Katharine Kenny - VP, IR Bill Nash - President and CEO Tom Reedy - EVP and CFO

Sharon Zackfia - William Blair Brian Nagel - Oppenheimer Matt Fassler - Goldman Sachs Rob Iannarone - RBC Capital Markets Craig Kennison - Baird John Murphy - Bank of America Mike Levin - Deutsche Bank Seth Basham - Wedbush Securities Derek Glynn - Consumer Edge Research Rick Nelson - Stephens Bill Armstrong - CL King & Associates Adam Jonas - Morgan Stanley 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 2018 Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Katharine Kenny, Vice President, Investor Relations.

Hi. Good morning and thank you for joining our fiscal 2018 second quarter earnings conference call. On the call with me today as usual are 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, 2017 filed with the SEC. Before I turn the call over to Bill, let me thank you again in advance for asking only one question and a follow-up before getting back in the queue. Bill?

Thank you, Katharine, and good morning, everyone. We are pleased to report another strong quarter. As always, I will talk about the quarterly results including the impact of Hurricane Harvey, then I will turn the call over to Tom to review financing after which I will comment on our initiatives as well as share some information on Hurricane Irma. Our used unit comps for the second quarter increased by 5.3% and total used units grew by 11.1%. Used unit comps continue to be driven by strong store execution as well as enhancements to the online customer experience, both of which support an increase in conversion. The impact of higher conversion on comps was partially offset by the effects of lower store traffic. As you may recall, Harvey hit Houston during the last week of our second quarter. CarMax’s first priority will always be the safety and wellbeing of our associates. We have approximately 1,000 associates in the Houston area and while all of them are safe now, many were affected by the hurricane. We supported them with financial assistance through our Associate Disaster Relief Fund and provided them pay for the regularly scheduled shifts while the stores were closed. In addition, we sent emergency supply to Houston as soon as possible to support associates and their families. All six of our stores in the Houston market were closed for the last 5.5 working days of the quarter. Five of the Houston stores reopened on Friday September 1st with relatively little damage. Our Gulf Freeway store remained closed until Friday September 8th. We estimate the impact to our comps to these closures was small and as we said in the past, weather can delay sales but we generally expect to make them up in future periods. This event reminded me once again of the incredible value of our national footprint and our nationwide transportation network. We have been able to leverage both as damaged vehicles needed to be removed and replaced with vehicles from other markets to quickly support the needs of our customers. Now, I’ll update you on some more of the numbers. In the quarter, we were pleased to see website traffic growth of 17%, which we believe was partially result of our efforts in SEO. Gross profit per used unit remained consistent at $2,178 compared to $2,160 in the second quarter of last year. Our wholesale units grew slightly in the second quarter. The growth in our store base and an increase in buy rates were offset by the continuation of lower appraisal traffic. Gross profit for wholesale unit increased to $950 compared to $870 in last year’s second quarter, largely due to a favorable depreciation environment in this second quarter. A few other topics and I’ll turn the call over to Tom. As a percentage of our sales mix, zero to four-year old vehicles increased to 80% versus about 76% in last year’s second quarter. As a percent of sales, large and medium SUVs and trucks rose to 27%, which is similar to last quarter but up from about 25% in last year’s second quarter. On SG&A, expenses for the quarter increased almost 11% to $405 million. This represents a year-over-year reduction of $9 per unit in SG&A. Several factors impacted SG&A growth including the 12% or 19-store increase in our base since the beginning of second quarter of last year, higher variable cost due to our increased sales, and an increase of about $16 million in our accrual for incentive pay. Remember that last year, we disclosed the measurable reduction in SG&A related to incentive pay. These were partially offset by an $11.4 million decrease in share-based compensation expense which was largely due to comping over the $10.9 million retirement related expense for our former CEO, recorded in last year’s second quarter. As we previously discussed, we continue to invest heavily in technology and digital initiatives to improve the customer experience. SG&A expense was in line with our expectations in the second quarter but recall that the first quarter saw the benefit from favorable expense timing, some of which could materialize later in the year. Lastly, during the second quarter, we opened three stores, one in the Hartford market, one in San Francisco and one in Salisbury, Maryland. During the third quarter, we plan to open five stores, one will open in Tyler, Texas, which is a new market for us, the other four stores are in current markets including Philadelphia which we just opened a couple of days ago, Las Vegas, San Francisco and Seattle. Now, I’ll turn the call over to Tom.

Thanks, Bill. Good morning, everybody. CAF net penetration was 43.5% compared to 45.3% last year’s second quarter. We continue to see overall growth in credit applications, but more pronounced at the high and low end of the credit spectrum. Remember, last year, we were seeing measurable growth in credit applications at the higher end of the credit spectrum and a decline in application volume at the lower end. Tier 2 financing represented 16% of sales compared to 17.5% in last year’s second quarter, and third-party Tier 3 grew modestly to 9.6% of used unit sales, this compared to 9% for the same period last year. We also continue to see growth in sales where customer paid cash or brought their own financing; that was up to 25.4%, as you can see in the table in the release. CAF net loan originated during the quarter rose 7.5% year-over-year to $1.5 billion. This was due to CarMax sales growth and an increase in average amount financed, partially offset by the lower penetration. CAF income increased 12.5% to $107.9 million, driven by the 10.6% growth in average managed receivables and a lower loss provision. This was partially offset by slight compression in the portfolio interest margin. Total portfolio interest margin was 5.8% of average managed receivables compared to 5.9% in the second quarter of last year, but consistent with what we reported in the first quarter. The loans originated during the quarter at the weighted average contract rate charged to customers was 7.6% compared to 7.4% a year ago and 7.8% in the first quarter. The ending allowance for loan losses at about $130 million was 1.15% of ending managed receivables, up from 1.08% in the second quarter of last year but down sequentially from the 1.18% in Q1. As you remember, we were seeing unfavorability in losses over the course of last year. This quarter’s loss experience is directly in line with our expectations. Losses in Q2 were not affected by Hurricane Harvey and the provision does not include any potential loss experience from weather events as the impacts are unknown at the current time. With regard to our capital structure, during the second quarter, we repurchased 2.5 million shares for $157 million. Now, turn it back over to Bill.

Thanks, Tom. We continue to be focused on driving what’s possible through both execution and innovation. We are in a unique position to combine the state-of-the-art online experience with the exceptional customer service our associates are known for. Whether in store or online, we want to give our customers the tools and support to find the perfect car, purchase that car and then receive that car all on their own terms. Last quarter, we gave you an update on the test of our online appraisal tool. This is a new online tool that allows customers to receive an appraisal value for the vehicle by submitting information online. We rolled out this product to the rest of our Charlotte market stores this past quarter and in the third quarter we plan to expand to more stores in the Midwest. We’re receiving great feedback from our customers and sales team about this new offering. The purpose of this test is to further learn about the customer demand for online appraisals and to ensure a great experience that is scalable across all stores. We’ll take the learnings from this next round of test to continue to enhance the product and determine when it should be rolled out to more of our stores. We also shared with you last quarter the progress we’re making in digital merchandising, which is how we showcase our vehicles on carmax.com. In addition to the rollout and improvement of indoor photo studios, we’re expanding our capabilities by offering 360 degree interior photos with zoom capability. We’re now testing this product in vehicles at seven stores. These are just a couple of examples improvements we’re working on. We will continue to build out our e-commerce capabilities and equip our associates with the right tools to make the entire car buying process simple and seamless, both online and in our stores, and we truly feel that no one is in a better position to do that than us. Before I open up the line for questions, let me give you a brief update on the impact of Hurricane Irma. We’re pleased to report that all of our stores are open for business. We closed 28 stores, primarily in Florida and Georgia for varying lengths of time in September. And as we previously discussed with weather events, we would expect to realize those sales later. Now, at this time, we’ll be happy to take your questions.

[Operator Instructions] Your first question comes from the line of Sharon Zackfia with William Blair.

Hi. Good morning. Just a question on the work you’re doing on the visual, the photography online. I know, you’re kind of in different processes and you just talked about another test that you’re working on. How are you assessing the impact of those tests as it relates to either traffic to the store or conversion? And then, assuming that these are going well, how long would it take to kind of implement better visuals online across the entire system?

Good morning, Sharon. Yes. So, on those, both the photo booths and the 360 photos, we assess the success of those by clicks on the websites on those particular cars. So, obviously, not all of our photos are done in photo booths. And so, we look at the success, the number of clicks we see on those cars, as well as the conversion of those vehicles compared to other inventory that doesn’t utilize those capabilities. As far as the time that it would take to roll it out, I talked about last quarter, the photo booths, at the time, we already had 16 open; this year, we’re on schedule to get 19 more of those open. And then for the 360, we’ll see. Right now, we already have it in seven stores, and we’ll see how it goes, and we’re still working on the equipment, that kind of thing. So, stay tuned. I can’t really tell you, okay, next quarter will be this number and that number, because we’re still looking at the experiences. We want to make sure, when we roll it out more widely that it meets what we would expect from a CarMax standpoint from exceptional experience.

And can I just a quick follow-up? So, the photo booths in particular is the rollout pace based on the expense of it or based on you just not being sure of the ROI of it?

No. I think the rollout is -- we can only handle so many different projects in any one given year, while there is an expense associated with it, that’s not the reason why we aren’t rolling them out quicker. So, we can only -- I mean, we’re adding an additional 19 more this year on a base of 16. It just takes time and resource to get those built.

Yes. Sharon, we’re also thinking it up a little bit with just planned rehabs of the stores.

Yes. So, on the remodels, we’re doing 10 more full remodels. We’d like to work to photo booths into that and then we go and we choose certain other markets to go back and put the booths in.

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

So, I have couple of questions with regard to the hurricanes. I appreciate the color you gave in your prepared comments. As far as recognizing that you don’t provide guidance, just looking back at history, is there any parameters you can give us to help us understand what type of demand benefit that could come as a result of storms we’ve seen recently, either in Texas or Florida or elsewhere? And then, the second question. You mentioned some of the -- I think you mentioned inventories in prepared comments. Was there damage to cars, vehicles in your inventory and would there be some type of charge that we’d see as a result of that?

Okay. So, Brian, I’ll talk about the first part. You hit it on the head. We’re not going to provide guidance. What I will tell you is that we are prepared with inventory; we’re prepared, if there is an inflow and extra inflow of vehicles being bought, we’re in great shape to handle that in the markets that were impacted by hurricane. Believe it or not, if you look at that historically, we had the benefit of not having big catastrophic events like this that often. I think the last time, we cited something like this was probably back with Wilma and Rita where we actually talked about it in the call. But, I would just tell you, we’ve positioned ourselves so that we’ll be able to meet any demand that surfaces. As far as were there -- any vehicles were damaged. We had about a 1,000 cars that were damaged that had to be gotten rid of, basically scrapped. And I will let Tom talk a little bit about the expense.

Yes. Brian, we’re relatively fortunate in the Houston market, as Bill said, we had a significant number of cars damaged or destroyed but fortunately we do carry insurance for that type of event. And between our deductibles and then out of pocket for property and vehicles that weren’t covered, we had about 1 million bucks of expense in the quarter. So, similar to other kind of catastrophic events that we’ve seen in the past, but that’s about the ballpark we have in there for property.

Got it, helpful. And then my follow-up question, with regard to on the finance side, looking at the recent securitization data, the table you provided, it seems as though you’ve been able to recently lift your lending rates. So, the question I have there is I guess to confirm that but also how should we think about the rates which you are charging customers going forward, is this kind of the beginning of the trend, any customer pushback at all in that?

Yes, you are correct. We talked about this last quarter and I think at the end of last year -- at late last year, we did raise rates pretty much across the board. I think this is the first securitization deal, 2017-3 where you are actually going to start seeing the impact of that and I think you can see the impact in that -- in the spread, if you look at that versus other recent deals. As far as where rates go. I am going to answer that the way that I always answer this for the last seven years, which, our ability to preserve that margin is going to be driven by the market and what’s going on with other lenders. We are constantly looking at how we feel about our competitiveness versus other offers out there. We test rates up, we test rates down. We try to make -- we watch our 3-day payoff rate, we watch conversion of the stores. So, it will be an ongoing analytical exercise. To the extent rates go up, you could imagine we’ll test increasing, I mean if the [cost of funds][ph] go up, we’ll test increasing APRs, but if it’s going to be detrimental to sales or make us uncompetitive relative to what other competitors are doing, we’ll have to take that into account.

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

Thanks a lot. Good morning. My first question is actually a follow-up to a point that you just made. So, to the extent that your CAF penetration was down a little bit and the so called other category financing was up by about 250 basis points in terms of penetration, is that a function you think of pricing? Clearly, your pricing in the totality of what CAF is doing is working on a unit basis. But, I am sort of wondering, is it penetration function of that? And also, we did note that the APRs on the new loans while favorably year-to-year did tick down slightly from where you were in Q1. So, if you kind of put that together for us, please?

Yes. So, I will just kind of run through what we saw coming in the door. As I mentioned, we were barbelled in the credit profile of the customer coming in applying. That means we saw the greatest growth at kind of 700 plus FICO range. So, those folks tend to be the ones that are going to be CAF or can arrange their financing elsewhere. So, Matt, I think some of what we saw was due to just the nature of the volume coming through. We did use some tightening in the quarter that may have impact in last year’s fourth quarter but that may have impacted a bit. But we look very closely at how competitive we think our rates are. Our offers, particularly at the high end I think are still very competitive. And we also track that 3-day payoff rate which is good indicator of whether people like the offers they get from CarMax. That rate is up modestly year-over-year, less than a point, and it’s actually down a little bit sequentially from last quarter. So, I wouldn’t read into that. We’re seeing a lot more people paying off the loans. When I look at it, I just think we’ve got more people that are bringing their own financing to the table whether it’s cash or something else, when they show up to buy the car.

And then, my follow-up relates to the Tier 3 piece, up slightly year-on-year. Should we kind of view this now as sort of a reasonable baseline that high-single digit level in terms of sustainable level of Tier 3 penetration?

Yes. I don’t -- we’ve talked about this before when Tier 3 was significantly higher. It is a business that we look at as incremental. So, I don’t know what the right baseline is? I’d like to see going forward just kind of nice growth across the credit spectrum, because I think that implies the healthy economy and healthy demand environment. But this year’s number is up slightly. As I said, we’re seeing some volume increase in applications down in the spectrum. And remember, last year, we were seeing significant declines in that Tier 3 volume, and last year’s number is a weak number. And this was actually the first quarter where we’re comping over that.

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

Hey, guys. Rob Iannarone on for Scot. Congrats on a good quarter. I was just wondering, you commented that conversion was up and there was a partial offset from the traffic. I was wondering if you can provide any order of magnitude around that. Is it consistent with what we’ve seen in recent quarters?

Yes. I mean, traffic was down a modest amount, which offset some of the conversion. It’s been similar to recent quarters.

Great. And just kind of on a different topic. When you think about the online appraisal and other online initiatives including SEO, can you update us on what kind of click through rates you’re seeing?

Yes. Let me talk a little bit about SEO, because I think we’re really pleased with the growth that we’ve seen there. In the second quarter, our non-brand SEO traffic continued to grow significantly; it was up nearly 250% from a year ago. And on the SEO, what we’ve really been focusing on is really three main things. One, we want to produce more content that links to other site, so putting articles out there to get picked by the folks, so that back linking is very helpful in the ratings. We’ve added in the quarter a few hundred thousand new pages and we continue to add them. So, last quarter, I talked about having a page -- we used to have a Ford F-150 page and we said Ford F-150 Raptor. Now, we’ve got a Ford F-150 Raptor 2016, 2017. Again, the more pages you have, the relevant you’re in the searches. And then, we also are pleased, we’ve been able to add content and put the content in there. So, Google can actually and the search engines can actually read it and see what we have, which also helps us. So, we’ve been very pleased with what’s been going on with SEO. And we’ll continue that work. And we think there is a lot of opportunity still there. The other thing I would just say on the earlier piece on the traffic, again, while that store traffic number’s gone down, we really look at it more holistically. And we think about the store traffic, we think about web traffic, which I talked about earlier and the great growth that we’ve had there. We also continue to see double-digit growth on leads, which is great because that gives us something to execute on. So, we feel very good about the momentum that we have when it comes to having possibilities to interact with the customers and turn them into sales.

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

Yes. Thanks for taking my questions. And this is getting back to the hurricane. With respect to Harvey and all of those flooded vehicles, what controls you have in place to avoid buying any lemons for example?

Yes. Well, similar to like Katrina, there are going to be a lot of flood vehicles out there. And all of the damaged cars that we had, we actually took them and sold them through. We did not sell them through auctions; we sold them through salvage auctions. Our systems are way more advanced today than they were back at the time of Hurricane Katrina. We know, for example the cars that were on our lot, we’ve got them on our system. So, if they ever pop up somewhere else, we’ll know not to purchase them. Now, they should all be marked salvage, so they shouldn’t pop up somewhere else. But the same thing for other vehicles, other vehicles that are marked salvage, we know that information and then when we’re at auctions or if they come to our appraisal lane, our systems will alert our buyers to the fact that hey this vehicle was at some point salvage. The other thing that I would tell you is -- and this is where our more than 1,000 skilled buyers come into play, there could be some cars out there that slipped through the cracks and didn’t get salvage, not our vehicles but ones that come in our appraisal lane. And our buyers are skilled and trained to be able to identify those vehicles. There is telltale times that they can look for and I think that’s a huge competitive advantage to make sure that we don’t end up buying any of those that might fall through the cracks of the data analytics.

Thanks. And my follow-up is on the extended protection plan growth, you’ve seen I think more rapid growth in that category than even your car sales growth. And curious what’s driving that and if there is a change in consumer behavior, or you’re changing the way you are marketing that to consumers?

Yes. I think the way to characterize it is that that number is going to move around a little bit every quarter because like the CarMax Auto Finance business, we put a reserve on that thing for returns. And then, some quarters you might see mildly favorable return experience, some quarters mildly negative; the last couple have been mildly favorable. So, there is a little bit of a tailwind on that number due to the return reserve percentage. But in general, it’s grown with the pace of growth of sales. And that’s how I think about it over the longer term.

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

Good morning. Just sort of a multipart single question here, so I’ll try to keep it simple. You talked about lower store traffic, but I’m just curious if you wrap it together with the 17% increase in website traffic, if you think in total your eyeballs or interaction with consumers were flat to up. As we think about that in the context of your online appraisals where you being kind of ticked off with the consumer spending more time online as opposed to coming into the showroom?

Yes. I think the way you should about it is we do know, first of all, 9 out of 10 of the customers buy from a start their search online and interact with us on the digital properties. I do absolutely feel like customers are coming to the stores more prepared. So, for example, they know that they’re going to need a step; they bring it with them versus coming in and having to leave. Certain things like that would actually cause your store traffic because we count it by being braced would actually cause it to go down or innovation like the online finance prequalification. There may be some customers that go online and realize I can’t afford a new used car and it keeps them from coming into the store where they would have come in before, sales consultants would have spent time with them only to find out that they weren’t eligible to buy a car. So, in some senses, I would expect because of our innovation, the traffic would go down, as we continue to innovate and make more of the functionality available online. So, again, I’m pleased with where we are, if I think about the touch points that we have with customers, whether it’s in the store or whether it’s online.

And then, maybe just a follow-up, when we think about it, I mean, it does sound like that may eat into year ability to bid on vehicles in the appraisal lane there and you may need to source more auctions. Do you think that may be the case, and as we think about profitability from sourcing vehicles on trading or appraisal versus the auction, is there a big delta in GPU there?

We’ve talked about our appraisal lane vehicles history have always been more profitable than the offsite. As far as, I think, if I understand your question, really asking about the online appraisals and how we think that’s going to manifest itself. Is that the question?

Well, I’m just trying to understand, because it seems like, your ability to convert appraisals or what are the online or in store from the consumer versus what you’re be doing at auction going forward might shift. I’m just curious, if that’s the case.

Yes. I don’t mean -- we’re not intending that shift. I mean, we think that the online appraisal offering is just another way to reach out to customers that maybe we wouldn’t have gotten before and also enhance the customer experience, so folks know what their vehicle is worth, prior to coming into the store, prior to selling it. So, the way I look at it is it’s really an extension to generate more appraisals. Look, we had 11% growth in sales. When you have double-digit growth in sales like that. You’re going to have to obviously rely on offsite. I would tell you, I think there is a lot of good offsite buys out there. It’s the number of year to four year all cars coming into the auction lanes is higher than it has been in the past and I think it will continue to be that way. So, I don’t see a real change in the dynamics. I think we’ll continue to go after as many appraisal buys as we can and then we’ll supplement with whatever need through outside channels.

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

Talked about rolling out the online appraisals to the Midwest. Just wanted to see, if you give a little bit of color around what sort of traffic uplift you’ve seen in the test markets. And how you’re expecting that to play out with the larger rollout?

No. It’s too early to talk about that Mike, at this point. I mean, like I said in my opening remarks. It seems to be well received by customers; our sales folk, sales teams are very pleased with it, but it’s too early to tell which is another reason why we’re going to roll it to some additional stores.

And just want to see if you can give a little bit of color from your perspective on what you’re seeing in the kind of just overall used pricing environment following all the storms, what you’re thinking about in terms of scrappage coming out of Harvey as well as Irma?

I think for the longest time, people have said that the sky is falling, when it comes to used car pricing and there is going to be a big drop in used car prices. While we are seeing some acquisition prices more favorable, like this quarter our ASPs actually went up, and that’s the combination of acquisition price going down a little bit, but then our mix impacting it to go up. So having more zero to four-year old cars, having more large SUVs and trucks. I think what we’ll continue to see is we’ll continue to see more late model cars entering into the marketplace. It’s hard to tell, what the two storms, this is lots of different numbers, I think anywhere from 0.5 million to 1 million cars. And you go to wonder of that, how many of them are actually going to be replaced. So, I think, it’s little early to tell us as far as what impact this is going to have on the overall market. I will tell you -- and I mentioned in the opening remarks, the depreciation environment has absolutely been more favorable. It’s more representative of what we saw two years ago, which is one of the reasons why our wholesale margin is up over last year. So, I think it’s little too early to tell us as far as the storms go as to what impact it’s going to have on values.

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

Thanks a lot and good morning. My first question is just on digital leads. You talked about continued double-digit growth, but is that figure accelerating or decelerating?

It’s pretty consistent with what’s it’s been the last few quarters. That’s double-digit and it’s a little bit more than the website traffic growth that we saw.

Got it. And as you think about the quality of those leads, how would you asses them relative to last few quarters, are they improving or not based on the types of leads that you are getting?

Yes. I think the quality of the leads is very similar to what we have seen over the last few quarters. So, there is no real big difference there.

Got it. So, as you go forward and you roll out some of these other tools, like appraisals as well as a soft credit pull associated with pre-approval of financing, how do you expect those things to trend?

Look, I think any time we get a lead is an opportunity for us to execute better. So, I would love for us to be able to have those leads convert at even higher. And again, I think our job is to make sure that we continue to put experiences out there and functionality out there and continue to train our associates on how to maximize those leads. So, that’s what we are focused on.

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

Yes, hi. Thanks for taking my question. This is Derek Glynn on for Jamie. I just want to get an update on home delivery. And broad strokes based on what you’ve seen in that past couple of quarters, are your efforts inspiring more confidence in home delivery as a service or is it perhaps reaffirming apprehensions you may have had before embarking on the testing?

Yes, no, look, we are pleased with where we are on home delivery at this point. I would remind you. I mean, we want to make sure that the customer can find the right car, take it out, buy that car and then we deliver it on whatever terms they want to receive that car. Home delivery is one of those ways. And expedite delivery in the store is another one of those ways. And I think the big success in home delivery at this point is the additional functionality that we’ve learned about and progress. So, for example, online appraisals, you need to be able to do that for home delivery. And as you see, we are continuing to move forward with online appraisals. We want to make sure that when we expand home delivery, it meets up to the exceptional customer experience that we would expect and that our customers would expect. We have not expanded beyond the Charlotte market right now. We are evaluating where to take it next. But what I would also tell you is, we’re progressing that with capabilities so that wherever we go the next experience is going to be even that much better. So, I am pleased with where we are in home delivery, and I am pleased with all the functionality that really enables home delivery, so that we can use it in other things.

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

Thanks. Good morning. A question on CAF and provision, which has been growing more than the charge-offs, we noticed every quarter since 2012; this quarter that growth was less than the charge-offs. Curious, if that says something about your expectation for future losses or just...

Yes. Rick, what it says is that I think as I mentioned in my prepared remarks that we’re seeing losses that are more in line with our expectations. And remember, last year, we were in environment where losses were kind of moving in unfavorable manner from us. And as we are look into provision, we were having to play some catch-up and getting the allowance to the level that it needed to be, based on the migration of those losses. So, I think we’re more of in an environment now where we’re booking we’re absolutely booking the loans at a higher expected loss than last year. But we’re not -- we haven’t been seen that migration of bad performance and we’re not playing -- the last two quarters are not playing catch-up.

My follow-up is on the weighted average contract rate, 7.8% last quarter, 7.6% this quarter. Is this due to origination shifting up the credit spectrum and curious, if you in fact are getting better pricing on loans of similar quality?

As I mentioned, all the pricing changes that we made were over the course of the fourth quarter of last year. So, if you look at sequentially versus last quarter, we’re behaving essentially the same in our underwriting decisions and our pricing decisions. So, I would attribute that then to kind of the credit quality coming in the door. And as I mentioned that the highest credits, what we’re seeing that -- where we’re seeing the largest growth this quarter, and that would translate into lower rates because those folks are going to qualify for better rates.

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

Hi. Good morning, everyone. Just kind of following up on Rick’s question. So, your allowance actually went down sequentially to 1.15%, and that’s the first decrease we’ve seen in a couple of years. Anything in the mix of customers that you’re seeing or any other commentary you can provide us with on why that went down?

So, I think, as I said, we have seen a higher mix of customers, but if any, we’re looking at the performance of the portfolio and recent trends. As we mentioned last quarter and at the end of the last year, we made some changes to the way that we are calculating our loss allowance to make it a little bit more reactive to current trends. And like I said, last year we were chasing unfavorability; this year, it’s been little bit more consistent.

Okay. And then, my follow-up question has to do with your wholesale gross profit per unit, benefiting from a more favorable depreciation environment. I’m not sure how to interpret that, and how your spreads between what you paid and what you fill them for benefited from that?

Yes. So, like I said, it’s a little bit representative of what happened a couple of years ago where the depreciation ramped. Normally, you see depreciation throughout the year. The slope of that ramp was pretty much muted. So, there wasn’t a lot of depreciation. And we’re wanting that doesn’t proactively speculate or whatever on what vehicles are worth. But when there is less depreciation in vehicles off their value, that’s typically not what normally happens this time of the year. So, when there is a favorable environment where there is not a lot of depreciation and the value holds up there, the dealers are willing to pay more money, and that’s what drove the prices up.

Okay, great. That’s kind of what I thought. But, yes, thanks for the clarification. Thank you.

Sure.

The next question comes from the line of Adam Jonas with Morgan Stanley.

Hey Bill, hey Tom. So, a strategic question for you guys. Amazon seems to have a rather aggressive definition of their total addressable market. They don’t seem to roll anything out including kind of auto or auto related retail. And of course, your management team and your Board are following Amazon’s moves very closely, I’m sure. One could argue the combination of Amazon’s digital commerce platform and technology buying power could make a really formidable combination with your best-in-class ecosystem. I’m just wondering if you view Amazon as emerging competitor or potential partner? Could CarMax be Amazon’s Whole Foods of automotive retail?

I don’t know. I mean, you’d have to ask Amazon that. I mean what we’re focused on is regardless of who the competitor might be, I think we’re focused on making our business better and we’re focused on continuing to be a leader in late model used cars. All the initiatives that we’re working on I think point us in the right direction. I feel really good about where we’re going and that’s what our focus is right now.

Thank you.

Yes.

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

Thanks. Good morning. I wanted to go back to online appraisal. Do you have any timeline on when you want that rolled out nationwide, say by end of calendar 2018? And then, my follow-up would be, after that what is the next big additional focus for you?

On the online appraisal, like is said in my opening remarks, we’re putting it into some of the stores in the Midwest and the purpose of doing that is one, to make sure that it’s a great experience and it’s what we want to do. There’s going to probably some enhancements that we’re going to want to make. And we’ll at that point determine what the next step is and what the roll out. So, I can’t tell you what the timeframe is. As far as when that will be rolled out, it depends on how this next test goes. And I am sorry. What was the second part of your question?

Once you’re either done rolling it out or completed what you want to do on online appraisal, what will be the next big digital focus for you?

We probably have 15 different product teams that are working on digital enhancements, everything from SEO to improving the financing. I mean, some of these things like finance online for example, but we made some big strides in this last quarter, putting out a new application that’s more mobile friendly, it’s easier and to accurately enter all the income sources that helps educate consumers about the value of co-applicants; it has an enhanced calculator. Some of these things that we’re doing, they’re going to be product teams and things that we continue to work on. In other words, there isn’t an end in sight. We need to continue to evolve and we can continue to make them better. So, some of these things, online appraisals, I think that’s one that will continue to evolve, even when we have it rolled that everywhere, it doesn’t mean we’re done. So, I think there is a lot of different things that we’re working on that will provide both, near-term, mid-term and long-term results for the organization.

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

Thanks for taking the question. Hoping to refresh understanding of the support you’re getting from your comp support from store growth. So, I was just wondering if you could remind us what your store rent is for new stores, what percent of target maturity do you do in year one, and how quickly does that ramp between years two and five?

So, as we’ve said all along, we’re going to open up between 13 and 16 stores, this year we’re doing 15 stores. We’ve said we’re pleased with how all of our new stores are performing; they’re meeting our internal growth rate. Outside of that, there is not a lot of color to add.

And then, 200 to 250, is that still the right number to think about in the 100 small format?

I’m sorry. What was the number?

200 to 250, I think have I in my note within the 100 small format stores?

I think what we said over time is you think about 200 to 300; 200, you can obviously drop from the equation; I think 300 still a good target to think about. But it’s -- I can’t tell you what the end game is going to be, because the customers’ expectations are continuing to change, our business changes, continues to evolve; we’re looking at different things. We’ve got a lot going on in the digital space. So, I don’t know where the cap is. I also don’t think that we found a 100% of our store delivery methods. We probably have some things and ways to reach customers that we don’t reach them today. So, it’s really hard to put a high-end number on what that could be.

[Operator Instructions] We do have a follow-up question from the line of Seth Basham with Wedbush.

Hi, follow-up question on hurricanes. Historically, after these events, have you guys been able to increase your market share in markets where they have occurred?

Yes. Like I said, earlier, Seth, we, believe or not, we haven’t had a whole bunch of, even like with Katrina, we didn’t have any stores down in that market. So, we haven’t had a lot of experience there. I think the last time, we cited something was again back with Wilma and Rita and we did see an impact on extra sales from that. But like said earlier, we’re prepared, if there are going to be incremental sales coming in for replacement vehicles, then, we will be prepared to service those customers. And we’ll talk about it -- we’ll talk about it in the third quarter, what we actually saw.

Fair enough. And then, one other question is related to innovation technology spend that you guys have; obviously ramped that in recent years. How do you think about the piece of that into your next fiscal year?

Yes. I think -- I don’t really want to talk about the fiscal year, next year’s fiscal year at this point. I think all along this year, I’ve told you that this is going to be a heavy year on spend there. While it’s not all incremental, we should reprioritize some of our existing SG&A. We’re putting a lot of money back into the business so much so that I’ve told you guys in the past that normally say 5% comps we’ll have as leverage. We’ve said mid-single-digits. I think it’s going to be higher end of mid-single-digits for this year. And depending on how much progress we make this year and what opportunities we see out there will dictate what we do next year.

There are currently no further questions.

Okay, great. Before we close, I definitely want to take a moment to thank the more than 24,000 associates we have across the country. These hurricanes have absolutely been challenging these last few weeks. And I’d tell you, I’m once again reminded why our associates are true differentiator for CarMax. Their determination, their spirit, their support for each other, for our customers, for our communities through these challenging times has truly been inspiring. I’ve never been more proud to work with them and I really want to thank them for what they do on a daily basis. It truly is incredible. And I want to thank you for joining our call. I want to thank you for your support. And we will talk to you next quarter.

Again, thank you for your participation. This concludes today’s call. You may now disconnect.