車美仕 (KMX) 2013 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the CarMax second quarter earnings 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 will now turn the call over to Katharine Kenny.

Please go ahead.

Thank you, and good morning.

Thank you for joining our fiscal 2013 second quarter earnings conference call.

On the call today with me as usual are Tom Folliard, our President and Chief Executive Officer; and Tom Reedy, our Executive 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 29, 2012, filed with the SEC.

Before I turn the call over to Tom, let me also remind you that we are holding two of our regular analyst days in our home office here in Richmond, on October 2 and October 30.

If you're interested in attending please let us know.

Tom?

Thank you, Katharine, and good morning, everyone.

Well, we were pleased to report used unit comps for the second quarter of 5% compared to last year and total growth in used units of 8%.

Traffic was somewhat lower than last year but conversion increased due to the continuation of better credit offers and strong execution by our store sales teams.

Total used vehicle gross profit grew with total sales by 8%.

Used vehicle gross profit per unit of $2,172 remained virtually unchanged compared to last year's second quarter.

Appraisal traffic was up again this quarter but wholesale unit sales decreased by 2% due to a drop in the buy rate compared to last year.

Remember, the buy rate for this quarter was approximately 28%, and as we've discussed before, the buy rate is correlated to changes in overall wholesale pricing, which affect the offers we can make to consumers and we recently have seen some moderating wholesale vehicle valuations.

Total wholesale gross profit fell as a result of lower unit sales, and a slightly lower per-unit gross profit of $907.

As far as cash, cash quarterly income grew by 19% -- Tom will talk more about that in a second -- to $76 million, largely as a result of a 14% increase in total managed receivables.

I'll talk a bit about supply and mix of sales.

We do believe the decrease in the supply of used vehicles since 2008 has adversely impacted our sales over the last couple of years.

Assuming current [star] trends continue, we expect to see an improving supply situation, particularly in zero to four-year-old cars where we have historically had higher share.

We believe that as supply rebounds, it will positively impact our business over the next year or two.

For mix, during the quarter, sales of five-year and older vehicles as a percentage of our total sales remained well above 25%.

Year-over-year sales of SUVs and trucks fell by about 2 percentage points this quarter, and was offset by a similar increase in the percentage of compact and mid-sized vehicles sold.

I'll now turn the call over to Tom Reedy to talk about financing.

Tom?

Thanks, Tom.

Good morning, everybody.

Just on the press release, CarMax Auto Finance continues to deliver strong results.

CAF income grew $12 million or 19% compared to the second quarter of fiscal 2012.

This modestly outpaced the growth in our portfolio of [average] managed receivables, which increased 14% to more than $5.2 billion.

Our interest margin after the provision for loan losses was up 16%, due to that receivables growth plus accommodation of the transition back to our pre-recession origination strategy, continued low funding costs, and favorable loss performance.

We also realized a year-over-year reduction in expenses arising from operating efficiencies.

The growth in managed receivables was largely driven by strong origination volumes over the course of fiscal 2012 and into early fiscal 2013, which were lifted by the expansion in CAF penetration over that period, increased average selling prices, and CarMax sales growth.

For the quarter, net penetration was 37%, down modestly compared to the second quarter of FY '12, and net loans originated in the quarter increased 7% year-over-year.

The allowance for loan losses grew by $13 million, or 37%, to $49.5 million.

This increase reflects the shift in our portfolio back to a pre-recession origination strategy, as well as the growth in average managed receivables.

Despite the change in credit risk, the allowance only increased 0.1% to 0.9% of average managed receivables, so our receivable loss performance remains very strong.

Regarding access to financing for our customers, it remains at historically high levels with more than 85% of applications continuing to receive at least one approval from us or one of our partners.

Third-party subprime providers accounted for about 14% of sales in the second quarter.

This is a continuation of the trend we have seen throughout the year.

During the quarter, we also renewed the $800 million warehouse facility that expired in August.

As you know, we maintain $1.6 billion of capacity and the other $800 million facility expires in February of 2013.

We continue to see a strong ABS market for bonds backed by auto receivables and we feel good about the availability of funding in the current environment.

Now I'll turn it back to Tom.

Thank you.

I'll comment on SG&A and growth and then we'll open it up for questions.

We continued to ramp our infrastructure for growth during the second quarter.

Given our store openings, our level of used unit comps, and the speed of our ramp-up, the level of SG&A spending we've reported in the first half of this year is about where we expected to be.

We remain pleased with the performance of our new stores.

During the second quarter, we opened three new superstores and we plan to open five more during the second half of fiscal '13, including three in our third quarter; one in Des Moines, Iowa, which is a new market for us, one in Oxnard, California, which is our 10th store in the Los Angeles market, and the first of two stores we will open this year in our new Denver market.

Our Des Moines and Denver stores will be the next two of what we refer to as our next-generation model, the first of which we opened in February in Chattanooga.

You will also note that in today's press release we included three planned openings in existing markets for the second quarter of our next fiscal year, in Houston, Sacramento, and Frederick, Maryland.

With that, I'd like to open it up for questions.

Operator?

(Operator Instructions) Your first question from the line of Scot Ciccarelli with RBC Capital Markets.

Hello, Scot.

Couple quick items, hopefully.

As the age mix has gotten a little bit older, Tom, are there certain vehicles that you're now retailing that maybe you would have wholesaled in the past?

It's a little bit of a tricky question because the answer is, yes, but not because we've changed our quality standards.

So we are retailing an older mix.

We've been talking about that for, I think, the last three quarters or so.

Our mix of five- to 10-year-old cars has gone up pretty significantly, but we have not lowered our quality standards at all.

However, there are some cars that we would have wholesaled maybe because they needed a little bit more time or a little extra reconditioning to get them up to our standard that we are now -- that we have shifted over the last year to retailing, and we've done quite well with that segment.

So it is pulling a little bit away from wholesale volumes.

Got it.

Any way to size that impact?

No.

Not really.

I probably could, but I don't have the numbers right here.

Got it.

Okay.

And then also, just in terms of the SG&A growth, I think you guys have done a good job prepping everybody for the rising SG&A as you support the new store infrastructure.

Can you give us an idea of how much of the SG&A growth might have been tied directly to the new store build and the pipeline that you're building for future openings?

First, let me talk about the -- SG&A sequentially from first to second quarter was pretty flat.

And when you look at it year-over-year there is a bigger increase in the second quarter compared to last year than there was in the first, but that was probably more due to kind of an unusually low SG&A for a couple of items last year's second quarter.

So sequentially it was pretty flat.

If you think about SG&A on a cost per store basis, it's roughly $1 million to $1.5 million, or maybe a little more per new store opened.

So that's part of that ramp-up.

When you see us getting ready to open more stores in this year than we did last and more in last year than we did the year before, that ramp-up includes approximately about $1 million to $1.5 million per store.

Okay.

Got it.

Thanks a lot, guys.

Thanks, Scot.

Your next question is from the line of John Murphy with Bank of America.

Good morning, John.

Just one quick follow-up on this SG&A, Tom, as you look at the 10 stores their opening this year and we look at the next year, would you expect their SG&A coverage, or SG&A to gross to be sort of more normal?

Will they be fully ramped on an SG&A basis versus your gross profits next year?

No.

We've always talked about our ramp life of a store to be around five years.

So it's not exactly linear, but it certainly does not get to, let's say, the chain average after one year.

So there's no question that a new store for us in terms of SG&A efficiency on a per units sold is significantly disadvantaged to the average of the chain.

So as we roll more and more of these new stores into it, we do get the SG&A negative impact of new stores, but obviously we believe it's the right decision long term and these stores make a terrific return over time, but they have a I'd say a bit of a slow ramp-up.

We've always said it takes about a year before they get to break-even covering their opening costs.

But in terms of, if you really look at SG&A on a per-unit basis, it takes longer than that.

Okay, that's very helpful.

Then a second question about the used vehicle market, just more in general on what you're seeing, if you look at a new vehicle to a used vehicle pricing and assume that you get 0% financing on a new vehicle and you're paying 8% to 9% to finance a used vehicle, the equation seems like it's getting to a point where you may see some traditional used-car buyers that would come into your stores tripping into buying a new vehicle.

I'm just curious if you're seeing that and how much pressure you think that's putting on volumes for you in general?

Yes.

We see it.

But we've always seen it.

So we always see it -- there's always some segment of car where that's true, particularly if manufacturers at any given point in time are running really aggressive financing programs.

But if you look broadly at the average, the average new car is now over $30,000 and has been for most of the year.

A number I'm a bit surprised by, to be honest with you, and the spread between the average new car sold and the average used car sold really hasn't diminished hardly at all because new cars continue to rise, as well.

But there's no question that there are some models, particularly with the financing piece, where if we have a very late model whatever that car is, and you compare it to a new and you get 0.9% financing, some customers are making the decision to buy a new car, but that's always been true for us.

All the way back to when we started the business in 1993, it's always been true, on some segment of cars depending on what's going on with the manufacturers, how aggressive they are being with incentives, how aggressive they are being with financing, and then again, on a specific set of make and models.

But broadly across the board, the environment really hasn't shifted very much.

Okay.

And then just lastly for the other Tom, on CAF, you talked to going back to pre-recession origination strategies here.

And I'm assuming you're just meaning buying deeper into subprime, which I think you guys have been talking about.

But then you talked about third-party subprime providers increasing their penetration from 7% last year to 14% of originations this year.

So it sounds like third-party subprime providers are actually really what's growing in the subprime portion of your business.

I'm just trying to understand is CAF getting crowded out there in the subprime?

Or what's going on?

John, I wouldn't characterize CAF as doing any subprime.

We historically approved a spectrum of credit that we've got comfortable with -- throughout our history.

During the recession, we dialed back on the lower end of that credit, and over the course of the last two years have taken that back.

So it's really CAF just getting back to the credit that it had historically originated.

The subprime partners over the last year and half or so have started taking up a bigger portion of sales, partly because we've seen lower credit coming through the door and I think if you look industrywide, we've seen some data from the credit bureaus that would indicate the percentage of auto sales getting financed today, a higher portion is subprime, and a lower portion is super-prime than a year ago or so.

But the biggest part of it is that those partners of ours increased their appetite for approving CarMax customers and more importantly, making them attractive offers.

So the offers that our subprime partners are making today are more attractive to the customers than they were a year, year and half ago, and we're getting more of the subprime customers getting taking them up on those offers.

Yes, and, John, the change in the subprime for us, the 7% to 14% year-over-year, it is kind of in line with what we've seen over the last several quarters.

And as Tom mentioned, the vast majority of that is not because we're seeing a dramatically different credit profile coming through the door, but because our subprime lenders over time have gotten more and more comfortable with the CarMax origination channel.

And as Tom said, they're giving both -- they are approving some more customers, but they are also giving better quality approvals, for example, lower down payment to existing customers that were already coming in.

So if we look at the increase from 7% to 14%, that accounts for the large majority of same-store sales growth, is really this increase in subprime loans going through?

It does in this quarter.

And as we've always said, our goal at CarMax is to make sure that every customer that comes in the door has a good chance to buy a car because we provide them access to financing and we're happy to be able to help these customers.

We're happy that we have providers that have worked with us over the years and continue to get more comfortable, as I said, with the origination channel.

So although these deals are not as profitable as a regular deal, we're happy to do every one of them because we also believe that they are 100% incremental.

Remember that a subprime customer at CarMax that gets approved through one of our partners, those partners don't even see the application until it declined by all of the other lenders.

So at that moment, that customer, in our opinion, is about to leave the store, and they get this approval and their able to drive away with a high-quality car.

And that's part of the reason why -- a big reason why our partners have gotten more comfortable, and they've told us this, is because of the quality of car that we provide and that just means that a customer is more likely to have their car operate longer and they're more likely to pay longer.

And then just lastly to follow up, and I promise it's the last one, that really does mean that this backlog of trade-ins and ensuring that you'll see from new vehicle SAAR picking up is still to come.

It's still on the come, and actually hasn't really benefited you just yet?

And I think that has absolutely nothing to do with the subprime.

That's just a straight math of the availability of zero to 4-year-old used cars.

The SAAR went from an average of 16.8 over eight years down to as low as, in one month, it was in the nines.

So as it continues to grow, it's not an exact science.

You can't just look out and sat the supply is going to pick up by this much and, therefore, our sales will benefit because customers' behaviors change.

We're not sure about turn-in rates going forward, but we're absolutely convinced that as the SAAR continues to grow and the supply of one-, two-, three- and four-year-old used cars grows that we will absolutely benefit.

It's a segment that we've always over-performed with.

When you look at our total share that we've reported over time of somewhere between 5.5% and 6%, if you broke that out by model years, we've historically done better in the zero to four segment.

That segment is not there in the volume that it used to be.

But it certainly is coming back.

That's very helpful.

Thank you.

All right, John.

Thank you.

Your next question is from the line of Ravi Shanker with Morgan Stanley.

Hello, Ravi.

What levers do you have that you can pull on the wholesale business to improve results here and get that increase in the buy rates?

Do you have to adjust something with how much you're paying for these cars, or how many cars you are getting on the wholesale side?

We've always talked about wholesale being a balance between wholesale and retail.

And there's no question we could increase our buy rate and we could increase our volume, but our margin would go down.

If we raised all of our offers by $500, I'm 100% sure we would buy a whole bunch more cars, but our margin would go down across the board by $500.

So it's always a balancing act for us.

28% for the quarter is -- I think it's over the top of 30% last year, although it's only 2 percentage points, I think it's around 6.5% change.

28% is still pretty high.

We're pretty happy with 28%.

We were down at 23% in the recession, so we still feel pretty pleased about it.

We've talked about wholesale over the last few quarters being abnormally high.

We've had massive increases in wholesale.

Our wholesale business has doubled over two years.

Believe it or not, we're pretty happy that our wholesale business is maintaining these really high volumes that we've achieved over the last couple of years.

So being down a couple of points and being able to maintain our margin and have a really, what we consider a very strong buy rate, we're still -- we still feel pretty good about our wholesale business.

Understood.

And are you seeing any impact at all from rental car companies aggressively [de-fleeting] over the summer in response to lower insurance business?

Is that starting to make an impact in the market?

No.

We haven't seen that at all.

Okay.

And finally, now that you have this very aggressive ramp of opening new stores, are there any levers that you can pull on the SG&A side to get these stores ramped up faster?

Are there, just doing things in bulk on the administrative side?

Or something that maybe reduces that five-year ramp rate to maybe three or four years?

We're always trying to figure out how to run our stores more efficiently, how to convert more customers that come through the door, how to lower our costs, how to lower our staffing, those are the things that can shorten up the ramp rate.

If sales pick up quicker, if we have a better environment, if the supply side of the business really drives extra comp sales, that would help with the ramp, but in general, even with that, we would still expect the store to grow out past its fifth year.

And every year that a store grows, it continues to get better and better on an SG&A perspective, so there's not one button we could push that could take it from five down to two or three.

And it's really not five.

It's a lot longer than that because we've seen our stores grow past their fifth year, and even at 2% or 3% comp rate in the later years is a terrific leverage point on SG&A.

Got it but --

And the last part is, we're opening 10 stores this year and 10 to 15 next year, so we'll still see some ramp, but for the next three years we've said 10 to 15 stores.

So if we have a reasonably similar amount of openings year-over-year, you won't get that chunk of SG&A deleverage that we have by increasing the growth rate like we have over the last three years.

Got it.

So just to clarify, you expect a store to get up to like a normal corporate level in run rate by year five, but it may still grow above that?

Is that the right way to think about it?

Well, historically, we've grown into the fifth year, and then we've seen growth path past that.

And we just don't have that many stores that are more than 10 years old, and then we had the recession knock down, so it's really difficult to judge, but our expectation is our stores can continue to grow, although slower, they grow pretty quick from zero to five, slower from five to 10, and even a little slower past 10.

But our belief is that our stores will continue to have some modest growth past their 10th year of life.

Understood.

Thanks very much.

Thank you.

Your next question is from the line of Sharon Zackfia with William Blair.

Hi, Sharon.

Hi, how are you?

Curious as to -- the improvement in sales trends is pretty nice this quarter.

I guess you mentioned conversion.

Is there -- what do you think has really changed in the business this summer?

And then if you could comment on new stores, how they're doing so far?

I know it's early, but I think it would be helpful to know if they're kind of adhering to the old plan that I think was -- the 10 year ago white paper, or if there's kind of a new paradigm?

Well, on the first question, I think our quarter, our second quarter last year was negative 2% or negative 3%.

So we have seen an increase in conversion.

There's no question that some of it is from the higher quality offers of our subprime lenders, but I think our stores are doing a really nice job with the customer flow and we continue to get benefits from training and development of our sales managers and our sales consultants and we're very pleased with the results there.

So all of our comp sales were from those two things.

So we're pretty pleased with it for the quarter, as I said.

In terms of the store and comparing it to the white paper, that's a difficult comparison because our profits on a per car basis have changed so much since the white paper and we have not updated it.

So even if our stores were underperforming to model of sales, if they are performing at our current margin levels and you factor in the money we're making in CAF and wholesale, which wasn't in the original white paper, then from a financial standpoint, we could still deliver the returns that we expected at a lower sales level, which is one of the great things we've done, I believe, over the last couple of years of improving the CarMax business model, is we can go to a lot of these markets with really high expectations, even if our sales expectations are lower.

So when we said that we're really pleased with our new store performance, we're going all the way back to when we restarted growth, when we opened the five stores, and then -- I'm sorry, the three stores and then the five and then the 10 this year.

When you put that group of stores together, as a group, they're performing at or better than the rest of the chain.

Okay.

And as you look at the longer term, as CarMax.com becomes more important as the leader in the business, are the stores -- do you expect them to continue to get modestly smaller over time?

Or what it does the store look like five years from now?

We've done -- I think we've actually done a pretty good job of taking square footage out of our stores and being able to squeeze more out of them.

But they're going to be sized based on the market that they're going into.

Our next-generation store in Chattanooga was a little bigger.

We put some more screens, some more technology, we had a little different customer experience in there.

We had some customer segmentation in there.

The square footage piece is not that expensive.

And if it pays off, we would gladly do that going forward.

But I'd say that it is an ever evolving model for us.

And we're just going to try to figure out what's the most efficient way to get most the most sales out of each box, each square footage, and each piece of acreage, which is actually the bigger chunk.

I think another thing we've been able to do over time is, we'll go to a market and be able to build a CarMax on five acres when before we might have needed 15, if I'm going back 12 or 14 years ago.

And so our ability to get -- it's equally as important for us to be able to get the A site, the best site in the best retail row.

And we feel very good about the progress we've made there.

Okay.

Great.

Thank you.

Thank you.

Your next question is from the line of Simeon Gutman with Credit Suisse.

Hello?

Hi, can you hear me?

Yes.

Sorry, it's Dan filling in for Simeon.

I guess the first question, just wanted to get your big picture thoughts on supply of late models.

Obviously, mathematically, it looks like the population of nearly new maybe turning into one- to two-year-old group, but if you look at the whole one- to six-year-old population, it doesn't seem like it's still there yet.

So, I guess, separate from the math, which you already referenced, how does it feel in the marketplace?

Is it any easier or about the same?

Just want to get your thinking there?

Because the math actually matters and it takes time for it to flow into the system, you said it right.

We have not seen a big movement in the supply just yet.

But, obviously, with the SAAR being in the 14.5 range now, if it stays and continues to grow, which we hope it does, then we'll see benefit in the next couple of years.

A year or two years and especially three years out.

But we just have to wait for that supply to come back.

But if you're saying what does it feel like right now, if you look at what we've done over the last year, is respond to what consumers have wanted, which is older cars.

And as I mentioned in the opening, our mix of 5- to 10-year-old cars is north of 25%.

Up close to 30%.

And that number doubled from a year prior to that.

So that's where more of the supply is, and that's where our customers have shown us that they want to buy more cars.

Our hope is that as the supply comes back, we've gotten better at that older segment, we've gotten better at reconditioning it, and our comp our customers are more comfortable buying that car from us.

As I said earlier, we have not lowered our quality at all.

And we're hopeful that as the supply comes back we'll be able to take advantage of the increased supply, again, in a segment that we've historically outperformed in.

And at the same time, continue to maintain some of the momentum we've built in some of the older stuff.

Right.

And then, hopefully, just, I guess, as a quick follow-up, just also want to get your thoughts on traffic.

I think it was down last quarter, obviously, new SAAR has been, like you said, pretty good which is generally good for you.

So we're just hoping to see what's going on to change that, maybe?

I mentioned traffic was slightly down.

The used car market is down.

We buy Polk data, we look at Polk data constantly.

We only have it through June, but through June zero to six-year-old car market was down 8%.

Zero to 10-year-old market was down by 1%.

So there's that piece.

Secondly, I think the economy is still pretty sluggish.

With unemployment where it is and with consumer confidence where it is I still think that that's impacting our traffic.

It impacting the customer's willingness to go out and sign up for -- as long as a six-year loan.

So I still think we have that -- the economy hanging over our customer traffic.

Right.

Thanks so much.

Thank you.

Your next question is from the line of Craig Kennison with Robert W. Baird.

Thank you for taking my questions.

Tom, you just mentioned the Polk data.

Do you have that data for 7- to 10-year-old cars, as well, just to clarify the impact on the older vehicles?

Well, I just said zero to six was down 8%.

This is through June, so this actually, it is missing two months of our quarter.

And zero to 10 was down 1%.

So as I said, there's more supply still in that 5 to 10, 6 to 10, whatever.

But the market and kind of our wheelhouse where our sweet spot is, is still down pretty big.

That's fair.

And then discussion on the supply has been helpful, but could you talk about the Manheim Index and used car prices in general?

And how a decline in that metric will affect both your retail business and your wholesale business?

I'm not sure that everyone gets that.

Well, the decline -- as wholesale -- the Manheim Index is an indication of depreciation over the course of the year.

And it's nothing new for us to have to deal with the depreciating car environment.

It's actually -- we did it for a long, long time before we had the unusual circumstance after the recession where we dealt with an appreciating environment for a couple of years.

But the impact is, since the market is going down and we make market offers to our customers, it's going to impact generally our appraisal buy rate.

I think that one of the reasons we saw our buy rate go down a couple points this quarter, particularly compared to last year, is we've seen some moderating of wholesale pricing through the summer, some depreciation.

So that's the biggest impact it has on our wholesale business.

On our retail business, a customer who's trying to sell us their car, if they sell us their car and they're trying to buy another car, then they're more likely to buy a car from us.

So you can make the correlation that if our buy rate's down a little bit, then there are a few less customers in there who would have bought a car from us because we didn't give them the offer that they expected.

But, again, 28% is a pretty high buy rate for us.

Yes.

You bet.

And then lastly, with Hurricane Isaac, did you lose any selling days in any stores due to the weather?

We did, but like we've always said, it doesn't really matter over -- by the end of the quarter, and it was mostly in kind of South Florida and along -- we only have one store in Louisiana, Baton Rouge.

Great.

Thank you.

Your next question is from the line of Matt Nemer with Wells Fargo Securities.

Good morning, everyone.

It's Josh on for Matt.

How is everyone?

Good, how are you?

Not bad, thanks.

Can you give us an idea of what's going on with your Web traffic and how that's trending?

I know last quarter it was up kind of in the lower mid-teens.

And maybe compare that to what's going on with decreased foot traffic and any sense of why that's not converting over?

Traffic was up again, I don't have the exact number, on the website.

But it's never connected.

Our Web traffic over the last few years has always grown at a much higher rate than our comp sales, and that's just the way consumers are behaving.

The other big shift in consumer behavior, which, obviously, we're not the only ones seeing this, is mobile devices and iPads and touch screens, and that traffic is now, I think, 30% of our total volume.

Just a year ago it was 10% to 15%, so we saw it go from 5% up to 10% and up to 30%.

So I think some of the change in our traffic, obviously, is the ease at which people can now go search things on a mobile device.

But, again, we're real happy with the website, we're really happy with our -- with where we are with mobile, but we've got a long way to go.

We don't have an app out yet.

We'll be doing that soon.

And we expect that mobile devices and iPads and things of that nature will continue to become a bigger and bigger chunk of our traffic.

All right.

Thanks.

That's helpful.

Continuing with online capabilities, can you give us an update of what's going on with the EasyShop, where that's been expanded, how that program is working out for you?

Sure.

We currently have EasyShop available in eight of our stores in North Carolina and Tennessee.

And there are -- as we said, the main goal is to give consumers more ability to do more of their -- to complete more of their shopping experience from home.

Whether it's filling out a credit app, initiating a transfer, paying for that transfer with a credit card, making an appointment, filling out a portion of their paperwork, all of that stuff is working great as far as the customers being able to complete those components of the transaction.

I expect we'll be rolling out parts or all of EasyShop to all of our stores over the next, say, 12 to 24 months.

But it's still a little bit early and it's still something that we have to get a read on for each of those different components and make sure that we roll it out effectively.

Sure.

Are you seeing increased penetration in people using EasyShop in those markets?

It's probably about flat over the last six months or so.

Fair.

All right.

Thank you very much.

All right, thank you.

Hey, I do need to correct, I said that the one- to six-year-old used car market was down 8 points.

It was down 2, so I misspoke there.

I apologize.

And zero to 10 was down 1. Both were down, but I misspoke on the magnitude of zero to six.

Your next question is from the line of James Albertine with Stifel Nicolaus.

Thanks for taking my question, and good morning, everybody.

Can you hear me okay?

Yes.

Perfect.

Wanted to ask you, on the competitive landscape, and I'm not asking for market share, I know you don't provide it on a quarterly basis, but really wanted to get a sense for how you're thinking about the gap that, for the better part of the last two decades, you've created relative to the majority of your peers.

We've had a market dislocation now, the late model supplies have been disrupted, obviously, for the last -- better part of the last three years, and in that time, technology across the board has been improving, and the industry in some sense has become more commoditized than ever had been before.

So as you're ramping growth within existing and new markets, what gives you comfort that you are maintaining, if not expanding, that gap you had, whether it's proprietary tools, technology, go-to-market strategies, versus your peers across the board?

Thanks.

Well, first and foremost would be our volumes.

Our average store sells about 330 cars a month.

The average new car dealer sells about 50 used cars a month.

That number -- that gap really has not moved at all over the last 10 years.

So if I just look at our volumes compared to whoever the competitor is in whatever market we're in, that gap really has not moved.

We operate 23 of the 25 top volume used car stores in the United States and 43 of the top 50.

And we're the number one volume used car seller in every market that we operate in.

So I feel like from just the numbers, it looks like customers are still choosing us over the competition.

That being said, there's no question that the availability of information to consumers has moved dramatically over the last, let's say, five years.

The availability of third-party tools for our competition to have access to has changed dramatically over the last five years, providing customers access to financing, providing dealers access to inventory management models and things of that nature.

The reason I think that our competitive edge remains as strong as ever is it's not like we haven't been evolving and improving over that same time period.

I feel like we're much better today running this business than we were five years ago.

We're more efficient, our data that we've talked about that we continue to build on year-over-year is cumulative and we continue to benefit from that.

Our ability to leverage our inventory is unparalleled.

We have 40,000 to 50,000 cars online at any given point in time.

We've gotten better and better at transferring and moving those cars for our customers.

We have a website that is dedicated to managing all 113 stores in the chain.

And from a store perspective, or a customer perspective, any car is available to them.

Our ability to build new stores and to move employees in without having to retrain them because our systems are all designed from scratch, we don't buy any of it off the shelf, it continues to, I believe, become a bigger and bigger competitive advantage over time.

And we have initiatives in place to improve in all of those areas.

So although there are tools available and we've seen some movement, and as you said, there's been a shift with the supply, I really believe that as we get these new stores open and as the supply comes back, we are poised to really take advantage of the advancements that we've made and our bigger positioning around the US with more stores.

That's a great answer.

And just as a quick follow-up to the subprime questions earlier, the increase in the third-party financing to 14% from 7%, just wanted to get your sense of where you see that targeted mix in a more normalized environment, be it this time next year if supply resurges or somewhere else down the road?

Thanks so much.

Sure.

First, it's kind of flattish to last quarter, so this is not really out of line with what we would have expected in terms of the percentage.

We don't have a targeted percentage.

As I said earlier, every one of these deals is a deal that we want to do.

What I'd really like to see happen -- we're not uncomfortable with the volume of deals that were doing.

What I'd really like to see happen over time, as I mentioned with the supply coming back and with all the things I just talked about, that as our volumes come back, we're able to make it up on the other side.

To me, if it's 14% and it goes down to 5% because the rest of our business grows dramatically, that would be fine.

But if they both grew, that would be fine with me, too.

So we don't have a targeted percent for that segment of our business.

We're very pleased to be able to make a competitive offer to that customer.

Very good.

Thanks, again, and good luck.

Your next question is from the line of Matthew Fassler with Goldman Sachs.

I want to start out with two questions, sort of mired in the details a bit, on the other revenue line.

The first relates to warranty penetration.

Your warranty dollar number is up over $7 million, I guess, pretty close to $0.03 a share year-on-year.

It was the biggest increase you've had in quite awhile.

Any insight as to the drivers of better penetration?

Was it pricing?

Was it penetration of vehicles sold?

Any other color would be great.

Yes, hey, Matt.

There's a number of things going on in ESP, but I think the disconnect your seeing is the math doesn't pencil out with an increase in attach rate on ESP, plus the growth rate in sales equal the same amount of growth in ESP.

Our contracts with our ESP partners are based on performance, and we simply received a fee back from one of them this quarter.

It's something that is not unusual, but doesn't happen every quarter.

Because of how the performance of claims has been over the last year, one of our partners gave us a rebate essentially.

Roughly how --

(Multiple speakers) absolutely better penetration.

We're up with penetration a couple points.

So it's -- the ESP penetration, the increased sales volume and the rebate.

How material was the rebate?

It's $2 million of the $7 million.

Got it.

So we should look on an ongoing basis for a growth rate that more approximates the growth rate in the used car revenue presumably?

Correct.

Okay.

And then you've obviously gotten a couple of questions on subprime, I guess that line item continues to grow year-on-year, but you are, I guess, a quarter away from cycling the beginning of the pop in subprime penetration.

So would it be your expectation that once you start to cycle this increase that that line item levels out for you, and if you could just remind us of the economics of subprime for you on that third-party financing fee line item?

Matt, I think you're right.

We have no indication that our partners will have any different appetite then they currently are doing today, either positive or negative.

I think we're in a comfortable spot, so as we start rolling over that change in behavior, I think we should see it be more consistent.

And as far as the economics of subprime, as you know, we pay them a fee, or we sell those loans at a discount, it's about $1,000.

And just also by way of reminder, is there any difference in the intrinsic characteristics of the cars that get sold to subprime customers that would help compensate for that, or do they look like, more or less, cars that would be sold through a higher quality credit?

Overall, I don't think there's anything that differentiates them too much.

We see some small variances, but nothing worth talking about.

Got it.

And then finally, there have been a couple of questions about the tools available and the environment, and the increased impact of online on the business, broadly speaking.

I guess the one area I would want to bore down into a little bit is the theme of price transparency, and think about that both from the sell side, that is your customers' perception of value, and also the buy side in terms of the deals that you're getting when you're buying cars through the wholesale business.

As you look at your pricing versus the competition, and this is something, I guess, it would behoove is to try to measure on our own, are you seeing any material difference in the way you're coming to market from that perspective, assuming that your competition, which historically was not wired at all over the past few years probably has -- where if you were, over the past few years, probably has developed somewhat greater capacity, to at least be thoughtful of that?

That's a very difficult thing to figure out when everybody is negotiating everything except for us.

So despite the fact that there's more availability of data for consumers, at the end of the day when you end up at the average car dealer, they'll negotiate the price, they'll negotiate the financing, they'll negotiate the trade, they'll negotiate the warranty, none of which we do.

So it's still very difficult to make price comparisons to prices that aren't really the price.

Understood.

Thanks, guys.

Okay, thank you.

Your next question is from the line of Rod Lache with Deutsche Bank.

Just had a couple follow-up questions.

I was hoping you can maybe give us a sense of when do you think the supply of vehicles improved for you just sort of adjusted for the weighted average age of the vehicles that you sell?

I would think that the supply of one- and two-year-old vehicles will improve first, so that's one factor.

And then also related to that, you commented that you're spending a little bit more time reconditioning as you are selling more greater than five-year-old vehicles.

How does the reconditioning cost get affected as the mix kind of normalizes?

So on the first question, again, it's not something we would project.

I would just say over the next one to four years, we're going to see those volumes and the supply pick up, because the thing we don't know is how significantly has consumer behavior changed in terms of how quickly they trade out of their car?

I think a lot of that behavior is driven by how comfortable people feel about the economy going forward.

So it's just -- it's too big a variable to try to say on a linear basis, we expect the supply to come back in a predictable manner to, I think, the level that you're asking.

So I just feel really good about the supply coming back over the next few years, but is it one, is it two, is it three?

It's really hard to say.

Again, just feel really good about the fact that it is picking up and we do expect the supply to come back.

And your second question was?

The second question is you said that -- I think you said that you're spending more money reconditioning now, that 25% to 30% of your sales are more than five-year-olds.

Yes, so on a gross basis, an eight-year-old car is going to need more reconditioning dollars to bring it up to our quality standard than a two-year-old car.

That has always been true for us.

It will always be true for us.

So our volume of cars in five- to 10-year-old has gone up, and, therefore, our reconditioning dollars have gone up.

But when we look at our savings, we have to mix adjust those savings to understand if we're really getting them.

So when we think of it that way, we're still getting the savings that we talked about earlier.

It's just that from the starting point of where we measure those savings, we would, obviously, be starting from a lower point if it was a one- or two-year-old car with, say, 10,000 miles on it compared to an eight-year-old car with 90,000 miles on it.

So, again, we just have to mix adjust our reconditioning when we're thinking about savings, but when you look at total gross reconditioning dollars as our mix has shifted older, those dollars have gone up.

Right.

But that's going to normalize --

(multiple speakers) -- impact our ability to sell that car or our profits.

Right.

My question is more along the lines of looking forward over the next, let's say, two years or so, wouldn't the mix normalize a little bit more and wouldn't that be another opportunity in terms of bringing the overall reconditioning dollars down?

Not really, because, again, all the reconditioning needs to be mix adjusted on a year-by-year basis.

So although the gross dollar would come down, as you said, that's not really a driver of our ability to sell the car or -- it is overall, but I'll just tell you we expect to spend more dollars on an older car and we always will expect that.

Okay.

And then just lastly, obviously, there's some pace of growth that you need in order to avoid the SG&A deleveraging, and it depends on the pace of your store growth and wholesale trends and other things like that.

I was hoping you might be able to update us on where you think that is roughly today?

Well, in general, in the past, we have always said mid- to high-single-digit comps can start to get some leverage in a ramp-up growth mode.

We're still in a ramp-up growth mode.

We will be again next year, and, look, we've only given guidance out for growth for the next three years.

If we got to a stable growth number, where we built roughly the same number of stores, but the base of the existing stores increased, then you would see SG&A leverage come quicker.

But all we've talked about is the next three years for now.

So we'll see.

Okay.

Great.

Thank you.

Your next question is from the line of Clint Fendley with Davenport.

Good morning, guys.

Good morning.

Just wondering, generally given the seasonality in your business, generally we have seen the SG&A flex down in the third quarter.

I'm wondering, just should that change for the upcoming quarter, given the plans to open three new stores in new markets in the quarter?

We're not going to give any guidance out on SG&A, Clint.

Sorry.

Okay.

I guess, going back a little bit to the previous question around some of the SG&A per retail unit, I know you've said mid- to high-single digits could potentially keep that number flat.

How much would that change if you were to go, say, from 10 new stores per year possibly up to 15 or so?

Or should we expect a big change in that?

Well, we've only given guidance for the next three years and it's 10 to 15.

But it all would depend on how many stores are in the base and there's a lot of variables in there.

How many stores are in the base?

What are comp sales over the next several years?

How big an impact do we get from the supply stuff we've talked about?

Comps are a beautiful thing on SG&A.

So at 15% comps we could build as many stores as we wanted probably and still get leverage.

Okay.

Thank you.

Your next question is from the line of Bill Armstrong with CL King & Associates.

To what extent -- and I'm not sure if you can determine this -- but to what extent might subprime growth be driven by the fact that you do have an older mix of vehicles in your inventory and in your sales mix?

And that might be attracting, just naturally attracting a higher percentage of subprime customers?

I think that has very little to do with what has happened, because the spike we saw at the last quarter -- I'm sorry, the spike we saw in the third quarter of last year, we were just really moving the inventory at that time, and as we said, it's not that our customer flow -- it's true that our credit is down slightly.

If you just look at our, let's say, our beacon score through the door.

But it's not down enough to explain the change.

Most of the change is, as we've said, our providers getting more and more comfortable with the CarMax origination channel and making better quality offers to the customers that were already showing up at the store.

Okay.

Thanks for that clarification.

Okay.

Your next question is from the line of Efraim Levy with S&P.

What do you see in terms of mix for trucks and SUV share?

We mentioned in our mix of trucks and SUV were down about 2 points year-over-year.

And that was offset by an increase in compacts and subcompacts, up about 2 points.

And the impact on profitability on a shift like that, is that meaningful?

It's not.

There's no impact at all.

Okay.

Thank you very much.

Thank you.

Your next question is from the line of David Whiston with Morningstar.

Morning.

Just a long-term capital allocation question for you.

I think, clearly, the best use of cash is to keep growing the store base, but is there ever a profit environment and a macroeconomic environment where the Board would be comfortable enough to do a share buyback to at least offset option issuance while also growing the store base?

As we said before, we understand our position.

We're pleased with all the improvements that we've made to the business model over the last few years, and we are generating cash at a faster rate than we can spend it building stores.

And also as we've said before, all options are on the table.

So we continue to look at what we think the best use of capital is in the short term, taking into account when our long-term goals are, but we've always said we think the best use of capital is to continue to build stores.

But in terms of a share buyback or dividends or any other use of -- any other traditional use of capital, we continue to evaluate each of them.

And if we have something to report, we'll tell you.

Okay.

Thank you.

Thank you.

And seeing no further questions, I want to thank all of you for joining us, and thanks for your support and interest and, of course, thanks to all of our CarMax associates once again for your dedication and hard work and all that you do every day.

We'll talk to you again next quarter.

Thank you.

Thank you for joining today's conference call.

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