Katharine Kenny - Vice President, Investor Relations Tom Folliard - Chief Executive Officer Bill Nash - President Tom Reedy - Executive Vice President and Chief Financial Officer

John Murphy - Bank of America-Merrill Lynch Scot Ciccarelli - RBC Capital Markets Craig Kennison - Robert Baird Matt Fassler - Goldman Sachs Michael Montani - Evercore ISI Mike Levin - Deutsche Bank Irina Hodakovsky - KeyBanc Seth Basham - Wedbush Rick Nelson - Stephens Paresh Jain - Morgan Stanley Bill Armstrong - CL King Associates David Whiston - Morningstar Chris Bottiglieri - Wolfe Research

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 Fiscal 2017 First 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, Victoria and good morning. Thank you all for joining our fiscal 2017 first quarter earnings conference call. On the call with me today are Tom Folliard, our Chief Executive Officer; Bill Nash, President; 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 made 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 with the SEC. As always, I hope you will all remember to ask only one question and follow-up before getting back in the queue in order to give everyone a chance to ask a question. Before I turn it over to Tom, I just want to say how about those Cavs? Tom?

Thank you, Katharine who has a hometown of Cleveland as you can tell. Good morning, everyone. Thanks for joining the call today. As usual, I will start with a quick overview of the key drivers of the quarter. Tom Reedy will then give some more detail around financing and we will turn over to Bill Nash who will share some additional information regarding the quarter. First quarter fiscal 2017 was a challenging one for us. Total revenues increased by 2.8%. Used unit comps were slightly positive and total used units grew 4%. Comp units were driven by an improvement in conversion, which offset a modest decrease in traffic. We do believe that the decline in traffic is both predominantly and disproportionately a result of the decrease in Tier 3 sales given the fact that Tier 3 conversion has historically been significantly lower than our non-Tier 3 conversion. For the non-Tier 3 customer base, comp units actually rose by 3.6%. Total web traffic increased by 7%. Wholesale units grew by 1.8%. CAF quarterly income fell 7.7% to $101 million. And net income for the first quarter declined by 3.6% to $175 million and EPS rose 4.7% to $0.90. During the first quarter, we bought back 2.6 million shares at a cost of $132 million. I will now turn the call over to Tom to talk about finance. Tom?

Thanks, Tom. Good morning, everybody. This quarter, consistent with last two quarters, we continue to experience a year-over-year increase in credit applications from customers at the higher end of the credit spectrum and a decline in applications across the lower end. Consequently, we saw growth in the percentage of sales financed by CAF. We also saw growth in the share of sales where customers paid cash or brought their own financing. CAF’s net penetration was up over 1 percentage point to 43.9% compared with 42.7% in last year’s first quarter. Net loans originated in the quarter rose 6% year-over-year to $1.4 billion due to a combination of CarMax’s sales growth and the higher penetration of CAF. Tier 2 financing, as a percent of sales, fell slightly year-over-year to 17.4% compared to 18%, due to the lower applicant flow, which was partially offset by stronger conversion in that space. Tier 3 financing as a percent of sales declined to 11.9% compared to 14.7% in the first quarter of fiscal 2016 due to a combination of lower applicant volume and some measurable credit tightening by our third-party lenders. As Tom mentioned, CAF income of $101 million represented a decrease of approximately 8% compared to the first quarter of fiscal 2016. This was due to a higher provision for loan losses, a lower interest margin partially offset by 12% growth in average managed receivables to $9.7 billion. The increase in the provision for loan losses in the first quarter reflected the favorability we commented on in last year’s first quarter, selling favorable experience in the current quarter as well as the growth in the receivables. Given last year’s favorability, much of the year-over-year increase in the provision was expected. However, we did have some unfavorable loss experience this quarter reflecting several factors, including a drop in wholesale recovery rate. Our ending allowance for loan losses at $104 million was 1.05% of ending managed receivables compared to 0.94% in last year’s first quarter and at 0.99% last quarter. This loss reserve is within our range of expectations given our origination strategy, which includes our Tier 3 activity. For loans originated during the quarter, the weighted average contract rate charged to customers was 7.5%, similar to the 7.4% in last year’s first quarter. Total interest margin declined to 5.9% of average managed receivables compared to 6.3% in the first quarter of last year, but that’s consistent with the last couple of quarters. Interest expense in the quarter rose to $11 million – turning over to CarMax overall now. Interest expense in the quarter rose to $11 million compared to $7 million in the first quarter of FY ‘16. This was partially due to higher average debt levels that more than half of the increase was a result of the completion of lease extensions related to some of our stores as we discussed in our last 10-K filing. During the first quarter, we executed a private debt placement of $500 million. We sold $300 million of the deal in the first quarter, which was primarily used to reduce our outstanding revolver balance. And we will fund the remaining $200 million sometime in the second quarter. We also repurchased 2.6 million shares for $132 million. And at quarter end, we had $1.3 billion remaining under the current authorization. I will turn over to Bill.

Great. Thanks, Tom. Good morning. As a percentage of our sales mix this quarter, 0 to 4-year-old vehicles remained essentially flat compared to last year at approximately 77%. Midsize and large SUVs and trucks as a percentage of sales increased by over 2% to approximately 25% in this first quarter compared to last year’s first quarter remained flat compared to the fourth quarter. SG&A expense for the first quarter increased 8.7% to $380 million. This growth primarily reflects the 11% or 16 store increase in our store base since the beginning of the first quarter of last year and a $7 million increase or $36 per unit in share-based compensation expense. Another $3 million increase in cost or roughly $18 a unit was related to hail damage incurred in several of our Texas markets during the quarter. In total, our SG&A per unit increased by $97 to $2,223. During our last call, I highlighted some of the advancements we are making to improve the customer experience and drive efficiency. Specifically, I mentioned that we would be rolling out a new adaptive and more personalized website. The new website was fully rolled out in April. It combines an upgraded and enhanced design with a seamless experience across all devices. We have also upgraded the entire site to a state-of-the-art technology platform. This will allow us to more quickly innovate, test new capabilities and personalize the experience based on the customer’s individual preferences. We will also continue to test different components of selling process online to better understand our customer needs. One of the new capabilities that we are currently testing is offering our customers online financing. Being pre-qualified for financing before the store visit helps build the customer’s confidence and will make the in-store shopping experience faster and more enjoyable. Our plan is to initially roll it out to 10 stores. We continue to believe that no one is in a better position than CarMax to deliver more of the transactions online or even deliver the car to the home. No one can match our existing infrastructure, our national footprint, our inventory scale and our brand strength. The ability to combine a state-of-the-art online experience, with the exceptional customer service our associates are known for is what will set us apart from our competitors. During the first quarter, we opened 2 stores, both in new markets, one in Springfield, Illinois and one in San Francisco. We plan to open 13 other stores during the fiscal year. Subsequent to the end of the first quarter, we opened a store in El Paso, another new market for us. During the second quarter, we expect to open two more stores, one in Bristol, Tennessee, which is another new market for us and the other will be our third store in the Boston market. Now we will open up the call for questions. Operator?

[Operator Instructions] Your first question comes from the line of John Murphy with Bank of America-Merrill Lynch.

Good morning guys, can you hear me?

Yes. Hi John.

Just maybe a longer term question just to kind of follow-up on what you were just talking about your enhanced website, do you foresee a time where your store count is not necessarily growing as quickly as you are expecting right now, but you are reaching a broader set of consumers, quite simplistically I mean do need as many stores to cover a market as you do now if you kind of increased this physical presence and can you go a lot more asset light as the business emerges over time?

Yes. John, I think it’s important that we do both very well. So I think in the short-term, we don’t have any intentions of changing up our growth as far as the physical stores as we said in the past, 13 to 16 stores is what we have committed to for this year and next year. And we think that’s to be ultimately successful, you need to have a really good presence in both. And so I think for us, it’s going to be a combination of continuing to expand our offering online and then continuing to evolve our in-store process. Could we get to a point down the road where that may change up, that’s hard to tell at this point.

And these efforts aren’t having any impact on your showroom traffic, are they at this point?

No, I think when you think about traffic, foot traffic, it’s broadly known that consumers are being much more informed before they come into the store. So they are doing a lot of the research upfront. In our case, we know nine out of ten of our consumers that end up purchasing from us do some homework ahead of time from – on carmax.com. So what we do think is they are coming in more informed. And as we look out and try to continue to get comps comes, we are going to be focused both on traffic, both in-store traffic to the web and then equally focused on conversion.

Okay, great. Thank you very much.

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

Good morning guys.

Good morning Scoot.

Hi, I guess my primary question is on the cap side and we did see obviously, a pickup in the loan loss reserves, where – how would you expect that to trend for the balance of the year given some of the unfavorable changes you saw happen during the course of the quarter?

Yes. Scot, one thing I would point out is that what we have booked in the quarter and is now booked in reserve is the 12-month look forward on losses. And our negative experience during the quarter is baked into our forecast direct for the rest of the year. So to the extent things were to worsen or improve, we would adjust accordingly. But at this point, everything we know about the environment including the experience we had in this quarter and having losses coming a little hot is baked into that forward-looking estimate. When you see the increase in that provision for loan losses, it’s a combination of both our experience in the quarter versus our expectation of what we had booked and an adjustment to the overall portfolio based on what we have learned. So as I said at this point, I think everything that we have learned based on methodology is baked in.

So when you kind of peel back the onion a little bit Tom, is it more a recent vintages or is it older vintages or is it kind of across the board?

I think it’s a combination of things, Scot. In general, if you step back and look at it, last year’s experience was very favorable. So I don’t think we would have expected to have a repeat of that, so that’s kind of the first point. We have also seen pretty significant growth in the portfolio, which means losses are going to step-up. And then also in the last 2 years, we have expanded on the credit front a bit. If you remember back in 2013, we got much more aggressive with customers at the very high end of credit, offering very low rates to the highest credit quality customers. That had an impact of kind of bringing down our expected losses on the portfolio. Over the last 2 years though we have been expanding at the lower end of what CAF has done with some testing and some I guess prudent expansion, in an effort to bring our targeted cumulative net loss back in line with where we have tried to run it at that 2% to 2.5%, which is a very highly financeable portfolio. So I think it’s fair to say that activity in the last couple of years, we have gotten a bit more aggressive internationally. And we get compensated for that with higher rates. And some of that has – you would have maybe expectation and that would increase losses in the portfolio. But we did have some unfavorable experience in the quarter as I mentioned due to – partially due to that expansion and partially due to the wholesale recovery rate.

Got it, okay. Thanks a lot guys.

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

Good morning. Thanks for taking my question. Before I begin I just want to say I consider Katharine the LeBron of Investor Relations.

Thank you, Craig.

And my question is just a follow-up on the prequalifying buyers online, could you share more detail on what is required to do that, how long it takes and how you plan to handle sort of a disappointing outcomes and if someone who doesn’t get what they want? Thanks.

Yes. So like I said we are currently just testing it, getting ready to put it in ten stores, really what we want to do is, we are going to a prequalify them or they come into the store. We have the sales consultant involved in the process. So if someone’s decline, we can – we will contact the customer. And again, the goal will be not only to give them an approval, but to also transition them into the store at this point.

Okay. Thanks.

Your next question comes from the line of Matt Fassler with Goldman Sachs.

Thanks a lot and good morning. If you think about the lower subprime penetration, this is a bit of an acceleration in the decline year-on-year in terms of penetration and do you expect declines to persist at this level, do you feel that your third-party providers are seeing similar experience to you and are in the process of pulling back further, do you feel like you have reached a stable level here?

Yes. Matt, it’s hard to say what we expect in the future. As I have always said our goal is to have sustainable partners that are there for our customers and can provide a wide range of financing. In the quarter though we did see one line in particular a pullback and it was Santander I mean you have seen them out in the public domain, talking about how they are pulling back in sub-prime auto, letting other business to other folks. So it’s not inconsistent with what they have been saying in the public domain. So as far as what they will do going forward, I could say we saw a couple of different things happened during the quarter. And I feel like it stabilized during the quarter. But looking forward, it’s their business, they are going to manage their portfolio as they see fit. And if they determine they need to dial back or get more aggressive, they are going to do that. I think Matt there is – out of the long time you know that sub-prime as a percentage of our total sales has at one point, it was pretty much zero. It’s been as high as 19 in a year and then I think last year, we ended at 16 or 16 for the year. So wherever it ends up is going to be a result of a whole bunch of different factors, lender behavior, applicant flow, but what we have always talked about with this phase is, we believe each customer is almost 100% incremental. Remember also that these points of sale are also significantly less profitable, that’s one of the reasons we wanted to point out that if you take out the decline of 2 points or 2.5 points, whatever it was in the quarter, then the rest of our business actually grew by 3.6%. And if you look at our mix of business as a base from which to grow, this is actually a better base from which to grow than if we go back when 19% of our sales were Tier 3. Again, we believe that 100% of it or almost 100% of it is incremental because of the way we were up we flow financing from lender to lender. But at the same time, it’s going to move around based on a whole bunch of different factors.

Totally understood and if I could just follow-up very briefly on this point, to the extent that Tier 2 extensions fell a bit and you talked about more consumers coming in with their own – other cash for their own versus credit, is there – are there other competitors, we are kind of hearing two different things in this sense, is to some degree, interest among low end is down and their willingness to extend credit, to the low income consumers down, on the other it does seem like perhaps on this competing away, I don’t know if it’s the middle part of the market or other consumers who might otherwise shop through Tier 2, so any kind of holistic comments on whether the competition is increasing in any part of the credit spectrum?

Well firstly, do remember that traffic of that FICO score applicant is down, so it kind of starts with traffic, I will let Tom comment on competition.

Yes. As far as Tier 2 goes Matt, I think we mentioned last quarter that we thought some of the Tier 3 degradation was due to their Tier 2s aggressiveness or at least there is the competitiveness. We have not seen any degradation in the quality of offers that the Tier – our Tier 2 partners are providing or the aggressiveness or even their conversion to sale rate, which in fact it’s better than it has been in the past couple of years. It’s just they are not seeing quite the same volume they were before. So the decline in Tier 2, I would say completely on the flow of traffic and we are very happy with how they have been performing in the quarter. We were looking on that but…

And the final follow-up, to the extent that Tier 3 traffic is down or are these consumers essentially anticipating a lot of credit availability given that this has been perhaps, brewing the market for a little while or is that customer finding a better deal elsewhere saying buy here, pay here channel or somewhere like that?

It’s really – that’s almost impossible for us to tell, Matt.

Okay. Thank you.

Thank you, Matt.

Your next question comes from the line of Michael Montani with Evercore ISI.

Hi guys. Good morning. Just wanted to ask if I could, can you provide some additional color on the recovery rate experience versus gross charge-offs in the quarter, specifically as it relates to the provisioning?

I can give you a little color on the recovery rate. It was down about 5 points year-over-year, so it’s 55-ish last year, 50 this year.

Okay, got it. Thank you. And then if I could also, can you provide the – an update on the CAF Tier 3 pilot that you all have been doing, what was the penetration there, how was the trending and a related question given that the Tier 3 penetration rate is down, do you feel the need to add additional lenders in that space or take on additional originations in that space?

Sure. As far as our Tier 3 activity, I would characterize it as steady as she goes. We are comfortable continuing at the same pace that we have been running at, which is roughly 5% of the Tier 3 volume, getting done at the stores. There is really no news there. I think the rationale for doing this program is still good, it still holds true. It’s not about driving additional sales, it’s more about knowledge, risk mitigation and some profitability. As far as looking at our other Tier 3 lenders, we will do that from time to time. We have – we test lenders when it makes sense. That space though is a little different than the Tier 2 space. I think there is fewer people that are equipped to do it on a national scale. And we are very concerned about making sure we are doing, we are working with partners who are experienced, credible and are going to have a sustainable business and be there. So we are not going to be interested and bringing a new player in that is too risky.

And if I could just, lastly ask the penetration from your website, I was there recently and saw a low-40% range of SUV truck, kind of crossover and van versus sedans being obviously high-50s, when you look at new vehicle SAAR, it’s basically the inverse, with 60% kind of SUV and truck, can you guys give us kind of what that average number would have been for you all during the quarter because just from what I can gather, that could have been a several hundreds of headwind to demand as well, if you assume the same dynamics in the used market as you get on new?

Are you asking if our mix should be as same as new?

I am just asking for the quarter, what’s the fair way to look at your SUV and truck mix, Tom, broadly speaking as you included crossovers and do you feel...?

We haven’t looked at it like that, I mean recently, so I couldn’t give that number to you off the top of my head, what I will tell you is we have always been a demand driven inventory model. So what you see on our – and we are big enough and have enough scale that has inventory turns. We are pretty good at going out and finding it. Occasionally, there are some pockets where we don’t think it’s a great deal for our customers so we might be in the light in a particular area. But what you see as an overall percent of sales for the company is largely driven by consumer demand and our inventory turns. On a pace of 600,000-ish cars a year, about half of which we have to buy offsite and half of which we buy through the appraisal line approximately. We are going to buy what customers are buying from us and replenish at that same pace. So I don’t expect us to match up exactly with new car sales.

Okay, thank you.

Your next question comes from the line of Mike Levin with Deutsche Bank.

Good morning everybody. I wanted to kind of see what you guys were seeing in terms of the ramp-up of mature store base, less than 5 years old, that’s in the comps at this point, maybe it’s about 30% of your store base, how are those maturing and kind of ramping up at this point in terms of their support of same-store sales and leveraging SG&A at this point or are they still kind of lagging in a bit of the drag?

So I think if you – first, our leverage in SG&A in any given quarter, that’s going to largely driven by comps in that quarter, particularly for a company that’s in a growth mode like we have been over the last several years and plan to be over the next several. But in terms of the performance of the newer stores, if you take a step back and you look at since we restarted growth in 2011, so fiscal 2011, we have increased our store count by 50%. So we had about 100 stores. We have a little over 150 now and over that same timeframe our net earnings are up by 65% and our EPS is up by 84%. So I mean, I think if we really step back and look at it that way, they are clearly delivering outsized returns and returns that justify continuing to build stores. So we are very pleased with the performance of the stores. They are at or above our financial expectation as a group. And I am glad you asked the question over a longer period of time of 5 years, you go back to 2011 and look at it, again the numbers are store base up 50%, net earnings up 65% and EPS up 84%.

Got it. And it was the first quarter, you guys held gross profit per used units flat on a year-over-year basis in about a year, just wondering what you are seeing there in terms of the gives and takes versus adding some more volume?

Yes. So I think what we are all – a couple of dollars, year-over-year, quarter – last quarter, we were about $39 off and we have said there is a range. We think this is an area where we excel from an inventory management standpoint and feel like that we can continue that range, staying in that range and keep it fairly tight. Now that being said, we will constantly be testing and the looking at trade-offs if you lower the gross profit, what’s the sales that you get back from that, all of the idea of looking also what your total gross profit is if you can get to. So again, we will continue to test but we feel like where we are right now is still the same, it’s sustainable.

Got it. And then just lastly, it was interesting to see that direct expense at CAF move up sequentially in Q1, we have seen it usually seasonally take the tick down from 4Q to Q1, is there anything in particular to read through there and is this kind of the level we should expect going forward?

There is some stock based impact there as well just like there is in the – but there is nothing extraordinary going on.

Got it, okay. Thank you.

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

Good morning everyone. We are waiting for Katharine to join us for the parade tomorrow, we think you should let her come visit us…

Thank you.

She is the one...

Absolutely and I know we have brought up cabs [ph] with her in the past, so definitely we would love to hear here for the parade, she should join in. We wanted to ask a couple of questions on the Tier 3 a little bit more into that, if you were to put a weight impact on lower Tier 3 traffic versus lower application approval rates, as you mentioned, some of your partners pulling back, how would you weigh that?

Sure. And let me be a little more clear, it’s not approval rate, we – if you look at the percent of customers that are up in approval of some kind in the stores that’s well above 90%, what we are seeing is the decline – a degradation in I guess both quality of the offers, meaning they might be asking for a little bit more money down or they are asking for stipulations and particularly we have seen a step-up in that with one of the lenders there is an increase in asking for proof of income, asking for proof of residence, asking for proof of phone number, things like that. So it’s not really a change in the number of approvals, but the quality of approvals and therefore, the ability the customer to accept or the willingness for the customer to accept it. And as far as the ratio, I think I would say that I can’t – we don’t want to be super excited about it because it’s not easy to calculate. But I think the preponderance of the change is due to the change in behavior, call it, two-third and a third to the traffic. And I think there – I mentioned traffic earlier as it relates to this space. I am not giving too many specifics, what I said was, we convert these customers at a significantly lower rate than we do non-Tier 3 customers. So if you just think about it that way, it takes more flow of customers to sell one car than it does to sell one car of a non-Tier 3 customer. So if we are down by 2.5 points in Tier 3 percent of sales, it represents a disproportionately higher percentage of traffic than the sale that it generates.

That makes sense. Did you see any geographical concentration in lower traffic and sub-prime?

Yes, we don’t comment on geography.

Got it. Thank you very much.

Okay, thank you.

Your next question comes from the line of Seth Basham with Wedbush.

Thanks a lot and good morning. My question is on the wholesale business. We have seen some softening trends there for the last couple of quarters in terms of wholesale to retail unit ratio as well as profit per unit. Can you give us a sense of what’s driving some of that softness and how you expect that business to perform through the balance of the year?

Yes. Seth, I think if you look out long-term for us, wholesale and retail pretty much grow at about the same pace. And this time, in this quarter, retail grew about 4, wholesale grew about 2. We don’t feel like there is anything really extraordinary to note even the profit, the gross profit margin is off a little bit, but again just like the retail side, that’s within a range and there is really nothing extraordinary to note from that.

Okay. What is your buy ratio? How has that been trending? And do you see more competition to acquire vehicles?

Yes. The buy rate is still around 30%, which has been a historical high. That’s similar to what it was last quarter, it’s to get that again this quarter. So, I would say that we haven’t seen any indication where customers are choosing to take their vehicles other places and have them purchased by other dealers.

Okay, thank you very much.

You bet.

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

Thanks. Good morning. Is there a way to size up the exposure on the wholesale side of the business to sub-prime?

I am not sure your question, Rick. Are you saying the...

Tom, it would seem here the customers that participate in the wholesale auctions, higher mileage, older vehicles would be perhaps even more dependent on sub-prime finance for them to stimulate sales?

Oh yes, that’s very difficult for us to ascertain with our customer base. I can tell you that we have, we have continued to see very, very strong attendance at our auctions and very, very strong sell-through rates. We have talked about this before and these numbers really haven’t moved very much. We are 98%, 99%ish sell-through rate through the auctions, turning our inventory more than 35 times a year. Our ratio, so our dealer ratio has been very, very strong. I think it’s 1.3 to 1, some of the strongest ratios we have seen. So, we haven’t seen any softening in the demand through our auctions, but you could then relate back to some of the things that we are hearing about in Tier 3.

Got it. Okay, thanks a lot. Good luck.

Thank you.

Your next question comes from the line of Paresh Jain with Morgan Stanley.

Good morning, everyone. Couple of questions. The first one on CAF and going back to something you said earlier, you mentioned you were a bit more aggressive in the last 2 years with your CAF offers and that’s leading to some increase in loan loss provisions. And yet when we look at the securitization, the average FICO score there has been impressively been around 700, so just trying to reconcile that if you can provide some color there?

I think I may not have done a great job explaining it earlier. But in 2013, we began getting more aggressive with the high FICO customers. Our current lowest invest rate is still below 2% today. So, what we saw as an increase in the volume of people at the very highest end of the credit spectrum, which was – have the effect of potentially bringing down our loss expectations. And so over the last 2 years, we have been trying to manage back towards a range that we have been comfortable with for a long time in the securitization market. So, you could almost think of that as a bit of a barbell effect. You wouldn’t see a dramatic step down in the overall FICO, because we are adding it at the top end and the lower end.

Understood. Thanks for the color. And then a question on traffic, a superstore, obviously, helps with the conversion rate, but traffic has been an issue for a few quarters now. And at the same time, readers’ report suggests industry retail sales are growing at a healthy clip. So, is that because of these aggregate of websites taking traffic elsewhere? And if so, would you consider having a bigger presence on aggregated websites?

I am sorry, we would actually consider any website and we have tried several. We have been on all of the big ones. We are on – we continue to test, I think all of our cars are currently on Car Gurus. So, we have tested all the aggregators and we will use anything that helps us drive incremental sales and delivers a good return. One additional comment on traffic, Bill mentioned some of this earlier is it’s been widely reported that customers are visiting less stores before they buy. So, it only makes sense that customers who show up would be more likely to buy. And as I have said, we think comps will be driven by traffic and conversion. It’s not going to always line up and it doesn’t matter to us which way to get it. So, lot of the efforts we are making around developing a new website given the customer more digital capability are – those efforts are to make sure that customers get more information, do more research, are more prepared. It’s clear that that’s what they want to do and we want to be in a position to do that for them. So, when they show up, they are more likely to buy.

Got it. Thank you.

Thank you.

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

Good morning, everyone. The charge-off, the increase in charge-off, was there any particular concentration in the profile of customers that you saw with these charge-offs or was this more driven by the lower recovery rate since this is the net number?

Yes, I think this quarter we feel like it was driven by the recovery – it’s a combination of both, but the recovery rates probably had a little more weight this quarter. And as far as any specifics around customers, we really don’t have anything.

Okay. And then with the recovery rate going down, is that simply a function of the Manheim or overall wholesale prices softening up a little bit during the quarter or were there some mix issues as well? Are you getting more sedans versus SUVs in the charge-off mix?

No, I think it’s just – it’s a by-product of overall pricing in the wholesale market. As you probably know, when we repo cars, we typically sell them off at our auctions and we realize whatever the auction market is delivering at that point in time. And as I said, year-over-year, we are down about 5 points in that wholesale recovery rate. And we never really see much mix impact on the recovery rate that’s always because it’s a pretty big sample. It’s generally going to be a macro trend that’s going to impact the recovery rate.

Got it, okay. Thank you.

Thank you.

[Operator Instructions] Your next question comes from the line of David Whiston with Morningstar.

Good morning. Just wanted to go back I think to an answer on an earlier question, I was trying to ascertain why applications in traffic are falling at the lower end of the credit spectrum. And it sounds like you are really just not sure, is that fair?

That’s fair.

Yes.

Okay. And then on auction prices, would you say are there any particular areas that are rather still too high in your opinion? Are you anticipating a huge falloff as more vehicles come off lease?

You are asking about supply now and not recovery rate?

Correct.

We have talked about lease volume in the past. And this past year, leases were 32% of used cars – of new car sales, roughly. That means you will see that flow come back in the next 3 years, 2 or 3 years. We have seen some increase this year, but I think we will see big increases in lease turn-ins in the next couple of years, not so much this year so far.

Okay, thank you.

Thank you.

We do have a follow-up question from the line of Matt Fassler with Goldman Sachs.

Thanks a lot. Just got back in line. So, my first question relates to stock comp, the number was up big year-on-year. Last year, Q1 had been a pretty big number too. If you look back over time, there hasn’t necessarily been that much seasonality at the stock comp and at the moment in time, the stock has been under some pressure, I was a bit surprised to see the number increase so much over anything you have had in the past, so can you talk about what that related to, please?

Yes. I mean, what you got to look at, Matt, is the year-over-year change in the stock price. So, I am not sure exactly what happened in the year ago quarter, but the lion’s share of the difference is going to be arising from the difference in the change this year versus the change last year’s first quarter….

And the change in the number of people.

And the change in the number of folks that are getting.

Is it the year-on-year change in the stock price, because year-on-year kind of today to exactly a year, got stuff down more than 20%. So, is it the magnitude of comp that’s being dumped through stock? Is it – does it have to do with exercise prices on options? What was that – what would the number be, what would the driver be to take the dollars up so much?

It’s largely related to our restricted stock program that the majority of our associates get, because those are going to fluctuate with the market value of the stock. And what you have to look at is not the year-over-year stock price, but the year-over-year change in stock price during the particular quarter.

Got it. Okay. So, to the extent that you might have started lower and moved higher that would have moved higher. Okay, we can follow-up. It’s a very big number and frankly, I think most of the shortfall versus consensus probably could be traced to that line item. Another question, since I have you, SUVs as a percent of the mix recovered nicely and do you feel like your ability to buy those cars at prices that you like is essentially back or the markets normalizing? Is your ability to navigate those dynamics improved as we have moved into 2016 here?

Yes. I think to what Tom spoke about earlier, we are going to get the mix in there based off of consumer demand. Are we are able to get that inventory? Yes, we feel like we are able to get it. I still think it’s probably a little bit high. But again, we are not having issues or troubles sourcing it.

And then finally a question on one financial detail, so you have this new disclosure on the other revenue and gross profit item essentially, the new vehicles plus the service piece is baked in there. So, the year-on-year increase in other gross profit is a bit bigger than what we can track explicitly to the higher warranty revenue and the lower third-party fees. I think you take those out and there is still a few million dollars. Is that all related to presumably lower losses or better grosses on new plus higher service gross profit or is there anything else from the number that would move it higher?

Matt, I think you hit it on the head. The [indiscernible] are up a little bit better than sales, because we have got some more margin in there and obviously the finance penetration is causing us to be favorable on that. And there is some service favorability in there that makes – that’s pretty much makes up the difference.

But nothing out of the ordinary, nothing extraordinary one-time, et cetera?

Yes, deeper than we expected and we did a little better than we expected.

Got it. Okay, thank you so much.

Thanks, Matt.

You have a follow-up question from the line of Irina Hodakovsky with KeyBanc. Irene, your line is open. Please proceed with your question.

Sorry about that. My question is also around SG&A. That line number was much higher than anyone anticipated. And if you could just maybe tell us how much of that you expect to stay and continue of course the higher store count and how much of that is something specific to the quarter than we can expect to improve going forward?

I think there was an increase of about $30 million and a large portion of that is attributable to new stores and store growth as a growth company. And then I highlighted in the opening comments, we had about $7 million or $36 per unit on share based comp and then we also had a one-time, where we had some hail damage in some of our Texas stores that was about $18 per unit increase as well.

Alright. Thank you very much.

Thanks.

You also have a follow-up question from the line of Michael Montani with Evercore ISI.

Hey, guys. Thanks. Just wanted to talk a bit if I could about the work you have been doing on the website, I think there was a re-launch in April and what have you seen from that that might be encouraging or incremental to justify kind of the investments in the work that you all have been doing?

Yes. So, I think it’s a little early on, but what I will tell you is one of the big drivers that we are looking for is what we call lead. So, it’s point to our customer either e-mails us, it sets an appointment, calls us and our goal with the new website is to make sure that we generate more leads, because leads are highly correlated to sales. So, ultimately, you want to drive traffic. Traffic will then drive the leads. We are at the point now where we are trying to figure out how those leads convert in comparison to the old website. We feel good about the leads it’s generating, but again we are trying to understand the conversion of those leads.

And then also can you update us on the thinking around the home delivery testing and then when might we be in a position to get a full transaction done online if that is you can hope?

Yes. So, the home delivery, we have referenced that in the last call. We did do a test. We have since pulled back on the test. We are looking at how to better operationalize that and we will be coming out with another test later this fall on the home delivery. As far as the full transaction online, that’s something that we will continue to explore. Like I said earlier today, we started looking online financing as a component of that. And again, part of that will also be driven by the consumer demand and need for doing the whole transaction online as well as making sure that we stay within the state restrictions of what can be done online and what can’t be done online.

Thank you.

We have a follow-up question from the line of Scot Ciccarelli with RBC Capital Markets.

Hi, guys. It seems like the thing to do today. I did have a question regarding buyback expectations. I thought the general plan was to do a pretty steady run-rate quarter-after-quarter, but obviously the buyback was a little bit softer than I think the pattern we have seen recently. What’s the general idea moving forward? Is it going to be more of an opportunistic pattern or it should be a relatively steady run-rate from what we just saw in 1Q?

Yes, Scot. I think, it’s – our goal as we have talked about before is to be kind of a steady player in there, but we are going to have some latitude around how aggressive we are based on where the stock price is in our view evaluation. As we talked about, we are targeting a certain capital structure that debt to capital, excluding the non-recourse stuff and account receivables of 35% to 45%. A quarter or so ago, we got up to the bottom end of that range. So, it would be natural to see a little bit of a tapering off as we have moved from a mode of moving to a newer capital structure, a more leveraged capital structure to one of maintaining that capital structure. That said, with the amount of cash that we have generated and becoming all things staying equal, the amount of cash we generate, the amount of growth we are doing, we would expect to continue to need to repurchase shares and add debt into the capital structure to maintain that. So, I would say, our expectation is to be in the market on a pretty consistent basis going forward, but we do have some parameters around our program that allow us to be more or less aggressive depending on market conditions.

Okay. So, the change in pace is more a function of kind of getting to that lower end of the cap structure rather than your assessment of the value of the stocks, I thought the other thing you just said, Tom, was regarding being opportunistic?

Yes, going from moving toward the capital structure to maintaining it. So, that would have a natural change of pace. But as I said, we are – I think we ended the quarter a little bit below this quarter. So, we have got that latitude of some 10 points that we will be working with them.

Got it. Okay, thanks guys.

Thanks, Scot.

Your next follow-up comes from the line of Mike Levin with Deutsche Bank.

Hey, guys. Thanks again. Just wanted to kind of get your feelings around the recovery rates that have been down on auto IBS across the market and for you guys this quarter. Is that playing a role in some of the tightening standards that you are seeing? How do you think that’s kind of going to progress going forward in terms of credit availability and cost of borrowing for your securitizations?

I guess, I would point to – we have been doing securitization, independent securitizations for over 13 years now and we have been able to manage through a lot of different market conditions, including recovery rates that are lower than what they are today. That said the structure and the enhancement in the deal might need to be modified if loss, if the perceived losses in the rating agency size change. What that usually means though is the change in the over-collateralization that gets built into the deals and builds over time, meaning we give money back a little bit slower. But in general, we have been – we will be able to maintain a pretty solid program through a lot of different environments. As far as our partner lenders, have you asked them about how they view that in their tightening, but again, they – I think, probably more of the impact is what they are experiencing in their portfolio than the overall wholesale market.

Got it. And if I remember correctly, a couple of years ago, when Santander did some pulling back, you guys added some lenders to the platform. Are you considering that now as well?

Yes. As I mentioned earlier, we would – we will test partners to the extent it makes sense for us. But as I also said, in this space, I think we need to be much more careful about who we are doing business with and make sure that we have established partners that can be reliable source of financing for our customers over a longer period of time. I know it’s been talked to a lot of players out there that are behaving aggressively. Santander has talked about that as well and that they are willing to let some of them get the business. But we are very focused on – in the right place for our customers and as I said, we will test as it is appropriate, but not many people have the national scale that we would need.

Understood.

Your next question comes from the line of Chris Bottiglieri with Wolfe Research.

Hi guys. Thanks for taking my question. I was hoping to follow-up on your CapEx guidance plan, I think last quarter, you took it up a little bit for the year, can you kind of explain that again, kind of how you said playing out the course of the year and what exactly that relates to?

Yes. I think and you saw a step-up a bit versus recent years, a lot of that is due to timing of what we expect land acquisitions to do over the next year. I really wouldn’t read into it too much as far as the existing stores or anything. We are working on a pipeline of many, many different locations, the next 3 years to 4 years of growth and our ability to acquire land is different in every situation. And I think as we look forward this year, we just saw a little bit heavier land acquisition than we have done in the past. And there is a lot of timing in there too as well, so if you look at the tail end of this year, there will be significant investment in the openings that are coming the following year. So that’s just our best guess that timing over the next 12 months.

Got it. Does that give you flexibility to uptake your store opening plan or is that just nothing read into there?

No, nothing to read into there, we have announced what our projections are and we are sticking to them.

Okay. And then one follow-up, just want to get your overall thoughts in the whole awfully supply that’s surging, I mean you are already sourcing about 77% of your units 0.4, which was really impressive, is there any reason to think that the added off-lease supply would actually accelerate that mix or is it really just instead of sourcing trade-ins, you are outsourcing off-lease supply like how do you think about that?

Yes. I kind of think they are unrelated we are going to drive – try to drive as much as we can through our own appraisal lane. I think when the off-lease supply starts to come back, like Tom said earlier, we haven’t seen a big off-lease supply coming back into the auction houses, but certainly when it does come back in, we will be in a position to buy them because we turn our inventory so quickly. If there are good deals we will be able to realize those good deals for our customers. So we kind of think about them separately, appraisal lane versus off-site.

But historically, when there has been a big lease volume and it comes back at the sale, we are usually in a pretty good position to take advantage of it. And just on a side note, it does organize the cars a lot better at the auction.

And how does the organization help, can you maybe just walk through that, you can play in better or?

Sure. In any given year, there is going to be – people are getting out of their car let’s say, every 3 years, 4 years, 5 years. Well, when it’s leasing, it’s pretty programmed that they are going to get out at a certain time. And a lot of those cars go back through whoever the lessor was. And then those lessors, then run big long lanes at the auction as opposed to those same cars, which might end up at the auction otherwise are spread out. And GMAC could be running 1,000 cars in a row.

Interesting. Okay cool. Thank you very much for the commentary. I appreciate that.

Okay. Thank you.

Thank you. That concludes the Q&A session. I would now like to turn the conference back to the presenters for any closing remarks.

Thank you very much. I want to thank everyone for joining the call today. And of course, I want to thank all of our associates for all they do everyday to make CarMax such a great success. And we will talk to you again next quarter. Thank you.