車美仕 (KMX) 2009 Q3 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the CarMax 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.

Thank you, good morning.

Welcome to our fiscal 2009 third quarter earnings conference call.

On the call with me today are Tom Folliard our President, Chief Executive Officer, and Keith Browning our Executive Vice President and Chief Financial Officer.

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

In 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 29th, 2008, filed with the S.E.C.

Before I turn the call over to Tom, let me just say one thing for all of our traveling comrades in Richmond.

Go spiders.

Tom?

Thank you, Katharine.

Good morning, everyone.

Thanks for joining us.

Well as you could all see from our press release this morning we continue to face extremely challenging marketplace conditions.

We operate in three industries, retail, auto, and credit; all of which have been among the hardest hit by current economic conditions.

Although we believe the issues are externally driven we plan to take effective action to preserve our profitability and capital.

Our used unit comp reduction of 24% was entirely a result of the decrease in store traffic.

In fact, traffic fell a little bit further than comp sales, but we managed to offset some of the decline with improved execution.

We once again reduced our used vehicle inventory this quarter by over 8,300 units or approximately $140 million.

Year-over-year inventory is lower by approximately 18,500 units, or over $340 million.

Our used inventory turns for the quarter improved somewhat over last year and we modestly decreased our borrowings over the course of the year.

We were also able to hold gross profit per vehicle nearly flat compared to last year despite the dramatic decrease in wholesale values.

Our cosmetic operations, restructuring and waste reduction initiatives will continue to make us more cost effective over time.

In addition we continued to shrink variable labor expense through attrition, a decrease in scheduled work hours and through a reduction in our workforce in early October.

And finally, we made the decision that I will discuss shortly to temporarily suspend our store growth until conditions improve.

We will also continually -- continue to aggressively seek further opportunities to lower costs throughout the Company.

Now let's go over some of the key financial results.

First sales.

In the third quarter total sales decreased to $1.46 billion compared to $1.89 billion in the third quarter of fiscal '08.

We opened just one store in Hickory, North Carolina, a non production store in our Charlotte market.

At the end of the third quarter we operated 99 stores in 46 US markets.

Used vehicle revenues declined 23% for the quarter due to a combination of a 7% decrease in average selling price and a 17% decrease in unit sales.

The average selling price was lower as a result of the industrywide decline in used car valuations.

Our average selling price for wholesale vehicles fell by 12% combined with a decrease in wholesale vehicles sold of approximately 15%, the result of lower appraisal traffic and a lower appraisal buy rate.

Total wholesale revenues decreased by 25%.

On to gross profit.

Our third quarter gross profit per used vehicle decreased by $32 compared with last year.

We were very pleased to be able to maintain our gross profit in a period of rapid depreciation, approximately triple the normal levels we see at this time while also reducing inventory and modestly improving our used vehicle turns.

Our wholesale profit per unit which increased $20 compared to the third quarter of last year is once again a positive reflection of our unique inventory management systems and the continued success of our auctions.

While absolute dealer attendance and wholesale volumes were down, our record dealer to car ratio and our industry leading wholesale industry turns are what we believe contributed to these results.

On to CarMax Auto Finance.

Our CAF results also continue to be impacted by the very difficult financial market conditions.

Earnings for the third quarter once again were again reduced by adjustments related to loans originated in prior periods.

This quarter these adjustments totaled $39.8 million or $0.12 per share.

Now I will ask Keith to review cash results in a little more detail.

Thanks, Tom.

Good morning.

I apologize for my cold, so hopefully you can understand me.

CAF reported a loss of $15.4 million in the third quarter of this fiscal year versus income of $16.3 million last year.

The gain on sales of loans originated and sold in this quarter fell to approximately $11 million compared to $21 million in last year's third quarter.

This decrease was primarily due to lower sales, higher loss and discount rate assumptions and lower average selling price per vehicle and a planned decrease in CAF's origination penetration.

The CAF percentage also declined from 3.6% to 2.8% this quarter.

Now the servicing fee and interest income -- note that servicing fee and interest income increased by 23% this quarter compared to last year.

This is partially due to higher outstanding securitized receivables, interest income received from subordinated bonds we hold on our books and a reflection of the increase in our discount rate assumption which results in less gain recognized in the quarter of origination and higher interest income in future quarters.

Offsetting CAF's income for the quarter as Tom highlighted were charges related to mark to market adjustments and higher loss assumptions.

The former carried approximately $24 million, and represented a reduction in the carrying value of our subordinated bonds we hold.

This noncash charge is significantly higher than in previous quarters due to the illiquidity in the secondary market.

We also took a $16 million charge due to the further increase in loss assumptions for some securitized loans, partially offset by favorable adjustments related to prepayment speeds.

Our worst performing pool of loans now has a cumulative loss expectation of 3.9%.

We continue to believe that this increase in expected losses is largely due to the weak economic conditions.

It is clearly being experienced industrywide.

Our data also confirms that our portfolio results continue to compare favorably to other loans of similar credit due to the transparency of our sales and financing processes.

However, we continually track the performance of our portfolios and have tightened our lending standards as necessary.

We have been disappointed but not surprised by the lack of promising activity in the asset backed securitization market.

It remains unclear that this market will reopen and what form it will take at that time.

Given the continued uncertainty we've taken steps to slow CAF's loan originations in order to extend the utilization of our $1.4 billion warehouse facility.

At the end of the third quarter, we had $493 million in warehouse capacity.

Our third-party lenders continue to tell us that our loans perform better for them and that they remain willing to make more loans to our customers.

As a result, we can slow the usage of our warehouse facility while continuing to make credit available to our customer and maximizing sales.

Our third-party provider mix has shifted some, along with changes to some of our discount arrangements resulting in lower third-party fee income over the last several quarters.

Now I will turn the call back over to Tom.

Thanks, Keith.

I'll talk about SG&A.

As expected, due to our lower sales rate and lower average selling price per vehicle our SG&A ratio in the third quarter increased significantly to 14.9% compared to 11.2% in the third quarter a year ago and 12.2% in the second quarter.

We are focused on reducing our costs as rapidly as possible to bring them in line with our sales rate while not hurting the customer experience or our ability to improve execution.

Recall that on our last conference call we indicated that we would reduce our expected store growth from 15% annually to between five and ten stores for fiscal 2010.

The further deterioration in our sales rate this quarter along with the uncertainty in the marketplace has convinced us that it is time to suspend growth for the time being.

This step will clearly allow us to further decrease capital spending and reduce additional costs.

Looking forward we currently have four stores under construction.

We'll finish work on those stores but only open one until we see improvement in the market conditions.

It will be our 100th store and our 8th store in the Baltimore/Washington market, which is historically our strongest penetrating market and requires no incremental advertising.

Although suspending growth is a near-term disappointment for CarMax, it is the appropriate response toward these current conditions.

We still fully expect to go to all our previously planned markets.

It will just take us a little bit longer to get there.

Our most recent data for the 90-day period ending in October indicates that we are gaining market share in the late model used vehicle market.

Our recent consumer surveys including those for shoppers, purchasers, appraisals, and service indicate that customer satisfaction levels at CarMax are at record highs.

We believe our long-term prospects remain as strong and perhaps stronger than ever before, but our current challenge is to navigate successfully through the near term, which is where we'll be focusing all of our efforts for the foreseeable future.

Thanks once again for joining us today.

And especially thank you to all of our CarMax associates for your understanding, your dedication and for all you do every day.

Now I will be happy to take your questions.

(Operator Instructions) Your first question is from the line of Brian Nagel.

Hi, good morning.

Hi, Brian.

A couple questions if I could.

The first one, with respect to, you mentioned in your prepared remarks and in your press release, that you routed more of your financing application to your third-party providers.

So the question there is, first, have the third -- your third-party or your partners, have they changed lending standards more than CarMax Auto Finance?

And if they have, has that resulted in more declined applications and then hence weaker sales at your stores?

Well, Brian, this is Keith.

The answer is, is that varies by lender.

But I can tell you that we carefully considered what they were currently underwriting and their approval rates.

And actually got feedback from them about their willingness to take on more loans before we made those decisions.

So this is kind of an iterative process that we're working on.

We're carefully measuring our sales to apps and trying to monitor the success of this strategy while maintaining -- maximizing sales given it.

But generally speaking everyone is tightened, including CAF.

That's understandable in the market.

But the good news is, is that for us, the tightening is not as significant as [for that] -- our third-party lenders outside of CarMax's channels.

The one thing I would add there, Brian, is that in terms of the total result of the customer flow, I mentioned that our traffic was actually down a little more than our comp sales.

So even in this difficult environment, our store teams have done a great job of executing the customer flow they have.

So when you add it all together with applications, approvals, whether it's prime or non prime, we actually improved our execution in the quarter year-over-year, just a little bit.

Then the second question, kind of related to that, but you mentioned in the press release your third-party finance fees declined 58%.

Can you just further explain what's causing the shift there?

Well, one of the key factors there is is that one of our third-party lenders was acquired by RoadLoans.

So we went from a fee paid basis, to where we're paying a rather substantial discount on a percentage of our loans.

And we had a choice not to do that, but we believe that those are generally incremental sales, and so we're -- we're not willing to walk away from that business.

So it's a matter of what the market is driving from a risk perspective and risk profile.

Okay.

Then the final question I have, with respect to gas prices, we've talked a lot over the last few quarters when gas prices were rising, what impact that was having on your business.

And clearly gas prices at the pump have come down significantly.

Sales are still weak but are you seeing any other shifts in demand trends at your stores as a result of much lower gas prices?

Well, I think, as you said, sales are still weak.

So I think if everybody thought that gas was the only reason for consumer demand sliding over the last several months, obviously that has proven not to be true.

I think there are a number of other factors that contribute to consumer confidence, and a number of things are going to have to change I think before the consumer comes back and decides to start spending money again.

But in terms of the shift of demand, one of the obvious impacts is that people aren't running away from sport utilities as much as they were before.

And I believe our mix for the third quarter this year of sport utilities was up over the second quarter and it was up over last year's third quarter.

So we've seen that before.

We saw it with Katrina.

We saw it with this last May when we really saw a big depreciation related to the $4 gas price.

I think the consumer, and just in regards to that particular item, actually moves pretty quickly up and down as gas prices move up and down.

Great.

Thanks a lot.

All right.

Your next question is from the line of Rex Henderson.

Good morning.

Good morning, Rex.

I had a couple questions on the residual value of the securitizations and the subordinated bonds.

First of all, with this increase in loan loss assumption are you near writing any of the residuals from any particular securitization down to zero?

And is the principal of any of that, the subordinated bonds, at risk as those loan losses accelerate?

I mean, the way we look at it is, is that even in this stressed environment, given the loss assumptions that we've taken, we would have to see more than a doubling of losses before those would be at risk.

And so we still feel very comfortable with the fact that those investments are going to be returning the return we originally expected.

And mark to market is an accounting fact that we just have to do it, and it doesn't change our perspective on the quality of that investment.

Okay.

And with the increase in the loan loss assumptions, do you know where you stand relative to comparable quality paper in the marketplace right now?

Well, the best we can do we're -- we do have an industry group that we're a member of, and we do compare notes.

And we -- when we look it at ranges of (technical difficulty) and our loss change shifts -- everyone is increasing.

We continue to get feedback, and based on the numbers that everyone is sharing with us, that our still -- aren't being this stressed as much as they are outside of the CarMax channel.

While that is certainly encouraging, and that's one of the reasons why we think that our third-party lenders also are sticking tight with us.

Okay.

Finally, in the press release you noted you think you're getting some market share gains; that's a reversal.

The last quarter you thought you lost a little bit of share.

Can you comment on what contributed to that change from losing a little share to gaining a little share in this quarter?

Well it's not.

Remember, too, Rex, on the data, it's not current with the quarter.

So the data we just reported is only through October so it's the 90-day period ending October.

Okay.

When we announced it the last time I said it was a very slight decline.

We've been referencing that number consistently for several years.

We've referenced it when it was up.

It was slightly down.

I thought it was important to note that.

I said at the time I thought it might be a temporary phenomenon based on all the different variables that were going on, none of which we could predict.

And it looks like that's what it was.

It's -- I couldn't really speculate further as to specifically why it shifted.

I thought it was temporary.

It looks like it was temporary, we're pleased that it looks like we are back to gaining share again.

But again that data is only in about half of our markets and it's the 90-day period ending October.

Is that in same-store markets or is that an overall share including new stores?

It's a consistent database that we report on.

Okay.

Finally, the gross profit per vehicle was really surprisingly good considering the compression in prices.

Did you see any disruption of that in October when we had a very sharp drop in vehicle wholesale prices?

Well, as you know, Rex, we comment on whole quarters, not months.

And I'm very proud of our teams and the job that we did, not only in this quarter but really going all the way back to the first quarter with the rapid depreciation we saw in sport utilities, the incredibly volatile market conditions that we've seen all the way back to May.

The improvement we made sequentially in profit margin from first quarter to second quarter, our ability to maintain our profit margin here in the third quarter, improve our turns a little bit, reduce our inventory as well -- I think it just -- I think it just shows that our kind of time-tested and continually evolving inventory management model runs pretty well even in a pretty distressed environment.

Okay.

Thank you.

That covers my questions for now.

Thanks, Rex.

Your next question is from the line of Bill Armstrong.

Good morning.

How long do you think you have until your warehouse -- you are at the top of your warehouse capacity?

I remember three months ago you were saying probably January or February.

Looks like that might have been stretched out a little bit?

Yes.

The answer, Rex, is we don't know.

As I mentioned earlier, one of the things we're doing is, we're still testing what makes the most sense for CarMax in trying to monitor the sales implications.

You are correct in assuming that we have extended it.

Our goal is to extend it as long as we possibly can without adversely affecting sales.

But that's going to be a moving dynamic as we work with our lenders and monitor the results.

So it's really too early to say how long we will be able to extend it.

In what way are you able to steer customer loans to your third-party lenders versus CAF?

Are you raising the bar in terms of lending standards or interest rates with CAF?

How would that work mechanically?

The answer is, it used to be that when you got an approval from CAF or Bank of America, because we don't condition those offers, we don't route to our other lenders, so one of the mechanisms is just to go ahead and route all things to our third-party lenders and give them a chance to compete and bid.

The other element is changing interest rates, letting people win more often by pricing a little bit above the market.

And given the risk in this environment, that's a prudent thing to do.

So we think that's a good strategy and that's why we're monitoring the results still and making sure that it works for us and our third-party lenders.

Right, it makes sense.

But it's a combination of those things that can slow the flow into the warehouse, and we are going to continue to work with that over the next several months.

And, the truth is we can stop the flow into the warehouse tomorrow and just not originate any more loans at CAF but we believe there would be a pretty significant sales impact.

So we're trying to make sure that we test it, and as Keith mentioned, the big key there is try to preserve sales.

Right.

Are you seeing any sales impact from your current practice or do you think customers are -- in other words, do you think you've lost any sales right now as a result of that?

I think it's still a little too early to tell.

We really just got going this quarter.

We're running various tests in various markets.

So we're still evaluating that.

Okay.

AmeriCredit, very recently about three weeks ago did a $500 million securitization for subprime auto loans which would make one think that the market isn't completely frozen.

But it sounds like you don't think you can tap the market?

From what we have heard, that was a prior commitment from the spring.

That really was a deal that was preset from eight, nine months ago, and not indicative of the current marketplace.

Okay.

And then finally, maybe just stepping back a little bit, there's more than an insignificant chance that GM and/or Chrysler will go into bankruptcy.

What do you see -- if that happens, how do you see that impacting the automotive market and the used car market and your business in particular, if at all?

Well, that's a pretty tricky question, and I'd say we have absolutely no idea what the impact would be.

It really depends what happens, it depends what happens with the restructuring.

I think it depends on whether consumers feel confident about continuing to buy that product.

Obviously our first piece of exposure is that we own a bunch of that product, and if consumers ran away from it and there was a de-valuation there, that could hurt.

Long-term, if there's a bunch less dealers around and there's less choice I think we would become more of a first choice for consumers.

Ultimately that could be good.

But there's also the warranty issue on product.

Will customers feel comfortable that their warranties will still be backed, both on existing product or buying additional products?

So, I think there's so many different variables there, it is very difficult to predict what impact it would have on us.

I think could you lay out a case that it could be a positive and you could lay out a case that it could be a negative.

We are kind of taking a little bit of a wait and see approach.

I don't think it's in our best interest to start moving our inventories around in advance of that.

We plan our inventory every single week like we've always done.

I think we can move pretty quickly with consumer demand.

Okay.

Great.

Thank you.

Your next question is from the line of Matthew Fassler.

Hi, Matthew.

Matthew, your line is open.

Matt, are you there?

We'll go ahead to the next question.

Can you go to the next one, operator?

Matthew, your line is open.

Can you hear me now?

Yes.

Great, okay.

I think I was on mute.

Couple questions, please.

First of all, as you talk about the shift of the loans to third parties, can you give us a sense of the magnitude?

Historically you talked about something like 40% of purchases going through CAF.

Can you give us a sense as to how much that has changed in the past quarter with this tilt in strategy?

What I would say, Matt is it's gone down a modest amount.

We started it in the middle of the quarter, but the key is, it may not be reflective of what we ultimately do.

So, and that's really the key.

We're still navigating this.

It's very early.

And we are going to monitor the results, and we are going to drive it down as low as we can without affecting sales, to preserve the sales that CAF uniquely brings to CarMax.

But we've historically -- you said 40%, we've historically said it's between 35% and 40% net at the end of the quarter and total it was slightly below that range but as Keith said that's a number that we can move.

And if you look at the economics of a third-party finance transaction today versus a CAF-financed transaction today, with the gains on sale that you are booking, assuming that those end up being the accurate assumptions over the life of the loan, how do those economics compare?

It's getting more and more difficult to predict and to look at how they compare, because until we actually go out and get a securitization done, you don't know what all your costs are.

So right now, we're way more focused on preserving sales through any channel, whether it's CAF or an additional lender.

The differences in profitability that we've talked about in the past have become almost impossible to predict.

Got you.

Just to game out a little bit, what might transpire on the credit front, if the ABS markets don't loosen up for you.

Would you anticipate taking more of these loans on balance sheet kind of as a last step prior to having a major strategic shift and temporarily exiting the origination business?

Matt, we're going to look at every possible option to keep, as I mentioned to preserve sales and keep the business going.

That's one.

That's not a great long-term strategy for us.

If we did it and we did it some temporarily, essentially that's what we've done with the bonds over this year that didn't get done through the deals, but that's not really a good long-term strategy for us.

But again, we're looking at every possible option, and the world is changing so quickly, we're just looking at those options every week, every day.

We think some things will change after the first of the year, but we are going to do whatever we can to preserve sales.

One other quick one on credit and then one other follow-up.

You talked about the markdowns that you took to the existing book of retained -- the existing book of loans that you had on balance sheet, and it was pretty big this quarter.

But you indicated that if current conditions persist you could see gains resulting from that.

So where is pricing in the market today versus where it was on average during your November quarter?

I mean, if you reference sub bonds, they're pricing at -- in the neighborhood of 2,000 above benchmarks.

The fact is if it doesn't change, then you are just going to get the higher accretive income over time, and obviously if, in fact, it gets better, then you will have a favorable consideration.

Got you.

We would have never predicted this level of dislocation.

And then finally, on SG&A, can you talk about how far you have gone on a per-store basis in terms of cuts?

Are we very close to kind of the fixed costs not -- where you can't reduce costs by that much, and what's your ability on a per-store basis if sales remain challenging going forward to take that number [down] further?

Well here's what I'd tell you, if you look at the -- over the course of this year we've made a number of steps, most of which we've already noted or talked about.

If you include all the variable expenses that go down as sales go down, and we have moved them down with sales, in addition to other cost cuts that we've made, by the end of this year, we will have taken approximately $75 million out of what our planned spend was at the beginning of the year.

So that's a combination of variable expenses going down with sales, additional cost cuts that we've made, whether it's slightly less advertising or some other additional cost cutting.

But by the end of this year, that number will be around $75 million that we've taken out from what we had planned to spend at the beginning of the year.

Got you, guys.

Thank you so much.

More for us to do going forward, that's just what we've done so far.

Got you.

Thank you.

Your next question is from the line of Scot Ciccarelli.

Hi guys.

How are you?

All right.

How are you, Scot?

All righty.

Tom, given the extreme price sensitivity of most customers today, do you think you could have an impact on sales if you were willing to become more price competitive or willing to sacrifice gross profit?

I know you guys always say you are going to do what you think is best for the business but obviously we're in kind of unprecedented times.

Do you think you can move the sales lever if you were to give up a little margin here?

That's the multimillion dollar question.

It's a question for us every quarter.

It's a question in good times, it's a question in times like this.

We think the decisions we've made over the last six or eight months -- the results we had in the third quarter are not decisions that we made just in the third quarter.

It's a result of managing our inventory for the entire year.

And we believe right now this is what's best overall for the long term best interest of our shareholders and for our customers, is to manage the business the way we've been managing it.

So, if the question is if we gave up a hundred or a couple hundred dollars in margin, would it have driven sales?

Maybe.

I'm sure it wouldn't have gone from negative 24 to 100% to budget.

So there's just no way of telling what kind of sales you would have got back.

I think right now we're doing what we think is in our best interest.

Okay.

And obviously the broader economic conditions are having a massive impact on the auto industry and retail in general.

How much of an impact do you think the massive used vehicle deflation is having in terms of the business?

It seems to me there's so many people that are kind of underwater, have negative equity out there, it's not really economical for a lot of them to have a -- make a transaction here.

Any kind of feel or color on that front?

I think that that is reflected in consumer traffic.

I think that's just -- it's reflect in sales in total for new car industry, for used car industry, all being down significantly.

I think there are a lot of people who are just waiting in the wings.

They may even -- they may not even know for sure that they have a bunch of negative equity, they just think they do, and they're deciding not to come out and spend.

If you look at our applications and the amount of negative equity in our loan to value, once again, we don't see it in there.

Even this last quarter, we don't see it in there.

But I think it's absolutely having an impact on our sales.

I think our negative 20% plus comp performance is largely related to consumers' thoughts about what that car is worth.

And so this rapidly depreciating environment is more driven by a lack of demand than the other way around.

Okay.

That's helpful.

And then lastly, if somebody comes in, let's say they are $2,000, $3,000, $4,000 underwater, given all the tightening credit standards, can somebody roll over the negative equity into a new loan?

I know that was a pretty common practice, let's call it even six to 12 months ago, and obviously before that, but is that something that can happen today, given what all the lenders are doing?

Sure, it's still a very common practice.

It just depends on that person's individual credit, the car that they're buying, and the bank.

So although there's tightening, one example of tightening, is I used to roll over $2,000 in negative equity and I charged an 8% APR.

Now if I'm going to roll $2,000 over I might raise the APR rate to do it.

It's all dependent on the individual, the individual's credit, the car they're buying, and the bank, whichever bank is making them the offer.

Okay.

So it still can happen (multiple speakers)

If you're asking if people are able to finance negative equity in this environment, absolutely.

Okay, great.

Thanks a lot, guys.

Your next question is from the line of Sharon Zackfia.

Good morning.

Hi, Sharon.

I'm not sure if you went through this already, but as you slow growth, have you -- I'm sure you've given thought to whether or not there are reductions in headcount that can go along with that.

And just generally what kind of savings will that get us next year, not just in terms of the P&L but also in your capex outlook for 2010?

We haven't given our capex outlook for 2010, yet.

We'll do that at the end of the next quarter but obviously we think we can take a significant amount out of our capex spend by what we just did, which is stopped growth.

So I mean, we don't have a number for you yet.

We will have it at the end of next quarter.

Our original planned spend for this year was around $375 million.

We've taken that down obviously dramatically.

We'll give you the outlook for next year at the end of the quarter but capital preservation is one of our goals right now.

It is one of the reasons why we suspended our growth as we said temporarily, and we'll give you our capex number at the end of the quarter.

But how about in terms of the P&L impact?

I mean, obviously as you open new stores, there's start-up expenses, there's a ramp there.

What kind of -- if you had a steady state sales environment, which I know is a long shot at this point, but what kind of margin buffer would that get you in a normal environment, in 2010?

Well, that's a little bit of a complicated question because as we -- in a normal environment, if we were opening stores, some of the stores we open contribute in their first year positively.

Some of the stores are a much longer term investment because it's a multi-store market and we've got to get fully stored in that market before we become profitable.

We look at our investments over a 30-year time period.

So we're just not ready to answer that question very specifically right now about what that change is from a P&L perspective next year.

But, obvious we think it's a positive or we wouldn't have done it.

Yes, and in terms of headcount reductions at corporate, I know you have -- you have a hiring freeze, but is there -- is that a thought process at this point, or is it something you are not really considering yet?

Well, for us, a reduction in force is always, and always will be, an absolute last resort.

I talked about taking a number of other additional steps to reduce costs.

It is pretty much preserving capital and managing through the short-term environment is pretty much all we work on as a management team.

We are trying to find every possible opportunity to either drive sales or eliminate costs, eliminate unnecessary costs and waste.

But a layoff for us is always a last resort.

Okay.

Maybe separately, I don't think anyone asked, so I'll ask, I mean what was the sales cadence like in the quarter?

Was it pretty consistently as bad as it looks?

Or did you see any shifts one way or the other?

I know I made the mistake of giving out some cadence in the second quarter.

It wasn't a mistake, it was a stroke of genius.

(multiple speakers)

I'm officially out of -- I'm out of the cadence business.

That's no fun.

I guess, lastly, are you testing -- Keith, maybe you mentioned this, but as you slow down the CAF originations, are you testing other prime lenders or I mean, where are those loans going?

At this point we haven't changed any lenders.

We are -- currently have one of our other lenders testing in a different category than -- our subprime lenders testing in the non prime space.

But beyond that there's no additional testing.

But we're always looking for other lenders, but we're very particular about the arrangements that we set forth.

But I think more importantly, Sharon, all the lenders that we have are still with us.

Yes.

Do you have any idea what the credit situation has done to your sales, other than it's bad?

I mean do you have any kind of consumer surveys or anything that would indicate what magnitude credit availability is having on your business?

I'm sure there's some selection (multiple speakers)

It's very difficult for us to survey customers who aren't coming to the store.

Fair enough.

All right.

Best of luck.

All right, thank you.

Your next question is from the line of Matt Nemer.

Hi, Matt.

Hi.

Good morning, everyone.

So my first question is, it looks like you played for margins versus units this quarter, and I'm just wondering, what are you looking for that would make you shift back to your previous strategy, which was to really drive units?

It is just traffic is so low that it doesn't really make sense to lower price?

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

Right now, consumers are just -- they're not coming outside.

They're not spending money.

I don't think $200 is going to make them spend money.

I don't think it's going to make them change what their plans are, right now.

I don't think they're going to decide, hey, I wasn't going to buy a car, and now I am going to buy a car.

And I think there's too many other factors involved there.

It's always a guessing game for us.

It's always a balancing act.

Right now, it's not just the lack of consumer demand, but the rapid depreciation we've seen in the third quarter.

I mean we are trying to manage our inventory and turn our inventory as quickly as we can.

I think we are going to remain focused on trying to balance those pieces and do what we think is best.

This is where we've ended up for the quarter.

Okay.

And then just to follow up on a question that Rex asked earlier about gross margin per unit, which was really impressive, is there any -- I realize you don't want to --

(multiple speakers) know the answer.

I realize you don't want to give that by month, but is there anything in that -- in the full month number that might be deceiving?

I mean did it trail off towards the end of the quarter?

I just want to make sure we're not modeling that going forward and maybe setting the bar too high.

No, as I said earlier, Matt, I don't even really think it's just the quarter.

It's really the whole year for us.

Managing inventory for us, although we do it weekly, we have some planning to do throughout the year to get there.

And we have made strategic decisions going all the way back to May about inventory levels, about purchasing, about appraisal offers, and managing margin that have allowed us to manage our inventory where it is.

I can't help you model going forward because the big unknown is what's going to happen with the consumer.

I'm hoping this is the bottom and that things turn around but we have no way of telling that.

If things started to pick up again -- we saw the consumer come back, we saw traffic come back, we saw sales come back -- you actually might see us go a little bit in the other direction to spur additional demand.

But until we see what happens with the consumer, it's very difficult to tell you how we would respond.

Okay.

And then can you give any detail on the buy rate and maybe how that changed in the quarter and sort of where you are sourcing the mix of your inventory, where it is coming from?

Well, I won't talk about how it went through the quarter, but by the end of the quarter we're down below 25%.

And as we have talked about our buy rate for over a year now, we've seen that number -- we had seen some growth in that over several years, and we've seen that number decline now.

And I just think that's a reflection of all the market conditions we already discussed.

And can you -- what about the appraisal traffic?

Is there any way to quantify the change there?

Well, the appraisal traffic is largely driven by consumer traffic, and as we said, consumer traffic is down more than 24%, appraisal traffic is also down more than 24%.

When you factor in the buy rate in there as well then the mix of sales that are sourced through the appraisal lane is less than we would like it to be and less than it has been in the past.

Okay.

And then lastly, this is more of a longer term question, but obviously even in spite of the bailout that was announced this morning, I suspect there will be a lot of empty dealerships around the US.

And I'm wondering if it makes sense when you reignite growth to start looking at second use real estate more aggressively?

We'll start thinking about that when we decide to reignite growth.

We just made the decision to stop growth.

So, do I think there might be some opportunities out there at some point?

Probably but honestly we're not focused on that at all right now.

Fair enough.

Good luck.

Thanks, Matt.

Your next question is from the line of Rick Kwas.

Good morning, Tom, good morning, Keith.

Wanted to ask about, in terms of SG&A here, where are you at current sales rates on the SG&A front?

Are you comfortable with your level right now, or do you expect -- I know you gave that $75 million number, but -- and it sounds like you are going to be cutting more, but how comfortable are you with where you are given where we are on the sales front?

We think we have some -- we still think we have some additional opportunities.

So the difficult thing with some of the spend in SG&A is what do you think is going to happen with sales.

If you thought sales were going to come back, then you might not be as aggressive.

If you thought they were going to get worse, you'd be even more aggressive.

We're running several different scenarios, several different models and trying to figure out what the right balance is for us.

But I think there's definitely some additional room for us.

So there's additional room -- so does that -- that means you have more to go?

At current sales rates, you're still not caught up.

I think there's some more opportunity there, yes.

Okay.

I thought your comment regarding LTVs was interesting.

I mean we're hearing from other dealers that traffic is actually okay, but people are coming in, and they just -- whether it's negative vehicle equity or lower LTVs, they're walking out the door without closing a sale.

I know your conversion rates are pretty good this quarter given the environment but are you seeing any signs of that with lower LTVs from third-party lenders and the impact from that on sales?

No, we're not.

And I find it hard to believe that anybody's traffic is okay.

When you see industrywide sales are down 30 and 40%, I just -- I can't believe that the same amount of customers are coming through the door.

It's certainly not true for us.

Okay.

I guess it's all relative right now.

We all have low expectations, so it's okay relative to low expectations.

Great, thanks.

Inventory.

You talked about -- somebody asked about the Detroit three, but one of the things is, where are you with Detroit three branded inventory at the end of the quarter?

We are where we think we should be with the current demand of that set of inventory, just like we feel like we have tried to do with our inventory all along.

So we're looking every single week at our sales, at our demand, at test drives of that product.

We are building our buy plans every single week off of the most recent demand data that we can possibly use to buy that inventory.

And we feel pretty good about our inventory position.

We feel pretty good about the way we managed it through the quarter.

And until something happens, as we've talked about, it's very difficult to say do you think you are where you need to be.

We try to reset the table every single week.

So as of Monday, we felt pretty good.

Okay.

And then what's your truck mix at the end of the quarter, or what was it at the end of the quarter?

I don't know if you mean truck or sport utility and truck.

We usually report SUV and trucks combined.

Right, that's the number, I'm looking for.

And that number is usually a little bit higher than 30% when you add it all together, trucks, big sport utilities and small sport utilities.

I talked about that mix being a little higher than it was in the second quarter, and actually a higher mix -- this is sales now, a higher mix of sales than it was even in the third quarter last year.

Okay.

So one would assume that you have a higher -- it's above 30%?

Yes, you'd assume that we are managing our inventory accordingly.

Okay.

So based on fuel -- so it seems like fuel prices are having some benefit here in terms of on the end market.

I don't think it's just fuel prices.

It's fuel prices and the actual cost of buying something.

I mean, the depreciation we've seen in that product since May is astronomical.

I mean thousands and thousands of dollars less to buy a bigger sport utility.

I mean you can go to a store now and buy a Tahoe for the same price as a Corolla.

And I think even if gas prices weren't as low as they were, we might not have seen the shift that we did.

Gas prices weren't as low in the second quarter and we told you our mix was about same.

For sport utilities, I think that was as much driven by price as it was by gas prices, and I think right now it's a combination of the two.

Okay.

Then lastly, ad spending, where are you on -- I know that's in SG&A, but are you -- how much of a decline is there available to you, given the current environment?

I imagine you are not spending like you did maybe six months ago.

No, we're not, and we're trying to match it up with sales.

But at the same time, it's one of those areas where in a declining environment, does it make sense that you try to keep investing in the brand, and the truth is during the quarter, we tested some up spend in a few markets to see what the results were there.

And it's a little too early to read those.

But everybody is spending less money on advertising.

So if you look at it, relatively speaking, I think we're still probably the biggest advertiser out there in most of the markets we operate in because so many car dealers are pulling out of advertising.

You see it in even some sport sponsorships and just regular ad spend is down for all dealers.

And even if ours is down we still think relatively speaking we'll be one of the bigger advertisers in most of the markets we operate in.

All right, okay.

Thanks.

Thank you.

Your next question is from the line of Larry Schumacher.

Hello?

Good morning.

We lost Larry.

Larry, your line is open.

Larry, your line is open.

Let's go to the next one, operator, please.

Your next question is from the line of [Matt Gardner].

Hi, it's Gary and Matt.

Hi, Gary.

Most of the questions have been asked, but there's a couple things just to follow up on.

One is, you probably saw earlier this week, I believe or last week Deere managed to get a financing done using basically their tractors and others through some government agency.

Have you been exploring different opportunities to work with the government to get financings?

Gary, we're looking at everything.

That's a totally different asset than what we deal in.

I think the more relevant deals were Nissan and Honda which surprisingly nobody has asked about.

The pricing on those deals was not great, and the amount that they both had to keep was not a sustainable percentage for us as well.

I didn't hear about that other deal.

I don't know, Keith, if you or Tom did.

It seems like there's all this government money sitting around at different agencies and they don't know what to do with it.

It does seem that way.

You may want to explore it.

It sounds like also they reached some agreements by the way, while we are on this call, with the automakers to give them $14.3 million from the TARP.

I hope it's billion, because million is not going to last even a week.

Billion, I'm sorry yes.

A million wouldn't go too far.

And another $3 billion coming if they approve the second half of the TARP, something like that.

So that just means another 14.3 deficit.

Thanks for your political opinions, Gary.

Okay.

In terms of going back on the market share, just trying to -- and I understand you want to preserve capital and it's great to have the gross margin and you've done a super job, by the way, managing gross margin, and other people have expressed how strong it's been, but I just want to say you've done a good job.

But as we watch other retailers, I'd go back all the way to Home Depot in '90, '91, they use the weakness to really gain share.

Now, they had a stronger balance sheet at the time.

So, what I'm trying to understand is, is there a concern on the balance sheet side, not so much that you can't finance the warehouse facility, but even deeper, that leads you to decide to completely freeze expansion opportunities at a time that on a relative basis you look stronger than some of the other competitors, and two, to continue to go for gross margin rather than market share?

I do want to point out we gained share.

And we gained share at a pace that we have gained share in the past.

So our most recent share data says that we did both.

We're able to preserve margin and gain share.

So that's one of the factors.

I will tell you, when we talked about this at the end of the second quarter, and we're paying very close attention to whatever share data that we have, if we saw continuing decline, then perhaps we would have made a different decision on margins.

But share is back up, and it's back up to a gain position that we're comfortable with.

And so it's always a balancing act there.

But we feel like we did gain share.

But you could be gaining so much more.

And the other part of the question is, is this the right time to completely freeze the expansion?

Well, we believe it is the right time.

That's why we did it.

In terms of gaining additional share, I personally, I'm very skeptical that the amount of dollars required to change consumer mind-set are just not there.

They are not available.

I don't believe we -- I don't believe we could substantially change demand and change our traffic by giving up a bunch of margin.

Okay.

Look how car dealers have historically done pricing, and you look how we've done pricing.

We're of the opinion that it's an everyday low price and that customers will come in based on our price, non negotiated, full information, ability to compare to everybody else.

In this last quarter as we said, it looks like we both gained share and preserved margin.

If you look at some of the discounts that are out there on new cars in other markets, people are announcing $5,000, $9,000 off a product.

That's just not how we play the game.

And for us, moving down a couple hundred bucks, I just don't think it's going to change the consumer mind-set right now.

That's helpful.

Okay, thank you.

Thank you.

Your next question is from the line of Rod Lache.

Good morning, guys this is Dan [Galis] in for Rod actually.

I might have missed it but did you give any capex guidance for the fourth quarter?

We did not.

Okay.

And I noticed there was some mention of covenants in the release.

Can you talk a little bit about why you put that in there?

Are you approaching something?

Well, everybody is asking about covenants.

You see it in almost all the other car dealers' questions.

We figured it would come up.

We wanted to make sure people understand that we were still in compliance, and we're acutely aware of what our debt covenants are and we're doing everything we can to make sure we remain in compliance.

Can you tell us what the ratio was at the end of the quarter, and what the test is?

Well, the test, I think you can find from public documents, and it's about 1.25.

Fixed coverage ratio.

Fixed coverage ratio.

We were comfortably above that at the end of the quarter.

Okay, thank you.

Then on the sale/lease-backs, can you talk a little bit about did the particular deal in Austin, was it an attractive rate, or are you going to try to pursue more deals such as that?

And can you give us any guidance on what lease rate we should be using?

We think it was an attractive rate in the current environment.

I don't know how we could possibly give anybody any guidance on what lease rate to use going forward.

It's kind of a deal by deal basis.

We were comfortable with that deal.

We thought it was a good deal, that's why we did it, but they are case by case going forward.

Can you give us a rate on that particular deal?

I would say it was in line with what we did in the 2006 time frame.

So it was relatively attractive.

Okay.

Thank you.

And then one last one, it looked like the gain on CAF originations was up quarter over quarter.

Was that due to higher customer rates or lower conduit costs because of LIBOR?

Really a combination of both.

Benchmark rates fell dramatically through the quarter and we did make some APR adjustments, as we mentioned earlier.

Part of that was aligned in trying to let our partner lenders win a little bit more and part of it was just strategy based on risk.

Okay, thanks very much.

Thank you.

Your next question is from the line of Cid Wilson.

Good morning all.

Most of my questions have been answered regarding sales and CAF so my one question is, we've seen a sequential increase in your service department sales.

You had a 6.3% increase, and I think last quarter it was somewhere around 5% or so.

And can you give us some color as to what's happening there?

Are you seeing more consumers coming in to have their vehicles serviced, and is that an opportunity to keep customers coming to the stores?

Any color?

Well, that's largely a capacity issue for us.

With the decrease in sales we've seen over the last couple of quarters we have a bunch of additional capacity in our shop.

So I think our store teams are doing a good job of servicing the customer and although I think there's obviously chance -- there's obviously opportunity there for additional revenue.

It's certainly not going to offset the big sales drop that we've seen.

But we're pleased to see it going up some but it's largely a result of additional excess capacity in the stores.

Okay.

And also, about any regional -- sales by region, which areas were the toughest regions?

Was it still the traditional California, Florida, those?

Yes, we've never really talked about regional differences.

Okay.

Thank you very much.

Thank you.

All right, thank you, everyone.

Thanks for joining us.

Once again, thanks to all of our CarMax associates.

Thank you for your hard work, your dedication.

We'll talk to you next call.

Thanks.

This concludes today's conference.

You may all disconnect.