CarMax, Inc.

CarMax, Inc.

$84.91
1.21 (1.45%)
New York Stock Exchange
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Auto - Dealerships

CarMax, Inc. (KMX) Q3 2009 Earnings Call Transcript

Published at 2008-12-19 17:00:00
Operator
At this time I would like to welcome everyone to the CarMax third quarter earnings conference call. (Operator Instructions) Ms. Kenny you may begin your conference.
Katharine Kenny
Good morning. Welcome to our fiscal 2009 third quarter earnings conference call. On the call with me 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 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 10K for the fiscal year ended February 29, 2008, filed with the SEC. Before I turn the call over to Tom, let me just say one thing for all of our traveling comrades in Richmond; Go Spiders. Tom?
Tom Folliard
Thank you. Good morning everyone. Thanks for joining us. As you can all see from our press release this morning we continue to face extremely challenging market place conditions. We operate in three industries; retail, auto and credit, all of which have been among the hardest hit by current economic conditions. Although we believe the issues are externally driven we plan to take effective action to preserve our profitability and capital. Our used unit comp reduction of 24% was entirely a result of the decrease in store traffic. In fact, traffic fell a little bit further than comp sales but we managed to offset some of the decline with improved execution. We once again reduced our used vehicle inventory this quarter by over 8,300 units or approximately $140 million. Year-over-year inventory is lower by approximately 18,500 units or over $340 million. Our used inventory turns for the quarter improved somewhat over last year and we modestly decreased our borrowings over the course of the year. We were also able to hold gross profit per vehicle nearly flat compared to last year despite the dramatic decrease in wholesale values. Our cosmetic operations, restructuring and waste reduction initiatives will continue to make us more cost effective over time. In addition, we continue to shrink variable labor expense through attrition, a decrease in scheduled work hours and through a reduction in our work force in early October. Finally, we made the decision that I will discuss shortly to temporarily suspend our store growth until conditions improve. We will also continue to aggressively seek further opportunities to lower costs throughout the company. Now let’s go over some of the key financial results. First, sales. In the third quarter total sales decreased to $1.46 billion compared to $1.89 billion in the third quarter of fiscal 2008. We opened just one store in Hickory, North Carolina, a non-production store in our Charlotte market. At the end of the third quarter we operated 99 stores in 46 U.S. markets. U.S. vehicle revenues declined 23% for the quarter due to a combination of a 7% decrease in average selling price and a 17% decrease in unit sales. The average selling price was lower as a result of the industry wide decline in used car valuations. Our average sale price for wholesale vehicles fell by 12% combined with a decrease of wholesale vehicles sold of approximately 15%, the result of lower appraisal traffic and a lower appraisal buy ring. Total wholesale revenues decreased by 25%. On the gross profit, our third quarter gross profit per used vehicle decreased by $32 compared with last year. We are very pleased to be able to maintain our gross profit in a period of rapid depreciation approximately triple the normal levels we see in this time while also reducing inventory levels and improving our used vehicle turns. Our wholesale profit per unit which increased $20 compared to the third quarter of last year is once again a positive reflection of our unique inventory management systems and the continued success of our auctions. While absolute dealer attendance and wholesale volumes were down our record dealer-to-car ratio and our industry leading wholesale industry turns are what we believe contributed to these results. On to CarMax auto finance, our CAF results also continue to be impacted by the very difficult financial market conditions. Earnings for the third quarter once again were again reduced by adjustments related to loans originated in prior periods. This quarter these adjustments totaled $39.8 million or $0.12 per share and I will ask Keith to review these results in a little more detail. Keith?
Keith Browning
Thanks Tom. Good morning. I apologize for my cold. Hopefully you can understand me. CAF reported a loss of $15.4 million in the third quarter of this fiscal year versus income of $16.3 million last year. The gain on sales of loans originated and sold in this quarter fell to approximately $11 million compared to $21 million in last year’s third quarter. The decrease was primarily due to lower sales, higher loss and discount rate assumptions and lower average selling price per vehicle and a planned decrease in CAF’s origination penetration. The CAF percentage also declined from 3.6% to 2.8% this quarter. Note that servicing fee and interest income increased by 23% this quarter compared to last year. This is partially due to higher outstanding securitized receivables, interest income received from subordinated bonds we hold on our books and a reflection of the increase in our discount rate assumption which results in less gain recognized in the quarter of origination and higher interest income in future quarters. Offsetting CAF's income for the quarter, as Tom highlighted, were charges related to mark to market adjustments and higher loss assumptions. The former carried approximately $24 million and represented a reduction in the carrying value of our subordinated bonds we hold. This non-cash charge is significantly higher than in previous quarters due to the illiquidity in the secondary market. We also took a $16 million charge due to the further increase in loss assumptions for some securitized loans partially offset by favorable adjustments related to prepayment fees. Our worst performing portfolio of loans now has accumulative loss expectation of 3.9%. We continue to believe that this increase in expected losses is largely due to the weak economic conditions that are clearly being experienced industry wide. Our data also confirms that our portfolio results continue to compare favorably to other loans of similar credit due to the transparency of our sales and financing processes. However, we continually track the performance of our portfolios and have tightened our lending standards as necessary. We have been disappointed but not surprised by lack of promise and activity in the asset backed securitization market. It remains unclear that this market will reopen and what form it will take at that time. Given the continued uncertainty we have taken steps to slow CAF’s loan originations in order to extend the utilization of our $1.4 billion warehouse facility. At the end of the third quarter we had $493 million in warehouse capacity. Our third-party lenders continue to tell us our loans perform better for them and that they remain willing to make more loans to our customers. As a result, we [can still] usage of our warehouse facility while continuing to make credit available to our customer and maximizing sales. Our third-party provider mix has shifted some, along with changes to some of our discount arrangements resulting in lower third-party income over the last several quarters. Now, I’ll turn the call back over to Tom.
Tom Folliard
Thank you Keith. I’ll talk about SG&A. As expected due to our lower sales rate and lower average sales price per vehicle, our SG&A ratio in the third quarter increased significantly to 14.9% compared to 11.2% in the third quarter a year ago and 12.2% in the second quarter. We are focused on reducing our costs as rapidly as possible to bring them in line with our sales rate while not hurting the customer experience or our ability to improve execution. Recall on our last conference call we indicated we reduced our expected store growth from 15% annually to between 5-10 stores for fiscal 2010. The further deterioration in our sales rate this quarter along with the uncertainty in the market place has convinced us that it is time to suspend growth for the time being. This step will further allow us to reduce capital spending and reduce additional costs. Looking forward we currently have four stores under construction. We will finish work on those stores but only open one until we see improvement in the market conditions. It will be our 100th store and our eighth store in the Baltimore/Washington market which is historically our strongest penetrating market and requires no incremental advertising. Although suspending growth is a near-term disappointment for CarMax, it is the appropriate response to these current conditions. We still fully expect to go to all our previously planned markets; it will just take us a little bit longer to get there. Our most recent data for the 90-day period ending in October indicates we are gaining market share in late model, used vehicles. Our recent consumer surveys including those for shoppers, purchasers, appraisals and service indicate that customer satisfaction levels at CarMax are at record highs. We believe our long-term prospects remain as strong, and perhaps stronger, than ever before but our current challenge is to navigate successfully through the near-term which is where we will be focusing all of our efforts for the foreseeable future. Thanks once again for joining us today and especially thank you to all of our CarMax associates for your outstanding dedication and for all you do every day. We will be happy to take your questions.
Operator
(Operator Instructions) Our first question comes from the line of Brian Nagel – UBS.
Brian Nagel
With respect, you mentioned in your prepared remarks and your press release, that you routed more of your financing applications to your third-party providers. First, have your third-party partners changed lending standards more than CarMax Auto Finance and if they have has that resulted in more declined applications and hence weaker sales at your stores?
Keith Browning
The answer is that varies by lender but I can tell you that we carefully consider what they are currently underwriting and their approval rates and actually got feedback from them about their willingness to take on more loans before we made those decisions. So this is kind of an interim process we are working on and we are carefully measuring our sales to apps and trying to monitor the success of this strategy while maintaining and maximizing sales. Generally speaking everyone has tightened including CAF. That is understandable in the market. But, the good news is that for us the tightening is not as significant for our third-party lenders outside of CarMax.
Tom Folliard
The one thing I would add there is that in terms of the total result of the customer flow, I mentioned that our traffic was actually down a little more than our comp sales so even in this difficult environment our store teams have done a great job of executing the customer flow they have. So when you add it all together with applications, approvals, whether it is prime or non-prime we actually improved our execution in the quarter year-over-year a little bit.
Brian Nagel
You mentioned in the press release your third party financing declined 58%. Can you further explain what is causing the shift there?
Keith Browning
One of the key factors there is that one of our third-party lenders was acquired by [Roadlend] so we went from a fee-paid basis to where we are paying a rather substantial discount on a percentage of our loans. We had a choice not to do that but we believe those are generally incremental sales and so we are not willing to walk away from that business. It is a matter of what the market is driving from a risk perspective and risk profile.
Brian Nagel
With respect to gas prices, you talked a lot over the last few quarters when gas prices were rising what impact that was having on your business. Clearly gas prices have come down significantly. Sales are still weak. Are you seeing any other shifts in demand trends at your stores as the result of much lower gas prices?
Tom Folliard
I think as you said sales are still weak so I think if everybody thought that gas was the only reason for consumer demand sliding over the last several months obviously that has proven not to be true. I think there are a number of other factors that contribute to consumer confidence and a number of things are going to have to change, I think, before the consumer comes back and decides to start spending money again. In terms of the shift in demand, one of the obvious impacts is that people aren’t running away from sport utilities as much as they were before and I believe our mix for the third quarter this year of sport utilities was up over the second quarter and it was up over last year’s third quarter. We have seen that before. We saw it with Katrina. We saw it with this last May when we really saw a big depreciation related to the $4.00 gas price. I think the consumer just in regards to that particular item actually moves pretty quickly up and down as gas prices move up and down.
Operator
The next question comes from Rex Henderson – Raymond James.
Rex Henderson
I had a couple of questions on the residual value of the securitization. First of all, with this increase in loan loss assumption are you near writing any of the residuals for any particular securitization down to zero? Is the principle of any of the subordinated bonds at risk as those loan losses accelerate?
Keith Browning
The way we look at it is even in this stressed environment given loss assumptions we have taken we would have to see more than a doubling of losses before those would be at risk and so we still feel very comfortable with the fact that those investments are going to be returning as originally expected and mark to market is an accounting fact that we just have to do. It doesn’t change our perspective on the quality of that investment.
Rex Henderson
With the increase in the loan loss assumptions do you know where you stand relative to comparable quality paper in the market place right now?
Keith Browning
The best we can do, we do have an industry group we are a member of, and we do compare notes. When we look at ranges of cycle bands and our loss range shifts, everyone is decreasing, we continue to get feedback and based on the numbers everyone is sharing with us ours still aren’t being as stressed as much as they are outside of the CarMax channel. While that is certainly encouraging and that is one of the reasons why we think our third party lenders are sticking tight with us.
Rex Henderson
In the press release you noted you think you are getting some market share gains. That is a reversal. Last quarter you though you lost a little bit of share. Can you comment on what contributed to that change from losing little share to gaining a little share in this quarter?
Tom Folliard
Remember on the data it is not current with the quarter so the data we just reported was only through October so it is the 90-day period ending October. When we announced it the last time I said it was a very slight decline. We have been referencing that number consistently for several years. We referenced it when it was up. It was slightly down. I thought it was important to note that. I said at the time I thought it might be a temporary phenomenon based on all the different variables that were going on, none of which we could predict. It looks like that is what it was. I couldn’t really speculate further as to specifically why it shifted. I thought it was temporary. It looks like it was temporary. We are pleased that it looks like we are back to gaining share again but again that data is only about half of our markets and it is the 90 day period ending October.
Rex Henderson
Is that in same store markets or is that an overall share including new stores?
Tom Folliard
It is a consistent database we report on.
Rex Henderson
The gross profit per vehicle was really surprisingly good considering the compression in prices. Did you see any disruption of that in October when we had a very sharp drop in vehicle wholesale prices?
Tom Folliard
As you know, we comment on whole quarters, not months. I am very proud of our teams and the job we did not only in this quarter but really going back to the first quarter with the rapid depreciation we saw in sport utilities, the incredibly volatile market conditions that we have seen all the way back to May, the improvement we made sequentially in profit margin from first quarter to second quarter, our ability to maintain our profit margin here in the third quarter, improve our turns a little bit, reduce our inventory as well. I think it just shows that our time tested and continually evolving inventory management model runs pretty well even in a pretty distressed environment.
Operator
The next question comes from Bill Armstrong – CL King.
Bill Armstrong
How long do you think you have until you are at the top of your warehouse capacity? I remember three months ago you were saying probably January or February. It looks like that might have been stretched out a little bit.
Keith Browning
The answer is we don’t know. As I mentioned earlier one of the things we are doing is we are still testing what makes the most sense for CarMax in trying to monitor the sales implications. You are correct in assuming we have extended it. Our goal is to extend it as long as we possibly can without adversely affecting sales but that is going to be a moving dynamic as we work with our lenders and monitor the results. It is really too early to say how long we will be able to extend it.
Bill Armstrong
In what way are you able to steer customer loans to your third-party lenders versus CAF? Are you raising the bar in terms of lending standards or interest rates with CAF? How would that work mechanically?
Keith Browning
It used to be that when you got an approval from CAF or Bank of America, because we don’t condition those offers, we don’t route to other lenders. So one of the mechanisms is just to go ahead and route all things to our third-party lenders to give them a chance to compete and bid. The other element is changing interest rates. Letting people win more often by pricing a little bit above the market and given the risk in this environment that is a prudent thing to do. So we think that is a good strategy and that is why we are monitoring the results still and making sure it works for us and our third-party lenders. It is a combination of those things that can slow the flow into the warehouse and we are going to continue to work with that over the next several months. The truth is we could stop the flow into the warehouse tomorrow and not originate any more loans at CAF but we believe there would be a pretty significant sales impact so we are trying to make sure we test it and as mentioned the big key there is to try to preserve sales.
Bill Armstrong
Are you seeing any sales impacts from your current process or do you think customers are…in other words do you think you have lost any sales right now as a result of that?
Tom Folliard
I think it is still too early to tell. We really just got going this quarter. We are running various tests in various markets so we are still evaluating that.
Bill Armstrong
Ameri Credit very recently, about three weeks ago, did a $500 million securitization for sub-prime auto loans which would make one think the market isn’t completely frozen but it sounds like you don’t think you can pass the market.
Tom Folliard
From what we have heard that was a prior commitment from the spring. That really was a deal that was preset from 8-9 months ago and not indicative of the current market place.
Bill Armstrong
Just stepping back a bit, there is more than a significant chance that GM and/or Chrysler will go into bankruptcy. What do you see if that happens? How do you see that impacting the automotive market and the used car market in your business in particular if at all?
Tom Folliard
That is a pretty tricky question and I’d say we have absolutely no idea what the impact would be. It really depends on what happens. It depends on what happens with the restructuring. I think it depends whether consumers feel comfortable in continuing to buy that product. Obviously our first piece of exposure is that we own a bunch of that product and if consumers ran away from it and there was a devaluation there that could hurt. Long-term if there is a bunch less dealers around and less choice I think we could become more of a first choice for consumers. Ultimately that could be good. There is also the warranty issue on product. Will customers feel comfortable that their warranties will still be backed both on existing product or buying any additional product. I think it is very difficult there so it is very difficult to predict what impact it would have on us. I think you could lay out a case that it could be positive and you could lay out a case it could be negative. We are kind of taking a wait and see approach. I don’t think it is in our best interest to start moving our inventories around in advance of that. We plan our inventory every single week like we have always done and I think we can move pretty quickly with consumer demand.
Operator
The next question comes from Matthew Fassler – Goldman Sachs.
Matthew Fassler
First of all as you talk about the shift of the loans to third parties can you give us a sense of the magnitude? Historically you talked about something like 40% of purchases going through CAF. Can you give us a sense of how much that has changed in the past quarter with this tilt in strategy?
Keith Browning
It has gone down a modest amount. We started it in the middle of the quarter. The key is it may not be reflective of what we ultimately do. That is really the key. We are still navigating this. It is very early and we are going to monitor the results and we are going to drive it down as low as we can without affecting sales to preserve the sales that CAF uniquely brings to CarMax.
Tom Folliard
Historically you said 40%. We have historically said it is between 35-40%. Net at the end of the quarter the total was slightly below that range but as Keith said that is a number we move.
Matthew Fassler
If you look at the economics of a third-party finance transaction today versus a CAF finance transaction today with the gains of sale that you are booking assuming those end up being the accurate assumptions over the life of the loan how do those economics compare?
Tom Folliard
It is getting more and more difficult to predict and look at how they compare because until we actually go out and get a securitization done you don’t know how low your costs are. Right now we are way more focused on preserving sales in any channel whether it is CAF or additional lender. The differences in profitability that we have talked about in the past have become almost impossible to predict.
Matthew Fassler
Just to game out a little bit what might transpire on the credit front if the ABS markets don’t loosen up for you would you anticipate taking more of these loans on balance sheet kind of as a last step prior to having a major strategic shift and temporarily exiting the origination business?
Tom Folliard
We are going to look at every possible option to keep as I mentioned to preserve sales and keep the business going. That is one. That is not a great long-term strategy for us. We did it and we did some temporarily. Essentially that is what we have done with the bonds over this year that didn’t get done through the deals but that is not really a good long-term strategy for us. Again, we are looking at every possible option and the world is changing so quickly we are just looking at those options every week, every day. We think some things will change after the first of the year but we are going to do whatever we can to preserve sales.
Matthew Fassler
You talked about the mark downs you took to the existing book of loans you have on balance sheet and it was pretty big this quarter but you indicated if current conditions persist you could see gains resulting from that. Where is pricing in the market today versus where it was on average during your November quarter?
Keith Browning
If you reference sub-bonds the pricing is in the neighborhood about $2,000 above benchmarks. The fact is if it doesn’t change then you are just going to get the higher accretive income over time and obviously if in fact it gets better then you will have a favorable. We would have never predicted this level of dislocation.
Matthew Fassler
Finally on SG&A can you talk about how far you have gone on a per store basis in terms of cuts? Are we very close to kind of a fixed cost where you can’t reduce costs by that much and what is your ability on a per store basis if sales remain challenging going forward to take that down further?
Tom Folliard
If you look at over the course of this year we have take a number of steps most of which we have already noted or talked about. If you include all the variable expenses that go down as sales go down and as we have moved them down with sales in addition to other cost cuts we have made by the end of this year we will have taken approximately $75 million out of what our planned spend was at the beginning of the year. That combination of variable expenses going down with sales, additional cost cuts we have made whether it is slightly less advertising or some other additional cost cutting, but by the end of this year that number will be around $75 million we have taken out from what we had planned to spend at the beginning of the year. That isn’t what we’ll do going forward, that is just what we have done so far.
Operator
The next question comes from Scot Ciccarelli – RBC Capital Markets.
Scot Ciccarelli
Given the extreme price sensitivity of most customers today do you think you could have an impact on sales if you were willing to become more price competitive or willing to sacrifice gross profit? I know you always say you are doing what you think is best for the business, but obviously we are in kind of unprecedented times. Do you think you can move the sales lever it you were to give up a little margin here?
Tom Folliard
That is the multi million-dollar question. It is a question for us every quarter. It is a question for us in good times and it is a question in times like this. We think the decisions we have made over the last six or eight months and the results we have had in the third quarter are not decisions we made just in the third quarter. It is a result of managing our inventory for the entire year. We believe right now this is what is best overall for the long-term best interest of our shareholders and for our customers to manage the business the way we have been managing it. If the question is if we gave up a hundred or a couple of hundred dollars in margin would it have driven sales, maybe. I’m sure it wouldn’t have gone from negative 24 to 100% to budget. So there is just no way of telling what kind of sales you would have got back. I think right now we are doing what we think is in our best interest.
Scot Ciccarelli
Obviously the broader economic conditions are having a massive impact on the auto industry and retail in general. How much of an impact do you think the massive used vehicle deflation is having in terms of the business? It seems to me there are so many people who are under water, have negative equity out there, it is not really economical for a lot of them to make a transaction here. Any kind of feel or color on that front?
Tom Folliard
I think that is reflected in consumer traffic. I think that is reflected in sales in total for the new car industry, the used car industry all being down significantly. I think there are a lot of people who are just waiting in the wings. They may not even know for sure they have a bunch of negative equity. They just think they do and they have decided not to come out and spend. If you look at our applications and the amount of negative equity in our loan to value once again we don’t see it in there. Even in this last quarter we don’t see it in there. I think it is absolutely having an impact on our sales. I think our negative 20% plus comp performance is largely related to consumer thoughts about what a car is worth. So when this rapidly depreciating environment is more driven by a lack of demand than the other way around.
Scot Ciccarelli
If somebody comes in and they are $2,000 to $4,000 under water given all the tightening credit standards can somebody roll over the negative equity into a new loan? I know that was a pretty common practice even 6-12 months ago and obviously even before that but is that something that can happen today given what the lenders are doing?
Tom Folliard
Sure. It is still very common practice. It depends on that person’s individual credit, the car they are buying and the bank. So although there is tightening, one example of tightening is I used to roll in $2,000 negative equity and I charged an 8% APR and now if I’m going to roll $2,000 over I might raise the APR rate to do it. It is all dependent on the individual, the individual’s credit, the car they are buying, and the bank, whichever bank is making them the offer. If you are asking if people are able to finance negative equity in this environment, absolutely.
Operator
The next question comes from Sharon Zackfia – William Blair.
Sharon Zackfia
I am not sure if you went through this already but as you slow growth I am sure you have given thought to whether or not there are reductions in headcount that can go along with that. Just generally what kind of savings will that get us next year not just in terms of the P&L but also in terms of your capEx outlook for 2010?
Tom Folliard
We haven’t given our capEx outlook for 2010 yet. We will do that at the end of the next quarter. Obviously we think we can take a significant amount of our cap expend by what we just did which is to stop growth. So, we don’t have a number for you yet. We’ll have it for you at the end of next quarter. Our original planned spend for this year was around $375 million. We have taken that down obviously dramatically. We will give you the outlook for next year at the end of the quarter but capital preservation is one of our goals right now. It is one of the reasons why we suspended our growth kind of early and we will give you our capEx number at the end of the quarter.
Sharon Zackfia
How about in terms of the P&L impact? Obviously as you open new stores there are start up expenses and a ramp there. If you had a steady state sales environment which I know is a long shot at this point but what kind of margin buffer would that give you in a normal environment in 2010?
Tom Folliard
That is a little bit of a complicated question because in a normal environment if we were opening stores some of the stores we open contribute in their first year positively. Some of the stores are a much longer-term investment because it is a multi store market and we have to get fully started in that market before we become profitable. We look at our investments over a 3-year time period so we are just not ready to answer that question very specifically right now about what that changes from a P&L perspective next year. Obviously we think it is a positive or we wouldn’t have done it.
Sharon Zackfia
And in terms of headcount reductions at corporate? I know you have a hiring freeze but is that a thought process at this point or is it something you are not really considering yet?
Tom Folliard
For us, a reduction in force is always and always will be an absolute last resort. I talked about taking a number of other additional steps to reduce costs. It is pretty much preserving capital and managing through this short-term environment is pretty much all we work on as a management team. We are trying to find every possible opportunity to either drive sales, eliminate unnecessary costs and waste but a layoff for us is always the last resort.
Sharon Zackfia
I don’t think anyone asked, what was the sales cadence like in the quarter? Was it pretty consistently as bad as it looks or did you see any shifts one way or the other?
Tom Folliard
I know I made the mistake of giving out some cadence in the second quarter. I am out of the cadence business.
Sharon Zackfia
Are you testing, maybe you mentioned this, but as you slow down the CAF originations are you testing other prime lenders? Where are those loans going?
Keith Browning
At this point we haven’t changed any lenders. We currently have one of our other lenders testing the other categories. Our sub-prime lender is testing in the non-prime space but beyond that there is no additional testing. We are always looking for other lenders but we are very particular about the arrangements we set forth.
Tom Folliard
I think more importantly all of the lenders we have are still with us.
Sharon Zackfia
Do you have any idea what the credit situation has done to your sales other than it is bad? Do you have any kind of consumer surveys or anything that would indicate what magnitude credit availability is having on your business?
Tom Folliard
It is very difficult for us to survey customers who aren’t coming to the store.
Operator
The next question comes from Matt Nemer – Thomas Weisel Partners.
Matt Nemer
It looks like you played margins versus units this quarter and I’m just wondering what are you looking for that would make you shift back to your previous strategy which was to really drive units? Is it traffic is so low that it doesn’t really make sense to lower price?
Tom Folliard
Yes, I kind of talked about that a little bit earlier. Right now consumers are not coming outside. They are not spending money. I don’t think $200 is going to make them spend money. I don’t think it is going to make them change what their plans are right now. I don’t think they are going to decide hey I wasn’t going to buy a car and now I am going to buy a car. I think there are too many other factors involved there. It is always a guessing game for us. It is always a balancing act. Right now it is not just the lack of consumer demand but the depreciation we have seen in the third quarter we are trying to manage our inventory and turn our inventory as quickly as we can and I think we are going to remain focused on trying to balance those pieces and try to do what we think is best. This is where we have ended up for the quarter.
Matt Nemer
Just to follow-up on a question Rex asked earlier on gross margin per unit which was really impressive, I realize you don’t want to give that by month, but is there anything in the full month number that might be deceiving? Did it trail off towards the end of the quarter? I just want to make sure we are not modeling that going forward and maybe set the bar too high.
Tom Folliard
As I said earlier, I don’t even really think it is just the quarter it is really the whole year for us. Managing inventory for us is not…although we do it weekly we have some planning to do throughout the year to get there and we have made strategic decisions going all the way back to May about inventory levels, about purchasing, about appraisal offers and managing margin that have allowed us to manage our inventory where it is. I can’t help you model going forward because the big unknown is what is going to happen with the consumer. I’m hoping this is the bottom and that things turn around but we have no way of telling that. If things started to pick up again and we saw the consumer come back and saw traffic come back and sales come back we actually might see us go a little in the other direction to spur additional demand. But until we see what happens with the consumer it is very difficult to tell you how we would respond.
Matt Nemer
Can you give any detail on the buy rate and how that changed in the quarter and where you are sourcing the mix of your inventory and where it is coming from?
Tom Folliard
I won’t talk about how it went through the quarter but by the end of the quarter we are down below 25% and as we talked about our buy rate for over a year now we had seen some growth in that over several years and we have seen that number decline now. I just think that is a reflection of all the market conditions we already discussed.
Matt Nemer
What about the appraisal traffic? Is there any way to quantify the change there?
Tom Folliard
The appraisal traffic is largely driven by consumer traffic and as we said consumer traffic is down more than 24%. Appraisal traffic is also down more than 24% when you factor in the buy rate in there as well then the mix of sales that are sourced through the appraisal is less than we would like it to be and less than it has been in the past.
Matt Nemer
This is more of a longer-term question but obviously even in spite of the bail out that was announced this morning I suspect there will be a lot of empty dealerships around the U.S. and I’m wondering if it makes sense when you re-ignite growth to start looking at second used real estate more aggressively?
Tom Folliard
We’ll start thinking about that when we decide to re-ignite growth. We just made the decision to stop growth. Do I think there might be some opportunities out there at some point? Probably. Honestly we are not focused on that right now at all.
Operator
The next question comes from Rich Kwas – Wachovia.
Rich Kwas
I wanted to ask in terms of SG&A here where are you in current sales rates on the SG&A front? Are you comfortable with your level right now or do you expect, I know you gave the $75 million number and it sounds like you are going to be cutting more, but how comfortable are you with where you are given where we are on the sales front?
Tom Folliard
We still think we have some additional opportunities. The difficult thing with some of the spend in SG&A is what do you think is going to happen with sales. If you thought sales were going to come back then you might not be as aggressive. If you thought they were going to get worse you’d be even more aggressive. We are running several different scenarios and several different models and trying to figure out what the right balance is for us. I think there is definitely some additional room for us.
Rich Kwas
So there is additional room, so that means you have more to go? Current sales rates you are still not caught up?
Tom Folliard
I think there is some more opportunity there. Yes.
Rich Kwas
I thought your comment regarding LTV was interesting. We are hearing from other dealers that traffic is okay but people are coming in and whether it is negative vehicle equity or lower LTV they are walking out the door without closing a sale. I know your conversion rates were pretty good this quarter given the environment but are you seeing any signs of that with lower LTV’s from third-party lenders or any impact from that on sales?
Tom Folliard
No we are not. I find that hard to believe that anybody’s traffic is okay. When you see industry wide sales are down 30-40% I just can’t believe the same amount of customers are coming through the door. It is certainly not true for us.
Rich Kwas
It is all relative right now. We all have low expectations so it is okay relative to low expectations. Inventory, somebody asked about the Detroit three but one of the things is where are you with Detroit three-branded inventory at the end of the quarter?
Tom Folliard
We are where we think we should be with the current demand of that set of inventory just like we feel we have tried to do with our inventory all along. So we are looking every single week at our sales, demand, test drives of that product. We are building our buy plans every single week off of the most recent demand data we can possibly use to buy that inventory. We feel pretty good about our inventory position. We feel pretty good about the way we managed it throughout the quarter. Until something happens, as we have talked about, it is very difficult to say do you think you are where you need to be. We try to reset the table every single week. So as of Monday we felt pretty good.
Rich Kwas
What is your truck mix at the end of the quarter?
Tom Folliard
I don’t know if you mean truck or sport utility and truck? We usually report SUV and trucks combined. That number is usually a little bit higher than 30% when you add it all together; trucks, big sport utilities and small sport utilities. I talked about that mix being a little higher than it was in the second quarter and actually a higher mix of sales than it was even in the third quarter last year.
Rich Kwas
So one would assume it is above 30%.
Tom Folliard
You would assume we are managing our inventory accordingly.
Rich Kwas
So it seems like fuel prices are having some benefit here in terms of the end…
Tom Folliard
I don’t think it is just fuel prices. It is fuel prices and the actual cost of buying something. I mean the depreciation we have seen in that product since May is astronomical. I mean thousands and thousands of dollars less to buy a bigger sport utility. You can go to a store now and buy a Tahoe for the same price as a Corolla. I think even if gas prices weren’t as low as they were we might not have seen the shift we did. Gas prices weren’t as low in the second quarter and we told you our mix was about the same for sport utilities. That was as much driven by price as it was by gas price and I think right now it is a combination of the two.
Rich Kwas
Ad spending, I know that is in SG&A but how much of a decline is there available to you given the current environment? I imagine you are not spending like you did maybe six months ago.
Tom Folliard
No we are not. We are trying to match it up with sales. But at the same time it is one of those areas where in the declining environment does it make sense to try and keep investing in the brand and the truth is during the quarter we tested some up spend in a few markets to see what the results were there and it is a little too early to read those. Everybody is spending less money on advertising. So if you look on a relatively speaking I think we are probably still the biggest advertiser out there in most of the markets we operate in because so many car dealers are pulling out of advertising. You see it in even some sports sponsorships and just regular ad spend is down for all dealers. Even if ours is down we still think relatively speaking we will be one of the bigger advertisers in most of the markets we operate in.
Operator
The next question comes from Matt Gardener – No Company Listed.
Matt Gardener
You probably saw earlier this week or later this week Deer managed to get a financing done using basically their tractors and others through some government agency. Have you been exploring the different opportunities to work with the government to get financing?
Tom Folliard
We are looking at everything. That is a totally different asset than what we deal in. I think the more relevant deals were Nissan and Honda which surprisingly nobody has asked about. The pricing on those deals was not great. The amount that they both had to keep was not a sustainable percentage for us as well. I didn’t hear about that other deal.
Matt Gardener
It seems like there is all this government money sitting around in the different agencies and they don’t know what to do with it.
Tom Folliard
It does seem that way.
Matt Gardener
It sounds like they made an agreement with them while we were on this call. $14.3 billion from the TARP. Another $3 billion coming if they approve this after TARP or something like that. So that just means another $14.3 billion deficit. Going back on the market share, just trying and I understand you want to preserve capital and it is great to have the gross margins and you have done a super job by the way of managing gross margin and other people have expressed how strong it has been, but as we watch other retailers and I go all the way back to Home Depot in 1991 they used the weakness to really gain share. Now they had a really strong balance sheet at the time. So what I’m trying to understand is there a concern on the balance sheet side? Not so much you can’t finance the warehouse facility but even deeper that leads you to decide to completely freeze expansion opportunities? On a relative basis you look stronger than some of the competitors. Also to continue to go for gross margin rather than market share?
Tom Folliard
I do want to point out we gained share and we gained share at a pace that we have gained share in the past. Our most recent share data says we did both. We were able to preserve margin and gain share. So that is one of the factors. When we talked about this at the end of the second quarter and we were paying very close attention to whatever share data we have if we saw continuing decline then perhaps we would have made a different decision on margins. But share is back up and it is back up to a gain position we are comfortable with and so it is always a balancing act there. We feel like we did gain share.
Matt Gardener
But you could be gaining so much more. The other part of the question is this the right time to completely freeze the expansion?
Tom Folliard
We believe it is the right time. That is why we did it. In terms of gaining additional share I personally am very skeptical that the amount of dollars required to change consumer mindset are just not there. They are not available. I don’t believe we could substantially change demand and change our traffic by giving up a bit of margin. Car dealers have historically done pricing and if you look at how we have done pricing we are of the opinion that it is an every day low price and that customers will come in based on our price, non-negotiated, full information, ability to compare to everybody else. In this last quarter it looks like, as we said, we both gained share and preserved margin. If you look at some of the discounts that are out there on new cars in the market people are announcing $5,000 or $9,000 off a product. That is just not how we play the game. For us moving down a couple hundred bucks I just don’t think is going to change the consumer mindset right now.
Operator
The next question comes from Rod Lache – Deutsche Bank.
Analyst for Rod Lache
Did you have any capEx guidance for the fourth quarter?
Tom Folliard
We did not.
Analyst for Rod Lache
I noticed there was some mention of covenants in the release. Can you talk a little bit about why you put it in there? Are you approaching something?
Tom Folliard
Everybody is asking about covenants. You see it in almost all the other car dealer questions. We figured it would come up. We want to make sure people understood we were still in compliance. We are acutely aware of what our debt covenants are and we are doing everything we can to make sure we remain in compliance.
Analyst for Rod Lache
Can you tell us what the ratio was at the end of the quarter and what the test is?
Tom Folliard
The test, I think, you can find from public documents and it is 1.25 fixed coverage ratio. We were comfortably above that at the end of the quarter.
Analyst for Rod Lache
On sale lease backs can you talk a little bit about did the particular deal in Austin was it an attractive rate or are you going to pursue more deals such as that? Can you give us any guidance on what lease rate we should be using?
Tom Folliard
We think it was an attractive rate in the current environment. I don’t know how we could possibly give anybody guidance on what lease rate to use going forward. It is kind of a deal by deal basis. We were comfortable with that deal. We thought it was a good deal. That is why we did it. But they are case by case going forward.
Analyst for Rod Lache
Can you give us the rate on that particular deal?
Keith Browning
Understand it was in line with what we did in the 2006 time frame. It was relatively attractive.
Analyst for Rod Lache
It looked like the gain on CAF originations was up quarter-over-quarter. Was that due to higher customer rates or lower conduit costs because of libor?
Keith Browning
Really a combination of both. Benchmark rates fell dramatically through the quarter and we did make some APR adjustments as we mentioned earlier. Part of that was aligned in trying to let our lenders lend a little bit more. Part of it was just strategy based on risk.
Operator
The next question comes from Cid Wilson – Kevin Dann & Partners.
Cid Wilson
We have seen a sequential increase in your service department sales. You had a 6.3% increase and I think last quarter it was somewhere around 5%. Can you give us some color as to what happened? Are you seeing more consumers coming in to have their vehicles serviced and is that an opportunity to keep customers coming to the stores?
Tom Folliard
That is largely a capacity issue for us. With the decrease in sales we have seen over the last couple of quarters we have a bunch of additional capacity in our shop. So, I think store teams are doing a good job of servicing the customer and although I think there is obviously opportunity there for additional revenue. It is certainly not going to offset the big sales drop we have seen but we are pleased to see it going up some but it is largely a result of additional excess capacity in the stores.
Cid Wilson
Any info by region? Were the toughest regions the traditional California, Florida?
Tom Folliard
We have never really talked about regional differences. Thank you everyone. Thanks for joining us. Once again thanks to all of our CarMax associates. Thank you for your hard work and dedication. We’ll talk to you next call.