車美仕 (KMX) 2017 Q3 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the CarMax FY17 third-quarter earnings conference call.

(Operator Instructions)

Thank you.

I would now like to turn the call over to Katharine Kenny, Vice President, Investor Relations.

Thank you and good morning.

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

On the call with me today is Bill Nash, our President and Chief Executive Officer, who, by the way, is very proud, along with Cliff Woods and our many CarMax JMU alumni, of the Dukes, who are playing in the FCS national championship.

And, of course, with us is 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, 2016 filed with the SEC.

Please remember to ask only one question and a follow-up before getting back in the queue.

Thank you so much.

I'll turn the call over to Bill.

Good morning, everyone.

Katharine, I was not going to mention JMU since we're a little bit more team agnostic now that Folliard has left.

But since you did mention it, I'm excited about it and I wish them well.

For today's call I will first review the key highlights of the quarter, then I'll turn the call over to Tom Reedy to cover financing, and then I'll close the call before Q&A with a brief update on some of our new initiatives.

As you read in our press release this morning, our total used unit comps for the third quarter increased by 5.4% and total used units grew by 9.1%.

Total used unit comps were driven by a strong improvement in conversion as well as by a small increase in store traffic.

We believe the increase in used units was due to a variety of factors.

These include improved store execution, our website redesign and related online capabilities which have made it easier for our customers to submit leads.

We continue to be very pleased with our core business as we again saw a headwind from Tier 3 sales.

We estimate used unit comps for our non-Tier 3 customers were again significantly stronger this quarter at 9.8%.

Our total web traffic was flat compared with the prior-year quarter, while web leads performed well in the quarter.

We continue to see a positive response to the website with increased activity such as engagement with the search tool and car pages, as well as submitting leads.

Our goal is to drive leads and convert more customers from the website to the store and finally to a sale.

Our wholesale units declined by approximately 2% in the third quarter.

This was driven by a decrease in appraisal traffic, partially offset by the growth in our store base and a higher buy rate.

The decline in industry new vehicle sales during the recession is affecting the supply of older vehicles.

Remember, we saw this dynamic in our core retail business following the recession.

We continue to maintain a consistent gross profit per used unit at $2,155 compared with $2,160 in the third quarter of last year.

Gross profit per wholesale unit decreased to $900 compared to $949 in last year's third quarter.

Again, as we reported in the second quarter, last year's wholesale gross profit per unit was the highest recorded in any third quarter.

So, like last quarter, it was again a tough comparison.

A few other topics before I turn the call over to Tom.

As a percentage of our sales mix, zero- to four-year-old vehicles fell this quarter to 78% compared to 81% last year, once again as a result of higher customer demand for older and less expensive vehicles.

SG&A expenses for the third quarter increased 5.7% to $357 million.

This growth partially reflects the 12% or 18-store increase in our base since the beginning of the third quarter of last year.

While we reported leverage of approximately $74 per unit, remember that our advertising expense in last year's third quarter was significantly higher due to the production and rollout of our new brand launch.

Absent this increased spend in the prior year, leverage was modestly positive.

Other overhead costs were up year over year, reflecting our continued investment in strategic initiatives.

Now I'll turn the call over to Tom.

Thanks, Bill.

Good morning, everybody.

In recent quarters we've discussed a trend of year-over-year increases in credit applications from customers at the higher end of the credit spectrum, and less application volume at the lower end, and we saw this continue in the third quarter.

We recently purchased credit bureau data related to auto credit inquiries in the marketplace and our analysis of this data suggests that this trend is not unique to CarMax.

This application mix drove growth in CAF's net penetration, which increased to 45% compared with 43.3% in last year's third quarter.

Net loans originated in the quarter rose more than 9% year over year to $1.3 billion due to a combination of CarMax sales growth and the higher penetration, partially offset by our lower average selling prices.

In addition, as you'd expect, the higher credit mix applications drove growth in the portion of sales where customers paid cash or brought their own financing.

Tier 2 penetration fell year over year in the quarter to 15.7% from 16.9%.

But just as we said last quarter, our Tier 2 lenders continue to provide strong offers based on what we have observed in customer conversion.

Tier 3 sales mix was 10.2% of used unit sales compared to 13.8% for the same period last year.

This decrease in penetration continues to be due to the same factors -- credit tightening earlier in the year and lower application volumes.

Performance by our Tier 3 partners, however, has been consistent since the middle of Q1.

CAF income fell 3.2% to about $89 million compared to the third quarter of FY16; while average managed receivables grew by 11% to $10.3 billion.

The provision for loan losses increased and the portfolio interest margin decreased very modestly.

During the third quarter we continued to see higher loss experience.

Our ending allowance for loan losses at $115 million was 1.1% of ending managed receivables compared to 1.08% last quarter and 0.97% in last year's third quarter.

This level of losses is a departure from our experience in recent years.

However, losses in the last several years have been quite favorable.

The current level of loan loss reserve is consistent with our range of expectations given our origination strategy and portfolio mix.

For loans originated during the quarter, the weighted average contract rate charged to customers was flat year over year at 7.3%.

Total interest margin declined slightly to 5.8% of average matched receivables.

This compared to 6% in the third quarter of last year and 5.9% sequentially from Q2.

During the quarter we repurchased 3.8 million shares for $199 million.

As of the end of Q3 we had $1.7 billion remaining in our stock repurchase authorization.

Now I'll turn the call back over to Bill.

Thanks, Tom.

During the third quarter we opened six stores, including two in new markets, Boise and Grand Rapids.

We also opened four stores in existing markets, Philadelphia, Dayton and two in San Francisco.

Late in the current fourth quarter we expect to open four more stores, two in our Los Angeles market, and the one in Marietta will include a centralized production and auction facility to support our growth in Southern California.

In addition, we plan to open two small format stores in the fourth quarter, both in new markets, Mobile, Alabama and Albany, New York.

Next, I would like to give an update on our new online offerings and the test we are conducting to continue to advance the customer experience.

First, as we discussed last quarter, we have been testing a new online financing capability that has helped our customers get prequalified for a loan.

When we talked at the end of the second quarter, we were piloting this product in 13 stores.

Towards the end of Q3, we successfully rolled this new capability out to all stores nationwide and we are pleased with the early results, which includes increased leads.

Second, we continue to test our home delivery offering in Charlotte, North Carolina.

As a reminder, home delivery allows the customers to shop for and buy a car at their convenience without coming into the store.

We continue to learn about the customer demand and operational scalability, while also ensuring it meets our standards for an exceptional experience.

The last update is recording a one-store test we will be conducting in the fourth quarter.

We plan to test a new digital solution for customers who are interested in getting an appraisal value for their vehicle by submitting their vehicle information online without having to come into the store.

These initiatives position CarMax to deliver more of the car buying experience online, and we remain committed to giving the customers the ability to go between the digital and in-store experience whenever and however they would like.

While we're constantly working to innovate and improve the business, we're also very focused on being cost-conscious and eliminating waste across the entire organization.

We continue to look for new opportunities to ensure we are growing in a way that is in the best interest of our customers, associates and shareholders.

Like last quarter I remain confident that we will continue to lead the industry.

We have 23 years of experience to build upon to help us excel into the future.

With our great associates, our national footprint, our unparalleled inventory, brand strength, and continued focus on improving the customer experience both online and in-store, no one is in a better position than CarMax to fully deliver the best car buying experience.

With that, I will open up the call for your questions.

So, Victoria?

(Operator Instructions)

Sharon Zackfia, William Blair.

Hi, good morning.

A question on the search engine optimization you have been working on, I think, earnestly this year.

I'm a little surprised that web traffic is flattish, given that.

So, if you could give us an update on where you stand on search engine optimization and how much of a driver that might really be going forward.

Sure.

Thanks Sharon.

SEO is a big focus for us.

The things that we've done so far this year to really focus on that, first of all, the website, which we've talked about in the past.

In addition to the website, here recently we have been working on some of the design of the website to make sure that search engines can get the information in a quick, time-sensitive fashion so that they can pull all the relevant data down.

So, that's something that we have been working on here more recently.

We've also been publishing some content that our customers want and expect.

But this is an area, now that we've got the website up, we've made some tweaks to it, this is an area that we think still has a lot of opportunity going forward.

Brian Nagel, Oppenheimer.

Hi, good morning Nice quarter.

My question is on used car unit comps, two parts, I'm going to put them together.

First off, a number of retailers, really across the board, have discussed some sales disruptions, like the change around the recent presidential election.

I know it's not typical for CarMax to talk about intra-quarter trends, but I thought maybe you could discuss that.

And then the second question, also relating to car sales, you talked a lot in your prepared comments about some of the internal initiatives.

We've clearly seen a sequential improvement in used car unit comps over the past few quarters.

From a market standpoint has CarMax started to benefit yet from the supply of vehicles improving within the industry?

Thank you

Brian, on the first question I really don't have a comment on that and the Trump effect.

On the second part of the question as it relates to the supply, I absolutely think that we're starting to see the supply come back in the auctions.

I think that's a good thing for CarMax.

As that supply comes back, it helps to drive the difference in price between a new car and a late-model used car.

So, while I didn't highlight that as one of the factors in the prepared remarks I absolutely think that that's also a contributing factor.

Thank you.

Craig Kennison, Baird.

Good morning.

Thanks a lot for taking my question.

It's on the wholesale business, which fell a little bit.

Do you think you are seeing your fair share of appraisal traffic?

Or are sellers starting to use some of these alternate channels, which, again, you may have access to with your new strategy?

And then on a related note, how does the increase in lease activity -- we've got a lot more leased cars today -- impact your opportunity for appraisal given those lessees are not selling a car.

Thanks.

On the wholesale piece, I think that's more indicative of what I talked about in the early remarks.

As the new car SAAR works its way through from the recession, the shortage of new cars, for us that's right in these seven- to nine-year-old vehicles.

And you know that's right in the sweet spot of wholesale.

And we saw the same phenomenon earlier on.

When those cars were zero to four year, we saw less of them coming through as appraisal traffic.

We expect and we're seeing the same thing come through in the seven- to nine-year-old vehicles.

We think that's more of a factor of what's in play there.

And, I'm sorry, the second question -- what was it, in regards to lease activity?

With the increase in overall lease activity, there are a lot of people who have cars that are leased and not therefore for sale.

Does that impact your ability in the wholesale business to attract those cars?

No, I don't think so at this point because, first of all, the leases are just starting to come back at this point, and our wholesale cars are generally older.

I do think that as the leases come back that's a good thing for the core business because that's a lot more selection of younger vehicles.

But I don't think that's having a big impact on the wholesale business.

Thanks.

Matt Fassler, Goldman Sachs.

Thanks a lot and good morning.

Within the SG&A, other than the advertising, which was down for reasons that you stated, your compensation expense was also quite well controlled.

It looks like on an aggregate basis it was up only 3% year on year, this comp in benefits, and really barely up on a two-year basis in aggregate dollars despite a big increase in stores.

Was there anything related to stock comp, which I know you have sometimes called out, or any other factor -- incentive comp -- that would have led this number to be so subdued here in the third quarter?

Hey, Matt.

Stock comp actually this quarter is the first time it's been at a level so small that it's not worth talking about on a year-over-year basis.

But there are some good guys embedded in that comp and benefit number, both some unfavorability last year and some favorability this year.

But despite that, we still did leverage that line relative to growth in unit sales.

You could probably double the percentage increase and it would be a rough idea of what we thought a run rate would be.

So, in other words, the run rate would have been something like 6% in dollars, normalized for everything, which still would have led you to good leverage.

Yes, that's fair to say.

Got it.

That's very helpful.

I'll count that as my follow-up and come back if we have more.

Thank you.

Mike Levin, Deutsche Bank.

Good morning, everybody.

I just wanted to focus on the loss provision rates at CAF for a second.

Is there a way that you can talk about, is this factoring in just what you are currently experiencing or does this take into account additional expected declines in used vehicle values moving forward?

If it's just now, how much do you think this could continue to move down with used values coming down further from here?

Let me hit on a couple things.

One is, used values definitely has an impact on loss rates but historically customer behavior has been a much bigger driver.

And on an ongoing basis there's many things moving, so it's hard to say that one individual factor could have a dramatic impact on a go-forward basis.

So, the determination, every quarter we determine, based on what we know to date rather than based on any speculation, a 12-month look-forward on loss expectation, as I said, it's based on historical information that we have and then how we are performing to date relative to that historical performance.

So, in a quarter where things are moving you are going to see us move that loss expectation.

We have not in the past, when things are going good, taken a view to try to get ahead of things, and we haven't done that here, as well.

Got it.

Maybe to put that in a little better perspective, these current rates versus history, I know the accounting was different at the time but could you compare where these loss rates are versus where we were, say, through the crisis?

Through the crisis, we typically tried to manage our portfolio to a 2% to 2.5% cumulative net loss rate.

And the average life of these loans has been roughly two years, as a proxy.

During the recession we saw loss rates go to double that in the portfolio.

But one thing I think I would point out, at one point, if you look at the size of the loan loss allowance today, which is a 12-month look, it's 1.10%.

If you double that, you can see that we're still well within the range of expectations in the zone that we are looking to originate.

And something to remember, also, is that our Tier 3 test is also part of that overall loan-loss provision and represents almost 10% of it.

10% of the 1.1%?

10% of the dollar volume, the $114 million, $115 million of loan loss allowance.

When we step back and look at this, yes, we've seen deterioration relative to recent years but still not to the point where we were pre recession.

Got it.

Thanks.

Scot Ciccarelli, RBC Capital Markets.

Good morning, guys.

You guys have always talked about Tier 3 sales as really being incremental to the core run rate.

So, my question is, when CAF increases penetration, do you have an estimate what percent of those CAF sales are incremented?

So, in other words is CAF financing some people that wouldn't have received credit elsewhere?

I think the answer to that is yes, and not necessarily because we are more aggressive than other folks.

Every lender has a way that they look at credit.

We think we have ways to look at our applicants and find pockets that work for us that may convert at a better rate because they got a CAF offer than if they get a Tier 2 or Tier 3 offer.

If you look at the conversion of customers based on a CAF offer versus based on a Tier 2 or Tier 3 offer, it's much more significant.

So, you would expect that some of the CAF offers would be incremental just because of that phenomenon.

But, Tom, if you had, let's call it, 7,600 extra unit sales because of the increase in CAF penetration, is there a percentage you would suggest that was incremental based on the way you guys look at your models?

Like I said, there would be some incremental there but we haven't shared anything as far as fractions.

I can tell you that percentage would not be expected to be up or down relative to recent years.

Right, okay.

Understood.

And then related to that, because it has to do with on the credit side, given the rise in interest rates that we have seen, I would assume that your funding costs have actually increased.

How should we generally think about how you guys plan to manage the spread versus moving interest rates too quickly on customers with the potential for negative unit elasticity?

Thanks.

The nice thing about our business is we can test quickly and we can test pretty accurately in the CAF space.

We have seen an increase in benchmarks in recent weeks, as we look at it.

And we have taken action to raise rates in certain pockets selectively to offset it to some extent.

Now what we'll need to do is, as we look at it going forward, see if the market will allow us to keep those rates up.

I've said many times, we're going to be a market lender, we've got to provide competitive rates to the customers so nobody's getting sour on CarMax over the finance offer they got.

And we will closely monitor our three-day pay-offs, we will closely monitor conversion as we ramp-up rates, and we will do what the market allows us.

This is something that's just ongoing business as usual for CarMax Auto Finance.

We're constantly testing ways to maximize the profit and sales coming from that portfolio.

Okay.

Got it.

I'll follow-up later.

Thank you.

John Murphy, Bank of America/Merrill Lynch.

Good morning, guys.

Just a question on supply and the impact potentially on grosses.

It seems like there's a lot of the new vehicle dealers that are getting off the stop sale wagon and retailing a lot of used vehicles they had stored on their lots in the short run.

So, I'm just curious what you think about supply there.

And then, also, as you look at this leasing bubble that's coming over the next three years, where you think we are in that increase in supply.

And as you think about those two legs of supply increases, what you think you can do as far as holding your gross.

Are you going to stay committed to this $2,100 to $2,200 range as we see that increase in supply really pick up?

John, on the first part of the question about the stop sales, I don't really think that's much of an impact.

There are lots of dealers that have been selling vehicles that have open recalls.

While you've got the franchise dealers that cannot -- the manufacturers saying you can't sell it per that franchise -- they still sell other non-brand franchise at those stores.

So, for me, I don't really see that as either a positive or negative.

I think it's just continuing on.

As far as the leasing, I said earlier we're seeing more vehicles come back from the leasing channels.

And we think it will continue through next year and even into the year after that.

And I think we've proven over time that we have been able to hold our margins throughout many different cycles.

Now, the only caveat that I would give there is you know we constantly do testing, and if we think that moving that margin down would more than pay for itself in units, then we would look at that.

So, we will continue to test.

But we feel confident that we can continue to maintain those gross profit margins.

And if I could just follow up, would we simply think that if you dropped your gross by 10% you would expect to get at least a 10% pick up in volume or else you wouldn't do it?

Is that correct?

Or 11% increase in volume to offset that drop in gross?

We would want to see total gross more than offset the drop in what we saw.

It would have to be a win on total gross.

Okay.

Great.

Thank you.

Mike Montani, Evercore.

Hey, guys, good morning.

Thanks for taking the question.

I just wanted to ask, if I could, and I apologize if I missed it, but what are you seeing now in terms of SUV truck penetration?

I think last year it was 23% by your measures.

And I was looking for it to be maybe low 30%s.

Could you talk about that?

Yes.

Our large SUV mix for the quarter was up year over year.

It was about 25.7% versus last year's third quarter it was 23.3%.

So, it was about 250 basis points.

It's up about 1 point from the second quarter of this year.

The mix is up a little bit, which would inherently drive our ASPs up a little bit, but then, because we had a shift in some of the older vehicles, that brought the ASPs down, as well as lower acquisition prices brought it down.

So, SUV mix was up a little bit.

Okay, that's helpful.

Can you talk a little bit about sourcing and how it's trended in terms of buys that you would do, appraisal weigh-in versus auction and other areas.

And just thinking about big picture, it would seem that you'd be in a better position to sort and merchandise given that acquisition costs have come down.

So, I wanted to see how it's playing out.

Is this in particular to large SUVs or just in general?

Just in general

I think what we're seeing out there is what we typically would see this time of year with fall depreciation.

And I think, with the fall depreciation, obviously it's going to lower the acquisition prices.

Again, we feel like that's a good thing for us because as the acquisition prices go down, we just can pass those lower prices on to the customers, and there's a bigger delta between new cars and late-model used cars.

So, we think it's good.

Thank you.

Rick Nelson, Stephens.

Thanks, good morning.

I wanted to ask about third-party lead generators, where you stand with those.

And did you do anything different this quarter with the lead generators?

We have all of our inventory listed for the quarter.

It was on cargurus.

And that was the only site that we had our inventory listed on during the third quarter.

Now, we will constantly test some different things but that was the only one during the quarter.

Okay.

Thank you for that.

James Albertine, Consumer Edge.

Great.

Thanks for taking the question and good morning, everyone.

I wanted to ask, and I know it's early, but certainly we're getting a lot of questions, and we hosted a call yesterday on the subject matter, in fact, wanted to understand your thinking and maybe what you're hearing from your advisors as it relates to tax planning for next year, maybe some of the pushes and pulls as you think about the potential deductibility of CapEx or PP&E and maybe the reversal of deducting interest expense, and so forth, as well as the reduction in corporate tax rate.

Just any strategy thoughts there would be helpful in helping us frame how you guys are thinking about it relative to peers, even.

Thanks.

James, since you had a call yesterday maybe you should brief us on it (laughter) because you probably have more information than we do.

We really don't have any thoughts at this point.

It's all so new and there's so much up in the air.

It's too early to really talk about.

Okay, great.

Thanks.

I'll get back in queue.

Bill Armstrong, CL King & Associates.

Good morning, everyone.

You mentioned a small increase in overall traffic into the stores, but you also had a reduction in appraisal traffic.

Are you seeing any change in consumer behavior in terms of fewer people coming in with trade-ins?

What do you think explains for that apparent disparity?

Like you said, we saw a small increase in store traffic.

I talked a little bit about store traffic last quarter and that you really can't look at just store traffic by itself, you really have to look at web traffic and, especially for us, leads and store traffic to understand the overall big picture.

Consumers are a lot more educated.

We know that, of the consumers that buy a vehicle from us, 9 out of 10 of them have already done a lot of research on CarMax.com, so they are already much better educated.

I think on the difference between getting a little bit more store traffic and the appraisal traffic down, again a lot of it is tied to what we're seeing as the SAAR rate works its way through the bubble.

And I think that's a main driver of why you see some of the appraisal traffic down.

Because they are getting less money for the --?

Just because there aren't as many.

Like I talked about earlier, the seven- to nine-year-old vehicles, there just aren't as many as there were because seven to nine years ago the new car sales rates were going down.

So, if there aren't as many customers that have those cars they are obviously not coming in to get them appraised.

Got it.

Thank you.

Seth Basham, Wedbush Securities.

Thanks a lot and good morning.

You guys called out increase in the mix of sales to higher credit customers and their supply of late-model vehicles.

At the same time you are selling a higher mix of older vehicles.

Can you help square away that dynamic, which has occurred for the last two quarters now?

Yes.

I think, contrary to what a lot of people think, is that your Tier 3 customers are going to be the ones buying your older, less expensive vehicles, and for us that's just not the case.

The majority of the vehicles that we sell of the older less expensive vehicles are to non-Tier 3 customers.

So, I think what it says is that consumers are still out there looking for a great deal and they've opted to go a little bit older and a little bit cheaper.

So I think that explains the dynamic.

It's not just Tier 3 customers that would be buying older, less expensive vehicles.

Okay, that's helpful.

And just as a follow-up, considering the increased supply of late-model vehicles, would you expect your mix to shift back to that direction over the next few quarters?

You know, Seth, we will sell whatever the consumers want.

So, if consumers want that late-model vehicle, then we will absolutely adjust our inventory accordingly.

If they want to continue to buy older vehicles, then you won't see that change.

So, it just depends.

It's all driven by consumer demand.

Thank you.

David Whiston, Morningstar.

Thanks, good morning.

I just wanted to talk about the future in e-commerce with the pilot programs you are doing.

Obviously there are consumers who want this process to be very easy, but at the same time it's still roughly a $20,000 purchase for people.

So, how willing do you think people are to buy a vehicle without even coming into the store to do a test drive?

Is it a small portion of the American public?

Is it ultimately going to be a lot of people?

I'd love to hear your thoughts on that.

It's a good question, David, and I think you hit the nail on the head.

It's not an easy transaction.

It's a complicated transaction.

That being said, I do think there's a small subset of customers that want to try that experience.

I think for us we certainly are going to meet those customers wherever and however they want to do business.

But I think, more importantly, is that I think consumers will want to do more of the transaction online in the near term, and we will have the ability to not only do more of the transaction online but it will be a seamless integration into the store.

And I think that's really what we're really focused on.

In addition to giving the customer the ability to do everything, it really is -- okay, you want to do part of it online, let's make sure it's a great experience -- and then when you walk into the store we just pick up from where you left off.

That's really what we're focused on.

I think that's really where the consumer demand is going to be in the near term.

Okay, that's helpful.

And for my follow-up I wanted to ask a comment about buybacks.

Stock has been near a 52-week high.

Are those still full steam ahead?

Pardon me, I didn't hear the tail end of your question.

The stock is near a 52-week high.

Are buybacks still full steam ahead or are you looking to be a bit more cautious on that going forward?

As we've discussed before, we take an enlightened averaging-in methodology to repurchases.

So, at any given time we are trying to average into the market and maintain our capital structure in the zone that we have targeted.

You saw that in this quarter we bought back $199 million versus $125 million in Q2.

That did represent a little bit of a step up in aggressiveness because we saw some weakness in the stock price.

But the parameters we put in place allow for a little bit of that, allowed us to be a little bit more aggressive when the price is weak and a little more conservative in the volume when the price is looking strong.

But we intend to be in the market on a regular basis.

Okay.

Thank you.

Paresh Jain, Morgan Stanley.

Good morning, everyone.

Just a quick question on inventory resourcing.

Would it be fair to say that you source about 40% of your inventory from auction?

How has that number changed in the last two years, if that's changed at all?

When we think about self-sufficiency, which is opposite of the auctions but actually getting it through our own appraisaling, we've given the range of 40% to 50%.

We're at the lower end of that range but we are higher than we were a year ago and we are very similar to where we were last quarter.

And a follow-up on the profitability of the vehicles sourced from auction, has the gap in profitability with those sourced through trade-ins changed at all in the last two years?

The gap is about hundreds of dollars between the two.

The vehicles that we source through our appraisaling are still more profitable than the ones that we source offsite, as you can imagine.

You don't have transportation fees, you don't have folks going out incurring expenses, and that kind of thing.

There's still about the same amount of profitability over what they were before.

And no change in the last two years in that gap?

I can't speak really off the top of my head on the last two years but it's been very similar.

Okay.

Thank you.

Chris Bottiglieri, Wolfe Research.

Hi, thanks for taking my question.

Did you guys give out the zero to four mix this quarter, like you historically have, and how that compared versus last year?

Zero to four, we were down slightly 81% to 78%.

Got you.

Okay.

And then just a follow-up to that, given the scarcity of those cars given supply, I'm wondering if you're holding back more of those vehicles from wholesale to sell it used, if the two are related at all.

Actually I think the supply is starting to come back on those, so we're seeing more out there.

But as far as the selectivity, we're always looking at selectivity when we purchase a car, whether we designate it wholesale or we put it through.

I would say at this point when you're talking about zero to four-year-old cars we really haven't changed anything recently as far selectivity goes.

I'm sorry, I meant holding back the seven to nines where you had tighter supply.

Have you held back some of those from wholesale to retail at this point?

I don't think it's considerably different than what we've been doing before.

It really depends on the vehicles as they roll through.

If they are good-quality vehicles and we can turn them into CarMax cars then we're going to do that.

But we look at selectivity every single quarter and make the decisions that are appropriate at that point.

And I wouldn't say that this one is necessarily -- there hasn't been a big change in this quarter versus other quarters.

Okay, great.

Then one quick follow-up.

Two questions have been asked on auction supply.

It seems to me just looking at the auction data that there seems to be a mix of improvement in SUV and truck availability at the auction lanes.

Has that been a driver for your business in terms of increased SUV and truck penetration?

I think when you see that increased inventory, that will drive the prices down.

That probably is a factor into whether customers want to buy that car, depending on how attractive it is from a price standpoint.

But, again, we really go off of customer demand and if they are looking for large SUVs and we can get them at prices that they will pay then we will put them on our front lot.

Just this quarter folks were looking more for older cheaper cars and so that's what we did.

Okay, that's helpful.

Thank you for the commentary.

Matt Fassler, Goldman Sachs.

Thanks a lot.

Good morning again.

If we were to be able to accurately calculate how new space productivity looked versus a year ago just in terms of raw numbers, what do you think we would see?

And how did new store performance compare to your expectations?

We are pleased with new store performance.

As we've talked about in the past, it's difficult to talk about store productivity when you look at the size of stores that we are building, when you throw in the small formats, when you look at going into new metro markets where awareness is at different levels, you're going to have different ramping up.

All of the new stores are reaching profitability quicker than the old stores because of the GPU.

And they are also meeting all of our internal rate of return.

So, we are pleased with new store productivity.

Got it.

And then, secondly, I know you are far more focused on your customers than on your competition, but we did see one piece of competitive fallout with one of the higher-profile, albeit small, online startups essentially ceasing operations in its prior form and merging with another company.

What is your sense about the competitive environment online?

Is it intensifying?

Are you starting to see any signs of more rationalization in terms of the kind of offers that your customers can pursue away from CarMax?

I think, first of all, just a comment on your first part about the online competitor ceasing operations, I think it goes back to something I talked about earlier which is, this is not a simple business.

This is a hard business.

It's not easy to go out, source inventory for the right amount.

It's not easy to go out and put a cash offer on every single car.

And I think that's an indication of why some of these folks are struggling.

I think competition, it's hot in both the online space and in the traditional.

And I think our challenge is to make sure that we continue to leverage the equity that's made us successful and make them even better, and leverage our data and our processes and our systems and our people to continue to widen the gap between us and our competition.

And, like I said earlier, we've got 23 years worth of experience and 23 years worth of data, and we are leveraging that data and tapping into it in ways we haven't been able to, and haven't done in the past.

Although the competition is hot and heavy, we feel really good about the position that we are in.

And I think ultimately to be as successful as we can be, we do need to make sure that we can be in the online space but, equally important, is we've got to be in the brick-and-mortar space.

I think you have to do both very well and I think we are positioning ourselves to do just that.

Got it.

Thanks so much.

Scot Ciccarelli, RBC Capital Markets.

Hey, guys.

This is a bit of a follow up on Matt's question.

What I'm trying to figure out is, on some of these delivery tests, are there any key differences to what you are trying to do versus the guys like Vroom and Beepi?

And also, how is it that you are allowed to close a transaction outside of the dealership, because I was always under the impression just legally you had to close the transaction at a dealership.

Thanks?

On the second part of your question, there are some states where you can't close it outside of the dealership.

Our delivery, where we are doing our test, that's obviously not the case.

I think as far as differences, one of the difference in our home delivery test is you don't have to buy the vehicle before we bring it out to you.

We will bring it to you, you can test drive it at your home, and if you decide to purchase it we can do the transaction right there.

That's different than any other tests that are out there where they make you purchase the vehicle before it's brought out to you.

And, again, it's a small test.

We are trying to understand exactly what the customers want.

And the good thing is, we can adjust the test as we move forward.

Got it.

Okay.

Thanks, guys.

Scott, Tom was just saying he thinks maybe one of the online competitors might allow you to --.

Yes, there's one that allows you to test drive but they also are making you give up your car if the person's trying to sell it.

That's right.

I'm sorry, can you repeat that?

It was broken up.

There is one competitor that allows you to test drive as a purchaser, but they are a C2C enabler and the other part of their business offer is that they take possession of your car while you are attempting to sell it, so you don't have use of your vehicle.

So, there's nobody doing it exactly the way we are from a business to consumer, but, to Tom's point, there's a C2C that will allow you to test drive without purchasing beforehand.

It's important, when we're looking at this, we're trying to make sure we're not doing anything that inhibits the customer from wanting to transact with us.

Got you.

Thanks, gentlemen.

James Albertine, Consumer Edge.

Great, thanks for taking the follow up here.

On the same theme, on the online versus your traditional sourcing methods, I was curious, from a qualitative perspective, given you are now pretty far along in terms of your investments digitally, how do you think about operating margin?

Are there any differences in the final operating income contribution whether you have sourced the customer through an online channel versus a traditional mechanism?

And if you can maybe at a high level talk about what are the differences and pushes and pulls from an expense perspective that we should think about that drive that delta, if there is one?

Jamie, I think it's a little early to be talking about the differences.

While we are committed to expanding our online capabilities, we have such a small test going on home delivery.

And outside of that all the other online capabilities, customers are utilizing them and then transitioning into the store.

So, it's a little early to talk about the economics of one versus the other and the delta.

Okay.

Then maybe a quick follow-up, you've done a great job of laying out milestones for us historically to think about pilot programs.

Are there any additional measures that we should look for in terms of calendar 2017?

Any other major investments coming or looming that you thought about and are willing to articulate, at least from a qualitative perspective?

The one that I highlighted was the one we're going to be doing in the fourth, which is the online appraisals.

And then in the fourth quarter we will highlight any new ones for the upcoming year.

Okay.

Great.

Thanks again.

Mike Montani, Evercore.

Hey, guys, I just wanted to follow up on two things.

One is for Tom, if you could just quantify what recovery rates were like in the quarter and contextualize that for us.

And then, secondly, what are you seeing in terms of credit availability from some of your third-party lenders?

If memory serves, I think it was last March or April that you saw a noteworthy pullback from one of the largest ones.

As far as recovery rates it's down a couple points year over year in the quarter.

But, as I mentioned, consumer behavior in payments and then recovering themselves out of trouble tends to be more impactful.

And, I'm sorry, I didn't quite get the tail end of your last question.

The last question was just, you did the 10% comp if you back out third-party subprime.

The question is, do you start to cycle the pullback in March-April, if memory serves.

And then, also, what are you seeing in terms of lender behavior from third parties?

Does it appear stable at this level or is there further pullback that you can see now?

Sure.

As far as cycling, in the current period right now we will begin to cycle over the trend we began observing in traffic.

Remember, we have been talking for several quarters about seeing fewer application volume at the lower end of the credit spectrum.

That started somewhere around this time last year.

So, that portion of the decrease will start to see some cycling.

As I mentioned in my comments, the most recent tightening we saw was in mid-Q1 from one of our T3 lenders.

Since that time they have been behaving very consistently.

If we look at conversion of customers in the Tier 3 space since the middle of Q1, it's been very consistent.

It's below last year but it's been consistent.

So, yes, all else equal, in April you'd start to see us rolling over that on a year-over-year basis.

In the Tier 2 space it's almost exactly the opposite phenomenon.

Conversion has been consistently better than last year since the first quarter.

And as I mentioned, they are doing a great job of converting the volume that they see.

The mix that we're seeing, a lot of it is from the customer traffic coming through the door.

That's why CAF is up, that's why other is up, and that's why Tier 2 and 3 are down

So, are you guys happy with the third-party subprime where it's at now at around 10%, or could we consider new lenders that might help to grow that again?

I think a lot of it is going to be a matter of what customers come through the door.

We're happy today with the amount we are investing in the Tier 3 space, which is about $1,000 a car of margin that we give away in order to enable those transactions.

The Tier 3 space is a lot more fragmented than the more prime space in auto lending.

We're happy with the performance of our partners.

We test other partners occasionally, and to the extent one can add value we consider bringing them in the mix.

But I think if you step back and think about our current base as a platform for growing, it's a much more profitable dynamic to grow at this mix than to have the mix migrate back to something higher.

Thank you.

Seth Basham, Wedbush.

Thanks for taking the follow-up question.

Just thinking about the fact that most of your customers are shopping online before visiting the stores, as you consider the store model of the future what kind of changes are you thinking about?

We notice, for example, in the Seattle area you're opening a pretty large megastore, which is likely a reconditioning focused facility, lower-cost area.

Is that something you'll consider in other markets too?

I think what you are seeing in Seattle is more driven by the market dynamics and what's available land-wise.

Obviously we're looking at a store prototypes.

We've got the small store out there.

You've seen we've opened more of those here more recently.

I think it's something that we will stay close to as we better understand the customer desire for transacting more and more parts of the transaction online.

But I'd tell you, it's not like we have 1,000 stores around the country.

We have 169 stores and I think they are all strategically located.

The products we sell, you need space and you need places to build those cars.

So, I feel very comfortable with our growth strategy, what we've done so far, and I feel very comfortable with what we've got in the pipeline currently.

All right.

Very good.

Thank you.

Mike Levin, Deutsche Bank.

Thanks, guys.

I wanted to follow up on your comments about increasing applications at the high end of the credit spectrum.

And you said you also bought some market data that you were taking a look at.

Just wondering if you could maybe put a few numbers behind what you are seeing at CarMax, how that compares to what you are seeing within the market.

Are you outperforming those increases?

And then how we might think about higher credits being a larger percentage of your mix impacting loss rates going forward.

I'll start with the last one.

We will see how it impacts loss rates going forward depending on the environment.

It's way too early to tell.

We're not in a position to give you any numbers regarding this but I can give you a little color around what we've looked at.

We bought data related to auto inquiries, meaning folks that are hitting the bureaus in conjunction with an application for credit for an automobile for the past several years, both through submissions to captives and submissions or inquiries through the major dealer groups.

While we likely started feeling the phenomenon a little earlier, the data is telling us that the lower and lower-middle part of the credit spectrum has seen a year-over-year decline in recent quarters for everybody.

As far as the higher credit folks and the growth there, our data appears to show we are growing a little bit stronger than the rest of them.

But there could be a lot of factors between new car mix/used car mix, et cetera that drive that.

I don't know if there's anything to really take away from that.

Okay.

I appreciate the color.

That concludes the Q&A portion of the call.

I would now like to turn the conference back over to the presenters for any closing remarks.

Thanks, Victoria.

In closing, I just want to thank you all for joining us today.

I want to thank you for your continued support.

I also want to thank our 23,000 associates that are working for us across the country.

Our success is absolutely due to them and the exceptional customer service they provide on a daily basis.

I'm really proud of everything they've accomplished this year.

I wish everyone a wonderful holiday and a happy new year, and we will talk to you next quarter.

Thank you.

Again, thank you for your participation.

This concludes today's call.

You may now disconnect.