車美仕 (KMX) 2004 Q4 法說會逐字稿

Good morning.

My name is Marcia and I will be your conference facilitator.

At this time I would like to welcome everyone to the CarMax fourth quarter earnings conference call. [ OPERATOR INSTRUCTIONS ] Thank you.

I will now turn the call over to Miss Dandy Barrett, Assistant Vice President of Investor Relations.

Ma'am, you may begin.

Good morning.

Thank you for joining us this morning.

On the call today are Austin Ligon, our President and Chief Executive Officer, and Keith Browning, our Executive Vice President and Chief Financial Officer.

Before we begin, please let me remind you that our statements today about the company's future business plans, prospects, and financial performance are forward-looking statements that we make relying on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements are based on management's current knowledge and assumptions about future events.

They involve risks and uncertainties that could cause actual results to differ materially from our expectations.

For additional information on important factors that could affect these expectations, please see the company's annual report on Form 10-K for the fiscal year ended February 29, 2004, and our quarterly and current reports on file with the SEC.

Now I'll turn the call over to Austin.

Thanks, Dandy.

Good morning.

As we said in our sales release a little earlier, we are quite pleased with the way this quarter came out, putting a good end on a pretty tough year.

Overall, we saw a 25 percent increase in total sales and revenues, 27 percent increase in used unit sales, and a 12 percent increase in comp unit sales.

The used car sales trend strengthened throughout the quarter.

We managed to take advantage of the strong tick up in traffic that we saw continuously throughout the quarter, and we experienced strong sales in all regions in both new or established stores.

The addition of the subprime finance provider, DRIVE, contributed 5 percent to used unit comps, reflecting the seasonal lift in subprime business during the tax refund season.

We achieved all this despite one fewer selling day, leap year, compared to last year.

This reinforces our belief that the first-half sales softness was due to macroeconomic and used car market factors, not in store execution or the pressure of growth.

We saw a 13% increase in other sales and revenue.

This growth lagged used vehicles primarily because of the addition of DRIVE and its related discount, which was reflected as an offset to third-party finance revenues.

We saw increases reported in all other components.

As far as gross margins go, gross profit dollars per unit increased versus the fourth quarter last year both for used retail and wholesale vehicles.

In general, the faster our inventory turns, the higher our gross profit dollars are because we make fewer price adjustments.

It's typical for our wholesale margins to be strongest in the fourth quarter.

This coincides with the normal seasonal increase in wholesale prices.

It's not unusual for us to see wholesale prices increase between the date we purchase the vehicle and when we sell that vehicle at wholesale auction which typically causes us to make a profit in the auctions in the fourth quarter.

Gross margin on other sales and revenues declined as a result of the DRIVE discounts.

As far as CarMax Auto Finance, CAF income was up modestly.

It benefited from the growth in CAF originations and managed receivables because of the overall strength of the business.

This was partly offset by continuing pressure on gain spread.

Gain spread was 3.7 percent in this year's fourth quarter versus 4.5 percent last year.

Our cost of funds has continued to rise faster than we've been able to raise consumer rates.

As far as SG&A goes, SG&A ratio at 10.3 percent was down 20 basis points from last year.

We saw some sales leverage generated on the SG&A as a result of the strong sales in the quarter, and this was achieved despite higher than expected store unit bonuses resulting from continually beating sales bonus targets during the fourth quarter, and also despite a high proportion of immature stores in our sore base, more than 40 percent at this point.

As far as expectations for the coming year, our full-year expectations as we stated are currently 5 to 9 percent for used unit comps, and EPS of $1.20 to $1.30.

As far as the first quarter goes, our expectation for used unit comps are in the 9 to 12 percent range because of the easier comparisons from last year, and the EPS in 35 to $0.38 range versus $0.33 last year.

These expectations assume that we see no undue disruption in the market environment from such factors as the rising gas prices, interest rates, and rising whole sale vehicle prices and from any unpredictable incentive behavior from domestic auto makers which seems to have calmed down but could raise its ugly head again.

We also assume that cash spreads will be slightly below the normalized 3.5, slightly below the bottom end of the normalized 3.5 to 4.5 percent gains spread range as we see funding costs continue to climb somewhat faster than we're able to pass that on to consumers.

This also assumes the launch of marketwide advertising in Los Angeles concurrent with the opening of our Ontario store and our Irvine store, the fifth stores in the market.

Irvine opens this Friday.

It also assumes incremental, 2 to $3 million of cost for separating our data center from Circuit City, the last of our separation related costs from Circuit City.

It does not include any potential impact from adopting new accounting rules on stock-based compensation, which we assume we will do if those rules stay in place as they are when the time is appropriate.

We'll continue to execute our growth plan in FY '06.

We plan to open nine superstores, roughly 16 percent store-on-store growth.

We'll be entering four new mid-size markets, Jacksonville, Salt Lake City, Wichita, and Virginia Beach.

We'll add two stores in Los Angeles, one standard and one satellite, Irvine and Ontario, both open officially as of Friday, and three other satellites, one in Nashville, one in Kansas City, and one in Miami.

With that, I'd be glad to take your questions.

Operator, we can take questions now, please.

Thank you, ma'am. [ OPERATOR INSTRUCTIONS ] Your first question comes from the line of Matthew Fassler with Goldman Sachs.

Thanks a lot, and good morning.

Hi, Matt.

Couple questions.

First of all, on the CAF numbers, what is it about the current interest rate environment, if you think about fed activity, if you think about the bond markets, as distinct from what we've seen over the past several quarters that would lead you below that 3.5 to 4.5 percent range today as opposed to, it's been certainly rising short rate environment over the last several quarters?

I'll let Keith answer that.

Yeah, Matt.

CAF has successfully been able to pass along the rate thus far, but our own analysis, one of the things we monitor is the level of bookings, the level of payoffs, and then our current spread, indicates that the ongoing pressure is going to actually push us below our ability to achieve the bottom end of the range.

One of the things we've always said is 3.5 to 4.5 is our normalized range, and given the acceleration in the forecast of ongoing increases by the fed, which ultimately impacts our cost of funds a little quicker than they actually make those increases, we just think that we're going to see pressure in the first half of the year at least that's going to keep us below that environment because we don't call that a normal environment.

And Keith, if you think about what's really changing, is it, changing versus your model, is it the rate of fed increases or the bond markets or the quickness of the bond markets' response to that, or is it more on the customer pricing side where you feel like things are getting perhaps a bit stickier?

The customers' expectations are lagging.

We are absolutely out there trying.

The bond market is absolutely anticipating what the fed is going to do.

So for example, since the end of January, our cost of funds have gone up more than 60 basis points, and you can bet we've gone out and actually made tests and tried to pass along those cost increases, and customers are voting with their checks and our payoffs are at the threshold where we believe that customers are telling us that they're not quite ready yet.

So we'll continue to test that and move as quickly as we can.

Our goal would be to get back in the range, but in the short-term, I think that's probably less realistic than otherwise.

Can you remind us kind of what point on the yield curve you're most sensitive in to terms of your credit earnings?

I'm sorry?

Kind of what maturities you're most sensitive to.

Should we be watching the two-year treasuries?

Yes, absolutely, two-year treasuries is a good benchmark.

Gotcha.

Secondly, if we can just kind of review the impact of DRIVE, you gave us a little more color on the timing of its contribution to sales when you reported, certainly your fourth quarter numbers, I think you talked about March also likely being a disproportionate beneficiary of that.

If you could just get a little more granular now that you have some more experience under your belt as to the impact that it's had on your economics per car and its anticipated contribution to top line in '05.

The economics haven't really changed.

The economics, we've said are, you know, running 40 to 50 percent.

If you look at all-in margin generated from all sources, we make about 40 to 50 percent as much off a DRIVE car as we do off a typical CarMax car.

And the seasonality, as far as we can tell, jumps up some in January, peaks in February, drops down a bit in March, you get a little bit of extra in April and then by mid-April it should be back to sort of what normal is, if you will, mid-April through --

Right, which will be the 3 to 4 percent range, for the most part.

Post mid-April.

And I think we've said --

And then we'll peak again in the fourth quarter next year.

At which point you'll more or less be cycling.

Exactly.

And then finally, a number of the full-line dealers talked about, and other retailers, for that matter, talked about hurricane rebuilding effect in South Florida, and you've alluded to, or in Florida, more broadly, rather, and you've alluded to it from time to time.

Can you just give us a sense as to the contribution of your stores in those markets and also whether you see that rolling off yet at all?

It's really hard to estimate given that we saw strength across all of our markets, and I believe that most of what we got back in Florida we got back actually in the third quarter.

It may have contributed a bit to the fourth quarter, but we certainly didn't see the Florida markets being systematically stronger in the fourth quarter than other markets were.

So it's always a little hard to tell with hurricanes, but our best estimate is that to the degree that we were still getting anything in the fourth quarter it's probably only in December in Florida.

Gotcha.

That's very helpful.

Thanks so much.

Your next question comes from the line of Sharon Zackfia with William Blair.

Hi.

Good morning,

Hi, Sharon.

Austin, you gave a lot of caveats there in your guidance for this year and I'm just wondering are you seeing any of those caveats come into play?

So far in the first quarter it doesn't sound like it.

Well, obviously we're seeing them out there.

I mean aw we've talked about interest rates not only are rising but the fed seems to be hinting they're going to rise faster.

Gas prices are rising.

It's less of a surprise this year, but they're certainly rising.

Wholesale market costs have been rising as much or more than last year, and the two things that are really different from last year, as far as we can tell are, meaning the overall economic environment, particularly as it relates to the war and the election, you know, although the war hasn't gone away, the anxiety about it appears to have calmed quite a bit, and obviously we're no longer facing a presidential election.

And also, at least for the moment, the competitive environment from the domestic players, which was initiated, if you will, by General Motors, and they were certainly the leader in some of the most aggressive incentives and also some of the unpredictability last year, that seems to have pulled back considerably, and you read a lot of press that says that General Motors is going to pull back from that on a longer term basis.

On the other hand their sales are really awful, and we just wouldn't begin to try to predict what they're going to do.

So those are all out there as factors.

It's really more an issue of understanding how they come together and, you know, my personal belief is that the circumstances of last year were a fairly unique combination of factors, but we do want to note for everybody that some of those key factors are still out there.

We'll see as we go through the spring and summer how they come together.

I think by the time we get to the fall again this year it will actually help us understand a lot about last year, because we'll be able to sort out a little bit which of these things were most important and how did they interact.

But I think it's appropriate to be a bit cautious and just recognize that there's still a lot of these things out there.

The 9 to 12 percent comp you're looking for, used unit comp in the first quarter, does that assume kind of the similar types of run rates to what you're running so far in March, or do you have any acceleration or deceleration built into that?

And what are you looking for for DRIVE in that number?

We're looking for a strong margin DRIVE that tails off by mid-April to normal.

And strong March and reasonably strong April and maybe a little bit softer May would sort of be the guess.

And DRIVE is 3 to 4 percent increase in that number.

Okay.

And then I guess more granularity on Los Angeles and the advertising expenses there.

Can you give us any idea on what you'll be spending in L.A. this year, and particularly here in the first quarter?

Hello?

Keith and I are talking about this.

Oh, sorry.

Hello?

We were just --

I've not been muted before on a conference call.

You have, you just didn't notice.

It was longer conversation.

Overall we're going to spend probably around $14 million on advertising in L.A., and that will probably be about a 7 to $8 million increase over what we spent last year.

It will be reasonably well spread although it will be a little more heavily loaded in the first quarter because we do have the grand opening costs.

So probably the biggest impact of L.A. will be in the first quarter.

Our expectation is that we won't make money in the L.A. market at all this year.

Obvious that will depend on sales, and if sales outperform what our current reasonably conservative expectations are, then we could do better than that, but right now our expectations are that L.A. will cost us money until we get a little more sales momentum there until we add some more stores.

Okay.

So the 7 to $8 million incremental over last year, I didn't realize you had advertising previously in L.A.

Yeah, it was, the difference is that we were spending our money on local cable TV and on local newspaper, not marketwide newspaper and marketwide TV and radio.

And it makes a big difference to do that.

Okay.

Thanks.

Thank you.

Your next question comes from the line of Carl Straum with JP Morgan.

Good morning.

Nice quarter.

Thank you.

A couple of questions.

Obviously DRIVE has been a pretty big contributor to comps in the quarter and I was wondering if you guys are currently testing on the other subprime lenders that may be rolled out later this year as you anniversary DRIVE, which I think is in August?

The answer is, we are testing, as we've said, several other folks.

We're testing non-primes.

We don't have any other subprime tests going right now.

Yeah.

We're testing several other non-primes, pretty much the folks that you'd expect us to be testing.

And the answer is, if we knew that we were going to roll somebody out, we'd tell you.

When we make that decision we'll announce it, but at this point we just continue to test.

Okay.

Fair enough.

The hurdle's pretty high to add any finance provider in a segment where we already have a finance provider because what they have to do is show that they're going to add something incremental that makes it worth potentially splitting the business because obviously we get better economics if we concentrate the business with fewer firms.

And you do anniversary DRIVE in August, correct?

Correct.

That's right.

And then, new store productivity was very strong in the fourth quarter.

I calculated roughly 121 percent.

What factors led to this performance?

I mean, how much was market related?

How much was CarMax related?

And how much was DRIVE related?

Well, DRIVE was, as far as individual stores go, DRIVE can vary a lot, but across the overall company it had a similar pattern if you averaged it out.

Most of it was really market related, you know, the stores have matured a bit, but the key thing is, we saw all markets improve, and in that environment you'd expect newer stores to be improving even more, I think, just because, if you think about the negative impact on a new store that doesn't have any established customer base of a general down draft in the used car business, we think that probably hurt those markets a little more, and they probably benefited a little more as we saw more traffic.

There's nothing that we've been able to identify either in the established comp stores or in the new stores that was CarMax execution related, as far as last year's performance.

So we think all of this is pretty much driven by the market, and, you know, we're happy with it.

Great.

And then last question.

On your comment earlier that you would expect some modest SG&A leverage by reaching, I think, the high end of your comp guidance, could you shed some light as to sensitivity here?

I.e., if you were to print a seven comp this year can you still leverage the SG&A line?

Very modestly, I think.

Okay.

Great.

Thanks a lot.

Certainly.

Your next question comes from the line of Brian Nagel with UBS.

Hi.

Good morning.

Hi.

A couple of questions.

First off, with respect to your guidance, and I think you've touched on this already, but I want to make sure it's clear, how much, you said of the Q1 volume guidance with four percentage points is coming from DRIVE, just clarify that.

Then how much of the annual guidance you guys gave, how much of that's coming from DRIVE?

A little over 1 percent, 1 to 2 percent since we're cycling around it in August.

Okay.

Very good.

That clears that up.

Second question I have, to the extent you could, I'm just trying to get my hands around where the good demand is coming for used cars.

Can you guys look at your business more in segments of say, almost age of car, if your very late model cars to your older cars and see, are demand trends different for those different types of vehicles right now?

That's a little bit hard to say, because the, I guess the one trend that's clearly been out there and remains out there is for compacts and for mid-size cars, cars that get better gas mileage.

Those have been doing better.

They've been doing better for almost the whole last year, because of people's reaction to gas.

SUVs did terribly for awhile, but then the price plunged enough that actually SUVs have gotten back in the game because their wholesale prices have been knocked down.

And that's what we generally see, is that if there's supply available in the market, the price will adjust to sort of get it sold.

So we do continuously adjust to those trends, but they tend not to be long, sustained trends, and other than the compacts and mid-size cars I don't think there's anything in particular that we'd comment on there.

So that's just a function, you think, mostly of gas prices?

Yes, appears to be.

Last question.

With respect to your new store openings, you guys talked about L.A., what are other markets you're going into?

Your expansion last year has been mostly infill-type markets.

Is that going to stay the plan here in '05 or are you guys going to start venturing into more new markets?

The overall plan if you look at it, the markets that we're, we're going into four brand-new markets this year.

Three of those fit the sort of classical mid-size market, million to two and a half million people.

That's Jacksonville, Salt Lake City, and Virginia Beach.

The fourth one, Wichita, is more similar to Knoxville and Columbia, what we call a smaller mid-size market, somewhere between half a million and a million people.

So four total new markets this year.

If you look forward, our plan is to run a mix of markets that manages, that spreads our growth geographically so that we don't overload growth on any one particular region, so that from an operational point of view, you know, we're spreading that load as much as possible, which helps get the best execution.

And then it will be a mix of some fill-in satellite stores in both large and mid-size markets, the new stand-alone mid-size markets in the million to two and a half million range, some of the smaller markets like a Wichita, Columbia, Knoxville, and then occasional tests as we've been running in Richmond, Charlotte, where we're trying to increase the density of our oldest markets and try to understand, how high can market share go if we store as closely as possible to a complete storing in the market so that we eliminate any convenience penalty of shopping at CarMax.

So what we're going to try to do is provide a mix of those each year and then a major market every year or two, depending on the size of the market.

And by major market, I mean a market that requires a minimum of three stores to open the market.

So those would be obviously the L.A.s of the world, but also the Phoenixes, the Denvers, the Seattles, markets like that.

And we'll typically do a new one of those every year or every two years, depending on the size of what we're doing.

Great.

Thank you very much and good luck for the next quarter.

Thanks a lot.

Your next question is from the line of Aram Rubinson with Banc of America.

Thanks.

How much cups of coffee did you have today?

A couple things.

First, in the L.A. market, Irvine, correct me if I'm wrong, is a standard and Ontario's a satellite, right?

Yeah.

In terms of thinking about, versus your business plan model, do you think is Irvine kind of in the middle of that model?

Is Ontario kind of in the middle of the satellite model?

How should we be thinking about that?

When you say the middle of the model do you mean expectations?

Yeah, I mean, how you're planning those stores?

Well, look, Irvine is one of the bigger markets in the L.A. market, but it's also going to be one of the costlier stores that we build in L.A. or anywhere.

Anybody who's ever dealt with the Irvine Corporation understands there's not a lot of negotiating power there.

Ontario is an interesting market because it is, in terms of population density, not a very big market, but the auto mall near the Ontario store is one of the four top auto areas in L.A.

So one of the slightly different things about trying to forecast sales in California is because some of the auto malls aggregate so many dealers in one place our model of forecasting off population density may not be the best forecasting tool, and since our major experience, so far the only experience we have with advertising, is in Sacramento.

As we told you before, it's kind of hard to forecast anything off Sacramento, so right now we have Ontario planned as a relatively small satellite.

We wouldn't be terribly surprised if it overperformed somewhat.

We have Irvine modeled as a strong basic standard store and we would expect that.

All the information we have is, in fact, during the brief life of Auto Nation used car superstores, the Irvine store was one of their two best stores in the country, and we just happen to be built right next-door to that old store, which is now a Power Toyota store.

And the advertising plan, if I were to kind of think about it in terms of points, whether it's points per week or points per every other week, however you look at it, how do your number of advertising points compare, or would your advertising points compare in L.A. to some of your other markets just to see whether you're kind of almost overdoing it or what?

Yeah, we're not overdoing it.

The, I mean L.A. is always daunting from an advertising point of view, because you're buying all 16 to 17 million people in the L.A. television market.

We're putting about the same number of television points in L.A. as we would typically put in a market.

We're putting a little bit less total newspaper and shifting some of that to radio, because the average Angelino spends an hour and a half commuting each way to work so this radio's a better than average.

So we've shifted the mix a little bit but in general it looks similar to what we would do in any other market, which is why it's pretty expensive.

We've been very thoughtful about not over spending in L.A. because it is so expensive.

So what we've tried to do is go to what we would call a standard advertising program, interpret it in the L.A. context.

And I have just two quick ones.

Also your comp guidance implies kind of a deceleration post Q1 with the comparisons getting dramatically easier.

If you can comment on that.

And then the second one is, your wholesale margins are now higher by a good margin than your used car retail margins.

Would you think about getting into the auction business?

I think as far as the comps go, you know, the first two quarters are going to be the strongest quarters, and the second half right now, based on our estimate, is going to be softer because we've got, particularly in the fourth quarter, some very tough comparisons to go up against.

So I think that's as much granularity as I'd give you on that.

As far as wholesale margins, one of the comments I made, and it may not have been clear, in particular, in the fourth quarter, if wholesale prices are rising, literally in the week to ten days between when we buy a car and when we sell a car, we always end up making money on those cars in the fourth quarter.

So although we come close to breaking even, you know, absent the fees on our auctions and sales, the auctions always make money in the fourth quarter and they typically lose money in the third quarter because we have seen strongly rising wholesale prices.

That made [the] wholesale performance even stronger.

As far as going to the auction business, no, because the difference between us and auctions is we take risk, auctions don't.

So every one of the cars that we have, that we end up, you know, recovering our costs on, making money on, however you want to look at it, is something that we take risk on and I'll tell you generally, they're cars that nobody else wants to take risk on.

That's one of the reasons that we have a pretty healthy ability to buy cars there.

So particularly the ones that are pure wholesale that we turn around and resale because they don't fit our market.

So we're glad that that business is performing well, but we wouldn't want to do it as a separate business.

Thanks.

Okay.

Your next question comes from the line of Larry Schumacher with Oppenheimer.

Hi, guys.

Curious if you are getting a bigger benefit from the source pricing or a bigger benefit from your pricing on the sale of the vehicles?

I'm not sure what you mean by a bigger benefit from the source pricing.

Are you able to buy your cars cheaper and sell them at the same prices, or buy them at the same prices and sell them at better prices?

In general I think if you look at our margins and the margins of the publicly traded new car guys who also sell used cars, they're not terribly different.

And the one difference is they transfer price.

Their margins are actually a little higher than ours because when they do reconditioning on their cars they charge reconditioning in their service bays at full retail rate.

We charge at a cost.

So they transfer a little bit of margin from used cars to service.

But in general, we don't buy cheaper than anybody else, and we try to sell at what we consider competitive prices, that is roughly what we'd call the sales manager price.

Not the initial price the sales person wants to you pay, but what you get to if you negotiate a bit and get to the sales manager.

We really make our money off of selling more cars.

We sell roughly ten times as many used cars per location and five times as many [inaudible] cars per location as the competition.

But in this particular business it's not clear to us that there's very much of a pricing advantage to be gotten in the acquisition.

The key on the acquisition side is, do you know what you want to buy and can you get access to what you want to buy, and we think we're better on both of those points, but we don't think we buy it any cheaper.

Okay.

Thanks very much.

Your next question comes from the line of Michael Heifler with Deutsche.

Thanks.

Good morning, everyone.

Good morning.

Just want to follow-up on some of the previous L.A. questions.

Austin, you mentioned that there's 7 to $8 million of incremental investment in that market.

Can you help us understand what the pay back is from that investment in terms of store ramp, in terms of productivity, both on the new stores and the existing stores?

Well, it really depends on a couple things.

It depends on how well the market responds to advertising.

L.A. is a bit of an unusual situation in that we've had a couple of stores there operating literally since 1999, because L.A. is the market that we were about to go into when we stopped growth.

L.A. is actually the market that convinced that it was time to stop growth because we knew weren't ready to do L.A. yet, because it is a high-risk, high-return market.

Because we've had those stores operating without any of the real benefits of market-wide advertising, they've performed as we would expect, significantly less well than similar stores would typically perform in our other markets.

And even though we expect everything to perform within the range of what our other markets have in terms of individual stores, we're a little cautious about forecasting exactly how strong that will be until we start to see some of that performance.

So our expectation is that you wouldn't see pay back from L.A. until at least next year, and maybe not until the following year, really depending on how sales ramp, if they ramp within the range of our large markets that we've opened, but at the lower end of those, it's probably be a couple of years, and if they're at the higher end it'd be a little faster.

It also depends on how quickly we get other stores open.

And we've got other stores that we're working on in the pipeline, but when we'll open those in the following year, really, we're not sure yet.

L.A. is a fairly complicated place to do development work.

But we've got a nice pipeline coming.

So it's, that's a summary way of saying I can't forecast it for you any better than that because we really don't know ourselves.

It's the first large market we've entered in a long time, and it's really hard to compare L.A. to anyplace else.

You know, obviously if you, our dream would be that it will perform like Sacramento, but we wouldn't expect that.

And then on the market share front, it seems like the numbers that you guys are posting are stronger than what the franchise dealers are looking at for the quarter.

But given that there's pretty spotty information on the used car market overall could you give us a sense of, you know, what you're doing from a market share standpoint?

Yeah.

Remember, the new car guys report on an annual basis and we report with a fiscal year that ends at the end of February.

But for the 12 months of last year we outperformed the publicly traded new car guys by roughly five comp points in our performance to their performance, based on their latest reports.

And what we saw from a market share point of view was that we ended up growing market share overall for the year probably roughly in line with or maybe just slightly slower than we have grown it on average.

So one way to think about that is our market share probably grows about 4 to 5 percent.

Not four to five percentage points, but 4 to 5 percent a year.

And it was at the lower end, or maybe slightly below the lower end of that range last year, but still pretty good, given the year.

Okay.

Thanks.

Thank you.

Your next question comes from the line of Bill Armstrong with CL King and Associates.

Good morning.

Austin, can you talk about the wholesale pricing environment now in your opening comments and in the press release you mentioned that prices are rising more than historical norms would indicate.

Could you comment on that and what the risks are out there?

Well, as I say, the prices are rising more than we have seen, and in the seven years that we've tracked it, which also occurred last year, but they're even a little stronger this year, and I presume that's a combination of, in one particular segment, the off lease segment, two to three-year-old off lease cars, there are once again fewer available this year, although the decline in availability in off-lease is much smaller than it was last year.

But more broadly, there appears to be pretty strong demand in the marketplace for used cars, and that seems to be driving prices a little more, or quite a bit more strongly than you typically see at this time of year.

What that means is that everybody is expecting that it's going to be a strong spring and summer selling season and it also implies that they're expecting that we're not going to see strong downward negative pricing trends in new cars, and I think if those things turn out to be true, the fact that wholesale prices are rising may be a non-event.

If they turn out not to be true, we're worried that you could see some of elements of last year.

So we're as eager as you to see what happens, but probably no better at forecasting.

So at this point, even with wholesale prices higher than normal, you're not seeing a deterioration in the spread between late-model used cars and comparable new cars?

Well, we generally target, you know, a fairly standard spread, and we're reasonably comfortable with that within reasonable plus or minus bounds, and as we said, so far March has gotten off to a pretty good start.

So far, so good.

We'll see how the rest of the spring evolves.

Okay.

On wholesale gross profit per vehicle, it was up big year-over-year.

I mean, is that really just a function of prices rising through the quarter more than they rose in the fourth quarter of a year ago?

One of the results is that we now have a full-year of acquisition costs recovery, or what we call the ACR fee.

In other words, fee we put on the car before we give the consumer a price, designed to fully recover all of our costs, including land, building, facilities, et cetera, and we've just cycled around on that, so that's part of the increase.

The other part of the increase is that, as I said earlier, we always make money in the auctions in the fourth quarter, and because we saw prices rising strongly this fourth quarter, we made more money than we usually do, because prices literally, by the time we sell the car, have gone up from where they were before, and that's typical in the fourth quarter but it was a little stronger than usual this fourth quarter.

And just one last question for Keith.

Looks like depreciation jumped up in the fourth quarter.

Was there anything non-recurring or unusual, and what sort of depreciation number should we be looking for in the coming year?

Depreciation or overall property and equipment?

No, depreciation.

It was 20 million for the year, which would imply 6.8 million for the fourth quarter, which is a jump over previous quarters.

We did have some minor adjustments, the million and a half that we talked about related to some of the lease accounting changes, and some of those changed into cap leases which may have flowed through depreciation, and that wouldn't be a meaningful, similar impact would be for next year relative to that particular accounting change.

But other than that, I don't know of anything particular to the quarter other than continued added stores that we haven't financed.

We have six stores that we added last year that we haven't done sale/lease-backs on and so we depreciate those until we decide to do that or not.

Okay.

Thank you.

Your next question comes from the line of David Campbell with Thompson Davis.

Good morning.

Hi, David.

Congratulations on a good quarter.

Thank you.

Two questions.

First of all, just going back to the cost recovery on the auctions, do you expect any further benefits from that, and how is that process going in general?

Well, the process is going pretty well.

Obviously, I mean, it produced a nice, quote unquote, margin on wholesale last year.

And we're pleased with the fact that we continue to have a higher buy rate as well.

So we think that's all gone well.

We'll continue to test things in that arena, but there's nothing significant that we'd forecast at this point.

We don't have anything that we're rolling out, but we do continuously run tests to try to make sure that we're doing the optimal thing there.

Okay.

And can you also give us an update on how your reconditionings are going and in-process improvements in that area?

Well, the process improvement in reconditioning is a pretty continuous effort.

We think we actually made some pretty strong success in understanding how we take the next step, but it will take quite a while before we actually see real benefit out of that.

One of the things we're focused on right now is based on work that we've done studying Toyota, Nissan, Herman Miller, Viking Stove and Fed Ex and some other companies is really trying to relook at our, what we call our detailing process, the cosmetic side of our reconditioning process, how to make that more streamlined, more efficient, and take some of the lag time out of it.

And all of which would probably lower our costs some, but also increase our quality, but I don't think we've seen any measurable change there so much as we've, we think we now understand how to get that next level of measurable change.

But it will probably take, you know, several years to get that in place.

We're, I think we've gotten to the point where these things take a little longer.

We're not going to see big jumps year-to-year.

And what's the level of turnaround time now?

Typically it takes us about six days from the time we acquire a car until we put it into saleable.

Okay.

All right.

Great.

Thank you very much.

Your next question comes from the line of John Zolidis with Buckingham Research.

Hi.

Good morning.

Good morning.

Two questions.

One, I was wondering if you could touch on the balance sheet and just comment on inventory levels year-over-year?

And then two, wondering if could you talk about in your most mature markets, what percentage of customers in your most mature markets are new to CarMax?

Thank you.

Okay.

I'll let Keith talk about inventory.

Inventory is up. 55 to 60 percent of that's just related to new stores that we've added versus last year, and then the balance of the increase is really related to the strength in sales in that we're obviously expecting that strength to continue based on our forecast and, you know, we, in front of spring we absolutely have to build up that inventory.

But we feel real comfortable with our inventory levels at this point.

Okay.

And then on your more mature markets?

Sure.

About in a Richmond or a Raleigh, about 25 percent of the people who buy a car from us would have bought a car from us before at this point.

And probably about 50 percent of the people who come in the door would have shopped with us before.

So there's a, you know there's still a , even in the most mature markets, a fairly high number of people who have not shopped or purchased with us before, which is one of the reasons that we believe that if we can reach a fairly high market share, it allows us to increase density and to store other auto rows that we're not on, because everything that we see implies that there's a fair convenience factor in this business that says if you're 20 miles away from me and there's a Toyota dealer 10 miles between us, and you're looking for a used Toyota, there's a fair chance you're going to stop there, and there's around a 40 to 50 percent chance, or probably around 40 percent chance that you're going to buy a car the first place you stop.

So that acts kind of like a filter, and that's one of the reasons we opened a second store here in Richmond on the second major auto row, and we're looking at doing another experiment or two to push that a little further in Richmond, Raleigh, Charlotte, or one of the other markets, to try to see, you know, how do we capture an even higher percentage of the customers, because we do find still a lot of new customers even in a fairly old market.

How do you think that that compares to the percentage of repeat versus new customers at the average dealer out there, non-CarMax?

It's kind of hard to talk about the average dealer.

I think if you go to the average Toyota or BMW or Mercedes dealer you'd find a very high degree of loyalty.

Here in Richmond you'd find 100% loyalty because there's no place else to buy, for instance, if you're buying a BMW.

At a Chevy or a Ford or a Chrysler dealer you'd find a much lower level of loyalty, which they've admitted and that's one of their struggles.

So I think it's probably low compared to an established dealer, because most dealers have been around, gee, probably the average dealer has been around 25 years and we have dealers here in town who have been around for 70 to 80 years.

So you have a fair degree of loyalty but a lot of it is driven by brand.

And then part of it is just maybe not loyalty but just continuity.

The fact that if you've been around long enough you get a lot of that cycling around.

And it's with a three to five-year repurchase cycle, it takes a long time before everybody has had a chance to buy from you again, particularly since we're only selling used cars in most markets, and a lot of people may buy a used car this cycle, a new car next cycle.

So we think it's a little hard to compare to new car guys but it would probably be lower compared to the better brands.

Great.

Thank you.

Thank you.

Your next question comes from the line of Scott Ciccarelli with RBC Capital Markets.

A couple questions.

First, Austin, can you comment on conversion rates?

It sounds like traffic is definitely improved, but it sounds like when you guys went through a rough patch in the spring and summer months that conversion rates were also an issue.

Can you make a comment on that?

Well in general, the decline we saw in conversion rates is almost all credit related so as we sort of disaggregate why somebody buys from us, and if we saw decline, and we saw decline for a period of time, it was almost all related to losing better quality credit customers.

And as far as we can tell, a good portion of that was driven by those guys being sucked into the new car business, particularly in July and August of last year.

And so we've actually seen a nice recovery in conversion rates, and we're quite happy with where they are, and we're getting some benefit out of that, too.

And probably related to that to a degree, do you guys have an estimate on what the actual earnings contribution from DRIVE was this past year?

I know what you've told us in terms of margin contribution but I also know you were experimenting with DRIVE for a while before it actually was rolled out and I would assume there was some sort of start-up costs associated with that as kind of an offset.

Do you guys have kind of a net figure is what I'm trying to get to?

Not really, but there weren't a lot of start-up costs.

It was a little bit of computer programming, but beyond that, not a lot of start-up costs.

It was just present in I think four stores initially and then gradually up to eight stores before we rolled it out.

But we haven't done a net total contribution for the year.

You could kind of go through and figure that out on your own from the numbers we've given you, but there weren't a whole lot of start-up costs.

Okay.

So we can assume 40, 50 percent as kind of a contribution margin?

Yeah.

Okay.

And then the last question is that I know that you've told us in the past that DRIVE is very specific or selective on what they're willing to finance.

As they get more comfortable with you guys as a partner, you know, as we roll out to the August-September time frame, could we actually see the DRIVE portion show growth as opposed to just go flat-line because they're willing to finance more than what they originally basically narrowed to?

I think the time frame that you're talking about there is probably way too short.

For one thing, recognize that we just went through a big boom in sales with DRIVE for the first time.

We just sold a ton more cars with them in January, February, and March than we've ever sold with them, and they're going to want to let that portfolio mature for awhile, more than just a few months, to make sure they understand, are the customers who buy with a tax refund meaningfully different than the customers who buy at other parts of the year.

And they know how that works with other dealers, but they don't know how it works with CarMax.

So I think, to begin with, you'd look at a longer time frame.

When you look at a longer time frame, we think if our portfolio performs well with DRIVE, it will open up several possible dimensions of change.

One, we might get a reduction in the fee.

Another is they might expand what they finance, either in terms of the customers they finance or the cars they finance.

The key for us is we want to make sure that it stays incremental, because with that kind of haircut on our margin, we don't want DRIVE cannibalizing even a single sales from anybody else.

It's got to be incremental sales.

But I think there's always a possibility there but we need to look to a longer time frame, a year or so, before we'd really see anything out of that.

Okay.

Fair enough.

And then the last question is, just regarding cannibalization, I know what you guys have said in the past, which is essentially you don't think your cannibalization has been any greater than what your original plan was but maybe it happened faster in some markets.

Do you have any kind of update on the way we should be thinking about that?

I think our best estimate is that the amount is going to be about what we typically estimate, and it varies dramatically.

I mean two good contrasts would be Fayetteville, which is in the Raleigh television area but it's 55 miles from the Raleigh store, so it really cannibalized Raleigh very little, or Midlothian, here in Richmond, which is only 10 miles from the store and in an area where we sell a lot and it had very substantial cannibalization of the Richmond store.

So the cannibalization is really store by store but it looks like our estimating methodology is accurate, it just happens a little faster, and that seems to be the best way to think about it.

And we now build that into our estimates, so it shouldn't have any impact on what we're estimating.

It's not really something you can estimate because you don't really know, you know, our market share by mile or our penetration by mile store by store to be able to do that.

Right.

If you wanted to share that, that would be fine.

It's more than you'd want to know, believe me.

Thanks, guys.

Thanks.

Your next question comes from the line of Eric Jemetz with Rockefeller and Company.

Hello there.

Good morning.

Good morning.

I just had a couple questions I guess with respect to CarMax Auto Finance.

First, I just wanted to get some comfort.

I mean, if the yield curve continues to flatten, or parallel, what's to stop that margin from depressing further, to 2 percent, whatever?

Operator, we're having difficulty hearing Mr. Jemetz.

Can you speak a little louder we didn't quite get all your question?

Sure.

Can you hear me now?

Speak as loudly as you can.

Okay.

I just had a question with respect to CarMax Auto Finance.

I'm just trying to get a feel for what potential downside on the margins are and what's really to prevent margins from depressing further as the yield curve flattens more?

I think that, you know, we're fairly comfortable, you know, we gave a potential downside of 3.25 yield spread in the first quarter.

I think we're fairly comfortable that that's pretty close to the bottom.

It may not be the very bottom but it's certainly very close to the bottom, based on our experience in lending.

I think only if there were some even more rapid improvements, increases in costs that we don't anticipate now, you know, in other words, instead of the fed going up 50 bips next time they go up 100, that could be a problem and we could actually miss that.

But I think based on what we know today, we feel like that's a reasonable estimate of what the downside is, and the most likely as well.

Okay.

And what kind of full-year cap spread do you have built into your full-year guidance?

We're actually saying that, you know, in the second half of the year, you know, again, not knowing what the fed's going to do or what our costs are going to do, that we are anticipating the rate of increases slow down slightly and that we get to the bottom of our range of 3.5 to 4.5.

Okay.

Thank you very much.

Thank you.

Your next question comes from line of Scott Nesson with Lehman Brothers.

Thanks.

Good morning.

I had two questions actually.

You talked about the run rate in revenue from DRIVE and how that's been boosted by the tax refund season.

But was there a meaningful contribution from tax refunds across your non-prime and prime businesses?

And I have a follow-up.

There's always some contribution but that's been built into the business for years so that we actually see the worst credit profile of customers coming into the store is always the credit profile of customers coming in in February, because the customers who have to rely on Uncle Sam to do their savings for them, that's when they typically come shopping.

That's always been true.

There's always some of in that both the prime and non-prime, but it's been there forever.

Okay.

So that's built into your outlook?

Yes.

All right.

Second question then is, are there other areas of spending that the company might target for savings if some of the caveats you articulated for 2005 earnings, if some of those situations materialize?

Well, if you look at what the truly variable costs are you can always choose to trim back some on advertising.

Most of the time we don't unless, we may decide not to run an experiment or two, but other than that, it's usually a bad idea to cut back your advertising when sales are soft.

There's a long history of retail and service companies that have gone out of business doing that.

So other than that, the biggest savings is usually management bonuses.

Everybody's giving me the look.

They know what the big savings is.

Is there's a fair chunk of savings in management bonuses, and we realized some of that this year unfortunately.

Well, it's certainly deserved.

Congratulations on a great quarter and good luck.

Your next question comes from the line of Aram Rubinson with Banc of America.

I don't know how I follow that one.

I just had one other follow-up.

Transfers as a percent of the total vehicles run what, again?

Transfers run roughly around 20 percent, you know, some months they'll run even higher than that.

And if you were to look at kind of market where you've got multi stores, whether it's a Chicago or a D.C. or now Richmond what are you running in markets where you've got multiple stores?

We absolutely run higher with local transfers, as would you expect.

I mean, there's a little bit of an offsetting effect, because if you're out in Sacramento, everything is at least a regional transfer, because you don't really have any nearby stores.

When you get into a market like a Washington or Chicago, where you've got a lot of stores, the number of local transfers goes up quite a bit higher.

The number of total transfers goes up a little bit higher, but partly those, the critical mass you have locally helps offset some of the longer distance transfers.

So it's not, there's not a dramatic difference from market-to-market, it's just a change in the mix.

I was just curious from an inventory productivity standpoint as you store up markets more effectively if inventory productivity would be on the rise?

Well, there's a plus and a minus there.

The good news is, that you've got more to choose from, and that helps drive your sales a little faster.

The bad news is, when you transfer a car, you're usually taking it out of inventory for a day or two, so you're introduce a lag there.

So I'm not sure that we've seen so far that you can get an inventory turn increase that's measurable out of this, net-net, other than just the overall increase you get by increasing sales.

Thanks.

Thanks a lot.

Looks like one last question?

Yes, sir.

Your last question comes from the line of Matthew Fassler with Goldman Sachs.

Sorry to drag this on.

Just one follow-up as well.

On the incentive levels we talked about having adjusted bonus levels up through the course of the quarter as the business got better.

If you could just give us a sense first as how that worked through the year, because I guess you had ratcheted them down at one point.

By the end of the day, were they higher than they had ultimately been?

And also, as you look out to 2005, can you talk about the kind of levels at which you sent incentive bonus payments out in the field rather than at corporate and what you need to do to get, I guess you said essentially what you need to do to get leverage but kind of at the store level ex the L.A. factor what that needs to look like?

The thing about, and we are talking about store bonuses here.

Management bonuses are based on the budget we give the board, and those are invariable.

So the store bonuses, we set a bonus based on budget, but then if we see that budget, if we see actual sales are running either above or below, we have a process by which we will adjust those bonus targets as long as we determine from the various benchmarks that a store is not underperforming due to execution issues.

So as long as everything looks like any challenges they're facing are market challenges and not execution challenges, we try to adjust their monthly bonus, which is fundamental important part of their pay, to target our best estimate of what sales are actually going to run at, and so the comment in the fourth quarter was, we kept moving those back up, back as you say, back up from lower levels to the original level, and even, in several cases, higher than the original level, and we still had a fair number of people beat those, which for them is a good thing, and in the grand scheme of the business, it just means as the trends stabilize a little bit you get back to a more normal forecast.

We have done the same thing we do every year with those forecasts this year.

We've done the best forecast we can for the year, but as we go along, we meet every month to go through store by store and look at should we adjust either up and down on each store.

And what we try to do is make sure that you get your target bonus at what we believe the sales should be for that store that month.

As far as leverage, I guess as Keith said earlier, when you get to the higher end the comp range that we've forecast, you should get leverage even if people are making max bonus, you'll still get leverage beyond that.

We try to manage this process so that we get leverage before that.

I think most of the things that will lead to challenges to leverage this year aren't store bonus related but related just to the, all of the challenge that we have on a comparable basis with CAF, with L.A. advertising, et cetera.

So we don't think we're going to be less able to forecast store bonuses so much as we have some headwinds that we're going into.

And on the incremental costs, I know you have some this year, you've had some in each of the prior years, if you could just kind of remind us what the separation costs were in your fiscal '05, the year just ended, compared to the year upcoming?

Do you want to talk about that?

They were about 4 million last year.

And as we indicated, the last remaining [vescue] is the data center which will be 2 to 3 million next year.

So on a year-to-year basis there's actually a little less of a drag than there had been?

Yes.

Thank you.

Thanks very much and thanks for joining us.

This concludes today's conference call.

You may now disconnect.