CarMax, Inc.
Q3 2007 Earnings Call Transcript

Published: 19 Dec 2007

Operator:

Good morning. My name is Lisa andI will be your conference operator today. At this time I would like to welcomeeveryone to the Third Quarter Earnings Call. All lines have been placed on muteto prevent any background noise. After the speakers’ remarks, there will be aquestion-and-answer session. (Operator Instructions). Thank you. Ms. Kenny, youmay begin your conference.
Katharine Kenny:

Good morning. Thanks for joiningus. I am Katharine Kenny. I am the Assistant Vice President of InvestorRelations at CarMax and I am here on the call today with Tom Folliard, ourPresident and Chief Executive Officer, and Keith Browning, our Executive VicePresident and Chief Financial Officer. Before we get started, I wouldlike to do a little commercial for our Analyst Day in January. The weather is alot nicer in Richmondthan it is where you are and we have an Analyst Day on the 9th and the 24th ofJanuary. So we would urge you if you have questions about this quarter's resultsto come to one of those days. Before we begin, please let meremind you that our statements today regarding the company's future businessplans, prospects and financial performances are forward-looking statements thatwe made pursuant to the Safe Harbor provisions of thePrivate Securities Litigation Reform Act of 1995. These statements are based onmanagement's current knowledge and assumptions about future events. Theyinvolve risks and uncertainties that could cause actual results to differmaterially from our expectations. In providing projections and otherforward-looking statements, the company disclaims any intent or obligation toupdate them. For additional information onimportant factors that could affect these expectations, please see thecompany's Annual Report on Form 10-K for the fiscal year ended February 28,2007, filed with the SEC and our other subsequent filings. After the call today Celeste andI will be available, as usual, to take your calls. Tom?
Tom Folliard:

Thank you, Katharine. Goodmorning everyone, and thank you for joining us. This morning we reported ourresults for the third quarter. As we projected during our last conference call,weak economic conditions continue to impact our sales, especially given thedifficult comparisons with last year's third quarter. However, our sales andgross profit for the quarter were consistent with our revised expectations andour comp sales were stronger than many of our competitors, from whom our datashows we continue to take market share. Total sales increased 7% to $1.89billion, compared with $1.77 billion in the third quarter of fiscal '07. Usedunit comps were flat compared with third quarter of fiscal '07, and we recordeda 13% increase in used unit comps. Total used unit sales grew by 9%,compared to an 18% increase in the prior year. The contribution from our newstores, not yet included in our comp base, increased this quarter because newstores represented a slightly higher percentage of our total store base. Our net earnings decreased 34% to$29.8 million or $0.14 per share, compared with $45.4 million or $0.21 pershare earned in the third quarter of last year. A weaker than expected thirdquarter net earnings were primarily the result of higher funding costs forCarMax Auto Finance in our short-term warehouse facility, due to the wellpublicized and unprecedented disruption in the asset-backed securities market. On the sales, total used vehiclerevenue grew by 10% in the third quarter. Customer traffic continued to growduring the quarter, but sales conversion rates remained below the third quarterof last year. While credit remained available at previous levels for ourcustomers, we are hesitant to commit to big-ticket purchases in the current andmore uncertain economic environment. Wholesale vehicle revenuesincreased by 4% in the third quarter, due to slight expansion in both ouraverage per-year unit selling price and units sold at our auctions. Over the long term, we expect ourwholesale unit sales to increase, consistent with our used retail sales. Year-to-dateretail used unit sales have grown approximately 11%, while wholesale unit saleshave grown by about 8%. We opened five superstores in thethird quarter, including a production store in Charlotteand four non-production stores in Atlanta, Newport News, Los Angelesand San Diego,which is a new market for us. Our inventories increased bysomewhat more than the requirements of newly opened stores. During the thirdquarter, we enlarged our inventory expansion test, which we have been runningthrough the summer, which proved promising in our initial trials. We increasedinventories in some of our stores by about 50 to 100 vehicles. We'll continueto monitor the impact of higher levels of inventory on our sales, which willhave a slightly negative impact on our returns. As far as gross profit, the thirdquarter is normally our weakest quarter in terms of sales and gross profits,due to the usual seasonal slow down in traffic and high vehicle depreciation.Our last two third quarters as we've talked about before have been exceptionalfor reasons we discussed at that time. This year's third quarter represents areturn to more normal seasonal patterns. On the CarMax Auto Finance, I'llgive you a few more details to start. CAF income fell $16 million in thequarter. CAF income includes the previously announced charge of $8 millionrelated to wider spreads and higher swap unwind costs related to our Septemberpublic securitization '07-3. Higher funding costs in our warehouse facilityreduced CAF income by an additional $4.6 million related to loans remaining inthe conduit that were originated in previous quarters. The higher warehouse facilitycosts also negatively affected the gain recognized on loans originated in thecurrent quarter, reducing our third quarter gain percentage to 3.6%, comparedwith 4.3% in prior year's quarter. In addition, this quarter's CAF incomereflected an immaterial net charge of $1.5 million for several favorable andunfavorable adjustments to our loss assumptions on previous securitizations. Includedin this charge was the effect of increasing the cumulative loss assumption onthe '07-1 deal, the highest of our securitizations from 2.7 to 2.8%. As far as SG&A, our SG&Aratio of 11.2% reflected the expected de-leverage that resulted from flat comps.In our last conference call, we discussed the fact that short-term industryconditions would not impact our planned investment in our long-term growth plan,or curtail our ongoing operational strategic and internet growth initiatives.It is our intention, however, to continue to monitor changes in the marketplaceconditions and manage our overall level of spending appropriately. For store growth, we now expectto open 12 stores this fiscal year as our Modesto, California opening has beendelayed for a month due to normal construction delays. As of the end of thethird quarter, we had opened nine stores. We opened Omaha,Nebraska last week and we opened up our Jackson, Mississippistore today. In February, we will open a new store in Ellicott City, our sixthstore in the Baltimore, Washington market. In our press release we alsoincluded a list of the 10 stores we are currently planning on opening in thefirst three quarters of fiscal '09, with the usual caution that opening datesare always subject to change. On to our expectations, lookingforward, we now project full year comparable store used unit sales growth ofapproximately 2%. However, the volatile conditions in the financial marketplacefor asset-backed securities have convinced us to lower our earningsexpectations for the full year to a range of $0.87 to $0.93 per share from ourpreviously reduced range of $0.92 to $0.98. We reported $0.92 in fiscal '07.Our CFO, Keith Browning will provide you with more color on our earningsexpectation, including the changes in our projections for funding costs in CAFin a moment, and then we will be happy to take your questions. Let me tell you once again, webelieve our superior consumer offer is unique in the industry and should allowus to outperform many of our competitors in both the short and long-terms. Itstill remains unclear how severe and long-lasting this current economicslowdown will be, but we will outline our expectations for fiscal '09 in ourfourth quarter press release and earnings call. We continue to projectlong-term comps between 4% and 8%, and store growth between 15% and 20%. Wealso remain confident that CarMax Auto Finance, even in a difficult environment,is critical to our ongoing operations and overall profitability. I also would likethank our 15,000 CarMax associates for all that they do every day. We couldn'tdo it without them. And now, I'll ask Keith to addhis comments. Keith?
Keith Browning:

Thank you Tom, and good morning.Our previous updated range of $0.92 to $0.98 included the $8 million additionalcosts related to our 2007-3 securitization. In addition, it included highercosts for our next public securitization, which we anticipated would occur inthe fourth fiscal quarter. Unfortunately, we haven't yet experienced theincrease in spreads on asset-backed commercial paper to support our warehouseconduit, nor did we anticipate that spreads would widen further in the publicasset-backed securities market. So, our revised forecast for the year includeshigher spreads to fund our conduit. As Tom reviewed in the thirdquarter, we incurred a charge of $4.6 million for loans originated prior to thethird quarter. In addition, our new forecast includes the impact of the higherfunding cost on third quarter originations and contemplates that those costswill remain at similar levels for the remainder of the fiscal year. Despitelighter spreads, we expect the gain percentage on originations will remainwithin our normalized range of 3.5% to 4.5%, although probably well below themid-point of that range. We also now expect the $5 million to $6 million inhigher costs being projected on our next public securitization, assuming thespreads stay fairly consistent with the recent ABS deals completed by GMAC andChrysler. However, because we believe there is a significant backlog of ABSdeals waiting to go to market and since we would like to have as muchflexibility as possible, we've arranged a temporary increase in our conduitcapacity of $300 million to $1.3 billion. Now, we'll be happy to take yourquestions.
Operator:

(Operator Instructions). Yourfirst question comes from the line of Seth Basham with Credit Suisse.
Seth Basham:

Good morning. Thank you fortaking my question.
Tom Folliard:

Good morning, Seth.
Seth Basham:

If we could focus a little bitmore on the CAF side, and Keith, thank you for your comments outlining the insand outs of the CAF income, but if you could be a little bit more specificrelated to Q4 and what the actual CAF income number is that you are expecting.
Keith Browning:

CAF income is obviously -- Ithink I've given you the detail that we expect a similar challenge on theconduit costs being a little bit higher than what we had been running or ahigher spread, which means the gain spread will be below 4% for CAF based onoriginations. But telling you the specific numbers kind of a level of detail,we haven’t actually gone to historically in -- that’s why we give a rangearound it anyway, because there are some uncertainties.
Seth Basham:

Okay. So, the lower gain on salesspread coupled with increased sort of valuation adjustments so to speak,associated with doing an ABS deal would bring your CAF income below 20 million.Is that the right way to think about it?
Keith Browning:

That's the way to look at it.
Seth Basham:

Okay. Thank you. And then as wego forward into 2008, how do you expect, and it's a very tough question toanswer, but how do you expect the ABS markets to perform and how do you thinkabout your options for the CAF business?
Tom Folliard:

Quite honestly, I can't forecastwhat's going to happen. I think that we'll watch very carefully. We'recautiously optimistic that the markets will stabilize over time, it's just amatter of how fast will they stabilize. I think we're also very confident,however, that there is a market at a price. So, while funding costs couldremain higher and CAF spreads could actually remain somewhat challenged, we areviewing this business as critical to our ongoing operations. And we're veryconfident that we'll be able to continue to contribute to the business to theextent the market lets us.
Seth Basham:

Okay. And just lastly on CAF, canyou give us some more details, which other pools did you raise the loss ratesassumptions on, besides 2007-1?
Tom Folliard:

Well, we raised the lossassumptions on the more recent pools and had offsetting adjustments in theother pools.
Seth Basham:

Okay. So, 2007-2 and 3 would beincluding those more recent ones that you're referring to?
Tom Folliard:

Yes.
Seth Basham:

Okay. I'll let others ask. Thankyou.
Tom Folliard:

And one thing on that, Seth, interms of our loss rate assumption changes, we've now gone five consecutivequarters without a material adjustment as it relates to the loss rateassumption change. So, all the volatility we are seeing here is from the costof the asset-backed securitizations.
Seth Basham:

Understood. Thank you, Tom.
Tom Folliard:

Okay, Seth. Thanks.
Operator:

Your next question comes fromSharon Zackfia with William Blair.
Sharon Zackfia:

Hi, good morning.
Tom Folliard:

Hi, Sharon.
Sharon Zackfia:

I have a few questions on CAF,and then I'll move to retail. But the 5 to 6 million in additional cost in theFebruary quarter, that if the securitization occurs or -- can you clarify that?
Keith Browning:

Yeah, correct. That's assumingthe securitization does occur. I mean, so, if it doesn't, then that's a costthat would move into the next fiscal year.
Sharon Zackfia:

Okay. And is that just kind oftruing up then the warehouse facility with the public asset-backed spreads outthere?
Keith Browning:

Well, it's just a realdifferential in the cost between those two particular facilities. The conduitis such a short-term facility that the spreads of the markets commanding aresignificantly lower than the warehouse -- the public markets.
Sharon Zackfia:

Okay. And then have you switchedto LIBOR swap now, rather than asset-backed or commercial paper swap?
Keith Browning:

Yes, we have.
Sharon Zackfia:

Okay. And then kind of moving onto sales, Tom, can you comment on your sales trends in the quarter? It soundslike they were relatively consistent, is that a fair assumption? And did yousee any kind of major regional disparities?
Tom Folliard:

No, I think one of things that Ididn't probably talk about enough is, we set our expectations at the end of thesecond quarter for the rest of the year and really for the third quarter. Yousaw we put a range out of one to three, for the year. We've now tightened it to two.So, we are pretty much right on track for the third quarter with what weexpected. It's really all these additional unexpected funding costs that arethe thing that's changed our earnings.
Sharon Zackfia:

Okay. And then, when youimplemented the beta of carmax.com, or I guess it's not a beta anymore and Iknow it's been relatively recent. Can you give us any kind of first look onwhat that is doing here traffic in the stores?
Tom Folliard:

It's hard to translate thatdirectly into traffic. One thing we can look at is, what's the impact of thecustomers who come to carmax.com and they go through news search and ultimatelyend up with a lead, and we feel like we'll get an increase there. It is awfullyearly. We've only rolled it, I think, over the last two weeks. So, I think we'd probably giveyou a little bit more color on that at the end of the fourth quarter. We'repretty confident that that along with other ongoing changes we made tocarmax.com continued to enhance the consumer experience on the website and makeit look more likely that they'll contact us and ultimately more likely thatthey'll show up at the store.
Sharon Zackfia:

Okay. And then lastly, can youremind me, what is the inventory expansion test?
Tom Folliard:

I am not sure that we hadmentioned that before, but what we have been trying to do, and as we've talkedabout many times, we are always running tests to try to spur sales. And onething we've tried to do on occasion, and done it for over 10 years, is moveinventory levels around to see if it has an impact on sales in those stores. We started with about 20% of ourstores. It wasn't really big enough for us to talk about. It didn't really havemuch impact on us financially. We are pretty encouraged with some of thoseresults. And so, I think it's about a 2% inventory difference in our totaldollar amount, but I figured we talk about and tell you that we're going tocontinue to run that through the fourth quarter and see if it has a difference,and like any other tests we do, we'll keep a control group stable or raiseinventory levels in subset of stores and see if it impact sales.
Sharon Zackfia:

Are you moving the inventory insome particular way or is it going lower ticket, higher ticket, foreign,domestic?
Tom Folliard:

No. How we do our inventorymanagement is basically based on segments, and pricing, and mileage anddifferent types of cars, and it will be consistent with whatever the store --if we raise the store to 50 to 100 cars, it will be consistent with what thatstore is already selling best. So, it will be very controlled and veryanalytical how we raise the inventory, but it will be store-specific based onthat store's trends.
Sharon Zackfia:

Okay. It's a weird time of theyear to be testing this, isn't it?
Tom Folliard:

Well, I think it's actually apretty decent time of the year because if you're going to run something likethis and it's going to work, it's going to work all year.
Sharon Zackfia:

Okay.
Tom Folliard:

So, we think it's all relative.If it works in the spring in high sales time, it should work in the fall, whenour sales are a little bit lower. And remember the inventory levels will berelative too. The base inventory level will be lower in the fall, so the placefrom where you start is a little lower. In the spring, the base inventory levelwill go up and the increment above would be similar.
Sharon Zackfia:

And I guess, I am trying to --
Keith Browning:

And we've already gone throughour fall depreciation cycle.
Sharon Zackfia:

Yeah. I am just trying toreconcile my head, I thought one of the advantages of the Internet becomingmore prominent in your business was maybe that you were transferring inventory,more a customer request in between stores, so maybe eventually you would haveless inventory on the loss, but it sounds like that was the wrong conclusion.
Tom Folliard:

Well, I think it's too early todetermine that, Sharon.I think as our brand gets stronger, I believe that what you just said isactually true and I feel like we'll be able to leverage it more. But if inshort increments we can -- 50 or 100 cars doesn't cost us very much money, andif we can get more sales out of it then it’s worth it, and it's that many morecars that are available to consumers and other stores as well. And again, thisis only a subset of stores and it's not a big percentage of our totalinventory.
Sharon Zackfia:

Okay. Thanks.
Tom Folliard:

Thank you.
Operator:

Your next question comes fromScot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:

Hey guys, how are you?
Tom Folliard:

Good, how are you Scot?
Scot Ciccarelli:

Alrighty. Couple of questionsrelated particularly to the CAF situation. We're still seeing pretty big spreadbetween the delinquency rates, trends in there, the Wall Street trends. How doyou guys think about these trends going forward, given the concerns that we'reseeing in the broader credit market?
Tom Folliard:

As we've indicated before, a lotof this, the difference in delinquencies was anticipated. We actually bought aset of customers in the new scorecard that we actually tested before we put inthe new scorecard. That actually we knew had delinquency patterns and paymentpatterns that weren't as consistent. However, we also know that basedon our test results anyway, that those customers are still likely to pay a carloan because it's a very high priority payment. So we do believe that if youlooked at our prior originations and the losses associated with delinquencies,that those are kind of apples-and-oranges comparisons. In that, we do expectthat delinquencies at a higher level won't translate into losses at the similarlevels that you would have seen historically on our pools.
Keith Browning:

It's not a direct correlationfrom delinquencies down to the loss rate and aggressive follow-up andaggressive servicing of the loans is something I think we're very good at. Andas I mentioned earlier, we've now gone five consecutive quarters without amaterial adjustment as it relates to the loss rate assumption.
Scot Ciccarelli:

Yeah, but I mean --
Keith Browning:

We feel pretty good about theperformance of our portfolios in that regard.
Scot Ciccarelli:

Right. No, I understand that, butI guess to be fair, I mean, we've now seen two quarters in a row where we'vehad an increase in loss assumptions for the one particular securitization. Andthat's the one of the ones, the 2007-1 that has obviously materially higherdelinquency rates. Is there something unique about that pool that it's causingyou to make changes to those assumptions but shouldn't imply to others?
Keith Browning:

I mean, I'll remind you that whenwe talked about 2001 last time, it was the earliest [in light] we'd ever madean adjustment, and so with the three more months data we feel very confidentthat we are actually now at a point where there is enough maturity in seasoningthat there won't be any more material adjustments for that particular pool. So, we are making adjustmentsgiven the economic environment, a little earlier than historically or than wewould have normally made. So we feel as confident as anyone can in predictingthe future based on the underlying mix of the portfolio and looking at themrelative to last time in curves and…
Tom Folliard:

And if you go back to those firstcouple of deals, we have done some tightening in our originations, with themore recent loans that we have originated in the store and remember too thatonce another three months has gone by in that pool, there is less balance leftthere, so a 10 basis point move is going to be less impactful going forwardbecause there is not that much left in it.
Scot Ciccarelli:

Great, thanks. That's helpful andthen the other question is, you've talked about, you guys really haven't seenany tightening from your third-party lenders, but I can tell you that out inthe marketplace some of the people in the auto lending sector are were kind of-- it seems like we are kind of at the front end of the beginning of thetightening and AmeriCredit and Capital One Auto Finance, for example, boast inpublic talking about tightening standards. Have you guys started to see any ofthat yet?
Keith Browning:

Not yet. I mean we were actuallycalling them proactively because we recognized that they may have to dosomething because of the broader macro economic conditions and asking them tolet us know before they do it, so that we can understand what they are doingand why they are doing it. And obviously we are taking theopportunity to remind them during those conversations that our portfoliooutperforms our other books of business from their other lending channels. So,so far, there hasn't been any changes; so far there has been positive feedbackthat they don't intend any changes, again because our portfolio outperforms ourother books of business. It doesn't mean that it won't happen, but I can tellyou that we are in constant communication with them and they really doappreciate the origination channel that CarMax provides and the consistency ofperformance.
Scot Ciccarelli:

Okay. That's helpful. And thenthe last question is shifting gears to the wholesale operations. We saw anotherpretty nice increase in terms of gross profit dollars per unit. We are nearingthat $800 level. Tom, is there anything going on in the market or withinCarMax's wholesale operation that can help you continue to drive that forward,because that’s obviously been a pretty important profit lever for the companyover the last couple of years?
Tom Folliard:

Yeah. It has, and I'll tell youwe are reluctant to push too hard there because of the reasons I mentioned inthe past, the impact it could have on our sales. So, you saw our rate actuallygo down. I mean our rate of growth is down a little bit this year. I think theimpact that we have seen on conversion on the sales side, we see that sameimpact where there's some hesitancy from consumers to sell us their car. Our offers are lower now thanthey were in the spring and summer as they usually are in the fall and maybeeven a little bit more impacted by the trends we see in the industry. So, ourbuy rate is down a little bit. It was down a little bit in the third quarter.So, I think some of that is reflected there.
Scot Ciccarelli:

Okay. So you are starting to seesome hesitancy on part of consumers?
Tom Folliard:

I just talked about it on theconversion side of -- when they are ready to pull the trigger to buy a car, butwe also see when they are about to sell their car.
Scot Ciccarelli:

Okay, great. That's very helpful.Thanks a lot guys.
Tom Folliard:

Thank you, Scot.
Operator:

Your next question comes from RexHenderson with Raymond James.
Rex Henderson:

Good morning. And thanks fortaking my question, again. Just a couple of clean-up questions on the CAFportfolio, can you give us a number -- the amount of loans originated and soldin the quarter?
Keith Browning:

Sure. That’s 574 million.
Rex Henderson:

574 million originated and sold?
Keith Browning:

Correct.
Rex Henderson:

Okay. And is - just a follow-upon that, have your lending standards remained consistent? Have you made anychanges or tweaks to those lending standards in the last couple of quarters inlight of what's going on with consumer credit?
Tom Folliard:

We actually made very minor tweaks at the end of thethird quarter. So we don't think you'll see it in sales and obviously we madethose with that in mind that our lending partners would pick up those loans andthat there's just a level of risk where we're constantly trying to do theanalysis of what are we buying that we shouldn't be and what are we not buyingthat we should be. And that was just a result of that but very minor.
Rex Henderson:

So, you are taking a little bit less risk than youwork. Can you give us any color on how that's changed? I mean what the changewas?
Tom Folliard:

We basically at the lower credit tiers, we areactually asking customers for a little more equity.
Rex Henderson:

Okay.
Tom Folliard:

You know, one thing I would like to add is,everybody -- I think the big concern is when a customer walks in the door ofCarMax, there's credit available to them. And if we look at 100 loanapplications and some percentage of those only get approved by CarMaxAuto Finance or BoA which are kind of our prime lenders and then the rest go onto our non-prime partners. The percentage of total applications that aregetting an approval for finance has hardly moved at all. I think people thinkthat number would be dropping dramatically. And I can tell you that, thatnumber has not moved hardly at all this year, even into the third quarter. So, when a customer walks in thedoor, there's credit available to him at the same level that it was before. Interms of percentages, the answer is absolutely yes. And are there rate changes?There are. But there -- this isn't the worst rate change environment we've seenin terms of the effective APR rates to the consumer. It's actually not evenclose. The impact is that the funding costs on the back-end. But even after youfactor that in, it's clearly more profitable for us to have CarMax Auto Financeas one of the partners not just from the additional profitability that it addsbut also from our ability to learn and our ability to add incremental sales.
Rex Henderson:

Okay. Moving on to the retailbusiness, I'm worrying about what you are seeing in the wholesale market forused cars. The information I have suggests that wholesale prices have beenrelatively firm, while the retail demand has actually been awesome. I'mwondering if you are seeing that same thing and what impact that may have ongross margins going forward?
Katharine Kenny:

Last month.
Tom Folliard:

Last month only, yeah. Rex,wholesale prices have been, I think relatively firm for the year, but in thelast month if you look at demand [helm] index, it's declined somewhat andthat's actually kind of what we expect seasonally. The last couple of years, Ithink we've had a little bit of a prop-up in the wholesale market, two yearsago related to Katrina, last year, I am not sure, we really understand. This year, it looks a little bitmore normal for us in terms of depreciation into the fourth quarter, on thewholesale side of the business. So -- and that index is across all vehiclessold. We are not a buyer for all of those cars. So, when we're in the marketbuying cars right now, things are above what we expected them to be.
Rex Henderson:

Okay. So, you're not seeing anypressure on the gross margin line then, that's how I can translate that answer?
Tom Folliard:

Well, I think we were 12 bucksoff our gross margin this year's third quarter compared to last year's thirdquarter. So, it hasn't impacted our results in terms of margin per car.
Rex Henderson:

Okay. Thank you.
Tom Folliard:

Thank you.
Operator:

Your next question comes fromMatthew Fassler with Goldman Sachs.
Matthew Fassler:

Thanks a lot, and good morning.
Tom Folliard:

Hi, Matt.
Matthew Fassler:

Couple of follow-up questions.The tests that you conducted on this new group of customers that had higherexpected delinquencies, what point in time did you run it?
Keith Browning:

Well, that was back in 2005.
Matthew Fassler:

So, I guess I am curious, if thisis a group of customers that was more inclined in a pretty robust environmentto come under payment pressure. Given that clearly the credit -- consumercredit environment has changed notably, particularly since September, I guess,is when the broader market really started to see it. Does that change yourthinking about that customer's likelihood to make good on their obligations?
Keith Browning:

Yeah. I'll go on and say we'vebeen originating those customers in 2006-2007. And some of the pools where wemade favorable adjustments were on those very customers for the 2006origination pools, for example. And so, the answer is, we -- based oncombination of mix and timing curves and everything we know, we believe we takethe losses as accurate as anyone can forecast.
Matthew Fassler:

Okay. Thank you. And thensecondly, in the retail business, you spoke about traffic and lower conversion.From a selling process perspective, what are the things that you're able to doto combat that customer reluctant in terms of selling tactics or follow-up oranything like that?
Tom Folliard:

Matt, youknow how our business model works, and as usual, there is never a silver bulletto change an execution trend. It's generally our normal blocking and tacklingand how we overcome objections with the consumer. I justthink, we've seen a level of reluctancy from the consumer that we're not usedto and we haven't seen before. So, since we don't negotiate on the price, wedon't negotiate on the trade, and we don't negotiate on the financing, therecertainly isn't any manipulation we can do with the numbers to get the consumerto behave differently.
Matthew Fassler:

Sure.
Tom Folliard:

So, forus really it's just more of the same and trying to figure out if we can just getmore consistent with those different aspects of how we manage the process.
Matthew Fassler:

And I guess --
Tom Folliard:

It is no differentfor us than it is any other time of year. We're just running into a slightlymore difficult environment.
Matthew Fassler:

Understood.And then, finally, if you could give us some sense of what you are seeing fromyour competition, I mean, to the extent that not everyone is experiencing thesame credit flexibility that you are, maybe sources of funding or drying upthat elsewhere, I guess, that can certainly be feasible? Are you seeing yourcompetitors pull back, if you think about the looks the customers are gettingaway and is that helping you competitively?
Tom Folliard:

Well, that's very difficult toascertain because of the fragmentation that we see from our competition, Imean, it's just so fragmented, it is so different in every market. If we lookat how we are projecting to finish out the year now, it will be – we are now expectinga 2% positive comp for the business. And if you take out all of the funding,unexpected funding costs, we would have grown our earnings slightly. And in this environment Iactually feel like that's pretty good compared to our competition. If you lookat our used car comp unit spreads, they have continued to be pretty significantbetween us and our competition. You know, our quarters don't match up. But ifyou look at our first three quarters this year, which are now finished, we hada 3% positive comp. If you match up against the competition, it's about anegative 3. So there is a spread there that has remained fairly consistent, andwe feel like we continue to gain share.
Matthew Fassler:

Got you. Thank you so much.
Operator:

Your next question comes from BradThomas with Lehman Brothers.
Brad Thomas:

Thank you. I wanted to follow-upquickly on some of the questions about your loss assumptions and how you havechanged those. I know at the end of the last quarter, the upper end of yourassumptions have been around 2.7%, could you just quantify what that upper endhas gone up to now?
Tom Folliard:

It's 2.8.
Brad Thomas:

Okay.
Tom Folliard:

The only pool we changed up wasthe one, the 2007-1 from 2.7 to 2.8.
Brad Thomas:

Okay. Okay. And are you stillfeeling comfortable that 3% is about the max level that you all would evertarget, and so it is used…
Tom Folliard:

One of the things we have said isthat, we are targeting a prime portfolio and the public markets view 3% or lessas prime. So that's clearly one of the reasons why we targeted 2 to 2.5, isthat it did give us room for economic fluctuations that may come and go, andstay prime.
Brad Thomas:

Got it. Okay. And so…
Keith Browning:

We are actually -- we are stilltargeting less than 2.5 on the stuff that we are originating now. And rememberthat we are always applying whatever it is we have learned after theperformance of the additional pools, and we apply that going forward. So, we'velearned a lot in the last year, and every quarter or every month that we seemore performance and we look at delinquencies and how they translate into lossrate. We are applying that learning into our origination strategy.
Brad Thomas:

Okay. And some of the – themoderate tightening that you had mentioned is in order to maybe get those lossrates down on some of the newer loans, is that correct?
Tom Folliard:

Yeah. And it's just our normal --our normal, the way we are going to operate the business, so I think what getslost in this is what Keith mentioned earlier as, all of our movement up intothe 2.3-2.5 loss rate range is on purpose. We were running 1.3-1.5. We wererunning at rates less than what we had booked the deals at. We were takingpositive adjustments. We took $25 million of positive adjustments over the lasttwo years, and our goal was to get back up into that range because we weregiving up both sales and profitability on the front end at the time to book thedeals. I mean, in terms of the loss rate performance, I feel great that we havegone five quarters without a material adjustment.
Brad Thomas:

Okay. Great. Then just afollow-up on the gross profit for the other line, it seemed to be downyear-over-year. I was wondering if you could just talk about some of thedrivers behind that.
Tom Folliard:

(inaudible).
Katharine Kenny:

Yeah.
Keith Browning:

Yeah, I mean, in that quarter,the -- I think, our year-over-year was only down $12, right? I think, we aredown sequentially from the second quarter to the third quarter.
Tom Folliard:

Is that the line you are askingabout?
Brad Thomas:

I wasn't sure if you were seeinga lower attachment rate from extended warranties or lower third-party financerevenues?
Tom Folliard:

No, we have not seen a lowerattachment rate on warranties. I think, some of that's service.
Katharine Kenny:

Service…
Brad Thomas:

Okay, okay.
Katharine Kenny:

-- and finance fees.
Keith Browning:

Yeah. Some of it's like leverageon service due to the flat comps and then in addition, [drive] actuallyincreased their overall buying versus a year ago. So, that actually -- becausewe pay a discount to them offset some of the income we're getting from theother third party providers.
Tom Folliard:

And that's not a big number, butthat impacts our total finance fee income. That’s a little bit of an odddynamic there, where if we get a little bit more drive income, it actuallydecreases the fee income.
Brad Thomas:

Okay, okay. And then just onelast question, in terms of your car buying pattern, are you seeing any changein the traffic level in your stores of the customers that come in to get anappraisal?
Tom Folliard:

Well, since it's really our -- Italked earlier about our buy rate going down. So, that other ones that weappraise, if we look at that year-over-year we're down some, and I wouldattribute that to the same hesitancy that we've seen from the consumer on thepulling the trigger on buying a car.
Brad Thomas:

Okay, great. Thanks so much.
Operator:

Your next question comes fromEdward Yruma with J.P. Morgan.
Tom Folliard:

Hi, Eddie.
Edward Yruma:

Hi, guys. Thanks for taking myquestion. You've made some changes to the website recently. Can you talk aboutsome of the metrics that you've looked at in terms of whether customers areusing it more and how that may be helping offset some of this macro weakness?
Tom Folliard:

Well, the metrics we're lookingat are the same metrics we always look at. How many people come on the website?Out of those people, how many do a vehicle search? Out of the ones who do avehicle search, how many get down to a specific fact sheet? When they get to aspecific fact sheet, how many of those contact the store, whether it's fromphone or email? So, the metrics that we're looking at are the same. And then ofthe ones who contact us, if we can track it specifically, how many of those actuallyshop at the store and then we take them through the waterfall metrics we do inour store right now, to see if they actually buy a car. So, the metrics haven't reallychanged very much, but what we're -- if you look at each aspect of thatbusiness, I mean of the website, we're trying to increase each of those areas.We'd like more people to visit the website, which we have done a little bit.We're starting to do a little bit more advertising about our website probablyto advertise our new search. Once they get on the website, is it more appealingto them, because we have more photos, because we've redesigned the landingpage, we've redesigned the fact sheet. And I think right now, our earlyindications are that that all of those things are going pretty well. But again,it's an ongoing process for us. We're not satisfied with where website is. Wewant to be the best website in the industry. We want people to be able to comeon our website, not have to go to any other sites. We want them to be able to dotheir research, their shopping. We want them to be able to compare cars. Wehave consumer reviews that we've added to the website. So, for us, it's a bigstrategic investment that we're going to continue to try to make improvementson.
Edward Yruma:

Got you. And should the creditmarkets remain volatile, what is your ability to ratchet up the warehousefacility once again?
Tom Folliard:

At this point, we think thatwe've really tapped the short-term limits. I mean, what we'll do if the marketsremain volatile, is we'll consider other alternatives which might include thewhole loan sale.
Edward Yruma:

Got you. And my final question,has this changed then the percentage of prime financing that goes to CAF versusBoA?
Tom Folliard:

No, not at all.
Edward Yruma:

Very good. Thank you.
Tom Folliard:

And one additional thing toremember is any alternative strategy for funding would mean less profit. If weget -- CAF provides a more profit on a per unit basis than if a car goes toanother vendor, and going to a straight commission and just originating thoseloans for somebody else going to a whole loan strategy, any of these strategiescompared to the way we are doing it, even in this environment, would mean less profit.
Edward Yruma:

Great. Thank you very much.
Operator:

Your next question comes fromBill Armstrong with CL King & Associates.
Bill Armstrong:

Good morning. I think my firstquestion was answered. So, your warehouse capacity now is pretty much tappedout is this what you are saying? So, what would your other options be ifsecuritizations really are not in the cards in the near term?
Keith Browning:

Well, the answer -- I mean, thewarehouse facility maybe expandable but at a price. I mean, it's just like thatI believe the ABS markets they are at a price I think that the warehousefacility we could probably expand it more, if we wanted to pay a price andwe'll just have to weigh those alternatives.
Bill Armstrong:

And did you mention whole loanstrategies as a…
Keith Browning:

Whole loan is the same thing andI think that that's probably even more expensive than anything we couldcurrently anticipate from the ABS market.
Bill Armstrong:

Whole loan meaning you would keepthose loans on your balance sheet and just service them?
Keith Browning:

No. We would absolutely sell themand we would either service them or actually get the results from if thepurchaser wanted to service them.
Bill Armstrong:

Okay. So, who would you beselling them to, if you can't securitize them?
Keith Browning:

Banks.
Bill Armstrong:

Okay. Are you able to get higherinterest rates from consumers now to reflect the higher funding costs to theCAF?
Keith Browning:

Well that's what a little bitunusual, is that historically what we've told you is that when funding goesdown consumer expectations lag, so we get a higher spread and then when fundinggoes up the offset occurs, and we get squeezed. The consumer today is actuallyseeing costs going down, so they are seeing the [debt] decreasing rates, andyet, our real costs actually have moderated up, because of the spread issue. And so, there is a little bit ofsqueeze there and I think what will happen is, if it stays, you will see thatthe market moves upward and we will move with the market as we can, but therecould be a little bit of a squeeze given the fact that we have an unusualdynamic here with consumer seeing rates going down, and yet, our actual fundingcosts are going in the opposite direction.
Bill Armstrong:

Presumably, all your competitorsare seeing funding costs rising too so.
Keith Browning:

Well that's correct, that's why Iam thinking that we'll all being moving as we can afford to move.
Bill Armstrong:

Right, okay. And did I hear yousay earlier that CAF income would be less than $20 million for Q4?
Keith Browning:

No, I was basically agreeing tohis logic. I wasn't agreeing to the numbers because that's not a number that Iwould endorse. His logic was that when we take the higher stretch in thequarter and then the 5 to 6 million on top of that and I said that's correct. Iwasn't endorsing the actual earnings number that he quoted.
Bill Armstrong:

Okay, thanks for theclarification. And finally, your implied Q4 earnings of $0.14 to $0.20obviously a wide range tightened your same-store sales outlook, so I assume thatthe variability really is just, I just want to clarify, just focused on CAFreally rather than the retail or wholesale side?
Keith Browning:

Exactly.
Bill Armstrong:

Okay.
Keith Browning:

There is always a little bit ofvariability. There is always some variability in sales and gross margin, butwhen you look at the range, the majority of the range that we put out there isfor the volatility in the markets.
Bill Armstrong:

Understood, okay. Thanks.
Tom Folliard:

Thank you.
Operator:

Your next question comes from HardyBowen with Arnhold Bleichroeder.
Hardy Bowen:

Tom, I guess we are going into Phoenix, which is a majormarket. Are we going to advertise at a high rate like we did in Los Angeles starting up in Phoenix?
Keith Browning:

The difference with Phoenix compared to Los Angelesis if we can get -- we could go into a Phoenixwith two stores and spend at a full level. So, Phoenixis nowhere near the size of LA, so when we have two stores in LA, we couldn'tspend at our full advertising level, just didn't make economic sense for us in Phoenix. We think Phoenix is somewhere between a two- andfive-store market, so at two stores it works economically for us to advertiseat our full level of advertising. That same amount of point to TV that wealways run, same amount of points to radio, same on internet advertising andthings of that nature.
Hardy Bowen:

What kind of locations do we havein Phoenix? Arewe next to auto-malls or what are we doing there?
Tom Folliard:

I think we have very goodlocations. You know what our criteria, our real estate criteria have been,which is we want to have highway visibility, we want to be near other cardealers, we want to be near high growth retail. And I am not sure which ofthose sites we already have under construction. I know, one is right in anauto-mall, and right off the highway, and the other one is pretty much in anauto-mall also. We have an additional site that we are working on in Scottsdale, which would be part of the Phoenix market for us and it's also meetsthat similar criteria.
Hardy Bowen:

Okay. I was talking to one ownerof automobile dealers, substantial amount of them. He said we haven’t had agood quarter in the last 18 months, are you worried about environment?
Tom Folliard:

You were here last year, if yougo back 18 months, for us it's been pretty good. And again, I actually feelreally good about where our sales are for this year. I just -- I feel like weare 2% used unit comps, and we have built, we have opened up all of our storeson time. Again if you take out all theunusual funding costs, we would have grown our earnings for this year. And Ijust don't see a lot of other people performing like that. I feel like theevidence that CarMax outperforms the competition is as strong now as it hasever been, if not stronger.
Hardy Bowen:

I guess as far as building thebrand, it still doesn't seem to be a brand very fast in very many places interms of the whole United States. I guess maybe we have 2% marketshare or something like that?
Tom Folliard:

Well, yes, if you look at ourgrowth strategy, which we are committed to, we are -- of the 15 to 20% storeswe are opening in a year, about half are going into existing markets and halfare going into new markets. So the pace at which we go into new markets is notthe 15 to 20% because we are filling in existing stores, growing market share,growing our brand, and becoming more defensible against competition in each ofthose markets. So, and that's the pace that wethink we should continue to grow at and we are committed to it. So, you areright. We are not going to be national as fast as some people might think whenyou look at our growth rate, but it’s part of the strategy.
Hardy Bowen:

Okay, Sounds good.
Tom Folliard:

Thank you, Hardy.
Operator:

Your next question comes from MattNemer with Thomas Weisel.
Matt Nemer:

Goodmorning, everyone.
Tom Folliard:

Hi, Matt.
Matt Nemer:

My firstquestion is, if you look at the third-party web traffic data, it suggests that carmax.comtraffic was up 40% plus in October, 25 in November. Is there something wrong withthat data, or can you explain why the conversion from web to retail might be aslow as it is?
Tom Folliard:

You know what, we have never beenable -- that data has never matched up with what our data shows, so – and so aswe think our traffic is up, we don't think it's up that much.
Matt Nemer:

Okay. Andthen secondly, just a follow-up on the inventory test, is that -- are thevehicles that you are adding, are they the same -- is it the same mix? Is ityou are just going deeper with existing models or change in years? Can you givea little more detail on that?
Tom Folliard:

Yeah, I kind of talked about it alittle bit earlier, Matt, it's very store specific, and it's not like we gointo a store -- I am just trying to pick a random example, I don't even know ifwe are running the test here, but if we were in the Clearwater Florida, we arenot going to go stack up with a bunch of high dollar Mercedes and things likethat. We are more likely to just toramp up. And again, it's only 50 to 100 cars in a lot -- in any particular lot,it's going to be matched up with what that store is already selling, but itwill be different in every store. If we are in Dallasor Irvine, California, you would see a higher-end mixbecause they have a higher-end sales mix.
Matt Nemer:

Right, Iam just trying to figure out, is that because you are running out of key modelsor you are actually expanding the breadth of the assortment?
Tom Folliard:

I think, it’s the breadth ofassortment. But when you get into breadth, sometimes you end up into somedifferent configurations of cars that actually add quite a bit to your variety.
Matt Nemer:

Got it. And then turning to thewholesale business, beyond the general aggregated Manheim Index, what’shappening in the wholesale lanes both on the buy side for you in sort of theone- to three-year old segment, and then on the sell side for older, highermileage vehicles. I mean obviously, we see the numbers, but can you give us anupdate on kind of what you are seeing in those lanes?
Tom Folliard:

Most of our older, higher mileagevehicles we buy through the appraisal lane. We don’t buy a ton as a percentageof older higher mileage stuff out at offsite auctions. Again, most of thatcomes from the appraisal lane. In terms of the stuff that we buy at auction,honestly this is just not very -- it’s not a very unusual environment. I thinkthe last two years were more unusual than this year. And remember too when we are outbuying in the wholesale environment, we are bidding against all of ourcompetition. So everybody is buying in the same environment, and a lot ofpeople say you buy an investment, you buy a mutual fund, you buy it all thetime throughout the year. You buy when it’s up, you buy when it’s down, that'skind of how we are in the marketplace with wholesale. We are pretty much always outthere buying. It's just -- it depends on what time of year it is and what levelwe are buying at. And I just think this a fairly -- I don't want to say normal,because I’m not sure what normal is anymore, but it has been a prettyconsistent year for us in terms of what we expect to do in the fall. We alwaystalk about depreciation coming out of the summer into the fall, and we areseeing that at the auction right now.
Matt Nemer:

Are you surprised at howresilient the wholesale activity has been on the sell-side for you? I wouldhave thought that some of the smaller dealers would be pulling back oninventory given some of the pressures they are facing?
Tom Folliard:

Well, one thing to remember, andit doesn't necessarily show up in just our gross profit number is, we arealways adjusting the offers to consumers on a weekly basis, because we areselling 98% of everything every time we run an auction. So we get real feedbackon real values back to our buyers every day, and that helps us figure out whatoffers to put on it. We run a very good auction. That 98, 99% sell rate, I thinkeven in a difficult environment is going to draw more buyers to our sale thansomewhere else. People don't want to go to an auction and spend all day lookingat cars, bid and be the top bidder and buy the car 20% of the time. We arerunning at 98% sell rate 12 months out of the year. So I think customers show upat our auction, and I think even in a down environment we might actuallybenefit a little bit from attendance. Our attendance has been very strong inour auctions through this quarter.
Matt Nemer:

Okay.
Tom Folliard:

So I think it's a combination ofhow we run the auction, the fact that we run such a high sell rate, and becausewe are able to adjust our offers to the consumer so quickly.
Matt Nemer:

Okay. And turning to CAF, havethere been any changes in the fee structure such as late payment fees relatedto delinquencies?
Tom Folliard:

No.
Matt Nemer:

Okay. And then, lastly…
Keith Browning:

[You gave shorter answer thanme].
Matt Nemer:

On the -- your comment in thepress release about investment spending, is there -- can you give us a sense ofhow large those three buckets are relative to each other strategic, operationaland Internet investment?
Tom Folliard:

Yeah. I probably couldn't giveyou that detail off the top of my head. It's just in general for us, when wetalk about strategic spending, it's kind of all strategic. The Internet isstrategic, our growth plan is part of our long-term strategy. And I can justtell you that we are constantly evaluating the spend levels in each of thosebuckets. And coming out of a year likethis, we'll go through the next three months and we'll take a really good longhard look and try to do the best job we can at forecasting next year, andfigure out what we have to spend. And then we'll go through our normalprioritization process and figure out where we need to allocate those dollars.
Matt Nemer:

So if the environment worsens, itsounds like you are willing to take some of those back a little bit?
Tom Folliard:

Oh, absolutely.
Matt Nemer:

Okay. So…
Tom Folliard:

I feel like the environment we'rein right now doesn't give us – we're nervous about it. We're going to pay veryclose attention to it. We don't feel right now like we need to stop our growthstrategy, which is, I think one of the big keys to everything else is thatgrowth strategy and how it contributes to our ability to invest long-term.
Matt Nemer:

Okay, great. Thank you.
Operator:

Your next question comes fromBrian Nagel with UBS.
Brian Nagel:

Hi. Good morning.
Tom Folliard:

Hi, Brian.
Brian Nagel:

Couple of questions. First off, Iguess for Keith and with respect to your full year guidance, the new guidanceyou guys put out there. And this is a follow-up from some previous questions thatwe [cruise out] credit market deterioration Q2 to Q3. So, the guidance we haveout there into the balance of the year, does that assume a credit market that'sconsistent with what we saw in Q3 or is that further deterioration?
Keith Browning:

That's consistent with what wesaw at the end of this quarter because it deteriorated during the thirdquarter. And so, it's kind of where we saw the most recent deals done.
Brian Nagel:

Okay. It's helpful. And then thesecond question, I guess, this is more for Tom, if I am doing the calculationcorrectly, it looks like the new store productivity -- and I know this could bekind of a suspect calculation, but it may have continued to weaken here in thethird quarter. So, I guess the two-part question. One is, how have your new storesperformed lately? And then the second part of the question would be, given thatthe challenges that you guys are seeing, I realized this is just a credit now,but is this all call you -- make you call on the questions may be youraggressive growth plans near-term?
Tom Folliard:

Well, as I’ve said right now, no.We feel like we are going to continue to grow at the pace that we've said.Again, that's something we'll continue to evaluate, but right now we're kind ofmoving along with the same growth strategy. In terms of the performance of ournew stores, we've always said that our -- I mean, we've continue to say thatour new stores in aggregate are performing at roughly at our sales estimate. But we also said at the end ofthe second quarter that they were immune to the environment that we are in, andour comp stores are down because of the environment and our new stores are downbecause of the environment, but the ratio of the two is about – is prettysimilar.
Brian Nagel:

Okay. Thank you.
Tom Folliard:

We think we have lesserperformance in the new stores, but it’s no difference than -- no different thanwhat we are seeing in our comp stores. And it doesn’t give us any reason tobelieve that there is some flaw in that strategy.
Brian Nagel:

Okay. Thanks a lot.
Tom Folliard:

Thank you.
Operator:

Your next question comes from Rich Kwas with Wachovia Capital Markets.
Rich Kwas:

Hi. Goodmorning everyone. First question, just back to the conversion rate issue. Tom,could you -- I know, you’ve talked about capital availability still beingprincipal in that the cost of funding to the consumer is not measurablydifferent than it has been. What do you chalked up the lower conversion rateto? Is it stock market? Is it media coverage? Is there anything that you canpoint to that you can cite it as being a meaningful factor?
Tom Folliard:

No. Idon’t know what the actual stat is on consumer confidence. But I just attributeit to consumer confidence. I don’t think you can point to any one thing. It isjust a different feeling out of people today and out of our customers todaythan there was a year ago. And I think it’s a combination of all the factorswe’ve talked about. This credit environment we are in is very challenging. And Ithink even to the consumer who actually isn’t even impacted by it, they areaware of it. There is a feeling there. There is a -- gas prices and oil pricescontinue to spike. Just heating your house is getting more expensive now. So Ijust think it’s the overall environment Rich.
Rich Kwas:

Okay.Thanks.
Tom Folliard:

Not anyone thing.
Rich Kwas:

Okay. Andthen, Keith, what was the recovery rate for the quarter?
Keith Browning:

I don’thappen to have it, but it wasn’t materially changed.
Rich Kwas:

Okay. And as you look at the wholesale market in 2008, I knowyou mentioned that -- really here in the last quarter it’s seasonally slowquarter for wholesale valuations and you usually see a decline, but it seemslike it has been a little more of a greater magnitude relative to recenthistory. So what are your thoughts here over the next quarter or so onwhere the wholesale market goes?
Keith Browning:

Yeah, I mean, as Tom indicated,it was really more in line with what we had seen not last year or the yearbefore, but a kind of [fight] our history. So, while recovery rates may beimpacted slightly, we don't think it will make a material difference on whatour expected ultimate loss rates are on our portfolios.
Tom Folliard:

And our recovery rates are over along period of time, and there is normal seasonality in that, that's built intothe projected recovery rates.
Rich Kwas:

Sure. Okay. All right. Thank you.
Tom Folliard:

Thank you.
Operator:

Your next question comes from IldikoHildreth with Waterstone Capital.
Ildiko Hildreth:

Can you give us some idea withyour type of portfolio, what the historical loss rates of that type of consumeris in car lending? And I'm thinking back to early '90s when you weren't inbusiness, but I'm sure you have done some research?
Tom Folliard:

Every portfolio is different, soit's really hard to say, there are another like portfolio to us plus we'vealways talked about our deals being different and cleaner. So it's verydifficult to benchmark against somebody else, I would look more at our ownperformance than I would look externally.
Ildiko Hildreth:

Is there -- if you have anyindustry information?
Tom Folliard:

We've never had a loss, we'venever had a loss rate above 3%, and in fact often we've run a loss rate below2% even though our expectation for that would be a little higher than that.
Ildiko Hildreth:

I'm sorry, in what period is thatfor you guys, or I missed that? You were saying 3%?
Tom Folliard:

I'm saying the loss rate of our-- I don't know how many total securitizations we've done, I think, we aremanaging 9 or 10 right now. And the range of loss rate as you can see it in ourreported numbers, the high end of the loss range is 2.8%, that's just one deal,the -- not the most recent but the third one back I think.
Keith Browning:

Yeah.
Tom Folliard:

So it's running out there.
Ildiko Hildreth:

And you've been doing these, howlong have you been underwriting this stuff, since what year?
Keith Browning:

Since it started.
Tom Folliard:

15 years.
Keith Browning:

Right.
Ildiko Hildreth:

I'm sorry, when?
Tom Folliard:

15 years, since we opened ourfirst store.
Ildiko Hildreth:

Okay. And is all that loss ratebased on Master Trust data that has been out since then?
Keith Browning:

I am sorry, I didn't hear it?
Tom Folliard:

Can you say that again? We didn'tget your question.
Ildiko Hildreth:

Is that loss data going way backthat far too to the early '90s, you are implying 15 years?
Keith Browning:

Well, we have loss data for allof those. Our first public securitization didn’t occur until 1999 because wejust didn't have a large enough base of portfolio where we could actually go tothe public markets. So, if you start with 1999 that actually aggregated theoriginations that were still on our books from '93, or actually in ourwarehouse facility from '93 until that point. So that was kind of mix mash andthat loss rate was about 1.5, 1.6 if I remember correctly. And then it went upto 2% to 2.5% thereafter, which is really what we've been targeting.
Ildiko Hildreth:

And then, correct me if I amwrong. Haven't the rates, the general terms of car loans been extending, whichwould imply a different loan-to-value mix as these things age?
Keith Browning:

Yeah, absolutely. One of thethings that we've done over time is that we've actually run -- we talked a lotabout testing different parameters and CarMax Auto Finance was actually theonly one of our lenders until a year ago that didn't offer 72 months across theboard. So, our non-prime lenders were actually giving 72 months terms orseveral years then. And we underwrote that test and got comfortable with theloss results and we are writing with everybody else now.
Ildiko Hildreth:

Thank you.
Tom Folliard:

Okay.
Operator:

Your next question comes fromScott Johnson with [Forest Capital].
Scott Johnson:

Hey. Good morning. A questionwith regards to the financing arm, as you guys have mentioned, this is acompetitive advantage for your business. But what competitive advantage do youguys have with lenders. I mean (inaudible) like I am trying to understand, itmake sense to do this when you could originate loans, flip them into an ABSstructure and pull out four points. But that game going forward has changeddramatically. So, what competitive advantage do you guys have?
Keith Browning:

We have a significant competitiveadvantage and that we only underwrite CarMax. And so, what we don’t have in ourportfolio of loans and how we evaluate our scorecard is any of the challengesthat other lenders have with third parties. So, because we know the actualvalue of the car, we actually know the actually equity of a consumer, becausewe don’t have any negotiation on whether -- on the trade end. We actually know the quality ofthe data. No one in our store gets paid a commission for financing. Just havingbeen -- we are going to focus still on the consumers' credit history and makedecision solely on that. And in other lending environments, the other -- ourthird-party lenders don't have the ability to have their scorecard to reallygive the right attributes to predictability of losses given the variousexperience of its customers coming in. And what that means is, weliterally have roles in our scorecard that the industry would say you need tohave something here and we don't have it, because it hasn't proved to bepredicable. As a result we end up buying things that they turned out.
Tom Folliard:

The other part is just by beingavailable to our consumers and having all the other partners available, itcreates a very competitive environment for the customer and they have access toall kinds of different options for lending. And I think the person who benefitsthe most is the consumer. We can help keep our lenders on us by moving ourrates along with the market and then it makes our lenders as well becompetitive also. So, I think the ultimate beneficiary is the consumer. We havejust time for one more question.
Scott Johnson:

(inaudible) an adverse selectionproblem with regard -- I mean --
Tom Folliard:

No. I think we demonstrate thatwe don't have an adverse selection problem based on our history of lossexperience. I mean that I think that we clearly understand and test before weactually underwrite different levels of consumers on a large scale before weroll it out.
Scott Johnson:

I mean we've been in 10-year poolmarket for the consumer, so I don't know that, I mean if you have data goingback to the late 90s, early 80s maybe I would say that, but going forward Iwould think that this is going to be huge drag on your business. You’ve getinventory levels, and sales associates and infrastructure you built on yourability to move loans -- move vehicles by being able to provide financing foryou customers.
Keith Browning:

I'll just go back to Tom'searlier comment. We haven't had a material adjustment in our retained interestor loss rates for five quarters. I think the evidence is that we have a goodscorecard and a good history and a good basis for our originations.
Tom Folliard:

And lastly, 80% of the customer-- more than 80% of customers who buy car from us get financing from somelender, and being able to get an automobile loan, I mean what you're reallytalking about is the customers can't get a loan anymore on a car, and we justdon't think that's going to happen. And whatever the environment thatwe're in, we think this gives us an advantage over not having it. So, even in abad environment, it's better to have it than not have it. And you're right, theenvironment could move up, it could move down, but we feel like regardless ofthat it's better to have CarMax Auto Finance for all the reasons we talkedabout.
Katharine Kenny:

Operator, we have time for justone more question.
Operator:

Okay, ma'am. Your last questioncomes from Seth Basham with Credit Suisse.
Seth Basham:

Hi. Just a quick follow up. Couldyou tell me what the warehouse facility balance was at the end of the quarter?
Keith Browning:

Roughly 900 million, or 850 --900 million, I don't know the exact number, but 850 to 900.
Seth Basham:

Okay. And the 300 millionincrease to that facility, would you care to share the cost of that increase?
Tom Folliard:

No.
Seth Basham:

Okay. And then lastly, taking thelast question in a different light maybe Tom or Keith you could give us asense. If the profitability on a car sold and financed your CAF is around $900 toa third-party lenders around $300, now what where the cost or the profit there,I should say, on a car sold and financed through the whole loan market?
Keith Browning:

We don't know that yet, becausewe haven't done a whole loan transaction, but that's clearly one of the thingswe are trying to ascertain as to whether that's a viable alternative to the ABSmarket.
Tom Folliard:

But it would definitely be lessthan 900?
Seth Basham:

And hopefully more than three.
Tom Folliard:

That's right, it'll be a littlemore than three.
Keith Browning:

Yeah. It's clearly, more thanthree.
Seth Basham:

Okay. All right, thank yougentlemen.
Tom Folliard:

All right, listen everybody thankyou very much for your support thanks for calling in. If you have anyadditional questions you can Katharine or Celeste directly. Thanks for youcontinued support and we will talk to you at the end of next quarter.
Operator:

Thank you for participating intoday's conference. You may now disconnect.

CarMax, Inc. Q3 2007 Earnings Call Transcript

Other CarMax, Inc. earnings call transcripts:

CarMax, Inc.
Q3 2007 Earnings Call Transcript