CarMax Q2 2025 Earnings Call Transcript

Quartr
Provided by Quartr
September 26, 2024

There are 16 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter Fiscal Year 2025 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.

Operator

I would now like to hand the conference over to your speaker today, David Lowenstein, AVP, Investor Relations. Please go ahead.

Speaker 1

Thank you, Todd. Good morning, everyone. Thank you for joining our fiscal 2025 second quarter earnings conference call. I'm here today with Bill Nash, our President and CEO Enrique Mayer Mora, 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.

Speaker 1

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 and risks that could affect these expectations, please see our Form 8 ks filed with the SEC this morning, our annual report on Form 10 ks for fiscal year 2024 and our quarterly results on Form 10 Q 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 7,865. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow ups.

Speaker 1

Bill?

Speaker 2

Great. Thank you, David. Good morning, everyone, and thanks for joining us. We're pleased with our team's execution in the Q2 as we achieved positive sales trends, strong margins, cost efficiencies and EPS growth while managing through industry wide auto loan loss pressure. Beyond great execution, our results also reflect the positive impact of delivering associate customer experience enhancements alongside declining prices in a more stable environment for vehicle valuations.

Speaker 2

In the Q2, we grew retail unit volume year over year. We delivered strong retail and wholesale GPUs and expanded EPP and service gross profit. We bought more vehicles from dealers achieving a 2nd quarter record. We maintained stable CAF net interest margin and began to test our new full spectrum underwriting model. We materially levered SG and A as a percent of gross profit and we achieved double digit EPS growth.

Speaker 2

For the Q2 of FY 2025, our diversified business model delivered total sales of $7,000,000,000 down 1% compared to last year, reflecting lower retail and wholesale prices, partially offset by higher retail volume. In our retail business, total unit sales increased 5.1% and used unit comps were up 4.3%. Average selling price declined approximately $12.50 per unit or 5% year over year. 2nd quarter retail gross profit per used unit was $2,269 consistent with last year's $2,251 Wholesale unit sales are down 0.3% versus the 2nd quarter last year and improved sequentially from being down 8.3% in the Q1 of this year. Average selling prices declined approximately $11.50 per unit or 13% year over year.

Speaker 2

2nd quarter wholesale gross profit per unit was $9.75 in line with $9.63 a year ago. We bought approximately 300,000 vehicles during the quarter, up 3% from last year. We purchased approximately 269,000 vehicles from consumers with more than half of those buys coming through our online instant appraisal experience. With the support of our Edmund sales team, we sourced the remaining approximately 31,000 vehicles through dealers, up 60% from last year. We continue to see increased adoption of our omnichannel retail experience.

Speaker 2

For our Q2 online metrics, approximately 15% of retail unit sales were online, up from 14% last year. Approximately 57% of retail unit sales were omni sales this quarter, up from 55% in the prior year. Total revenue from online transactions was approximately 29%, slightly down from last year due to wholesale pricing coming down. All of our Q2 wholesale auctions and sales were virtual and are considered online transactions, which represented 17% of total revenue for the quarter. CarMax Auto Finance, or CAF, delivered income of $116,000,000 down 14% from the same period last year.

Speaker 2

CAF results were pressured by an uptick in losses that are being experienced industry wide. In a few minutes, John will provide more detail on customer financing, the loan loss provision, CAF contribution and our progress on becoming a full credit spectrum lender. But at this point, I'd like to turn the call over to Enrique, who will share more information on our Q2 financial performance. Enrique?

Speaker 3

Thanks, Bill, and good morning, everyone. As Bill noted, we delivered on multiple fronts in the quarter: positive retail unit comps, robust vehicle margins, material growth and other gross profit per retail unit, maintaining CAF's net interest margin and strong flow through to the bottom line. 2nd quarter net earnings per diluted share was $0.85 up 30% versus a year ago. This was despite the increase in our loan loss provision. Total gross profit was $760,000,000 up 9% from last year's Q2.

Speaker 3

Used retail margin of $479,000,000 increased by 6% with higher volume and relatively flat per unit margins. Wholesale vehicle margin of $138,000,000 grew by 1% with margins offsetting a slight decrease in volume. Other gross profit was $144,000,000 up 33% from a year ago. This was driven primarily by a combination of EPP and service. EPP increased by $20,000,000 as we continue to benefit from the higher MaxCare margins per contract that we previously rolled out.

Speaker 3

Service delivered $3,000,000 in margin, up $17,000,000 from last year's Q2. This performance reflected the combined impact of successful efficiency and cost coverage measures and positive sales growth. We expect continued year over year improvement for the balance of the year as governed by sales performance given the leverage deleveraged nature of service. On the SG and A front, expenses for the Q2 were $611,000,000 up 4% or $25,000,000 from the prior year's quarter, but leveraged 4 percentage points supported by our continued discipline in spend and investment levels. This SG and A leverage would have been even stronger if not for 2 main factors that impacted the Q2.

Speaker 3

First, total compensation and benefits increased by $16,000,000 This was primarily driven by our corporate bonus accrual, which was lowered in last year's Q2. 2nd, occupancy costs rose by $7,000,000 a higher increase than recent trends driven by the timing of store maintenance related spend. I also want to point out 2 noteworthy items. First, our omnichannel selling model, which includes commissions plus the cost of operating our CECs, continues to be more efficient as we further strengthen our digital progression tools and the optimal use of CEC labor. This quarter, we were more efficient year over year and versus pre omni in the 3 key metrics per retail unit, per total unit and per gross margin dollar.

Speaker 3

2nd, as Bill will discuss further, we continue to evaluate all aspects of our logistics operations to drive efficiencies. This includes equipment and leasing arrangements. As part of this evaluation, we may incur charges that we estimate will be less than $10,000,000 in the near term that would likely hit other income expense line. These charges will be more than offset by the efficiencies gained in our logistics operations over time. Regarding capital allocation, during the Q2, we repurchased approximately 1,400,000 shares for a total spend of $106,000,000 As of the end of the quarter, we had approximately $2,150,000,000 of repurchase authorization remaining.

Speaker 3

Now I'd like to turn the call over to John.

Speaker 4

Thanks, Enrique, and good morning, everyone. During the Q2, CarMax Auto Finance originated approximately $2,200,000,000 resulting in sales penetration of 42% net of 3 day payoffs as compared to 42.8% during last year's Q2. The weighted average contract rate charged to new customers was 11.5%, an increase of 40 basis points from a year ago. 3rd party Tier 2 penetration in the quarter was 17.7%, down slightly from 18.1 percent a year ago. And 3rd party Tier 3 volume accounted for 6.7% of sales compared to the 6.4% seen in last year's Q2.

Speaker 4

The combined third party penetration of 24.4% remains in line with Q2 FY 2020 4. GAAP income for the quarter was $116,000,000 down $19,000,000 from the same period last year, predominantly impacted by a year over year provision increase of $23,000,000 Net interest margin for the quarter was 6.1 percent in line with last year. The provision for loan losses for the quarter was $113,000,000 and resulted in a reserve balance of $501,000,000 This compares to a provision of $90,000,000 in last year's Q2. Included in the $113,000,000 provision is a $52,000,000 or roughly 11% increase in our estimate of lifetime losses on existing loans, which we believe reflects industry wide credit challenges. Also included in the provision is $61,000,000 for expected losses on current quarter originations.

Speaker 4

The resulting reserve to receivables ratio was 2.82% as compared to 2.79% at the end of Q1 and 3.08% from a year ago. Despite the growth in year over year provision, the reserve to receivables percentage only increased 3 basis points,

Speaker 5

which is

Speaker 4

a result of credit tightening measures we deployed over the course of the last 2 years and their growing impact on the near $18,000,000,000 portfolio. Regarding the broader credit industry, it has been well cited that a number of auto loan consumers are struggling in this inflationary environment, especially those borrowers who originated contracts in 20222023 when elevated prices were coupled with high interest rates. To combat these results, lenders have generally tightened underwriting where necessary and have adjusted lifetime loss expectations based on weakening performance. CAF has to some degree experienced similar challenges emerging within the industry, but our customers have largely shown an ability to navigate this added inflationary burden. During this last quarter, we observed additional pressure on the consumer.

Speaker 4

And as a result, we added to our provision accordingly. Despite the adjustment, these higher ASP originations from 20222023 remain significantly profitable for CarMax, and it is clear that the material tightening deployed in early 2023 has had a meaningful impact on our vintage level loss rates. In addition, we observed a pocket of customers generally concentrated at the lower end of the Tier 1 credit spectrum that were of noticeably higher risk, which we addressed through the further tightening of our underwriting strategy for cautionary reasons beginning in April 2024. While the loss allowance was previously adjusted for this pocket in the Q1 as a part of our standard loan loss modeling process, during the Q2, we observed further deterioration, which necessitated an additional adjustment on the pre existing receivables. We believe this quarter's provision adequately captures the performance within the quarter and the resulting reserve is our best estimate of the remaining lifetime loss for portfolio.

Speaker 4

As always, CAF will continue to balance credit risk, driving Carmack sales and capturing its optimal share of highly profitable finance contracts. Now I will share an update on CAF's securitization program and full spectrum lending initiative. During the month of June, we successfully executed our 1st non prime ABS transaction and followed in July with our 1st higher prime ABS deal. The success of these transactions reaffirms our belief that these complementary programs will provide significant additional funding capacity to support CarMax growth, while giving us the flexibility to capture a larger piece of the Tier 2 and Tier 3 landscape. Also during the Q2, CAF successfully began testing its new full spectrum credit scoring models and corresponding strategies across both the Tier 1 and Tier 2 spaces.

Speaker 4

And we expect our Tier 3 testing of the new model to begin during the Q3. Now I'll turn the call back over to Bill.

Speaker 2

Thank you, John and Enrique. As I mentioned on our last earnings call, I'm proud of the durable actions we've been taking to support our business and further differentiate our offering. We're continuing to refine the experience and realize efficiencies that will support future growth. Some examples include, we've completed the nationwide rollout of our new order processing system across our stores and customer experience centers. As a reminder, this system helps associates guide customers through each step of the buying journey and provides a more seamless experience for customers who prefer to blend self progression with assistance from associates.

Speaker 2

We're now focused on customer shopping accounts. These make it even easier for customers to see the steps they have taken on their shopping journey, whether on their own or with help from an associate. These accounts guide next steps and promote MaxCare, our extended service plan offering. We're currently testing in several stores and plan to deploy nationwide later this year. Our data science, CEC and product teams have recently developed a new knowledge management system that we are testing in our CECs, which leverages generative AI to empower associates with instant access to the information they need.

Speaker 2

Associates can ask questions through a chatbot and receive an immediate response. We are finding this tool especially helpful for customer questions where the response varies from state to state. This will enable our CECs to be more effective and efficient and we plan to launch the system across all CECs later this year. For finance based shopping, we released an enhancement that seamlessly incorporates existing instant appraisal offers into our prequalification offering, giving customers more precise credit terms. And finally, we launched an EV hub on carmax.com.

Speaker 2

The hub contains information and research tools that address top questions shoppers have about electric vehicles, including hybrids, and helps consumers determine if an electric vehicle is right for them. As I mentioned last quarter, we're focused on driving down cost of goods sold by pursuing incremental efficiency opportunities that we've identified across our logistics network and reconditioning operations. This supports affordability as we pass savings on to our customers and also supports our margins. After completing a comprehensive review of our logistics operation, we determined that centralizing some key functions will help us best leverage our network. During the Q2, we centralized our home delivery, appraisal pickup and max offer moves by market.

Speaker 2

We plan to achieve further efficiencies in upcoming quarters as we roll out our enhanced transportation management system, which provides new planning and execution capabilities. In conclusion, we're encouraged by our Q2 performance and assuming current market conditions continue, we feel good about our sales in the second half of the year. We're excited about our future and our ability to grow sales and earnings while continuing to enhance our best in class omnichannel experience for our associates and customers, strengthening our competitive mode. With that, we'll be happy to take your questions. Todd?

Speaker 3

Thank

Speaker 6

you.

Operator

Your first question will come from the line of Seth Basham with Wedbush Securities. Please go ahead. Your line is open.

Speaker 7

Thanks a lot and good morning. Great to see the progress on sales. My first question is just if you could give us an update on how unit comps are trending quarter to date?

Speaker 2

Yes, sure, Seth. So first of all, we're pleased with how the sales have progressed. If I look at the comp cadence for the quarter, they actually sequentially got better, which was great to see. For September with almost one full month into the Q3, we're trending positive for the quarter in line with the second quarter, but a little bit softer at this point. I would also just point out that September has some heavy day of the week headwinds, less one less Friday, one less Saturday, pick up a Sunday, but we get all that back in the quarter.

Speaker 7

That's helpful color. And then secondly on CAF, can you give some color on your view of the market at this juncture? Does it make sense to push forward with the full spectrum lending given the credit headwinds and do you expect further tightening on your underwriting standards?

Speaker 4

Sure. Appreciate the question, Seth. So first on the overall market, again, I think we stated clearly and I think you've reported this, industry wide loss rates clearly are out there. It's a stress consumer. I think that's why we've done the tightening that we've done April 23, we're clearly seeing improvement in losses on those vintages.

Speaker 4

We mentioned again further tightening in April 24. I'll address your tightening question right now. Right now, we feel good about where we sit. Everything that we've tightened on previously, highly profitable for CarMax, but just moves that we felt we wanted to make proactively on a cautionary basis. But right now, we feel good about where we are.

Speaker 4

Again, never say never. We'll watch our portfolio very, very closely, but we feel good about what we're originating right now. And with regard to is this the right time for Tier 2 and Tier 3? Well, we're in learning mode and we're really excited about it. We deployed our Tier 2 underwriting model and strategies in the back portion of Q2.

Speaker 4

We're looking to get into the Tier 3 in probably the back portion of Q3. And we're excited to learn and we're going to continue to learn throughout probably the fiscal quarter. We will decide when it makes sense to go in to go after more volume. We think it's great for the customer that there's going to be CAF in there. We know it's great for CarMax that CAF is going to be there.

Speaker 4

We think there's more opportunity there as we've all stated. So we'll pick the right time, but we're excited to learn and we'll move in prudently and when it makes sense.

Speaker 3

Yes. And Seth, what I'd say is even in this kind of environment, I mean, these are really profitable loans that John and team can target and do an excellent job of targeting those loans and originations. So we're really excited about the full credit spectrum. And yes, we'll continue to test in the back half of the year.

Speaker 4

And I'd be remiss if I didn't finish up with and that's what made the securitization program this summer so exciting for us. It really was a great success both of those issuances. And I think it really sets us up well for the future both in capacity and flexibility.

Speaker 7

Thank you.

Operator

Thank you. We'll take our next question from Sharon Zackfia with William Blair. Please go ahead.

Speaker 6

Hi, good morning. Thanks for taking the call or question. I guess another question on the finance business. How do we think about the profitability of CAF when you've got the higher losses on the one hand, but we also are seeing funding costs obviously start to come down. Is this kind of the trough in terms of year over year decrease that we should expect?

Speaker 6

I mean, when do you think cap can start to grow again in income? Just any kind of perspective around that would be helpful.

Speaker 4

Yes, I appreciate the question, Sharon. So I'll kind of break it down between 2 of our obviously our biggest line items. You mentioned the interest rate aspect. So right, that's going to show through in our NIM. Obviously, we've been very pleased with how we've managed NIM in this environment.

Speaker 4

We've said 6 felt about the right level. We've hovered around that area and we've done that in the face of tightening, which actually is generally going to put pressure on NIM. And obviously, we've been able to capture our share finance contracts, while in a raised rate environment. So we've been pleased about how that's operated. Obviously, as rates trend down often there's an opportunity for a lender to enjoy stickier rates and maybe capture a little bit more.

Speaker 4

But largely, you've got an $18,000,000,000 portfolio at current name. It's going to be hard to make a lot of headway against that. But we would hope that would be a tailwind for us. With regard to the loss environment, which is kind of the other end of the spectrum, I really want to point out our provision. Let's talk about that this quarter.

Speaker 4

Ultimately, if you think about it, when we set our provision and our reserve at the end of a quarter, our goal clearly is to only have to in the successive quarter set a provision for what we newly originated in that quarter. It never happens that way as you're well aware. You're going to have points where sometimes it's going to be you're going to have the ability to release loans because release provision because performance is excellent. You're going to have in a higher delinquency environment, higher loss environment, which we're operating in right now. We've seen seen change that we've had to make in the $10,000,000 $20,000,000 $30,000,000 range.

Speaker 4

Let's make clear, we felt the $52,000,000 adjustment on the existing portfolio was outsized versus previous quarters. And it was important we noted that for everyone. And we would hope that obviously we have the provision and the reserve nailed for this quarter, but it's a big deal. So the difference between the $50,000,000 and what I would say is in the last 7, 8 quarters $10,000,000 $20,000,000 $30,000,000 on the high side a year ago. I think the $50,000,000 is certainly more than we would hope to do going forward.

Speaker 4

So again, you've got to gauge what you think our origination volume is, the provision there and then what the true up is going to be. But again, I think this is outsized hopefully on a go forward basis.

Speaker 3

I think the way to think about that is, of the $50,000,000 probably $20,000,000,000 is probably what we've seen over the past year here, I would say. So you're looking at probably like a $30,000,000 adjustment versus what we typically would have seen on the quarter.

Speaker 6

Very helpful. Thank you.

Speaker 8

Thank you, Sharon.

Operator

Thank you. Our next question will come from John Murphy with Bank of America. Please go ahead.

Speaker 9

Good morning. Maybe just to stay on credit here. I mean, as you see the trajectory get a bit worse, but it's still within the bounds of normal and even the lower end of the normal range. I'm just curious how you gauge sort of absolutely how you think about this going forward or sort of the rate of change? Are there specific metrics you guys are looking at internally?

Speaker 9

I mean, you kind of cited tightening in April and then tightening again during the quarter. So it seems like you're moving with this, but I mean, how do you gauge where this may ultimately land?

Speaker 4

Yes. I appreciate the question, John. Yes, I'll point to one metric, which is, again, our reserve to receivables, which is $2,82,000,000 And I think what that number highlights quarter over quarter in the face of a provision of $50,000,000 which we've just said is relatively outsized is the tightening that we've done and you mentioned that. The tightening that we've done, we've looked at our portfolio, we've looked at what we originate, highly profitable loans. We feel good about what's on our books, no doubt about that.

Speaker 4

But we really wanted to pinpoint those receivables and those customers that we felt could sustain or really perform extremely well in a stressed environment like we're in. And we've done that. And we've tightened and we're seeing the relative performance play through in our vintage level early looks at losses. How bad could it get? Again, hard to say.

Speaker 4

We feel good about what we have. You've seen a provision that we think really captures where we think losses are headed. We've tightened to the right pockets. It's all very, very profitable. It's the question of what loss rate are we willing to accept provision for accordingly.

Speaker 4

We have the funding we think in place to really do whatever we want to do going forward. But again, we're going to be cautious and careful and do what we think makes sense in the quarters to go. So hopefully that addresses your question.

Speaker 2

And John, just a point of clarification. I think you said tightening in this quarter. We actually tightened in the we didn't do any tightening in this quarter. We didn't see the need to. We tightened in

Speaker 4

the previous quarter. 23 April 24 April, we have not done anything significant since April of 24 and don't see anything in the horizon right now.

Speaker 9

Okay. That's super helpful. And just one just quick follow-up on the sourcing side. I mean everybody we talked to in the industry is having a tough time finding late model vehicles. It seems like you guys did a really good job in the quarter and actually got the 31,000 out of dealers.

Speaker 9

So I'm just curious what is changing there? What Edmunds is doing to help you source from dealers who seem like they have a pretty tight hold of these vehicles and don't want to let them go? And what kind of an impact can that have going forward? Because there is a real shortage, but you did a good job this quarter. So just trying to understand what changed.

Speaker 2

Yes. I think the shortage is really highlighted by the off lease, John, which you know, it's I think it actually bottomed out in 2022. I think there's a little bit of a step down next year in 2025 and then it'll start going back up. But the reality is because of our diversification of buyers whether the increase in our instant appraisal offers and certainly the MAX offer, the Edmunds team has done a great job. If you look at year over year, we've probably got 50% more dealers that are active on it than they were a year ago.

Speaker 2

And when it comes to like for example leases, that's never been a a significant part of our sales. But the interesting thing is with our IO and MaxOff, we actually have better access to them than we did historically even though the volume is down. So for us the supply just hasn't been an issue.

Speaker 9

Got it. Impressive in maintaining grosses. Thank you.

Speaker 2

Thank you, John.

Operator

Thank you. Our next question will come from Brian Nagel with Oppenheimer. Please go ahead.

Speaker 5

Good morning. Thanks for taking my questions.

Speaker 10

So I have 2 quick questions. I'll merge them together. First off, with regard to the improvement in used car unit comps, so first off, congratulations. But is there anything you could really point in the quarter that sort of say underpins that strengthening what we've seen in prior quarters? And then the second question I have with regard to finance, as you look at this, the higher loan loss provision that you took here in the fiscal Q2, is that more a reflection of what you're seeing in your portfolio or the inputs that come as a result of your analysis of the overall environment?

Speaker 2

All right. So I'll take the first part of that and John will tackle the second part. So Brian on your first part just kind of improvements in comps kind of drivers. I talked a little bit about this in my opening remarks. I think it's both internal things that we're doing.

Speaker 2

I also think there's some macro benefits as well. From an internal standpoint, I'm really pleased with the team and the execution across the board, whether it's finding efficiencies and areas of cost of goods sold, which allow us to do different things with better conversion in our CECs and stores. The experience I highlighted that we got order processing. Last quarter I talked about the fact that we were testing that we had it in some stores we plan to get it out everywhere by the end of the year. We actually got it all out in this the very next quarter which we're thrilled about which really puts all of our stores, the CEC and the customer all on the same format.

Speaker 2

So it makes it much easier and seamless to go back and forth between assistance and help. So I think that's great from a macro standpoint. Look, prices continue to come down and I think Enrique help me on this, but I think this is the 7th quarter in a row of year over year price declines in our ASP, which certainly they're not back to where they were, but every bit helps. And then of course, interest rates, the future of interest rates coming down, I think will help that. We were able to source and have for sale more, less than $25,000 cars and more 0 to 4 cars, which I think is great.

Speaker 2

And then of course, we also in this much more of a stable pricing environment. We've talked about that many times over the last few quarters about what happens when you see big price swings of which we saw 2 last fiscal year, 1 the year before. We've got up and down depreciation, but it's much more normal. So I think it's a combination of things.

Speaker 4

All right, Brian. And I'll take your second question. Basically, it was, hey, with our larger provision this quarter, but your question was, is it really on our portfolio or is it the broader economic environment? I'm paraphrasing. But I want to be precise in my answer here.

Speaker 4

So for CECL and for our reserve methodology, we look at economic factors that are out there as you might imagine. And so we weigh them into our decision. But more specifically, our adjustments are based on the observations that we have on our portfolio and the performance that we believe is broad in the industry. You take banks, obviously, the Ally Bank, Sutter World, other banks, other finance companies, you can see that they're citing similar performance issues. So I think it's occurring on books across the industry.

Speaker 4

We observed it on ours. We take into account economic factors, but it's largely on us like on us on industry performance.

Speaker 10

I appreciate the color. Thanks guys.

Speaker 2

Thank you, Brian.

Operator

Thank you. Our next question will come from Rajat Gupta with JPMorgan. Please go ahead.

Speaker 5

Great. Thanks for taking the question. Just had one clarification and another question. On the September comps, did I just hear correctly that you're tracking positive year over year on same store basis so far?

Speaker 2

Yes. For the September, well, really I'm talking about the quarter trend is tracking positive for the quarter. It's in line with the Q2. It's a little bit softer. But again, I want to point out, Rajat, that there is a day of week headwind there for sure with the one less Friday, one less Saturday, picking up a Sunday where a bunch of our stores are closed.

Speaker 2

All that will square away throughout the quarter.

Speaker 5

So you mean for the quarter you would expect it to be positive still? That was the comment you were making on September.

Speaker 3

That's the current trend of sales, yes.

Speaker 5

Okay, got it. And then just on the advertising spending, I was surprised to see a big drop there. Curious like is there what's happening there? I mean is there like some efficiency you're getting with the advertising spending? I mean is this the right level of per unit spending we should be expecting?

Speaker 5

Any further thoughts there would be helpful. Thanks.

Speaker 3

Yes. No, absolutely. I would say that quarter to quarter there's going to be some variation, right? But if you look at the first half of this year, we're pretty much in line with where what we've communicated is our target. And if you take a look at the back half of the year, it's going to be very similar.

Speaker 3

So I wouldn't read anything into this particular quarter with the marketing spend year over year on a total unit basis. It's just variances within a quarter. But again, first half of the year, pretty much in line with what our expectations are and the back half of the year is in line with what we've communicated.

Speaker 5

Understood. Great. Thank you.

Operator

Thank you. Our next question will come from David Bellinger with Mizuho. Please go ahead.

Speaker 11

Hey, thanks for the questions. First one, just on the worsting trends in the broader auto loan market. You've already got Tier 3 down to about a 7% penetration today. You've tightened up again. Just what's next here?

Speaker 11

Are you beginning to plan the business with any type of contingencies or any potential downshift in volumes over the next few quarters? Maybe just help us think there are any further offsets or cost pullbacks you could have in a weakening credit environment?

Speaker 4

Yes. So I guess let's speak about you mentioned the Tier 3 percentage. I think there's a couple of things going on in the industry. You've got again worsening performance that we've talked about and Cap cited, they're tightening. I think again there's tightening that has occurred across the industry as well.

Speaker 4

That's well documented too. So I think we've done a great job of absorbing that tightening. Our lenders on our book of business, we think we have the best credit platform in the industry. We have very loyal partners and they've done some tightening, no doubt. Every lender is going to do their own thing, but they've done some tightening just as we have.

Speaker 4

And we don't know what they're going to do going forward. When we speak to them, they feel like they're in a spot similar to us where they feel good about what they're originating. I want to mention your speak to your Tier 3 comment down to 7%. I think that's maybe less about the tightening. Sure, there's some in there, but a lot of the Tier 2 and Tier 3 volume being down, I think that's really an affordability challenge that we've mentioned repeatedly, where the consumer that's looking to purchase, that is shopping is just not in a position to pull the trigger given the payments and the situation occurs.

Speaker 4

Some of that could be from tightening, no doubt. But if you look at the sheer price point and the monthly payment, I think that's where they're struggling. So I think that's coming from as much the consumer as it is the tightening. So I don't know anything. Yes.

Speaker 2

The only thing I would add is, David, is that look, I think we feel great about the actions we've done. We feel great about the tightening that we've done. Our lenders and having conversations with them, they've already tightened. They feel good about the CarMax book of business. John talked about this lower income customer and he's absolutely right.

Speaker 2

I think where you're seeing the Tier 3 is not because of necessarily tightening. Sure, where there's been tightening, it's just an affordability issue. And when I look at lower income, household income consumers, it's still a fraction of what it used to be. So we actually think at some point that will come back.

Speaker 11

Got it. And if I could just ask one more on the digital progression tools. You mentioned order processing. I think there's a new functionality where consumers can complete a transaction from home that started in store. So is that something available in every location now?

Speaker 11

And can you talk about any improvement in conversion that you're seeing early on with this?

Speaker 2

Yes. So we just rolled it out everywhere recently. You're exactly right. It makes it more seamless whether you start in the store or you start online. What was happening before is if you started it online and you worked with the CEC and you did the whole thing through the CEC online, great, because all of our CECs were up on it.

Speaker 2

But if you started online, work with the CEC and then when you went into the store, it wasn't as seamless because we didn't have the stores on the new order processing. Now we have it everywhere. So it doesn't matter where you start. And this is a benefit not only for the customer, but for the associate as well because when a store associate is working with a customer that's been doing something online, it's now transparent what they did. The next thing that we're doing, which I talked about is really this shopping cart is what I kind of call it, where now the consumer because you had to get order processing everywhere first.

Speaker 2

Now when they log into my CarMax account, they see everything they did in the store, they see everything they've done online. So again, it's a nice little continuation and it prompts them on the next step. So it's a little early to talk about what it's generating from a conversion standpoint, although our conversion was up both in the CECs and the stores. We feel like it's just a better customer experience and it will pay off in dividends in the future because the consumers are going to continue to want more.

Speaker 11

Very good. Thanks, Bill.

Speaker 5

Thank you.

Operator

Thank you. Our next question will come from Craig Kennison with Baird. Please go ahead.

Speaker 12

Hey, good morning. Thanks for taking my question. It's somewhat of a follow-up to the last question. But online sales as a percentage of total sales moved up to 15% from 14%. I think it was stuck around 14% for a while.

Speaker 12

Where do you think that metric should be in the coming years? And then as you shift to a lower touch process, should we start to see a benefit in unit profitability because of the low touch nature of that transaction?

Speaker 2

Yes. So on the 15%, it's been around 14%, I think for a couple of quarters. It did tick up a little more. Quite honestly, I'm more excited about the 2 point tick up in Omni because that's where most of the customers are. There's only so many folks that just want to do everything online.

Speaker 2

And I would point out the 15% of people that did it online, the vast majority of them still wanted to come into the store to actually do the pickup, talk about the car, that kind of thing. As far as more look, the more self progression customers do, that is from an efficiency standpoint, that is a win. And I'll let Enrique talk a little bit

Speaker 11

more about that.

Speaker 3

As I mentioned in my prepared remarks, we're really excited about the progress that we've made on our omni selling model as compared to their pre omni time period, not only from a year over year basis, but also relative to pre omni. This quarter, we were actually more efficient on those key metrics, right? So these key metrics that we've been talking about consistently here for a while is on a per total unit basis, on a per gross margin basis, and then also on a per retail unit basis, which we were more efficient. So we had committed to making progress on that and being as efficient and even more efficient and we're delivering on that and that should continue to accelerate here in an environment where sales come back and we should continue to see that flow through. So we're really, really pleased.

Speaker 12

Bill, just to push back on your point, customers that wanted purely digital experience really only have a couple of choices, you and a top competitor. And I would think that your perspective is you should have your fair share of that. Do you think you're getting it?

Speaker 2

Yes. The way I think about it is I don't have a target for any whether they want to do it all in the store, whether they want to do a combination of the 2, which is really what Omni is all about. They want to do everything. We want to have the best process for all three of those. So we're kind of agnostic when it comes to how they want to deliver.

Speaker 2

I think it's great 15% of them, but we don't force them one way or the other. So, yes, I want my I definitely want our fair share of that. But I also don't mind if they think that that's what they want to do and they end up coming in or doing everything in the store.

Speaker 12

That's fair. Thanks, Bill.

Speaker 2

Thank you, Craig.

Operator

Thank you. Our next question will come from Scot Ciccarelli with Truist. Please go ahead.

Speaker 7

Good morning, guys. Apologies in advance for another finance question. Previously, you guys had been lowering provisions despite higher delinquencies. And I know, John, you were talking about a lot of different factors that you guys consider. But was the provision change based primarily on delinquencies increasingly converting into write offs in your book?

Speaker 7

And then related to that, with delinquencies hitting 8% rates on your subprime after about 3 months, what are your initial loss expectations for the subprime pools? Thanks.

Speaker 4

Sure. Yes. On your first question, yes, if you look at kind of and again, we've said our provision is going to be a function of our origination mix, which is going to have different levels of provision at any point in time. But certainly there's this added component. And if you look, we have been, we call it showing up adding volume based on the performance we've seen beside the delinquency level.

Speaker 4

In any given month and I think we've said this, we've definitely had seen our customers operate fine in delinquency. They might come in, they might come out, but they were not rolling to loss at nearly the historic levels that we may have seen 5, 10 years ago. It clearly was somebody that was navigating the environment fairly well. It so happens in this quarter, we saw that erode a little bit and that's why we made the outsized adjustment. But again, it's always sort of on us performance what we're seeing coupled with obviously the external or the economic factors, but it's mostly the on us performance.

Speaker 4

We feel good about where we sit today with our reserve. We've made the adjustment. It was certainly outsized. It captures the performance. And we think our tightening will drive through to actually ultimately hopefully not having to make additional adjustments.

Speaker 5

Yes. It's Scott. I mean, I think that's

Speaker 2

a fine point that I want to make sure I kind of reinforced in that. Just because you're lowering the provision in previous months doesn't mean you're not doing true up. We were doing true ups. It's just the origination piece just speaks to the tightening that we've been doing. So again, I just want to make sure that that point resonates with everyone.

Speaker 4

Okay. And then I'll touch on your last question. I think you spoke about the subprime. So let's just talk about the different pockets. And again, it's more of a continuous rather than this sort of discrete the way I'll describe it.

Speaker 4

But the Tier 1 book of business, obviously, we've cited that is our bread and butter as where we've operated. Historically, it has been that 2% to 2.5% loss range. Obviously, we're excited about getting more full spectrum. We've operated in the Tier 3 space. We've said certainly a higher loss level.

Speaker 4

It's been way back in the day, it was maybe 1% of our portfolio, but 10% of our losses. So you can do the math there on the loss level you'd expect. And then Tier 2 is somewhere in between at different continuum. So when we look at a higher delinquency book, it is something that we manage. We believe it's highly profitable.

Speaker 4

We provide a great credit offer to the customer. I think per an earlier question, we'll go in that space when we think it make sense and with the volume it makes sense. We're just excited for the flexibility to be able to do it, have the models that we're going to hone to be able to do it. And again, we think it's just good business to be a part of.

Speaker 11

Thanks Scott.

Operator

Thank you. Our next question will come from Chris Pierce with Needham. Please go ahead.

Speaker 8

Hey, good morning. Just two questions. Do you think CDK helped the comp at all in the quarter given more independent dealers kind of rely on their software suite? And then other gross margins, you called out some we've seen headwinds, you called out some tailwinds. I just

Speaker 6

want to know the right way to kind

Speaker 8

of think what the piece is going forward.

Speaker 2

Okay. On the CDK, look, I don't think it really had any material impact. I think a lot of dealers had some workarounds. Plus, if I just look at our comp cadence through the quarter, it got better each month. So, August was over July.

Speaker 2

I think CDK kind of worked itself out through that point. So that's why I just don't think it had a material impact. And then what was your second question?

Speaker 3

Other gross margins.

Speaker 8

Other gross margins, yes, it's been trending quite positively. And then we had the EPP tailwinds, but you called out some equipment headwinds. I just want to know kind

Speaker 6

of the right way to think about it, if I heard that right.

Speaker 3

Yes. No, absolutely. So for other margins, look, we are really pleased with our performance and other gross margin. It rose by $36,000,000 this quarter. That's a 33% year over year increase really driven by 2 components, right?

Speaker 3

Service continues to see year over year improvement, which we committed to at the beginning of the year. I expect to continue to see that improvement in the back half of the year. It is somewhat governed by sales given the leverage deleverage nature. But all things being equal, I would expect to see continued improvement year over year. And for EPP, we just again continue to see improvement.

Speaker 3

I'd expect to see that because it's really margin that we took earlier in the period. And so I'd expect to see that increase in Q3. And then in Q4, we're going to start comping over some of the margin testing that we've done the previous year, but nevertheless, we'd still expect to see some favorability year over year. So we're bullish on our other margin performance. In relation to in my prepared remarks, I talked about a potentially there may be up to $10,000,000 impact that would not be in gross margin, that would be in other income and expense.

Speaker 3

So, a non gross margin, non SG and A impact. And that's really just taking a potentially taking a charge on as we optimize our logistics network, we took a look at the associate side, we got to take a look at truck side as well. So we need to make sure that we have the right amount of trucks ourselves and our dedicated partners also have the right amount of trucks and we expect that there may be a charge off there. But we're still working through that and that would be a one time hit. So just wanted to call that out for the 3rd or Q4.

Speaker 8

Perfect. And then just one last one. We've seen strength in the wholesale market, kind of non seasonal strength. And I don't think used car retailers have much pricing power right now. So how should we think about GPUs from here?

Speaker 8

Could there be modest GPU compression around that? Or am I over reading to a month of strength in the wholesale market?

Speaker 2

You mean, are we thinking that our GPU would come under strain going forward? Is that the question? Yes.

Speaker 8

It's been it's costing used car dealers more to buy cars in the wholesale market and pricing power is sort of limited right now based on where we're at as far as affordability.

Speaker 2

Yes. Look, our self sufficiency when you look at what we're buying through the appraisal and through dealers is well over 70%. I think that plays a lot into our ability to get supply. I feel great about our own wholesale business. The team is doing a phenomenal job.

Speaker 2

If I look at and it probably speaks to your point, I look at the how many dealers are for every car that continues to improve, which obviously helps us continue to manage margin, be able to offer the customers as much as possible for their vehicles. So again, I think some of the concerns on the supply side, again, we just have not because of our self sufficiency is so high, we just have not had an issue.

Speaker 6

Okay,

Speaker 8

perfect. Thank you. Thank you.

Operator

Thank you. Our next question will come from Chris Bottiglieri with BNP Paribas. Please go ahead.

Speaker 13

Hey guys, this is Ian Davis on for Chris. Thanks for taking the question. Another one on credit, but hopefully a little bit more high level. What are your peers, online peers has been able to meaningfully expand their credit penetration at a level that we would estimate to be in the mid-80s versus your low 70s today. So acknowledging some of the conditions in the current environment that you've alluded to previously, what are the constraints that prevent you from getting to those levels today?

Speaker 13

And maybe what could you tell us about the makeup of the other 30% of customers that aren't procuring financing from CarMax or your lending partners?

Speaker 4

Sure. Yes, I mean, I think speaking to us specifically, and I'll just break down our penetration. Again, we are looking to be a full spectrum lender, provide all customers availability to credit. So we think that's why we have many lenders in our platform that have been there a long time. And we think we provide great credit offers across this credit spectrum.

Speaker 4

We're not trying to focus on a lower end, a middle end, a high end. We want to provide it to all customers. And so therefore we have additional lenders. Everybody is going to benefit from CarMax. Our partner lenders want volume as well.

Speaker 4

We have volume. We know there's opportunity potentially to grow our volume, but we're looking to provide great offers to all customers within the credit spectrum. That's just an overarching goal of ours. With regard to the what prevents CAF from growing meaningfully, I think we've decided we're very excited about the ability to choose to grow when it makes sense. But again, we're not going to target one particular pocket.

Speaker 4

We want to make sure we're making offers across Tier 2, across Tier 3, but staying true to who we are in Tier 1 that is what we do. So that's specifically to CAF. You asked the question about those not procuring finance from CarMax and using a 3rd party. Again, those customers are absolutely going to be your higher end consumer. It's going to be those that are going to come down and put cash right down because they don't want to pay higher interest rates that are out there in this environment.

Speaker 4

They're affiliated with the credit union who absolutely is operating at a cost upon advantage. So they're very rate sensitive. And those are folks that we try to compete with at CAF, but sometimes it's an environment where it's difficult to do so. And as long as we are looking to sell cars to those consumers and focusing on those consumers, which we are, we are going to have percentage of volume. In this case, it's maybe a little more outsized, more than 30% this quarter of using external financing.

Speaker 4

That will shrink as the low rank consumer comes back. We believe that 100% because they will again increase their size of the pie thus lowering other the non finance size of the pie. So a lot in that answer, a lot in your question. I want to make sure I captured it holistically. Yes.

Speaker 2

I'm going to add a little bit more to that answer, which is, look, we could absolutely go there tomorrow. We would just limit the number of partners. We wouldn't allow 3 day payoffs. But in reality, when you sell this many cars to the wide spectrum, especially your rate sensitive customers, having more partners for lots of reasons is a great thing. Now do we have an opportunity to continue to increase our penetration?

Speaker 2

Absolutely. And we absolutely will over time. But I think you have to do it in a thoughtful way, especially as your volume grows.

Speaker 13

Got it. Really appreciate the answers from both of you.

Speaker 3

Thank you. We'll take

Operator

our next question from John Healy with Northcoast Research. Please go ahead.

Speaker 14

Thanks for taking my question. Just wanted to ask just one big picture type question. You guys have talked about doing some things on the logistics side, which kind of gets you to where you want to be. But I haven't heard a lot of talk about the recon side of things. And I was just curious if you could address that, if you're kind of happy with the state and approach to reconditioning and the ability to get solid margin out of the business?

Speaker 14

Or are you maybe rethinking or retooling some things there in the background? Thanks.

Speaker 2

Yes. No, John. I mean, look, this is an area of focus. I talked about it last quarter. I mentioned it in the March just high level.

Speaker 2

I didn't give any specific examples, but I feel great about the initiatives that we're doing on the reconditioning side. The difference in reconditioning and logistics is reconditioning is going to be a lot of little things adding up. So think about we're seeing some great improvements in some part utilization, whether it's OEM, non OEM, when to replace, not to replace. We've got bringing some stuff in house, so not subletting as much, better capacity utilization, outlier store performance, with improvements time frame. There's a lot of things that will add up to some of the internal goals that we talked about.

Speaker 2

And quite honestly, last quarter, I said, look, we're going after a couple of $100 between reconditioning and logistics, which that's not insignificant. And obviously, as you realize that you then have the luxury of deciding what to do with it, pass it on to customers or take it to margin. So we feel good about our progress there on both fronts, whether it's logistics or it's in the reconditioning and both of which we're going to continue to get things over the next year from a benefit standpoint.

Speaker 14

Got it. And just one minutia question for me. I think ad expense advertising expense was actually down year over year for you guys and the comps were up. So just kind of wondering if there was some timing thing there or if you guys are maybe holding back or changing the way you're thinking about ad spending? Thanks.

Speaker 3

Yes. No, it was purely timing. If you look at the first half of the year, we're pretty much on course for what we had communicated was the target for the year. And so the first half of the year, I expect, is going to be similar to the back half in terms of the per total unit spend. So it was purely some timing in the second quarter.

Speaker 8

Great. Thank you.

Operator

Thank you. We'll take our next question from David Whiston with Morningstar. Please go ahead.

Speaker 15

Thanks. Good morning. Wanted to go back to that explanation on the other financing channel. You said that they're very interest rate sensitive consumers, but you also said that they're more able to pay cash. So are most buyers in that bucket, are they more budget conscious or are they more wealthy or unable to pay cash?

Speaker 15

In other words, are they borrowing more or are they just more all cash buyers?

Speaker 4

Yes. That consumer typically is definitely your higher end consumer. Again, they're coming in with the affinity check with their bank or their credit union, but generally a very rate sensitive consumer. But absolutely, a majority of that is cash. It's in cash in some form.

Speaker 4

It may be true cash. It may be home equity loan. It may be personal loan. But those are people that have generally have the wherewithal to not pay the higher interest rates that are out there today. And you'll find people that are going to do that in all interest rate environments, but especially in this environment, it's cash users, highly rate sensitive.

Speaker 15

Okay. And on the capital allocation, do you see buybacks continuing? Are you feeling more cautious given the declines in credit quality?

Speaker 3

I'm feeling like we're on the pace that we communicated and I would expect to continue to see that pace for the balance of the year.

Speaker 8

Okay. Thank you.

Operator

Thank you. At this time, I'm showing no further questions in queue. I'll turn the call back to Bill for any closing remarks.

Speaker 5

Great.

Speaker 2

Thank you, Todd. Listen, I want to thank everybody for joining the call and your questions and your support. Obviously, we feel good about our progress. Also, I just want to share my thoughts are definitely with our associates and their families and the communities as hurricane Helene approaches. We have a number of stores in the storms past and as always the safety of our associates is our top priority.

Speaker 2

To those associates and everyone that's been impacted, please stay safe And we will talk again next quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, that concludes the Q2 fiscal year 2025 earnings release conference call. You may disconnect your line at this time and have a wonderful day.

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CarMax Q2 2025
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