CarMax, Inc. (NYSE:KMX) Q1 2024 Earnings Call Transcript

CarMax, Inc. (NYSE:KMX) Q1 2024 Earnings Call Transcript June 23, 2023

CarMax, Inc. beats earnings expectations. Reported EPS is $1.16, expectations were $0.79.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the FY’24 Q1 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. Thank you, everyone for joining our fiscal 2024 first 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 that 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 factors 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 28th, 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 queue for more follow-ups. Bill?

Bill Nash: Great. Thank you, David. Good morning, everyone, and thanks for joining us. Although the first quarter remained challenging due to the same factors we cited in fiscal ’23, we’re seeing sequential quarterly improvements across our business. We are focused on controlling what we can as we take deliberate steps to support our business for both the near-term and the long run. This quarter, we reduced SG&A independent of the legal settlement. We delivered strong retail GPU. We increased used saleable inventory units while driving down total inventory dollars 13% year-over-year. We drove strong wholesale GPU as our unit volume continued to recover. And finally, we grew CAF’s penetration even as we raised CAF’s consumer rates to help offset higher cost of funds and tighten lending standards in reaction to the current environment.

For the first quarter of FY’24, our diversified business model delivered total sales of $7.7 billion, down 17% compared to last year, driven by lower retail and wholesale volume and prices. In our retail business, total unit sales declined 9.6% and used unit comps were down 11.4%, which reflects an improvement from down 22.4% and 14.1% year-over-year during last year’s third and fourth quarters. Average selling price declined approximately $1,600 per unit or 5% year-over-year. First quarter retail gross profit per used unit was $2,361, consistent with the $2,339 last year. Historically, margin tends to run higher during the first quarter compared to the rest of the year. In the current environment, we expect this year’s second quarter and full year margins will be similar to last year, slightly ahead of the full year $2,100 to $2,200 range that we spoke to last quarter.

As always, we’ll continue to test price elasticity and monitor the competitive landscape. Wholesale unit sales were down 13.6% versus the first quarter last year, which reflects continued improvement from the 36.7% and the 19.3% year-over-year declines during last year’s third and fourth quarter. Average selling price declined approximately $2,000 per unit or 18% year-over-year. Wholesale gross profit per unit was $1,042 in line with $1,029 during last year’s first quarter. We bought approximately 343,000 vehicles from consumers and dealers during the quarter, down 5% from last year, and an improvement from the 40% and 22% year-over-year declines during last year’s third and fourth quarters. Of these vehicles, we purchased approximately 323,000 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. We sourced the remaining approximately 20,000 vehicles through dealers, up 20% from last year, supported by Edmunds sales team. In regard to our first quarter online metrics, approximately 14% of retail unit sales were online, up from 11% last year. Approximately 54% of retail unit sales were omni sales this quarter, which is consistent with the prior year. Nearly all of our first quarter wholesale auctions and sales, which represents 20% of total revenue, remained virtual and are considered online transactions. Total revenue resulting from online transactions was approximately 31%, which is in line with last year. CarMax Auto Finance or CAF delivered income of $137 million, down from $204 million during the same period last year.

Photo by Matthijs Waanders on Unsplash

Jon will provide more detail on customer financing, the loan loss provision and CAF contributions in a few moments. At this point, I’d like to turn the call over to Enrique, who will provide more information on our first quarter financial performance. Enrique?

Enrique Mayor-Mora: Thanks, Bill, and good morning, everyone. Our continued focus on managing what is in our control drove another quarter of sequential improvement in year-over-year performance across key financial metrics, including unit sales, SG&A leverage, gross profit and EPS. First quarter net earnings per diluted share was $1.44, down from $1.56 a year ago. Included in our EPS this quarter was the equivalent of $0.28 or $59 million related to a legal settlement. Total gross profit was $817 million, down 7% from last year’s first quarter. Used retail margin of $515 million and wholesale vehicle margin of $168 million declined 9% and 12%, respectively. The year-over-year decreases were driven by lower volume across retail and wholesale.

This was partially offset by strong margin performance with both retail and wholesale per unit margins up slightly from last year’s numbers. Other gross profit was $135 million, up 12% from last year’s first quarter. This increase was driven by service, which delivered $4 million in margin, a $26 million improvement over last year. As we communicated in our Q4 FY’23 year-end earnings call, our expectation is that service will deliver improved year-over-year performance in FY’24, driven by the efficiency and cost coverage measures that we put in place. Our first quarter has us off to a solid start. The improvement in service was partially offset by reductions in extended protection plan or EPP revenues and third-party finance fees. EPP revenues were down $5 million, primarily due to lower sales, partially offset by stronger margins that were implemented at the end of last year’s first quarter.

Third-party finance fees were down $3 million to last year’s first quarter. Lower volume in Tier 2, for which we receive a fee, was partially offset by a reduction in Tier 3 volume for which we pay a fee. On the SG&A front, expenses for the first quarter were $560 million, down 15% from the prior year’s quarter. Excluding the benefit from the legal settlement, SG&A was down 6% from the prior year’s quarter, as we continue to see the benefits of our cost management efforts. SG&A as a percent of gross profit was 68%. Excluding the benefit from the settlement, our SG&A leverage was 76%, roughly flat to last year’s first quarter. The change in SG&A dollars over last year was mainly due to the following factors. First, other overhead decreased by $79 million, of which $59 million was due to the settlement.

The balance of year-over-year favorability was driven by several factors, including favorability in non-CAF uncollectible receivables, which benefited partially from timing, favorability and costs associated with lower staffing levels and a variety of other smaller costs. Second, we reduced advertising by $17 million. While our advertising expense on a total dollar and per unit basis was lower year-over-year on the quarter, our investments for the quarter on a per unit basis remained aligned with last year’s second half spend level. Third, total compensation and benefits, excluding a $13 million increase in share-based compensation decreased $15 million. This decrease was primarily driven by our continued focus in stores and CECs on aligning staffing levels to sales and driving efficiency gains.

As I noted in our Q4 FY’23 year-end call, we expect to require low single-digit gross profit growth to lever SG&A for the full FY’24 year, well below the levels we guided to during the investment heavy phases of our omni transformation. As a result, we expect to deliver stronger flow through of gross profit to profitability. Our first quarter performance has us on track to deliver on this goal. While we delivered SG&A leverage point in the mid 70% range in the first quarter, it is important to remember that the first quarter is typically our strongest for SG&A leverage as it’s historically our highest used unit volume and margin per unit quarter. Regarding capital structure, our first priority remains to fund the business While our adjusted net debt to capital ratio was slightly below our 35% to 45% targeted range, given ongoing market uncertainties, we continue to appropriately manage our net leverage to maintain the flexibility that allows us to efficiently access the capital markets for both CAF and CarMax as a whole.

In keeping with this goal of maintaining flexibility, we continue to pause our share buybacks in the first quarter. Our $2.45 billion authorization remains in place, as does our commitment to return capital to shareholders over time. Additionally, post quarter calendar end, we successfully renewed our $2 billion revolving lending facility with materially similar terms. We plan to include additional information in our forthcoming 10-Q, which we plan to file on Monday. Now, I’d like to turn the call over to Jon.

Jon Daniels: Thanks, Enrique, and good morning, everyone. During the first quarter, CarMax Auto Finance originated $2.3 billion, resulting in penetration of 42.7% net of three-day payoffs, up from 39.3% observed during the first quarter last year. This growth in penetration came despite cash credit tightening within the higher risk, higher APR portion of Tier 1 as well as the reduction of CAF’s targeted volume of Tier 3 that began at the end of Q4. Despite the decrease of volume in these higher APR segments, the weighted average contract rate charged to new customers was 11.1%, an increase of 20 basis points from Q4 and 200 basis points from the same period last year. Tier 2 penetration in the quarter was 20.4% up from Q4, but still down from the historically high 25.2% seen in Q1 of FY’23.

Tier three penetration was 6.7%, down 40 basis points from last year. While CAF and other lending partners have tightened lending standards over the previous few quarters, our robust multi-lender credit platform was still able to approve approximately 95% of credit applications during the first quarter. CAF income for the quarter was $137 million, down from $204 million in the same period last year. This $67 million year-over-year decrease is primarily driven by a $23 million increase in loss provision, as well as a $94 million increase in interest expense, partially offset by growth in interest and fee income. Note our interest expense was impacted by a negative $9 million fair market value adjustment from our hedging strategy versus a positive $9 million adjustment seen in the same period last year.

Within the quarter, total interest margin decreased to $258 million, down $40 million from the same period last year. The corresponding margin to receivables rate of 6.1% continued to come down from the 10-year peak seen in last year’s first quarter, but has moderated in its decline from previous quarters, as was expected and previewed during last quarter’s conference call. The slowing in NIM reduction comes as a result of targeted rate increases on new originations executed over the last year that effectively manage CAF penetration, finance margin and sales conversion to generate the most valuable outcome for CarMax as a whole. The loan loss provision in Q1 of $81 million results in an ending reserve balance of $535 million or 3.11% of ending receivables.

This is compared to a reserve of $507 million last quarter, which was 3.02% of receivables. The sequential nine basis point adjustment in the reserve receivable ratio reflects unfavorable performance within the existing portfolio as well as the uncertain macro environment. Despite this increase, the existing Tier 1 portfolio continues to trend within the targeted 2% to 2.5% cumulative net credit loss range and the recent tightening is expected to provide a reduction in loss rate for future originations. Regarding continued improvements in our best-in-class pre-qualification product. During the first quarter, we began broadly scaling yet another of our large lending partners within FBS, our finance based shopping platform. This marks the sixth lender that is now capable of providing millions of additional customized credit decisions in minutes to our online customers.

While we continue to add enhancements to our online credit experience, we believe our FBS platform is currently an industry leader and truly empowers consumers by providing simple access to penny perfect multi-lender credit decisions in seconds while having no impact to their credit score. Now, I’ll turn the call back over to Bill.

Bill Nash: Thank you, Jon. Over the past several years, we’ve built a leading omni-channel platform that enables us to deliver what we believe is the most customer centric experience in the industry. Our ability to offer integration across digital and physical transactions gives us access to the largest total addressable market and is a key differentiator. With our core omni capabilities now in place, we are continuing to prioritize projects that drive operating efficiencies and optimize experience for our associates and customers. We believe the steps we will be taking enable us to further expand our competitive moat and will position us well for the future. Some examples from the first quarter beyond what Jon just spoke about related to CAF include one, as we work to deliver a seamless digital first shopping experience, we are increasingly leveraging Sky our 24/7 virtual assistant.

Sky enables us to efficiently assist customers via chat functionality while taking work out of our CEC system. During the first quarter, we expanded these capabilities to include workflows related to finance applications, vehicle transfers and appointment reservations. Since going live, we’ve had great success reducing CEC work volume routed to associates, enabling us to provide a quicker response at a lower cost per transaction. We anticipate rolling out additional functionality to Sky throughout fiscal 2024. Second, we are currently rolling out express drop off, which enables customers with instant offer or store generated appraisals to progress the selling process from home. When utilized, this option offers customers the ability to complete their transaction at one of our stores in under 30 minutes and our research shows that customers and associates both love this experience.

Finally, we’re continuing to modernize our auction platform to enhance the experience for dealers. This quarter, we launched an integrated check-in experience that enables single sign-on across our systems and streamlines access to the information that dealers rely on the most when bidding on vehicles. Additionally, we initiated proxy bidding capabilities in a limited number of markets. This allows dealers to bid on vehicles in advance so they don’t have to participate live during each auction. It also unlocks the ability to take part in multiple auctions and bid on multiple vehicles simultaneously. Feedback on both of these capabilities has been positive. We plan to expand proxy bidding to additional markets as well as launch other enhancements in upcoming quarters.

With our focus on improving experiences and gaining efficiencies, we believe we are well positioned to emerge from the current environment and even stronger company. We’re confident in the future of our diversified business model and believe that the deliberate steps that we are taking will enable us to drive robust growth as the market improves. With that, we will be happy to take your questions. Chelsea? Chelsea, can you remind folks of how to enter the question portal.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question will come from Brian Nagel with Oppenheimer. Your line is open.

Brian Nagel: Hey, good morning, everyone. Thank you for taking my question.

Bill Nash: Good morning, Brian.

Brian Nagel: So the question I’ll ask with one question, but I’ll have two parts of it. Just maybe you could talk about the market share dynamic you witnessed here early in, I guess, so far in the year? And then secondarily, as you talked about in your script, we are seeing this improving [indiscernible] in used car sales, obviously, still down year-on-year, but better than it had been in the prior two quarters. If you look at the drivers behind that, is that more what CarMax is doing? Or you’ve seen an excess solidifying backdrop within the sector? Thank you.

Bill Nash: Yeah, great. Thank you for the question, Brian. First of all, on the market share question, Brian, you might remember that last quarter, given the title data that we had, we thought we had bottomed out in the December, January time frame. We actually have title data now through April, and we did bottom out in December. And although we aren’t growing it year-over-year yet, we’re pleased that January through April, we saw some good sequential growth, and we did that while maintaining strong margins. So we feel good about the trajectory we’re on. And if I compare it to previous times when we had given up market share, again, we talked about that last quarter, COVID in ’08, ’09. I would tell you the coming out of it is more similar to the COVID period than the ’08,’09.

As far as your second question on just the used car sales, yes, I mean, the overall used market obviously is still depressed. I do think while depreciation is a little bit of a headwind on parts of the business, so for example, wholesale, I think it’s good for the overall industry. So having vehicles depreciate during the quarter, I think, was a good thing. It was a little unusual quarter because it first started off appreciating and then it ended up actually decreasing a little bit. So I think that’s a – I think that’s good for the industry. But I think there’s also things that are specific to CarMax and how we’re managing our inventory, how we’re managing our margin, the right cars out there that are unique to CarMax. So I think it’s probably a combination of both.

Brian Nagel: I appreciate all the color, Bill. Thank you.

Bill Nash: Sure.

Operator: Thank you. Our next question will come from Craig Kennison with Baird. Your line is open.

Craig Kennison: Hey, good morning. Thank you for taking my question as well. I’m trying to anticipate down the road when student loan payments are required again. Do you have a feel for the percentage of your buyers that are also making student loan payments and whether that could be a significant impact on demand?

Bill Nash: Yes. That’s a great question, Craig. It’s one that we’ve actually talked about internally, both from a sales standpoint and from a finance standpoint. I think from a sales standpoint, it’s hard to tell because folks have been taking consumer loans out for longer periods of time. And I would think probably the majority of our customers are outside of the student loan — the majority of our retail customers are outside of that period. I think when you think about the CAF business, and Jon, you might have some different thoughts on this. But when you think about the CAF business, because we skew to a higher credit customer, that probably puts us in a little bit better position, but I don’t know if you have any additional thoughts beyond that?