frankly, it is not a priority to spend a lot of time on that because we have so many opportunities within the range we're already operating.

We have spent some time thinking about it.

We think it will be possible.

It will particularly be possible because as we get more dense and CarMax.com gives us the ability to move cars anywhere, the virtual inventory every store has to draw off of is enormous.

It is one of our biggest competitive advantages.

Right now you can select from 13,000 used cars, and if you're in a high density area for us, like Chicago or Washington, you've probably got 3,000 or 4,000 cars you can buy without having to pay to move them.

Some of the density benefits should be translatable to smaller markets that are reasonably close to big markets over time.

That's why I raised Wyoming when I was speaking somewhat facetiously, could we go to all 40 or 50 states.

The toughest place is like Wyoming where you have small cities.

The biggest of which are less than 100,000 people and you have nothing close by to it.

So the answer is it will be a while before we experiment with that.

We think if somebody can sell cars, we will find a format that does it better than anybody else.

Thanks.

Thank you.

Marty Bowen of [inaudible], you may ask your question.

Hello.

Good morning

Hello, Marty.

Most of the new car dealers have reported that the store sales have gone down after the war.

Have you seen nothing for the war?

Have you seen anything on the new car side?

I have one follow up.

I'd say nothing significant.

The first few days after the war started, you could see a little bit of softness.

I think most people like me were glued to CNN for hours every night before they figured out, gee, I have to continue to live my life.

I won't say we saw nothing.

It was not significant.

And right now it looks that we don't see, you know, a measurable impact from that.

Now, obviously, the situation appears that it's going to go on longer than anyone originally expected or, certainly, maybe we misled ourselves.

Certainly most people, I don't think, thought we were going to end it with half a million people and have it go on for several months.

We haven't seen an impact yet.

Okay.

On Oaklawn, Lithia Springs and Las Vegas, are the close rates what you expect in these stores and how do you feel about the management of the stores coming up, the management that you have to put in the new stores?

I'm not going to comment on the close rates in individual stores.

Here's what I would say we've seen.

As a general rule, the new stores have opened with better close rates than we experienced last time we were opening stores, two to three years ago, and they have ramped up faster.

Now, every store is going to be different in its close rate.

Probably the single biggest influence is the credit environment around the store.

The more high quality credit you have, the higher close rate you can get more easily.

Low quality credit, the tougher it's going to be.

Given those issues, what we've generally found is everybody is starting out better than we would have seen previously, and they ramp up over time.

I will tell you that some of the ones that have been open now for a year or close to a year are up in the range of, you know, relatively mature stores.

We're extremely happy.

I would be surprised if every store got that far in the first year.

I would be surprised and very pleased.

I don't expect that.

What I expect is we're opening a little higher and we'll make steady progress, but each store is different in terms of what it achieves based on its potential.

In general, the satellite stores seem to be doing very well.

I'm wondering if they have exceeded your expectations from a year ago and whether there's more of a plan to put up more satellite stores as we go forward?

I'll say two things.

One, our expectations were reasonably high.

In general, the satellite stores have exceeded them.

However, our expectations for profits were already very high because satellite stores bring so much leverage.

Although we've exceeded sales levels, we already had such a strong expectation that the incentive is fully there for us to add satellite stores whenever we can find the good one.

So I would say that hasn't really changed, and we continue to very actively look for satellite stores because they're easy to open, they ramp up quickly.

They're lower risk, both in terms of the total investment you have to make and the hurdle they have to hit to break-even, and they're generally going in the markets where you have, you know, established awareness.

So I wouldn't say that we're increasing our focus.

I would say that our focus has been strong on satellite stores all along.

That's why I encourage people not to spend too much time trying to figure out what the mix of satellite and regular stores is.

It doesn't matter much in the first year or two because mid-size market stores will do more sales, the satellite store has economic advantage that it ought to produce comparable profits in the first year or two.

Sounds good.

Brian Macaulay (ph) of Akri Capital, you may ask your question.

Yes.

Can you give us a sense for the trends you are seeing in the loss rates and finance division, particularly the default rates and recovery rates?

Sure.

Basically, as you look at cash flows every quarter.

The cash flows continue to perform consistently for all of our pools.

Underpinning the cash flow assumptions, our losses and prepay fees, and we have adjusted both.

The key thing we have noticed recently is until the last few months, if you take our 2001-1 pool, which has the highest rate of loss expectations, it has performed on our loss curve we forecast for it, but the last couple of months it's actually continued to trend up.

So that's what caused us to take a harder look at all of our underlying assumptions.

Basically, we've reforecast our losses anticipating that the loss will continue higher and later in the curve.

So that's implicit in all of our adjustments going forward.

Is there anything that gives you confidence that the loss rates bill not accelerate?

I think the key is that the majority of the loss change really is attributable to a change in wholesale values.

What we don't see and what would cause you some anxiety is large increases in frequency of losses.

So we're still real comfortable that our predictability based on frequency, is looking solid.

The adjustment was the result of recovery values.

Great.

And just one more question.

The latest forecast I've seen has called for 30% or 40% increase in the sales of certified used vehicles in 2003.

What kind of impact do you think that's going to have on your business, both in terms of demand from customers and, also, in sourcing product, late-model used cars?

As far as we can tell so far, it doesn't have impact on us.

Certification is, really, something that a dealer has to decide – what certification is a manufacturer sets a standard and says, you need to do the following work on a used car.

If do you that work, then you can pay me somewhere between $250 and $500 and I'll let you say it is a GM certified car or Honda certified car or Toyota certified car.

That generally comes with a power train warranty, which is some incremental value, but not much.

The decision among dealers as to whether they decide to certify a car often comes down to, do they believe that paying the manufacturer that amount of money for work that they, the dealer, could do themselves anyway, is the brand value of having that certification stamp worth it.

What you see in the marketplace is the dealers who tend to say yes more frequently are the ones who already have the brands that are most highly valued in the marketplace, Honda, Toyota, Acura, Lexus, Mercedes and BMW.

They have had some pretty good strength in certified cars for a while.

Having said that, at the very best all that does for a dealer is it may equalize for him his ability to say he's competitive with CarMax on one of four dimensions of our offer.

He's still uncompetitive on the other three and that’s at the very best.

I can tell you we're most familiar with the Toyota program because we sell Toyota certified used cars.

The Toyota program was developed by studying CarMax.

We know the best of the programs out there does nothing better than bring a car up to our standards.

So I don't see so far any impact -- you know, we've gone out and tried to do some analysis and testing.

We don't see any impact.

It really -- it's a limited number of cars.

It doesn't fundamentally change the dealer's offer.

Quite frankly, many of the better dealers who have reconditioned their cars -- there's some good dealers out there and have done reconditioning a long time.

Their view, particularly if they sell one of the more mass brand names, their brand name is perhaps the stronger brand name in saying it is a Sunny Haims (ph) reconditioned Jeep, Sunny Haims being the local Jeep dealer in Richmond.

The strongest thing you with say in Richmond is I stand behind it.

There are dynamics there.

As far as access to cars, it doesn't have any impact on us at all.

We get our cars from the same places.

The vast majority come from consumers.

A fair number come out of lease fleets.

We have equal opportunity to those cars coming out of lease.

Almost all of those are resold at auction.

Although in theory the dealer has the opportunity to buy it from the manufacturer.

They almost never do.

The third area are off-rental cars.

There are some closed auctions of off-rental cars.

Not many.

You can always buy a car that has been sold in a closed auction.

Dealers will resell them in the open marketplace.

Those are generally not the most desirable cars.

That's why they were in rental fleets in the first play.

We don't find it has any impact on our access to cars.

Thank you.

Thank you.

Last question.

James Shannek (ph) of Jewel Investments, you may ask your question.

My question has been answered.

Thanks very much.

I appreciate it.

Thank you very much for joining us.

We look forward to talking to you again.