CarMax, Inc. (NYSE:KMX) Q2 2024 Earnings Call Transcript

CarMax, Inc. (NYSE:KMX) Q2 2024 Earnings Call Transcript September 28, 2023

CarMax, Inc. reports earnings inline with expectations. Reported EPS is $0.75 EPS, expectations were $0.75.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter Fiscal Year 2024 CarMax Earnings Release Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, David Lowenstein, AVP Investor Relations. Please go ahead.

David Lowenstein: Thank you, Chelsea. Good morning everyone. Thank you for joining our fiscal 2024 second quarter earnings conference call. I’m here today with Bill Nash, our President and CEO; Enrique Mayor-Mora, our Executive Vice President and CFO; and Jon Daniels, our Senior Vice President, CarMax Auto Finance Operations. Let me remind you, our statements today that are not statements of historical fact, including statements regarding the company’s future business plans, prospects and financial performance are forward-looking statements we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on our current knowledge, expectations and assumptions and are subject to substantial risks and uncertainties that could cause actual results to differ materially from our expectations.

In providing projections and other forward-looking statements, we disclaim any intent or obligation to update them. For additional information on important facts that could affect these expectations, please see our Form 8-K filed with the SEC this morning and our Annual Report on Form 10-K for the fiscal year ended February 28, 2023 previously filed with the SEC. Should you have any follow-up questions after the call, please feel free to contact our Investor Relations Department at 804-747-0422, extension 7865. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow-ups. Bill?

Bill Nash: Great, thank you, David. Good morning, everyone, and thanks for joining us. Although our second quarter results largely reflect the same widespread pressures that we cited over the past year, we continue to see sequential quarterly improvement across our business. We believe the deliberate steps we are taking to control what we can are supporting our business now while also positioning us well for the future. This quarter we delivered strong retail GPU. We further reduced SG&A year-over-year. We maintained used sellable inventory units at a similar level to the first quarter, while total inventory dollars decreased by 18% year-over-year, split approximately evenly between lower units and reduced acquisition costs.

We drove strong wholesale GPU despite experiencing steep depreciation and we stabilized CAF’s net interest margins while we maintained penetration. For the second quarter of FY ’24, our diversified business model delivered total sales of $7.1 billion, down 13% compared to last year, driven by lower retail and wholesale volume and prices. In our retail business, while total unit sales declined 7.4% and used unit comps were down 9%, we continued to achieve sequential quarterly improvement. Further, comp sales improved sequentially by month across the second quarter. Average selling price declined approximately $1200 per unit or 4% year-over-year. Retail gross profit per used unit was $2,251, similar to last year’s second quarter record high of $2,282.

We continue to expect this year’s full year per unit margin will be similar to last year. As always, we will continue to test price elasticity and monitor the competitive landscape. Wholesale unit sales were down 11.2% versus the second quarter last year. Like used unit sales, this reflects continued sequential improvement year-over-year from the second half of last year and this year’s first quarter. Average selling price declined approximately $1,300 per unit or 12% year-over-year. Wholesale gross profit per unit was $963, up from $881 a year ago. We achieved this despite experiencing steep depreciation that was concentrated primarily in June and July. We bought approximately 292,000 vehicles from consumers and dealers during the quarter, down 15% from last year as we adjusted offers to reflect the steep depreciation that we’re seeing in the marketplace.

Of these vehicles, we purchased approximately 273,000 from consumers in the quarter with a little more than half of those buyers coming through our online instant appraisal experience. As a result, our self-sufficiency remained above 70% during the quarter. Supported by Edmunds sales team, we sourced the remaining approximately 19,000 vehicles through dealers, down 5% from last year. In regard to our second quarter online metrics, approximately 14% of retail unit sales were online, up from 11% last year. Approximately 55% of retail unit sales were omni sales this quarter, up from 53% in the prior year. Nearly all of our second quarter wholesale auctions in sales, which represents 19% of total revenue remained virtual and are considered online transactions.

Total revenue resulting from online transactions was approximately 31%, up slightly from 30% last year. CarMax Auto Finance or CAF delivered income of $135 million, down from $183 million during the same period last year. Jon will provide more detail on customer financing, the loan loss provision and cash contributions in a few minutes. At this point, I’d like to turn the call over to Enrique, who will provide more information on our second quarter financial performance. Enrique?

Enrique Mayor-Mora: Thanks Bill and good morning everyone. As Bill noted, we drove another quarter of sequential improvement in year-over-year performance across key financial metrics, including unit sales, wholesale margins, gross profit, SG&A, and EPS. Second quarter net earnings per diluted share was $0.75 versus $0.79 a year ago. Total gross profit was $697 million, down 5% from last year’s second quarter. Used retail margin declined by 9% to $452 million, driven by lower volume at similar per unit margins. Wholesale vehicle margin declined by 3% to $137 million with a decrease in volume partially offset by stronger per unit margin performance. Other gross profit was $108 million, up 6% from last year’s second quarter. This increase was driven by service, which delivered a $20 million improvement over last year with this year’s quarter reporting a $14 million loss.

As we communicated in our last two earnings calls, our expectation is that service will deliver improved year-over-year performance for FY ’24 as a result of the efficiency and cost coverage measures that we’ve put in place. The extent of the improvement will also depend on sales performance given the leveraged deleveraged nature of service. The improvement in service was partially offset by reduction in extended protection planned or EPP revenues and third party finance fees. EPP revenues were down $8 million primarily due to lower sales and were to a lesser degree impacted by slightly lower penetration rates, partially due to recent pricing increases taken to offset cost pressures experienced by our third party providers. These items were partially offset by favorability in year-over-year reserve adjustments.

Third party finance fees were down $4 million from last year’s second quarter, driven by lower volume in Tier 2 for which we receive a fee. On the SG&A front, expenses for the second quarter were $586 million, down 12% from the prior year’s quarter as we continue to see the benefits of our cost management efforts. To a lesser degree, we also had some timing favorability in the quarter. SG&A as a percent of gross profit was 84%, a leverage of 6.3 points as compared to last year’s second quarter. The decrease in SG&A dollars over last year was mainly due to the following. First, other overhead decreased by $41 million. This decrease was driven by several factors, including continued favorability in non-CAF uncollectible receivables, favorability in costs associated with lower staffing levels, and from reductions in spend for our technology platforms and strategic initiatives, which included a timing benefit this quarter.

We also had two smaller items in the quarter that largely offset each other. These consisted of additional settlement dollars from the same class action lawsuit we spoke to in the first quarter, offset by unfavorable self-insured losses related to multiple hailstorm events. Second, total compensation and benefits decreased $28 million, excluding a $7 million increase in share based compensation. This decrease was primarily driven by our continued focus on driving efficiency gains and aligning staffing levels in stores and CECs to sales. Third, we reduced advertising by $17 million. This decrease was due to a reduction in per unit spend as compared to last year’s peak per unit spend, lower volume and timing. As we communicated on our fourth quarter call, as we enter the back half of FY ’24, we will have largely anniversaried over the year-over-year benefits from our cost management efforts.

With that said, we remain disciplined with our spend. We also expect timing in marketing and technology spend to impact the back half of FY ’24. In regard to marketing, we still expect our full year spend on a per unit basis to be similar to FY ’23 spend level. Accordingly, our spend in the back half of FY ’24 will exceed the per unit spend from the front half. Regarding technology spend, approximately $10 million of the year-to-date, the year-over-year favorability experience and other overhead will hit the back half of FY ’24. We remain committed to effectively managing our cost structure. Our performance in the first half of the year has us on track to deliver on our goal of low single digit gross profit growth to lever SG&A for the full year, even when excluding the benefits from this year’s legal settlements.

Regarding capital structure, while we paused the repurchase of our common stocks during the third quarter of fiscal 2023, we intend to restart our share repurchase program this quarter. We expect a modest initial pace that would be below the average quarterly paces prior to our pause. Our objective is to appropriately manage our net leverage to maintain financial flexibility and to efficiently access capital markets for both CAF and CarMax as a whole, while also returning capital back to shareholders. As of the end of the quarter, we had $2.45 billion of repurchase authorization remaining. Now, I’d like to turn the call over to Jon.

Jon Daniels: Thanks, Enrique and good morning everyone. During the second quarter, CarMax Auto Finance originated $2.2 billion resulting in penetration of 42.8% net of three day payoffs, which was consistent with Q1 and up from 41.2% observed during the second quarter last year. Within the quarter, CAF tightened further within Tier 3 and is retaining only a modest amount of volume at this time. We have however, slightly increased our investment in the Tier 2 space in an effort to continue our learning and additional credit pockets that we believe will provide future opportunity. The weighted average contract rate charged to new customers was 11.1%, an increase of 170 basis points from the same period last year and in line with Q1.

Tier 2 penetration in the quarter was 18.1% as a combination of previous lender tightening and consumer hesitation, especially in the lower credit tiers, drove the majority of reduction versus the 21.6% penetration observed last year. Tier 3 accounted for 6.4% of sales as compared to 6% last year, as lenders benefited slightly from CAFs and Tier 2s tightening. CAF income for the quarter was $135 million, down from $183 million in the same period last year. This $48 million year-over-year decrease is driven by a $90 million increase in interest expense, partially offset by $60 million of growth in interest and fee income as well as a $14 million increase in loss provision. Note our interest expense was impacted by a negative $1.2 million fair market value adjustment from our hedging strategy versus a positive $9.4 million adjustment seen in the same period last year.

Within the quarter, total interest margin on the full portfolio decreased to $265 million, down $30 million from the same period last year. The corresponding margin to receivables rate of 6.1% however has levelled off as expected and is in line with Q1. I am proud of the teams’ continued ability to effectively manage finance margin CAF penetration and sales conversion to benefit CarMax as a whole. The loan loss provision in Q2 of $90 million results in an ending reserve balance of $538 million or 3.08% of ending receivables. This is compared to a reserve of $535 million last quarter, which was 3.11% of receivables. The slight reduction in the reserve to receivables rate is a function of the portfolio tightening, partially offset by the modest additional investment in the Tier 2 business and adjustments on loss expectations within the existing portfolio.

We believe the tightening will have a positive impact on the future required reserve, but we will also continue to look for opportunities to capture long-term profitability for CarMax while maintaining a targeted Tier 1 cumulative net credit loss rate of 2% to 2.5%. Now I’ll turn the call back over to Bill.

Bill Nash: Thank you Jon and Enrique. As I mentioned at the start of the call, we believe the steps we are taking in response to the current environment are supporting our business in the near-term while also positioning us well for the long run. We will continue to focus on delivering what we believe is the most customer centric experience in the industry as we prioritize initiatives that drive operational efficiencies and make our omni channel experience faster, simpler and more seamless for our associates and customers. Some examples from the second quarter include for online, we’re rolling out a number of new capabilities that enhance our digital shopping experience and our customer experience centers or CECs. We launched a new order processing system.

Sales orders generated through the new system automatically connect to customers’ online accounts and to our progression tracker. This tool guides customers through each step of the car buying journey and provides a more seamless experience for customers who prefer to blend self-progression with assistance from associates. We’ve begun testing this system in our stores, which will unlock this functionality for all of our customers, regardless of where they start their buying journey. We are also expanding capabilities for Sky, our 24/7 virtual assistant. As you might recall, Sky enables us to officially assist customers via automated chat functionality while taking work out of our CEC system. In addition to supporting workflows related to the finance applications, vehicle transfers and appointment reservations, Sky is now able to identify customers who have an appraisal instant offer.

Sky helps these customers complete the next steps for their trade in. Previously, associates would have to reach out to provide further support. We’ve been pleased with our customers’ adoption of Sky as they progress in their shopping journey. For our stores, we’re continuing to leverage data automation to reduce costs and improve transaction speed and accuracy. We have deployed an integrated payoff service in our business office, which allows associates to obtain automated payoff amounts for over 40% of the lenders holding titles for the cars we buy from consumers. In many instances, this service also enables us to receive titles faster by expediting payoffs. For auctions, we continue to test enhancements to our platform by upgrading the information we provide dealers, which enables them to submit more informed bids.

For example, we launched the test using technology from our investment and partnership with UBI [ph] that provides more detailed information on tire conditions including brand, speed, size and tread depth of each tire. Dealer feedback on this offering has been positive and we plan to roll out other enhancements in the upcoming quarters. Before turning to Q&A, I want to recognize two significant milestones in the company’s history. First, this June, we celebrated the two-year anniversary of welcoming all the talented Edmunds associates to our team. We’re very excited with the value that we have created together so far as we continue to build out our vehicle and customer acquisition programs. For example, as I’ve previously mentioned, we utilized the Edmunds sales team to sign up and support dealers for our Max software product, which has enabled us to extend our market leading position as a buyer of cars.

We also recently launched an appraisal tool for dealer websites that makes instant offers based on CarMax’s algorithm that are redeemable via Max offer. We have received positive feedback from dealers that are utilizing this service and are pleased with the initial results.

Recurrent: Second, we’ve launched customized range maps on edmunds.com that enable customers to determine how far they can drive on a single charge based on zip code specific to their route. And third, we have built guide to help customers evaluate potential tax credits and incentives for EVs. These cover all available federal and state EV programs, plus thousands of incentive offers from local utilities and municipalities across the country, with more to come. Also this month, we are celebrating CarMax’s 30th anniversary. I want to thank and congratulate all of our associates for the work that they do. They are the differentiator and they are the key to our success. Not many companies have the opportunity to revolutionize an industry twice.

We’re proud to have reshaped the used car industry by driving integrity, honesty and transparency in every interaction. We are excited to reshape the industry again by offering a uniquely personalized car buying experience that enables customers to do as much or as little online and in stores they want. We’re confident in the future of our diversified business model and believe the deliberate steps we are taking today will drive growth in the years ahead. With that, we’ll be happy to take your questions. Chelsea?

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Q&A Session

Operator: And our first question will come from Craig Kennison with Baird. Your line is open.

Craig Kennison: Yes, thank you. My question goes to trade in cycles, with rates moving higher, are you seeing elongated trade in cycles from your customers that are reluctant to give up lower rates that they might have locked in during the pandemic?

Bill Nash: Yes, Craig, good morning. I think what we’re seeing is, there’s absolutely some customers that are because of either the affordability issue which really goes into their monthly payment, customers staying on the sidelines, which would answer the question, are the trade in cycles a little longer? Yes, I would say the trade in cycle is a little longer. As far as how to quantify that, I can’t give you a specific number, but we absolutely see traffic flow coming in at the top of the funnel where there’s interest and again continue to fall off at the conversion point when people actually start to see their monthly payments and this is especially true in the lower credit customers.

Craig Kennison: Thank you.

Bill Nash: Sure.

Operator: Our next question will come from Brian Nagel with Oppenheimer. Your line is open.

Brian Nagel: Hey, guys. Good morning.

Bill Nash: Good morning.

Enrique Mayor-Mora: Good morning.

Jon Daniels: Good morning.

Brian Nagel: So I have a couple of questions, I’ll merge them together. First off with regard to the buyback, just maybe talk a little about the decision to restart here and then maybe explain a little bit your comment about the modest start, how you expect to start modestly? Then the second question just with respect to demand, so as we’re seeing as you highlighted in your comments, there’s been a sequential improvement in your used car unit comps and they are still negative, but better than they have been. Comparison is getting easier because you look at the data, are you seeing anything that suggests that, that in certain pockets you’re actually seeing real demand improve or maybe some benefits of what you’ve done to merchandise better older lower priced vehicles? Thanks.

Enrique Mayor-Mora: Yes, I’ll jump in on the first question. So an important component of our capital allocation strategy has been returning capital back to shareholders. Our goal in that strategy is really to balance investing in the business, ensuring the capital structure that we have is where we want it to be and then returning capital back to shareholders. The past few quarters of our sequential improvement in our performance has really placed us in a position where we’re able to restart albeit at a modest pace. Modest really means an initial amount below our average from the pre-pause quarterly pace which was about $150 million a quarter. So initially we’re going to begin with roughly $50 million a quarter, plus or minus. It’s a quarterly amount that when annualized would roughly offset annual dilution. So it could be a little heavy, it could be a little light in our goal, but that’s what we’re initially targeting.

Bill Nash: Yes, and Brian on the second part of your question, I’ll go back to a little bit of what I told Craig. We’re seeing good top of funnel folks shopping. It’s just when it comes to actually meeting the monthly payments that’s where we see the fall off. I think specific to your question, we are seeing still an increased demand for the little bit older vehicles. In our own sales for the quarter, if I think about cars over six years old, 60,000 miles, the sales for that pocket sequentially ticked up not only quarter-over-quarter but certainly year-over-year. So there still is that demand. I think the market data would also tell you if you look at vehicles that are older than 10 years old that sector of vehicle is actually performing a little bit better than the zero to 10 at this point.

Brian Nagel: Very helpful. I appreciate it. Thank you.

Bill Nash: Thank you, Brian.

Operator: Our next question will come from Seth Basham with Wedbush Securities. Your line is open.

Seth Basham: Thanks a lot and good morning. My question is on the competitive environment. How are you thinking about the outlook here over the next six months or so based on a shift in demand to those older vehicles as well as the potential ripple effects of the UAW strikes?

Bill Nash: Yes, good morning, Seth. Well, first of all on the UAW strikes, I think it’s a little too early to know exactly what the price — the precise impact of those strikes are going to be. Obviously we’re closely monitoring the situation to try to identify downstream impacts of the vehicle supply pricing and parts and a lot of that’s going to depend on how long the strike goes on. Obviously this isn’t the first time we’ve worked through an issue like this and I think it’s one of our strengths having gone through cycles like this in the past and been able to navigate them and I don’t expect any difference there. I think as far as the competitive environment, again I think consumers are pressured right now and we’ll continue to monitor and provide vehicles that are a little bit older.

Keep in mind there’s a large subset of the zero to 10 year old cars that just don’t meet our parameters so much. Our technicians are great and no matter how good they are and how much money we put into them, they just can’t make the cut as a CarMax car, and so we’re not going to sacrifice on quality. But we’ll continue to put out their vehicles that match our quality that they’re also looking for.

Enrique Mayor-Mora: In terms of affordability as well, we still have over a quarter of our inventory is priced less than $20,000. So in terms of hitting that affordability, it certainly is a focus for us.

Seth Basham: Just as a followup, in terms of your ability to source late model vehicles, which are still a majority of what you’re selling, are you seeing any more challenges or do you expect that to change going forward?

Bill Nash: No, we aren’t seeing any anymore. In fact this quarter I think compared to the previous quarter, we actually went up a little bit in the 0 to 4 category as far as sales go. And again I think the fact that our self-sufficiency is above 70% which doesn’t take into consideration anything that we’re getting through our Max offer and Max offer there’s a nice selection of retail cars in there as well. So I haven’t really seen much of a change there and again we’ve been through cycles like this where we’ve seen a shortage of late model cars to a more extreme degree than we’re seeing right now.