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Executives

Katharine W. Kenny - Vice President of Investor Relations

Thomas J. Folliard - Chief Executive Officer, President and Director

Thomas W. Reedy - Chief Financial Officer and Executive Vice President

Analysts

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Gary Balter - Crédit Suisse AG, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

John Murphy - BofA Merrill Lynch, Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Clint D. Fendley - Davenport & Company, LLC, Research Division

Dan Galves - Deutsche Bank AG, Research Division

Chad Potter - Gradient Analytics, Inc.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Joe Edelstein - Stephens Inc., Research Division

William Armstrong

David Whiston - Morningstar Inc., Research Division

CarMax (KMX) Q3 2013 Earnings Call December 20, 2012 9:00 AM ET

Operator

Good morning, my name is Mo, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter Fiscal '13 Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to today's host, Ms. Katharine Kenny, Vice President of Investor Relations. Ma'am, you may begin your conference.

Katharine W. Kenny

Thank you, Mo, and happy holidays to everybody. Thank you for joining our fiscal 2013 third quarter earnings conference call. On the call with me are Tom Folliard, our President and Chief Executive Officer; and Tom Reedy, our Executive Vice President and CFO.

Before we begin, let me remind you, as always, that our statements today regarding the company's future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current knowledge and assumptions about future events that involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see the company's annual report on Form 10-K for the fiscal year ended February 29, 2012, filed with the SEC.

I'll turn it over to Tom.

Thomas J. Folliard

Thank you, Katharine. Good morning, everyone. Well, we're very pleased to report used unit comps for the third quarter of 12% and total growth in used units of 16%. Almost all of our comp growth was due to improved conversion. We believe improved conversion was due to a number of factors, more compelling finance offers from CAF and our third-party lenders, increased inventory selection and strong execution by our store sales teams.

In addition, we believe consumer sentiment has improved somewhat, which may be resulting in more engaged customers in our stores. Total used vehicle gross profit grew by 15% as our used unit sales increase was slightly offset by a $25 decrease in used vehicle gross profit per unit to $2,146 per car. Our wholesale unit sales increased 10% compared to last year due to higher appraisal traffic. Our buy ratio of 28% remained about the same as in the third quarter of last year. Total wholesale gross profit grew by 11% as a result of higher unit sales and a $9 increase in per unit gross profit to $923.

CAF quarterly income grew 16% to $72.5 million, Tom Reedy will comment more in a moment. During the quarter, sales of 5-year and older vehicles as a percentage of our total sales remained well above 25%, as we've been seeing for a while. Year-over-year sales of SUVs and trucks fell by about 4 percentage points of our total, offset by a similar increase in the percentage of compact and midsized vehicles.

You'll also notice that our total inventory at the end of the quarter was up substantially. This is also for a number of different reasons. First and foremost, our sales are up 12% and we usually move our inventory along with sales. We had 10 new stores in the quarter compared to last year, which was about 1/4 of the increase. And lastly, historically, we've built inventory levels in the fall. And in last year's third quarter, we moderated this build given the negative comp levels we were experiencing at the time. But this year, we reverted to a more aggressive level of production given the improved condition.

I'll now turn the call over to Tom and he'll comment on financing. Tom?

Thomas J. Folliard

Thanks, Tom. Good morning, everybody. CAF income grew $10 million or 16% compared to the third quarter of fiscal 2012, in line with our portfolio of managed receivables, which increased 15% to $5.5 billion. For the quarter, interest margin after the provision for loan losses increased 14%. The growth in managed receivables was largely driven by strong origination volumes over the course of fiscal 2012 and fiscal 2013. These were lifted by CAF's expanded penetration and increase in the average amount of financed and CarMax's sales volume growth.

The allowance for loan losses grew $12.9 million or 31% to $54.3 million. As a percent of average managed receivables, it increased 0.1 point to 1.0%. This increase reflects the growth in our portfolio and the shift in credit mix as we return to our pre-recession origination strategy. The magnitude of the increase was tempered somewhat by favorable loss experience.

Net loans originated in the third quarter increased 29% year-over-year. This was largely driven by higher CarMax sales and an increase in CAF net penetration, which was 41% compared to 38% in the third quarter of 2012. Penetration increased due to the transition back to the pre-recession origination strategy and the extension of more compelling finance offers to our customers. As you know, we test offers and policies on an ongoing basis in attempt to optimize sales and profitability within our risk profile.

During the quarter, we believe consumers responded favorably to our finance offers, providing both incremental sales and higher CAF originations. We experienced continued strong access to financing for our customers. And as we've seen throughout the year, third-party subprime remains a higher percentage of our sales, 14% versus 9% in last year's third quarter.

Now I'll turn it back to Tom.

Thomas J. Folliard

Thank you. Our improved sales rate also drove SG&A expense leverage during the quarter even as we continue to ramp up our infrastructure growth -- our infrastructure per store growth. SG&A expenses per retail unit decreased by $43 a car.

We remain pleased with our new store performance. During the third quarter, we opened 3 new superstores: One in Des Moines, Iowa; one in Denver, Colorado; and our 10th store in Los Angeles. Last week, we opened our second store in the Denver market, and we plan to open one more store during the fourth quarter, a second location in Jacksonville, Florida. In today's press release, we included 4 planned openings in the third quarter of our next fiscal year: One in our existing Washington D.C. market; and 3 in new markets for CarMax, Jackson, Tennessee, which will be our second small-market store; and 2 in St. Louis, Missouri.

Also during the quarter, we launched our CarMax app available now on the iPhone. It already represents about 5% of the traffic to our website. Overall, web visits continue to increase, averaging now approximately 9 million per month, and this represents about a 16% increase year-over-year.

And with that, we'll open it up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of Matt Nemer with Wells Fargo Securities.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Just a few questions. First, can you talk about the improved inventory selection that you mentioned? Is that depth within certain models or is it more availability at certain age brackets?

Thomas J. Folliard

Well, it's really representative of what we're selling at this time. But as I said, about 2/3 of the inventory increase is explained through just 12% comps. And as you know, we move our inventory along with sales, 10 new stores, which was about 1/4 of the increase, and the remaining 1/3 was, we always build inventory in the fall. Last year, we didn't, we moderated it some, so it created a kind of a bigger spike this year because we didn't build as aggressively as we normally do.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Okay. And then secondly, I'm wondering if any of the changes in your store, the future, your next generation store format, have been working their way into the rest of the store base. Is there anything in that new store that you're planning on exporting to the base?

Thomas J. Folliard

Yes. It's still pretty early and there's a lot of the technology -- some of the changes in technology, with the display screens and how we present some of the consumer offer that we think we'll be able to push back into the existing stores pretty quickly. We have some process stuff that really doesn't require any capital, just some basic things like unlock in all of our cars, allowing our customers to test drive without a sales consultant, just some things we hadn't done in the past. We have yet to roll those out into existing stores because we want to be pretty certain what's working and what's not working. We do plan on going back in and remodeling 5 or so existing stores over the next 12 months to really see if we get a spike and get a read on kind of the whole package. But to date, we have our Chattanooga store open, Des Moines and 2 stores in Denver that are kind of our full next-generation package. But we're still learning which components are advantageous and which ones we can roll back into the stores pretty quickly. But there isn't any one thing that's jumping out right now.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

And on the remodel, how big of a capital expense per store are you anticipating?

Thomas J. Folliard

We're still working on that. We tried to select some stores that had some capital coming anyway, like some -- they were up for some refreshing to begin with, so we think it'll be pretty manageable, but we don't have a number yet.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

And then lastly, on the change in finance -- on the change in the finance environment, you mentioned that -- some changes at CAF, is that -- are the APRs coming down and is that due to higher 3-day payoffs or more sort of competitive rates from other folks in the industry?

Thomas W. Reedy

Yes. Matt, we talk about that we're constantly testing to see if changes in APR and in our offer will move the needle for customers, and we do that on an ongoing basis. And we've been testing in the past 2 years in this low interest rate environment. But I think what we saw in Q2 -- starting in Q2, is that customers have become more responsive to changes in interest rates and more receptive to it, which means we get better attach, fewer payoffs and more sales, so that's a good package for CarMax. And you can see in our APR for the quarter, which we started providing now in the earnings release instead of the Q so you have a couple weeks head start with it, that we're down at 7.7% for the originations during the quarter versus 8.1% in Q2 and 8.7% a year ago. So we have dropped rates, but all in all, it's -- we think -- believe it's positive for CarMax. And it's really -- that's our barometer for testing the competitive environment is whether customers are receptive to those changes and we found that we believe they have been recently.

Thomas J. Folliard

But that's about as low a total APR as we've had, Matt, in a long time.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

It sounds like it's more offense than defense, that decision.

Thomas W. Reedy

Yes, I think it's a proactive and responsive way of looking at the world and that's how -- we've just seen customers actually move this time. So the point of reference, our best credit customers during Q3 were offered a rate of 2.45%, which is pretty low and pretty competitive.

Operator

Your next question comes from the line of Simeon Gutman with Crédit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

It's Gary Balter for Simeon. You talked about 3 things and 2 of them were just discussed, the CAF, the inventory selection and strong execution at the stores as being behind the comp. Can you go -- are there any changes in the way you're talking -- your employees are approaching customers or anything along those lines that we should be thinking about?

Thomas J. Folliard

No, not really, Gary. That's pretty much -- we believe it's those factors that we referenced, but we -- there's no substantial change in the way we're talking to customers at all. We're always training and trying to get better and better at how we greet, handle customers, take them through objections, so -- but that's more of a marathon than it is a sprint. So if we're making some progress there, it's steady, slow progress over time.

Gary Balter - Crédit Suisse AG, Research Division

And I think where there was a surprise in the quarter or in the trend has been the fact that the common perception has been that inventory is going to stay tight until we start seeing more stuff coming off leases, yet you're showing really strong inventory and really strong sales. What are your thoughts on the availability of cars as we go into next year and the following year?

Thomas J. Folliard

We've never felt like the lease issue had anything to do with our inventory levels. Our inventory levels were always a function of where we expected sales to come out and kind of how we felt about the next several weeks. As I mentioned, part of the unique comparison this year than last year, when we normally build inventory in the fall -- and there's a few reasons we build inventory in the fall. We have a really -- we usually have a pretty good sales week between Christmas and New Year's. We head into tax season in January and February, which you can see in our seasonality, there's always a pickup in sales there. There's also -- less of the auctions are opened on a more consistent basis, so if you want to build your inventory, you kind of have to do it in a bit of a spike during the fall season. If you think over the next couple of weeks, with Christmas and New Year's falling on a Tuesday, that's when, for example, Florida Auto Auction runs, that's one of the biggest auctions in the country, so they'll be closed for 2 weeks. And that's just something that we normally do. Last year, we had a negative comp quarter in the second quarter and we weren't as optimistic, so we just did not build inventory like we normally would. And this year, we're kind of back to where we were before in addition to moving inventory along with sales and having 10 new stores in the pipeline. So it's not something really -- it looks really big because it's 30% up year-over-year, but 2/3 of it is explained by improved sales and new stores in the pipeline.

Gary Balter - Crédit Suisse AG, Research Division

Right. And then last, when are you coming to New Jersey?

Thomas J. Folliard

We'll probably get to New Jersey as part of our Philadelphia market first. We're looking at Philadelphia now, but we're probably still a couple of years away. We do have a site in King of Prussia in New Jersey. The advertising market for Philadelphia, I think, would include parts of New Jersey like Cherry Hill, as well as Newark, Delaware. So Philly is a big market for us. It's complicated, it'll be multiple stores, but it's a place that we're excited to go to, and then you can buy a car from us.

Operator

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

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

So I wanted to follow up, I know the 2 previous questions touched on finance too. But as you talk about the lower rates and more -- maybe more aggressive financing, is this something that you're beginning to advertise more aggressively to your customers or is it just something that comes up in your -- in the finance discussions to essentially aid conversion?

Thomas W. Reedy

It's the latter, Brian. We historically have not promoted finance in our marketing. We want to provide the customer the competitive and best offer that we can get at the point-of-sale and that's where they're seeing it.

Thomas J. Folliard

We have, on occasion, done some stuff on the website, advertising a particularly attractive rate, but remember -- Tom referenced the 2.45% rate, remember, that's only available to the very top tier of customers. So oftentimes, if you advertise too much of a low rate, your -- most customers don't qualify for that. So although we've done that some in the past that has very -- nothing to do with what we've seen this quarter.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Got it. And then just regarding the sales trends, you mentioned it's -- the uptick in comps is largely a function of better conversion, but how would you characterize -- clearly, we had a shift here in Q3 from what we'd seen the prior 2 quarters and further back than that. The overall activity of your customers, something I know we watch a lot is -- you're starting to see that, I guess you'd call it maybe that aspirational customer come back to the store whether -- it's maybe not as much of a need purchase, but they're buying that car they kind of want, maybe kind of a fun car. Are you seeing the beginnings of a shift like that or is it basically just the same customer coming to your store now converting more?

Thomas J. Folliard

That part is really hard to judge, Brian, whether or not people are going back to buying, I guess, an extra car or a fun car. Our history with that is that usually doesn't happen in the fall anyway. And we had a negative 3% comp last year's third quarter, so this was our easiest comparison of the year. But I think consumer sentiment has come back some but -- and the customers that are coming to the store now seem a little bit more engaged maybe than they had been before, as has shown up in our conversion. And like I said, I think it's from a number of different reasons, and the credit availability and attractiveness of rate is no small part of the picture. I think it's people get involved, they get involved in considering to buy car and then they find out how cheap their payment's going to be, and they're probably a little bit more likely to buy a car, so. But it's really hard to tell if behavior is shifting back to what we saw pre-recession. I'd say not yet.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Got it. And the final question, just you've been opening a number of new stores, just any comments on the performance of those units as you're opening them?

Thomas J. Folliard

Just as a group, we're very pleased with the performance of all of our new stores. And it's a pretty diverse set. There's some in brand new markets. We have a couple of our -- what we've called our next-generation format, we have some satellites going back into existing markets, so -- but we've only been back to growth here for whatever it is, about 2 years. And we've really -- since the recession, we opened those 3 stores that were already built. We opened 5 during the year last year and 10 this year, so there's not a lot of time really to read them, but as a group, we're very pleased.

Operator

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

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

My first question relates to traffic. Just want to make sure I understand the relationship, if any, between appraisal traffic, which sounds like it was quite strong and drove the wholesale number, and traffic for used car sales, which sounds like it wasn't a big part of the comp generation. So has there ever been a consistency, any type of relationship between those 2 factors to the extent where this divergence would be unusual?

Thomas J. Folliard

I'm not sure how unusual it is, but in general, we would think that as traffic grows, appraisal traffic grows, it's probably a bit unusual in this quarter that our traffic was relatively flat in aggregate, but our -- those -- of those customers who came to the store, about 10% more decided to get their car appraised. And since we bought at the same rate, that delivers the wholesale increase. So yes, it might be a little bit unusual, but I would still think that over time, we would see those numbers move directionally pretty similar.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. And any relationship, do you think perhaps between that development and conversion to the extent that maybe the link just didn't shown up in used car traffic but more people who were there, were kind of already transacting with you in one way or the other?

Thomas J. Folliard

Yes, probably. Some of the people who -- obviously, some people who sell us the car also buy a car from us. So I mentioned the factors that we thought were improved conversion. And clearly, some of those customers had to get out of whatever it was that they were driving, so that probably had something to do with it as well.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. A second question relates to subprime. So obviously, over the past 4 quarters including this quarter, albeit to a somewhat lesser degree in this quarter, subprime has been ramping as a percent of the business. So there's obviously some cost to you for that. So you're about to cycle the first quarter where subprime begin to pop, that was the Feb 2012 quarter. What do you anticipate happening to the subprime mix of the business based on your positioning within CAF, based on your thought process on the cost of doing this business as we cycle that development?

Thomas W. Reedy

Yes, Matt. I don't think we can predict exactly what's going to happen as we cycle. And in fact, the subprime actually started elevating last fall and then we saw another pickup in kind of the wintertime Q4, Q1 period. But because we did see an increase in subprime over the course of Q4 last year, we expect that the subprime mix will likely be a bit higher this year than last year because we are rolling over a period of transition. But I wouldn't expect the same kind of proportional increase you've seen in other quarters this year.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

One or 2 more very quick ones. So obviously, the supply of late-model used vehicles has been a pretty big theme surrounding your stock and most likely, surrounding your outlook legitimately. It sounds, Tom, from what you said, like the mix of business didn't change a whole lot from recent quarters and whatever changes we saw on supply, and I know those come slow, probably didn't really move the needle here. Any updated thinking on this starting to have an impact for you going forward?

Thomas J. Folliard

So we've been talking about the supply issue, we've been talking about the spark coming back, which would help us from a supply standpoint. But it really -- our ability to predict when that'll happen, there are so many other factors there with consumer behavior and lots of other -- how quickly people turn out of their car, cars per household. We think it's coming. It's hard to really say whether or not it happened this quarter. We did see a mix shift within our mix, within the 1- to 4-year old cars, where this quarter, we had a bigger percentage of our sales were 1- to 2-year-old cars, so you could see it coming back a little bit. That was offset by a decrease in 3- to 4-year-old cars, but if you look at the mix of break it into 2 groups, 1 to 4 and 5 to 10, it was pretty similar to what it has been. So embedded in there is some movement towards 1- and 2-year-old cars, but in aggregate, we haven't seen it very much.

Operator

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

John Murphy - BofA Merrill Lynch, Research Division

First question, I mean, is there anything that you're seeing in the market or with this new store opening experience, which sounds like it's going very well, which would lead you to accelerate your new store openings? I mean I know you're targeting this 10 to 15. But it sounds like the market's coming back, you're doing really well. Could this ever go up to a 15 to 20 rate?

Thomas J. Folliard

We've announced the next 3 years, we're very comfortable with that number. We said all along that we think we need a balance between opening up new stores and continuing to improve our existing business model. I think I'm very proud of the way our teams have reacted and the progress that we've made in both of those areas. I think the build that we've announced for stores: 3, 2 years ago; 5, last year; 10, this year; 10 to 15 in the next 3 years. We think that 10 to 15 gives us a range of acceleration to push it up if need be. Really, the next year for us is a largely baked because those stores are already under construction. It takes about a year to build one of these, so we're pretty happy with what we've -- what our plans are over the next few years. We don't want to get too overly excited over any short-term trends nor do we want to move in the other direction if something were to go south a little bit.

John Murphy - BofA Merrill Lynch, Research Division

Okay, got you. Then if we think about used vehicle pricing, meaning over time, if supply comes back, there'll probably be a little bit of natural pressure on pricing. I'm just curious, as we see that, your sales will pick up, but would your gross profit come under any pressure there? Do you think you can still hold this $2,100 to $2,200 gross profit? Is there a reason to think that might fade?

Thomas J. Folliard

Well, we've operated in depreciating environments before and been able to manage our margins pretty good, but it's really hard to say. There's just too many other factors. I mean, I would take lower margins for much higher sales, so it really just depends what's going on in the overall market place, including wholesale, including finance and including demand and supply. There's just too many factors there to really say I'm 100% sure we can keep our margins within such a tight window.

John Murphy - BofA Merrill Lynch, Research Division

Okay. And then just lastly on the wholesale gross profit per unit at $923, that's been pretty strong for the last few years. I mean, as we think about that going forward and it's same phenomena that supply comes back in, should we think about that at least having a base for at $400 to $500 the buy-sell fee at an auction, that would be sort of the worst case scenario you get on a wholesale gross profit per unit? It just seems like that should be at least a bare minimum floor and everything above that is your execution. Is that a fair way to think about that?

Thomas J. Folliard

Yes, I mean, as we're -- you've seen how finely we've managed it. So without giving any guidance, I don't expect our wholesale margins to go down to $400. So I mean, I think we're able to manage it pretty well.

Operator

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

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Tom, you outlined a couple of items that helped the conversion rates in the quarter. And I know it may not be a scientific exercise, but any way to tell kind of the size of the impact of those different factors, or at least put them in some sort of ranking or order?

Thomas J. Folliard

Yes. Not really, I wish there was. But even with the financing piece, which we know we're giving better offers, we know what's going on in the subprime world as it relates to our customers. Every time somebody gets an approval, we still have to execute in the store, we still have to overcome objections. Oftentimes, we have to convince customers to put more money down. Oftentimes, we're making them an offer on their car that's less than what they owe at the bank, so I just -- I couldn't be more proud of our store teams and our execution and our ability to manage customers effectively. So it's really hard to say. I mean, if you just changed a rate, it's not necessarily going to sell you more cars if you don't actually execute that in the stores and provide great customer service. So it's just -- it's really hard to say, almost impossible for us, really. It's a combination of all of those factors and they work well in the quarter and we're really pleased with the results.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

You had mentioned the better store execution. Was there any extra training or kind of change in terms of how you approach the customers? Or I know you guys have a checklist in terms of trying to knock down customer objections, et cetera, was there any kind of change on that front?

Thomas J. Folliard

No. As I said earlier, I think this is a -- it's -- I said it's more of a marathon than it is a sprint. I think we're providing lots of great training in the stores, but it's a very long, slow, continuous improvement type environment, not we're going to come up with some new thing that's going to change our fortunes overnight, we don't expect that at all.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Okay, that's helpful. And then I mean you guys have stores kind of entering your comp base now. And given that the level of new store productivity that you're seeing, any feel for the kind of the level of comps that you're seeing from the first stores entering the comp base, the younger stores entering the comp base?

Thomas J. Folliard

It probably wasn't much in the quarter just from straight math. We have 10 stores we opened this year, none of those are in the comp base. We only opened the 3 2 years ago and then the 5 last year, so when you look at 116 or 117 store total and then the fact that the stores opened up in terms of a volume compared to one of our bigger stores pretty low, I'd say it had very little impact. Although I haven't actually gone and done it, I just -- it couldn't have had much of an impact on comps.

Operator

Your next question comes from line of Clint Fendley with Davenport.

Clint D. Fendley - Davenport & Company, LLC, Research Division

I'm curious if you have any thoughts on customer recognition of the brand and how that might be changing? I know when I look at the new markets or cities that you plan to enter within the next year, most of them are in states such as the Virginia, Georgia, Tennessee, where you have been for a long time. I'm wondering, should that help you gain share there in an accelerated way?

Thomas J. Folliard

I think in general, our brand has gotten stronger since we started, so I think that has some truth in any new market we go to, particularly since we've been doing a portion of our TV ads have been national advertising over the last couple of years. It's about 40% of our TV spend is now national. So even a place like Denver, where we didn't have a presence, has been seeing some CarMax ads over the last couple of years. But clearly, in a market that we have a more established base of stores and established base of customers that we've been selling to, we would have a stronger brand awareness for sure, but that's not a factor in us selecting where we're going next. We're basically trying to go everywhere that we're not.

Clint D. Fendley - Davenport & Company, LLC, Research Division

Okay. And I wonder if you could discuss your strategy with the small-market stores? Why now given the large growth opportunity that is still in front of you in some of the larger markets?

Thomas J. Folliard

We think that is part of our growth opportunity and it represents somewhere between 80 and 100 markets in the U.S. that currently would -- they would not be in the growth plan, if not for figuring out how to do a small format store. I think we can do both. I think we can go after the markets that are more traditional or even bigger metro markets, and at the same time, on a limited basis, go after some of these small markets, figure it out, see if it works, and if it does, we can build them into the pipeline going forward. So when you look at what it represents of our total growth, it's a very small percentage of it. Next year, we'll open up Harrisonburg, Virginia and Jackson, Tennessee as 2 small format stores, but we got to get a couple of them opened and read the results for a while before we determine how aggressively we want to go after that opportunity.

Operator

Next question comes from line of Rod Lache from Deutsche Bank.

Dan Galves - Deutsche Bank AG, Research Division

It's Dan Galves for Rod. Just a couple follow-ups on CAF. The latest ABS issuance that you did loans through September was done at an 8.6% customer rate. Is the 7.7% origination rate on loans during this quarter, is that -- are those 2 numbers comparable?

Thomas W. Reedy

Yes, it's the same calculation. But if you look back sequentially, in Q2, you saw that, that number was 8.1%. But if you -- and if you look at a deal, it's a combination of loans we've originated probably over the last 6 months plus things that have rolled off of other deals. So there's -- each deal can be very pretty -- not significantly, but there can be some variance in APR on deals depending what's in there.

Dan Galves - Deutsche Bank AG, Research Division

Okay, got you. I just wanted to clarify that. And then on the loan loss provision, I mean, the provisioning on the quarter looks like it was maybe 1.3% and the allowance is 1.0%. Realize that the allowance is a reflection of all the loans in the pool and your expectations. But as the loans that were originated kind of during the crisis with higher average FICOs, as those become a smaller piece of the overall pool, do you think that the loan loss allowance migrates higher than the 1.0% you're at right now?

Thomas W. Reedy

Yes. I think if you think about how -- the life cycle of our portfolio, as we're adding -- if we change the mix of the portfolio, it takes a couple of years for the portfolio to normalize to kind of equate to that steady-state mix, and we're still seeing that happen here with regard to taking back the lower end of the credit spectrum that we've been doing over the last 18-or-so months. So I think as the portfolio continues to normalize to what we're originating today, we would expect to see that number move up, but it also depends on what's going on with loss experience, which has been positive in the last several quarters. It's hard to predict exactly where it'll go, but I would -- we would expect that it's going to trend upward. Now at the same time, you got to remember, we're charging up more for those loans because they're higher risk and it's a good business proposition for CarMax. At the end of the day, it's a profitable endeavor for us and that's why we're doing it, so you've got to remember, we're getting paid more too on this.

Chad Potter - Gradient Analytics, Inc.

Absolutely. And just one additional question. In terms of your competition from new car -- the used car lots from new car dealers, if you could just talk about, a lot of new car dealers have been talking about getting a bit more aggressive on what they'll retail versus what they'll wholesale. In addition, you're probably selling more 1- to 2-year-old vehicles now. Has there been any change in the competitive dynamic that you're seeing from the new car stores?

Thomas J. Folliard

There's been a lot of talk about that for the last couple of years, so the shifting that we've seen, I think we've already seen. So it's not like there was something unique in the quarter with the way everybody else behaved. And as it relates to us, we are selling older mix of -- an older mix of cars than we did pre-recession, but we never lowered our quality standards. So we've seen pretty significant growth in our wholesale business and that's the type of stuff that people are saying that they're retailing. We've chosen not to do that, but we've seen growth in that area of our business pretty substantially over the last couple years, as you've seen.

Operator

Next question comes from line of James Albertine with Stifel, Nicolaus.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

On the 1- to 2-year-old vehicle comment, I just wanted to clarify sort of how you typically source those vehicles or have been sourcing them during the third quarter. And then – well, I guess I'll let you answer that question, and I have a follow-up to that.

Thomas J. Folliard

Yes, those cars are going to be bought the same way we buy everything, either a combination of buying cars directly from the consumer and buying cars in the open marketplace, whether it's at auction or elsewhere, so it's a combination of those 2.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And have you ever detailed sort of the gross margin implications, the difference between when you buy at auction versus when you buy directly from a consumer?

Thomas J. Folliard

We have not, other than to say that our -- what we buy from consumers is more profitable than what we buy offsite. Remember, there's some costs involved with buying offsite, shipping and things of that nature, so it's always been a more profitable source to buy internally, but we've been able to manage the mix pretty effectively to a margin target.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Understood. And then lastly, just on your comp leverage point, I think I probably share with sort of my peer view that the leverage was impressive, considering not only the 12% comp, but that you're investing in your new growth strategy. So I guess if there's a way to sort of peel back the investments that you're making. Has there been a shift perhaps to a slightly lower comp leverage point as you see it?

Thomas J. Folliard

No. I mean, it's -- again, it's one of those things that's -- it's not really -- I don't think that it should be measured on what happened this quarter and therefore, that means this forever because there's a lot of timing stuff in there as well, but we've always said mid to high single digits plus that even in a growth environment we thought we could leverage SG&A. We had a 12% comp, we leveraged SG&A, we're building infrastructure for growth at a higher rate than we were the year before, so we're pretty pleased with the results ourselves, but I'm not sure that it's -- that you should read into it any more than that.

Operator

Next question comes from line of Joseph Edelstein with Stephens Inc.

Joe Edelstein - Stephens Inc., Research Division

Just wanted to follow up on the leverage question that was just asked. And given that you will be up against a more difficult subprime mix, starting really fourth quarter here, I mean, do you think that you'll be able to leverage in the fourth quarter?

Thomas J. Folliard

Again, like I said, it's hard to tell. If I knew what comps were going to be, I'd have a better idea. And there's no doubt, I think if you're asking that an increase in Tier 3 or subprime percentage is less beneficial, you're right. So it's a little tougher to leverage when you have a higher percent mix, but we did it this quarter, so we'll have to see how the quarter comes out.

Joe Edelstein - Stephens Inc., Research Division

Sure. And just kind of tied into -- we're all trying to get a handle on where the comps will go, but earlier, you mentioned that there was improved consumer sentiment, and part of that helped you this quarter. But I'm just trying to get a sense for how you think consumers will react under any sort of fiscal cliff, those headlines have been getting louder.

Thomas J. Folliard

Yes. If you knew, it would be really helpful for us if you could tell us, but it's really hard to say. When you look at all the things that are in the fiscal cliff and you have to jump to a conclusion that therefore consumers are going to behave in a certain way. What I feel really good about is our ability to react, move our business, move our inventory accordingly and operate in lots of different economic environments. So I feel super confident in our teams' ability to respond to whatever happens with the consumer. It feels a little better this quarter. I think that's part of why conversion was up. It's not – this is just what I believe, it's not -- I can't go give you a statistic that says consumer sentiment added x amount to our sales, but it's just impossible to tell what will happen at the end of the year.

Joe Edelstein - Stephens Inc., Research Division

Okay. And as you try to then manage the inventory levels, et cetera, can you just tell us what your expectations are for used vehicle margins as we look out really kind of through the rest of this year just because there has been increased supply as a result of Hurricane Sandy, but then just also looking out a little further into next year where you think margins could go?

Thomas J. Folliard

Yes, we don't give any guidance on margin or sales.

Operator

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

William Armstrong

Can you talk about what you're seeing in terms of pricing trends for used cars in your wholesale sources or from consumers?

Thomas J. Folliard

I think -- I don't have the Manheim trends in front of me, but there's been some depreciation during the last few months in the fall, which is pretty normal for -- actually, I'm not sure what normal is anymore but it used to be normal several years ago. We went through a couple years of unusual appreciation for a long time, but I think we've seen some movement -- some depreciation in the last few months that is just a little more normal than the fall, so I mean, nothing shocking.

William Armstrong

So we haven't gotten to a point yet where you're starting to see that spread between retail prices of a new car and a comparable 1- or 2-year-old car starting to widen again is what it sounds like.

Thomas J. Folliard

I think what's lost in that whole conversation of new car appreciation over the last couple of years -- I mean, I'm sorry, used car appreciation over the last couple of years, is that new car prices have gone up equal or more. The average price of a new car is over $30,000. So the spread, if you just look at our average sale price and the average of a new car, the spread really never tightened up very much. Now on an individual car basis, there's always examples, there's been examples the whole time we've been in business, where on a specific make or model depending on how hot it is and depending how much pressure the manufacturer's putting on pricing that, that window could get kind of tight and consumers might decide to buy a new car over a used car on a specific make-model basis. But in general, we think the spread is attractive enough that we're providing great value to our customers.

William Armstrong

Okay. Moving on to CAF, your penetration rate is over 40%. Where is that compared with historical levels, if you could remind us? And do you see it going higher?

Thomas W. Reedy

I'd say historical levels, it's going to depend on the quarter. But I think in -- low-40s is not an abnormal number for CAF. We said high 30s to low 40s. And it all depends on what's going on with the customer flow through the door and how they're receptive to our offers. It's very hard to comment on where it's going to go.

Thomas J. Folliard

It's not a number we're uncomfortable with.

Thomas W. Reedy

Right.

William Armstrong

Okay. And maybe just looking at the last cyclical peak, I would assume prior to the credit crisis, where -- I don't know if you have those numbers handy or not.

Thomas W. Reedy

We can get back to you after the call, but you've got to remember, we also had other partners lending in the same spaces as back as that time period, so it's not really an apples-to-apples comparison.

William Armstrong

Right, right, I remember that. And then just one sort of technical point of clarification, we're in December of '12, when we're talking about your sales of cars that are 5 years or older, are we talking about '08 model years and earlier at this point?

Thomas J. Folliard

What are we in, '12?

William Armstrong

We're in December of '12, but we've got...

Thomas J. Folliard

Yes, '08 would be 5 years and older.

Operator

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

David Whiston - Morningstar Inc., Research Division

Wanted to go back first to the -- accelerating the store opening question, up or down, I should say. Specifically, is there any kind of -- on the macro side, is there kind of any factors such as SAR or unemployment, consumer confidence that would make you change those plans?

Thomas J. Folliard

No. Only if those things impacted our sales.

David Whiston - Morningstar Inc., Research Division

Okay. And on the buyback, was the rationale for doing a buyback over a dividend just that buyback can be done at the board's discretion rather than a fixed cash outlay of a dividend?

Thomas J. Folliard

Want to get that one, Tom?

Thomas W. Reedy

Yes. I think we -- the way we looked at it is we're still a growth company. A dividend is more of a longer-term commitment. We're committed to looking at returning value to our shareholders in any method that is appropriate and makes sense and the repurchase just seemed, given our current situation, was a more appropriate vehicle. I really can't comment much beyond that but...

David Whiston - Morningstar Inc., Research Division

Okay. Would you say then a dividend is something you wouldn't do until your store expansion is completed across the U.S.?

Thomas W. Reedy

I think we'll cross those kind of bridges when the time's appropriate. We look at our capital structure. We look at how the business is doing and what we're returning on an ongoing basis. And I think what we can say is we'll, like I said, we'll use the tools that are available, and we'll do what we think is most appropriate for our shareholders at that time. At this point, we don't have anything new to report. We're buying back programmatically right now.

Operator

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

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

First of all, we were delighted to see you launch the mobile app. And I'm curious, you've talked about it being 5% of traffic. Are you seeing higher levels of conversion and can you tell if people are using it in the stores as a supplement to your systems and to your people?

Thomas J. Folliard

It's way too early to tell on that. The other part is we had it available with Android as well and we had a few issues with it, so we had to take it down this week. We expect it to be back up quickly, but until we have both the iPhone and the Android app up and running and get some more time to read it, it's almost -- what we can tell is what percentage of hits it represents, so that's the number we gave you.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And second final question, I know you're in the process of making a change in terms of EVP of Marketing, and I'm interested in whether you're taking a fresh look at all at the company's marketing strategy and what direction we might anticipate for you going forward.

Thomas J. Folliard

Matt, we're really proud of everything we've done here. I think we've done some phenomenal things in marketing. We've built a terrific brand over time. I think our marketing team has done an outstanding job in pretty much every area. We are looking forward and looking at staying ahead of the consumer and some of the things that are going on in mobile and digital. We had a terrific guy who you know, Joe, who was in -- who had multiple responsibilities here, and we really want to have a Chief Marketing Officer specifically dedicated to that one area alone. But I'm really proud of the stuff that we've accomplished so far. And as we look at growth over the next 5 to 10 years and we look at adding between 30 and 45 stores and continue to have our existing stores' growth, I'm just really excited about the opportunities we have to continue to build our brand.

Operator

And at this time, there are no further questions. I would like to pass the call back to the speakers for closing remarks.

Thomas J. Folliard

All right. Thank you very much. Thanks, everyone, for joining us. Happy holidays. Thank you, everyone, for your support. And especially, I want to thank all of our associates for all you do every day. And we'll see you after the 1st of the year. Thanks a lot.

Operator

And this concludes today's presentation. We thank you for joining. You may now disconnect.

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