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

Brian Nagel - Oppenheimer & Co. Sharon Zackfia - William Blair Scot Ciccarelli - RBC Capital Markets Matthew Fassler - Goldman Sachs Craig Kennison - Robert Baird John Murphy - Bank of America Merrill Lynch Rod Lache - Deutsche Bank Michael Montani - Evercore ISI Irina Hodakovsky - KeyBanc Capital Markets Jamie Albertine - Consumer Edge Research Rick Nelson - Stephens Seth Basham - Wedbush Securities Chris Bottiglieri - Wolfe Research Bill Armstrong - CL King & Associates Paresh Jain - Morgan Stanley David Whiston - Morningstar

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 Second 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, everyone. Thank you for joining our fiscal 2017 second quarter earnings conference call. On the call with me today is Bill Nash, our President and Chief Executive Officer, and Tom Reedy, our Executive Vice President and CFO. Before we begin, let me remind you that our statements today regarding the company’s future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current knowledge and assumptions about future events that involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see the company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2016 filed with the SEC. Before I turn the call over to Bill, I hope you will all remember to ask only one question and a follow up before getting back in the queue. Bill?

Thank you, Katharine, and good morning everyone. First, I want to take a moment just to thank Tom Folliard for his significant contributions to CarMax over the last 23 years. We are very fortunate that he is still involved and will be Chairman of our Board and I am looking forward to continuing to work with him. So, Tom, if you are listening, which I am sure you are since I know there are no Boston sports teams playing at this time of the morning, thank you. Thank you from all of us here at CarMax. Over these past few months I have spent a lot of time on the road, visiting our stores and talking with our associates. I am incredibly proud of them. Our 22,000 associates across the country are doing an awesome job delivering the best car shopping experience in the industry. The success of our company is due to our great associates and I am committed to maintaining our strong workplace culture. I am also very excited about the opportunity we have ahead of us. In addition to our great associates, we have a top-notch management team here at the home office, CarMax Auto Finance, and in all of our stores to lead us into the future. More than 20 years ago CarMax was founded to fundamentally change the way used car buying is done. We have revolutionized the used car buying experience and our brand offer continues to resonate with customers. Now we are focused on extending that revolutionary experience. We are in a unique position to leverage our core strength which is the exceptional customer experience our associates are known for and extend it into a state-of-the-art online experience. We have launched a new Web site. We are testing new online shopping capabilities and we are continuing to build out a new technology infrastructure. All of these elements will ensure the entire car buying process is simple and seamless, both online and in our stores. And we are confident that our systems and processes put us in the best position to drive scalability and efficient execution nationwide. Keep in mind, we still only reach about 65% of the U.S. population. We are committed to our national expansion and will open 15 stores this year and 13 to 16 stores next year. Now I'll take a few moments to review some of the highlights of our second quarter results before I turn the call over to Tom Reedy to address financing. Then I will conclude with an update on some of our strategic initiatives. Our total used unit comps for the second quarter increased by over 3% and total used units grew 7%. Total used unit comps were driven by a strong improvement in conversion but it was partially offset by a decline in traffic. As we discussed last quarter, we believe our decrease in traffic was largely due to the continuation of less traffic from customers at the lower end of the credit spectrum. Used unit comps for our non-Tier 3 customers were significantly stronger this quarter at over 8%. When it comes to our total web traffic, it increased 4% compared with the prior year quarter. Gross profit per used unit at $2,160 remained consistent with $2,166 in the second quarter of last year. Our wholesale units declined by 1.3% in the second quarter. Compared to the second quarter of last year we had one less Monday this quarter and approximately 55% of our auctions take place on Mondays. Excluding the effect of the calendar shift, we estimate this year's wholesale vehicle unit sales growth would have been 1.4% year-over-year. Gross profit per wholesale unit decreased to $870 compared to the gross profit per unit of $951 last second quarter. Last year's gross profit per unit was exceptionally strong, so it was a tough comparison. Let me cover a few other topics before I turn the call over to Tom. As a percentage of sales mix this quarter, zero to four year old vehicles fell to 76% compared to 79% last year as a result of higher customer demand for older and less expensive vehicles. On the expense side, SG&A for the second quarter increased 11% to $366 million. This growth partially reflects the 11% or 16 store increase in our store base since the beginning of the second quarter of last year and an $18 million increase in share-based compensation expense. Included in the share-based compensation expense was approximately $7 million which relates, like every quarter, to nonexecutive compensation units that are settled in cash. This expense is driven by the change in CarMax's stock price during a quarter versus the change in the previous year's quarter. So the expense in this second quarter was based on a five dollar increase in price versus a decrease of $10 in last year's second quarter. The other $11 million included in share-based compensation expense is related to the Board's decision to modify certain equity awards previously granted to Tom Folliard. These modifications effectively treated Tom as a retiree even though he is somewhat younger but he far exceeded the service requirement having been here for 23 years. These changes did not accelerate the original vesting of his awards or extend the original terms. Now I will turn the call over to Tom.

Thanks, Bill. Good morning, everybody. Consistent with recent quarters, we experienced a year-over-year increase in credit applications from customers at the higher end of the credit spectrum and a decline across the lower end. This mix drove growth in the percentage of sales financed by CAF and growth in sales where customers paid cash or brought their own financing. CAF's net penetration increased to 45.3% compared with 43.3% in last year's second quarter. Net loans originated in the quarter rose more than 8% year-over-year to $1.4 billion due to a combination of CarMax's sales growth and our higher penetration. Tier 2 penetration fell year-over-year in the quarter by about 1 percentage point to 16.2%. While our tier 2 lenders performance based on what we see on their conversion of customers to sale, continued to be strong they were impacted by the decrease in volume for lower end credit applications as well. In addition to the slower volume, tier 3 sales continued to be affected by credit tightening at one of our third-party lenders. Tier 3 sales mix was 9.5% of used unit sales compared to 13.7% for the same period last year. This level of decline does not represent further tightening from what we experienced starting in the middle of Q1 of this year. CAF income of $96 million represented a decrease of 2.3% compared to the second quarter of fiscal 2016. This was due to a higher provision for loan losses and a lower interest margin, partially offset by a 12% growth in average managed receivables to over $10 billion. The year-over-year increase in the provision for loan losses in the second quarter reflected some unfavorable experience in the current quarter, the growth in receivables, and additional allowance that we booked based on our Q1 experience. Our ending allowance for loan losses at $110 million was 1.08% of ending managed receivables compared to 1.05% last quarter and 0.96% in prior year's second quarter. The allowance reflects the combination of both our experience in the quarter and adjustment for the overall portfolio based on what we have learned. This current level of loss reserve is consistent with our range of expectations, given our origination strategy and our portfolio mix. For loans originated during the quarter, the weighted average contract rate charged to customers was 7.4%, similar to 7.2% in the last year's second quarter. Total interest margin declined to 5.9% of average managed receivables compared to 6.2% in the second quarter of last year. The total interest margin however has been at about 5.9% for three consecutive quarters. Now switching gears from CAF to CarMax. Like last quarter, interest expense is up year-over-year to $14 million compared to $7 million in the second quarter of fiscal 2016. This was due to higher average debt levels which as we have discussed, are a deliberate component of our capital structure strategy, as well as the store lease extensions that we have previously discussed in our filings. During the second quarter we took down the remaining $200 million of a private debt deal we closed in Q1 and we repurchased $2.4 million shares for $126 million. Now I will turn the call back over to Bill.

Thanks. Tom. During the second quarter we opened three stores. El Paso, Texas, and Bristol, Tennessee, both of which were in new markets for us. We also opened a third store in Boston. Subsequent to the end of the second quarter, we opened a store in Boise, Idaho, another new market for us. During the third quarter, we expect to open five more stores. Four will be in current markets including Philadelphia, Orlando and two in San Francisco. The fifth will be in Grand Rapids, a new market for us. Last quarter I talked about how we are testing different online components of the selling process to better understand and meet our customers' needs. I would like to give you an update on those efforts. I previously shared with you that we had rolled out a new adaptive, more intuitive Web site. The new Web site combines an upgraded and enhanced design with a seamless experience across all devices. We also upgraded the entire site to a state of the art technology platform which will allow us to more quickly innovate, test new capabilities and personalize the experience. This is the first full quarter with the new Web site in place and we are pleased with the performance so far. We have seen a positive response based on increased engagement activity such as inventory searches, viewing of car page details and creating personalized accounts. With our new site, we have to continue to drive leads and convert more customers from the Web site to store and finally to a sale. Second, we have been testing an online financing capability to help our customers to get pre-qualified for a loan before they choose a specific vehicle. They can get pre-qualified for financing from any computer or mobile device and then finish their shopping experience more quickly in the store. We have expanded the pilot to 13 stores and we are encouraged by the customer response. We are looking forward to rolling out the finished product to all our stores in the next couple of months and we will provide with you an update next quarter. Lastly, we have previously mentioned that we conducted a small test of home delivery. This allows the customers to shop for and buy a car at their convenience without coming into the store. We are now conducting another larger test in Charlotte, North Carolina. Through this test we hope to learn the best ways to further operationalize this offering and deliver our hallmark exceptional customer service experience outside the store. We believe no one is in a better position to deliver as much of the car buying experience online as the customer wants. We believe that we are uniquely positioned to give customers the ability to go between the digital experience and the in-store experience whenever and however they would like. CarMax's national footprint, unparalleled inventory and brand strength position us to continue to lead the industry. Now I will open it up for questions. Victoria?

[Operator Instructions] Your first question comes from the line of Brian Nagel with Oppenheimer.

Bill, welcome to the CEO role.

Thank you.

So I have a couple of questions, and I'll squish them together here. First off, with respect to used car unit comps, clearly there was a lot of estimate for, I guess a lot of noise with regard to forecast for the quarter. As I look at the results today, call it the 3% used car unit comp, was quite good in the sense that it suggested an acceleration from first quarter levels. So the question I have there is, as you look at the dynamic behind that, can you help us identify what may have changed in the environment for CarMax here in Q2 versus Q1 to help to facilitate that acceleration in used car unit comps? And then I'll do my follow-up.

Yes. So, first of all, Brian, we are encouraged by the overall comps of the little over 3%. We are equally encouraged that we got that even with the headwind that we faced in the tier 3 space. So, again, if you looked at just the non-core -- I am sorry, the non-tier 3 sales, it was really at 8%. So we feel good about that. And I think really what you are seeing is the culmination of a bunch of different initiatives and better execution at the store level. I can't pinpoint it to necessarily one thing that’s driving comps this quarter over last quarter. I think it's the culmination of some of the strategic initiatives that we have been talking about and I think also just better execution at the store level.

So on that, is the supply situation, I know we talk a lot about supply over the last several quarters now, but are you seeing some relief on the supply side, is that positive?

Yes, I think on the supply side I think the expectations were that was going to be coming back more in full force at this point and continue on later into next year and in the year after. We really haven't seen a big, huge increase in the supply of late model cars. I think there is some coming out there but we haven't seen the big increase that I think was originally expected and we think it will come, our external partners being the auctions think they will come later this year into next year and even the year after.

Okay. And then my follow up on the -- with respect to the credit business. The loan loss provision there, just help us understand that. I get it, they're still very small numbers but the 1.4% here in the second quarter was up modestly year-on-year and sequentially. How should we think about that increase? Is it more one time in nature? Is there something happening in the business?

What I can say, Brian, is that it incorporates everything we have learned about the portfolio to date. We can't speak to how things are going to migrate in the future but I think it's important to point out that we have been in an environment of very favorable, not just we but the overall credit markets in general, have been in a very favorable loss environment for the last few years, the last couple of years at least. And it's not hugely surprising to see things starting to migrate a little bit differently. That said, all we can put into -- all we put into our provision is what we learned to date. We are not making any prognostications about the future and continued movement and obviously we will keep a close eye on it and adjust our strategies if it merits that. I mean it -- as I think you pointed out, quarter-over-quarter sequentially it's not that big of an uptick. If you look year-over-year, it's a pretty significant jump about, but about half of that jump we would have expected based on the fact that the portfolio has grown 12% and the experience that we had in Q1, we incorporated into our provision for this quarter. So there was some unexpected unfavorable experience but much of the change in the provision shouldn’t be too unexpected even though it was a pretty big step up.

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

I guess I'm going to ask two questions but really quickly. The subprime degradation you're seeing, Tom, can you talk about whether that's more on the applications or the approval side? If you're seeing a little bit of both and whether there's any stabilization occurring there?

Sure. Sure. Yes, I think mentioned -- we are seeing it on both sides, right. If you kind of looked at our degradation year-over-year, we would estimate that about 40% of the decline is due to application volume and the remaining 60% is really due to a change in behavior of our lenders, one lender in particular. So as far as stabilization, I think what we saw happen last quarter was during the quarter, during Q1, Santander, who has been in the press about and talking about how they are pulling back in different spaces, we saw change in behavior there in the middle of the quarter, so we didn’t really get a full quarter's impact of it in Q1, but since May we have seen stable performance in the tier three space that doesn’t, I am not speaking to the future, but we’ve seen four months of stability and this quarter reflects kind of a full quarter of the new world as it was since those changes. As far as the change, it's more of the same that we have talked about in the past as we have seen changes in lender behavior. Our global approval rate is still well above 90% but the quality of the offers and the attractiveness of those offers to the customers, it becomes worse if they are asking for more down or if they are asking for stipulations like proof of income etcetera. And so that’s the nature of the tightening that we have seen.

I guess as a follow up to that. Does this in any way kind of change your attitude towards maybe expanding the CAF test in subprime or, I know you're always testing other lenders. Is there anything you can do there to augment what's happening with Santander?

I think, as you pointed out, we are always looking at testing other lenders, we have got a test running right now but it's not big enough to talk about. The interesting thing about this space is there is very few national players, it's like much more a regional space in the financing world. So we can test additional lenders. As far as CarMax Auto Finance, we are comfortable with our level of activity where it is. I mean we are not -- Santander is not pulling back because they are delighted with what they are seeing in that portfolio. And when we think about that space, there is more to it than just the profit, there is the impact on our brand. There is the impact on our reputation with customers and in this current environment I think we are happier being thought of as a prime lender that has some activity in the tier 3 space. We are learning from it. We are learning how to originate. We are learning how to service. We are leaning how to perform and we are building a track record in that space. But we haven't determined that. Now is the time to go forward with anything greater. And if you remember, when we first rolled this out a couple of years ago, we have said specifically that we were not interested in this space in order to augment sales at CarMax. It was more of a learning and potential profit play and that we could be one of several players in this space.

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

You guys did talk about seeing some slower traffic trends from lower credit quality customers last quarter as well. With more time to analyze your data and any kind of surveys you're doing, do you have any more clarity on what may be driving that? I'm trying to figure out, are people kind of disqualifying themselves from even walking in because they know they're going to be declined credit or is this just fewer footsteps coming from a certain portion of the consumer base?

Yes. It's difficult to pry all that data apart, Scot. So unfortunately I think we are not going to have a real satisfying answer for you on that. We can really only comment on what we have seen in our stores. One thing we do believe is there is some co-relation between the quality of offer that we are providing in the stores and the application volume because there is word of mouth in the customer space. The quality of offers is currently down year-over-year and has declined over the last several quarters.

When you say quality of offer, you're talking about terms?

I am talking about the terms, not whether they are approved or not but whether they are approved and need another $1000 down or if there is something else. So what we have observed in the stores is a reduction in those applications, call it the below $600 FICO level and continued increases in the volume of applications on the high end. Now I can't speak to what other people are experiencing but we have seen some communications from other retailers that this particular segment of customers is a bit challenged today. So to the extent that might plan the things that’s there. But when you ask about that and what you might do about it, is we think about hypothesis where we could be driving this it's not apparent to us that there is a course of change in our action in this segment that would be appropriate. Remember, we have always talked about this business as incremental and we already invest $1000 per car into this channel in order to realize half, a third to half of the profit of a tier two or a CAF deal. So we could speculate that, would our lenders like to see more money from us in order to be more aggressive. I am sure they would say they would try. But I don’t think we are interested in increasing the, or decreasing our margin any further on this space and we are certainly not interested in increasing prices to subsidize our tier 3 partners. That’s just not good business for us. I think the investments Bill discussed in our online capabilities and customer experience are a high priority for us and looking at the business absent the effects of the tier 3 space, we are pretty pleased with the momentum we see at the 8% comps. And in the longer-term growing off the base of 45% CAF and 10% tier 3, is a much more profitable equation than when we were seeing tier 3 in your 20% a couple of years ago. So I don’t know what it makes of the overall environment but like I said, I don’t think there is any action or course we would change to try to address the phenomena we are seeing.

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

I've got one question and one follow up, if you'll let me. We talk about traffic and some of the traffic declines. We haven't spoken a lot about the quality of traffic, not in terms of creditworthiness but in terms of how much research consumers have done and one would think that the attachment rate of heavy web research with the transactions growing substantially. So, is traffic as relevant of a metric for you? That could be a function of why, that could be why your conversion is rising the way it is. So should we even be looking at traffic at this moment in time? I realize it's a good legacy metric, but it doesn't seem to be aligning with your comps and perhaps that's the reason why.

No. Matt, I think that’s a good point. I think we know that nine out of ten of our customers that are buying from us start their shopping experience online. And they are coming in with better research already having been done. I think for us store traffic is still important and to your point, it has been kind of a legacy metric for us but I think equally important is we need to be looking at web traffic, we need to be looking at leads. Leads are highly, in the past they have been highly co-related to sales. So I think you have to step back and take more of a holistic picture and not just look at traffic. Because I do think part of the reason conversion is up, I think it's from execution, but I also think it's partly because people are coming in more informed and knowing what they want.

My follow up relates to cut and stop sale. All independent used car retailers are operating, I believe, with less restriction than franchise dealers, at least when it relates to the brands associated with, that those dealers typically sell. Are you getting a sense that this is taking your share higher? Are more customers coming to you because they can't get access to the cars they want at the franchise dealers?

No. I mean that’s really a hard thing to come out and I would say we believe that we are not necessarily getting some big benefit from that. We are real proud of the transparency that we have when it comes to recalls. We have led the industry. If you shop online, you will see, you will get the ability to check them into Web site to see if there is any open recalls. When you come in the stores, you can't buy a car without working through the sales consultant to understand, are there any open recalls on these vehicles and if they are signing off on those recalls. So we feel good about that. And to your point, there are lots of other dealers out there selling vehicles with open recalls. I just think that we do it in the most transparent way.

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

Bill, you mentioned that CarMax covers about 65% of the addressable U.S. market today. But with your opportunity to invest in some of your digital initiatives, could the pace of investment in those bricks and mortar stores slow in some of the out years?

So, Craig, what we said and we will probably update this later on, but we are still committed to the national expansion. We have got 13 to 16 stores planned next year. Certainly I think as we go forward, we will look at the design of the stores and the design of the prototypes may change but at this point we are still committed to building brick and mortar facilities.

And just as a follow up. How many states will allow you to use home delivery as part of that new service you've piloted?

Yes. I don’t know that off the top of my head, Craig. I would have to get back to you on that. With your earlier question, the other thing I would just reiterate is we think that the advantage for us will be, as we look forward it's going to be a combination of having that store presence but then also being able to do the transactions online and being able to combine those two. And I think to be ultimately successful, or as successful as I think we can be, we need to do both of those really well. Well, that’s why we are still committed to building out facilities.

Your next question comes from the line of John Murphy with Bank of America Merrill Lynch.

Good morning, guys. Just wanted to touch on SG&A because it seemed like a pretty good performance in the quarter. I mean when we back out the increase in stock comp, there really wasn't much deleveraging and we're looking at a store base that's almost 11% greater year-over-year. We're looking at investment in online opportunities and all your new efforts, yet we're not seeing a deleveraging in SG&A. So just curious, as we think about all the buckets of potential increases in deleveraging that we usually would expect, how are they playing out in SG&A and how do you think that should work going forward because it really is a very impressive performance. There really was no SG&A deleverage and traditionally we would look for like a 7% to 8% increase in same store sales to see this kind of performance and you put up a good number, 3.1%, but I mean it's not what we would have expected. It was a very good performance. Is there anything going on here in thrifting in certain areas or investment that might not be as great as we're thinking?

John, this is Tom. One think I would point out is something we called that in the release, is that there is some other favorable things going on with regard to incentive comp in this quarter that were larger than what we have seen in prior quarters. And it's relatively in line, I mean that stock-based comp was up quite a bit. But if you look at that and then the full year adjustment, they're of similar magnitude. So I wouldn't read into this that we're doing a better job with SG&A than we had been in the past. We're investing comp and benefits. If you look at those two things, absent those two things, is in line with that, the 11% you see on the table in the graph. Store occupancy is up in line with our growth of stores. So there's nothing really to talk about there. Advertising looks light relative to last year, but that's because last year we were in the midst of creating a new ad campaign that rolled out in Q3. So, both Q2 and Q3 last year were heavy ad spend.

And John, the only thing I'd add to that, I mean we still feel like we can leverage at the mid-single digit comps and to Tom Reedy's point, we're continuing to invest in some of the technologies, in the digital experiences that I talked about earlier. Now that being said, we have an SG&A on a yearly basis over $1 billion and we're certainly focused on continuing to look at opportunities and continuing to do things better to continue to leverage more in the future.

So maybe to put a finer point on it, you would say that roughly something in the 5% to 7.5% range on same store sales comps would be enough to create some small leverage on SG&A, given all the efforts that are going on right now?

I think that's fair. I...

We see some leverage at mid-single digit. 7% is pretty big. Once you start getting above that fulcrum of leverage, it gets pretty powerful. So I would say 7%, we feel pretty good.

Okay. So, 5% plus or minus is breakeven and as we get above that there's potential for some really good operating leverage to kick in?

And I'd just use that as a rule of thumb. We haven't dusted that off.

That's incredibly helpful. Just one quick follow-up. We see rates ratchet up on the cost side on CAF. You guys increased the cost to the consumer, I think, 20 bps. What is your comfort level in passing through the cost increase through to the customer so we don't see spreads sort of on a continuous basis, compress?

Yes. I think we're constantly testing at CAF, both up and down, depending on what we're seeing in the marketplace. And I think I've said this before on calls, the performance of the finance business is going to be somewhat market driven. We have to be an attractive alternative for our customers in financing or else we'd be turning people off to CarMax. So, if competition is aggressive and willing to accept a slightly lower spread than they are currently, we will have to adjust our offers over time to meet that competition and make sure that we're still relevant to the customer. That said, if you look at the last eight or nine securitization deals, the spread has been pretty consistent in the mid-5s. And that's not out of line with what we've seen in higher interest rate environment. So like I said, we've been in higher interest rate environments before where cost of funds have been higher, where we've been able to achieve the spreads we are today. What's really the wild card is competition and how aggressive they get. And like I said, we'll have to be a market player, and that's just part of being in the finance business.

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

Two questions. One is, there have been a few anecdotal reports, I think Experian and a few others, talking about a trend of consumers shifting from the new market to the used market, just given the inflation that's occurred in new car pricing. And I was wondering if this is something that you're observing and whether that you feel is a trend that could be quite meaningful? Obviously, seeing 8% comps in the prime side of things might support that.

Yes. I have not heard that. I hope it's the case but I think part of what's helping is the prices of wholesale vehicles have gone down. Our ASP went down slightly. I think it's a factor of -- part of it's a shift from the zero to four to a little bit older vehicle for us. Part of it is the cheaper acquisition price as well, with a little offset in the fact that our large SUVs as a percent of mix are a little bit higher, a couple of points higher than they were a year ago. But I have not heard what you're referencing.

Okay. Thanks. And just, I guess, a follow-up on CAF. It's been a relatively modest increase in provisions but just in terms of the trends that you're observing, is the decline mostly a function of frequency or is it severity as you're seeing some modest declines in used car prices?

I think what we observed is a little bit of both. Last quarter it was a little bit more severity. So, if you look at kind of recovery rate year over year, it was more impactful last quarter. But at the end of the day, we've just got to keep an eye on both of them and we watch what's happening in the portfolio and we can adjust as we go.

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

I wanted to ask first, if I could, can you just give an update on SUV and truck penetration this quarter versus a year ago? And then just talk about your ability to source between those buckets and toggle between them as prices soften a little bit.

Yes. So SUVs for us was up about 2 points. I think it was 25% of our mix, which is about 2 points higher than a year ago. And again, we're out in the market every week, every day, buying cars, and if we feel like they're at a good price, we're certainly going to buy them if that's what the customers are demanding. We want to make sure it's a good price. Again, we sell what the consumer demand is on our lot. So as prices shift, that's pretty much standard operating procedure for us. We're able to go in and take advantage of those offers.

If I could just follow up on some of the online initiatives that you have, one question there is what you're seeing in particular if you can share, Bill, around the rollout of home delivery that's encouraging and making you expand it? And then the second question was, when you look at search engine optimization, if I do a Google search for used cars, you all are coming up on page four. And it just doesn't make sense to me. So I guess the question is, what kind of priority do you assign to search engine optimization and moving up that non-paid list on Google?

Right. So on the home delivery, if you remember, we did a very limited test back in February and the goal of that test was really to see, does this resonate with our customers. And we felt like there is enough interest at the customer level that we decided to, okay, let's look at this, try to operationalize a little bit better and we had talked about coming back with a second test. It's really too early to give you any results because we just started the second test, just in the last couple weeks. And, again, the plan for this test is to understand, have we been able to operationalize it better, can we operationalize it even more. And then, really important to that also, is that we want to make sure that the experience meets our high standards of great customer service that we have in the stores. So that's really what we're trying to understand with this piece. It's too early to really talk about any type of results. On the search engine optimization, obviously a big part of the web redesign is making sure that when customers search for us, that we come up organically. That's the best thing. When you don't have to pay for a lead and you just automatically come up on the first page. And what I can tell you, if I look at over a year ago, about a year ago if you searched for us in some generic terms we didn't show up on the first page. We were in some cases several pages below the first page. And if you search for something, you typically don't go many pages past the first page. I'm pleased to tell you that we've made great strides. And when you type in key words now, we're on that first page and our goal is to continue to climb that first page. So, we're encouraged by the results and the progress that we've made since we've been working on it.

Your next question comes from the line of Brett Hoselton with KeyBanc.

This is actually Irina Hodakovsky on for Brett Hoselton. How are you? Most of the questions have been asked. I do want to ask a basic question on the share buyback. In your release you stated you have $1.89 billion remaining open. Last quarter your release stated $1.27 billion. Has there been an increase and what should we expect going forward?

Yes, I think, our board authorized a $750 million increase last quarter and they also took off the time limitations on the program. So I think the message there is it's become a part of what we do. As far as on a go forward basis, we talked about having a target capital structure in the adjusted debt to capital range of 35% to 45%. Both last quarter and this quarter we're scratching up on the bottom end of that. And as I said last quarter, I think you can look to be more in a maintenance mode rather than a shifting the capital structure mode on a go forward basis. That said, with the cash flow nature of the business as it stands today, we'll continue to generate significant cash and we would expect to continue to buy back stock and continue to add debt to maintain those targets. And as we've said before, we try to do a little bit of an enlightened averaging in. So I wouldn't read into volume in any given quarter. It may be dictated by our view on valuation versus where things are.

What is the new updated expiration date on the program?

As I said, they eliminated the expiration feature of the program.

Oh, eliminated, I'm sorry. I didn't hear that correctly.

It's part of what we do now and we expect to be in the market maintaining the capital structure.

Your next question comes from the line of Jamie Albertine with Consumer Edge.

I just wanted to understand if there were any changes from an inventory management perspective as it relates to when a vehicle's VIN would go in and out of your system as it's perceived on the web. Whether it's related to transfers across stores or if it's always a sale, or if it has something to do with recalls. Just wanted to get some underpinnings as to what may be driving the shifts in inventory we might be seeing from a web [indiscernible] perspective intra-quarter. Thanks.

Yes. We haven't changed any of our practices or processes or behaviors. So I really can't speak to that.

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

I have a question about wholesale operation. The participants in those auctions, the independent used car lots, how dependent on subprime finance do you think those independents are?

Yes, Rick, I think they're probably more dependent than a franchise dealer, but some of them finance themselves. It's really hard to say.

This is Tom. One thing I'd point out also, and I can't speak for the practice at all of those customers, but they do usually as a matter of course, have the ability to change the price that they charge the customer. So to the extent it's getting more challenging in subprime and their vendors may be asking for more money up front, they have more flexibility to do it than we would in our fixed price system. So the answer is, we don't know and I think it's across the board but there are some levers that they may pull that we certainly wouldn't.

And I think that phenomenon exists even with other franchise dealers.

Okay. Thank you for that. Is all the decline in the tier 3 at all due to the tier 2 dipping into that tier 3 bucket? I know you've discussed that in the past.

I think in past quarters we've observed that. Tier 2 is clearly, from the data we look at, clearly behaving more aggressively, which is great for us, than they were a year ago, and when we look at conversion of the applications that they're seeing. So that would de facto be another thing that impacts the volume that tier 3 is seeing. But as I mentioned, tier 2 is down a little bit as well, just because of the overall mix shift. So, while they're behaving more aggressively and they're doing a great job for us and we're happy with the partners we have in that space, less is filtering down to them because more of it is getting caught by the high end credit and CAF.

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

Thanks a lot and good morning. My first question is a little bit more broader on the wholesale business. With wholesale gross profit down 10% year-over-year, obviously you had a calendar shift. But are there any other things you can point to which led to that decline and how do you think it's going to perform going forward?

Yes. So if you look at the wholesale margin GPU, I called out earlier in my remarks, it's a very tough comparison. When I say tough comparison, last year's second quarter was the highest GPU for wholesale we've ever experienced as an organization, so -- I'm sorry, in the second quarter. So, it was a very tough comparison. I think what you're seeing is the amount that we're at now is more representative of a typical second quarter. The other thing that I would point out is, last year's second quarter from a depreciation or appreciation standpoint, it was really stable. This year it was a depreciating market and you know we aren't proactive, we're more reactive and we move as the market moves. We don't speculate. So I think it's a combined factor of tough comparison and also a different type of market this second quarter, which really is more representative of what we would typically see in the second quarter versus last year.

Got it. Okay, that's helpful. And then a follow up question, Bill. The company has had a practice of trying to maintain gross profit per unit pretty flattish for the last five years or so. How do you think about the balancing of comps versus GPU going forward?

Yes. I've been involved with the organization for a long time and we've held that $2,100 to $2,200 pretty consistent for multiple quarters. Like we've talked about in the past, we're always willing and we're always trying, if you give up a little bit of margin, do you make it up more in sales, so that your total GPU or total gross profit goes up. We'll continue to test. But I also feel good about the fact that we're able to maintain that GPU. And as I think about levers to pull, if we want to make sure our price stays competitive, it's not just GPU, it's also acquisition price and it's also about the dollars that you put into a vehicle to get it to our quality standards. So again, I think our focus is going to be on acquisition price, it will be on the reconditioning, because again we're more focused on the spread between what we buy a car and what a customer ultimately pays for it. And we think that we feel good about where the margin is right now. We'll continue to test, obviously, but we're really focused on acquisition cost and the amount that we put into it.

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

So SUV and truck mix was up pretty considerably. That should have driven ASPs higher. I'm not sure what you said about late model vehicles, the zero to fours, if those increased or not at the penetration level. I guess taking that together, your ASPs were actually down year-over-year. So, do we read into that, that you took a price investment this quarter? That being said, you held your GPU per unit even though your wholesale acquisition cost per unit seemed to increase. I'm just trying to triangulate all of that. Like what's the takeaway from all of that?

Yes. Chris, earlier I mentioned, while our mix was up slightly in the large SUVs, and you're right, that would drive the average ASP up a little bit. But we more than offset that with the fact that we had a mix shift. We didn't sell as many zero to four as we did last year, zero to four year old cars. This year we sold a few percentage points more in the older vehicles and those are typically less expensive. And the other thing that I would point out, that I spoke about earlier was we saw a cheaper acquisition price and that's reflective of what's going on or what went on in the market during the second quarter. So, it's really a combination of those three factors to get us down to a lower ASP.

Okay. That makes sense. And then on tier 2, I'm not sure if you guys disclosed this historically, but what percentage of those loans would you say are subprime by FICO standards, like less than 620? I think you called [intentional] [ph] a slight pullback there.

A majority of them.

Majority of tier 2.

Yes. I think, like I said before, I think subprime can be in the eye of the beholder.

Yes, I agree.

CAF, a wide spectrum of folks and FICO score is not the only indicator that lenders use to determine creditworthiness and whether they're going to advance. So some of what CAF does falls into that lower end. A good amount of tier 2 falls into that lower end and clearly all of tier 3, unless there is something really funny about the deal, fall into that lower end of the FICO. So as I said, tier 2s, their volume has been impacted but their behavior we're very happy with.

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

You took out a new $100 million warehouse facility for CAF tier 3 financing. Does this portend, perhaps, an appetite with CAF for more tier 3 lending or should we not really read anything into this?

I guess the short answer is, I would not read anything into this. As I discussed a little bit earlier, we are comfortable with our current level of activity and have no intentions at this time to change that. That said, like we want to learn about the space. We think it's good to build a track record on the financing side and I would rather use that capital to buy back stock and build new stores than fund the subprime initiative. So it makes sense, even though it's a small amount, it makes sense to take out debt against it because we can use third party capital.

Got it. And would you be -- you wouldn't be securitizing this, you would just keep these loans in the warehouse facility and work through it like that?

Well, the warehouse legally is a securitization. So it's a non-recourse facility just like the warehouse for the core business but I think at this point we're comfortable with what we're doing. To the extent it ever got bigger, then we'd start contemplating permanent financing vehicles but we're not anywhere near that at this point.

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

Just a question on superstores. When you look at some of your peers, particularly on the franchise front, they're increasingly moving to a smaller store format. Can you remind us again as to what the relative advantages of a superstore are in today's environment?

Well, Paresh, what I would tell you is, I actually haven't heard the superstore name in a long time. We used to have what we called superstores. The mix of stores today are dramatically different than they were even 10, 15 years ago. And when I look at our stores today, we have small format stores which has been introduced in the last five years. We also have satellite stores that don't have production. We have satellite stores with production. We have bigger production stores and then typical size CarMax stores. So, I think what you've seen over time with us is that we've shifted our prototypes and our models depending on the market that we're going in and we don't open up just one standard store size.

I think I'd add to that is, when we go into a market, no matter what kind, we're taking into account what our expectations are for sales volume in that location, which means how much inventory we need and also whether there's going to need to be an auction production. It's a bigger puzzle and it might involve various locations, and we try to flex the size of the space to the need that we view is in that particular market. As Bill said, we've got a number of smaller prototypes now than we did several years ago.

Understood. And just a follow-up on home delivery. When you look at some of the new entrants in this space, customer acquisition costs could be significantly higher, perhaps more than double the $200 to $250 range that you guys might be seeing. Is that something you'd be comfortable with to gain traction for that business or take it up a little bit higher than what your current range is?

Yes. That's one of the reasons why we're testing it. We want to make sure that it resonates. We're talking about probably a very small subset of CarMax customers that would take advantage of this. We still think about how complicated the used car transaction is and how it needs human intervention, which we do a phenomenal job in our stores. Again, it's a test for us and we'll give you more updates in the future.

It's too early to talk about whether it would be worth the additional cost because we need to scope what those additional costs would be and vet that out more significantly, and also determine how much incrementality there would be in that particular segment. We think it's much too early to tell.

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

You touched on this a little bit earlier. I just still wasn't clear. Any idea why your zero to four year old mix fell despite there being less traffic from the lower credit quality customers? Is there a bit of a supply issue there?

No, there is not a supply issue. Again, we're meeting the demands of our customers and if our customers are looking for more older vehicles that are less expensive, then we're going to meet that need. So, it's more driven off of the customer need than any supply issue.

Okay. Thanks. And, Bill, now that you've had some time to travel around the store base a bit, is there anything you want to change or improve about the operations or the company as a whole?

No. Like I said earlier, I'm really excited and proud of what our associates do on a daily basis. Their job is not an easy job. And when I go out to the store, I see improvements. I see dedication to the company. I see everybody looking to figure out, how can we execute better and do our jobs better and provide a better customer experience to our customers? So, no, I think it's going great.

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

Thanks for having me back for a couple of follow-ups. The other overhead line within SG&A was up meaningfully. Is that technology investment or is something else showing up in that line item?

The bulk of that, you've hit it right on the head, the bulk of it is investment in technology and digital.

Is that likely to persist directionally?

Yes, we're going to continue to invest in that. And to my point earlier, we spend over $1 billion. So our job is to make sure that we refocus some of that money, so it's not all incremental. But, yes, we will continue to invest in this.

And then, secondly, you've spoken a bit about zero to four and the age of cars that you're selling. I want to try to tie that in to the sources of used cars coming back onto the market. Presumably with the SAAR stabilizing or even slowing somewhat, transactions emanating from consumers buying new cars are flattening out or moderating but the institutional supply of cars coming off lease, I think, continues to grow. Are more of the cars that are hitting the market in that zero to four coming through auction rather than through trade in the marketplace at large? And is that one of the factors that, given your desire to maintain self sufficiency at a fairly high rate, is that one of the factors that could be impacting what you're selling? And, if so, does that impact profitability at all? It doesn't seem to be doing so, yes, but just to play that out.

No, I don't think there's any big meaningful difference that we've seen through the appraisaling or through the auctions as it relates to zero to four. I do think we're a little surprised we haven't seen more of it funnel back. But, again, to my point earlier, we think that that's coming and it will be over multiple years. It certainly won't come back all at one time. And when we talk to our auction partners they agree that there's probably a lot that will be coming back next year and even the year after.

That's our last question. I'd like to turn the call back over to the presenters for any closing remarks.

Great. Thank you, Victoria. In closing, again, I just want to thank all of our associates nationwide. They're doing an outstanding job delivering an incredible customer experience every day. We would not be the successful company we are today without our associates and their dedication to the customer. We have a long runway of growth ahead of us. No one is in a better position than we are to continue to give the customers the best car buying experience online or in the store and we look forward to the opportunity to continue to lead the used car retailing industry. Thanks for your interest in CarMax and your support and we will talk again next quarter.

Again, thank you for your participation. This concludes today's call.