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CarMax, Inc. (NYSE:KMX)

F4Q08 Earnings Call

April 2, 2008 9:00 am ET

Executives

Katharine Kenny, Assistant Vice President, Investor Relations

Tom Folliard - President and Chief Executive Officer

Keith Browning - Executive Vice President and Chief Financial Officer

Tom Reedy - Vice President and Treasurer

Analysts

Matt Fassler – Goldman Sachs

Sharon Zachfia – William Blair

Seth Basham – Credit Suisse

Rex Henderson – Raymond James

Scot Ciccarelli – RBC Capital Markets

Matt Nemer – Thomas Weisel Partners

John Fox – Fenimore Asset Management

Bill Armstrong – CL King and Associates

Rod Lache – Deutsche Bank

Rich Kwas – Wachovia

Daniel Moore – Aquamarine Capital

Brian Nagel – UBS

Jordan Hymowitz – Philadelphia Financial

Scott Valentin – FBR Capital Markets

Adam Wright – Nicos Associates

Operator

At this time I would like to welcome everyone to the Fourth Quarter Earnings Conference Call. [Operator Instructions] Ms. Kenny you may begin your conference.

Katharine Kenny

Good morning, my name is Katharine Kenny; I want to thank you for joining us this morning. On the call today are Tom Folliard our President and Chief Executive Officer, Keith Browning our Executive Vice President and Chief Financial Officer and Tom Reedy our Vice President and Treasurer.

Before we begin let me give you a brief update on where we will be appearing. This is my little commercial. I will be in New York next week and at the end of the month. I’ll also be with management in Chicago in April and in California and Boston in May. We also have our usual analyst days that we do every month, May, June and July.

Let me remind you that our statements today regarding the company’s future business plans, prospects and financial performance are forward looking statements that we make pursuant to 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.

In providing projects and other forward looking statements the company disclaims any intent or obligation to update them. 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please see the company’s annual report on Form 10-K for the fiscal year ended February 28, 2007, which will soon be out of date, filed with the SEC in our subsequent filings. Now I’ll turn the call over to Tom.

Tom Folliard

Good morning everyone thanks for joining us. As you saw in this mornings press release CarMax just concluded a very challenging year and a disappointing fourth quarter from an earnings perspective. However, most of the earning shortfall came as a result of the turbulence and illiquidity in the global credit market especially for asset backed securities. Keith will describe the resulting valuation adjustments and increased funding costs we reported in a few minutes.

The good news, though was we reported 3% used unit comps for the fourth quarter and the full year. Above our most recent expectations and at the low end of the original guidance that we shared at the beginning of this fiscal year. Our ongoing belief is that CarMax will consistently outperform the competition in a variety of economic environments, primarily due to the unique aspects of our model. Our data continues to indicate that we are gaining market share.

Let me review a few of our key financial results. First sales, in the fourth quarter total sales increased 9% to $2 billion compared with $1.9 billion in the fourth quarter of fiscal ’07. For the full year total sales increased 10% to $8.2 billion from $7.5 billion last year. We opened three stores in the fourth quarter for a total of 12 during the fiscal year representing a 16% expansion over last year. At the close of fiscal ’08 we operated 89 stores.

Used vehicle revenues increased 11% for the quarter due to a 13% increase in unit sales and a 2% decrease in average selling price. The decrease in average selling price was primarily due to a mix shift as consumers focus on older more affordable vehicles and smaller more fuel efficient ones. During the fourth quarter we saw increases in traffic in both the stores and on CarMax.com as compared to last year’s fourth quarter and execution in our stores also improved.

In fiscal ’08 we sold more than 377,000 used vehicles, a 12% increase over 2007. Wholesale revenues remain flat during the quarter as a 1% increase in unit sales was offset by a slight decrease in the average selling price. Wholesale units grew less than retail sales primarily due to a lower appraisal buy rate. For the fiscal year we sold more than 222,000 vehicles at our auctions an increase of 6% compared with last year.

As for gross profit in the fourth quarter our total gross profit per unit decreased by $120 due largely to a decline in gross profit per used unit. A trade off we are willing to make in order to support unit sales in a period of weaker demand. Nevertheless wholesale profit per unit increased slightly due in part to strong attendance at our auctions. Total gross profit per unit for the full year was flat compared to fiscal ’07.

Now on to CarMax Auto Finance, I’m going to turn it over to Keith and he’ll review those results.

Keith Browning

Per Tom’s earlier remarks CAF had a very tough quarter. Many of the charges we took in the quarter we related to things beyond our control. Items related to the ongoing turmoil in the global credit markets. In total CAF income was reduced by $34.6 million or $0.10 per share and recorded a $1 million loss for the quarter. I’ll briefly review the three most significant items that contributed to that loss.

First, the discount rate, each quarter we evaluate the appropriateness of the key assumptions for our gain on sale model. Prior to the third quarter of fiscal 2008 most of our retained interest adjustments had been confined to prepayments, fees and loss rates. Recently we’ve also been affected by volatility in funding costs. Historically the assumption we used for discount rate has been 12%. We increased this discount rate to 17% this quarter reflecting the dramatic increase in market rates for investments in similar financial instruments.

This change resulted in a non-cash charge of $14.7 million which included an adjustment to our reported gain percentage in the fourth quarter. Remember that this change should impact the timing of future income recognition not the amount of that income. It essentially results in less income this year and more in future periods assuming that nothing else changes.

The second major adjustment was loss assumptions. We increased our cumulative loss rate assumptions to 2.9% or 3% for the four most recent public securitizations. We also increase the loss assumption on receivables in our warehouse facility. These loss adjustments total $8.7 million. As we discussed previously we feel comfortable with our current credit standards but we acknowledge that our losses are running somewhat higher than our originally projected due to the stress of the current economic environment.

We view this as a temporary cycle that has affected most financial institutions and it’s not unique to CarMax. We continue to regularly monitor losses and have tightened sub standards at the lower end of the range we buy. More recently we’ve increased down payments for these customers at that lower end which often times results in a sale financed by one of our third party lenders instead of CAF.

Third our funding cost increase as expected and as we discussed in our third quarter conference call we recorded a charge of $6.1 million due to the higher funding costs for our 2008-1 public securitization in January. Now I’ll turn the call back over to Tom.

Tom Folliard

I’ll talk about SG&A for a second. The SG&A ratio in the fourth quarter was 10.8% compared to 10.7% in the fourth quarter of last year. Last year included a $4.9 million impairment charge. Net income decreased $22 million or $0.10 per share from $42.1 million or $0.19 in last years fourth quarter. For the year net income decreased to $182 million or $0.83 per share from $198 million or $0.92 per share last year.

Now looking forward, our annual store growth plan of approximately 15% remains solidly in place during fiscal ’09. We expect to open 14 stores including seven production and seven non-production stores. Nine will be opened in new markets for CarMax. These include several larger markets, Phoenix and Philadelphia. While our plans are always subject to change we currently expect to open nine stores in the first half of the fiscal year.

The uncertainty of current market conditions in both the used vehicle market place and global credit markets mandates that we take a more conservative approach to our range of projections for fiscal ’09. We therefore project used unit comps in the range of -2% to 5%. Total revenue growth between 7% and 14% and earnings per share of $0.78 to $0.94. We expect to be able to deliver flat gross profit for used and wholesale units in fiscal ’09.

We don’t expect a significant decline in credit availability to our customers despite the fact that AmeriCredit will no longer be originating loans for us effective yesterday. Recently AmeriCredit had originated only about 1% of our loans and we anticipate the majority of these loans will be picked by our other third party lenders. We’ve been reassured by our remaining third party lenders that CarMax is an important part of their strategic business plans and we do not expect any noticeable impact resulting from their need to tighten lending standards outside of CarMax.

Our other lenders continue to tell us they prefer our loans which generally perform better than those of other dealers even in this stressed economy. We also regularly talk to and test additional lenders. While we continue to believe there will be a market at a price to fund CAF we clearly expect it to remain expensive relative to historic norms due to the current market disruption. Based on current spreads in the market place we anticipate CAF will absorb approximately $14 million in incremental funding costs when we refinance loans residing in our warehouse facility at year end which is approximately $855 million.

We also expect to see a continuation of the affects of economic stress on our originations resulting in loss rates similar to the higher levels we saw in fiscal ’08 which will also impact CAF earnings in fiscal ’09. While we will continue to look for opportunities to improve our credit underwriting at this point I would describe it as just fine tuning. We do not anticipate making any significant changes to CAF’s current underwriting standards.

Lastly, at projected comp levels we would expect SG&A de-leverage in fiscal ’09 especially as we plan to continue to spend on growth and selected strategic initiatives. Since we expect debt levels to grow we also project higher interest expense. Despite a difficult fiscal ’08 and a challenging fiscal ’09 we remain confident in the strength of the CarMax model and the ability of our associates to successfully help us achieve our long term goals.

We believe that CAF is a key competitive advantage that helps us provide higher value to customers and to our shareholders. CAF is more profitable even in extremely difficult environments like fiscal ’08. The average profit we recorded per vehicle financed by CAF in fiscal ’08 was roughly $600 still significantly higher than the average fee we received from our other lenders. It is in fact for just this kind of environment that we originally conceived of CAF.

Before I close and take your questions let me take a moment to thank the nearly 16,000 dedicated CarMax associates for all they do every day to help us achieve our short and long term goals. Now we’ll be happy to take your questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Matt Fassler with Goldman Sachs.

Matt Fassler – Goldman Sachs

A couple questions if we could. First on the gross margin side and your strategy of taking a lower gross profit per vehicle how do you think that worked out for you. It’s a bit of a departure from how you had come at the business prior to this quarter. Were you satisfied with the results and is it something you would expect to continue to pursue in 2008?

Tom Folliard

In fiscal ’09 we expect to be able to run flat margins year over year. We believe that our projection for comps sales reflects our ability to be able to deliver that and deliver in that range of comps. In terms of the strategy for moving margins to move sales, I talked about it at the end of the second quarter and that was at a time when we didn’t believe it would have had much of an impact. As things continued along the way they did over the next several months we thought it made sense to try and help spur sales a little bit with slightly lower margins.

How did it work out is very difficult to say. We are pleased with our sales results for the quarter, how much of that can we directly attribute to the lower margin is very difficult to say.

Matt Fassler – Goldman Sachs

A couple questions on credit. To the extent that you took the discount rate up to 17% from 12% if you could give us a sense as to the thinking behind that and whether that covers prospective securitizations, I don’t believe it does and what the implications of that higher discount rate are for sale ratio going forward?

Keith Browning

The discount rate covers everything that we have obviously financed so far. I can tell you that our forecast for next year does include anticipation of a higher discount rate at similar levels. We don’t see the stress caused by the global credit market changing dramatically next year and so it contemplates that we are going to see discount rates at similar levels. The thinking was generally that we saw credit spreads dramatically raise. If you go back since the end of the third quarter we’ve seen them raise over 200 basis points. It was hard to stand on our old discount rate of 12% given that dramatic increase which was really unprecedented in our history.

Matt Fassler – Goldman Sachs

You guided to gain on sales percentage significantly below the 3.5% to 4.5% range or well below. Does that include the $14 million item that you disclosed in your guidance for fiscal ’09 or is it incremental to that?

Keith Browning

It includes that.

Matt Fassler – Goldman Sachs

That is one of the factors. If you were to back that out would you still be below the 3.5% threshold?

Keith Browning

The answer is I really don’t know off the top of my head. I would tell you that we have a wide range on our earnings estimate really related to the uncertainty of what our cost of funds are going to be. Even backing that out would we achieving that, I don’t know. What the Fed is going do and its impact on us I don’t know. It’s part of the reason why we have a much wider range on next years earnings is the ongoing uncertainty with what our funding cuts are going to be.

Matt Fassler – Goldman Sachs

My final question, there is a piece of your sales pie that you do outsource a few other third party vendors some of that relates to sub-prime customers. How big a piece of the business is that right now and how much has that changed and what happens to it going forward in your forecast?

Keith Browning

In fourth quarter we had a nice increase from our true sub-prime provider. It actually contributed about a percent of our overall sales increase year over year. On an ongoing basis we don’t expect any substantive changes.

Matt Fassler – Goldman Sachs

Remind us who that provider is.

Keith Browning

[Indiscernible].

Matt Fassler – Goldman Sachs

How big a piece of the business has that become for you?

Keith Browning

For the quarter it was slightly less than 2%. It always has its peak of seasonality in the fourth quarter associated with income tax refunds. That’s why it grows dramatically; it will be on average less than 1% for the year.

Matt Fassler – Goldman Sachs

That’s the true true sub-prime customer.

Keith Browning

True.

Tom Folliard

That small percentage of sales is at a lower average profitability as well so even that whole amount of sales went away that amount of profitability wouldn’t go away.

Operator

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

Sharon Zachfia – William Blair

I have a few questions on retail and a few questions on finance. First on retail, I’m a little confused on the gross profit tightening in the fourth quarter because I know that velocity picked up in your comp but then it sounds as if you are projecting similar gross profit per vehicle in ’09 which implies to me your feedback on the test or the experiment was a little bit mixed in the fourth quarter. Can you talk through what you saw? I know Matt asked the same question but maybe in a little more detail. I know you have tremendous analytics so is there enough stimulation that you can have on demand if you drive down the gross profit to pick up sales or is it truly a wash at this point?

Tom Folliard

One of the problems is its really difficult to figure exactly what you’ve got for that money. Would we have gotten those same sales without the margin decrease, probably not? I can’t tell you how many percentage points of sales we picked up. When we tried to forecast all of next year assuming some movement in margin throughout the year and some changes in sales and looking at our projected comps we feel pretty good about our ability to be flat at the end of the year.

There is obviously going to be some movement throughout the year just like there was this year. When we look at the comp range that we set and our margin expectation we think we can deliver flat margins.

Sharon Zachfia – William Blair

As we sit here today do you still have somewhat tighter margins targeted on the loss?

Tom Folliard

I’m sorry, say that again.

Sharon Zachfia – William Blair

As we sit here today are you still targeting somewhat tighter margins on the loss in the first quarter, for example? I don’t mean to pin you down on quarterly guidance I’m just trying to figure out strategically whether what you did in the fourth quarter has continued into the first quarter.

Tom Folliard

I’m not going to talk about the quarter but I’ll tell you that we looked at the year, we looked at our ending place at the end of the fourth quarter and where we were on margins and we looked at our ability to manage through the next 12 months and we think at the end of the year we’ll be flat.

Sharon Zachfia – William Blair

Separately on the inventory expansion test which you brought up after the third quarter. Can you give us an update on how many stores that’s in and what you are seeing in those stores and how that might impact this year?

Tom Folliard

Right now it’s in roughly a third of our stores. We are in the early stages, pretty pleased with the results. We will probably expand it some in the beginning of the year. We want to read results on something like that for a much longer period of time than just three or four months. We want to see it run through some different economic situations as well. We are pretty pleased with it. This is not the kind of thing where you can specifically attribute ‘x’ number of percentage points for the inventory up test. We are pretty pleased with the results.

One other point to make is we had one set of stores that we tested inventory up in the fourth quarter, we had the majority of the stores did not have inventory up and sales on average were up in both groups.

Sharon Zachfia – William Blair

Are you going to the asset backed market in April, is that still the plan?

Tom Folliard

We’ll do our next financing in the first quarter whether it’s in the asset backed market or takes other shapes we are still working on it.

Sharon Zachfia – William Blair

In terms of the tighter credit standards at CAF do you have any idea how much market share you are likely to give up in CAF to third party lenders this year?

Tom Folliard

It won’t be significant. We did most of that adjustment at the end of the third quarter and the good news is we don’t think we saw any sales loss and didn’t see a significant market shift but there was some but less than a percent.

Sharon Zachfia – William Blair

On AmeriCredit, did I hear correctly that AmeriCredit that only generates about 1% of your loans because I thought it was much higher than that?

Tom Folliard

That was more recently. Obviously even much less than that if you went down to what you would call unique or incremental and that doesn’t even count that we have two layers below them that obviously would likely buy most of those if not all of them.

Operator

Your next question comes from the line of Seth Basham with Credit Suisse.

Seth Basham – Credit Suisse

Can I ask you a couple questions on CAF then a couple questions on the business? First on the plans for April, you mentioned doing some sort of financing, are you considering something else besides the ABS market and what’s going to determine where you go?

Keith Browning

We’ve been talking about exploring a couple alternatives to the ABS market. Because we are in April and we are going to do something in the first quarter it’s not a period where we can really talk more broadly about that but we are exploring our options.

Seth Basham – Credit Suisse

You didn’t specify if you expected an increase in cost of funding in the warehouse facility in 2008 particularly as that facility renews in July. Is that anticipated in your guidance?

Keith Browning

Quite honestly at the end of the day our ultimate cost is the public market or whatever form we choose. It’s implicit in there in the fact that that’s step one of our pricing and then step two is to go ahead and refinance ones out of the warehouse. I think it will be higher but it won’t have any impact on our guidance because the ultimate cost is what we are paying in the public market or other markets that we choose.

Seth Basham – Credit Suisse

As you think about where you are to finance these loans do you still consider yourself to be a prime lender as some of your losses push up against 3%? If they move above 3% what does that imply for spreads going forward?

Keith Browning

We absolutely believe that we are still a prime lender and I believe we can tap the ABS market should we choose to do so. What it may affect is there may be a change in enhancements if we linger slightly north of the 3%. Because this is affecting the market more broadly we believe the rating agencies and investors all will consider that and feel comfortable with the prime rating.

Seth Basham – Credit Suisse

Turning to the business on the wholesale side could you talk about why the buy rate decline and whether that was planned and whether you expect that to continue forward on the wholesale side?

Tom Folliard

I talked about the buy rate decline at the end of the third quarter and we thought that had a lot to do with consumer uncertainty, the economic environment along with the impact it had on our sales. This quarter you saw our sales were stronger than we expected but our buy rate continue to lag. To be honest with you we don’t know exactly why that is. There are a number of factors that could have contributed to it. We’ve been talking about negative equity for a long time and maybe that’s starting to catch up a little bit but we don’t have any specific number of points to that.

There is a difference in wholesale depreciation this year that we haven’t seen in a little while that may be also is contributing and I still think that consumer uncertainty pieces in there as well. Whether or not that will continue its very difficult for us to forecast that but our expectation is that we can at least maintain where it is right now and possibly build some time during the year.

Seth Basham – Credit Suisse

Lastly, on the guidance for costs for 2008 I know you don’t like to give quarterly guidance but how do you think about the cadence of that cost run rate throughout the year, do you expect it back half weighted?

Tom Folliard

You said it right the first time about not giving quarterly guidance. It’s not an easy thing to predict on a quarter to quarter basis and you can look at the way the cadence has gone in the past. You can’t make any sense out of it. We had 13 and 12 in the third and fourth quarter last year and this year you saw what they were for the two quarters ended. It’s very difficult to figure out for the year. We’d rather stick to the guidance for the year and be able to hit it.

Operator

Your next question comes from the line of Rex Henderson with Raymond James.

Rex Henderson – Raymond James

I think the CarMax Auto Finance questions have been explored in some detail; I wanted to ask a little bit about profitability and gross margin, return to that topic. You said that the mix shift had gone toward older and lower priced vehicles and I’m wondering how much of the gross profit per vehicle impact in this quarter was the result of that shift and how much of it was discretionary and what you are expecting going forward, any continued impact in that mix shift and what it means?

Tom Folliard

I can tell you that none of it was the result of the mix shift and all of it was discretionary. Any expected projection on the mix shift going forward our margins don’t flow based on that mix. They don’t flow based on whether it’s a fuel efficient car, an SUV, we have a variety of margin targets within each of those segments and the factors that contribute to those margin targets are unrelated to whether or not it’s a fuel efficient car or a sport utility.

Rex Henderson – Raymond James

I have a question on the portfolio, in taking the discount rate from 12% to 17% how much of an EPS impact is that if you could isolate that change what is the EPS impact on your FY2009 guidance?

Keith Browning

It hasn’t been calculated on 2009, obviously it was $0.04 for this year but I’d have to go calculate.

Rex Henderson – Raymond James

Would it be somewhere in that same range.

Tom Folliard

It’s in our expectations. It was $14.7 million for fiscal ’08.

Rex Henderson – Raymond James

It was $14.7 million in this quarter on the EPS line for this quarter I’m wondering what the impact is going forward?

Keith Browning

We’ll have to get back to you on that.

Operator

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

Scot Ciccarelli – RBC Capital Markets

I know you guys don’t want to talk about the cadence of the quarter itself but you do make a comment in the press release that sales were stronger than expected at the beginning of the quarter and what I’m trying to figure out is does that imply a slow down as the quarter progressed or were you already expecting some sort of ramp and it got back to expectations as the quarter progress there.

Tom Folliard

What it really meant was at the beginning of the quarter was when we announced the third quarter. When we set our expectations for the fourth quarter we are not referring to the timing of sales in the quarter we were referring to when we gave the guidance. The guidance at the beginning of the quarter a couple weeks in after the end of the third quarter and so from that point forward sales were stronger than we expected.

Scot Ciccarelli – RBC Capital Markets

Could you remind us how long your $300 million extension exists on the warehouse facility and what is the plan for that going forward? Could you expand that further, I know you said it’s an expensive extension that’s not something you were necessarily shooting for. Can you give us a game plan on that?

Keith Browning

It expires at the end of this month on April 30. As I indicated earlier what we are in the midst of is looking at the other alternatives. We believe that we could expand that again if necessary but it will depend on the timing of our next transaction whether we have a need to do so or not.

Scot Ciccarelli – RBC Capital Markets

I know you guys are still in exploratory mode but what is the most likely alternative is it doing whole loan sales or are there other things that maybe we aren’t considering?

Keith Browning

We set whole lone sales as a possible alternative and there’s another one or two that we are considering in this outside of the ABS markets. We don’t want to be more specific now since we are in the midst of discussions and negotiations.

Scot Ciccarelli – RBC Capital Markets

The last question is you referenced you are expecting flat margins in terms of gross profit dollars per unit in the wholesale business. If we were under more normal circumstances whatever that may actually be, lets just call it a better overall sales environment, would you expect any material change going forward in that gross profit dollars per unit or where you expect to be and what you think is a sustainable rate at this point?

Tom Folliard

We hope this is a sustainable rate. We are not aggressively trying to move that margin up. As I talked about before its an integrated piece with all the other parts with retail sales, with CarMax Auto Finance, with ValueMax and we are managing the total margin on a per used unit basis that we can deliver to the shareholders not each of those individual components by themselves. As I’ve said before you really can’t do that it has too much of an impact on other areas. If we were in a better environment I would have expected to have more units that we sold.

Scot Ciccarelli – RBC Capital Markets

The gross profit dollars that’s what we’ve achieved at the target and that’s not what you guys are planning for on a sustained basis.

Tom Folliard

Yes, as long as none of those other factors change which would cause us to make an adjustment.

Scot Ciccarelli – RBC Capital Markets

Related to that, given the mix shift that you are seeing towards lower end vehicles, maybe cheaper vehicles, does that have much of an impact on the wholesale side?

Tom Folliard

I don’t know. I don’t think so. I couldn’t really answer that.

Operator

Your next question comes from the line of Matt Nemer with Thomas Weisel Partners.

Matt Nemer – Thomas Weisel Partners

My first question was on the wholesale business. Could you discuss why you think attendance has been so robust and how is that end customer financing their purchase and have you seen any issues in that end of the market?

Tom Folliard

You would think there would be some more trouble there but remember that our average car is only a little over $4,000. I really can’t explain it. Our attendance has been very strong. Our attendance in the fourth quarter this year on a dealer to car ratio was stronger than it was in the fourth quarter of last year. There’s clearly still a market out there for that product and the dealers that we are selling to are buying pretty strong from us.

One thing that could be happening and this is sheer speculation is that some of the other sources that these dealers normally go to maybe they are spending more of their attention on us and not spreading their purchases out as much as maybe they would in a more robust environment. We sell 97% of everything that we run so it’s almost an absolute auction. When dealers come to our sale they know if they are the top bidder they are going to get the car. Maybe when there is a choice to be made, should I go to this auction or that auction we hope they choose us and it looks they have continued to do that.

Matt Nemer – Thomas Weisel Partners

Secondly, I was wondering if you have any significant additions to the consumer offer this year or new product launches. I’m referring to things like internet appraisals, direct internet sales, etcetera?

Tom Folliard

No, nothing that dramatic planned. As I’ve talked about in the past, continued refinements to all aspects of our business are the things that we are most focused on. We’ve obviously made a lot of progress on our website and on the internet. I can tell you that the chances of us doing internet appraisals without looking at cars anytime soon is slim to none. We don’t feel real good about making offers on cars that we don’t get to look at first. I don’t want to say never on that but it’s unlikely that we will do anything like that soon.

In terms of delivering the car and consummating more of the deal online, I think we continue to make progress in that area but we don’t expect to be able to consummate the entire deal online this year.

Matt Nemer – Thomas Weisel Partners

Lastly, regarding CAF can you comment on whether you’ve had discussion with private investors to sell off whole loans?

Tom Folliard

I think Keith has commented on that enough. We are in the middle of trying to get some stuff done here and it doesn’t make any sense for us to talk about all the different alternatives at this time when we are in the middle of trying to get some deals done.

Operator

Your next question comes from the line of John Fox with Fenimore Asset Management.

John Fox – Fenimore Asset Management

I have two questions; the first one is the $855 million in the warehouse you are going to secure some portion of this quarter and the $14 million will be against the gain on sales that you would take on that this quarter?

Keith Browning

To the extent we finance it. We will not be refinance the entire $855 million this quarter because there are requirements for some minimum number of payments before you can turn around and refinance the other channels. The majority of it yes.

John Fox – Fenimore Asset Management

There would be some additional costs assuming the markets don’t change if you secure ties in the second or third or fourth quarter is that correct?

Keith Browning

Right. It’s all contemplated in our forecast.

John Fox – Fenimore Asset Management

You are just breaking out the $14 million on the first securitization finance.

Keith Browning

Because it pertains to originations from a prior year.

John Fox – Fenimore Asset Management

I wonder if you could tell us a little more about the accounting on the discount rate change. Your last sentence in that little paragraph said it affects the timing of income recognition and the adjustment should result in higher levels of interest income in future periods. Could you talk about the amounts and how fast those might be recognized through the CAF income statement?

Keith Browning

I’d say the majority of them will flow through next fiscal year. We do expect a higher level of interest income on CAF next year.

Tom Folliard

That assumes nothing changes.

Keith Browning

The rest will come in in the next couple of years.

Operator

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

Bill Armstrong – CL King and Associates

Your decision to sacrifice some gross margin did that improve inventory turns during the quarter?

Tom Folliard

Strong sales improved inventory turns during the quarter. Whether we attribute that all to giving up the margin I couldn’t say as I said earlier. We had strong sales and I don’t know.

Bill Armstrong – CL King and Associates

When you lower prices on cars did you see them moving faster, another way of asking?

Tom Folliard

Remember we had a couple of different things going on during the quarter. We just talked earlier about the inventory up test so we had some additional inventory that we carried so our turns are actually slightly down this years fourth quarter over last years fourth quarter. Relatively speaking yes, we would think that we would have sold cars a little bit quicker but if you are carrying a little bit more inventory again its relative.

Bill Armstrong – CL King and Associates

Are you still hoping to use the asset backed securities market but you’ve said you are going to have higher debt levels? Do those higher debt levels refer to support your receivables or is this for other capital needs?

Keith Browning

We have $350 million planned CapEx so we are planning on spending more money for our continued growth plan. Currently we are anticipating that we will be having to support our receivables at least the sub-conscious for some part of the year which is part of the reason why we are anticipating a higher debt level.

Bill Armstrong – CL King and Associates

You would be retaining rather than selling in other words.

Keith Browning

Right.

Bill Armstrong – CL King and Associates

Just to clarify, the warehouse facility that’s all balance sheet to you, right?

Keith Browning

Right.

Bill Armstrong – CL King and Associates

Finally, you’re lowering your long term store growth target to the low end of your previous long standing range. Does this imply should we read anything into this in terms of your view of the long term growth prospects of the CarMax business model? Obviously your company has been viewed rightly so as a big long term growth retail story. How should we look at that?

Tom Folliard

I wouldn’t look at it like that at all. We talked about making this subtle change to the way we talk about growth for a long time. It’s totally unrelated to the economic environment. It really is actually, look at our last six years growth its averaged right at 15%. Like you said its long standing, we’ve been saying 15% to 20% for six or seven years. You look back at the last six years I think the actual number is right at 16%. We just wanted to put out a number that more accurately reflected the pace at which we’ve been opening stores and how we plan going forward.

Do I expect some year we will have 17% year and another year we’ll have a 13% year because of construction delays and things of that nature, absolutely. We believe 15% is just an accurate reflection of what we’ve delivered on for six years.

Bill Armstrong – CL King and Associates

No change then in your view as a long term growth prospects of the company?

Tom Folliard

None whatsoever.

Operator

Your next question comes from the line of Rod Lache with Deutsche Bank.

Rod Lache – Deutsche Bank

You said you are taking your money down percentages up for CAF what are you doing to retail rates at this point? Are you slowing down the pace of CAF originations, can you give us some color on what percentage of the business does CAF have and where is that going?

Keith Browning

CAF share of the business has been relatively consistent and quite honestly what’s happened because the spreads have widened the good news is that some of that has been offset by the Feds lowering of rates. Generally all in we are seeing no movement in the market place. We are not moving on our rates to customers either. They tell us on a regular basis with our three day payoffs if we are out of line and so far we feel like we are in great shape and don’t anticipate any major changes but we are obviously watching that on a regular basis.

Rod Lache – Deutsche Bank

Can you tell us where the warehouse stood at the end of March? Is it going up at $200 million a month kind of pace?

Keith Browning

Yes, in that neighborhood.

Rod Lache – Deutsche Bank

If losses do go above the 2.9% to 3% range does that have any implication at all on funding options for you longer term or is that a cost issue?

Keith Browning

I think it’s primarily a cost issue quite honestly. It will be enhancements, the timing of when we get the cash flows should that happen. I don’t think that there is a funding issue based on what we’ve been originating.

Rod Lache – Deutsche Bank

Lastly, you’ve talked before about a 6% organic growth or same store sales growth and an objective that you would need in order to avoid negative SG&A leverage. Can you talk about or give us any color on how you see SG&A playing out this year given your revised same store sales growth?

Tom Folliard

As I said we expect some de-leverage this year and we have said all along we need mid to high single digits to start getting some leverage as long as we are going to continue to invest in our growth plan and our strategic initiatives. This is a year where we are expecting some de-leverage at that comp range. If we deliver above the high end of the range on the comps that we’ve put out then we would expect to get a little bit.

Rod Lache – Deutsche Bank

Any thoughts on the magnitude of the de-leveraging is there anything that you could do to constrain costs in the interim or is that not part of the plan?

Tom Folliard

We are looking to contain costs all the time. We pay very close attention to that but at the same time we are investing in the long term prospects of the business. We are just trying to make the best decision we can each year about how we should spend our money in the upcoming year and that’s what we’ve done this year.

Operator

Your next question comes from the line of Rich Kwas with Wachovia.

Rich Kwas – Wachovia

I’m a little confused in terms of the $14 million. If you haven’t decided how you are going to fund the business for fiscal 2009 beyond maybe the next month or so with the public securitization is that $14 million related whatever financing you are going to do in the near term? I think you did mention that you factored in the higher costs associated with whatever you choose to do for fiscal ’09. How can you quantify that if you haven’t quite figured out which route you are going to take?

Keith Browning

The $14 million is looking at the most recent public deal that have been out done and anticipating that our costs will be similar to those. If you took the $855 million and looked at the more recent public deals that looked more similar to CarMax from a characteristic and how they got priced that’s what we used to actually go and calculate what that estimate is. It absolutely will likely be different. It could be slightly below $14 million it could be above $14 million depending on what our cost is and what form we take to go finance these.

Rich Kwas – Wachovia

Assuming that you have to do multiple securitizations as the year progresses and I realize that may not be the case but assuming that is the case then if spreads widen there would be incremental costs is that how we should interpret it?

Keith Browning

If spreads widen above what the more recent deals have done that will have an impact on CAF earnings. Currently we are basically saying the most recent deals we believe are indicative of where the market will be for the year and that’s baked into our forecast.

Rich Kwas – Wachovia

Essentially no spread widening beyond where it is now.

Keith Browning

It’s widened significantly over the last three months. Part of the bits as I indicated.

Rich Kwas – Wachovia

Do you benchmark that is that the most recent in the last couple weeks or do you benchmark that at the end of the quarter?

Keith Browning

We used the ones that occurred in March.

Rich Kwas – Wachovia

What was the recovery rate for the quarter?

Keith Browning

Recover rate was about 46% or 47%.

Rich Kwas – Wachovia

So that’s down fairly materially year over year.

Keith Browning

Correct and obviously that’s baked into our expectations as well.

Rich Kwas – Wachovia

Do you have any deterioration from that level or is that the assumed level.

Keith Browning

I can tell you historically we’ve seen recover rates for a year as low as 42% and as high as 52%. If recovery rates were to go to the lowest we’ve seen for any year could that affect us by another couple pennies, yes. Currently the answer is we are always dealing with a depreciating asset and I don’t expect it to be material in any case. That’s why we have that wider range around our earnings expectations because of the uncertainty of the current market place, that’s a piece of it.

Tom Folliard

All these factors that we talk about.

Rich Kwas – Wachovia

Finally, in terms of independent dealers on the wholesale business, any signs that it’s getting more difficult for those dealers to get financing to buy vehicles. Based on your commentary it didn’t seem that way but…

Tom Folliard

I answered a question on that as well I mentioned our attendance at our auctions was stronger this year’s fourth quarter on a per car ratio than it was last year’s fourth quarter. We haven’t seen it.

Operator

Your next question comes from the line of Daniel Moore with Aquamarine Capital.

Daniel Moore – Aquamarine Capital

In terms of capital allocation obviously I applaud your decision to continue to invest heavily in your business to continue to build out aggressively new stores and widen the mode of the business. Is there anything that you can envision be it change in environment, stock price, something else that would cause you to revisit how you are allocating cash flow in the near term?

Tom Folliard

I think I got asked this question last quarter and we pay attention to this all the time. This is not something that we look at once a year. We are looking at it every month, every quarter and deciding what should we be doing from this point forward. At this time, taking into account all the things that have happened this year, all the economic uncertainty but also looking at the strength of our business, the strength of our consumer offer, our confidence in our associates, our confidence in our ability to keep building stores in new markets we don’t see any reason to allocate capital any differently right now.

We also, obviously like everybody else we hope that this economic environment that we are in is temporary. We are looking at it all the time. If things continue to get worse then we would be more than willing to make the types of decisions we need to slow down if we had to.

Operator

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

Brian Nagel – UBS

With respect to the decision made in the quarter to sacrifice margin to gain sales. In terms of how you went to market with it you guys regularly mark down your cars as they sit on the lot. Is this simply an acceleration of that or did you do something different to advertise lower prices to your customers?

Tom Folliard

We don’t ever advertise, was this and is that in terms of pricing. Generally we let our model flow through. If we are going to go after lower margins then what it really means is when cars are made saleable we are shooting for a lower target at that beginning point. We didn’t go into the inventory and slice margin to do this. We managed our margin throughout the quarter and we did it as cars were made saleable. Once they are made saleable at a lower margin target then that lower margin target flows through our pricing curve.

Two summers ago, after Katrina and gas prices spiked we talked about going into our inventory and specifically cutting prices on gas guzzlers and big SUV’s and that was for a specific market condition that we felt we needed to address more aggressively. In this case that’s not what we did.

Brian Nagel – UBS

Is there any way then, as you look at the lower priced vehicles you sold, is there any way to gauge how the elasticity of demand for those cars. What impact this had on your sales which were pretty good in the quarter?

Tom Folliard

There is a lot of speculation around here at CarMax about what the affect is of $100 or $200 but I would tell you that we don’t have enough data to definitively tell you if we move ‘x’ then we will get ‘x’ in sales. Honestly we feel pleased with the results but if you said what would happen if you went another $200 I really couldn’t give you that answer. If you said what would happen if you didn’t take the margin cut, I would be able to give you that answer either.

This is the kind of thing that we are managing on a daily basis. We are not going into this and say this quarter let’s shoot for this, we are looking at it every day, every week and making pricing decision with all the best information we have and trying to do what we think is best for the overall business.

Brian Nagel – UBS

The second question I have, there have been a lot of questions with respect to your credit operations. More from a strategic standpoint, the issues right now seem to be probably near term so you are having to keep more large number of lines in your warehouse facility. At some point, if you look at your business model, is keeping a larger number of loans in the warehouse facility or the inability to secure these loans in a more timely manner, does that affect other parts of your business from a capital standpoint?

Tom Folliard

It hasn’t yet but part of going and expanding the warehouse facility was to give us some more flexibility. Taking the warehouse facility from $1 million to $1.3 billion just gives us a little bit more flexibility. If you are asking have we specifically taken some capital from somewhere else and allocated it over hear the answer is we have not done that yet. We did talk about having a higher debt this year so that is a decision to allocate more capital in this direction.

Keith Browning

We believe that’s related to the extraordinary unprecedented market and that will be temporary and so we think that a few years down the road who knows when we won’t have to make that decision again.

Operator

Your next question comes from the line of Jordan Hymowitz with Philadelphia Financial.

Jordan Hymowitz – Philadelphia Financial

On the wholesale side what range in your estimates to you have for wholesale vehicles next year from a high low dollar number in the estimate guidance?

Tom Folliard

Do you mean the price of the car or the margin?

Jordan Hymowitz – Philadelphia Financial

Price of the car.

Tom Folliard

That doesn’t move as much as you might think. It’s a little over $4,000. I think we have it budgeted…

Jordan Hymowitz – Philadelphia Financial

I’m sorry I’m asking the wrong question, I apologize. The gross profit per vehicle.

Tom Folliard

As I said at the beginning we are expecting to deliver flat margins year over year.

Jordan Hymowitz – Philadelphia Financial

Somewhere around $700?

Tom Folliard

I forget if we talk about it as a dollar amount or a percentage. Either way it’s flat.

Jordan Hymowitz – Philadelphia Financial

If there is margin pressure on the retail side might that follow down the line and give you margin pressure on that side as well?

Tom Folliard

Maybe. In this case it wasn’t but I think that’s more reflected in the volume than it was in the margin. We saw our wholesale volume this year did not track with retail. I think that that was more where we saw the impact was on a lower buy rate and lower units through the auctions. I think that’s where we saw that this year.

Operator

Your next question comes from the line of Scott Valentin with FBR Capital Markets.

Scott Valentin – FBR Capital Markets

With regards to CAF, the increase loss assumptions in the warehouse, I assume it’s just due to increased seasoning due to less frequent securitizations?

Keith Browning

It’s that and just the overall stress of the economy on our assumptions. As we saw our other pulls exceed our expectations we assumed the same trend that’s going on in the underlying market place will affect what’s currently in the warehouse facility.

Scott Valentin – FBR Capital Markets

Regarding the cumulative loss assumptions, the increase there, are you seeing any impact, I guess everyone is seeing impact from the housing market, any regional performance issues that you are seeing in terms of the southeast performing worse or better?

Keith Browning

I don’t have that and I’m not sure we’d comment on it if we did. We generally talk globally.

Scott Valentin – FBR Capital Markets

The stimulus package it’s supposed to get the checks go out in May, do you expect any measurable impact on credit performance there?

Keith Browning

We are actually hoping that we can get some customers to spend that with us and bring their delinquencies down and have a net positive and/or use that to buy a car.

Tom Folliard

We hope some of that stimulus comes our way.

Operator

Your next question comes from the line of Adam Wright with Nicos Associates.

Adam Wright – Nicos Associates

A couple quick questions, you mentioned that AmeriCredit was only 1% of loans in the quarter if I’m not mistaken and you mention that that as if it were higher in the past. I was wondering do last year or even a year ago, how high was it? I’m trying to get an idea.

Keith Browning

I think they had reached the height of 1.5% at some times in the past but like I said more recently it had been 1%. They way we really look at it is what are the unique opportunities that they are bringing to the table and what’s the likelihood of others picking that up.

Adam Wright – Nicos Associates

They were always very low, I was thinking much higher. I don’t know if you explicitly mentioned this but so far the impact of the credit problems has been pretty much confined to CarMax Auto Financing hasn’t it. It doesn’t seem like it has impacted the top line in terms of unit sales, am I right on that? To what extend to you expect unit sales to be impacted by the credit turmoil as opposed to simply funding costs, etcetera going forward?

Tom Folliard

For the year we came in at 3% comps, we set our range at the beginning of the year of 3% to 9%, if you look at the mid point of that its 6%. I think a lot of our miss on sales was related to the economic environment. If you look at the range we set for next year it’s the first time we’ve ever put out a range that the first number is a negative comp number. We are expecting this to still have some impact on our sales. We don’t think it means anything in terms of the long term viability of the business but we absolutely think it has impacted our sales.

Adam Wright – Nicos Associates

I know that when you all took your numbers down during the second quarter call I took that to be people pulling back away from larger ticket items as opposed to not being able to get financing. The difference between economic impact and literally not being able to get financing.

Tom Folliard

We are not anticipating a pull back or the lack of availability on credit to be a material impact, it’s really the broader economic impact that we are forecasting this on for softer sales.

Operator

Your final question is a follow up from the line of Matt Fassler with Goldman Sachs.

Matt Fassler – Goldman Sachs

Two quick things, I don’t think you got this question yet but what do you make of the delinquency trends the prior couple months disclosures. I know that seasonally the data that we tend to get for January and February and mid March tends to be a little bit better. The data that we saw last month seemed like it came down to a greater degree than the seasonal trends would justify. Is that significant in your view?

Keith Browning

The fact that we moved loss rates up in light of even those trends looking better really says that it is largely seasonal. That’s why we put a lot of weight on that. We absolutely focus on what we believe the true seasonality is in coming up with our loss forecast. The fact that we felt a need to increase in spite of the optics of delinquencies looking a little bit better said that we don’t believe that that’s anything other than seasonality.

Matt Fassler – Goldman Sachs

One other question, back to the fundamental core business. One of the questions we hear a little bit more about is that as your public full line competition grows out more comprehensive software packages like Auto Exchange, etcetera, that they are starting to get smarter when they come to market. If you could just address what you see transpiring competitively, have you seen any change at all in the efficiency of your competition as they come to market be it on the buy side, be it in terms of pricing or do you feel like the gap that you’ve come to market with historically remain in tact?

Tom Folliard

I think it remains in tact, again we haven’t seen dramatic changes in volumes from the competition. Again our average store sells over 420 cars a month. The average of the public new car dealers if you put it all together on used cars is about 50 cars a month. We have quoted that number for a number of years and it hasn’t moved very much. I’m not saying they aren’t getting better and they’re not doing a little better job but in terms of on a store by store basis we don’t really see it.

Matt Fassler – Goldman Sachs

Nothing in terms of the way they come to market at auction on the sell side or the buy side suggest any kind of real behavioral change?

Tom Folliard

Not that we’ve seen but it would probably be better to ask them.

Thanks very much for joining us today and once again I want to thank our almost 16,000 CarMax associates for all you to every day. Our employees are truly our most valuable asset. We’ll talk to you on the next call.

Operator

This will conclude today’s conference you may now disconnect.

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Source: CarMax, Inc. F4Q08 (Qtr End 02/29/08) Earnings Call Transcript
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