車美仕 (KMX) 2008 Q3 法說會逐字稿

Good morning.

My name is Lisa and I will be your conference operator today.

At this time I would like to welcome everyone to the third quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS).

Thank you.

Ms.

Kenny, you may begin your conference.

Good morning.

Thanks for joining us.

My name is Katharine Kenny.

I am the Assistant Vice President of Investor Relations at CarMax, and I am here on the call today with Tom Folliard, our President and Chief Executive Officer and Keith Browning, our Executive Vice President and Chief Financial Officer.

Before we get started I would like to do a little commercial for our analyst days in January.

The weather is a lot nicer in Richmond than it is where you are, and we have an analyst day on the 9th of January and the 24th, so we'd urge you if you have questions about this quarter's results to come to one of those days.

Before we begin, please 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 and providing projections 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 filed with the SEC and our other subsequent filings.

After the call today, Celeste and I will be available, as usual, to take your calls.

Tom.

Thank you, Katharine.

Good morning, everyone.

Thank you for joining us.

This morning we reported our results for the third quarter.

As we projected during our last conference call weak economic conditions continued to impact our sales, especially given the difficult comparisons with last year's third quarter.

However, our sales and gross profit for the quarter were consistent with our revised expectations, and our comp sales were stronger than many of our competitors from who our data shows we continue to take market share.

Total sales increased 7% to $1.89 billion compared with $1.77 billion in the third quarter of fiscal '07.

Used unit comps were flat compared with third quarter of fiscal '07, and we recorded a 13% increase -- when we recorded a 13% increase in used unit comps.

Total used unit sales grew by 9% compared to an 18% increase in the prior year, and contribution from new stores not yet included in our comp phase increased this quarter because new stores represented a slightly higher percentage of our total store base.

Our net earnings decreased 34% to $29.8 million or $0.14 per share compared with $45.4 million or $0.21 per share earned in the third quarter of last year.

Our weaker than expected third quarter net earnings were primarily the result of higher funding costs for CarMax Auto Finance and our short-term warehouse facility due to the well-publicized and unprecedented disruption in the asset backed securities market.

On to sales, total used vehicle revenue grew by 10% in the third quarter.

Customer traffic continued to grow during the quarter, but sales conversion rates remained below the third quarter of last year.

While credit remained available at previous levels for our customers, we believe more of them were hesitant to commit to big-ticket purchases in the current more uncertain economic environment.

Wholesale vehicle revenues increased by 4% in the third quarter due to slight expansion in both our average per unit selling price and units sold at our auctions.

Over the long-term we expect our wholesale unit sales to increase consistent with our used retail sales and year-to-date retail used unit sales have grown approximately 11% while wholesale unit sales have grown by about 8%.

We opened five superstores in the third quarter including a production store in Charlotte and four nonproduction stores in Atlanta, Newport News, Los Angeles and San Diego which is a new market for us.

Our inventories increased by somewhat more than the requirements of newly opened stores.

During the third quarter we enlarged our inventory expansion test, which we have been running through the summer, which proved promising in our initial trials.

We increased inventories in some of our stores by about 50 to 100 vehicles.

We will continue to monitor the impact of higher levels of inventory on our sales, which will have a slightly negative impact on our turns.

As far as gross profit, the third quarter is normally our weakest quarter in terms of sales and gross profits due to the usual seasonal slowdown in traffic and high vehicle depreciation.

Our last two third quarters as we've talked about before have been exceptional for reasons we discussed at that time.

This year's third quarter represents a return to more normal seasonal patterns.

On the CarMax Auto Finance, I'll give you a few more details to start.

CAF income fell $16 million in the quarter.

CAF income includes the previously announced charge of $8 million related to wider spreads and higher swap unwind costs related to our September public securitization 073.

Higher funding costs in our warehouse facility reduced CAF income by an additional $4.6 million related to loans remaining in the conduit that were originated in previous quarters.

The higher warehouse facility costs also negatively affected the gain recognized on loans originated in the current quarter, reducing our third quarter gain percentage to 3.6% compared with 4.3% in the prior year's quarter.

In addition, this quarter's CAF income reflected an immaterial net charge of $1.5 million for several favorable and unfavorable adjustments to our loss assumptions on previous securitizations.

Included in this charge was the effect of increasing the cumulative loss assumption on the 071 deal, the highest of our securitizations from 2.7 to 2.8%.

As far as SG&A, our SG&A ratio of 11.2% reflected the expected deleverage that resulted from flat comps, in our last conference call we discussed the fact that short-term industry conditions would not impact our plant investment and our long-term growth plan or curtail our ongoing operational, strategic and Internet growth initiatives.

It is our intention, however, to continue to monitor changes in the marketplace conditions and manage our overall level of spending appropriately.

For store growth we now expect to open 12 stores this fiscal year as our Modesto, California opening has been delayed for a month due to normal construction delays.

As of the end of the third quarter we had opened nine stores.

We opened Omaha, Nebraska last week, and we open up our Jackson, Mississippi store today.

In February we will open a new store in Ellicott City, our sixth store in the Baltimore, Washington market.

In our press release we also included a list of the 10 stores we're currently planning on opening in the first three quarters of fiscal '09 with the usual caution that opening dates are always subject to change.

On to our expectations; looking forward, we now project full-year comparable store used unit sales growth of approximately 2%.

However, the volatile conditions in the financial marketplace for asset backed securities have convinced us to lower our earnings expectations for the full year to a range of $0.87 to $0.93 per share from our previously reduced range of $0.92 to $0.98.

We reported $0.92 in fiscal '07.

Our CFO, Keith Browning, will provide you with more color on our earnings expectation, including the changes in our projections for funding costs and CAF in a moment, and then we will be happy to take your questions.

Let me say once again we believe our superior consumer offer is unique in the industry and should allow us to outperform many of our competitors in both the short and long terms.

It still remains unclear how severe and long-lasting this current economic slowdown will be, but we will outline our expectations for fiscal '09 in our fourth quarter press release and earnings call.

We continue to project long-term comps between 4% and 8% and store growth between 15% and 20%.

We also remain confident that CarMax Auto Finance, even in a difficult environment, is critical to our ongoing operations and overall profitability.

I also would like to thank our 15,000 CarMax associates for all they do every day.

We couldn't do it without them.

Now I will ask Keith to add his comments.

Keith.

Thank you, Tom.

Good morning.

Our previous updated range of $0.92 to $0.98 included the $8 million additional costs related to our 2007-3 securitization.

In addition, this included higher costs for our next public securitization, which we anticipated would occur in the fourth fiscal quarter.

Unfortunately, we had not yet experienced the increase in spreads on asset-backed commercial paper to support our warehouse conduit.

Nor did we anticipate that spreads would widen further in the public asset backed securities market.

So our revised forecast for the year includes higher spreads to fund our conduit.

As Tom reviewed, in the third quarter we incurred a charge of $4.6 million for loans originated prior to the third quarter.

In addition, our new forecast includes the impacts of the higher funding costs on third quarter originations, and contemplates that those costs will remain at similar levels for the remainder of the fiscal year.

Despite wider spreads we expect the gained percentage on originations will remain within our normalized range of 3.5% to 4.5%, although probably well below the midpoint of that range.

We also now expect that 5 to $6 million in higher costs have been projected on our next public securitization assuming that spreads stay fairly consistent with the recent ABS deals contemplated or completed by GMAC and Chrysler.

However, because we believe there is a significant backlog of ABS deals waiting to go to market and since we would like to have as much flexibility as possible, we've arranged a temporary increase in our conduit capacity of $300 million to $1.3 billion.

Now we would be happy to take your questions.

(OPERATOR INSTRUCTIONS) Seth Basham, Credit Suisse.

Thank you for taking my questions.

If we could focus a little bit more on the CAF side, and Keith thank you for your comments outlining the ins and outs of the CAF income, but if you could be a little bit more specific related to Q4 and what the actual CAF income number is that you are expecting.

CAF income is obviously -- I think I have given you the detail.

We expect a similar challenge on the conduit costs being (technical difficulty) higher than what we have been running or a higher spread, which means the gain spread will be below 4% for CAF based on originations.

But telling you the specific numbers, kind of a level of detail we haven't actually gone to historically, and that is why we give a range around it anyway because there is some uncertainties.

Okay, so the lower gain on sales spread coupled with increased sort of valuation adjustments so to speak associated with doing an ABS deal would bring your CAF income below $20 million?

Is that the right way to think about it?

That is the way to look at it.

Okay, thank you.

And as we go forward into 2008, how do you expect -- and it is a very tough question to answer -- but how do you expect the ABS markets to perform, and how do you think about your options for the CAF business?

Quite honestly, I can't forecast what is going to happen.

I think that we will watch very carefully.

We are cautiously optimistic that the markets will stabilize over time.

It is just a matter of how fast will they stabilize.

I think we are also very confident, however, that there is a market at a price.

So while funding costs could remain higher, and CAF spreads could actually remain somewhat challenged, we are viewing this business is critical to our ongoing operations, and we are very confident that we will be able to continue to contribute to the business to the extent the market lets us.

And just lastly on CAF, can you give us more details, which other pools did you raise the loss rate assumptions on besides 2007-1?

We raised the loss assumptions on the more recent pools and had offsetting adjustments in the other pools.

So 2007-2 and -3 would be included in those more recent ones you're referring to?

Yes.

Okay.

I'll let others ask.

Thank you.

And one thing on that, Seth, in terms of our loss rate assumption changes we've now gone five consecutive quarters without a material adjustment as it relates to the loss rate assumption change.

So all the volatility we are seeing here is from the cost of the asset-backed securitization.

Understood.

Thank you, Tom.

Sharon Zackfia, William Blair.

I have a few questions on CAF, and then I will move to retail.

But the 5 to $6 million in additional costs in the February quarter, that is if the securitization occurs, or can you clarify that?

That's correct.

That is assuming the securitization does occur.

So if it doesn't, then that is a cost that would move into the next fiscal year.

Okay, and is that just kind of truing up, then, the warehouse facility with the public asset-backed spreads out there?

It is just the real differential in the costs between those two particular facilities.

The conduit is such a short-term facility that the spreads that the market is commanding are significantly lower than the warehouse, the public markets.

Okay, and then are you -- have you switched to LIBOR swap now rather than asset-backed or commercial paper swap?

Yes, we have.

Okay, and kind of moving onto sales, Tom, can you comment on your sales trends in the quarter?

It sounds like they were relatively consistent.

Is that a fair assumption, and did you see any kind of major regional disparities?

No, I think one of the things I didn't probably talk about enough is we set our expectations at the end of the second quarter for the rest of the year and really for the third quarter.

You saw we put a range out of one to three for the year.

We've now tightened it to two.

So we're pretty much right on track for the third quarter with what we expected.

It is really all these additional unexpected funding costs that are the thing that has changed our earnings.

Okay, and when you implemented the Beta of CarMax.com or I guess it is not a Beta anymore and I know it has been relatively recent.

Can you give us any kind of first look on what that is doing to your traffic in the stores?

It is hard to translate that directly into traffic.

One thing we can look at is what is the impact of the customers who come to CarMax.com and they go through the new search and ultimately end up with a lead and we feel like we will get an increase there.

It is awfully early.

We've only rolled it I think over the last two weeks.

So I think we would probably give you a little bit more color on that at the end of the fourth quarter.

We are pretty confident that that, along with other ongoing changes we make to CarMax.com continue to enhance the consumer experience on the website and make it more likely that they will contact us and ultimately more likely that they will show up at the store.

And then lastly, can you remind me what is the inventory expansion tests?

I'm not sure that we had mentioned that before, but what we have been trying to do -- and as we've talked about many times we are always running tests to try to spur sales.

And one thing we've tried to do on occasion and done it for over ten years is move inventory levels around to see if it has an impact on sales in those stores.

We started with about 20% of our stores.

It wasn't really big enough for us to talk about.

It didn't really have much impact on us financially.

We are pretty encouraged with some of those results, and so there is only about a I think about a 2% inventory difference in our total dollar amount.

But I figured we'd talk about it and tell you we are going to continue to run that through the fourth quarter and see if it has a difference.

And like any other test we do, we will keep a control group stable.

We will rate the inventory levels in subset of stores and see if it impacts sales.

Are you moving inventory in some particular way?

Is it going lower ticket, higher ticket, (multiple speakers)

You know how we do our inventory management is basically based on segments and pricing and mileage and different types of cars.

And it will be consistent with whatever the store -- if we raise a store 50 to 100 cars, it will be consistent with what that store is already selling best.

So it would be very controlled and very analytical how we raise the inventory.

But it will be store specific based on that store's trends.

It is a weird time of year to be testing this, isn't it?

I think it is actually a pretty decent time of year because if you're going to run something like this and it's going to work, it's going to work all year.

Okay.

We think it is all relative.

If it works in the spring in high sales time it should work in the fall when our sales are a little bit lower, and remember the inventory levels will be relative, too.

The base inventory level will be lower in the fall so the place from where you start is a little lower.

In the spring the base inventory level will go up, and the increment above would be similar.

I guess I'm trying to (multiple speakers)

And we've already gone through our fall depreciation cycle.

I'm just trying to reconcile in my head.

I thought one of the advantages of the Internet becoming more prominent in your business was maybe that you were transferring inventory, more customer requests in between stores; so maybe eventually you would have less inventory on the lots.

But it sounds like that was the wrong conclusion.

I think it is too early to determine that, Sharon.

I think as our brand gets stronger I believe that what you just said is actually true, and I feel like we will be able to leverage it more.

But if in short increments we can -- 50 or 100 cars doesn't cost us very much money -- and if we can get more sales out of it, then it's worth it.

And it is that many more cars that are available to consumers in other stores, as well.

And again, this is only a subset of stores, and it is not a big percentage of our total inventory.

Okay, thanks.

Scot Ciccarelli, RBC Capital Markets.

A couple questions related particularly to the CAF situation.

We are still seeing pretty big spreads between the delinquency rates trends and the loss rate trends.

How do you guys think about these trends going forward given the concerns we're seeing in the broader credit market?

As we've indicated before, a lot of the difference in delinquencies was anticipated.

We actually bought a set of customers in the new scorecard that actually tested before we put in the new scorecard, that actually we knew had delinquency patterns and payment patterns that weren't as consistent.

However, we also know that based on our test results anyway, that those customers are still likely to pay a car loan because it is a very high priority payment.

So we do believe that if you look at our prior originations and the losses associated with delinquencies that those are kind of apples and oranges comparisons in that we do expect that delinquencies at a higher level won't translate into losses at the similar levels that you would have seen historically on our pools.

It is not a direct correlation from delinquencies down to the loss rate, and aggressive follow-up and aggressive servicing of the loans is something I think we are very good at.

And as I mentioned earlier, we've now gone five consecutive quarters without a material adjustment as it relates to the loss rate assumption.

Yes, but I mean --.

We feel pretty good about the performance of our portfolios in that regard.

Right, no, I understand that.

But I guess to be fair we've now seen two quarters in a row where we have had an increase in loss assumptions for the one particular securitization.

And that is one of the ones the 2007-1 that had obviously materially higher delinquency rates.

Is there something unique about that pool that is causing you to make the changes to those assumptions but shouldn't apply to others?

I will remind you that when we talked about 2001 last time it was the earliest in life we had ever made an adjustment.

So with the three more months data we feel very confident that we're actually now at a point where there is enough maturity and seasoning that there will not be any more material adjustments to that particular pool.

So we are making adjustments given the economic environment a little earlier than historically or than we would have normally made.

So we feel as confident as anyone can in predicting the future based on the underlying mix of the portfolio and looking at them relative to loss timing curves.

And if you go back to those first couple deals, we have done some tightening in our originations with the more recent loans that we've originated in the store.

And remember, too, that once another three months has gone by in that pool there is less balance left there.

So a 10 basis point move is going to be less impactful going forward because there is not that much left in it.

Thanks.

That's helpful.

And the other question is you talked about you really haven't seen any tightening from your third party lenders but I can tell you that out in the marketplace some of the people in the auto lending sector are -- it seems like we are kind of at the front end of the beginning of tightening.

And Americredit and Capital One Auto Finance, for example, both have been public talking about tightening standards.

Have you guys started to see any of that yet?

Not yet; we are actually calling them proactively because we recognize that they may have to do something because of the broader macro economic conditions and asking them to let us know before they do it so that we can understand what they are doing and why they are doing it.

And obviously we are taking the opportunity to remind them during those conversations that our portfolio outperforms their other books of business from their other lending channels.

So, so far there hasn't been any changes.

So far there has been positive feedback that they don't intend any changes again because our portfolio outperforms their other books of business.

It doesn't mean it won't happen, but I can tell you that we are in constant communication with them, and they really do appreciate the origination channel that CarMax provides and the consistency of performance.

That is helpful.

And the last question is shifting gears to the wholesale operation.

We saw another pretty nice increase in terms of gross profit dollars per unit, we are nearing that $800 dollar level.

Tom, is there anything going on in the market or within CarMax's wholesale operation that can help you continue to drive that forward?

Because that has obviously been a pretty important profit lever for the company over the last couple of years.

Yes, it has, and I'll tell you we are reluctant to push too hard there because of the reasons I mentioned in the past, the impact it could have on our sales.

So you saw our rate actually go down, I mean our rate of growth is down a little bit this year.

I think the impact that we've seen on conversion on the sale side, we see that same impact where there is some hesitancy from consumers to sell us their car.

Our offers are lower now than they were in the spring and summer as they usually are in the fall and maybe even a little bit more impacted by the trends we see in the industry.

So our buy rate is down a little bit and was down a little bit in the third quarter, so I think some of that is reflected there.

Okay, so you are starting to see some hesitancy on the part of consumers?

We see it -- I just talked about it on the conversion side of when they are ready to pull the trigger to buy a car, but we also see it when they are about to sell their car.

That is very helpful.

Thanks a lot, guys.

Rex Henderson, Raymond James.

Thanks for taking my question, again.

A couple of cleanup questions on the CAF portfolio.

Can you give us a number, the amount of loans originated and sold in the quarter?

Sure, 574 million.

574 million originated and sold?

Correct.

And just a follow-up on that.

Have your lending standards remained consistent?

Have you made any changes or tweaks to those lending standards in the last couple quarters in light of what is going on with consumer credit?

We actually made very minor tweaks at the end of the third quarter.

So we don't think you will see it in sales and obviously we made those with that in mind.

And our lending partners would pick up those loans in that there is just a level of risk where we are constantly trying to do the analysis of what are we buying that we shouldn't be and what are we not buying that we should be.

And that was just a result of that but very minor.

So you are taking a little bit less risk than you were.

Can you give us any color on how that has changed?

What the change was?

Basically at the lower credit tiers we are actually asking customers for a little more equity.

Okay.

One thing I would like to add is everybody -- I think the big concern is when a customer walks in the door at CarMax, is credit available to them.

And if we look at 100 loan applications and some percentage of those are going to get approved by CarMax Auto Finance or BofA, which are kind of our prime lenders and then the rest go on to our nonprime partners, the percentage of total applications that are getting an approval for finance has hardly moved at all.

I think people think that number would be dropping dramatically, and I can tell you that that number has not moved hardly at all this year, even into the third quarter.

So when a customer walks in the door is credit available to them at the same level that it was before in terms of percentages?

The answer is absolutely yes.

And are there rate changes?

There are, but this is not the worst rate change environment we have seen in terms of the effect of APR rate to consumer.

It is actually not even close.

The impact, the funding costs on the back end, but even after you factor that in it is clearly more profitable for us to have CarMax Auto Finance as one of the partners, not just from the additional profitability that it adds, but also from our ability to learn and our ability to add incremental sales.

Okay.

Moving on to the retail business, I am wondering about what you are seeing in the wholesale market for used cars.

The information I have suggested wholesale prices have been relatively firm while the retail demand has actually been off some.

I'm wondering if you are seeing that same thing and what impact that may have on gross margins going forward.

Last month (multiple speakers)

The last month only, yes.

Our wholesale prices have been I think relatively firm for the year.

But in the last month, if you look at the Mannheim Index it has declined somewhat.

And that is actually kind of what we expect seasonally.

The last couple of years I think we've had a little bit of a prop up in the wholesale market two years ago related to Katrina; last year I am not sure we really understand.

This year looks a little bit more normal for us in terms of a depreciation into the fourth quarter on the wholesale side of the business.

And that index is across all vehicles sold.

We're not a buyer for all of those cars, so when we are in the market buying cars right now, things are about what we expected them to be.

So you are not seeing any pressure on the gross margin line then?

(inaudible) if I can translate that answer.

Well I think we were $12 off our gross margin this year's third quarter compared to last year's third quarter, so it has not impacted our results in terms of our margin per car.

Okay, thank you.

Matthew Fassler, Goldman Sachs.

Good morning.

A couple of follow-up questions.

The test that you conducted on this new group of customers that had higher expected delinquencies, at what point in time did you run it?

That was back in 2005.

So I guess I'm curious if this is a group of customers that was more inclined in a pretty robust environment to come under payment pressure given that clearly the credit consumer credit environment has changed notably, particularly since September I guess is when the broader market really started to see it.

Does that change your thinking about that customer's likelihood to make good on their obligations?

I will go on and say we've been originating those customers in 2006, 2007.

And some of the pools where we made favorable adjustments were on those very customers for the 2006 origination pools, for example.

So the answer is, based on a combination of mix and timing curves and everything we know, we believe we think the loss is as accurate as anyone can forecast.

Thank you.

Secondly, in the retail business you spoke about traffic and lower conversion.

From a selling process perspective what are the things that you are able to do to combat that customer reluctance in terms of selling tactics or follow-up or anything like that?

Matt, you know how our business model works.

And as usual, there is never a silver bullet to change an execution trend.

It is generally our normal blocking and tackling and how we overcome objections with the consumer.

I think we've seen a level of reluctance from the consumer that we are not used to and we hadn't seen before.

So since we do not negotiate on the price, we do not negotiate on the trade in and we do not negotiate on the financing, there certainly isn't any manipulation we can do with the numbers to get the consumer to behave differently.

So for us really it is just more of the same and trying to figure out if we can just get more consistent with those different aspects of how we manage the process.

It is no different for us than it is any other time of year.

We are just running into a slightly more difficult environment.

Understood.

And then finally, if you could give us some sense of what you are seeing from your competition, to the extent that not everyone is experiencing the same credit flexibility that you are.

Maybe sources of funding are drying up elsewhere I guess that could certainly be seasonable.

Are you seeing your competitors pull back if you think about the looks that customers are getting away and is that helping you competitively?

That is very difficult to ascertain because of the fragmentation that we see from our competition.

It is just so fragmented and so different in every market.

If we look at how we are projecting to finish out the year now it will be, we are now expecting a 2% positive comp for the business.

And if you take out all of the funding, unexpected funding costs we would have grown our earnings slightly.

And in this environment I actually feel like that is pretty good compared to our competition.

If you look at our used car comp unit spread, they have continued to be pretty significant between us and our competition.

Our quarters don't match up but if you look at our first three quarters this year which are now finished, we had a 3% positive comp, if you match up against the competition it is about a negative 3.

So there is a spread there that remains fairly consistent.

And we feel like we continue to gain share.

Thank you so much.

Brad Thomas, Lehman Brothers.

Wanted to follow up quickly on some of the questions about your loss assumptions and how you've changed those.

I know at the end of the last quarter the upper end of your assumptions had been around 2.7%.

Could you just quantify what that upper end has gone up to now?

It is 2.8%.

The only pool we changed up was the 2007-1 from 2007 to 2008.

Okay, and are you still feeling comfortable that 3% is about the maximum level that you all would ever target?

One of the things we've said is that we are targeting a prime portfolio in the public markets view, 2%, 3% or less is prime.

So that is clearly one of the reasons why we targeted 2% to 2.5% is it did give us room for economic fluctuations that may come and go and stay prime.

Got it, okay.

We are still targeting less than 2.5 on the stuff that we are originating now.

And remember, we are always applying whatever it is we've learned off of the performance of the additional pools.

And we apply that going forward.

So we've learned a lot in the last year.

And every quarter or every month that we see more performance and we look at delinquencies and how they translate into loss rate, we are applying that learning into our origination strategy.

Okay, and some of the moderate tightening that you had mentioned is in order to maybe get those loss rates down on some of the newer loans.

Is that correct?

Yes, and it is just our normal the way we are going to operate the business.

So I think what gets lost in this is what Keith mentioned earlier is all of our movement up into the 2.3, 2.5 loss rate range is on purpose.

We were running 1.3, 1.5 -- we were running at rates less than what we had booked the deals at.

We were taking positive adjustments.

We took $25 million of positive adjustments over the last two years, and our goal was to get back up into that range because we were giving up both sales and profitability on the front end at the time to book the deals.

In terms of the loss rate performance I feel great that we've gone 5 quarters without a material adjustment.

Okay, great.

Then just a follow-up on the gross profit for the other line, it seems to be down year-over-year.

I was wondering if you could talk about some of the drivers behind that.

(inaudible) Yes, I mean, that quarter I think our year-over-year was only down $12.

I think we are down sequentially from the second quarter to the third quarter.

Is that the line you're asking about?

I wasn't sure if you were seeing a lower attachment rate from extended warranties or lower third-party finance revenue.

No, we have not seen a lower attachment rate on warranties.

I think some of it is service.

Some of it is like the leverage on service due to the flat comps.

And in addition, [drive] actually increased their overall buying versus a year ago.

So that actually -- because we pay a discount to them offset some of the income we are getting from the other third-party providers.

And that is not a big number, but that impacts our total finance fee income.

That is a little bit of an odd dynamic there where if we get a little bit more drive income it actually decreases the fee income.

Okay, and then one last question.

In terms of your car buying pattern are you seeing any change in the traffic level in your stores?

Have the customers that come in to get an appraisal?

Since it is really our -- I talked earlier about our buy rate going down so that is of the ones that we appraise, if we look at that year-over-year we are down some, and I would attribute that to the same hesitancy that we've seen from the consumer on the pulling the trigger on buying a car.

Okay, great.

Thanks so much.

Edward Yruma, JPMorgan.

Thanks for taking my question.

You've made some changes to the website recently.

Can you talk about some of the metrics that you've looked at in terms of whether customers are using it more and how that may be helping offset some of this macro weakness?

The metrics we are looking at are the same metrics we always look at; how many people come on the website?

Of those people how many do a vehicle search?

Of the ones who do a vehicle search, how many get down to a specific fact sheet?

When they get to a specific fact sheet how many of those contact the store whether it is from phone or email?

So the metrics that we are looking at are the same.

And then of the ones who contact us, if we can track it specifically how many of those actually show up at the store.

And then we take them through the same waterfall metrics we do in our store right down to seeing if they actually buy a car.

So the metrics haven't really changed very much but what we are -- if you look at each aspect of that business, I mean of the website, we are trying to increase each of those areas.

We would like more people to visit the website, which we have done a little bit.

We are starting to do a little bit more advertising about our website partly to advertise our new search.

Once they get on the website is it more appealing to them because we have more photos?

Because we've redesigned the landing page, we've redesigned the fact sheet.

And I think right now our early indications that all those things are going pretty well.

But again, it is an ongoing process for us.

We are not satisfied with where the website is.

We want to be the best website in the industry.

We want people to be able to come on our website, not have to go to any other sites.

We want them to be able to do their research, their shopping.

We want them to be able to compare cars.

We have consumer reviews that we've added to the website.

So for us it is a big strategic investment that we are going to continue to try to make improvements on.

And should the credit markets remain volatile what is your ability to ratchet up the warehouse facility once again?

At this point we think that we really tapped the short term limits.

What we would do is if the markets remain volatile is we will consider other alternatives which might include a whole loan sale.

And my final question, has this changed then, the percentage of prime financing that goes to CAF versus BofA?

No, not at all.

Very good.

Thank you.

One additional thing to remember is any alternative strategy for funding would mean less profit.

If we get -- CAF provides more profit on a per unit basis than if a car goes to another lender.

And going to a straight commission and just originating those loans for somebody else, going to a whole loan strategy, any of these strategies compared to the way we are doing it, even in this environment would mean less profit.

Great.

Thank you very much.

Bill Armstrong, B.L.

King & Associates.

I think my first question was answered, so your warehouse capacity now is pretty much tapped out is what you are saying.

So what would your other options be if securitizations are really, are not in the cards in the near-term?

The warehouse facility may be expandable, but at a price.

It is just like I believe the ABS market is there at a price.

I think that the warehouse facility we could probably expand it more if we wanted to pay a price, and we will just have to weigh those alternatives.

And did you mention whole loan strategies as a --

Whole loan is the same thing and I think that that is probably even more expensive than anything we could currently anticipate from the ABS market.

Whole loan meaning you would keep those loans on your balance sheet and just service them?

No.

We would absolutely sell them, and we would either service them or actually get the results from if the purchaser wanted to service them.

Okay, so who would you be selling them to if you can't securitize them?

Banks.

Okay.

Are you able to get higher interest rates from consumers now to reflect the higher funding costs to the CAF?

That is what it is a little bit unusual is that historically what we've told you is that when funding goes down consumer expectations lag so we get a higher spread.

And when funding goes up the opposite occurs and we get squeezed.

The consumer today is actually seeing costs going down so they are seeing the Fed decreasing rates.

And yet our real costs actually have moderated up because of the spread issue.

And so there is a little bit of squeeze there.

And I think what will happen is if it stays you will see that the market moves upward and we will move with the market as we can.

But there could be a little bit of a squeeze given the fact that we have an unusual dynamic here with consumers seeing rates going down and yet our actual funding costs are going the opposite direction.

Presumably, only your competitors are seeing funding costs rising?

Well, that's exactly right.

That is why I am thinking that we will all be been moving as we can afford to move.

Right, okay.

And did I hear you say earlier that CAF income would be less than $20 million for Q4?

No.

I was basically agreeing to his logic.

I wasn't agreeing to the number.

That is not a number that I would endorse.

His logic was is that would we take the higher spreads in the quarter and then the $5 million to $6 million on top of that.

And I said that is correct.

I wasn't endorsing the actual earnings numbers that he quoted.

Okay, thanks for the clarification.

And finally, your implied Q4 earnings of $0.14 to $0.20, obviously a wide range, tightened your same-store sales outlook.

So I assume that the variability really is -- I just want to clarify -- just focused on CAF really rather than the retail or wholesale side.

Exactly.

There is always a little bit of variability -- there's always some variability in sales and gross margin, but when you look at the range, the majority of the range that we put out there is for the volatility in the markets.

Understood.

Thanks.

Hardy Bowen, Arnhold Bleichroeder.

Tom, I guess we're going into Phoenix, which is a major market.

Are we going to advertise at a high rate like we did in Los Angeles starting off in Phoenix?

The difference with Phoenix compared to Los Angeles is if we can get -- we could go into Phoenix with two stores and spend at a full level, so Phoenix is nowhere near the size of L.A.

So when we had two stores in L.A., we couldn't spend at our full advertising level.

It just didn't make economic sense for us.

In Phoenix, we think Phoenix is somewhere between a two and five store market.

So at two stores, it works economically for us to advertise at our full level of advertising.

The same amount of [point] to TV that we always run, the same amount of point to radio, same amount of internet advertising and things of that nature.

What kind of locations do we have in Phoenix?

I mean next to auto malls or -- what are we doing there?

I think we have very good locations.

You know what our criteria -- our real estate criteria have been, which is we want to have highway visibility.

We want to them to be near other car dealers.

We want to be near high-growth retail.

And I'm not sure which of those sites we already have under construction.

I know one is right in an auto mall and right off the highway and the other one is pretty much in an auto mall also.

We have an additional site that we are working on in Scottsdale, which would be part of the Phoenix market for us, and it also meets that similar criteria.

Okay.

[Respecting] the one owner of automobile dealers, a substantial amount of them, he said we haven't had a good quarter in the last 18 months.

Very bad environment.

Do you --

We had a great year last year.

If you go back 18 months for us, it has been pretty good.

And again, I actually feel really good about where our sales are for this year.

I feel like we are 2% used unit comps and we've built -- we've opened up all of our stores on time.

Again, if you take out all the unusual funding costs, we would have grown our earnings for this year and I just don't see a lot of other people performing like that.

I feel like the evidence that CarMax outperforms the competition is as strong now it has ever been, if not stronger.

I guess as far as building the brand it still doesn't seem to be a brand very fast in very many places in terms of the whole United States.

I guess maybe we have 2% market share or something like that?

Well, yes, if you look at our growth strategy, which we are committed to, of the 15% to 20% stores we are opening in a year, about half are going into existing markets and half are going into new markets.

So the pace at which we go into new markets is not the 15% to 20% because we're filling in existing stores, growing market share, growing our brand and becoming more defensible against competition in each of those markets.

So and that is the pace that we think we should continue to grow at.

And we are committed to it.

So you're right, we're not going to be national as fast as some people might think when you look at our growth rate.

But it is part of the strategy.

Okay, sounds good.

Matt Nemer, Thomas Weisel.

My first question is if you look at the third party Web traffic data, it suggests that CarMax.com traffic was up 40% plus in October, 25% in November.

Is there something wrong with that data or can you explain why the conversion from Web to retail might be as low as it is?

You know what, that data has never matched up with what our data shows.

So I've told you we think our traffic is up.

We don't think it is up that much.

Secondly, just a follow-up on the inventory test, are the vehicles that you are adding, are they the same?

Is it the same mix; is it you are just going deeper with existing models or change in years?

Can you give a little more detail on that?

Yes, I kind of talked about it a little bit earlier, Matt.

It is very store specific.

And it's not like we go into a store -- I am just trying to pick a random example.

I don't even know if we are running the test here, but if we were in Clearwater, Florida we are not going to go stack up with a bunch of high dollar Mercedes and things like that.

We are more likely to ramp up -- and again, it is only 50 to 100 cars in any particular lot.

It's going to be matched up with what that store is already selling.

But again, it will be different in every store.

If we were in Dallas or Irvine, California, you'd see a higher end mix because they have a higher end sale mix.

I am just trying to figure out is that because you're running out of key models or you're actually expanding the breadth of assortment?

I think it is the breadth of assortment.

But when you get into breadth sometimes you end up into some different configurations of cars that actually add quite a bit to your variety.

Got it.

And then turning to the wholesale business, beyond the general aggregated Mannheim Index, what is happening in the wholesale lanes, both on the buy side for you and the one to three-year-old segment and then on the sell side for older, higher mileage vehicles?

Obviously we see the numbers, but can you give us an update on kind of what you are seeing in those lanes?

Most of our older, higher mileage vehicles we buy through the appraisal lane.

We don't buy a ton as a percentage of older, higher mileage stuff out at offsite auctions.

Again most of that comes from the appraisal lane.

In terms of the stuff that we buy at auction, honestly this is just not very -- it is not a very unusual environment.

I think the last two years were more unusual than this year and remember, too, that when we are out buying in the wholesale environment we are bidding against all of our competition so everybody is buying in the same environment.

And a lot of people say you buy an investment, you buy a mutual fund, you buy it all the time throughout the year, you buy it when it is up, you buy it when it is down.

That is kind of how we are in the marketplace with wholesale.

We are pretty much always out there buying.

It just depends on what time of year it is and what level we are buying at.

And I just think this is a fairly -- I don't want to say normal because I'm not sure what normal is anymore -- but it has been a pretty consistent year for us in terms of what we expect to do in the fall.

We always talk about depreciation coming out of the summer into the fall.

We are seeing that at the auction right now.

Are you surprised at how resilient the wholesale activity has been on the sell side for you?

I would have thought that some of the smaller dealers would be pulling back on inventory given some of the pressures they are facing.

Well, one thing to remember, and it doesn't necessarily show up in just our gross profit number, is we are always adjusting the offers to consumers on a weekly basis because we are selling 98% of everything every time we run an auction.

So we are getting real feedback on real values back to our buyers every day.

And that helps us figure out what offers to put on it.

We run a very good auction.

That 98%, 99% sell rate, I think even in a difficult environment is going to draw more buyers to our sales than somewhere else.

People don't want to go to an auction, spend all day looking at cars, bid and be the top bidder and buy the car 20% of the time.

We are running a 98% sell rate, twelve months out of the year.

So I think customers show up at our auction, and I think even in a down environment we might actually benefit a little bit from attendance.

Our attendance has been very strong in our auctions through this quarter.

So I think it is a combination of how we run the auction and the fact that we run such a high sell rate and because we are able to adjust our offer to the consumer so quickly.

Okay, and turning to CAF, have there been any changes in the fee structure such as late payment fees related to delinquencies?

No.

No.

(inaudible) a shorter answer than me.

And then lastly on your comment in the press release about investment spending, can you give us a sense of how large those three buckets are relative to each other's strategic operational and Internet investment?

Yes.

I probably could not give you that detail off the top of my head.

It is just in general for us, when we talk about strategic spending it is kind of all strategic.

The Internet is strategic.

Our growth plan is part of our long-term strategy, and I can just tell you that we are constantly evaluating the spend levels in each of those buckets.

And coming out of a year like this we will go through the next three months and we will take a really good, long, hard look and try to do the best job we can at forecasting next year.

And figure out what we have to spend.

And then we will go through our normal prioritization process and figure out where we need to allocate those dollars.

So if the environment worsens, it sounds like you are willing to tick some of those back a little bit.

Absolutely.

I feel like the environment we are in right now doesn't give us -- we are nervous about it.

We are going to pay very close attention to it.

We don't feel right now like we need to stop our growth strategy, which is I think one of the big keys to everything else is that growth strategy and how it contributes to our ability to invest long-term.

Thank you.

Brian Nagel, UBS.

First off I guess for Keith and with respect to your full-year guidance, the new guidance you guys put out there; a follow-up from some previous questions, but we clearly saw the credit market deterioration Q2 to Q3.

So the guidance we have out there for the balance of the year, does that assume a credit market that is consistent with what we saw in Q3 or is that further deterioration?

That is consistent with what we saw at the end of this quarter.

Because it deteriorated during the third quarter, and so what it is kind of where we saw the most recent deals done.

It's helpful.

Second question I guess for Tom if I'm doing the calculation correctly it looks like the new store productivity -- and I know this that can be kind of a suspect calculation but it may have continued to weaken here in the third quarter.

So I guess the two-part question.

One is, how have your new stores performed lately?

And the second part of the question would be, given the challenges you guys are seeing I realize this is just in credit now, but does this at all make you call into question maybe your aggressive growth plans nearer term?

As I said right now, no.

We feel like we're going to continue to grow at the pace that we've set.

Again, that is something we will continue to evaluate but right now we are kind of moving along with the same growth strategy.

In terms of the performance of our new stores we've always said that our -- we've continued to say that our new stores in aggregate are performing at, roughly at our sales estimate.

But we also said at the end of the second quarter that they weren't immune to the environment that we are in and our comp stores are down because of the environment and our new stores are down because of the environment.

But the ratio of the two is pretty similar.

Okay, thank you.

We might have lesser performance in the new stores but it is no different than what we are seeing in our comp stores.

And it doesn't give us any reason to believe that there is some flaw in that strategy.

Thanks a lot.

Rich Kwas, Wachovia Capital Market.

Good morning, everyone.

First question just back to the conversion rate issue.

Tom, could you -- I know you talked about capital availability still being funded along that, the cost of funding, that the consumers not measurably different than it has been.

What do you chalk up the lower conversion rates to?

Is it stock market?

Is it media coverage?

Is there anything that you could point to that you could cite as it being a meaningful factor?

I don't know what the actual stat is on consumer confidence, but I just attribute it to consumer confidence.

I don't think you can point to any one thing.

There is just a different feeling out of people today and out of our customers today than there was a year ago.

And I think it is a combination of all the factors we've talked about.

This credit environment we are in is very challenging.

And I think even to the consumer who actually isn't even impacted by it, they are aware of it, there is a feeling there.

Gas prices and oil prices continue to spike.

Just heating your house is getting more expensive now.

So I just think it is the overall environment that we are in.

Not any one thing.

Okay, and then Keith, what was the recovery rate for the quarter?

I don't happen to have it, but it wasn't materially changed.

Okay, and as you look at the wholesale market in 2008 I know you mentioned that really here in the last quarter it is a seasonally slow quarter for wholesale evaluation than you usually see a decline.

But it seems like it has been a little more of a greater magnitude relative to recent history.

So what is your thoughts here over the next quarter or so on where the wholesale market goes?

As Tom indicated, it was really more in line with what we had seen, not last year or the year before, but kind of prior history.

So while recovery rates may be impacted slightly we don't think it will make a material difference on what our expected ultimate loss rates are on our portfolios.

And our recovery rates are over a long period of time.

And there is normal seasonality in that built in to the projected recovery rates.

Sure.

Okay.

All right, thank you.

Ildiko Hildreth, Waterstone Capital.

Can you give us some idea with your type of portfolio what the historical loss rates of that type of consumer is in car lending, and I am thinking back to early '90s when you weren't in business.

But I am sure you've done some research.

Every portfolio is different, so it is really hard to say is there another like portfolio to us?

Plus we've always talked about our deals being different and cleaner.

So it is very difficult to benchmark against somebody else; I would look more at our own performance than I would look externally.

Is there industry information?

(multiple speakers)

We've never run a loss rate above 3%, and in fact oftentimes we've run a loss rate below 2% even though our expectations for that would be a little higher than that.

I'm sorry, in what period is that for you guys or -- I missed that.

You were saying 3%?

I am saying the loss rate of our -- I don't know how many total securitizations we've done; I think we are managing 9 or 10 right now.

And the range of loss rate, as you can see in our reported numbers, the high end of the loss range is 2.8%.

That is just one deal.

Not the most recent, but the third one back, I think.

Have you been doing these -- how long have you been underwriting this stuff?

Since what year?

Since the beginning (multiple speakers)

For fifteen years.

Right.

I'm sorry, when?

Fifteen years, since we opened our first store.

And is all that loss rate based on master trust data that has been out since then?

Can you say that again?

We didn't get your question.

Is that loss data going way back that far, too, to the early '90s you're implying fifteen years?

We have loss data for all of those.

Our first public securitization didn't occur until 1999 because we just didn't have a large enough base of portfolio where we could actually go to the public market.

So if you start with 1999 that actually aggregated the originations that were still on our books from '93 or actually in our warehouse facility from '93 until that point.

So that was kind of mix mash and that loss rate was about 1.5, 1.6 if I remember correctly.

And then it went up to 2% to 2.5% thereafter which is really what we've been targeting.

And then correct me if I'm wrong, haven't the rates, the general terms of car loans been extending which would imply a different loan to value mix as these things age?

Absolutely.

One of the things that we've done over time is that we've actually run -- we talked a lot about testing different parameters and CarMax Auto Finance was actually the only one of our lenders until a year ago that didn't offer 72 months across the board.

So our nonprime lenders were actually given 72 months terms for several years then.

And we underwrote that test and got comfortable with the loss results, and we are writing with everybody else now.

Thank you.

Scott Johnson, Forest Capital.

A question with regards to the financing arm.

You guys have mentioned this is a competitive advantage for your business.

But what competitive advantage do you guys have against lenders?

(inaudible) I'm trying to understand it made sense to do this when you could originate loans, flip them into an ABS structure and pull out four points, but that game going forward is changed dramatically.

So what competitive advantage do you guys have?

We have a significant competitive advantage in that we only underwrite CarMax.

And so what we don't have in our portfolio of loans and how we evaluate our scorecard is any of the challenges that other lenders have with third parties.

So because we know the actual value of the car, we know the actual equity of a consumer because we don't have any negotiation on whether, on the trade-in.

We actually know the quality of the data.

No one in our store gets paid a commission for financing; just having been us, we focused in on the consumers' credit history and make decisions solely on that.

And in other lending environments the other or third party lenders don't have the ability to have their scorecard really get the right attributes to predictability of losses given the various experience of customers coming in.

And what that means is we literally have rules in our scorecard that the industry would say you need to have something here and we don't have it, because it has not proved to be predictable.

As a result we end up buying things that they turned down.

The other part is just by being available to our consumers and having all the other partners available it creates a very competitive environment for the customer and they have access to all kinds of different options for lending.

And I think the person who benefits the most is the consumer.

We can help keep our lenders honest by moving our rates along with the market and then it makes our lenders as well be competitive also.

So I think the ultimate beneficiary is the consumer.

(multiple speakers) an adverse selection problem?

With regards -- I mean.

I think we've demonstrated we don't have an adverse selection problem based on our history of loss experience.

I think that we clearly understand and test before we actually underwrite different levels of consumers on a large scale before we roll it out.

We've been in a 10-year bull market for the consumer, so I don't know that if you have data going back to the late '90s, early '80s maybe I would say that, but going forward I would think that this is going to be a huge drag on your business.

You've got inventory levels that, and sales associates and infrastructure you've built on the ability to move loans or move vehicles by being able to provide financing for your customers.

I will just go back to Tom's earlier comment.

We haven't had a material adjustment in our retained interest or loss rates for five quarters.

I think the evidence is that we have a good scorecard and a good history and a good basis for our originations.

And lastly, more than 80% of customers that buy a car from us get financing from some lender.

And being able to get an automobile loan, what you're really talking about is customers can't get a loan anymore on a car and we just don't think that is going to happen.

And whatever the environment that we are in, we think this gives us an advantage over not having it.

So even in a bad environment it is better to have it than not have it.

And you're right, the environment could move up.

It could move down but we feel like regardless of that, it is better to have CarMax Auto Finance for all the reasons we've talked about.

Operator, we have time for just one more question.

Seth Basham, Credit Suisse.

Just a quick follow-up.

Could you tell me what the warehouse facility balance was at the end of the quarter?

Roughly 900 million, 850, 900 million.

I don't know the exact number but 850 to 900.

Okay, and the $300 million increase to that facility would you care to share the cost of that increase?

No.

Okay, and lastly, taking the last question in a different light, maybe Tom or Keith you could give us a sense of the profitability on a car sold and finance through CAF is around $900, to a third party lender it is around $300.

Now what would the cost or the profit be I should say on a car sold and financed through the whole loan market?

We don't know that yet because we haven't done a whole loan transaction, but that is clearly one of the things we are trying to ascertain as to whether that is a viable alternative to the ABS market.

But it would definitely be less than 900.

And hopefully more than 3.

And it might be a little more than 3.

Clearly more than 3, right.

All right.

Thank you, gentlemen.

Listen, everybody, thank you very much for your support.

Thanks for calling in.

If you have any additional questions you can call Katharine or Celeste directly.

Thanks for your continued support, and we will talk to you at the end of next quarter.

Thank you for participating in today's conference; you may now disconnect.