CarMax, Inc. (KMX) Q2 2009 Earnings Call Transcript
Published at 2008-09-22 14:15:31
Katharine Kenny - Head of Investor Relations Tom Folliard - President and Chief Executive Officer Keith Browning - Executive Vice President and Chief Financial Officer
Rex Henderson – Raymond James Sharon Zackfia – William Blair Rich Kwas – Wachovia Brian Nagel – UBS Matthew Fassler – Goldman Sachs Hardy Bowen - Arnhold Bleichroeder Bill Armstrong – CL King Rod Lache – Deutsche Bank Cid Wilson – Kevin Dann & Partners Jordan Heimowitz - Philadelphia Financial Victor Consoli – Perella Weinberg
At this time I would like to welcome everyone to the CarMax second quarter earnings conference call. (Operator Instructions) Ms. Kenny you may begin your conference.
I’m Katharine Kenny, Head of Investor Relations at CarMax. On the call today 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 statements are based on management’s current knowledge and assumptions about future events. They involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing protections 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 our Annual Report on Form 10-K for the fiscal year ended February 28, 2008, filed with the SEC and our subsequent filings. I’ll turn the call over to Tom.
As you may have seen like many US retailers and financial institutions we had a very challenging summer as we discussed in our release on August 6. Our comps sales declined dramatically starting with Memorial Day weekend and remained weak throughout our second quarter. The 17% decline in used unit comp sales reflected a similar decline in traffic at our stores while conversion actually held up pretty well compared to last year’s second quarter. We remain confident that our reduced earnings primarily reflected the impact of the volatile financial marketplace and the weak environment for consumer spending. We are currently taking measures to preserve our profitability and our capital as well as our long term growth plans. We have made significant progress in reducing our inventory and variable expenses to bring them in line with our lower sales levels. During the second quarter we lowered our inventory by more than 13,300 units in excess of $200 million. The speed at which we did this is a testament to the strength of our model and our inventory management system. We were also successful in shrinking costs including the reduction of labor hours although given the magnitude of our fixed costs and the sales decline we still reported SG&A de-leverage for the quarter. We expect to continue to find opportunities to lower costs in the future. Despite the sharp decline in used unit comps we made progress towards recapturing per vehicle used unit gross profit due to reduced acquisition costs we were able to keep consumer prices low but still increase gross profit by $128 per unit sequentially over the first quarter of this fiscal year. By getting our inventory in line so quickly we minimized the need for mark downs. Now let me review some of our other key financial results, first in sales. In the second quarter total sales decreased 13% to $1.84 billion compared with $2.12 billion in the second quarter of fiscal ’08. We opened three stores during the second quarter, a non-production store in the L.A. market and two production stores in new markets for CarMax, Colorado Springs and Tulsa, Oklahoma. At the end of the second quarter we operated 98 stores in 46 US markets. Used vehicle revenues declined 12% for the quarter due to the combination of a 6% decrease in average selling price and a 7% decrease in unit sales. The average selling price was lower as a result of the decrease in industry used car prices which contributed to our reduced acquisition costs. Wholesale revenues decreased as well as unit sales fell by almost 9% and average selling price fell by 8%. Wholesale units again declined as a result of less appraisal traffic and a lower appraisal buy rate. On to gross profit, the decrease in our second quarter total gross profit of $116 per unit compared with last year was due to several factors. They included the sizeable sales decrease in the quarter and our inability to achieve the normal seasonal gross profit improvement earlier in the year. In addition, as in the first quarter the reduction in appraisal traffic and the appraisal buy rate led to the sourcing of more used vehicles at auction which negatively impacted our average gross profit per unit. Despite the lower appraisal buy rate and the resulting decreasing wholesale volume we did report that our wholesale profit per unit increased by more than $100 to $897 in the second quarter of this fiscal year compared to last year. At the same time although I mentioned our buy rate was down, we did see it gradually improve during the quarter. Our auctions continue to draw more attendance on a per vehicle basis and also on an absolute level and we believe our wholesale inventory is even more attractive to dealers in this difficult environment, where more credit challenged customers may be looking for older higher mileage vehicles. On to CarMax Auto Finance, our results at CAF also continue to reflect the volatility we’ve seen in the financial markets. Earnings for the second quarter were reduced by $0.08 per share, largely due to unfavorable adjustments of $28 million at CAF. I’ll ask Keith to review the details.
CAF reported a loss of $7 million in the second quarter this year versus income of $33.4 million last year. The gain recorded for loans originated and sold this quarter was down more than 60% compared to last year. This was due to a variety of factors including lower sales, higher funding costs, higher loss and discount rate assumptions, a slight decrease in CAFs penetration, and a lower average selling price per retail vehicle. Recall that during the increase in our discount rate assumption, now at 19%, some of the gain that would have been recorded in the current quarter will now be reflected as higher interest income in future quarters. Excluding the $28 million in unfavorable adjustments which primarily related to prior year originations our estimated CAF income per vehicle financed would have still been much higher than the average fee we receive from our third party lenders. Let me review the components of these charges. First, $15.7 million related to the increase in loss assumption of un-securitized loans mostly of 2006 through 2008 vintage. Several polls now have expected cumulative loss assumptions at or near 3.5%. In today’s marketplace where everyone’s losses are substantially higher than expected our data indicates that our losses are still lower than others within comparable bands of credit. We believe this continues to be a reflection of our transparent sales and financing processes and the strength of our customized score cards which significantly mitigate the risk in used care lending. In addition, we have continued to tighten our credit standards by decreasing the loan to value percentage for some customer segments. Second, $7.7 million represented a mark to market reduction in the carrying value of the subordinated bonds we hold with a face amount of $115 million. This non-cash charge primarily reflects the timing of the recognition of income. Third, $4 million is the result of the need to again increase the discount rate used to value our retained interest from 17% to 19%. We discussed this originally in the fourth quarter of last fiscal year when we increased the discount rate from 12% to 17%. This change also primarily affects the timing of recognition of CAF income from the current quarter to future ones. As many of you are aware, there appears to be limited liquidity currently available in the asset backed securitization market. In anticipation of continued market volatility we increased the capacity of our warehouse facility to $1.4 billion and at the end of the quarter had approximately $800 million in available capacity. Let me finally comment briefly on the decrease in income from our third party finance providers. This decrease primarily reflects our lower sales; it is also a result of some changes in the mix amount in the discount arrangements with some of those lenders. This largely was due to some tightening on part of some lenders and a reduction in the credit profile of the average customer. One item of note that is of particular importance is that Frye Financial Services recently acquired Road Loans previously owned by Triad and it’s share of the businesses thus increased. Now I’ll turn the call back over to Tom.
The SG&A rate ratio in the second quarter was 12.2% compared to 10.1% in the second quarter of last year. As you recall at the start of this fiscal year we projected some modest SG&A de-leverage but the magnitude of the negative comp stores is [inaudible] then originally expected. However, our success in rapidly reducing costs helped moderate the de-leveraging that would otherwise have occurred. As I mentioned earlier we were acutely focused on reducing variable expenses to bring our costs in line with sales. During the quarter we decreased labor hours where possible, instituted a hiring freeze at our home office and are carefully monitoring all expenditures throughout our organization. We will continue to look for ways to achieve cost reductions. Looking forward, by the end of this fiscal year we’ll have opened a total of 10 stores including the last one in this upcoming third quarter. We currently plan to open five to 10 super stores in fiscal 2010. We plan to open three of these stores in the first half of next year, two of which will be in new markets for us, Augusta, Georgia and Cincinnati, Ohio. As you know, our plans are always subject to change due to construction scheduling. The reduction in our store openings for the next fiscal year reflects our previously announced decision to temporarily slow growth. While we still consider ourselves a solid growth story, we pulled back the pace of our long term growth goals in order to reduce our expenses and capital spending at a time when we’re generating less cash from operations. We believe this is a prudent decision for the near term and will help us protect our long term objectives. Let me close by saying we retain every confidence in the unique CarMax model, our consumer offer and the long runway of growth ahead of us. It is during tough times like these that we rely even more on the skill and dedication of our associates. Thanks once again for joining us today and especially thanks to all of our CarMax associates for your understanding, patience and for all you do every day. Now we’ll open it up for questions.
(Operator Instructions) Your first question comes from Rex Henderson – Raymond James. Rex Henderson – Raymond James: I want to focus a little bit on CAF and your assumptions for the loan losses now being originated. You told us what the peak loan loss assumption is for the previous securitizations, I’m wondering about what you’re expectations are for the new crop of loans?
I’ll just give you a general description, we currently now have our six most recently public securitizations range in loss assumptions from 3.1% to 3.5%. Our current originations are projected slightly less than that range for the simple matter is that we continue to do significant tightening and the impact of that tightening we believe will bring them down somewhat under that range. Rex Henderson – Raymond James: As you tighten a little bit what do you think the impact on sales has been so far and going forward?
That’s the thing that we continue to monitor. One of the things, the reason we don’t jump out and go tighten everything immediately is we try to balance the sales impact with the loss impact. The good news is that we feel like we found some significant opportunities to reduce losses without having a substantial sales impact thus far. We’ll continue to test going forward other pockets and see what happens. I wouldn’t expect any material impact on sales at this point. Rex Henderson – Raymond James: Can you give me some color on trends in same store sales in August? It must have been better than July but can you give me how it progress through August and into September?
When we came out on August 6th we talked about June and July being negative 17% and the quarter ended up being negative 17%. Rex Henderson – Raymond James: I also remember hearing that July was worse than June so July must have been worse than minus 17%, August must have been right in line overall. Tom Folliard That’s about as much detail as we’re going to give; it was negative 17% as of August 6th when we announced it through the two months, that’s kind of where we ended up.
Your next question comes from Sharon Zackfia – William Blair. Sharon Zackfia – William Blair: I wanted to follow up on one of the financing questions. My understanding historically was that you wanted to keep losses topped out at that 3% range to keep the prime status of your loan portfolio. I’m curious, I know you’re tightening but it sounds like you’re still looking for a little north of 3% in your current origination. Is this something where we’re going to kind of see permanently lower spreads going forward as you morph into something that’s a little less prime then historically?
I basically indicated that our current assumptions look like they’ll be under the range of 3.1% to 3.5% which is the six polls that I mentioned earlier. We’re going to be in that vicinity of 3%. The market has obviously changed and the comparative stats we’re going up against are also changed and so whether we are prime or not the real issue is the liquidity issue over all the marketplace. We feel like given our experience and our history in the marketplace that assuming there’s a market there we’ll be able to get these funded in due course and shouldn’t have any significant price problems. Sharon Zackfia – William Blair: When do you anticipate doing your next securitization?
That will depend on the liquidity of the market. Quite honestly we’re hoping that what Government’s working on right now will help loosen up some pockets and get people interested in buying securitizations again. Sharon Zackfia – William Blair: Are you still evaluating other scenarios or is the securitization route pretty much the one that you’re committed to at this point?
Sure, we’re talking to our banks and trying to be creative and see what other options are out there for us as I’m sure everyone is. The primary mode for us and most of our lenders that support CarMax are really the public securitization market.
That’s one of the reasons we increased our warehouse facility is so we had some flexibility here to wait and see what happens to the market. Sharon Zackfia – William Blair: I’ve been following the stock more than six years and I don’t think I’ve ever heard you guys say that you might have lost some market share in a quarter. I understand it’s lousy everywhere but if you look at either geographically where you think you split some or else wise, where do you think you lost a little bit of edge vis-à-vis the competition.
Whenever we talk about market share we always talk about the data not being as good as we’d like it to be. We’ve reference it often as we have gained share so we felt like we should reference it when we saw a very, very slight decline. That decline was only through July so we really haven’t seen August data. We always do it on a 90 day rolling basis and it’s only available in half of the markets that we operate in. We’re very concerned about it; we don’t have enough information or visibility into it to really. It could be an anomaly in the data. At this point I felt the need to mention it but we don’t have a lot to talk about. As some more time passes I think we’ll be able to have a little more visibility and a little more scope into what’s actually happening. Again, it was very, very slight and it was only through July. We don’t even have August data yet. Sharon Zackfia – William Blair: I know model year change over is also somewhat excruciating every year, is there anything in the pipeline from the manufacturers that’s going to make this season more challenging for you or do you feel like your inventories are really lean and it’s not as worse than as normal.
It feels pretty challenging right now. I’m not sure the manufacturers can do anything to really change it very much. In terms of our inventory we have been aggressively, as we’ve said numerous times, getting our inventory down to our sales rate. We’re also heading into normal seasonality into the fall. We feel pretty good about our inventory position right now regardless of what’s happening with model year change over. Model year change over is kind of built into our methodology every year for inventory management. We’re kind of paying attention to all those normal trends in addition to this significant drop off that we’ve seen over the last few months.
Your next question comes from Rich Kwas – Wachovia. Rich Kwas – Wachovia: Back to the inventory question, could you share with us any data on your body of frame truck mix and how it trended and where you are now versus last quarter?
I don’t know what you mean body on frame truck mix. Rich Kwas – Wachovia: Traditional pickup, traditional SUV.
Pickup and SUV for us has run about 30% of our total mix and honestly our mix didn’t change very much through the quarter. What has moved all over the place is our ability to make a profit on it. We subsidized that by cutting margins significantly to keep that inventory turning. What we did see towards the end of the quarter, particularly in August is a flattening out of the depreciation and the demands came back kind of enough for us to begin to make what we would consider normalized profits again on that segment. Surprisingly the mix didn’t shift as much and I think that was partly driven by us because we were willing to take significantly less margin to sell the product. Rich Kwas – Wachovia: The big swing factor is going to be the wholesale market going forward not necessarily the change in your inventory.
To be honest with you I would have expected this quarter to be significantly lower on mix and it just wasn’t. I think that that’s largely due again to our willingness to take such a lower profit on the product. If you asked me at the beginning of the quarter with all that was going on I would have expected that to shift a little bit more than it did. Rich Kwas – Wachovia: In terms of SG&A you cut the store growth rate how are you managing the SG&A cost management given that it sounds like you expect to return to the 15% store growth rate at some point. How are you managing long term versus short term SG&A costs?
It’s always a challenge. The decision to slow growth I think will have a pretty good impact on SG&A over time. You don’t necessarily see that all at once. You don’t see it in the second quarter really. I think over time we’ll be able to pull those expenses down. We thought it was a good idea to keep the growth train moving even if it was at a slow pace so we wouldn’t have a huge cost when we decide to start up again as you said, so we kept it like it is. In terms of the rest of SG&A a lot of, for a retailer particularly, a lot of your costs are in variable SG&A which I think we’ve done a really nice job of controlling through the quarter and we’ll continue to pay attention going forward. Advertising is obviously a big piece and we’re really just looking at the second half of the year and deciding how much we should be spending on advertising. There’s an argument that when you have a situation like this you should spend even more in advertising. That of course, all those people who make that argument are in advertising. At the same time I’m not sure that in this current environment spending a whole bunch of extra money is going to make much of a different. That’s another area we can control SG&A. Rich Kwas – Wachovia: What percentage are your SG&As truly variable versus fixed?
I don’t know that off the top of my head but about 75% or 80% of our total SG&A is in the stores and that’s where the majority of our variable labor is. I couldn’t give you the breakdown of variable to fixed. Rich Kwas – Wachovia: On the warehouse facility, do you have room to move that up beyond $1.4 billion?
Obviously if need be we will ask and try but the answer is I can’t give any assurances that we have the ability to do that at this point.
Your next question comes from Brian Nagel – UBS. Brian Nagel – UBS: On the warehouse facility what was the cost of getting the extra $400 million of capacity? Where are we right now in utilization of that facility?
The cusp really was in form of enhancements so that it really changed the timing of earnings and capsule it back to the company. Net net about roughly $1 million a year from interest costs if you wanted to apply that. Brian Nagel – UBS: How far are we into the facility at the end of Q2?
We have about $800 million capacity left at this point.
About $600 million in. Brian Nagel – UBS: Last time you completed that large private deal that was several months ago as you look at the securitization market now is it clearly more difficult now than it was then, what’s your read on that?
Right now as we look at securitization markets we’re looking for any deals to get done. We’ll be ready to go if and when the market opens up it’s just not open right now. It’s much more challenging. Brian Nagel – UBS: On the new store growth you pulled back the growth, you guys have a long lead time at opening stores is it fair to assume that if you didn’t have some of these already in the worksheet open far fewer stores in 2009?
We had a lot of stuff in the works as you can imagine with the growth plan we had in place. The answer is we could have probably pulled back more of these. We think this is a good level for us. We think that five to ten stores is right now the right decision and we’re being extremely diligent on the mix of what those five to ten stores look like. A few of then were just pushed from this year so we really didn’t have much of a choice there but in terms of going forward we’re just trying to be as thorough as possible with analyzing what’s the best possible way to go. The number of five to ten stores I think gives us a little bit of flexibility from the low end and the high end at the same time it keeps our growth going even though it’s at a modest pace so that we have some of those critical functions still in place if we want to get going again. We’re pretty comfortable with the decision we made.
Your next question comes from Matthew Fassler – Goldman Sachs. Matthew Fassler – Goldman Sachs: As you think about, this is really going to focus on credit and the impact on sales, both your own tightening of your standards on CAF and of your third party lenders tightening of their standards were those dynamics that intensified as the quarter progressed and then here into the third quarter or would you say they were consistent through the second quarter?
What’s happened is that our lenders are trying to make changes and unfortunately none of them have a CarMax unique scorecard. As they make those changes what’s happened is kind of bits and starts where we’ll also get caught up in a change, we’ll point it out to them and then they’ll come back and they’ll focus, no, no we didn’t intend that for CarMax. That’s kind of a push pull that we’re doing in communicating weekly with them, letting them know when we’re seeing a change that’s either detrimental or positive so that they can know whether they’re moving in the right direction or not. They also indicate that our polls, our portfolio outperforms other books of business so it’s not necessarily intentional. Although I would tell you that all of them are facing the same liquidity issues that we are for those that need the ABS market. It hasn’t been a dramatic factor. The good news is that thus far really what’s happened is that when they tightened either another one of them that picked it up and/or it’s fallen down the channel sometimes all the way to drive in which case we pay a discount but at least we’re not losing the sale. Matthew Fassler – Goldman Sachs: Can you talk about the proportion of sales represented by third party credit vendors this quarter versus a year ago?
It’s down very modestly. When I say that, you have to caution it because the other thing that we see both in prime and non-prime is we have more customers coming to us this year with prearranged financing. It’s really hard to say how much of that is just attributable to their own financing versus what the consumer is doing in advance. Matthew Fassler – Goldman Sachs: You reduced your SG&A dollars $13 or $14 million sequentially which we had rarely seen previously and second quarter versus first quarter given that typical pick up in volume. Given that your store expansion is going to slow substantially and new stores shouldn’t add materially to the expense base is this $225 million pre-CAF a sustainable level of SG&A dollars on a quarterly basis or would you say that there needs to be some creep in that number?
First of all one of the things we did do is we have a model for SG&A just like we do inventory but given the precipitous drop in sales they were at unprecedented nature we actually consciously accelerated that model in variable selling expenses and adjusting store hours. I was very pleased to that how much we could get those down. When you go forward I would tell you that SG&A is largely derived on variable SG&A on comps. If comp sales increase we’ll absolutely see SG&A increase ratably. We have to have the store staffing in order to support the customer flow that’s coming back in. That’s just a matter of when do customers come back. If we were to run flat for the next year and at this pace, yes there would be very modest creep just from inflation. I’m hoping that we’re going to see the economy turn around here and we won’t have to worry about that.
We’d be happy to have that SG&A back because we get a great return on it. Matthew Fassler – Goldman Sachs: If the sales weren’t there you’d be able to keep pretty close to here. The other question is were there any significant reversals of accruals for incentive comp or anything else that might have driven the number down versus Q1?
We didn’t accrue any bonuses for corporate as you might imagine. Matthew Fassler – Goldman Sachs: But you didn’t have to reverse any accruals?
No. Matthew Fassler – Goldman Sachs: You talked to some element of stabilization in your implied residual values on the truck and SUV side contributing to some normalization and margin patterns there etc. If that were to be continued and presumably that relates in part to the volatility of energy prices, is that something that might aid sales? In other words, do you feel like the markets froze up to such a great degree, obviously they did and that impeded your sales numbers and that some more normalization of those markets might lead to a little bit of renewed velocity or would you say that the comp decline that you experienced is less a function of that internal use car market then than more a function of money in peoples pockets?
It helps sales and profit in that segment. To be honest with you what’s really missing is customer traffic. Until consumer spending comes back I’m not sure we’re going to see a dramatic change in our sales rate. There are so many different things going on, there’s so much volatility in the marketplace right now the SUV piece of it is only a small factor. Within our inventory we might see that piece within the total mix pick up some but until we see consumers come back and start wanting to spend money and in some cases the used care is discretionary spend I don’t think until we see that we’re going to see a dramatic change. Matthew Fassler – Goldman Sachs: You think then it’s more a function of consumer spending then it is people’s reluctance to take the trade in with a big hit?
I think there are lots of factors in there but yes, I think its more consumers spending. As we keep saying we saw a roughly 17% drop in our traffic, in customer flow, walking through the door.
Your next question comes from Hardy Bowen - Arnhold & Bleichroeder. Hardy Bowen - Arnhold Bleichroeder: In past times used car business has gone down less relative to new car business now it seems, in your mind is this out of whack with what should be the case that is new car business down 25% and we’re down 17%. A lot of times it’s been used cars would be down a lot less than that. If you look out to next year and the year after do you think this is going to stabilize or you think the relationship is changed for some reason.
I really don’t know. I would say if new cars are down 25% and we’re down 17% at least we’re not down 25%. There’s still a difference there between used and new. We are at the higher end of the used car market as you know with our average retails in the $16,000 to $17,000 range. As we talked about with wholesale we’ve seen some pretty strong demand in the lower end of the market down around $4,000 where from a retail perspective we don’t play in that market. In terms of what’s going to happen going forward it’s almost impossible to predict. The only thing we’re trying to do is make sure we line up our expenses and we prepare ourselves to weather through this and come out of it a stronger company. In terms of trying to predict what’s going to happen over the next six months or year you could ask 10 different people and get 10 different answers.
Your next question comes from Bill Armstrong – CL King. Bill Armstrong – CL King: One of the drivers of SG&A in the past has always been your real estate organization which is necessary to continue your growth in the store base. With a pull back in store growth is that an area that you are cutting back on in terms of headcount or other capacity? What would it take to restart that once things get better and you decide to reaccelerate store growth?
You mentioned real estate but we have lots of areas of the company that are directly related to growth. In those areas we are paying attention to our expenses and our costs as closely as possible. We have a lot of great people in this company and some of those folks have multiple skills. In some cases we’re looking where we have somebody that might not be fully utilized and we’ll allocate them to something else that we think is a high importance to the company, we haven’t actually. We’re still growing so there’s still work to be done although we have slowed it down. Your second question on what it would take for us to get going again, it would take a big change in what’s going on in the economy for us to get rolling again. We’d have to see a big pick up in sales; we’d have to see a pick up in traffic. I think consumer spending is going to have to come back pretty dramatically. When we see that happen then we’ll take a good look forward and see what our best plan of growth is going forward and how much to accelerate the plan that we have now. Bill Armstrong – CL King: From what you can tell, maybe some of the details are sketchy but the bail out plans by the Fed and the Treasury what effect do you see this having on the asset backed securities market going forward? Do you think that this is going to be what it takes to open that market back up for you?
We have no idea but we have our fingers crossed. Bill Armstrong – CL King: You can’t really tell.
We can’t tell you, until we see it its hard to really speculate. I hoping it has a positive impact. Until we actually see some stuff loosen up, see some deals get done it’s really hard to say what’s going to happen. Bill Armstrong – CL King: Any feedback from your bankers at this point or is it too early?
Your next question comes from Rod Lache – Deutsche Bank. Rod Lache – Deutsche Bank: Can you confirm that 1.8% gain on sales was that net of a 3% not a 3.5% loss assumption?
That was net of our current, yes, slightly less than the 3.1% to 3.5%. Rod Lache – Deutsche Bank: So your average APR on originations is holding in the high 9% basically?
Yes, basically. Rod Lache – Deutsche Bank: You’re assuming plus 200 on the warehouse something like this?
Yes, in that ballpark. Rod Lache – Deutsche Bank: Is the CAF penetration still around 40% and if the commercial paper market remains tough, third party financing sources just tighten a bit more are you comfortable increasing CAF penetration for a while?
That’s a difficult decision not seeing any liquidity in the marketplace. Where we could pull back is perhaps at the upper end and we have B of A there. The challenge there is that it does alter the mix of the portfolio and obviously we could adjust the assumptions there. We’re trying to navigate carefully through this and watching carefully. Right now we’re staying the course but I can’t tell you what we’ll do, it really depends on how quickly some of the actions that are being taken by the Fed and Government, Congress and what impact they have on the securitization market. There aren’t a lot of attractive alternatives. Rod Lache – Deutsche Bank: Are you at 40% currently or above, I think that’s been the historical penetration?
We’re not meaningfully different then our historical penetration. Rod Lache – Deutsche Bank: To control penetration levels is that something that you would do by just adjusting APRs which would then support your financing margins or would you do that through other means?
The challenge is we have our three day payoffs. Obviously our cost of funds even the consumer sees the Fed staying steady on rates at 2% our cost of funds are up significantly to your point earlier. We have and will continue to test increasing rates. Customers have the ability, especially the better customers have the ability to pay those off in three days and they actually do take full advantage of that. We have to balance the better liquidity and pricing issues with our own ability to finance them and it’s not as simple as it might seem on the surface.
It also depends what the lenders do that we have available for them at our own store. If we move our APRs and none of the other lenders move then we move them up we lose a lot of share. Rod Lache – Deutsche Bank: It appears that given where the asset backed market is today, the spreads would clearly be lower than that 1.8% on securitizations currently.
Remember we also mentioned that we had a change in enhancements on our facility and that we also had a change in discount rates. Our actual APR to customers are just slightly over 10%. When you put those two on top of that with the higher losses then that’s why we end up at the 1.8%. Rod Lache – Deutsche Bank: The message you’re sending is the strategy here in this business is not so much to protect the profitability of CAF it’s just to keep the volume flowing through the stores at this point.
The principle reason CAF exists is to support CarMax. Yes, temporarily there’s a balancing act that we have to manage through. Rod Lache – Deutsche Bank: Are there any strategic alternatives that would be available to you that might be a better balance in the future just to eliminate some of the volatility you’re having here in this financing source?
All of our partners, with the exception of one, to my knowledge, have similar challenges from liquidity and the asset backed market. It’s not clear to me that there are a lot of strategic alternatives that are significantly different.
Your next question comes from Cid Wilson – Kevin Dann & Partners. Cid Wilson – Kevin Dann & Partners: Can you give us any thoughts in terms of how sales were from a geographical basis?
We don’t generally talk about geography too much. Cid Wilson – Kevin Dann & Partners: You have a meaningful presence in Texas was there any impact from the Hurricanes or you think that might have increased expenses we should be aware of?
We’re only talking about second quarter and the Hurricane didn’t hit until the third quarter. We’ll talk about that at the end of the quarter. It did hit Houston, Houston was largely, a lot of people were moved out of Houston, there’s a lot of power loss in Houston. Our stores were without power for some time. We’re still working on getting them all back up and functioning. That’s all third quarter impact.
Your next question comes from Jordan Heimowitz - Philadelphia Financial. Jordan Heimowitz - Philadelphia Financial: The first question concerns the gain on sale it was a 19% discount rate and a 3.5% loss rate. What do you think would be your range on pre-tax gain margins at that point?
I’d have to go calculate it and we’re currently not anticipating a 3.5% loss rate on our current originations. Jordan Heimowitz - Philadelphia Financial: Given the variability and gain on sales which continues in that it’s probably going to be eliminated by the end of next year. Why don’t you guys just go off gain on sale early and just report portfolio accounting it would eliminate a lot of volatility in the earnings and give a pure cash flow picture what the business looks like.
We’ve discussed that. We actually think that gain on sale even though it does look likely that it might change in the future does a better job of reflecting the environment that you’re originating in. For example, looking at the current market and increasing the discount rate and the funding costs related to what’s going on matches that portion of it. Historically cash flows have generally been in line on an annual basis with our overall accounting.
Your next question comes from Rex Henderson – Raymond James. Rex Henderson – Raymond James: I wanted to ask a little bit about inventory and inventory mix and whether you’re satisfied with your mix of higher mileage, lower priced vehicles right now or maybe they’re higher priced with the demand there and whether or not you think your sales would have been a little better had you had some more of those higher mileage vehicles.
It’s really hard to say unless; it’s just hard to predict what the results would have been. In this environment if we had some lower cost vehicles maybe it would have helped. We were very, very focused through the quarter of getting our inventory in line with our sales as we talked about numerous times. Our average retail is down almost $1,000 year over year. We do have a lower cost inventory then we had before. Some of its lower acquisition costs; some of it’s a reflection of the demand. I’m not sure that it would have changed it dramatically but again there’s no way of telling. Rex Henderson – Raymond James: Are you finding sources for higher mileage vehicles, are consumers bringing them in, are you finding then at the auction or are you struggling to find those kinds of vehicles?
That’s largely been sourced through the appraisal lane and as we’ve talked about we have seen a decline of traffic and a decline in our buy rate. That has hurt our ability to get some of that stuff. That’s not generally something that we source off sight because you just don’t have as much time to evaluate the product when you’re at an auction as you do when it’s in your own store. We’re constantly evaluating our mix and seeing which direction we think we should be moving in. We feel pretty good about our inventory right now.
Your next question comes from Victor Consoli – Perella Weinberg. Victor Consoli – Perella Weinberg: The $800 million you have left on your ABS facility how many months is that typically, what is your average draw down per month on a run rate basis?
It should take us into late January or early February at our current sales level. It really depends on what our sales levels are and whether customers come back or not between now and then. Victor Consoli – Perella Weinberg: When will you start exploring in the ABS market rolling over into a new facility, probably now, it’s ongoing?
We’ve been in discussion with banks as I’m sure all of our other lenders have been, what are the other alternatives out there. Victor Consoli – Perella Weinberg: Isn’t there a reason of fear that you exhaust that facility there’s just no money left? There’s always some kind of a source, you mentioned B of A line but when you start getting to the lower cost vehicles would you literally be shut out of there if you didn’t have an ABS line? I’m trying to understand how it works.
The answer is I’ve always believed that there’s a market at a price. We may not like that price but I think that’s generally going to be true. That market may change from the current ABS structure given what’s going on in the economy, I don’t know. The answer is, if we were unable to find any sources then yes we could find ourselves shut out and like I said we’re already in intense discussions on alternatives might be out there. Victor Consoli – Perella Weinberg: It just gets passed on to the consumer at the end of the day, it’s got to be a rational market so if it costs an extra 100 bps for you it’s probably going to cost an extra 100 bps for everybody then the consumer just picks it up.
That’s exactly right, at the end of the day that’s one of the things that hasn’t happened is that the market hasn’t been as efficient as usual given that what’s happening is it’s happening in the spreads to what the underlying credit is. It’s not as transparent to the consumer and so their receptiveness to doing it. We’ve already seen some indications that our competition is moving rates up and I think that’s inevitable.
Your next question comes from Rich Kwas – Wachovia. Rich Kwas – Wachovia: You mentioned that more customers are coming in with prearranged financing. I thought that was interesting because a lot of franchise dealers are saying that penetration rates are up. Do you have any data that shows what your customers are coming in with in terms of the source of financing?
We can only source that after the fact and I don’t happen to have that right now. We can do some drilling on it. It has been in this market an unusual phenomenon. In prior times when that’s happened we used to speculate that it was related to mortgage refinancing and things along those lines. Obviously that’s probably not what’s causing it right now. I don’t have the data, the sources for that right now. Rich Kwas – Wachovia: That would be helpful if that type of trend continues.
Your next question comes from Jordan Heimowitz - Philadelphia Financial. Jordan Heimowitz - Philadelphia Financial: In the presentation you have a lot of loans originated and sold $526 million did you both originate and sell $526 million or is there a difference between what you originated and what you sold in the quarter?
There is a timing difference between what’s available and held for sale at the end of the quarter versus the other so it’s not precisely tied to what we actually originated during the quarter but it’s fairly close. Jordan Heimowitz - Philadelphia Financial: The number is within like $5 or $10 million of each other?
Probably a little bit more than that given the timing of this quarter because we had a weekend at the end of this quarter. Jordan Heimowitz - Philadelphia Financial: So you would have actually originated more than you sold in the quarter?
Apparently. Jordan Heimowitz - Philadelphia Financial: Arguably had you sold the full amount the number would be a little higher then.
Your next question comes from Bill Armstrong – CL King. Bill Armstrong – CL King: With the slow down in store growth what sort of capital expenditures should we see this year?
You mean next year. Bill Armstrong – CL King: In the current year and next year if you have that.
Approximately $225 million. Bill Armstrong – CL King: For this current year?
Yes. Bill Armstrong – CL King: How about next year?
We haven’t done next year yet.
There are no further questions at this time.