CarMax Inc

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 speaker's 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.

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 Moore, our executive vice president and CFO, and John 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?

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 use-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 margin while we maintained penetration. For the second quarter of FY24, 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 $1,200 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 buyouts coming through our online instant appraisal experience. As a result, our self-sufficiency remained above 70% during the quarter. Supported by our Edmund 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, remain virtual and are considered online transactions. Total revenue resulting from online transactions was approximately 31%, up slightly from 30% last year. Carmack Auto Finance, or CAF, delivered income of $135 million, down from $183 million during the same period last year. John will provide more detail on customer financing, the loan loss provision, and CAF 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?

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 margin, gross profit, SG&A, and EPS. Second quarter net earnings per diluted share was 75 cents versus 79 cents 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 FY24 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 plan 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 and non-CAF uncollectible receivables, favorability and 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 FY24, we will have largely anniversaries 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 FY24. In regard to marketing, we still expect our full year spend on a per unit basis to be similar to FY23 spend level. Accordingly, our spend in the back half of FY24 will exceed the per unit spend from the front half. Regarding technology spend, approximately $10 million of the year-to-date, year-over-year favorability experienced in other overhead will hit the back half of FY24. 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 pause 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 John.

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, cap 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 in 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 leveled off as expected and is in line with Q1. I am proud of the team's continued ability to effectively manage finance margin, cash 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. This 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.

Thank you, John 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 omnichannel 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. In 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 efficiently 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 payoffs 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 our 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 a test using technology from our investment partnership with UVI that provides more detailed information on tire conditions, including brand, speed, size, and tread depth of each tire. Dealer feedback in 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 previously mentioned, we utilize the admin sales team to sign up and support dealers for our max offer 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. Additionally, Edmunds has launched a number of research and buy tools in support of our goal to be the leader in used EV sales. I'd like to speak to three of these. First, Edmunds has conducted hands-on range testing of more than 60 EVs, which enables us to provide insights into how far a vehicle will go on a single charge and its energy consumption. Beginning in late 2022, we partnered with Recurrent, a leader in EV battery health analytics. This allowed Edmunds to become the first online car shopping resource to offer intelligence to consumers about the health and range of used EV batteries at the VIN level. Second, we have launched customized range maps on Edmunds.com that enable customers to determine how far they can drive on a single charge based on zip codes specific to their route. And third, we have built guides 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-store as 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?

At this time, if you would like to ask a question, please press the star and one keys on your telephone keypad. You may remove yourself from the queue at any time by pressing star two. Once again, that is star one to ask a question. And our first question will come from Craig Kennison with Baird. Your line is open.

Yeah, 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?

Yeah, 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.

Thank you.

Sure.

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

Hey, guys. Good morning. Morning. Morning. Morning. A couple of questions, I'll merge them together. First off, with regard to the buyback, just maybe talk further 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, as we're seeing, as you highlighted in your comments, there's been a sequential improvement in your used car unit comps, and they're still negative, but better than they've been. Comparison's getting easier. As you look at the data, are you seeing anything to suggest 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.

Yeah, 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 with 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 to that goal, but that's what we're initially targeting.

Yeah, and Brian, on the second part of your question, I'll go back to a little bit of what I told Craig. You know, 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 demand sector of vehicle is actually performing a little bit better than the 0 to 10 at this point.

Very helpful. I appreciate it. Thank you.

Thank you, Brian.

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

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?

Yeah, good morning, Seth. Well, first of all, on the UAW strikes, I think it's a little too early to know exactly what 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. 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. So we're not going to sacrifice on quality, but we'll continue to put out there vehicles that match our quality that they're also looking for.

In terms of affordability as well, we still have over a quarter of our inventory is priced less than $20,000. In terms of hitting that affordability, it certainly is the focus for us.

Just as a follow-up, in terms of your ability to source late model vehicles, which are still the majority of what you're selling, are you seeing any more challenges? Do you expect that to change going forward?

No, we aren't seeing any more. In fact, this quarter, I think, compared to the previous quarter, we actually went up a little bit in the zero to four 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. Thank you. Thank you, Seth.

Our next question will come from John Healy with North Coast Research. Your line is open.

I think you just want to ask a follow-up question to your comment, Bill, about the conversion cycle. What's happening after that initial disappointment with the consumer that they can't afford the vehicle? Are you seeing them come back a couple weeks later? Do you think they're going to the private market? Are they just sitting on the sidelines? I know your sales folks are persistent, so We just love to kind of get perspective of what's happening after they, you know, they meet that surprise affordability roadblock.

Yeah, it's a great question, John. You know, if I look at just web traffic and kind of use that as a proxy, we're, you know, we probably were averaging for the quarter about 37 million hits, which is up substantially year over year, and even up over the quarter probably by about 3 million, 2 to 3 million hits. tits, which tells me, you know, look, we've got a lot of folks that are out there and they're interested in their window shopping, you know, and some of those are absolutely repeat offenders. You know, those aren't unique visits. As far as where they're going, look, I think there's a lot of folks, unless, you know, their car isn't running anymore, they're just delaying the purchase. I do think that for some of the folks that cannot delay the purchase, I absolutely think that some of them are going down to a different level of car just to make sure that they can afford the monthly payments and to have reliable transportation.

And I'll tack on to that, John. I think that's one of the real values of our finance product. You can easily apply online and then providing the answers back on all the vehicles, you can very easily pivot and find something in your range, sort, filter accordingly. So I think that's one of the things that we're real excited about being able to provide that to our customer.

Well, and the fact that having so many lenders on the platform basically competing for the customers also gives them the best interest rate, which is a key component of the monthly payment.

Great. Thanks, Ed.

Thanks, John.

Thank you. Our next question will come from Scott Ciccarelli with Truist. Your line is open.

Thank you. Good morning, guys. So I think on the call you commented, Bill, that comps improved by month, but I think comparison challenges eased, if I'm not mistaken. So what would the monthly cadence look like on a two or three-year stack basis? And then kind of related to that, I know you guys don't guide, haven't for a very long time, but any reason to believe comps shouldn't turn positive in the back half just based on current trends and comparisons?

Yeah, Scott, if we look at the quarter specifically, You know, I think I talked about the last call that the beginning of the quarter was starting out how the last quarter ended on average. And we did, as I said in the call, we did see improvement each month of the quarter. And, you know, September so far is very similar to – similar with a little bit of improvement to where August was. You know, we're not going to give guidance on the rest of the year. But as you said, I mean, the comps do – because of last year's performance, the comps do get a little bit easier.

Okay, so if I were just to break down 2Q, not commenting on 3Q, obviously. If I was looking at stacks, is there a way to kind of look at it on a two- or three-year stack and help us understand whether there was improvement on that basis?

Well, the two-year stack, the second quarter was better than the first quarter. I think when it comes to intra-quarter, we try not to talk too much about the details of month-to-month. especially when looking over a year. But I would tell you that second quarter or two-year basis better than the first quarter, like Bill said.

Okay. I'll take the rest offline. Thanks, guys. Thank you.

Our next question will come from Sharon Zakthia with William Blair. Your line is open.

Hi. Good morning. I apologize if you answered this myself cut out and I had to redial in. You know, obviously you're resuming the share repurchase program. What are the thoughts at this point on store openings? I don't know if you even reiterated the plan for this year, and I know you had kind of left the door open to maybe accelerating next year. So just thoughts on that, or if perhaps the idea has changed in terms of harvesting more sales at existing locations rather than growing the store base meaningfully.

Good morning, Sharon. Yeah, our outlook at this point, what we've already said hasn't changed. So this year, we have a few more stores that we're going to open up. So that'll get us to a total of five this year, plus the one standalone production facility that we've talked about down in the Atlanta market. We have not come out and said exactly the number of stores that we'll be building. next year yet. We'll talk about that later on in the year, probably Q4 and let you know.

Yeah, and that's regular routine. We provide that update on an annual basis along with our CapEx guidance for the year.

Okay, thanks.

Thanks, Sharon.

Our next question comes from Michael Montani with Evercore ISI. Your line is open.

Great. Thanks for taking the question. I just wanted to ask on the credit front if you can provide an update on credit availability and then also to the extent some of the credit behavior was less favorable, how should we think about provisioning given the current background is kind of $90 million the right number for now? Any call you can give there would be great.

Sure. Yeah, I'll take them in order. So credit availability for CarMax is Again, I think this is one of the values of having the multitude of lenders that we have. We really continue to provide our customers with great access to credit. Now, I think it's not surprising in the industry that obviously lenders are always looking to shore up their portfolios and they've tightened where they've needed to. We've seen most of our tightening from our partners, if you will, probably the back half of last calendar year. Cap has tightened over the course of the year. And I think that's just standard lending practices that you're going to find right now. But ultimately, I think we provide fantastic access to credit. you know certainly in the high 90 range uh from mid to over probably 95 approval rate to customers when they apply and again i think we give them access to to see other vehicles that are available to them regarding overall performance in the quarter for cap in particular um you know we continue to look at our overall portfolio i'm going to look at this from the lens of our tier one business we securitize everything we report on that on a monthly basis how that's performing If you really look at the older deals that you might compare the newer deals to the 17 to 18 to 2019 even the 2020 deals exceptionally low loss rates well below the two to two and a half percent range. they're trending towards right now. And obviously for all the reasons that we've cited before, access to cash, government stimulus, all that. So they really outperformed. What we're seeing currently in the newer vintages is really highly expected. It's just a reversion back to sort of the normalized levels that the industry has seen from a lending perspective. So we were anticipating the 21, the 22 deals to go back to that two to two and a half percent range. I would tell you, we're seeing with these higher monthly payments. We're probably at the higher portion of that range. And that's why we've done the tightening that we've done. We've done it over the course of the last year. Some to some degree in tier three and also pockets in tier one where we see opportunity to pull back. We want to make sure we operate well within that two to two and a half range. And I think we've done a nice job there. So ultimately, as you think about the provision going forward. It's a combination of several things I cited in the prepared remarks, the existing portfolio, which again. Yeah, I think we have, we have a good handle on. I think it's going to operate in that two to two and a half range and we've done a nice job there. You've got the new originations, which are certainly going to come in lower given the tightening We've pulled back to some degree on the Tier 3. It's a small portion of our business. And the Tier 2, we're excited about that space, and we see great opportunities. So you put all that together, I think our reserve speaks for itself. We've come from a 311 to a 308. I think it's relatively stable. We think we're well-reserved, and we'll see how the consumer performs. But I think we're in a good spot right now. Thank you.

Our next question will come from John Murphy with Bank of America. Your line is open.

Good morning, guys. I just wanted to ask, Bill, as you go through periods of steep depreciation like you're talking about and we've seen in the used car market on pricing, typically they're accompanied by supply increases, which would drive same-store sales higher. I'm just curious what you're seeing in the market right now as far as availability and flow of vehicles, maybe in the zero- to six-year-old bucket, which is the target, and then maybe in the six- to ten-year-old, which is a growing target for you over time.

Yeah, good morning, John. When I look back at the depreciation for the core, like I said, there was steep depreciation in June and July, and quite honestly – It started in May. If you look at May, June, and July, there was probably about $3,000 of depreciation, which is absolutely steep. The biggest impact it has on us, obviously, is really more on the buys because we're going to adjust accordingly and consumers are always thinking that their vehicles are worth more. It impacts the buys early on until the rest of the market shifts. From a buy standpoint, it's a headwind in the short term. But again, I think the team did a phenomenal job not only maintaining the retail margins, but the wholesale margins, which we haven't talked about because year over year they were up even in this steep environment. As far as availability, look, if you're having to rely on outside sources, there's a limited supply. And if I think back over at least my tenure here at CarMax, There's just less vehicles available through third party auctions. And it's been that way for a while. And I don't foresee that changing greatly in the near term, which is also why we're thrilled to have our self-sufficiency so high. And we're continuing to look for avenues to continue to source inventory, really retail or wholesale, however we can outside of those sources.

And maybe just to follow up, I mean, do you think you could ever get meaningfully above that 70% self-sufficiency that you're at right now, which is pretty damn good to start with? But, I mean, are there other avenues, maybe through Edmonds or other ways that you could increase that meaningfully?

Yeah, look, we could take it to 100% tomorrow. You know, it all depends on what you put on the vehicles. I think, you know, we probably... I say this, we probably would never get to 100% self-sufficiency because you're always going to want to have little pockets of inventory that you're going to want to supplement or whatever. But again, our goal is to drive it as high as possible. It's been pretty steady in that 70-ish, in that range, which we feel good about. And again, I think the key thing here is it's not only on the retail cars, but we'll also buy every wholesale car as well. So we're absolutely focused on that.

Okay. All right. Thank you very much.

Thank you, John.

Our next question will come from Chris Bodeglieri with BNP Paribas. Your line is open. Hi.

Thanks for taking the question. I hope you can elaborate more on compensation expense. I know you said you're lapping cost cuts, but it seems like that compensation cost cuts have sequentially ramped each quarter. So my question is, like, if you look at the four-year CAGR that's gotten particularly better relative to units, particularly Q2 versus Q1, are you still actively reducing headcount? If unit trends maintain normal seasonality from here, what would happen to compensation? Would that also behave normal, or would that be better or worse than normal seasonality?

Thanks for the question, Chris. Yeah, at this point with compensation, as I mentioned in our prepared remarks, we have pretty much anniversaried over the benefits of some of the stronger levers we put in place. So when thinking of compensation, But I would think of that for the back half of the year, one of the more pressured lines, if you will, relative to where we've been here for the past couple quarters. So we've copped over those levers. At the same time, we go through the decision process at this time of year about staffing for tax time. And depending on what the expectation is for tax time, we start to ramp up our associate level there as well. I do expect compensation will be one of the line items moving forward. That will be a little bit more pressure relative to where we've been for the past few quarters here.

Yeah, Chris, and just to bring it to home with some numbers, you know, if you look at a year ago, staffing-wise, total company, we're down about 3,000 or so associates, and that's pretty consistent with what the first quarter was as well. So we've kind of, you know, as long as we're keeping staffing to where we feel like needs sales, to Enrique's point, you know, it'll be The back half of the year will just be, you won't see as much pickup there.

Yeah, we believe we're appropriately staffed. So those cost management efforts we undertook successfully at this point were largely successfully staffed and appropriately staffed.

Yeah, the only other thing would be, Enrique touched on this in his earlier remarks, for everyone to keep in mind, is the back half of the year progresses. That's generally from a seasonality standpoint when we start to think about next year's tax time and building for that. And so that generally requires a little bit larger headcount. So we'll be monitoring that as we go through the back half.

Gotcha. That makes sense. And then just quickly on car buying, I think you called that out. It seemed like it was July and August when pricing was the worst, or sorry, June and July. Has pricing kind of stabilized a bit in September and lesser extent August? Have you seen Are you buying cars more often or more frequently, higher conversion from customers? Is that kind of trying to maintain its pace?

Yeah, so June and July were the worst. August actually was up a little bit. And then, you know, September, NAAA data is probably flattish to a little bit up from a depreciation standpoint or an appreciation standpoint. I would call August and September fairly similar, but it was a reversal of the steep depreciation. And I think as we look forward to the rest of the year, I think what we'll probably see now, this is assuming no other macro factors, and obviously there's a lot of things out there, especially when you start thinking about the strike. But outside of that, I would think we would continue to see probably more normal seasonal depreciation barring any other new event.

And that helps your car buying? Like you expect that to pick back up from here? Or do you think it's like the level?

Well, I think what that does is it does a couple things. One, as depreciation continues, obviously that feeds out onto your front lot prices. So I think that helps some on the affordability issue. I think also more stable depreciation. It just makes it easier to run the business. We do a phenomenal job and the team did a phenomenal job even with that steep depreciation that we saw in the quarter. But, you know, when you're starting to see normal depreciation, that's just that's kind of business as usual for us.

Yeah, that makes sense. Okay. Thank you for that. I appreciate it.

Thank you.

Our next question will come from Rajat Gupta with JP Morgan. Your line is open.

Great. Thanks for taking the question. Just had one question, one clarification. On retail GPU, it was a little larger than seasonal decline in the second quarter versus first quarter. You know, last, you know, 10 plus years, the average sequential move has been $50. I mean, this quarter was more than 100. Just curious if there were any one-time items that impacted that or, you know, were there any pricing tests, you know, anything you would call out and one clarification?

Yeah, thanks for the question, Rajat. Yeah, when I think about this quarter, actually, I'm pleased. I'm pleased because we talked about last quarter coming in to more in line with where we were last year, which, remember, last year was a record high for us. And as you pointed out, I mean, $30 is within the noise for us. You know, I feel good about that, especially considering the environment that's out there. I think, you know, the first quarter obviously was a record high, and I think there were some dynamics in that quarter where you purchased the vehicles, and then we saw some appreciation in that quarter, which, you know, keeps you from having to do markdowns, that kind of thing. So I look at the first quarter as more of an anomaly, which is why we said what we did last quarter. We thought we'd be more in line in the second quarter with the second quarter last year, and we reiterate we think we'll be more in line for the whole year with the whole year of last year, which is still a step up from where we've historically run of $80 to $100.

And Rajat, just as a reminder, the first quarter, there's some seasonality benefit too, right? So the first quarter tends to be our strongest from a GPU standpoint, just within tax time. So is that happening as well?

Right, right. Yeah, that's helpful. And Jesse, you mentioned earlier around the supply situation and the fact that there are several cars in the zero to 10-year-old that do not meet your reconditioning needs. As you look into later this year, into the next couple of years, it looks like there'll be more dependency on the greater than six-year-old cars to grow your business. How do you get around some of those quality constraints, reconditioned constraints for those cars because the zero to four-year-old supply is likely going to get worse before it gets better. So how do we manage through that in order to return to growth in the business in the next couple of years? Thanks.

Yeah. Well, what I would remind you, Rajat, is if you go back when we had the last big bubble go through on late model cars, back in the financial crisis, you know, the new car sales rate in 08, 09, 10, 11, you know, it bounced around anywhere between 10 and a half million and a little over 13 million. If you look at the period from like 2020, 21, 22, and even the estimate for this year, you're talking about 14 to over 15. So, My point in pointing that out is we've been through far worse situations than what we're seeing now as far as a bubble of zero to four or zero to six-year-old cars that we're going to be facing. Again, we're in a better position than we were back then because our self-sufficiency is so high and we're getting those cars directly from consumers and other sources. We feel very good about our ability to navigate the future, whether it's consumers wanting zero to six-year-old cars or whether it's consumers wanting to buy something a little bit older.

Understood. Thank you.

Thank you.

Our next question comes from Daniel Imbrow with Stevens. Your line is open.

Hey, good morning, guys. Good morning. I wanted to ask a follow-up on CAF, and maybe it ties into the affordability discussion. But the weighted average rate here was flat, I think, sequentially at 11.1%, despite maybe rising benchmark rates and your recent trend of passing through price. So I guess, are we seeing customers push back on rates? Should we maybe take that as a sign customers have reached their limit on affordability? And are you guys at maybe the end of your ability to pass through more APR at CAF despite the rising kind of rate environment? Just curious why that's sequentially flatlined from here.

Sure, yeah, great question, Daniel. A couple things that are subtle in there to point out. First, the flat quarter over quarter also realized we did some tightening in there. you know, if you pull back in the tier three space, we pick pockets in the tier one space, you know, that's going to offset any sequential growth in the APR. I can tell you that we did continue to test and raise APRs within the quarter. But bear in mind, I think one of the key things for us is we're not looking to maximize finance margin. You know, when we do our testing and pass this along to the customer, we're taking into account, you know, are they able to purchase the car Are they going to end up paying off with someone else where we wouldn't gain any finance income? So we very carefully test different rates and then adjust those rates in smaller pockets to optimize the overall CarMax value. So I think that's why you're seeing the sequential piece. But certainly, obviously, there are payment pressures, as Bill mentioned. So we continue to be very careful with that. But that's why you're seeing sequential quarter over quarter flats. It's the tightening is offsetting it.

So to follow up that question, your strategy would more be to maximize units sold, not maximize margin at CAF. Did we hear that right?

No, I would say we contemplate that in the decision. We look at units sold. We look at amount of finance margin that CAF captures and also constantly remember they can pay off in three days. So we could sell the car, but CAF could lose the financing if they choose to go down the street to their bank or their credit union. So we put all that together to optimize for CarMax in total, not just maximize one dimension or the other.

CarMax total profitability. Right.

That's right. Perfect. Thanks for the color. Appreciate it.

Our next question will come from David Whiston with Morningstar. Your line is open.

thanks good morning um just sticking with those other financing channels you just mentioned enrique i'm just curious why this year uh other is gaining a lot at the expense of tier two are there just more cash only buyers in the market now or is there a problem with tier two consumers willing to buy or other lenders just taking the opportunity from you uh sure yeah david um i think there's a couple things going on there uh first i think

what you really do see is the affordability is definitely a challenge in the bottom portion of the credit spectrum, kind of that mid-tier to the subprime space. We see great demand across the credit spectrum, but ultimately when they see the monthly payment, it's the higher-end guys that are able to follow through with the purchase. So that's going to benefit both CAFs and kind of the outside financing population. You did see some pullback, as I mentioned, the back half of last year in the tier two space. So there's also some tightening that's hurting the penetration there. Just to round it out in tier three, they did benefit from that tightening, right? Those customers flow down to the tier three space. But I think it predominantly it's It's affordability. Those higher-end customers can buy, and that's why you see the percentage of sales a little more skewed to the high end. I think there's demand everywhere, but that's really what's driving it.

Okay, and could you just briefly give me some examples of what non-CAF uncollectible receivables are?

Yeah, so those are going to be – so this hits in the SG&A bucket, right? And these are going to be receivables that our finance partners originate and underwrite. that end up having a title processing issue or a down payment challenge that we end up having to buy back. So that's an area of focus for us over the past year. We've made material improvements, as I've talked about on previous quarters, both in execution in our stores and our home office. The DMVs have also got better in terms of turning around those titles, as well as the banks in terms of turning around the processing. So we saw another quarter of benefit this quarter. We expect to see some more benefit Yeah, in the back half of the year, probably not as strong as the first half of the year as we start to lap over that accentuated focus last year that we had on making sure we're managing those.

And I'm sorry, do you do 100% of that servicing for the third-party lenders in terms of the collections stuff?

No, we do not. We do not underwrite it. That's the third-party partners that underwrite it and then service it.

That's right. All right, thank you.

We do have another question from Michael Montani with Evercore ISI. Your line is open.

Hey, guys. Thanks for letting me sneak one more in. I just wanted to ask about if you could give any incremental color around the sales trends by income level. And when you think about the improvement sequentially to the down nine comp and then throughout the quarter, what are you seeing for upper income versus lower income consumers? And then how does that filter into your desire to spend into ad dollars for the back half of the year?

Okay. Yeah. So as I said earlier, I mean, we're seeing the biggest pinch probably on the, not probably on the, we are seeing it on the lower consumer and think about it, you know, from a monthly household income of let's say three to $4,000 that had that segment of sales for us has, has, uh, shrank dramatically. So it's probably in the last couple of years, It's probably down about 50% in the $3,000 and less household incomes, about 50% less than what it used to be. So that's absolutely a headwind, which again speaks to the affordability. As far as advertising goes, that's an area where Jim and Sarah and team, they constantly are looking at it. And I think an interesting thing that everybody needs to keep in mind is because we've got this big buying engine also, when we talk about advertising, it's advertising for sales, but it's also advertising for buys. So while you may pull back on sales, you may do more on buys. So it's a walk that we do. And that team does a great job measuring the ROI. So to Enrique's comments earlier, what we're expecting to do in the back half, That certainly could shift if we see something in the marketplace that says, hey, you don't need to spend as much. It's not fruitful. Or on the flip side, hey, you may want to spend a little bit more. And so we're constantly monitoring that. But I think the guidance that Enrique gave is really the way to think about it, and we'll continue to monitor it. Thank you.

Thank you. We don't have any further questions at this time. I'll hand the call back to Bill for any closing remarks.

Great. Well, thank you all for joining the call today and for your questions and your continued support. I do want to one more time congratulate the CarMax team on achieving our 30th anniversary, and I just want to thank them for everything that they do every day to take care of each other and our customers and the communities, and we will talk again next quarter. Thank you.

Thank you, ladies and gentlemen. That concludes the second quarter fiscal year 2024 CarMax Earnings Release Conference call.