CarMax, Inc. (KMX) Q3 2010 Earnings Report, Transcript and Summary

(Operator Instructions) At this time I would like to welcome everyone to the CarMax Third Quarter Earnings Conference Call. I would now like to turn the call over to Ms. Katharine Kenny, Vice President Investor Relations, may begin your conference.

We’re all here and soon to be very snowy Richmond. We thank you for joining so early today for our third quarter earnings conference call. On the call with me today, as usual, are Tom Folliard our President and Chief Executive Officer and Keith Browning our Executive Vice President and Chief Financial Officer. Before we begin let me remind you that our statements today regarding the company’s future business plans, prospects, and financial performance are forward looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These 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 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 the company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2009, filed with the SEC. Before I turn the call over to Tom, let me also remind all our investors and analysts that we have our next Analyst Day here in Richmond scheduled for January 28th. We hope some of you will be able to attend.

We are pleased today to report strong third quarter results driven by the 19% increase in total revenues, a 13% increase in per unit total gross profit, and excluding CarMax Auto Finance adjustments, a 40% increase in Cap income as compared to the third quarter of last year. Comp store used unit sales increased 8% this quarter compared to a decrease of 24% last year. We were able to achieve these results despite continued low consumer confidence and demand resulting from the weak economic environment and double digit unemployment. Let me briefly review our key financial results in a little more detail. First on the sales front, the significant increase in used vehicle revenue was due in roughly equal measure to increases in unit sales and average selling price. Unit sales grew due to a combination of improvement in traffic and sales execution, the majority coming from traffic but also a reflection of the easy comparison to weak sales in the third quarter of last year. We were pleased to see on a year over year basis execution improved despite tighter lending standards implemented in previous quarterly by our third party lenders and CAF. We estimate CAF’s tightening continued to negatively impact comp used unit sales by several percentage points in the third quarter. As we’ve discussed before, the higher selling price largely reflected the increase in year over year wholesale pricing. We did not see a significant change in our vehicle sales mix. The improvement in wholesale revenues was also due about equally to increases in unit sales and average selling price. Appraisal traffic remained approximately flat with last year’s level but similar to last quarter our buy rate improved significantly due to the higher year over year wholesale industry pricing. The third quarter buy rate finished above 25%. On the gross profit, our used vehicle gross profit per unit remained above $2,000 in the third quarter. As we’ve said, the year over year increases in wholesale valuations have provided a gross profit tailwind. Compared with the second quarter, our increased appraisal buy ratio improved our inventory purchasing sell sufficiency which also supported our gross profit. Please remember, however, that we continually evaluate the marketplace and assess strategies that will allow us to achieve optimal margins from the standpoint of our total business. Now I’ll ask Keith to review the CarMax Auto Finance results.

CAF’s significantly higher income this quarter resulted from several factors. Our loan penetration was up slightly compared to last year’s third quarter despite the tightening of our lending standards earlier this year. However, CAF’s penetration was up substantially versus the second quarter. Given the improvements in the automotive ABS market we felt more confident that CAF would be able to efficiently secure ties its origination. As a result, we chose to increase CAF’s penetration during the quarter. We did this by lowering rates and taking back business that had been routed to and financed by our third party lenders in previous quarters. The increase in penetration substantially offset the effect of incremental tightening that we implemented at the beginning of the second quarter. The gain percentage also increased from last year’s third quarter largely due to lower benchmark rates. More significantly, CAF income this quarter was supported by approximately $32 million in favorable adjustments related to loans originated in prior periods whereas income for the third quarter of last year was negatively impacted by almost $40 million in unfavorable adjustments. The primary drivers of this quarter’s adjustment included mark to market write ups and the value of our retained subordinated bonds some of which are now carried above face value and more favorable funding costs for the loans that were refinance and the term securitization during the quarter. Note that since most of the loans in the securitization were originated in fiscal 2010 the favorable $12 million or $0.03 per share of funding cost adjustments is a timing adjustment that is part of CAF’s year to date gain income. The mark to market write ups reflect the significant narrowing in the automotive ABS spread that has occurred over the last few months. Let me make a few other comments about CAF. Because our new short term agreement with Santander was implemented late in the quarter, it did not have a material impact on current quarter sales. However, we do anticipate that in the fourth quarter it will largely offset the negative effect of the sales on CAF’s latest tightening which we implemented in June. Under this agreement Santander will purchase a large portion of the loans that CAF would have approved prior to our latest tightening. As part of this strategy, CAF will also originate a small portion of these loans. We are comfortable with this credit segment but will remain conservative until we see more stability in the credit markets. Most of you are all aware that we will implement FAS 166 and 167 as of March 1, 2010, which is the beginning of our next fiscal year 2011. We utilize two primary funding sources for CAF, our warehouse facility and the term ABS market. Historically both of these structures have been off balance sheet and have been accounted for using gain on sale accounting. Existing and future term ABS transaction will now be consolidated under FAS 167 which allows for but does not require restatement of prior year results. Transfers to the warehouse facility will no longer qualify as sales under 166. FAS 166 must be applied prospectively and it does not allow for restatement of prior years. As a result, we will not be restating CAF income for period previously reported using gain on sale accounting. Nevertheless we continue to be committed to the most transparent communication possible about the impact of these changes on CAF’s reported income. Although we now recognize that we may be somewhat limited. We will keep you abreast of further developments. Now I’ll turn the call back over to Tom.

On to SG&A, we are very pleased with the progress we continue to make in reducing our SG&A despite higher sales. The year over year decline reflected a reduction in advertising in fiscal 2010, decreases in growth related costs, and benefits from a variety of waste reduction initiatives. We also believe we are now in a position to move forward with the openings in fiscal 2011 of the three stores we completed earlier this year in Dayton, Augusta, and Cincinnati. Despite this, and despite the fact that we will opportunistically evaluate and perhaps purchase land for the future development of stores, we do not plan on restarting growth at this time. In closing, I’d like to once again express my thanks to all the CarMax associates for everything they do to help us successfully navigate through these very difficult economic times and I wish all of them a safe and Happy Holiday. Now Keith and I will be happy to take your questions.

(Operator Instructions) Your first question comes from Jaison Blair - Rochdale

I was wondering about the fiscal ’11 store openings. My impression is that at least one of those stores is in a new market which requires high levels of advertising to introduce the brand to the marketplace. If those stores are expected to be accretive in I guess what you would characterize as the worst automotive downturn of the post war period, why wouldn’t you consider restarting growth?

Those three stores already have a sunk cost to them. That’s why they’re accretive.

They’re already incurring the depreciation and amortization so we looked at these as an incremental investment as this point.

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

Correct.

You talked about purchasing land for future stores. What is your current land position look like, or your pipeline? How many stores do you have in the pipeline, how long would it take for you to restart growth?

The three stores that we’re opening are the only three stores that we have any type of construction working on. We have a few pieces of land that we still either own or control. When we talk about opportunistically looking for other pieces of property it doesn’t mean we’ll go out there and start building, just that we’re looking and see if there’s any type of deal out there that we might take advantage of.

Your new credit agreement with Santander is that in effect on doing the June tightening of credit standards? Can you provide a little bit more color on that?

It substantially does that. What we ended up doing is through the relationship that we built over the last few years they’ve gotten comfortable with our lending standards and they really stepped in and basically are now underwriting the majority of those loans that we tightened back at the beginning of June.

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

We really like that segment; it’s just that the credit markets we want to see them solidify before we take a bigger portion. We’re currently underwriting a smaller portion of those loans along with Santander because we do like that segment. It’s just that we want to see more visibility and stability in our ability to go ahead and finance these and we’ll wait and see how things unfold. It is a short term agreement, we are pretty optimistic that we can extend it if need be.

How would you characterize your overhead or your employment levels? If we saw a recovery of demand in fiscal ’11 are you yet in hiring mode to prepare for recovery? How would you characterize how you’re positioning and how you feel in your outlook for fiscal ’11?

Right now we feel very good about our staffing levels. We’re staffed appropriately to our current sales level. If things were to recover we feel very confident in our ability to hire. It’s a pretty attractive market to be hiring in right now. We’re retail so we have a reasonable amount of turnover even in good times. Essentially we’re hiring sales consultants right now in all of our stores because we’re always hiring to replace turnover once we’re staffed to our current sales level. We feel very good about our ability to respond if the market was to pick up.

Your next question comes from Sharon Zackfia – William Blair Sharon Zackfia – William Blair: How long is the Santander agreement?

Its a few months. Sharon Zackfia – William Blair: The other thing I was confused by in the reporting on the finance side was it looked like you had some sort of offset in third party lending revenues. What happened there and can you walk us through that?

One of the things that happened during the quarter is because CAF stepped up and took back a large piece of the business, revenue that would have showed up in third party income ended up showing up in CAF segment versus the prior quarter. That wasn’t intentional because we made a lot more money by originating that through CAF then our third parties. Santander does charge a sizeable discount for the sub-prime space where they originate and that’s been a consistent very large piece. When you pull back the other third party that’s substantially offsetting the revenue from our other third party lenders. Sharon Zackfia – William Blair: I know you pulled back the ad spend this year and obviously sales are coming back. I’m curious as to how much of the SG&A leverage you’re getting from that decision to curtail advertising spending and whether this is a more structural shift and how you think about advertising spending on a go forward basis?

We listed the items in SG&A savings in the order of their magnitude so we listed advertising first because it’s the biggest chunk of the difference between this year and last. We monitor our advertising continuously. We try to manage it on a cost per car basis. Although sales are up 8% in the quarter it’s up against a -24% we’re still down 16 points over just two years ago. We’re managing our advertising accordingly. There’s not a structural shift in the way we have through about it. If we think about it in terms of cost per car then we’re hopeful that we’ll be spending more on advertising going forward because sales will pick up.

Your next question comes from Matthew Fassler – Goldman Sachs Matthew Fassler – Goldman Sachs: It looks to us from comparing your numbers with any outside third party assessment that you probably gained used car market share during the quarter. You usually have a view on how that transpired and I’m interested in what you think happened here.

We used to have a view on a shorter term basis. Because of the inaccuracy of the data at the beginning of the year this year we said we would talk about market share annually from this point forward. We’re looking at the data all the time but it’s so inaccurate in the short term that we have made the decision that we will discuss it at year end. Matthew Fassler – Goldman Sachs: On cost structure, to your point last year as sales were under pressure your costs were not coming down commensurately. This year your costs came down more than commensurately and you seem to more or less catch up on a two year basis as you look at the delta and expenses per store versus the delta in sales per store. Are we yet at the point where you would expect to see costs increase more or less along with revenues or do you still feel like you have more to go on the cost structure front?

We feel pretty good about the progress we’ve made. I think there’s always room for improvement in managing your costs and becoming more efficient and we have a number of different initiatives to try and maximize the savings and run the business as lean as possible. In terms of going back up as sales pick back up you have to remember there’s a couple big chunks that’ll come back advertising we already talked about but when we get back to opening up stores again which as we said we’re not doing right not. When we do there’ll be a big chunk of SG&A that’ll come back as well. Some of the stuff that came out we want to come back because we want to get back to doing what we were doing before which is building stores. Matthew Fassler – Goldman Sachs: On the credit front, as you look at gain on sale you’re at 3.6% this quarter, you’re at 4% last quarter. Is that essentially the trade off that you discussed with the opening up the spigot a bit more and taking in some more volume into CAF?

That’s substantially it. Part of taking more volume was we did reduce our rates and therefore won more often because we felt confident that we could go ahead and securitize these. Matthew Fassler – Goldman Sachs: Is that 3.6% reflective of your real life current cost of funds in the marketplace as well as what you’re charging your consumers?

To some extent. Part of the gain, the $12 million we experienced was a difference between the warehouse and the public market. A portion of that 3.6% was included in that transaction. If the market stayed the same for the fourth quarter there’s a possibility that there would be another pick up in the fourth quarter. Matthew Fassler – Goldman Sachs: On the Santander front if you could just remind us where they fit into your hierarchy to the extent that you still have some partners who are helping you out below them and how significant that piece of the market is which I assume lies directly south of where CAF would fund transactions but maybe north of where some of your other partners live.

There have been a couple changes with Santander. They’ve obviously been our key sub-prime provider now for quite a while. Two things happened this quarter is that Wells/Wachovia merged and what happened is then we lost the Wells originations as a result of that. Santander actually moved up into that space and is originating in that place and substantially offset the impact from the Wells going away. The second piece was what we talked about the piece them buying the originations CAF had decided to decline beginning in June. If we look forward to the fourth quarter we would expect Santander to be north of 15% of our total business. Matthew Fassler – Goldman Sachs: The economics of their involvement in the space versus either your other sub-prime partners for that piece of it and inn terms of CAF economics for the mid level please.

In the mid level piece they’re paying basically the same as our third party. They are paying us for that piece of it. On the other space currently since it is a test and it’s new to them they’re buying those at par so there’s no discount or no origination income. Part of why we entered into a short term agreement is for both of us to evaluate that going forward.

Your next question comes from John Murphy – Bank of America John Murphy – Bank of America: On the borrowing costs that CAF saw in the last securitization at 1.71% I’m just wondering if you think that’s something sustainable in the near term because of the strength in the ABS market what that has to do with TALF support there. Is there anything that will change in the near term that would raise that borrowing cost?

It’s hard to say. The encouraging thing is our deal was a non-TALF deal, completely, even though TALF is out there we actually think that a transaction. You know as well as I do that the vagaries of the market and things happening somewhere in the economy can ripple through fairly quickly. All I can do is say I hope that it’s an indication and how long it will be sustainable your guess is probably as good as mind. John Murphy – Bank of America: As far as the penetration of CAF where was that in the quarter and do you see that increasing over time or is it going to be impacted by the Santander expansion in funding. How do you expect that to change over time?

CAF penetration was approximately 33% before payoffs. The answer is that it shouldn’t go down depending on Santander is, it could go up depending on what the long term arrangement is. If we get to the point where we’re confident about where Santander plays in our ability to go ahead and finance that it could be that we decide to step back into that space and take more. I think we’re open and willing to have Santander continue to play in that arena just because we can’t control the overall ABS market and the financeability of it. We think long term its going to be part of our strategy to have someone playing in that space but we’re absolutely willing and interested in taking more of that in the future because of the economics on it. We make a lot more than par obviously on it. I misspoke; the 33% is net of payoffs. John Murphy – Bank of America: You mentioned in a number of places in the press release and in your comments that showroom traffic was strong than what you financed. If you financed more obviously you would have gotten higher sales. Is there anything going on that you’re seeing unique in showroom traffic where its picking up markedly as consumer sentiment is getting better? What’s going on with showroom traffic? If you get this higher percentage of folks financed at the lower end are we looking at a 2% or a 10% increase in the folks that are getting financed? Something in that range is it really just a couple percent or is it pretty high.

We weren’t referencing our traffic in relation to financed customers; we were referencing our traffic in relation to our sales number. We talked about an 8% comp that the components of which were partially traffic and partially sales execution and that traffic was the bigger chunk of it. Although traffic was up in the third quarter year over year sales were up 8% and traffic was a portion of that. It was 5% or 6% compared to 3% or 4% of sales execution improvement. We don’t see the customer coming back and the volume that we’d like to see the customer come back. This is an 8% improvement on a 24% decline. We’re still 16 points off of where we were just two years ago. Some of the external factors we continue to reference like high unemployment and low consumer confidence continue to impact our ability to get back to where we once were. John Murphy – Bank of America: On used car pricing, obviously we’ve gone through a massive spike out of the trough in the beginning of this year. It seems like there’s some stabilization but some recent weakening. Is there anything that you’re seeing in the market that is sort of an aberration or something that’s concerning or do you think what we’re seeing in the market right now is just more seasonal and something that’s very easy to deal with.

I think it’s more seasonal right now in the fall. We always see depreciation in the fall. The aberration has been what’s gone on over the last year and a half or so, particularly this year when we saw appreciation continue all the way through August at a much steeper rate then we’d seen in the past. I think the aberration is more hopefully behind us and it gets a little bit more predictable going forward. I’ll tell you, in this environment it’s impossible to predict what’s going to happen. So much is dependent on what happens with new car sales.

Your next question comes from Matt Nemer – Wells Fargo Securities Matt Nemer – Wells Fargo Securities: On the traffic topic is there any sense for whether we’re still in the hangover period for “Cash for Clunkers” or do you think that we’re now at a place where that’s behind us and this is the steady state traffic that we’re going to see for some time?

We don’t really know. It’s been three months since “Cash for Clunkers” and we talked about a spike coming from “Cash for Clunkers” and we were looking for a let down. The numbers are what they are. I’m not sure we’ll ever really know how much of it was a pull forward but this is how the numbers came out for the quarter. We haven’t really been able to assess specifically how much of the traffic shift was due to “Cash for Clunkers.” Matt Nemer – Wells Fargo Securities: On gross profit per unit, historically I think your philosophy was really to try to drive comps and you ran at $1,900 for a very long time. Should we read into this other then what’s going on in the market and pricing for used cars, can we read into your gross profit that you’ve tested the elasticity of demand and you don’t really get much more volume at $100 or $200 lower then where you’re at?

We believe that has been true for most of this year but I wouldn’t read into it and believe that it’s true going forward. I feel like we’ll constantly and always be testing the elasticity of price to see if we can drive more sales. Our preference would always be to drive more sales. We’ve talked about it a number of different quarters that we didn’t believe lowering price would help us very much and that has been true through the year but I don’t think you can draw any conclusion going forward. Matt Nemer – Wells Fargo Securities: As of now your modeling is basically telling you that this is the optimal place to be, you’re not getting much more at $1,900 or $2,000.

Instead of as of now I’d say as of then, when the third quarter ended. I’ll tell you that we’re constantly testing and evaluating price and see if it can drive sales and we do it in a controlled manner. We’ll take a few markets and move them around and see what happens and we’re going to continue to do that going forward. When we see evidence that it will help us move sales then we’ll do what we think is right for the total business. Matt Nemer – Wells Fargo Securities: On advertising, is there a point where we anniversary the big reduction. Are you about as low as you can go now and what quarter do we really start to see that compare get more difficult?

We feel pretty good about where we are. As I said before, we are trying to manage our costs on a cost per car basis. We’re running less points then we used to on TV, we’re spending less total money but so is everybody else. We still feel pretty good about what’s called our share of voice and how much our brand name and our message is getting out there with the consumer. We feel very good about that. We’re going to manage our advertising commensurate with our sales. As I said before, if sales continue to go up we plan on spending more on advertising.

Your next question comes from Brian Nagel – Oppenheimer Brian Nagel – Oppenheimer: I want to talk about SG&A and follow along some of the questions that have already been asked. As we look at SG&A you’ve done a great job controlling expenses on several fronts over the past several quarters. Now we have two quarters where you’ve had nice positive comps, I think that to some extent is probably stress testing the cost controls you put in place. Putting aside the impact of costs coming back as you potentially open more stores going forward or even on the advertising side. From a structural standpoint, how much lower from an operating expense standpoint now do you think you can run the business?

That’s a tough question. I mentioned earlier I always feel like we can improve our efficiencies. It’s difficult to slice that piece out and project forward how much more room there is. Remember too that for us another big piece of cost that we focus on is our reconditioning costs which are not included in SG&A they’re in cost of goods sold. We’ve talked in the past about progress we’ve made there. We think we have more room to go in that area as well. I couldn’t really specifically define for your how much more costs we can take out other than to caution that when we get going again there’s going to be a big chunk coming back. Brian Nagel – Oppenheimer: The stores that you had previously constructed and now are going to open again. The last time we spoke it sounded like to me that it would take a longer time for you to decide to open those. The decision to open them is it simply a reflection of the improving traffic you’re seeing or is there something else in that process?

The traffic has been, sales are up as we said, over a last year, although not where we’d like them to be. This is more of just a financial decision for us. There are three stores, there’s a sunk cost involved there. We mentioned that opening those stores in the first half of the year would be accretive to earnings. We’re not sure what the negative impact is of having two brand new markets like Cincinnati and Dayton where our store is sitting there built and having consumers drive by and well like at this time we feel comfortable from a balance sheet and financial perspective that we can go ahead and open those stores. Again, it doesn’t mean we’re going to go start building other stores because sales still aren’t where they need to be. It’s just a pure financial decision on the fact that we have $50 or $60 million of sunk cost in those three stores. Brian Nagel – Oppenheimer: I know in the past you have not commented on sales trends for the quarter, but I’m going to ask if you could this time just given the potential variability with “Cash for Clunkers” that we talked about and how sales actually tracked through the quarter.

We’re still not going to do that. I appreciate the question.

Your next question comes from Ryan Brinkman – JP Morgan Ryan Brinkman – JP Morgan: Given that the sub-bonds continue to be written up so substantially, this of course suggests that underlying markets for these relatively liquid securities has improved considerably. Could we expect to perhaps see you actually sell some of these securities to a third party buyer as was the original intend at the time that you stepped into purchase them when that market wasn’t there perhaps now it is there to remarket them?

Clearly there’s a market, it’s just that at this point when you look at our balance sheet we quite honestly don’t need the capital. We’re making a good return on those. I won’t say that we won’t. I think at a price we would but currently we are not actively considering that.

Your next question comes from Craig Kennison – Robert Baird Craig Kennison – Robert Baird: Your team has done a very good job by focusing on the younger, lower mileage cars. Given the aging vehicle population though do you see a need to adjust that age mileage threshold or tweak the mix at all?

That’s where we talked about the majority of our sales. We do quite a bit of business in the older higher mileage segment as well. We are pretty good at tracking the velocity and the turns of all cars by mileage and by year. If we see that demand picking up then we kind of ramp up that slice of our inventory. What’s been a little unique in this environment is as sales have dropped off it’s really been just a complete loss of customer flow over the last, let’s say since last May. Our mix hasn’t changed that much. You would think our mix would have changed more then it did but it really hasn’t moved very much. Craig Kennison – Robert Baird: With respect to CarMax Auto Finance could you walk through the various payments you receive at the thresholds? I had in my model the sub-prime being still an outflow of cash to your lender. Maybe just review where that’s at today.

I’m not sure what you’re looking for. Craig Kennison – Robert Baird: At the prime level typically your lending partner will pay you an origination.

Third parties. At the prime level basically the prime to non-prime we basically have said we get several hundred dollars so you could use $300 as an average between our prime and non-prime partners. The shift goes to when you go into the non-prime segment where we pay a discount that’s $1,000 or so.

Your next question comes from Scot Ciccarelli – RBC Capital Markets Scot Ciccarelli – RBC Capital Markets: We have seen a bit of a flattening in the overall wholesale used vehicle market and yet your used vehicle ASPs were up very sharply on a sequential basis. Was there anything maybe you guys did to drive that higher or was that just a function of whatever mix you sold. I’m curious as to why we saw such a delta between what you experienced and what we’re seeing in the overall market?

I don’t think it’s that much of a delta. If you look back to the beginning of January the amount of appreciation we saw through August was like nothing we’ve ever seen before which is the biggest driver of our change in ASP. Remember this announcement is through November so although we’ve seen some depreciation you can see Manheim & Odessa numbers its come down some but not that much. It’s nowhere near where it would be in a normalized year. When you compare year over year I think it’s obviously for us its still the main driver of our change in ASP. Though it’s come down slightly it’s coming down from a peak like we’ve never seen. Scot Ciccarelli – RBC Capital Markets: Can you also talk about, you mentioned conversion rates, can you talk about conversion rate versus last quarter, versus the second quarter, because something you had talked about, if I remember properly in the second quarter was you had seen actually a drop in traffic but improvement in conversion rate. Can you compare what you guys experienced in the third quarter so we can guess C04 whether execution continues to improve or we met a new threshold, etc.

I think it’s better to compare because there’s a lot seasonality in conversion because there’s different consumer behavior throughout the year. It’s better to compare, at least we feel it’s better to compare conversion year over year. In the second quarter we said conversion it was improved year over year and we said the same thing in this quarter. We were just attributing the amount of the change in sales and dividing it between traffic and conversion. Conversion in our third quarter was once again up year over year. We’re very pleased with that. We’ve made a lot of improvements in our training and our stores and we feel like our sales consultants and our store teams have done an outstanding job in this environment of making sure they take care of the customers and I think the consumer is responding positively if they actually come to the store. Remember to, I mentioned this in the press release, with tightening lending standards not just from CarMax Auto Finance but from all of our third parties our sales people have less quality approvals to work with if you made the comparison to the same customer with the same FICO score a year prior. It’s kind of a headwind for conversion. Scot Ciccarelli – RBC Capital Markets: I know there’s been a bunch of questions on the SG&A side which I think has continued to surprise most of the investment community. Thinking about calendar 2010 do you think you’re going to need to invest more in the business. You already made the comment about advertising but just as a general thought process, is there a point where we need to start investing more in the business?

We feel like we’ve had a pretty decent balance of investments in the business and at the same time continuing to try and become more and more efficient. Part of becoming more efficient requires additional investment. We talked about that in some of the other quarters. To try and lower our reconditioning costs requires us to invest in engineering and lots of other things to try and drive those costs down. Improving our execution doesn’t come for free, that requires investment as well. We’ve continued to make new ads; we’re not running the same ads we ran a year ago. We’ve had two rounds of new TV ads that we’ve invested in. I feel like we have continued to invest in our business and we will going forward as well.

Your next question comes from Simeon Gutman – Credit Suisse Simeon Gutman – Credit Suisse: Can you comment on your inventory plans heading into next year? I believe last year you were a bit tentative but other than some seasonal changes do you have any different thoughts going into this year end?

Last year at this time, this is the end of the third quarter, the beginning of the fourth quarter, we were more conservative then we had been in the past because of the record depreciation we’d seen in a three month period. It’s not as dramatic this year as it was before. We’re doing the best job we can with trying to predict our sales going forward and then our plan is to inventory to our sales rate. It’s kind of our plan every year. Last year we got a little more conservative because we had seen a short term depreciation curve like we’d never seen before. Simeon Gutman – Credit Suisse: Connected to that, a follow up on the comps and the expectations. Recognizing that Clunkers definitely benefited your sales last quarter which made forecasting this quarter all the more tricky. You hinted that sales aren’t where you want them to be. Can you talk about where your internal expectations were and how far off are they? That comes into how you can predict the inventory build as you go into year end.

I don’t know if this will make you feel better but it’s almost impossible to predict, its not just “Cash for Clunkers” the last year and a half has been impossible to really project going forward. The good thing about how we manage our inventory, I’ve talked about this a number of times, we literally manage our inventory every week. We try to do the best job we can predicting the next seven days. We make all of our acquisition decisions accordingly. We continue to have a very tight window around inventory planning and inventory management. We’re not trying to figure out what sales are going to be next year and then planning inventory now, we’re literally looking at a week by week basis. Simeon Gutman – Credit Suisse: I know you mentioned this but just to clarify, the decision then to go ahead and open the stores, its not that you’re necessarily feeling better about the business from the top line its just the cost structure is in better shape, I think CAF is stabilize doing well and now its just you made a determination that made sense to cover some of these costs.

That’s correct. Its almost pure math.

Your next question comes from William Truelove - UBS

Things for next store growth and your 16 points down from the peak in terms of sales. Is there a certain level of sales that you’d like to see before you consider store growth?

I don’t know if there’s a level that we’d like to see, it’s more of a trend line that we want to believe in. These stores have very long economic models and if we thought we would get back to our old sales levels in six months time or a years time then it wouldn’t make much difference in terms of getting going again with building stores. It’s more the trend and a believable growth rate that we want to see as opposed to a particular number.

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

Its possible but from what we’ve seen so far it’s not like the biggest, best car dealers in the best retail location which is where we want to be are the ones that are closing. You see a lot of fringe dealers closing on the outskirts of town and that historically has not been the best location for us. When we go to a new market we want to be in the biggest dealer row, we want to have highway visibility, we want to be near high growth retail, and it just doesn’t seem like those are the places that have been closing. In terms of us trying to find the absolute best location possible to maximize our sales that strategy maybe there’s something that will work here and there but I wouldn’t think it would be the main way that we would build stores.

Your next question comes from Bill Armstrong – CL King Bill Armstrong – CL King: Under your new agreement with Santander are they purchasing loans for CAF from CAF or are they directly making loan offers to your customers?

The loan offers are showing up on the store screen that’s coming from Santander is a way a consumer is going to see it. Bill Armstrong – CL King: They’re not actually buying loans from CAF.

Actually they’re buying them from the store like they would normally buy them from the store. Bill Armstrong – CL King: Inventory per store was up around 23% or 24% on a year over year basis. I assume some of that was from price inflation but I assume also you got more units. Is that true? What should we infer from that?

We had an 8% positive comp so that’s part of it. The rest is all from higher ASPs. Bill Armstrong – CL King: You’re not loading up in anticipation of a big sales burst in the near term?

I’m sorry, say that again. Bill Armstrong – CL King: Looking at that 24% increase we shouldn’t infer that you’re anticipating those levels of sales growth. In other words, 20% plus type sales growth.

No, the truth is you would never see that in our inventory numbers because we don’t manage our inventory like that. We never are 20% over stocked with the expectation of increased sales. As I mentioned earlier, we aggressively manage our inventory to our current sales rate. Bill Armstrong – CL King: Are you seeing any benefit in the market from all these dealer closings that we’ve seen? I know you mentioned before that a lot of them are sort of on the fringes of local markets. Is there any way you can measure any benefit in terms of market share or just any other benefits to your business?

Its hard to see a benefit when we’re so far off of where we were just two years ago. To Matt’s question earlier about market share, we’ll discuss that at year end. That’s where you probably see that number show up if we feel like we’re gaining share. Its just the market has gone away so fast it’s a little difficult to measure. Bill Armstrong – CL King: Your ASP on retail sales was up about $1,700 year over year. Sounds like that was mostly from price inflation and really mix didn’t really have much of an impact, is that correct?

That’s absolutely correct. Mix had almost no impact.

Your next question comes from Scott Stember – Sidoti Scott Stember – Sidoti: You guys probably quantify the lower reconditioning costs how much of a benefit that had in this quarter? I know that in the next quarter or two you are going to anniversary some of these benefits but could you talk about that.

I think at the end of the first quarter we talked about $100 of savings that we said was sustainable. That’s the same number that we have to report in this quarter. We believe there’s more to be had there and when we achieve it and we achieve it in a sustainable way then we’ll talk more about what that number is. Scott Stember – Sidoti: With regard to these three new stores that will be opening, will they be employing the new flow concept for reconditioning?

At this time if they open as full reconditioning stores they will open under our new format. We have two of these stores are full production stores. One is built as a satellite but we have the option to open all three as satellites if we think that makes the best financial sense. When we get closer to opening those stores we’ll make those decisions. Scott Stember – Sidoti: Did you give what the CAF penetration rate was in the quarter versus last year?

33% versus 32.5%

It was about flat to last year. Scott Stember – Sidoti: What was it again in the second quarter of this year?

It was 27%.

Your last question comes from Mark Mandel – FTN Equity Capital Mark Mandel – FTN Equity Capital: Bonus accruals, does that have any impact this year versus last year?

Yes, because we have them this year and didn’t last year. Mark Mandel – FTN Equity Capital: Can you quantify that at all?

We haven’t quantified them. Mark Mandel – FTN Equity Capital: In terms of your expansion, if you take into account the lead times in opening new stores, if you look at the economy clearly there’ll be an expansion perhaps in 2010 I think most people are assuming that. If you look at the weakened state of the real estate market, I can understand a dramatic cut back in expansion plans but given you’ve basically gone to zero and you’re still on hold. Just a little confused about your crystal ball.

We wish we had a crystal ball. The one we have is faulty. The big number is sales. You look at our quarter and we’re up 8% on a -24%. I don’t know that I can stress that enough that we’re down 16% from just two years ago. Although we’re optimistic that there’s a recovery on the horizon when that happens and the steepness of the recovery is a big, big unknown and until we have some more clarity and visibility we’re just not willing to go out and invest the capital. We’re also very pleased with the progress we’ve been making. Growth takes up a lot of energy and a lot of resources in an organization. Over the last year we’ve made enormous progress in improving the profitability of our business. I’m actually excited about the prospects of continuing to make improvements there. When we see a trend we believe in we’ll get to building stores. We’re only in 45% of US markets; we have a 2% market share. I think our best days are ahead of us, I feel just as optimistic today as I ever have about our ability to grow as a company, we’re just on hold right now, that’s all. That’s it for this quarter. We’ll talk to you next quarter. Everybody have a safe and happy holiday. Thanks for joining us. We’ll talk to you soon.

Thank you for participating in today’s conference. You may now disconnect.