車美仕 (KMX) 2012 Q3 法說會逐字稿

Good morning.

My name is Ashley, and I will be your conference operator today.

At this time, I would like to welcome everyone to the third quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

(Operator Instructions).

Thank you.

I would now like to turn today's conference over to Katharine Kenny.

Ma'am, you may begin your conference.

Good morning.

Thanks, Ashley, and happy holidays to everyone.

Thank you for joining our fiscal 2012 third quarter earnings conference call.

On the call with me today are Tom Folliard, our President and Chief Executive Officer, and Tom Reedy, our Senior Vice President and CFO.

Before we begin, let me remind you that our statements today regarding the Company's future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements are based on management's current knowledge and assumptions about future events that involve risks and uncertainties that could cause actual results to differ materially from our expectations.

In providing projections and other forward-looking statements, the Company disclaims any intent or obligation to update them.

For additional information on important factors that could affect these expectations, please see the Company's annual report on Form 10-K for the fiscal year ended February 28, 2011 filed with the SEC.

Tom?

Thank you, Katharine.

Good morning, everyone, and thanks for joining us today.

We're pleased again to report solid financial results, despite soft used unit comps.

We believe our comps continue to be a reflection of weak economic conditions and low consumer confidence.

In addition, we had an extremely difficult comparison to 16% comps in last year's third quarter.

But as we said last quarter, we remain focused on our long-term growth, and we are excited to report this quarter on our store opening plans for the next four years.

First, let me highlight some of the key factors that contributed to our results, as compared to last year's third quarter.

Total gross profit for CarMax increased by 2%, driven by growth in our retail and wholesale gross profit.

Gross profit per used unit grew by 3% to $2,171.

Our Wholesale unit sales grew by 13%, and Wholesale gross profit per unit grew by $36.00 to $914.00.

Our appraisal buy rate was 29%, higher than historical levels, but slightly lower than last year's buy rate.

CAF quarterly income grew by 12% to $62.6 million.

During the quarter, our mix of vehicles changed somewhat.

Sales of older vehicles, five years plus, increased to approximately 30% of sales, compared with 16% a year ago, and 24% in the second quarter.

Meanwhile, sales of SUVs and trucks increased a few percentage points to 31%, up from 28%, while sales of smaller, more fuel efficient vehicles decreased to 32%, down from around 35%.

Our mix will clearly vary over time in reaction to market demand, again reflecting the strength of our model, and how quickly we can adjust our inventory mix to meet the needs of our customers.

Now I'll ask Tom to share some information about CAF and our other lenders.

Tom?

Thanks, Tom.

Good morning, everyone.

As Tom mentioned, CAF income this quarter increased $7 million or 12%, compared to the third quarter of fiscal 2011.

CAF portfolio grew 11%.

Net loans originated were up 34%, compared with the third quarter fiscal '11 due to continued higher CAF penetration, and the increase in average selling prices.

CAF's net penetration for the quarter was approximately 38%, which is similar to last quarter, and up from 29% last year.

As we discussed previously, we have elected to retain a greater portion of loans that CAF had historically approved, and our good business for CarMax, but in recent years had been purchased by third party partners.

The provision for loan losses grew by $6.5 million year over year, largely due to the fact that we originated and retained more loans with greater credit risk.

CAF's interest margin expanded to $89 million, 7.4% of average managed receivables, versus 6.9% in Q3 of fiscal '11.

As far as the components of interest margin, interest and fee income grew by $7.5 million, as the increase in managed receivables more than offset the decline in interest income as a percent of managed receivables.

And portfolio interest expense fell $7.4 million year over year, as older, higher cost securitizations pay down, and the deals with lower interest expense continue to become a greater portion of our financing.

Third party sub-prime penetration grew to 9% of sales, compared with 8% last year.

This increase in sub-prime loans, which our lenders buy from us at a discount, as well as CAF's decision to retain more loans were the primary drivers between our decrease in other sales and revenues.

During the quarter, access to financing for our customers continued to be as high as ever.

More than 85% of customers who applied for financing in our stores received an approval from at least one of our in-house lenders.

Tom?

Thank you.

Also during the quarter, we opened up our North Attleboro store which is our first store in Massachusetts, and first in the Providence, Rhode Island market.

We expect to open our Chattanooga, Tennessee store in the fourth quarter.

In addition to the six stores we previously announced that we'll open up in the first half of our next fiscal year, we also reported our planned openings for the third quarter.

These include three stores in new CarMax markets, one in Des Moines, Iowa and two in Denver, Colorado.

We plan to open 10 stores in fiscal 2013, and we are pleased to announce our future plans to open between 10 and 15 stores in each of the following three fiscal years.

With that, we'll open it up for questions.

Thank you.

(Operator Instructions).

Your first question comes from the line of John Murphy, Bank of America, Merrill Lynch.

Good morning.

Hi, John.

Quick question first on the pressure on the same-store sale units.

I'm just wondering, Tom, if you have any rule of thumb for when new car sales pick up, those trade-ins become available in the market, and they eventually flow into your stores in the form of sales?

Because it seems like the pressure that we've seen from the summer months, and the lack of trade-ins from those depressed sales levels in the summer, may actually be what's driving some of the weakness in your units now.

Just trying to understand how that flow works, and how you think about that going forward?

We don't necessarily have a rule of thumb.

And what we've always believed and still do, is that directionally, we'll move with SAAR.

And if SAAR continues to go up, we think that's good for our business.

We think it's good for sales The benefit you have seen from the increase in SAAR, is the amount of cars we're buying through our appraisal lane, which is part of the activity that goes along with new car sales.

And you've seen it in our Wholesale numbers, and you've seen it in our self-sufficiency number, which is the percent of cars that we sell at retail, that we bought through the appraisal lane.

So again, we're not concerned for -- a little bit of these short-term, I would call them disconnects with SAAR, because we still believe that over time, we're going to move along with SAAR.

Okay.

Got you.

Then second question, gross profit per unit at $2,171 is holding in pretty strong.

I was just wondering if you've been running any of those tests on price elasticity of demand, just to see if you could maybe drop that a little bit, and drive better volume?

And really what the break points are as you think about those levels, as you get down to 2,000, could you get that same store unit growth flat, or maybe up a little bit?

I'm just trying to understand what you have been seeing in the market lately, on price elasticity of demand, and the impact?

We still haven't seen much, John.

With a 107 stores now in 50 markets, it's easier for us to run tests on a pretty continuous basis.

We're pretty pleased with our ability to manage our margin consistently through all kinds of different volatility in the marketplace.

Our last 12 quarters have been between $2,000 and $2,200 roughly, a pretty tight band of managing margins despite all kinds of volatility in lots of different areas.

So we're pretty pleased with our ability to do that, and we'll always be running tests for pricing around elasticity, to see if we can drive incremental sales.

It's always -- if you asked me, if we ran at $2,000, would we have sold more cars?

Probably, but it's very difficult to ascertain.

And when we do run the test, it doesn't -- the elasticity is not there like it used to be.

Okay.

And then just lastly, if we looked at the 107 stores that your have right now, if we maxed out on your store openings, you'd have 162 stores by 2016.

I'm just curious, as you look at the ramp-up costs and the infrastructure in your systems, and your unit capital, your people, do you think that you have the infrastructure in place to really support that, and there wouldn't be big incremental sort of central costs that would come in?

It would just really be store costs to support those 162 stores?

It would probably be ratable growth, with all of the things that go along with that.

So we opened up three stores a year ago, five this year.

We've said eight to 10 next year, 10 to 15 the year after.

So when you ramp up like that, we don't have to do anything for three years out, other than really look for real estate and prepare for those kinds of things.

We don't have to start adding overhead.

We don't have to change our advertising model.

So I think some of the SG&A that would you expect to go with growth is going to come over time.

So put quite simply, there should be some operating leverage from the incremental stores over time?

Well, I think leverage, if we're going to ramp at the speed that we expect to ramp, leverage is going to depend on comps.

And with very low -- if we run low comps, which we of course hope to do better than that, then I wouldn't expect much leverage.

But at the same time, I still think it's the right decision long-term.

If we run bigger comps, then I think we can both, grow the business and get some leverage.

Okay.

Great.

Thank you very much.

Thank you.

Our next question comes from the line of Himanshu Patel with JPMorgan.

Hi, this is [Amy Caroline] for Himanshu.

Good morning.

Hi, Amy.

Good morning.

Hi.

Just following on some of John's points, and what you wrote in the press release.

Of the factors you listed, how would you rank those factors, in terms of their impact between the tough comps and the year over -- and I guess, market conditions right now?

Well, I don't know that we really could rank them.

We really just talked about the tough economy as a whole, and consumer confidence.

So I don't know that we could rank, to come up with why we ended up at negative 3.

And remember, we had a really tough comparison as well.

I guess, what are you seeing so far in December?

We won't comment on anything in this quarter.

Okay.

Thank you.

Thank you.

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

Good morning, everyone.

Hi, Matt.

So my first question is, could you just talk to the implications of a lower priced mix, or the mix to lower priced vehicles on your gross profit per unit?

Clearly, it didn't matter at all this quarter.

And I know in the past you've said, that doesn't necessarily mean lower dollars per unit.

But could you just kind of walk through that?

Yes, it obviously it didn't matter this quarter.

And in terms of our ability to get margin, if it's an older car, and it's in great shape, and we bring it up to our high quality standard which we do on all of our cars, and have not lowered our standards one bit, our ability to get margin on those cars, is just as strong as it is on any other segment of inventory.

So we're -- if the consumer wants to buy an older car, we're happy to sell it.

And in terms of it's impact on margin, it doesn't really have much.

Okay.

And then secondly, your provision for loan losses was up a good bit from last quarter, but obviously we didn't see any deterioration in the credit metrics.

So I'm assuming that this is a function of CAF's expansion into -- to essentially originate more of the loans that they were sending to third parties.

But could you just talk to that?

Yes, Matt.

As we mentioned in the call, we're retaining a greater portion of the loans, and greater retention of the portfolio overall.

Those loans that were taken back from the third parties are at the bottom end of the credit spectrum, of what we've become accustomed to approving and living with.

So as we ramp up, and are increasing the proportion of those loans in the portfolio, remember, it's going to take a couple years to kind of normalize, and get to the point where the proportion of those loans in the overall portfolio is equal to the proportion that we're originating today.

It wouldn't be unexpected for us to see that loss provision going up over time, as we normalize our -- that's assuming all else is equal -- the loss experience.

So the greatest part of the increase in the provision is due to expansion in volume and in credit quality, what we're doing.

Okay.

But it's not really a one-time true-up.

It is a number, there could be some upward pressure on the provision, as the mix changes over time?

Yes, Matt.

We look at the provision every quarter.

And we take a forward-looking view on our losses, based on what we're adding to the portfolio and what experience we're having with the loans that are already in the existing portfolio.

So yes, and as I mentioned, as we -- as this lower credit stuff begins to ramp up, and become a greater portion of the portfolio, I wouldn't be surprised to see loan losses going up until it normalizes.

Right.

But don't forget, Matt, that, that comes along with upward pressure on profits.

Yes.

Obviously, we -- (Multiple Speakers).

They offset --

Obviously, we intend to price for that and collect more interest income or interest and fees as a result, and make more money than we would by giving it to third parties.

Yes, makes sense.

And then lastly, on your store growth that announced this morning, could you just talk to the mix of production and non-production stores?

And then also, new and existing markets, not just this year, but really over the next few years?

Yes, it's -- we're going to build whatever we need, to do the production that's required for the stores that we build.

And I know that sounds a little simplistic, but it's not necessarily the mix of production and non-production stores.

If we went to a bigger market, and found we could build one giant production store, and have three satellites, that would be fine with us.

If we needed to build, because of real estate availability, if we had two production stores and two satellites, that would be fine with us too.

So we're going to build whatever is necessary, based on the markets we're going in, and make sure we have the right acreage and production to support our sales.

And the mix of markets will be, as we said before and still believe, right now, about 50% new markets, and about 50% filling out existing markets.

Great.

Thanks so much.

Happy holidays.

You too, Matt.

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

Hi, good morning.

Hi, Sharon.

Tom, a few questions.

So the gross profit per car growth on the used side was, I think it's the strongest we've seen in over a year.

And just I'm sure it's probably something as simplistic as inventory management, which sounds simple on my side, but is hard to do on your side.

But is there anything that really went into that gross profit growth in the quarter?

And then on sourcing of older cars, I know historically it's been a little bit of challenge to find enough cars that are --that meet your quality standards.

Is there something different you did from sourcing?

On the first question, the margin didn't move much from the second quarter.

So you're talking -- are you're talking about the growth from third quarter over third quarter?

Right.

I'd say it's more a reflection of where we came from.

So -- and within the $50 or $60, it's a bit of -- we can't target it that closely.

We're shooting for a range, and we come within the range.

If we're up a few bucks or down a few bucks, that's not anything to look into.

And on the second question, in terms of older stuff, we've always bought a lot of this stuff through the appraisal lane, and we've sold a good portion of it.

So even last year, it was 15% of our sales were over five years old, and the second quarter was 24% of our sales.

And the answer is some of those cars come from cars that would have gone to Wholesale, that we just decided that either there wasn't enough demand for them, but we were still buying them, and then making the decision to Wholesale them.

Or the -- we weren't sure about whether or not we could recondition then up to our standards.

So over the last couple of quarters, we've just moved more of those cars over, and taken chances, and seeing, can we get it through the shop, can we get it up to our standard?

And that's allowed us to source more cars through the appraisal lane.

And then we've gotten better and more effective at buying those cars off-site.

Just as a rule over the past several years we just don't buy a lot of those cars off-site.

And as our systems have continued to improve, and as our direction we give to our buyers has continued to improve, we've done a much better job of sourcing those cars off-site as well.

Okay.

But you haven't changed your quality standards?

We have not.

Okay.

And then just one last question, I guess.

As you're thinking about the store growth through 2016 or fiscal 2016, I know I think at one point you had a think tank on kind of the CarMax of the future.

So what should we look at in terms of refinements for the stores over the next several years?

Well, that's a little far out.

My guess is that whatever we're working on, it will be different by 2016.

And I think we've been able to be fairly nimble with making adjustments to our building, and what it looks like and the amount of acreage that's required to build our stores.

And I expect to be a much more efficient Company in 2016 than we are today.

In terms of giving you the specifics of how that would shake out, I don't really know.

We've talked about our next generation store which is going to be in Chattanooga in February.

But I expect that the stores after that, will also be adjusted accordingly, as we learn more and more from not only that store, but all the other adjustments we're making in our existing stores.

Okay.

Great.

Merry Christmas.

Same to you.

Thanks.

Our next question comes from the line of Craig Kennison with Robert W.

Baird.

Good morning.

Thanks for taking my questions.

I wanted to follow up on the new store format.

Does the number you contemplate include any of the smaller store formats that you had talked about, or would this be more along the lines of the traditional format?

We put a range out there, and it's fairly flexible, but we do contemplate some smaller stores in that mix -- and -- the exact number, we don't know yet.

But it would be included in that 10 to 15 range?

Yes.

Yes.

And then I know you don't like to comment on specific stores, but would you say the new stores themselves that you opened this year performed at least in line with your expectations?

Or have you learned anything that maybe allowed those stores to accelerate?

We haven't talked about the performance of our new stores yet, and they really haven't been open that long.

So we'll update on that when we get a little more time behind us.

But perhaps fair to assume that the traditional ramp that you saw, should be what we would expect in these new stores that you open up?

We haven't changed our assumptions on the ramp.

The starting point is something that is difficult to figure out, when we had such a big drop during the recession.

And as you saw, we're still not back to where we were before.

So the starting point's a little more difficult to figure out, in terms of store growth over time -- we haven't changed our assumptions there, but what has changed is our profitability per car sold.

In terms of making the same return we expected before, we can do it at a lower sales volume than we used to.

And then from a modeling perspective, it's helpful to know about when you expect to open these new stores?

And I know you can't predict that, but would you say that it's fairly easy to balance the opening of stores over the course of the year, such that each quarter would be about the same, or is there seasonality to it?

We have enough experience with our growth from before, that we try to balance it.

It's just easier on the organization to have it balanced.

It's easier for staffing.

It's easier for planning to balance it throughout the year.

So, yes, it's our goal to have it as balanced as possible.

Thanks, and last question.

How high would you be willing to let that sub-prime mix go?

I know you're basically happy to sell a sub-prime car because you offer a better deal than maybe some buy-here pay-here dealers, but how high do you think that metric could actually go?

I think you answered the question yourself.

On any given sale, we're happy to have that transaction, because the ones we know is that customer is not going to be a CarMax customer any other way.

They've not been approved by either CarMax Auto Finance, or one of our tier two lenders, so it's an incremental customer to us.

That number moves seasonally.

We usually see it go up during tax season.

But as far as what the -- we don't have a specific target or goal for that mix.

And it's something we can think about long term.

But as I said on any given day, you want to take every one you can get.

Great.

Thank you.

Thank you.

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

Hi.

Good morning.

Hi, Brian.

The first question I want to ask, and it's a topic we've discussed a lot over the last few quarters, but assuming that one of the bigger pressures upon your used car business has been the artificially high used car prices.

And to tag along to comments you made, Tom, in your prepared remarks, we have started to see the SAAR tick up now.

As you look at underneath your business, maybe some what I consider some of the leading indicators of your business, are you starting to see that used car pricing at auction ease a bit, maybe with some of the inventory you've taken in recently, or even through the third quarter, we may see some relief, at least on that pressure into the fourth quarter, into 2012?

Yes, we have seen, if you look at some of the external data, you've seen moderation in pricing.

But -- and even with our move towards older cars which are at a lower retail price, our average retail for the quarter was still off compared to last year's third quarter.

So I think the SAAR's got a long way to go before we start to see some real movement down on pricing, due to supply.

We're still in a supply-constrained environment.

If you look at the last I guess it's four or five years.

And you compare the SAAR, the actual SAAR to what the average SAAR was for several years prior to that, there's about 20 million cars missing from the supply chain.

And until we get some movement, and it's a few years worth, I'm not sure that we're going to see any dramatic change.

Okay.

Second question I wanted to ask, is on yourself -- I guess the percent self sufficiency we saw in the quarter, the improvement there, maybe some more color on what's driving that, and how should we think about that aspect of your business going forward?

So for the quarter, that number was up over 60%.

It might be an all-time high for the Company.

We hit 50% in the second quarter, and that was the first time we hit 50% since pre-recession time.

So some of it is, to be honest, we sold less cars than we thought we would sell.

We certainly didn't plan for a negative 3, nor did we plan for negative 2 in the second quarter.

So self sufficiency is helped a little bit by that.

And then the movement in the SAAR does help our appraisal volume.

As we have talked about over several quarters, we've had a disconnect in our appraisal volume increase, compared to the -- compared to our retail sales.

Remember, our Wholesale volume, which is just one piece of appraisal volume, was up 23% in the second quarter, 32% in the first quarter, despite sales being up in the first quarter 6, and down in the second quarter 2, an even in this quarter up 13, compared to a negative 3.

So some of it is just this -- this unique dynamic of higher appraisal volumes, than what we're getting through our -- higher appraisal volumes compared to what we're selling.

So how should we think about the gross margin implication of that higher self sufficiency rate?

How much more profitable is a car that you buy for a trade-in versus a --

Well, we've always said those cars are more profitable than what we buy offsite and they are.

But what we've -- what we're pretty good at is managing margins on the different segments to try to maximize and optimize our sales.

So you've seen our margin, as I mentioned earlier for the last 12 quarters in a pretty consistent band.

Our self sufficiency during that time has been as low as 30%, and as high as over 60%.

So I feel really good about our ability to manage margin.

If we have a segment that's more profitable, we might use those extra dollars to reduce prices on other cars to try and optimize and maximize our sales.

So margin for us, is not just what you see in the reported number across.

It's a pretty complex process of managing by segment, managing by source, managing by year, mileage, band, and trying to figure out what's the best way to sell the most cars possible.

So I wouldn't look at it and say, well, if self sufficiency goes way up or way down, we expect to see big swings in margin per car, because we have seen it go way up and way down.

And we've been able to deliver a margin in a pretty consistent range.

Got it.

And then just one final question.

I know you and I have spoke over the last -- really since the economic downturn.

But I've always kind of -- I think the tone from CarMax has been, that you were hesitant to really reaccelerate growth until you got some clarity in the macro environment, internal operations.

We've seen over the last few quarters, you've suddenly accelerate -- you accelerated you new growth plans.

And today you come out with an announcement that's very encouraging, kind of a longer term growth plan, which I think higher than most people were expecting.

As we're looking at this announcement, kind of reading between the lines, should we take that as some indication that you're -- it's incrementally favorable now from what you seeing your in business, as well as your outlook for the macro environment for the used car business?

I think you should take it as, if things don't get any worse, and we can continue to manage our business the way we have in terms of efficiencies and margins, then that's our growth plan.

If things got worse, we would cut back.

And if things got better, I feel like we put out a range that would cover that.

So I wouldn't look at it as optimism, or as anything other than right now those are our plans, and if things don't change for us we think we can deliver on those plans.

We're very excited about it.

But in terms of making any outlook on the economy going forward, we're not in a position to do that.

Thank you, and happy holidays to everyone.

Same to you.

Thanks.

Our next question comes from the line of Ryan Brinkman with Goldman Sachs.

Hi, good morning.

Good morning.

On market share, I know that CNW industry used car sales are to some extent, a guesstimate maybe at best.

But they reported in your August quarter, industry sales rose 2% year over year when you fell 2%, suggesting perhaps 4 percentage points of market under performance.

In November quarter, they were reporting sales were up 6%, versus you down 3, suggesting now a 9 point under performance.

Could you please talk about what factors you think might be contributing to this implied same-store share loss?

And the extent perhaps that you think these factors are cyclical rather than structural in nature?

We'll talk about market share at the end of the year, as we have said in the past.

And when we look at market share, we use internal data sources that we buy throughout the year in the markets that we operate in.

CNW has not been as reliable a source for us to determine whether or not the market's growing or shrinking.

So we don't really look at it.

But at the end of the year, we'll let you know how it looks from our internal data.

Okay, great.

I know that you've already addressed gross profit per car on the retail side in couple of ways.

But Tom, I seem to remember you saying on the call last year, that the seasonal trend in gross profit per car from August, November quarters tends be about minus $100.

You didn't really experience any sequential decline.

And so it does sort of suggest, there was something which provided upward pressure on gross profit per car during the quarter.

Did you maybe realize any gains on the reconditioning front?

Or maybe benefit from the significant highly higher in-house sourcing?

Was that enough to explain the out performance of seasonal trend there?

You remember last year, it did go down a little bit, but the two years prior it didn't go down at all.

We're not really sure what normal is anymore, because five years prior to that, it went down pretty much every second to third quarter.

Last year when it went down a little bit, we attribute it to a more normal depreciation schedule throughout the year.

And this year has been, I'd say, somewhat normal in terms of depreciation.

There's a lot of factors that go into it.

And a lot of the things you mentioned are part of it, including self sufficiency.

That helps margin a little bit, obviously.

So I wouldn't read into it too much.

It's not a big enough movement for anybody to get concerned about, at least not on our side.

Okay.

And then just last question, given that you must be paying I imagine fewer commission dollars on retail vehicles sold during the quarter on a year over year basis, can you speak to the primary drivers of the higher SG&A dollars year over year, is this primarily related to investments, say to drive the store growth that you talked about earlier?

Yes.

SG&A in the quarter is driven by a combination of things.

But as you said, although selling expenses would have been down a little bit, we did increase our commission for our sales consultants during the year which offset the decline in sales.

And in terms of the rest of SG&A, it's around building for growth and investing in our future.

Okay.

Thanks very much.

Happy holidays.

Thank you.

You too.

Our next question comes from the line of James Albertine with Stifel Nicolaus.

Great.

Thank you.

Good morning and thanks for taking my question.

I wanted to drill down a little bit more on the Wholesale business.

And was hoping you could shed some light on kind of the opportunity as you see it longer term to continue gaining share there?

And then relatedly, maybe drill down a little bit or a little more detail on the appraisal trends you saw during the quarter, whether in terms of aggregate number or conversion rates?

Any sort of detail there would be helpful.

Thanks.

Yes.

As we've said in the past, Wholesale has outpaced retail growth, and it moderated some in the quarter.

It's really difficult to figure out what our share is of that.

When you get into that older stuff, the market is gigantic, and we're a tiny, tiny player in it.

We are the third largest auction chain now in the US, but all of our auction volume comes in that -- the caliber of car that doesn't meet our retail standard.

And it's only cars that we source through the appraisal lane.

So it's not like we're out there trying to buy those cars, and then sell them in the auction.

We sell whatever we get through the appraisal lane that doesn't meet our standard.

I'm not sure how we could predict what that wholesale volume could look like going forward.

Okay.

Then I guess relatedly, could you drill down on the appraisal trends this quarter, relative to maybe last quarter or on a year over year basis, either an aggregate number or what you're seeing on the conversion rates in general?

So we talked about buy rate being 29%, and I think that was slightly off of last year, which was around 30%.

And appraisal volume was up some year over year, but not up as much as it has been in the second quarter and the first quarter of this year.

So it goes right along with that number.

If you look at our Wholesale volume of -- our Wholesale increases this year, 32%, 23% and 13%, appraisal volumes in terms of comparison to last year, moved pretty much like that.

Very helpful.

Thanks and happy holidays.

Same to you.

Our next question comes from the line of Scot Ciccarelli with RBC Capital.

Good morning.

How are you?

All right How are you, Scot?

Not too bad.

Tom, do you think you would have better sales, used unit sales, if you had more late model inventory available?

As long as the customers that wanted to buy them, came along with it.

No, well -- seriously, I guess my question is --

Well, I'm serious too.

Is this a supply -- do you think you have a supply-driven issue in terms of sales?

No, I think we have a demand-driven issue.

If customers came in and wanted to buy more of those cars, we would go buy more of those cars.

Despite the fact that there's less of those cars available, there's still a huge number of those cars out there.

We're a tiny, tiny percentage of late model used cars in the US.

We move our inventory along with demand.

It's not like we don't sell those cars.

We actually sell probably more of those cars than anybody else.

And if that segment of inventory was turning faster, we would go out and buy more of those cars.

And do you think --

I think some people get a little wrapped up when we talk about supply constraint, it absolutely is a supply constraint environment.

But there are tons of cars out there.

All right.

So you don't think you -- because you had mentioned $20 million void there or whatever the phrase was.

20 million cars.

Yes, 20 million cars that just aren't there.

So you don't think that necessarily impacts your business?

No, I think it does impact our business.

I think that's why our sales are dropped by 25% during the recession, and have yet to fully recover.

But I do think it's connected.

You can't really say it's just -- if there was more supply, I don't know if that's going to make a consumer decide to go out and spend $20,000 for a car, and sign a loan for 6 or 7 years.

I still think there's enough uncertainty in the economy, that we're just not seeing the demand that we saw pre-recession.

Okay.

If we would see higher volumes in our stores, we would see higher traffic on our website, and we would respond to that.

Okay.

And do you think pricing has played a role in that demand issue?

I think it's hard to figure out, but it would be hard for me to imagine that it hasn't, because pricing for similar cars today, compared to, for example the fall of '08, we're largely selling about the same stuff, but it has a $3,000 higher average retail than it did in the fall of '08.

And I've got to think that has some impact on people's decision making.

So that's just another impact on -- of the lack of supply.

But I thought you said earlier, you really haven't seen much elasticity, so I guess I'm trying to just reconcile the two.

We haven't seen much elasticity, because we don't see a lot of elasticity when we move our prices by a $200, when you are talking $19,000.

I got it.

So it's different than if -- (Multiple Speakers).

-- it's by the price point.

Yes, if we're talking about a $3,000 move in average retail.

And if we lower our prices by $200, I don't think -- we haven't seen that to make much of a difference.

Understood.

All right.

Thanks a lot, guys.

Okay.

Our next question comes from the line of Rick Nelson with Stephens.

Thank you, and good morning.

I'd like to ask about the collateral spreads, on the last two secured positions.

It looks to us like the spread came down a bit with the most recent deal.

We would have thought it would have gone the other direction with your decision to underwrite more lower quality credits.

Well, remember a couple things.

One is that -- actually, if you adjust for the fact that we hedged those deals, the spread between APR and our coupon on those bonds is very similar deal to deal.

And APRs, I think if you look at over the last four public deals have hung in there right about 9% or just a little bit under.

I don't think we'll be seeing a disconnect in this particular transaction, but it's obviously something you can keep an eye on going forward.

All right.

Got you.

And the decision to underwrite these lower quality products, how do you think that impacted profitability in the quarter?

Was it accretive, -- I realize that you amortize over the life of the loan versus the upfront fees.

Right.

If you look at the decision overall, what's going on throughout the year, we believe it is essentially neutral in the quarter, maybe moderately accretive.

But for the year, we think it will be a little bit accretive.

Nothing material.

But for the life of the loan, it's a no-brainer.

Yes, yes.

Understand.

Thanks a lot and good luck.

Thank you.

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

Thanks.

Good morning.

The -- a couple questions on the other gross profit piece.

Can you provide a little more detail or maybe parse out what happened, in terms of lower fees versus the service department?

And then how should we think about that segment going forward?

Is there some timing, if you're getting lower fees, is that going to be made up in another division, and is there a little timing gap that we should think about?

Thanks.

I think the way -- with regard to the shortfall in service, the way we account for service contemplates costs associated with reconditioning and fixed overhead in there, and we try to apply it on a per car basis.

So when we see a shortfall in units, you're going to see a deleveraging in the service department, and an impact on what we report as profit.

But, over time, meaning over several years, yes, we absolutely try to predict that correctly but we're not always going to be right.

In fact, we're rarely going to be right, off the bat.

But in the lower third party fees, that's because is the CAF penetration absorbing some of that?

Yes, absolutely.

From the perspective of lower finance fees, it's two-fold.

One is that CAF is taking more volume, and that reduces third party fees.

And also as you saw, there's a step-up in sub-prime penetration from our third-party providers.

And if you remember, we pay them a discount on every loan.

So the combination of those two things drove the decrease in third party finance.

But as to that fee being offset, even though it may not be more than offset in the quarter, it's way more than offset over the life of the deal.

Right.

And that's what I wanted to confirm.

That makes sense.

Okay.

And then second, on the store growth, for next year I think originally it was 8 to 10.

Now you're going do 10.

For the out years, what's going to be the difference in doing 10 versus 15 stores, I mean assuming the macro is cooperative.

Is it just real estate?

Or do you want to -- is 15 the plan, and it depends on real estate?

That 10 to 15 is a range that we're comfortable with, and we think it covers our ability to fluctuate, based on how well the economy is going.

That's largely going to be the driver, to move within that band.

Right now in terms of real estate availability, in terms of our ability to ramp up our staffing, and ramp up all the things necessary to deliver, we feel comfortable that we can deliver within that range.

Okay.

And then lastly, on the Wholesale business, and this was asked in a couple different ways.

The outlook for next year for units in that Wholesale world, at least in the auction lane, is not great.

You're taking tremendous share.

You're going to be cycling some excellent growth rates next year.

How do you think that plays out?

You said earlier SAAR goes up.

That should increase appraisal traffic some more.

Do you sort of comp those very difficult numbers from a year ago, and keep the gross profit rates high?

Yes, we don't -- we're not really giving guidance going forward.

And we're just going to do the best we can, with the volume that we get.

But as I said earlier, I don't think our share in average car 10 years old, average miles over 100,000, our share is actually very, very small in that segment of what's sold annually in the US.

And I don't know how it's measured, or how it could be measured, of whether or not we're taking share from other auctions, since we're not trying to get dealers to bring -- we don't get any dealers to bring any cars to our auction.

It's only what we buy through the appraisal lane.

So the movement -- I think, as I said earlier, if SAAR moves considerably, we would expect our appraisal volumes to move as well.

Okay.

Got it.

Thanks.

Thank you.

Our next question comes from the lane of Jordan Hymowitz with Philadelphia Financial.

Can you hear me, guys?

Yes.

Thanks for taking my question.

Two small things.

What is your average FICO or LTV this quarter versus, say two quarters ago, on what's originated, not in the overall portfolio?

Hold on, Jordan.

We'll get that for you.

(Multiple Speakers).

We're looking.

What's your other question?

When you -- you give more disclosure this quarter, or maybe I noticed this quarter on the breakout of the Auto Finance income.

And you always disclosed just the other direct costs related to the Auto Finance business.

Do you have a sense of magnitude of the indirect cost?

I mean, if I assume it's like $20 million a quarter, is that a good guess, or is it very difficult to break out?

Yes, it's very difficult to break out, and probably there is enough detail that you might want to call us after.

Because I'm not really sure we can give you all those answers right there.

Okay.

Yes, Jordan, this is Katharine.

Just give me a call later today, and we'll talk in more detail.

We can get you the FICO.

The FICO information, LTV is also in our web dock that we put out, the updated version on our website.

But we can talk that through if you give me a call.

And that's not new, Jordan.

That's been in there the whole time.

Right, I'm just wondering this quarter one, is the current quarter number out?

January.

It will come out in January.

It will come out in January.

Could you give, if not the exact number, just the magnitude?

I can give you, from the beginning, kind of Q2 last year to Q2 this year.

It's trended down slightly.

It was slightly over 100, 700 in fiscal '10.

And now, kind of upper middle 600s.

And the lowest this got, if I remember was 640, 650?

Is that about what's trending again?

It's been about 680, Jordan.

Say that again, I'm sorry.

Our average historically has been about 680.

Right.

If you if you look over time, 2005, 2006 time frame, we averaged 675, 680 for the entire portfolio.

In recent years, we've had a higher FICO because we've deliberately dialed back on the lower credit, and farmed that off to some of our partners.

And now we're moving back to a similar range that we've been in the past.

We're not quite back there yet but.

Okay.

So the loss reserves should probably reflect the same numbers that you had in the past as well then?

The loss reserve is going to reflect what's going on in the current environment, based on what we are putting in the portfolio, our expectation of loss for that, and what we originate and what we experience with the existing loans in the portfolio.

And we have to look at that every quarter on a forward-looking basis.

So I can't make any comment about what it will look like vis-a-vis two years ago, three years ago.

Are you financing any of your auction sales at this point as well to facilitate that?

No.

No.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Bill Armstrong with CL King & Associates.

Good morning.

Could you talk about the overall customer traffic and conversion rates during the quarter?

Yes.

So sales were down 3%.

Traffic was up slightly and conversion was down slightly on a gross basis.

But I think we talked a little bit about this last quarter.

We have had this unique dynamic of a much higher appraisal-only volume, and we really haven't separated that out and talked about it.

But if you were to take that out, then obviously the traffic number, the customers who are there to buy traffic number, would go down some, and conversion would have increased a little bit.

From the way we have historically talked about it, traffic was up slightly in the quarter, and conversion was down slightly.

Got it.

Is there any way to quantify the impact that the pricing may have on demand, in terms of just the narrowing of the price spread between new and used?

It's very difficult to quantify.

But and we have not -- I don't -- I know I haven't looked at this since the first quarter, but at the end of the first quarter, when we looked back to the low point of our average retail, which is when it was down around $16,000 in the fall of '08, and we looked at new car pricing at that time, our average retails had gone up $3,000.

And the average price of a new car had gone up $4,000 over that same time period.

That was just five or six months ago the last time we looked at that.

So, no, I couldn't give you an answer there.

But the spread is still pretty high, between the price of a like used car and the same new car.

Got it.

Particularly when the car is three years old, our average car is a little over three years old, a little over 35,000 miles.

Right.

Okay.

And then shifting gears, on new store growth going forward.

When we see you entering new markets, is it fair to assume that that first store is almost always going to be a production store?

No.

It depends on its proximity to another store.

For example, North Attleboro is a satellite store, and we're doing the production out of Hartford.

We obviously expect to have production stores in that area, but as of now we don't.

So it depends how isolated the store is.

If a store is very isolated, like you said, it almost needs to be a production store.

But just because it's a new market, doesn't mean it has to be a production store.

I see.

Okay.

Thanks.

Thank you.

Our next question comes from the line of Irina Hodakovsky with KeyBanc.

Hi.

Good morning.

You are actively moving back into a lower FICO sores in your portfolio.

Is that because you're more confident about the macro environment, or is it because you're selling older cars, and you kind of can't find third-party financing out there?

Just to give a little history on this again, we historically had approved a range of credit through CarMax Auto Finance.

And during the recession and during the financial crisis, when funding got very difficult in the ABS markets, we elected to dial back a little bit on the credit we were approving, and farm that off to some of our third-party lending partners.

That decision was not because we were uncomfortable with the credit risk associated with those loans.

It was purely based on our view, on ability to finance those loans efficiently.

So as we've seen the ABS market recover, as we've gotten more confident in our ability to fund, it makes perfect sense for us to get back into that business that we've done all along, and start taking that volume back from the partners.

So it's not really a byproduct of what's coming in the door, what we're selling, just rather a byproduct of what we're comfortable buying and our ability to fund it.

Okay.

Excellent.

Thank you very much.

Merry Christmas.

Same to you.

Thank you.

Okay.

With that, thank you very much for joining us.

I want to once again thank all of our associates for all they do every day and wish everybody a happy holidays.

We'll talk to you next quarter.

Thanks.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may now disconnect.