Good morning. My name is Jenisha and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 FY2016 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. If you’d like to ask a question during this time, simply press star then the number one on your telephone keypad. If you’d like to withdraw your question, press the pound key. Thank you. Ms. Katharine Kenny, you may begin your conference.

Thank you and good morning everyone. On the call with me today for our second quarter fiscal 2016 earnings conference call are Tom Folliard, 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, 2015, filed with the SEC. As always, I know you will remember to ask only one question and follow-up before getting back in queue in order to give everyone a chance. Thanks. Tom?

Thank you, Katharine. Good morning everyone. Thanks for joining the call today. As you saw, we had a record second quarter due to the continued growth in our store base and solid performances in used and wholesale unit sales, as well as CarMax auto finance. Here are some of the key highlights for the quarter: used unit comps increased by 4.6% and total used units rose by 9.2%. Gross profit per unit was flat at $21.66 compared to $21.73 in the second quarter of last year. Total wholesale units grew by 8.7% partially driven by one more auction date in the quarter compared to last year. Without the additional day of auctions, wholesale units would have grown about 5%. Gross profit per wholesale unit of $951 grew nearly 9% compared to $874 in the second quarter of last year, and CAF income grew 6% to approximately $98 million. I’ll turn it over to Tom to give you some more details on finance. Tom?

Thanks Tom. Good morning everybody. As Tom mentioned, CAF income grew 6.2% compared to the second quarter of fiscal 2015, and average managed receivables grew by 16% to $9 billion, or just under $9 billion. The weighted average contract rate - the rate charged to customers - was at 7.2%, up slightly from last year’s second quarter of 7.0%. Our allowance for loan losses grew to about $88 million or 0.96% of managed receivables. CAF net penetration was 42.7%, half a point of which came from loans originated under our sub-prime test. That compares with 40.7% in last year’s second quarter, of which 0.6% related to loans originated under that test. Net loan dollars originated in the quarter rose 14% to $1.3 billion due to a combination of CarMax unit sales growth and higher penetration at CAF. Finally, during the second quarter we repurchased 3.9 million shares for about $250 million. Tom?

Thank you. This quarter, our comp unit sales were driven by improved conversion achieved by our store teams. Our total web traffic increased nearly 12% compared to the same period last year, and now approximately 65% of our visits are coming from something other than a laptop or a desktop. As for our sales mix this quarter, zero to four-year-old vehicles increased by 5% to 79% of our total sales, and SUVs and trucks were down slightly from 24% to 22% compared to last year’s second quarter. For SG&A, excluding the $21 million reduction in last second quarter’s SG&A due to the receipt of legal settlement proceeds, SG&A for this second quarter increased approximately 4% to $331 million. Contributing to this growth was the addition of 16 stores since the beginning of second quarter last year, partially offset by a decrease of $10.5 million in share-based compensation expense. On a per-unit basis, excluding the settlement gain, SG&A decreased $100 to $2,083. The stock-based compensation expense decrease accounted for $78 of that leverage. During the second quarter, we opened four stores, three in existing markets: one in Providence and two in Denver, and a small format store in Tallahassee, which is a new market for CarMax. After the second quarter ended, we opened two more stores, our sixth store in the Houston market and our second store in Minneapolis, and we also relocated our Rockville, Maryland store to its new larger location in Gaithersburg. Also during the quarter, we notified Nissan that we would terminating our new car franchise at White Marsh, which is just outside of Baltimore, and we notified Chrysler that we would be terminating our new car franchise at our Norcross store in Atlanta. Both terminations will become effective in the third quarter. With that, we’d be happy to take your questions. Operator?

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

Hi, good morning.

Hi Brian.

So my question, I wanted to focus on the used car unit comp. If I look at the number, in my view, the 4.6% you put in was very respectable given what we’re seeing elsewhere from other dealers, or even other retailers. But Tom, as you look at the data, so maybe take a step back from the data, and you had a 4.6 here in Q2, a 4.9 in Q1, and it was only a few quarters before that used car unit comps are tracking upwards of--you know, in the upper single digits. Is there something to explain as you look at the data this kind of downshift we’ve seen in the trend there?

You know, Brian, I don’t know that there’s something to explain. We have very big stores, average volume of 320 cars a month. I’m very pleased with a 4.6% comp in one of our--you know, the first and second quarter are our two highest volume quarters of the year. At the same time, we’re building stores, continuing to refine our model, continuing to develop our website and our apps so our customers have a better experience, and our store teams continue to execute very, very well. So you know, I don’t spend too much time--we don’t spend too much time trying to analyze a couple of points here or there in a quarter when you’re building a business over a very long period of time, so we’re very pleased with the performance of the business in the quarter.

Got it. If I can just follow up on that, as we think about--I mean, partially you’ve already answered this, but as we think about the third and fourth quarters, where the comparisons at least on a single-year basis get more difficult, is that something that you manage around in any way?

You know, as you know, we don’t give any guidance, any forward-looking guidance, but I will tell you that when we look at the business each year and over a long period of time, a lot of our trending analysis is going to take into account whatever the factors were in the years prior. So it matters what the comps were the year before, but it only matters in our forecasting at the beginning of the year.

Got it. Thank you.

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

Morning everyone.

Hi Matt.

So just to follow up on Brian’s question, I’m just curious if the later Labor Day holiday this year potentially impacted the result. I would assume--it looked like August was a bit of a tougher month from a unit standpoint for the auto industry and that some of those sales had shifted to September.

You know, it’s possible, but we don’t really look at it--I mean, we don’t really think of it in that level of detail. To me, Labor Day was in the third quarter last year and it was in the third quarter this year, so the only real difference would be the Saturday and Sunday of Labor Day compared to the year prior. So there might have been something in there, but we don’t really consider it. We don’t consider it to be any factor in the quarter, or we maybe would have called it out.

Okay, that’s fair. Then just as a follow-up, your advertising expense was up about 18% year-over-year. Combined with the recent NFL affiliations, I’m just wondering if this signals a change in strategy and perhaps we could see some higher ad expense per vehicle on a go-forward basis.

You know, our sales are up a little over 9%, so if we had just flat advertising per car, the expense would have been up 9%. It was up 18%. A good portion of the difference between those two is we actually had ad production during the quarter, and we did not have ad production during the quarter last year. That’s a big chunk of it. Another big chunk of it is we’ve outsourced our media buying, so some of those dollars have just moved from one bucket to the other, where we used to have that not in SG&A but in corporate overhead. So there’s not really much to read into in terms of this quarter. In terms of the affiliations with sports teams, we have gotten bigger. We are entering some big metro markets, but none of that expense would have really showed up in the second quarter because they are only starting now. We have a big launch in Denver, as you know. We have two stores that we had prior to this year, we added two more. We have a fifth store in Colorado Springs - that’s a big market for us. In terms of New England and the Boston market, we have two stores in the Hartford market, we have two stores in the Providence, Rhode Island market. In December of this year, we’ll launch Boston officially and we’ll have three stores, one in Danvers, one in Norwood, and one in Westborough. We’re continuing to look at sites. We own a site in Portland, Maine. We’re looking in Manchester and Nashua, New Hampshire, so when we think about New England as a broad market, we have a huge investment coming there over the next several years, and as you know, Matt, Boston is a little bit of a sports town and you really have to try and connect with your customer base. I think that affiliating yourself with at least one of the sports teams is something you need to do. We also just announced a partnership with University of Minnesota as we’re opening up the Minneapolis market, where we opened up our second store there. So we’ve done some sports marketing in the past. I think this got a little bit more press because it was a little bit bigger, but as a company we’ve gotten a lot bigger too.

Sounds good. Looks like based on your store openings that either the Raiders or the 49ers are going to be next.

Well, the Raiders beat the Ravens, so maybe they’re not as bad as everyone thinks.

Thanks again.

Your next question comes from the line of Aram Rubinson of Wolfe Research.

Hey guys, good morning. Can you give us a little bit of the lay of the land of new competitors as you see it, and also kind of where you sit and handicap yourself on your own ecommerce capabilities, your internet site? What again are the capabilities that you believe you’ve got that are virtuous to you, and what capabilities do you really need to still work on and when do you think you’re going to start attacking some of those?

So I don’t know that we have anything that’s just virtuous to us where nobody else can do it. It’s a free market, and what we are trying to do is make sure our customers can do as much of the transaction as they want to do from home. We’ve definitely seen the sentiment shift where customers are looking to do more and more research, more and more pieces of the transaction from home, and in some cases the entire transaction from home. Our current capabilities are our customer can obviously do all kinds of inventory searches. We have 50,000 cars online - I think that’s a huge competitive advantage for us, is the selection of inventory and the ability to transfer our cars at the customer’s request, and as you know, Aram, that’s about a third of our total sales. We also give the customer the ability to put a car on hold. We give the customer the ability to transfer a car. If it’s a paid transfer, they can do it with a credit card without speaking to anybody and have that car transferred to the store of their choice. They can fill out a big chunk of the paperwork from home. We have tested online credit applications, and we are continuing to enhance our capabilities there. We’ve seen some start-ups and some smaller competitors that are doing kind of beginning-to-end transactions online. I don’t think anybody is in a better position than we are to be able to do those things, and those are some of the things that we’ll continue to work on and continue to evaluate as our business grows. But I think we have a bunch of significant advantages. The one I mentioned which I think is the most significant is the selection of inventory that we have and the ability to transfer it. As a company, last year we moved 2 million cars. We sold 600,000, but cars moving from store to store, moving from auction to store, we moved over 2 million cars. We have a very extensive network of and ability to move cars very quickly at the customer’s request. But I think we need to keep working on our app, we need to keep working on our capabilities, and we need to make sure we stay out in front of the consumer and give them the capability to do what they want to do from home.

Thanks Tom.

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

Hi, good morning. Two questions, I guess. Tom, there are a lot of investors that seem to be concerned about off-lease vehicles and what’s going to happen there, and that this time might be different than prior years where there were a lot of off-lease vehicles. Can you kind of give us your perspective on how CarMax has done in years where there have been a lot of off-lease vehicles coming up, and whether or not your ability to procure those vehicles is any different than it would have been, say, 10 years ago?

Yeah, that’s a good question, Sharon. I don’t remember exactly, because remember that the supply comes back two, three years after the lease rate is at whatever it is. Right now, it’s pretty high - I think it’s in the high 20s as a percent of new car sales. I’ve always said before, cars tend to come back whether they are leased or sold, not totally predictable but at a somewhat predictable rate as the years roll forward. When it’s a very high lease percentage, it’s kind of more predictable, so if there’s a bunch of leases going out now, if it’s almost 30% of new cars sales, two years out, three years out we’re going to see a lot of leases coming back. They tend to be a lot more organized at the auction, maybe even a little bit easier for us to have access to. In terms of our capabilities, we are much more organized today than we were 10 years ago. We’re much more analytical about the way we approach car buying at the auction, and I think we’re in a better position today to optimize the inventory that we acquire at the auction because of all the analytics that we’ve put into it and all the digital capabilities that we’ve given our buyers. Our buyers are now all using tablets at the auctions. We’re tracking every single car that a buyer at CarMax looks at at the auction and deciding whether or not that car is worthy, and then the next time a buyer goes to the auction, they don’t have to look at that same car and we’re saving an enormous amount of time in evaluating cars at the auction. We have all the auctions on a program where the CarMax buyers are buying under one kind of generic card, and we can analytically decide where those cars go later. If you back up 10 or 15 years, we used to buy on a store-by-store basis, so I’m really pleased with the progress we’ve made in our ability to analyze and purchase inventory, and then I think--I really do think that leasing provides a more organized way because you’ll see a lot of the big leasing companies will run hundreds and hundreds of cars a week on a very regular basis at the auction, and it’s pretty predictable and we have the ability to look at that inventory in advance and decide which ones we are or are not going to bid on.

Okay, great. Then a question for the other Tom - obviously the leverage on SG&A this quarter was largely related to the share-based comp decline. Can you talk about in the back half of the year what kind of comp you need to hold your SG&A?

I think what we’ve talked about in the past, Sharon, is we need kind of a mid-single digit comp to get SG&A leverage. If you look at this quarter, I think we levered about $23 if you back out the stock-based comp. There is some timing going on there, so I feel like at the comps we’re at this quarter, we are right at the inflection point or thereabouts. When I say some timing, I think there is some favorability in prior years that I wouldn’t give us a huge amount of credit for leveraging this quarter. So we’re still in growth mode, I think we’re still in the same mind that we need comps about this or a little north of it to get meaningful leverage.

Okay, great. Thank you.

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

Good morning. Thanks for taking my question. It’s a regulatory question. I’m curious if the government were to pass some law requiring CarMax to fix recalls, would you be able to seek reimbursement from the OEM in the same way that a franchise dealer would?

The way we would do it is the cars would go to the franchise dealer, and the franchise dealer would fix them under warranty and then they would get reimbursed for it, and then we would go back and get the car. We are not authorized to do repairs of any kind that run through the warranty system, and that’s the category that recalls fall under, so for us it would be--we would have to take the car to a franchise dealer where it would repaired, and they would get reimbursed and we would get the car back, but it would be at no cost to us.

Got it. Then just following up on that, Volkswagen has a big recall they’ve announced. What’s your exposure overall to Volkswagen vehicles? Thanks.

You know, the Volkswagen, which just came out so we’re really still just evaluating it. It only relates to diesel product. We have about-- I mentioned earlier we have about 50,000 cars online. We have only a couple of hundred diesel products, Volkswagens or Audis, so very, very small.

Great, thank you.

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

Good morning, guys.

Hi Scot.

Tom, you talked about or highlighted that conversion rates drove the comp. Does that imply that traffic did not contribute to the comp this quarter?

It does, and as I’ve said before, Scot, I never focus on one quarter’s traffic or conversion. I always feel like, and it has been true over a very long period of time, I feel like our comps will be driven roughly half and half by traffic increases and conversion increases over time, and that has been true for a very long period of time. I think it will be true going forward, so in any given quarter, and it has happened in the past, our comps could be driven by just traffic increases and no conversion increases, or vice versa. This is a quarter where our store teams did a great job of converting the customers that they had in addition to constantly optimizing our finance offer and all the other things that go into conversion - buying the right product, having it at the right store at the right time. That’s what delivered our comps this quarter.

I know you guys don’t typically give a lot of detail regarding kind of trends during the quarter, but taking a look at geography, did you see anything noticeable? I mean, obviously you have a lot of exposure to Texas, for instance, which is starting to have maybe some issues in certain areas just because of all the energy-related exposure there.

Yeah, you were right at the beginning, Scot - we don’t give any guidance or trending during the quarter, or market-specific data.

All right, you can’t blame a guy for trying. Last question is--

It’s probably the eighth or ninth time you’ve asked in 10 years, so.

I know. I keep trying, right? Is there anything you could put your finger on that drove the gross profit dollars per unit on the wholesale side? I mean, it was a pretty big spike, and I know there is some natural volatility to that category, but I was just wondering if there was anything you could point to this particular quarter.

You know, as I’ve always said, it’s not a--we sell cars to the top bidder, so it’s not a manageable business for us within a very--I mean, it is within a narrow range, obviously, because we’ve been able to do it, but within $50 or so, it kind of comes out the way it does If you look at the first quarter this year, it was, I think, right around $1,000, so we have normally a little seasonal drop in margin per car from the first quarter to the second quarter, and that’s what I would say--I would look at it more sequentially than I would year-over-year. So we came off of $1,000 in the first quarter, and we’re down to $950 in the second quarter. Last year’s sequential drop was a little bit steeper, but I didn’t see anything unusual there.

Got you. All right, thanks a lot, guys.

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

Thanks a lot. Good morning. My primary question relates to SUVs. You disclosed the change in mix. I’m interested in your read on what’s transpiring in pricing in the SUV market, and also whether you think perhaps some of the change in traffic trends would have reflected consumers’ awareness of where you are in the SUV market.

Yeah, our sales were down 2% in SUVs and medium SUVs and trucks, so 24% down to 22%. It’s still a really big number for us, so I don’t think traffic had anything to do with it. As you know, we try to manage our inventory based on turns and consumer demand. I don’t view 2% as a very big move, and that’s on a year-over-year basis. It’s still almost a fourth of all of our sales, so still a really big chunk of our sales.

To the extent that that happened during a quarter when for the market more broadly, at least on the new car side so presumably used paralleled this, SUVs gained share within the mix. Is that a function of pricing in that market at a moment when gas prices are down and there’s lots of demand for that product?

You know, what I’ve seen in that product is prices have gone up because there’s more demand, so I think the lowering of gas prices has caused some higher prices when you’re looking to buy those cars at auction, but not something that caused it to move meaningfully one way or the other in terms of our sales.

Got it. Then just one quick financial question. On the warranty side, you got dinged a little bit, I guess, by warranty cancellation reversals, some accruals there that hit you. Can you quantify that for us, please?

Hey Matt, it’s Tom. That reserve has gotten to be a really big number over time. It’s over $100 million now, and we’re going to have movement in any given quarter as we learn new things about the business. So I don’t think we want to get in the habit of calling out everything that is an adjustment in that line because, frankly, it’s part of life going forward and we don’t want to call it out as a one-timer. I can tell you, though, margin and penetration in that space are relatively consistent with what we’ve been seeing over the last year, so we’re happy with how the business is going so absent the adjustment, you would have expected to see that line item increase relatively close to where unit growth was.

Matt, one additional thing - if you go back a year and a half ago when we had the much bigger reserve, which we announced, called out and talked about, we also said from that point forward we would look at this in a much more granular way on a more frequent basis, so when it’s a reserve the size that Tom mentioned, you could expect us to be looking at it more frequently and probably make adjustments as necessary on a quarterly basis, and unless they are material or something worthy of discussing, it will just be part of us normally running that business.

Got it. Thank you so much.

You’re welcome.

Your next question comes from the line of Irina Hodakovsky of Keybanc.

Good morning, everyone. A quick question for you guys on CAF. The income growth slowed substantially sequentially, it was even down. I was wondering if there is anything to point out there, any material changes in the strategy or in terms of the end markets, anything of note?

Yeah, I think from the perspective of CAF, it was a straightforward--you know, a boring quarter, which is what we like to see. That means everything is going as expected. If you remember, last quarter and, I believe, the quarter before, we had some adjustments--or not adjustments, but changes in our loss expectations which were favorable and actually boosted income growth in those quarters. This quarter, we’ve seen loss experience come in as expected, right where we booked it, which is how we like to see things. So there’s nothing different going on, it’s just a matter of we’ve seen losses come in exactly as we’d been planning on.

Great. There was a lot of detailed discussion in terms of the used vehicles and the trends there and year-over-year comps, and all this other stuff. Can you talk on a broader level any material changes in terms of consumer demand out there? You mentioned a mix shift in SUVs. Do you see demand holding as it was before, slowing down, or anything of note?

Nothing really. If you look at the first quarter and the second quarter, they are very, very similar - a little over 9% total sales growth, so that’s our new stores kicking in about half of the company growth and then comps of 4.5 to 5%. So it looks very similar to the first quarter, nothing of note.

Thank you, guys. Congratulations on a strong beat.

Thank you.

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

Thanks. Can you discuss the sub-prime market, what you’re seeing in terms of appetite from your lenders? I saw the Tier 3 proportion was down sequentially and year-over-year.

Yeah, I think the Tier 3 portion was down only very slightly year-over-year, just a couple of tenths of a point. But I think as we mentioned last quarter on the call, we’ve seen pretty consistent behavior from our Tier 3 lenders, and when I say consistent behavior, it doesn’t necessarily mean what percentage of sales are getting done by Tier 3 because they are impacted by what is actually flowing down through the channel and that they’re able to see, so if there is a change in credit mix or if our other Tier 2 lenders are becoming more aggressive, it changes the nature of what they are seeing. What we look at is their behavior on how many of the applications that they see, they approve, and if they convert, and on those bases we’ve seen pretty consistent behavior.

Got you, and if I could follow up with a question about [indiscernible] now over, say, the non-bank auto finance companies like CarMax. Has there been any changes that you’ve implemented operationally?

Sure. The larger participant ruling is out there, and frankly it was nothing of any surprise for us. There is no direct impact on our dealer operations, but as we expected all along, CarMax Auto Finance will be subject to the Bureau’s supervisory authority, and what that means is we’ll be interacting with them in the future, as we were pretty certain. As far as what we’ve been doing, we’ve been paying careful attention to developments in the industry as we see new announcements and new actions by them. We’ve been assessing our practices as we see what we think are the expectations of the Bureau, and we’ve been working hard to make sure that our compliance and program is up to snuff and will be ready for examination, if and when it comes.

Okay, thanks Tom.

Sure.

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

Good morning, guys. Just a follow-up on the same store sales and the showroom traffic. I mean, obviously it sounds like the showroom traffic was pretty stagnant, or up only slightly year-over-year. Tom, what do you think is driving that? I mean, we’re at a point where miles driven is increasing, gas prices are low, rates are low, employment is improving. It just seems like we’re in an environment where showroom traffic for you should really be stepping up. I mean, is there something going on with the relative price of used cars versus new cars? I’m just trying to understand why showroom traffic isn’t up a lot.

As I said earlier, I don’t think it’s something you can look at on a quarter to quarter basis and get a true read. Because we have so much traffic both on our website and in our stores, if customers are not visiting as many places as they used to visit before because they’re more prepared before they show up, then that could change the quality of traffic, and that’s just as good as getting more traffic. So there are just so many factors that are involved in there, I don’t think there’s any one item that we could point to and say, this is why traffic was up or down in any given quarter. Again, we’re trying to manage it over a much longer period of time. I don’t have a great answer there.

Yeah, it just seems like the factors should be moving for you in the right direction here. Maybe just a second question - as we look at the store openings, obviously you guys are doing a great job there. What would it take to accelerate your plan for store openings? I mean, the business is operating very well, you’re executing on these store openings well. Could you ramp up the pace of openings?

We clearly could from a financial standpoint. We are very focused on making operational improvements in our existing stores and growing store base as well, and we don’t want to do one at the expense of the other. Some of the markets that we’re opening and some of the stores that we’re opening in the next couple of years are very big and very complicated. When you think about us opening a big production store in San Francisco, Los Angeles, Boston, Seattle - all markets which we have construction coming in the next few years, they are not just a store that opens and sells a few hundred cars a month. They also recondition in some cases 2,000 cars a month and then run an 800 or 1,000 car a week auction. So we’re starting up really a business within a business when you think about the auctions, and then building a giant reconditioning center in some cases attached, so really one store for us in some cases is very, very complicated. If you look at, as I said, our opening plan over the next several years, we’re going into some pretty big metro markets, building some pretty big, complicated stores, and what we don’t want to do is accelerate the growth pace and say, oh, we opened two more extra stores this year but the ones that we did open, we didn’t open as well and we lost the ability to improve execution. So I don’t know exactly what the right number is, but I can tell you that at this pace of about a store a month, I feel like it’s a pretty aggressive growth pace and I’m really comfortable that we’re growing the business effectively, and at the same time not losing track of maybe the most important thing, which is improving existing store execution.

Great, that’s very helpful. Thank you very much.

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

Good morning, guys. It’s Mike Levin on for Rod. Tom, I remember last quarter, you were a little puzzled by the down year-over-year ASPs. We kind of saw something small similar this quarter. Just wondering if you guys are getting a better handle of what might be going on, or if some of the used car supply might be starting to get better affordability for your consumers, just any kind of a beginning of a trend here.

Puzzled is a good word. I think I probably was a little puzzled in the first quarter, but this quarter our ASPs are actually up sequentially, and I think ASPs should be looked at on a sequential basis more than a year-over-year basis. I think it’s the more relevant data point, and I think we’re up $150 from the first quarter to the second quarter. I’m sure that a lot of it for us is mix related. It turned into a much bigger deal at the end of the first quarter last year when we were down by $300. I think people thought it was some type of an indicator of other things in the marketplace, and honestly we just didn’t see it that way, and it hasn’t borne out to be that way. So we manage the business on a per-unit basis, not on a revenue basis, so we don’t really look at it that closely. But coming from the first quarter to the second quarter, we’re up $150, so.

Got it, okay. Maybe just on CAF, it looks like the collateral spread is starting to stabilize here around 6.2%. Do you guys still feel like that might have a little room to soften from here, or with rates possibly on the rise in the near future, are you getting the ability to raise prices to end consumers at this point?

I think the answer to both of those is probably a bit of a yes. You know, it’s going to be a byproduct of where we--what customers are demanding, what the market is for auto loans, and what cost of financing does. We saw our costs on the last deal tick up about 20 basis points, which we see in any given period is not a big deal, but they actually were up relative to the last three deals. We are constantly testing both up and down in different pockets of the business to make sure we’re optimizing what we have available for the customers, and we’re going to manage the spreads at whatever the market will allow us. So hopefully--I tried to answer it, but I think the answer is both. If rates go up and we’re not able to raise APRs, we’d continue to see some compression. If the market allows us to keep that spread there, we’ll do that; but we’re absolutely going to be a competitive lender and be providing excellent opportunities for our customers from a financing perspective.

I’d just say if you look at this over a very long period of time, as Tom mentioned, we’re one of the lenders in our store and we have to be competitive, and we also give our customers three business days to go get a better deal somewhere else and they can turn it in with no charge. Generally over time in a raising rate environment, spreads tend to compress, and in an environment where rates are going down, spreads tend to widen. Other than that, we’re not in the business of trying to predict where it’s going to go, but there’s been a lot of talk about cost of funds increasing over time, and we’ll see what happens.

Yeah, and I think I said this on last quarter’s call - we’ve been in rate environments where benchmarks are significantly higher than they are today and lived with similar spreads to what we’re doing today. That doesn’t mean it’s the case in the future, but as a point of reference if you want to look back at the mid-2000s, we were in a higher rate environment with pretty strong spreads of CAF.

Got it. Appreciate the color, guys.

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

Good morning and thank you for taking my question. My first question is just a follow-up on CAF. Obviously the penetration improved a little bit year-over-year, about 200 basis points. Would you say that you guys were a little bit more aggressive in terms to get that type of penetration, or is there anything else you could point to there?

I think there’s a couple things going on from that perspective. Part of it is what’s coming in the door. Credit quality in the door was up a couple points year-over-year, so that naturally would lend towards CAF getting more of the volume. Also, we have been a bit more aggressive in our testing, and we probably did take a little volume from Tier 2. You can see that in the other financing margin line where even given the fact that Tier 3 was down a little bit, that we had a slight increase in fees paid to other financial parties, and that’s because Tier 2 was down a little bit as well.

Got it, that’s helpful. Then secondly, in terms of inventory availability, Tom, you spoke to the huge competitive advantage you guys have there, but it seems like nowadays almost every other used car in a given market is online and customers are willing to travel a bit further to buy those cars. Does that sort of change the competitive dynamics in your view, or not?

It depends on who the competitor is that they then go and buy the car from. I mean, we’ve been consistently the retailer that offers a no-haggle price, easy access to financing with no negotiation, a cash offer on every car, a 30-day warranty, a five-day money back guarantee, three days to go get a better loan somewhere else. We stand behind the product that we sell. We have a seamless process. Our sales consultants are not paid a commission based on which car you buy or how much profit we make, so I don’t think it’s just the fact that the car is available. I think it still goes back to the process that the customer has to go through and whether or not they are comfortable doing that, and I think that’s something that we continue to have a very large competitive advantage on. So the market is extremely fragmented and the fact that all of those cars are online doesn’t change the fact that when the customer goes and actually goes through the process, they still have to go through a process in a way that makes them uncomfortable.

Got it, so increased price transparency isn’t really a big issue for you guys because of the offer that you had all around, not just price?

Well, increased price transparency is price transparency on the price of the car only, which is almost always negotiable, and then the price of the trade, which is always negotiable, and then the price of the financing, which is ridiculously negotiable, and then the price of all the add-on products like extended service plan or accessories, which are also negotiable. So when you look at it from top to bottom and the fact that we are straightforward and transparent on all of the pieces of the transaction, I think we have a significant competitive advantage and it shows up in our volumes.

Got it. Thanks and good luck.

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

Good morning, guys. Just one question on CAF. Your weighted contract rate was up a little bit year-over-year but down sequentially. Are there any seasonal factors involved, or was it more the customer mix? How should we look at that?

Yeah, Q4 and Q1 are typically lower credit mixes, so you might see a little bit it skews down our Bs and Cs then, but I don’t think there’s really anything to read into it. There’s nothing from a behavioral perspective that we did differently.

Okay, so you would just kind of consider it within the norm?

I’d say what’s coming through the door is probably driving that.

Yeah, got it. Okay, thank you.

Again ladies and gentlemen, in order to ask a question, please press star and the number one. Your next question comes from the line of David Whiston of Morningstar.

Thanks, good morning. Going back to the NFL endorsement deals, should we think of this more as a very large scale trial, or should we expect more deals like this going forward because, as you noted, you are a bigger company?

You know, like any other advertising program that we have tried or run in the past, we’ll evaluate it based on its performance and determine if it should be a bigger piece of what we do going forward. We’ve been a sponsor of the Los Angeles Clippers for almost 10 years now, so this isn’t our first sports sponsorship, it’s just our first NFL sponsorship.

Okay. You mentioned at the beginning of the call, about 65% of your business is coming from something other than a laptop or desktop. Is there anything that a smartphone or tablet user cannot do today that someone on a laptop or desktop can do?

That was 65% of our web hits, not 65% of our business. So it’s 65% of the total hits coming to our website are coming from a tablet or on a--you know, we have a different site for each, so there’s a mobile site you go through on the mobile device and then there’s an app, and the app has somewhat limited capability, but all the things that we think are most important - the ability to search for a car, the ability to look at 40 high definition pictures, the ability to zoom in on each of them, the ability to find a store and contact a sales consultant. We are continuing to work on adding additional capabilities, but clearly there are more capabilities on a desktop just because there’s more room and there is more access for the customer to do more things online. But we are continuing to work on our app and continuing to give the customer more capabilities based on their demands.

Okay. Can you transfer on an app?

Can you transfer on an app? You cannot transfer on the app right now. You can’t go in and enter your credit card information and transfer a car, no.

Okay. Thank you very much.

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

Hey guys, good morning. I wanted to ask on the retail gross profit per unit, which was quite consistent there, a lot of the public competitors on the dealer side have been seeing mid-single digit declines, and you guys have been really persistent. So can you just discuss some of the levers you might have, and how should we think about that going forward?

You know, we’ve been pretty consistent with managing our margins over a pretty long period of time now. I can’t comment on the way others manage their business, but we’re pretty confident in our ability to manage margin through all kinds of different environments. Even going back to the recession, we were able to manage margin pretty effectively and inventory turns during that time, which is the most significant single piece of volatility that we’ve seen in our time running the business. So we feel pretty confident in our ability to be pretty consistent with our margins.

Thanks. Just one other issue was on the buyback potential. From a debt to cap standpoint, I think that you all have said that there is opportunity there to perhaps be a little bit more aggressive, so maybe for Tom Reedy, if you could just go through how you’re thinking about that, and then also what are the metrics you would use to evaluate if you want to get more aggressive with the buyback.

Yeah, we’ve tried to be pretty consistent in our approach, and the fundamental to it was that we obviously are continuing having a priority of returning capital to shareholders as it’s appropriate, and we also believe that we could use a little additional leverage in our capital structure. We’ve talked about getting back to levels that are closer to where we ran pre-recession than where we are today. We’ve made some progress - we’ve bought back about 1.8 billion since the start of the program, or about 15% of the shares that were outstanding as of October of 2012, but we still think there’s--as you’ve seen, and we’ve made a little bit of progress on the cash balance this past quarter, it’s gone down about $250 million. But to get back to the levels we were considering, we would need significantly more debt than we have today, so I think we’d expect to continue on with the program as is. As far as how aggressive we get, we set up the program with bumpers in place that essentially govern our buy volume based on stock price and valuation, allow us to be a little more aggressive as price and valuation drop, and vice versa if price and valuation are up. We review that on an ongoing basis and will adjust it as appropriate. As you saw this quarter, the stock price was down, we were a bit up on our volume; last quarter, it was the opposite, so you can see we do take a bit of a view on how much volume to buy at given prices, but remember, it’s going to be a programmatic approach over time.

Again ladies and gentlemen, if you would like to ask a question, please press star and the number one. Your next question comes from the line of Irina Hodakovsky of Keybanc. Irina, your line is open.

Sorry about that - I was on mute. I have one follow-up question on the recall question that was asked earlier. Auto Nation made a move to ground all vehicles under recall. There was a recent attempt to implement a law similar to that - it didn’t work right now, and in near term nobody expects that, but longer term it could become an issue if the industry moves in that direction. Was just wondering if you had discussed that internally, if this is a concern, how material--is it just a higher cost issue, maybe higher inventory cost? And if it’s not a concern, then why not?

Well, it is a concern. We’ve talked about it at length. It’s something that we’re always trying to do what’s the most transparent thing that we can do for our customers. Something to remember is we’re in a different--we are almost exclusively used cars. We operate almost no new car franchises, and actually two less as of this quarter. We’re down to just two Toyota stores, one in Baltimore, one in Kenosha, and any repairs that are under warranty, which include recalls for us, have to be taken to a dealer and done at that location. If there were laws passed, we have always complied with all the laws. If there was a law passed that required us to fix recalls, we would absolutely do that; but then, everybody would be in the exact same boat and all others who sell used cars would have to get those repaired at manufacturers’ locations. We think the most important thing is to make sure that customers are fully informed of whether or not there’s an open recall on the car and also how important it is to register on a manufacturer’s website. We may sell them a car and a week later a recall may come out, and if they haven’t registered with the manufacturer, then they won’t ever know about that. Every customer that buys a car at CarMax is made aware in several different points of the transaction about recalls. We have a direct link on our website to the NHTSA database. It automatically populates the VIN for the customer so they can see exactly what’s going on with that individual car, and then at the point of sale our sales consultants are walking through with the customer exactly what I just said - whether or not the call has a open recall, and the importance of registering with the manufacturer on their website so they can be notified of recalls going forward. So we’re absolutely committed to transparency, and if there’s any changes in the law, obviously we’ll comply with all those laws.

Thank you.

All right, thanks very much for your interest in CarMax, and thanks to all of our associates for all they do every day. We’ll talk to you next quarter.

This concludes today’s call. You may now disconnect.