車美仕 (KMX) 2010 Q3 法說會逐字稿

Good morning, my name is Nicole 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.

(Operator Instructions)

I would now like to turn the call over to Ms.

Katharine Kenny, Vice President, Investor Relations.

You may begin your conference.

Good morning.

We're all here, and soon to be very snowy Richmond, but we thank you for joining us so early today for our third quarter earnings conference call.

On the call with me today as usual are Tom Folliard, our President and 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 such statements are based on managements 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 28, 2009, filed with the SEC.

Before I turn the call over to Tom, let me also remind all our investors and analysts that we have our next Analyst day here in Richmond scheduled for January 28th.

So, we hope some of you will be able to attend.

Tom?

Thank you, Katharine.

Good morning, everyone.

Welcome to our third quarter conference call.

We are pleased to report strong third quarter results driven by a 19% increase in total revenues, a 13% increase in per unit total gross profit, and excluding CarMax auto finance adjustments, a 40% increase in cap income as compared to the third quarter of last year.

Comp store used unit sales increased 8% this quarter, compared to a decrease of 24% last year.

We were able to achieve these results despite continued low consumer confidence, resulting from the weak economic environment and double digit unemployment.

Let me briefly review our key financial results in a little more detail.

First, on the sales front.

The significant increase in used vehicle revenues was due in roughly equal measure, to increases in unit sales and average selling price.

Unit sales grew due to a combination of improvement in traffic and sales execution, the majority coming from traffic, but were also a reflection of easy comparison to weak sales in the third quarter of last year.

We were pleased to see on a year-over-year basis execution improved despite tighter lending standards implemented in previous quarters by our third party lenders and CAF.

We estimate CAF's tightening to continue to negatively impact comp used unit sales by several percentage points in the third quarter.

As we've discussed before, the higher selling price largely reflected the increase in year-over-year wholesale pricing.

We did not see a significant change in our vehicle sales mix.

The improvement in wholesale revenues was also due about equally to increases in unit sales and average selling price.

Appraisal traffic remained approximately flat with last years level, but similar to last quarter our buy rate improved significantly due to the higher year-over-year wholesale industry pricing.

The third quarter buy rate finished above 25%.

On the gross profit, our used vehicle gross profit per unit remained above $2000 in the third quarter.

As we've said the year-over-year increases in wholesale valuations have provided a gross profit tailwind, and compared with the second quarter our increased appraisal buy ratio improved our inventory purchasing sell sufficiency, which also supported our gross profit.

Please remember however, that we continually evaluate the marketplace and assess strategies that will allow us to achieve optimal margins from the standpoint of our total business.

Now I'll ask Keith to review the CarMax auto finance results.

Keith?

Thanks, Tom.

Good morning.

CAF's significantly higher income this quarter resulted from several factors.

Our load penetration was up slightly compared to last year's third quarter, despite the tightening of our lending standards earlier this year, however CAF's penetration was up substantially versus the second quarter.

Given the improvements in the automotive ABS market, we felt more confident that CAF would be able to sufficiently securitize it's origination.

As a result we chose to increase CAFf's penetration during the quarter.

We did this by lowering rates and taking back business that had been routed to and financed by our third party lenders in previous quarters.

The increase in penetration substantially offset the effective incremental tightening that we implemented at the beginning of the second quarter.

The gain percentage also increased from last year's third quarter, largely due to lower benchmark rates.

But more significantly, CAF income this quarter was supported by approximately $32 million in favorable adjustments, related to loans originated in prior periods, whereas income for the third quarter of last year was negatively impacted by almost $40 million in unfavorable adjustments.

The primary drivers of this quarter's adjustments included mark-to-market write-ups in the value of our retained subordinated bonds.

some of which are now carried above face value, and more favorable funding costs of the loans that were refinanced and the term securitization during the quarter.

Note that since most of the loans in this securitization were originated in fiscal 2010, the favorable $12 million, or $0.03 per share of funding cost adjustments, is a timing adjustment that is part of CAF's year-to-date gain income.

The mark-to-market write-ups reflect the significant narrowing in the automotive ABS spreads that has occurred over the last few months.

Let me make a few other comments about CAF.

Because our new short-term agreement with Santander was implemented late in the quarter, it did not have a material impact on current quarter sales.

However, we do anticipate that in the fourth quarter, it will largely offset the negative affect of the sales on CAF's latest tightening which we implemented in June.

Under this agreement, Santander will purchase a large portion of the loans that CAF would have approved prior to our latest tightening.

As part of this strategy, CAF will also originate a small portion of these loans.

We are comfortable with this credit segment, but will remain conservative until we see more stability in the credit markets.

Most of you are all aware that we will implement FAS 166 and 167 as of March 1, 2010 which is the beginning of our next fiscal year 2011.

We utilize two primary funding sources for CAF, our warehouse facility and the term ABS market.

Historically both of these structures have been off balance sheet and have been accounted for using gain on sale accounting.

Existing and future term ABS transactions will now be consolidated under FAS 167, which allows, for but does not require restatement of prior year results.

Transfers to the warehouse facility will no longer qualify as sales under 166.

FAS 166 must be applied prospectively, and it does not allow for restatement of prior years.

As a result, we will not be restating CAF income for periods previously reported using gain on sale accounting.

Nevertheless, we continue to be committed to the most transparent communication possible about the impact of these changes on CAF's reported income, although we now recognize that we may be somewhat limited.

We will keep you abreast of further developments.

Now I'll turn the call back over to Tom.

Tom?

Thanks, Keith.

On to SG&A, we were very pleased with the progress we continue to make in reducing our SG&A despite higher sales.

The year-over-year decline reflected a reduction in advertising in fiscal 2010, decreases in growth related costs, and benefits from a variety of waste reduction initiatives.

We also believe we are now in a position to move forward with the openings in fiscal 2011 of the three stores we completed earlier this year in Dayton, Augusta and Cincinnati.

Despite this, and despite the fact we will opportunistically evaluate and perhaps purchase land for the future development of stores, we do not plan on restarting growth at this time.

In closing I'd like to once again express my thanks to all of the CarMax associates for everything they do to help us successfully navigate through these very difficult economic types and I wish all of them a safe and happy holiday.

Now Keith and I will be happy to take your questions.

(Operator Instructions)

Your first question comes from the line of Jaison Blair with Rochdale.

Good morning, and congratulations on your performance.

Thank you.

I was wondering about the fiscal 2011 store openings.

My impression is that at least one of those stores is in a new market, which requires high levels of advertising to introduce the brand to the marketplace.

And if those stores are expected to be accretive, in I guess what you would characterize as the worst automotive downturn of the post-war period, why wouldn't you consider restarting growth?

Well, those three stores already have a sunk cost to them, so that's why they're accretive.

We are already incurring the depreciation and amortization, so we looked at these as an incremental investment at this point.

So you're already taking the depreciation even though the stores haven't opened?

Correct.

Okay, and you talked about purchasing land for future stores.

What is your current land position look like, or your pipeline for -- how long -- do you have stores -- how many stores do you have in the pipeline, how long would it take for you to restart growth?

The three stores that we're opening, are the only three stores that we have any type of construction working on.

We have a few pieces of land that we still either own or control.

And when we talk about opportunistically looking for other pieces of property, it doesn't mean we'll go out there and start building, just that we're looking to see if there's any type of deal we might take advantage of.

Okay, and your new credit agreement with Santander, is that kind of in effect on doing the June tightening of credit standards?

Or can you provide a little bit more color on that?

Yes, it substantially does that.

What we ended up doing, is through the relationship that we've built over the last few years, they've gotten comfortable with our lending standards.

And they've really stepped in and basically are now underwriting the majority of those loans that we tightened back at the beginning of June.

And is that a permanent agreement, or at some point you might take those back if you loosen up your credit?

We really like that segment.

It's just that the credit markets, we want to see them solidify before we take a bigger portion.

So we're currently underwriting a smaller portion of those loans along with Santander, because we do like that segment.

It's just that we want to see more visibility and stability in our ability, to go ahead and finance these.

And we'll wait and see how things unfold.

It is a short-term agreement.

We are pretty optimistic that we can extend it, if need be.

And then one last question.

How would you characterize I guess your overhead or your employment levels?

If we saw a recovery of demand in fiscal 2011, are you yet in hiring mode to prepare for a recovery or are you still in, how would you characterize how you're positioning and how you feel in your outlook for Fiscal 11?

Well, right now, we feel very good about our staffing levels.

We're staffed appropriately to our current sales level.

And if things were to recover, we feel very confident in our ability to hire.

It's a pretty attractive market to be hiring in right now.

We're resale, so we have a reasonable amount of turnover even in good times.

So we're -- essentially we're hiring sales consultants in all of our stores, because we're always hiring to replace turnover once we're staffed to our current sales level.

But we feel very good about our ability to respond if the market was to pick up.

Okay, great.

Thank you so much and congratulations again.

Thanks a lot.

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

Good morning.

I had a few questions.

First, Keith, how long is the -- I'm sorry -- the Santander agreement?

It's a few months.

Okay.

I guess the other thing I was kind of confused by, in the reporting on the finance side, was just it looked like you had some sort of offset in third party lending revenues.

What happened there, and can you kind of walk us through that?

Well, if you -- one of the things that happened during the quarter, is because CAF stepped up and took back a large piece of the business, revenue that would have showed up in third party income, ended up showing up in CAF's segment, versus the prior quarter.

So that was intentional, because we made a lot more money by originating that through CAF than our third parties.

And then Santander does charge a sizeable discount for the subprime space where they originate, and that's been a consistent very large piece.

So when you pull back the other third party that's substantially offsetting the revenue from our other third party lenders.

One last question, and I'll give this one to Tom, but it will be more of an operational question.

I know you've pulled back the ad spend this year, and obviously sales are coming back.

And I guess I'm curious as to how much of the SG&A leverage you're getting from that decision to curtail advertising spending?

And whether this is a more structural shift, and how you think about advertising spending on a go forward basis?

Well, we listed the items in SG&A savings in the order of their magnitude.

So we listed advertising first because it's the biggest chunk of the difference between this year and last, but we monitor our advertising continuously.

We try to manage it on a cost per car basis.

So with sales, although sales are up 8% in quarter, it's up against a negative 24.

We're still down 16 points over just two years ago.

So we're managing our advertising accordingly.

There's not a structural shift in the way we have thought about it.

If we think about it in terms of cost per car, then we're hopeful that we'll be spending more on advertising going forward, because sales will pick up.

Okay, thank you.

All right, thank you.

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

Good morning.

A couple questions.

First of all, it looks to us from comparing your numbers with any outside third party assessment, that you probably gained used car market share during the quarter.

You usually have a view on how that transpired, and I'm interested what you think happened here.

Yes, we used to have a view on a shorter term basis, but because of the inaccuracy of the data at the beginning of the year this year, we said we would talk about market share annually from this point forward.

So we're looking at the data all the time, but it's so inaccurate in the short-term, that we have made the decision that we will discuss it at year-end.

Understood.

On cost structure, to your point last year as sales were under pressure, your costs were not coming down commensurately.

This year, your costs came down more than commensurately, if you will.

And you seem to more or less catch up on a two year basis as you look at the delta and expenses per store, versus the delta in sales per store.

Are we yet at the point where you would expect to see costs increase more or less in line with revenues?

Or do you still feel like you have more to go on the cost structure front?

We feel pretty good about the progress we've made.

I think there's always room for improvement in managing your costs, and becoming more efficient.

And we have a number of different initiatives to try and maximize the savings, and run the business as lean as possible.

In terms of going back up, as sales pick back up, you have to remember, there's a couple big chunks that will come back.

Advertising, we already talked about.

But when we get back to opening up stores again, which as we said, we aren't doing right now.

But when we do, there will be a big chunk of SG&A that will come back as well.

So some of the stuff that came out, we want to get back to doing what we were doing before, which is building stores.

Of course.

I guess on the credit front as you look at gain on sale, you're at 3.6% this quarter.

You're at 4% last quarter.

Is that essentially the tradeoff, Keith, that you discussed with opening up the spigot a bit more, and taking in some more volume into CAF?

Yes, I mean that's substantially it.

Part of the -- taking more volume was, we did reduce our rates and therefore, one, more often, because we felt confident that we could go ahead and securitize these.

And is that 3.6 reflective of your real-life cost of current funds in the marketplace, as well as what you're charging your consumers?

Well to some extent.

Part of the gain, the $12 million we experienced, was a difference between the warehouse and the public market.

A portion of that was the 3.6 included in that transaction.

So if the market stays the same for the fourth quarter, there's a possibility that there would be another pick up in the fourth quarter.

And then finally on the Santander front, if you could just remind us sort of where they fit into your heirarchy to the extent that you still have some partners who are helping you out kind of below them, and how significant that piece of the market, is which I assume lies directly south of where CAFwould fund transactions, but maybe north of where some of your other partners live.

I mean, there's been a couple of changes with Santander.

They've obviously been our key subprime provider now for quite a while.

Two things happened this quarter is that, Wells Wachovia merged, and what happened is then we lost the Wells originations as a result of that.

Santander actually moved up into that space, and is originating in place, and substantially offset the impact from the Wells going away.

The second piece was what we talked about, was the piece that in buying the originations that CAF had decided to decline beginning in June.

And so if we look forward in those fourth quarter, we would expect Santander to be north of 15% of our total business.

And the economics of their involvement in the space, versus either your other subprime partners for that, for that piece of it, and in terms of CAF economics for the I guess, the mid level piece?

Sure.

In the mid level piece, they're paying basically the same as our third party, so they are paying us for that piece of it.

On the other space currently, since it is a test, and it's new to them, we're currently, they're buying those at par, so there's no discount or no origination income.

And part of why we entered a short-term agreement, is for both of us to evaluate that going forward.

Got it.

Thank you so much.

You bet.

Your next question comes from the line of John Murphy with Banc of America.

Hi, good morning guys.

First, Keith, on the borrowing costs that CAF saw in the last securitization of 1.71%, just wondering if you think that's something sustainable in the near term, because of the strengthen the ABS market?

And what that has to do with TALF support there, or really is there anything that will change in the near term that would raise that borrowing cost?

It's hard to say.

I mean the encouraging thing is our deal was a non-TALF deal.

And so completely, even though TALF was out there, we actually think that a great transaction.

But you know as well as I do, that the vagaries of the market, and things happening somewhere in the economy can ripple through fairly quickly.

So all I can do is say, I hope that it's an indication, and how long it will be sustainable, your guess is probably as good as mine.

Okay, and then the second question just as far as the penetration of CAF, I mean where was that in the quarter?

And do you see that improving over, I mean increasing over time?

Or is it going to be impacted by the Santander sort of expansion here in funding?

I mean, how is that going to, how do you expect that to change over time?

CAF penetration was approximately 33% before pay outs.

And the answer is, that it shouldn't go down depending on where Santader is.

It could go up depending on what the long term arrangement is.

If we get to the point where we're confident about where Santander plays, and our ability, excuse me, our ability to go ahead and finance that, it could be that we decide to step back into that space and take more.

I think we're open and willing to have Santander continue to play in that arena, just because we can't control the overall ABS market and the financability of it.

So we think long term, it's going to be part of our strategy to have someone playing in that space.

But we're absolutely willing and interested taking more of that in the future, because of the economics on it.

We make a lot more than par obviously on it.

And I missspoke.

It is the 33% is net of pay (inaudible).

Got it.

And Tom, you mentioned on a number, in a number of places in the press release and in your comments, that showroom traffic was stronger than what you financed.

Or if you financed more of your showroom traffic obviously you would have gotten higher sales.

Is there anything going on that you're seeing unique in showroom traffic where it's picking up markedly, as sort of consumer sentiment is getting better?

Or what's going on with showroom traffic?

And if you get this higher percentage of folks financed to lower end, are we looking at like 2% or 10% increase in the folks that are getting financed?

Or something in that range, is really just a couple percent or is it pretty high?

We're referencing our traffic in relation to financed customers, we're referencing our traffic in relation to our sales number.

And we talked about an 8% comp that the components of which were partially traffic and partially sales execution, and that traffic was a bigger chunk of it.

So although traffic was up in the third quarter year-over-year, sales were up 8%, and traffic was a portion of that.

So it was 5% or 6%, compared to 3% or 4% of sales execution improvement.

And we don't see the customer coming back in the volume that we'd like to see the customer come back.

Again this is an 8% improvement on a 24% decline.

We're still 16 points off of where we were just two years ago.

Some of the external factors we continue to reference like high unemployment and low consumer confidence, continue to impact our ability to get back to where we once were.

Okay, and then just lastly, on used car pricing, obviously we've gone through a massive spike out of the trough in the beginning of this year.

Seems like there's some stabilization but recent weakening, is there anything that you're seeing in the market that is sort of an abberaration or something that's concerning?

Or do you think what we're seeing in the market is more seasonal and something very easy to deal with?

Well I think it's more seasonal right now than the fall.

We always see depreciation in the fall.

What's gone on over the last year and a half or so, particularly this year, when we saw appreciation continue all the way through August at a much steeper rate than we seen in the past.

So I think the abboreation is more hopefully behind us, and it gets a little more predictable going forward.

But in this environment it's impossible to predict what's going to happen.

So much is dependent on what happens with new car sales.

Great.

Thank you very much.

Thank you.

Your next question comes from the line of Matt Nemer also with Wells Fargo Securities.

Good morning everyone.

Good morning, Matt.

So just on the traffic topic, any sense for whether we're still in a hang over period for Cash for Clunkers?

Or do you think that this is sort of we're now at a place where that's behind us, and this is the steady state traffic that we're going to see for some time?

I mean, we don't really know.

It's been three months since Cash for Clunkers, and we've talked about a spike coming from Cash for Clunkers, and we were looking for a let down.

You know the numbers are what they are.

I'm not sure we'll ever really know how much of it was a pull forward.

But this is how the numbers came out for the quarter, and we haven't really been able to assess specifically how much of the traffic shift was due to Cash for Clunkers.

Okay, and then secondly, on gross profit per unit, historically I think your philosophy was really to try to drive comps, and you ran at 1900 for a very long time.

Should we read into this, other than what's going on in the market and pricing for used cars, can we read into your gross profit that you've tested the elasticity of demand, and you don't really get much more volume at $100 or $200 lower than where you're at?

I think that we believe that has been true for most of this year, but I wouldn't read into it and believe that it's true going forward.

I feel like we'll constantly, and always be testing the elasticity of price, to see if we can drive more sales.

And our preference would always be to drive more sales.

We've talked about it a number of different quarters that we didn't believe lowering price would help us very much.

And that has been true through the year, but I just don't think you can make any conclusion, draw any conclusion going forward.

But as of now, your modeling is basically telling you that this is the optimal place to be, that you're not getting much more at 1900 or 2000?

Well instead of as of now, I'd say as of then, when the third quarter ended.

But I'll tell you that we're constantly testing and evaluating price and see if it can drive sales.

And we do it in a controlled manner, we'll take a few markets and move them around, and see what happens.

And we'll continue to do that going forward, and when we see evidence that it will help us move sales, then we'll do what we think is right for the total business.

Okay, and then lastly, on advertising.

Is there a point where we kind of anniversary the big reduction?

Are you about as low as you can go now, and which -- what quarter do we really start to see that compare get more difficult?

We feel pretty good about where we are.

As I said before, we are trying to manage our cost on a cost per car basis.

We're running less points than we used to on TV.

We're spending less total money, but so is everybody else.

So we still feel pretty good about what's called our share of voice, and how much our brand name and message is getting out there with the consumer.

We feel very good about that.

But we're going to manage our advertising kind of commensurate with our sales.

So as I said before, if sales continue to go up we plan on spending more on advertising.

Got it.

Thanks very much.

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

Good morning.

Hi, Brian.

So, a few questions.

First off, I want to just ask about, talk about SG&A, and kind of follow along some of the questions that have already been asked.

But as you look at SG&A, and you've done a great job controlling expenses on several fronts over the past several quarters.

And so now we have two quarters where you've had nice positive comps.

I think that is to some extent is probably stress testing, these cost controls as you put in place.

But putting aside the impact of cost coming back, as you potentially open more stores going forward ,or even on the advertising side, from a structural standpoint, Tom, how much lower from an operating expense standpoint do you think you can run the business?

That's a tough question.

As I mentioned earlier, I always feel like we can improve our efficiencies.

It's difficult to slice that piece out, and project forward how much more room there is.

Remember too that for us, another big piece of cost that we focus on is our reconditioning costs, which are not included in SG&A.

They're in cost of goods sold.

And we talked in the past about progress we've made there.

And we think we have more room to go in that area as well.

So I couldn't really specifically define for you how much more cost we can take out, other than to caution when we get going there is going to be a big chunk coming back.

Okay, and then the second question, the stores you're going to -- that you had previously constructed and are now going to open again, the last time we spoke it, it sounded like to me, that it would take a longer time for you to decide to open those.

The decision to open them, is it simply a reflection of the improving traffic you're seeing, or is there something else in that process?

It -- the traffic has been, sales are up as we said over last year, although not where we would like them to be.

This is more of just a financial decision for us.

It's the -- there are three stores, there's a sunk cost involved there.

We mentioned that opening those stores in the first half of the year would be accretive to earnings.

We're not sure what the negative impact is of having two brand new markets like Cincinnati and Dayton where our store is sitting there built and having consumers drive by.

And we feel like at this time we feel comfortable from a balance sheet, and financial perspective that we can go ahead and open those stores.

But again, it doesn't mean we're going to start building other store, because sales still aren't where they need to be.

So this is just a pure financial decision on the fact that we have $50 million or $60 million of sunk costs in those three stores.

And then the final question, and I know in the past you have not commented on sales trends through the quarter, but I'm going to ask you if you could this time, just given the potential variability with Cash for Clunkers that we talked about how sales actually tracked through the quarter?

Yes, we're still not going to do that.

Okay.

But I appreciate the question, Brian.

I'll try again, okay, thanks.

Your next question comes from the line of Ryan Brinkman with JPMorgan.

Given that the sub bonds continue to be written up so substantially, this of course suggests the underlying market for these relatively liquid securities has improved considerably.

Could we expect perhaps expect to see you sell some of these securities to a third party buyer, as was the original intent at the time you stepped into purchase them, when that market wasn't there, perhaps now it is there, to remarket them?

Well, that's clearly a market -- that's just at this point when you look at our balance sheet, we quite honestly don't need the capital.

And we're making a good return on those.

So I won't say that we won't, I think at a price we would, but currently we're not actively considering that.

Okay, thank you very much.

Your next question comes from the line of Craig Kennison with Robert Baird.

Tom, your team has done a very good job by focusing on the younger lower mileage cars.

Given the aging vehicle population though, do you see a need to adjust that age, mileage threshold or tweak the mix at all?

Well that's where we talked about the majority of our sales.

But we do quite a bit of business in the older, higher mileage segment as well.

And we're pretty good at tracking the velocity and the turns of all cars by mileage and by year.

And if we see that demand picking up, then we kind of ramp up the supplies our inventory.

What's been a little unique in this environment, is that as sales have dropped off, it's really a complete loss of customer flow over the last, let's say, since last May, and our mix hasn't changed that much.

You would think that our mix would of changed more than it did.

But it really hasn't moved very much.

Thank you.

And then with respect to CarMax Auto Finance, could you walk through the various payments you receive at the threshold?

I had in my model, the subprime being still an outflow of cash to your lender, but maybe just review where that's at today?

I'm not sure what you're looking for.

So at the prime level, typically your lending partner will pay you--

Versus third parties, yes.

At the prime level, basically prime to non-prime, we basically get several hundred dollars in there, so you could $300 as an average between our prime and non-prime partners.

The shift goes to when you go into non-prime segment, where you pay a discount that's a $1000 or so.

Okay, that's helpful.

Thank you, congratulations.

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

Hey, guys.

How are you?

Hi, Scott.

Tom, we have seen a bit of flattening in the overall wholesale used vehicle market, and yet your used vehicle ASPs were up very sharply on a sequential basis.

Was there anything that maybe you guys did to drive that higher, or was that just a function of whatever mix you sold?

I'm just curious as to why we saw such a delta between what you experienced, and what we're seeing in the overall market.

I don't think there's that much of a delta there, Scott.

If you look back to the beginning of January, the amount of appreciation we saw through August was like nothing we've ever seen, before which is the biggest driver of our change in ASP.

Remember this announcement is through November, so although we've seen depreciation, you can see it in the (inaudible) numbers, it's come down some but not that much.

So it's know where near where it would be in a normalized year, and when you compare year-over-year, it's still obviously for us still the main driver of our change in ASP.

So although it's come down slightly, it's coming down from a peak like we've never seen.

Right, okay.

Can you also talk about -- you mentioned conversion rates, can you talk about conversion rates verse last quarter, versus the second quarter, because it's something you talked about if I remember properly, in the second quarter was, you had seen actually a drop in traffic, but improvement in conversion rates.

Can you just kind of compare what you guys experienced in the third quarter, so we can get a feel for in whether execution continued to improve or we met a new threshold, etc.?

Well I think it's better to compare, because there's a lot of seasonality in conversion, because there's different consumer behavior throughout the year.

And it's better -- well, we feel its better to compare conversion year-over-year.

So in the second quarter, we said conversion was improved year-over-year, and we said the same thing in this quarter.

We were just attributing the amount of the change in sales, and dividing it between traffic and conversion.

But conversion in our third quarter was once again up year-over-year.

And we're very pleased with that, we made a lot of improvements in our training in our stores.

And we feel like our sales consultants and store teams have done an outstanding job in this environment of making sure they are taking care of the customer.

And I think the consumer is responding positively, if they actually come to the store.

And remember too, I mentioned this in the press release, with tightening lending standards, not just from CarMax Auto Finance, but from all of our third parties, our salespeople have less approval to work with, on or less quality approvals to work with, if you made the comparison to the same customer with the same FICO score a year prior, so it's kind of a head wind for conversion.

Okay, that's helpful.

And then last question is, I know there's been a bunch of questions on the SG&A side, which I think has continued to surprise most of the investment community here.

And just kind of thinking about 2010, calendar 2010, do you think you're going to need to invest more in the business?

You already made the comment about advertising, but just as kind of a general thought process, is there a point where we need to start investing more in the business?

Well, we feel like we've had a decent balance of investment in the business, and at the same time trying to become more and more efficient.

Part of becoming more efficient requires additional investment.

We talked about that in some of the other quarters.

But to try and lower our reconditioning cost requires us to invest in engineering, and lots of other things to try and drive those costs down.

Improving our execution doesn't come for free, and that requires investment as well.

We've continued to make new ads.

We're not running the same ads we ran a year ago.

We had two rounds of new tv ads we've invested in.

So I feel like we have continued to invest in our business, and we will going forward as well.

Okay, that's helpful.

Thanks, guys.

Your next question comes from the line of Simeon Gutman with Credit Suisse.

Hi guys.

First, can you comment on your inventory plans heading into next year?

I believe last year you were a bit tentative, but other than some seasonal changes, do you have any different thoughts going into this year-end?

Well last year, at this time frame, so this is the end of the third quarter, the beginning of the fourth quarter, we were more conservative than we had been in the past, because of the record depreciation we seen in the three-month period.

It's not as dramatic this year as it was before.

We're doing the best job to predict our sales going forward, and then our plan is to inventory to our sales rate.

It's kind of our plan every year.

Last year we got a little more conservative, because we are seen a short-term depreciation curve like we had never seen before.

And I guess connected to that, a follow-up on the comps, and the expectations.

Recognizing that Clunkers definitely benefited your sales last quarter, which made forecasting this quarter all the more tricky, and you hinted that sales aren't where you want them to be, can you just talk about where your internal expectations were, and how far off are they?

I mean and I guess that comes into how you can predict the inventory build as you go into year-end.

I don't know if this will make you feel better, but it's almost impossible to predict.

It's not just Cash for Clunkers, the last year and a half have been impossible to really project going forward.

The good thing about how we manage our inventory, and I've talked about this a number of times, we literally manage our inventory every week.

And we predict -- we try to do the best job we can predicting the next seven days.

And we make all of our acquisition decisions accordingly.

And we continue to have a very tight window around inventory planning and inventory management.

But we're not trying to figure out what sales are going to be next year, and then planning inventory now.

We're literally looking at a week by week basis.

And I know you mentioned this, but just to clarify, the decision then to go ahead and open the stores, it's not that you're necessarily feeling better about the business from the top line.

It's just the cost structure is in better shape, I think CAF has stabilized, and is doing well, and now it's just you made a determination that makes sense to cover some of these costs.

That's correct.

Okay, thanks.

It's almost pure math.

Thanks.

Your next question comes from the line of William Truelove with UBS.

Hi, good quarter guys.

Thanks.

In terms of -- you talk a lot about things for next store growth, and you're 16 points down from the peak in terms of sales.

Is there a certain level of sales that you'd like to see before you can consider store growth, Tom?

I don't know if there's a level we would like to see.

It's more of a trend line that we want to believe in.

These stores have very long economic models, and if we thought we would get back to our old sales levels in six months time, or a year's time, it wouldn't make much difference in terms of getting going again with building stores.

So it's more of the trend and a believable growth rate that we want to see, as opposed to a particular number.

Okay, and secondly, in terms of new stores, is it possible that rather than acquiring the raw land, and then building on it, you might be able to take some of these existing dealerships that have gone out of business, and where the land and maybe buildings are still there, and do it more economically that way, is it possible?

It's possible, but from what we've seen so far, it's not like the biggest best car dealers in the best retail location, which is where we want to be are the ones that are closing.

You see a lot of fringe dealers closing on the outskirts of town, and that historically is not the best location for us.

So when we go to a new market we want to be in the biggest dealer row.

We want highway visibility.

We want to be near high growth retail.

And it just doesn't seem like those are the places that have been closing.

So in terms of us trying to find the absolute best location possible to maximize our sales, that strategy, maybe there's something that will work here and there, but I wouldn't think it would be the main way that we would build stores.

Great.

Thanks so much guys.

Appreciate it.

Your next question comes from the line of Bill Armstrong with C.L.

King & Associates.

Good morning, so will Sander -- under your new agreement with Santander, are they purchasing loans for CAF from CAF, or are they directly making loan offers to your customers?

Well, the loan offers are showing up on the store screen as coming from Santander, is the way the consumer is going to see it.

So they aren't actually buying loans from CAF?

Actually they're buying them from the store, like they would normally buy them from the store.

Right, okay.

Inventory per store was up around 23%, 24% on a year-over-year basis.

Is -- I assume some of that was from price inflation, but I assume also you've got more units.

Is that true, and what should we infer from that?

It's mostly from, we have an 8% positive comp, so that's part of it.

And then the rest is all from higher ASPs.

So you're not loading up in anticipation of a big sales burst in the near term?

I'm sorry, say that again?

So in other words, looking at that 24% increase, we shouldn't infer any kind of -- that you're anticipating those levels of sales growth?

In other words, 20% plus type sales growth?

No, and the truth is, you would never see that in our inventory numbers because we don't manage our inventory like that.

So we never -- are 20% overstocked with the expectation of increased sales.

As I mentioned earlier, we aggressively manage inventory to our current sales rate.

Got it.

Okay.

Are you seeing benefit in the market from all these dealer closings that we've seen?

I know you mentioned before that a lot of them are sort of on the fringes of local markets, but is there any way you can measure any benefit in terms of market share?

Or just any other benefit to your business?

It's hard to see a benefit when we're so far off of where we were just two years ago, to Matt's question earlier about market share, we'll discuss that at year-end.

That's where you probably see that number show up, if we feel like we're gaining share.

It's just the market has gone away so fast, it's a little difficult to measure.

Right, and then finally, I think you answered this already, but your ASP on retail sales was up about $1700 year-over-year.

Sounds like that was mostly from price inflation, and really not, mix didn't really have much of an impact; is that correct?

That's absolutely correct.

Mix had almost no impact.

Okay, great, thank you.

Thank you.

Your next question comes from the line of Scott Stember with Sidoti.

Can you guys probably quantify the lower reconditioning costs, how much of a benefit that had in this quarter?

I know in the next quarter you are going to anniversary some of these benefits, but could you just talk about that?

Yes, I think at the end of the first quarter we talked about $100 of savings that we said was sustainable.

And that's the same number that we have to report in this quarter.

We believe there's more to be had there, and when we achieve it and we achieve it in a sustainable way, then we'll talk more about what that number is.

And with regards to these three new stores that will be opening, will they be employing the new flow concept for reconditioning?

At this time we -- if they open as full reconditioning stores, they will open under our new format.

We have two of these stores that are full production stores.

One is built as a satellite, but we have the option to open all three as satellites if we think that makes the best financial sense.

So when we get closer to opening those stores, we'll make those decisions.

Great, and last question, did you give what the CAF penetration rate was in the quarter, versus last year?

It was 33, versus 32.5.

It was about flat to last year.

And what was it again in the second quarter of this year?

It was 27.

Great.

That's all I have, thank you.

Thank you.

Your next question comes from the line of Mark Mandell with FTN Equity Capital.

Thanks, good morning.

Just one quick short question.

Bonus accruals, does that have any impact this year, versus last year?

Yes, because we have them this year and didn't last year.

Okay.

Can you quantify that at all?

No, we haven't quantified it.

Okay, and then I guess one clarification.

I hate to beat a dead horse, but in terms of your expansion, if you take into account the lead times in opening new stores, if you look at the economy, I mean clearly there will be an expansion perhaps in 2010.

I think most people are assuming that.

And if you look at the weakened state of the real estate market, I can understand a dramatic cut back in expansion plans.

But given you've basically gone to zero, and you're still on hold just a little confused about your crystal ball.

Well we wish we had a crystal ball, because the one we have is faulty.

But I mean the big number is sales.

You look at our quarter and we're up 8% on a negative 24.

I don't know I can stress that enough that we're down 16% from just two years ago.

And although we're optimistic there's a recovery on the horizon, when that happens, and the steepness of the recovery is a big, big unknown.

And until we have more clarity and visibility, we aren't just not willing to go out and invest the capital.

And we're also very pleased with the progress we've been making.

Growth takes up a lot of energy and a lot of resources in an organization.

And over the last year we've made enormous progress in improving the profitability of our business.

And I'm actually excited about the prospects of continuing to make improvements there.

Okay, good.

And when we feel we see a trend we believe in, we'll get back to building stores.

We're only in 45% of the US markets.

We have a 2% market share.

I think our best days are ahead of us, and I feel just as optimistic today, as I ever have about our ability to grow as a company.

We're just on hold right now, that's all.

Thanks, have a nice holiday.

Thank you, you too.

Okay, that's it for this quarter.

We'll talk to you next quarter.

Everybody have a safe and happy holiday.

Thanks for joining us.

We'll talk to you soon.

Thank you for participating in today's conference.

You may now disconnect.