Q1 2023 Carmax Inc Earnings Call
You are currently on hold for this car Max first quarter fiscal year 2023 earnings release Conference call. At this time, we are assembling today's audience and plan to be underway. Shortly we appreciate your patience and please remain on the line.
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Once again you are currently on hold for this Carmax first quarter fiscal year 2023 earnings release conference call. At this time, we are still assembling today's audience and plan to be underway. Shortly we appreciate your patience and please remain on the line.
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Good day and welcome to the Carmax first quarter fiscal year 2023 earnings release Conference call. Today's conference is being recorded at this time I would like to turn the conference over to David Lewis Tonight. Please go ahead Sir.
Thank you Orlando and good morning. Thank you for joining our fiscal 2023 first quarter earnings conference call.
Here today with Bill Nash, our president and CEO .
We gave me or more 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.
Or 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 and.
In providing projections and other forward looking statements, we disclaim any intent or obligation to update them for.
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 interim report on Form 10-K for the fiscal year ended February 28th 2022 previously filed with the SEC.
Do you have any follow up questions. After the call. Please feel free to contact our Investor Relations Department at eight O four seven and four seven O.
For two two 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.
Thank you David Good morning, everyone and thanks for joining us for.
For the first quarter of FY 'twenty three our diversified business model delivered total sales of $9 3 billion up 21% compared with last year's first quarter driven by growth in average selling prices and wholesale volume gains partially offset by a decline in retail used units sold.
Across our retail and wholesale channels, we sold approximately 427000 cars in total during the first quarter down five 5% versus last year's period.
In our retail business total unit sales in the first quarter declined 11% in used unit comps were down 12, 7% versus the first quarter last year.
Our performance was driven by the same macro factors that led to a market wide decline in used auto sales during the quarter, including lapping materials stimulus benefits paid in the prior year widespread inflationary pressures, including challenges to vehicle affordability and lower consumer confidence.
We began the first quarter with a double digit decline in comp sales during March.
Continuing to fourth quarter performance, we discussed on our last earnings call comps, then improved sequentially with may ending in a low single digit decline.
While we don't intend to talk about it each quarter market share data provides additional context to our performance and indicates that our relative performance remains strong.
Based on external data regained share each month from January through April the latest periods, which title data is available.
We believe this share gain reflects the strength of our business model and Omnichannel platform, which gives us the ability to successfully manage through cycles like this one.
In short we remain focused on delivering the most customer centric experience in the industry and we believe we are well positioned to deliver a profitable market share gains in any environment.
We reported first quarter retail gross profit per used unit of $23 39 up $134 per unit versus the prior year period.
We continue to focus on striking the right balance between covering cost increases maintaining margin and passing along efficiencies to consumers to support vehicle affordability.
Wholesale units were up two 7% versus the first quarter last year, despite a calendar shift which negatively impacted auction volume compared with the prior year wholesale volume was also pressured by our decision to reallocate some older vehicles from wholesale to retail to meet consumer demand for lower price vehicles.
We estimate that without these two factors our wholesale unit growth would've been above 10%.
Gross profit per unit was 1029 in line with 1025 a year ago.
We are pleased that we continued to drive wholesale unit growth, even as we lap last year's nationwide launch of our instant online appraisal offering on Carmax Dot com and and then and in the face of the industry wide decline in used sales.
We believe our wholesale business provides an incremental growth lever and is a valuable component of our diversified business model.
We bought approximately 362000 vehicles from consumers and dealers during the first quarter up 6% versus last year's period.
We continued to be the nation's largest buyer vehicles from consumers purchasing approximately 345000 cars in the quarter up 3% versus last year's record result.
This enabled our self sufficiency to remain above 70% during the quarter.
We also sourced approximately 17000 vehicles through our Max offer our digital appraisal product for dealers that we mentioned during our last call. This was up 183% versus last year's period as a reminder, buying directly from consumers and dealers lowers our acquisition costs enhances our inventory selection and provides profitable incremental wholesale.
Yes.
Carmax auto finance, our Caf delivered income of $204 million down from $242 million. During the same period last year as the provision for loan losses normalized versus last year's favorable adjustment.
John will provide more detail on customer financing the loan loss provision and can't end caps contribution in a few moments at this point I'd like to turn the call over to Enrique who will provide more information on our first quarter financial performance and recap thanks, Bill and good morning, everyone.
First quarter net earnings per diluted share was $1 56 down from $2 63, a year ago.
While the decline in <unk> sales was a key contributor. The comparison was also impacted by the following two items first as John will gas and $82 million a year over year swing in the provision for loan losses, reflecting a more normalized environment.
Second earnings in last year's first quarter reflected a $22 million unrealized gain on an investment.
Total gross profit was $875 million down 5% from last year's first quarter.
This decrease was driven primarily by the 11% drop in total used unit sales.
Which was partially offset by the increase in retail gross profit per unit and the continued growth in wholesale units.
Well, let's say of vehicle margin was $192 million up 3%. Despite the headwinds in the quarter that Bill noted.
Other gross profit was $120 million down 15% from last year's first quarter.
This decrease was driven primarily by the effects of lower retail unit sales on service and <unk> profits.
Service results declined $31 million.
As lower sales and secondarily impacts from inflationary pressures drove a deleveraging results.
E P P gross profit decreased by $18 million or 13%.
Slightly more than the retail unit sales rate decline.
While penetration was stable at approximately 61% in this year's first quarter also reflected a $2 $3 million unfavorable shift in the return reserve adjustments versus last year's period.
Partially offsetting this decline in other gross profit was favorably in third party finance income, which improved by $8 million with income of $3 $4 million compared to a cost of $4 $6 million last year.
This improvement was driven by lower tier three volume compared with last year's first quarter.
First quarter also benefited from $20 million of margin contribution from Edmunds.
On the SG&A front expenses for the first quarter increased to $657 million up 19% from the prior year's quarter.
An increase in staffing costs and marketing.
The continued investment in our strategic initiatives.
Growth costs related to the increase in appraisal buys and new stores and the consolidation of Edmunds.
SG&A as a percent of gross profit deleveraged, the 75% from 59, 9% during the first quarter last year.
The increase in SG&A dollars over last year was mainly due to three factors first a $61 million increase in compensation and benefits excluding share based compensation.
Driven by the annualized nation of the strong growth in staffing we experienced in the back half of last year.
The inclusion of Edmunds payroll this quarter versus a year ago wage.
Wage pressures and a ramp in field staffing in anticipation of a stronger tax season.
Partially offsetting this increase was a $16 million decrease in share based compensation.
Second at $26 million increase in other overhead the primary drivers of this increase include investments to advance our technology platforms and strategic initiatives as well as growth related costs.
Third a $16 million increase in advertising expense.
This increase was primarily due to last year's lower level of spend in the first quarter, given our then tight inventory position and robust customer demand.
In addition, this quarter spend had anticipated a stronger tax season.
We've navigated many challenging consumer cycles throughout our history and remain committed to operating efficiently and effectively in every macro environment.
We have already begun to better align staffing in our stores and see he sees to consumer demand as part of our ability to quickly adapt our business.
From a capital structure perspective, we remain in a very strong position.
We ended the quarter with an adjusted debt to capital ratio in the middle of our targeted range of 35% to 45%.
We also generated sufficient cash to both pay down our revolver by more than $580 million.
And increase the pace of our share repurchase program relative to the back half of fiscal year 'twenty two.
In the first quarter, we repurchased approximately one 6 million shares for $158 million.
First quarter also marked our entry into the New York City Metro market, We opened a store in Edison, New Jersey and in the second quarter, we expect to open stores in Wayne, New Jersey, and East Meadow in New York.
We anticipate adding two more stores in this market next year.
Now I'd like to turn the call over to John .
Thanks, Enrique and good morning, everyone.
Carmax Auto finance business delivered solid results again this quarter, despite the volatile broader lending environment.
During the first quarter caps net loans originated was over $2 $4 billion weighted.
The weighted average contract rate charged to new customers was 9%, which was in line with a year ago, but has significantly increased from eight 2% in the previous quarter.
The majority of this quarter over quarter change came from increased rates charged to consumers rather than from the mix of the credit.
As the fed clearly signaled interest rate hikes at the beginning of the calendar year cap was able to quickly test and methodically adjust consumer rates to carefully manage sales finance margin and penetration.
As a result of these proactive rate changes cast penetration in the first quarter net of three day payoffs was 39, 3% compared with 43, 7% last year.
Of importance capsule its penetration level improved during the quarter as we observed banks and credit unions raising their own consumer rates during this period.
Our tier two partners continue to compete for the attractive carmax business, resulting in a penetration rate of 25, 2% compared with 22, 8% last year.
Tier three accounted for 7.1% abuse unit sales compared with 10% a year ago and we believe this is an indication that these customers have been impacted the most by challenges to vehicle affordability.
GAAP income for the quarter was $204 million, a decrease of 15% or $37 million from the same period last year.
I wanted to take a moment to clarify the year over year swing in our loan loss provision.
You'll recall that last year Caf recognized $24 million of income in Q1 related to the loan loss provision as we continued to adjust our reserve based on favorable loss performance versus expectations set at the start of the Covid pandemic.
Gasoline loss provision this quarter, it was $58 million, reflecting a more normalized dollar amount given the loss performance observed within the quarter.
Significantly offsetting the provision headwind was our total interest margin, which grew $53 million year over year, including a $36 million increase in interest and fee income and a $17 million reduction in interest expense.
The lower interest expense was supported by a $9 million benefit from our hedging strategy.
The current quarter's provision of $58 million resulted in an ending reserve balance of $458 million or $2, 85% of managed receivables.
This is a slight increase from the $2, 77% at the end of the fourth quarter and includes a five basis point adjustment for the growth in tier two and tier three volume originated by Caf.
We remain confident in both the resiliency of the Caf consumer and our ability to serve them well.
Delinquency rates have increased our tier one credit losses remained comfortably within our historical operating range of two to two 5%.
At this point I would like to also provide an update on our industry, leading online finance experience.
As a reminder, our unique finance based shopping engine or FBS allows for multiple lenders to decision a single customer or co applicants on our entire retail inventory for.
Abiding, our full suite of personalized decisions available at the consumer's fingertips within Carmax Dot com.
During the month of March we further enhanced this experienced by testing a no impact to your credit score Prequalification feature along with a streamlined application process that provides real time credit decisions. When our full inventory. We are extremely excited about the results. Thus far is currently available to approximately 25% of our online.
<unk> and we anticipating anticipate scaling nationwide during the rest of the year now I will turn the call back over to Bill great. Thank you John Thank you Enrique.
For the past several years, our priorities and investments have focused on building a leading e-commerce platform that integrates buying and selling cars with our best in class store experience.
I am pleased to share that during the first quarter, we achieved a significant milestone as we have now enabled online self progression capabilities for all of our retail customers.
Our journey to this point required a massive organizational transformation and I want to thank all our associates for their tremendous support throughout as we work together to create our omnichannel experience for our customers.
In regard to our first quarter online metrics approximately 11% of retail unit sales were online up from 8% in the prior year's quarter.
Approximately 54% of retail unit sales were army sales this quarter down slightly from 56% in the prior year's quarter.
Online omni and in person sales can vary from quarter to quarter, depending on consumer preferences, and how they choose to interact with us while we expect our online and omni sales to grow over time. Our goal is to provide the best experience, whether that's in store online or a seamless combination of the two.
Our wholesale auctions remain virtually 100% of wholesale sales, which represents 23% of total revenue are considered online transactions.
Total revenue, resulting from online transactions was approximately 31%. This is up from 24% in last year's first quarter.
Our E Commerce engine combined with our unparalleled nationwide physical footprint as a competitive advantage our ability to deliver integration across digital and physical transactions gives us access to the largest total addressable market relative to others in our industry and is a key differentiator.
We're now going to turn our efforts to further improving the experience for our customers and our associates by focusing on the Seamlessness of our online and in store offerings.
Some of our key areas of focus include.
First as John just mentioned, we're deploying a more sophisticated version of our finance based shopping product as interest rates rise consumers' ability to confidently secure financing is more important than ever the expansion of our best in class Prequalification product once fully deployed who will provide frictionless and seamless access to multi lender credit turns terms.
On every car within our retail inventory, whether the consumer chooses to browse and purchase from the comfort of their home walked a lot on their own with their mobile device or shopper alongside one of our exceptional sales consultants.
Our second area of focus is continuing to leverage data science automation, and AI to improve and improve efficiency and effectiveness across our buying organization business office business offices and customer experience centers.
Finally, we will continue to use Max offer to acquire vehicles and build on our market leading position as a buyer of cars with Max offer we can utilize the edman sales team to open new markets and sign up new dealers for the service. It's another example of our ongoing focus on innovating and finding new opportunities and the white space adjacent to our exists.
Capabilities.
We are currently live in over 30 markets and anticipate launching additional markets throughout FY 'twenty three.
Staying on <unk> for a moment I want to acknowledge it as of June 1st we reached the one year anniversary of this acquisition. We are glad to have all of the talented admin associates on our team and have been very pleased with the value. That's been created so far we are equally excited about our path forward as we continue to build out together, our vehicle and customer acquisition programs.
Before closing I want to acknowledge there is uncertainty in the market and in Ricard regard to consumer behavior. We believe that our fundamentals are strong and that our diversified business model enables us to gain profitable market share in any environment multiple opportunities exist to grow the business as we roll forward and we're excited about the <unk>.
<unk> with that we'll be happy to take your questions.
Orlando.
Thank you and if you would like to ask a question. Please signal by pressing star one on your telephone keypad, if using a speakerphone make sure. Your mute function is turned off to allow your signal to reach our equipment.
If you'd like to ask a question press star one at this time.
Okay.
Alright, and we will take our first question from Brian Nagel with Oppenheimer. Please go ahead.
Okay.
Good morning can you hear me.
Yeah. Thanks, good morning, sorry about that transmits Robert Congrats on the continued progress. So the question I wanted to ask and just from a bigger picture perspective, we look at the sales trends here Bill in your prepared comments you mentioned again some of the same factors, obviously the difficult comparisons last year against stimulus.
Oh elevated prices carpets, and such but because we're as we're progressing now into 'twenty. Two are you seeing more clearly kind of how the consumer really is.
How the consumer's behavior are doing health of the consumer and what's what's really driving the business at this point, particularly as you mentioned the I guess it strikes me trend through fiscal Q1.
As the health of the consumer getting better or is that more of a function of comparisons.
Yes, Brian look I think overall, the consumers that absolutely a little softer just because of all the things that I've talked about it I think it's hard to quantify if you think about lapping over stimulus vehicle affordability to general inflationary pressures rising interest rates. If you think about those it's hard to quantify the impact of each one now I would tell you.
The further we've gotten from lapping the stimulus obviously the better we perform as I noted in my opening remarks, we got sequentially better on on comps throughout the quarter, which is which is encouraging but that being said I think the consumer software, but there's still there's still some demand out there and I think that's what we're trying to really maximize on and were taken.
Several steps to take advantage of that and it's one of the reasons why we are where we.
We continue to take efficiencies and past, what we can't along to consumers to make the vehicles are a bit more affordable.
Remarks, I talked about selling a little bit more of older vehicles, you know, making the vehicles a little bit more affordable because we know some of the consumers are looking for that in fact, Brian you've followed us long enough to know that we used to have what we call. It a value Max which was really six years old vehicle older than six or more than 60000 miles.
Typically that that type of inventory runs let's call. It you know and I gave a near 20% 25% of our sales.
Well for this quarter it was more like 35% of ourselves. So there is some demand for that and I think the other thing I would point out is.
It's the reason why we also have the lending platform that we do with that we have great third party lenders and cap just to make sure that we can get the most competitive interest rate for our customers. So I think those are the things that we're doing to kind of work through this and while the consumer softer theres still some some demand out there.
That's very helpful. Maybe if I could just slip one follow up to that so are you seeing.
As you look at maybe across the different cohorts of your business are higher priced vehicles lower price vehicles are you seeing now more significant demand dynamic across the cohorts.
On the vehicle prices.
Yeah.
Just to get an IGF debt okay.
What's interesting about it Brian is if you look back a year ago, 70% of our inventory was under $25000 fast forward to today, it's more like <unk>.
43% to 45% and that's really a result of inflationary pressures, which again is one of the reasons why we're focused on on.
Getting more affordable inventory out there so that's what our big pushes right now now realizing some folks are interested in a in a higher mile car in or an older older car, but again, that's what our focus is right now.
I appreciate all the color. Thank you.
Yes.
Next question will come from John Healy with Northcoast Research. Please go ahead.
Thank you wanted to try to follow up on that first question, maybe in a little bit different way.
When I think about the way you kind of talked about is going on in the business re merchandize, you've got investments into the sales and not the labor force, obviously those mature at different rates, but.
If you looked at kind of going from low double digit declines in say March or April to low single digit declines now in comps.
What would you attribute the improvement to is it conversion is it the people in the stores is it the consumer might have paused and now they're realizing they have to make a transaction with just wanted to kind of hear how you and the team are <unk>.
Distributing the.
The sequential improvement and maybe to what initiatives or are they more.
Consumer related.
Yeah. It's a good question John I mean, obviously I'd love to tell you that its because of our continued focus on improving the experience getting the right inventory and theyre improving prices and all of that while I do think Thats a factor I don't think you can ignore the fact that a.
A year ago in March the biggest stimulus checks hit the ground and when you think about it tax season. This year versus last year would have looked very similar the only difference though is last year you know.
<unk> thousand $500 checks went out to consumers darn tax team in fact tax season that did not happen. This year. So that absolutely had an impact. So you know I'm not going to sit here and say, it's all of US that's driving I think there are some macro factors that are allowing it to improve the further you get away from that stimulus.
And we've taken as well like our success in buying cars directly from consumers as reflected in our self sufficiency rate really allows us to buy those older cars and as bill talked about or as a percent of sales coming from older cars went up because of the consumer demand is there those cars are not easy to buy and options. So it's really a nod to <unk>.
Our ability to buy cars directly from consumers.
Great and then just one follow up question I think you mentioned the auction calendar working against the wholesale business this quarter.
<unk>.
Will that revert will we pick that up in Q2 I was just curious how the timing impact might.
But there might be a benefit quarter here as we look out for the remainder of the year.
Yes, no great question first of all we are.
We're very pleased with the auction performance wholesale performance in general we're pleased with the fact that we actually grew at the dynamic was that we had one less Monday sale and swapped it for Tuesday, and Monday is a bigger auction volume day than a Tuesday and that actually we got the benefit of that at some point last year, so that will not.
Be a pick up the other thing that I cited that it was that we have made the decision to pull some what we normally run through the auctions.
Build those cars to retail and absent those two things if you pull them out the wholesale would have grown.
By more than 10%, which again we're excited about.
Great. Thank you.
Yep.
Up next we'll hear from Sharon Zackfia with William Blair. Please go ahead.
Hi, good morning, So as you think about offering some more value oriented cars have you also considered kind of swayed from the I guess I would say fully reconditioned status that you've historically had maybe leaving from scratches or whatever end market. It out is to further enhance the.
<unk> proposition I know that's been something you've been leery of in the past from a brand perspective.
And then secondarily obviously.
There's a lot of concern that things are going to get worse before they get better I mean, how are you positioning controllable standpoint in the event that there's another leg down I mean, how should we think about SG&A and what you can cut if you need to cut it.
Yep.
Yes, I'll tackle both of those I'm sure Enrico will have some comments on the.
Kind of the concerns going forward.
Your first question as far as the older inventory.
Sharon we're if we're going to make it a carmax car that's going to be a carmax car and you know you take these older cars not all of them can make the cut and.
Well, we'll end up trying to run through some through retail and they won't they won't make it but were bringing them up to the Carmax standard. So I think that answers. Your first question. The other thing I would just point out there is.
Those cars and we've talked about this but we haven't talked about it for a while those cars are generally more profitable. So they also provide us a tailwind when you think about margin management pricing inventory that kind of thing so.
We will continue to do that we'll continue to bring them up to Carmax standards and not go with a lower standard as far as the concerns about what may manifest in the future with the consumer and where the consumers going.
Sure and we've been through this several times in the past and you know whether it's OE to a non recession, whether it's you know the depths of Covid, we've been able to navigate it profitably both times and we have lots of levers we've shown that we've been able to pull those levers whether their expense leverage when you think about you can slow down some of your growth you can slow down some of your initiatives you can pull back on advertising.
<unk> your variable, we'll we'll adjust or if it's just.
If you want to secure cash.
Can modify your stock buyback you can start on some of your capital expenditures or delay. So these are just some of the levers that you know that we've pulled in the past and we're going to we're going to continue to monitor the conditions, but I would tell you as I sit here today, yes, the consumer soft but.
Now is not the time I don't think to be pulling back on our initiatives because the initiatives of what had been a really help us grow in the future, but that being said, we're certainly aware of the outside factors and we'll continue to monitor.
Yeah, I would just add to that by saying you know what we're giving away. Our objective really is to ensure that our expenses are in line with customer demand while at the same time, making sure that we're investing in the key areas of the business.
Enable us to grow profitability and market share over time.
I mentioned in my prepared remarks, I mean.
The view of that we've already begun to kind of align our cost structure to current demand.
Through scheduling through natural attrition. So we've already done those and look if a recession comes.
Confident in our ability to weather it as we're coming at it from a position of strength we're profitable.
<unk> balance sheet, and we generate cash so we feel again as bill mentioned, we've been through these cycles before and we feel confident we can manage through it effectively while growing our market share as well.
Okay. Thank you.
Thank you Sir.
Our next question will come from Rajat Gupta with Jpmorgan. Please go ahead.
Great. Thanks for taking the question.
Nice execution on the retail gross profit per unit.
Can you help us unpack that a little bit narrow versus the prior quarter.
What drove the sequential uptick there you know is it you know.
Reconditioning saving you know is it just the sourcing mix.
Is it pricing related.
Curious if you could bucket those as possible.
Yes.
Yeah.
Thanks for the question Richard Yes, the way I think about it and I talked about this in your opening remarks, you know, we're really trying to walk a fine balance here, we have some efficiencies historically, we've always passed our efficiencies along in the big efficiencies that we're working with right. Now are the fact that we've got self sufficiency is still at a.
At a high.
But we also have this new dynamic where we're selling some more older cars and as I talked about earlier. These older cars generally carry more margin. So that's also an opportunity to to manage your margin and pass along efficiencies to the consumers.
This quarter.
Obviously, it's a little higher than last year, and even our five year average and thats because with these efficiencies. We we continue to pass along in price savings, but we also.
It took a little bit more to the bottom line and we monitor.
Sales elasticity competitors' inventory levels that kind of things and we'll continue to do that going forward, but we feel really good about our margin position right now.
And baring any other big changes and.
Keeping an eye on the testing we feel good about the margins the margins going forward as well.
Got it got it really tells me you know on that topic, you know you're shifting to SG&A I mean is any of this change in.
The sourcing mix or you know trying to maintain that GPU coming in some way the expenses will more more cost.
On the SG&A side.
No you're right roughly $2700 per unit.
This is the seasonally strongest quarter typically you'll be or.
So curious like how what what takes us down further.
Aggressive.
We're out here was up opportunity you know if you could just give us some puts and takes on that front on the SG&A.
And it should progress going forward.
Yes.
Costa Rica, just like them, but just just to be clear like these the margin improvements are not coming at the expense of of SG&A and the way. We think about margin you know when we were building the cars, we've absolutely seen inflationary pressures and the build of cards, which goes through the Cogs, but we're also working very hard to offset those so not only we are passing along some savings to the consumer.
Through some of these efficiencies, but I also feel like because we're offsetting these costs. That's also passing along to consumers because some competitors won't have levers and as the costs go up which everyone, saying, whether it's gas it's parts. It's labor if they don't have levers to pull their prices are going up so I think about that as also an efficiency on price as well.
Yeah, and I would say just to build on that you know there is some pressure on SG&A from the amount of buys right. So we've had tremendous success around the amount of buys there we have to staff up to make sure. We can accommodate that and that then flows through to it through our self sufficiency rate. So there is some pressure on SG&A, but what I'd tell you the story in Q1 and important story on the deleverage.
It's really driven by a couple of things right year over year. When you look at the deleverage number one is like we were understaffed last year in the first quarter as you recall going back to the pandemic coming out of the pandemic. We were understaffed and we spent the back half of last year under staffed how you're staffing up until last year was that just after we also spent less on a per unit in marketing last year in the first quarter.
Because our inventory was fairly limited.
So we spent a little bit last time, we had very strong demand. So we're comping over those two things in the first quarter, which put a fair bit of pressure on that leverage range I think the second thing as well as in anticipation of a stronger tax season.
<unk>, we had staffed up in our stores and in our CS and we had spent more on marketing now those sales net income, but as I've talked about.
We're fairly nimble and we can manage those back down which is what we've already begun to do when it comes to staffing in <unk> and in our stores and again, we're doing that through just nutrition and through better scheduling or we can manage that down but I think it's important to understand that Q1 deleverage what drove it.
Got it great. Thanks for the color I'll jump back in queue.
Thank you Lisa.
Right up next we'll hear from Daniel <unk> with Stephens, Inc. Please go ahead.
Yeah, Hey, good morning, guys. Thanks for taking my question.
I wanted to ask on the competitive environment for C. A F. Right now you know I think last quarter, we talked about how some of the other lenders were extending terms 84 months. They werent passing through higher cost of funds. It feels like you mentioned in your prepared remarks that they were starting to pass through some of those higher cost of funds during the quarter, but just curious how that competitive backdrop is changing and.
And obviously see a penetration went down in the quarter I mean was that intentional on your part walking away from business or can you talk about what drove that thanks.
Sure I appreciate the question Daniel Yeah, but thanks for the recognition in the prepared remarks, we did state I think the story or the headline for penetration. This quarter was really about cost pricing moves we're not walking away from business at all if you looked at the the average APR, we charge to our customers last quarter. It was eight 2% this quarter, it's 9% largely coming from.
US passing along our increased costs on to the consumer it's always a delicate balance you are trying to figure out.
Managing making sure you're highly competitive to your customer remember, we're competing directly with predominantly credit unions and to some degree external banks.
<unk> installed that we observed we just went a little sooner than they did are kind of trough of penetration in the quarter was more in that February March timeframe, and we watched our competition, we observe them or raise rates throughout the quarter. We were just a little sooner and therefore, our penetration came back the cadence within the quarter. So I think it will continue to be that way.
Again trying to manage our penetration our net interest margin capture.
And obviously, making sure we're extremely competitive for our customers. So it's a delicate balance it will continue on.
But we will continue to watch what our competitors do and what the fed does John .
Penetration went down those consumers that brought their own financing went up great Thats generally the offset so you know in our space usually at customer sees the car they want it making either choose the financing from Caf, where again, that's what's great about our program as they can go externally not feel like they have to walk away from the car and that's generally what they do so they just chose to do that this quarter.
Got it I'll hop back in the queue. Thanks, so much Rob.
Thanks Daniel.
Alright up next we'll take a question from Seth Basham with Wedbush Securities. Please go ahead.
Yeah, Hi, this is Nathan Friedman on for Seth Thanks for taking my questions. The.
The first question I wanted to ask was regarding retail gross profit per unit.
Are you expecting this level of GPU going forward given the current used car pricing environment, and a return to normalized or possibly accelerated depreciation through the duration of the year, how should we be thinking about that.
Yes, Nathan as you know as I said earlier, we feel good about our margins.
Got some tailwind there I would tell you.
You know, we've navigated through times of depreciation before I think we excel at it and in those times of depreciation before we've been able to maintain our margins. So I would expect that to be similar I think the only times, where our margins have come under pressure a little bit is when you see rapid rapid depreciation over a very short period of time.
But even then it's short lived so we feel very comfortable about.
Our ability to continue to maintain margins, but again, we're going to also like I said earlier, we'll be testing a lot of different things and making sure that we have an outward eye on where the consumer is in and sales elasticity competitors and all of that.
Alright. Thanks for that my second question is focused on strong net interest margin performance this quarter and the sequential increase here. Despite your last the ABS securitizations margins experiencing pretty large sequential margin declines can you provide more detail or quantify how much benefit you experienced in your hedging strategy this quarter and how.
Youre envisioning net interest margins going forward.
Sure Yes.
<unk> I will probably tag team on that first just to talk about the net interest margin growth that we saw during the quarter again, the key to remember is our business model and our accounting processes, we earn in over time, rather than a gain on sale model. So the.
The assets that are providing our net interest margin in this quarter are coming from a year ago two years ago, three years ago, where spreads were incredibly healthy. So obviously, what we bring on this quarter on most recent ABS term ABS transaction, it's really going to offset what we're rolling off of the portfolio. So it just so happens that timing.
As such that such such strong margin assets still remain in our portfolio and will for some time and eventually if we can keep our margin high we will continue to keep a manage that well then the falloff will be may be minimized or at least slow on the on the downturn with regard to hedging strategy I'll, let Enrique talk.
Tough to that yeah, and as John mentioned in his prepared remarks, we had experienced in the quarter and $9 million gain from our hedge benefit in just maybe explain that a little bit more.
Vast majority of our receivables are funded through the securitization market and we have an accounting hedge on all of those.
But we also have alternative funding vehicles as we've been talking about for a few years right with our banking partners.
Portion of those receivables have a cash flow hedge, but not an accounting hedge and that's really due to our desire to maintain flexibility in the funding profile.
So as those receivables that don't have an accounting hedge get mark to market every quarter. So we benefited this quarter given the recent sharp and material change in interest rates, but moving forward, we would only expect us to be material to any degree in period again, where there are sharp and material changes in any interest rate.
Understood. Thank you for the time and best of luck.
Thank you.
Okay.
Alright, and up next we will take a question from.
John Murphy with Bank of America. Please go ahead.
Hi, good morning, everybody.
I just wanted to go back to the shift towards.
Older vehicles, and Bill I mean, as we look at the next few years zero to six year old car population is likely to shrink pretty dramatically or not really recover much.
If that.
What we're seeing on the new vehicle sales side I mean, the vehicles just don't exist in reality. So as you as you look at going older two beyond six years. It just seems like there's a real opportunity in the seven to 10 year old vehicles are high quality products are very different than they were 10 to 20 years ago. So you can wrap them.
Well to the consumers so they're good products for you to wrapping.
So just curious as we think about this idea that I think you said you went from 25% value Max where value Max light vehicles to 35%.
This quarter could that be significantly higher over time and it is the kind of thing that could be not just sort of a move to offset some of the shortage of supply of zero to six year old side, but something you'd be more structural and if you think five to 10 years down the line could dramatically increase your addressable market for each each.
Or in total.
Yeah. Good morning, John Yes, that's a great question, you know that the beauty of our businesses wherever the consumers are looking for we'll put out there now obviously, it's a little harder to find some of these vehicles and build them.
We've been through a similar situation. If you go back to O eight no not in the recession, when the new car Saar dropped dramatically.
It was actually more pronounced back then I think what that did to like a 10 year supply of newer type cars.
The Saar was down to really low double digits I think at one point, if not even below that so there was a there was this bubble that had to work itself through and.
I would expect to see a similar bubble, but not nearly to the magnitude that we saw back in <unk> I would tell you the great thing thats different than back then and we were able to navigate navigate them, but the great thing that we have now that we didn't adjust ourselves sufficiency and when I think about that type of inventory.
Our best source of that is from consumers and so the fact that our self sufficiency. So high it just gives us a lot of that a lot of that inventory and I talked a little bit about those over six but it really doesn't matter. If you break it down zero to four.
No.
It's generally like a year ago that 66% of our sales or so this quarter is about 50% five to seven year old vehicles again, it's 20 to 25 now its 30 to 35 eight plus.
Just like 15% it's across the board and we have a better source of inventory now so we're excited about the opportunity going forward.
Okay, and then maybe just to follow up on that on the on the let me just like on the acquisition side, if youre doing a good job on the self sufficiency side, but if we think about that consumer buying that vehicle. It sounds like they actually have a higher propensity then.
The younger vehicles to actually purchase online I mean, when youre looking at your omni channel efforts and actually conversion based on the age groups. I mean is that true that basically this seven plus year old vehicles actually that buyer is actually more apt to buy online and sort of the one to three year olds bucket I mean, I'm just curious what youre seeing there.
Yes, John .
Honestly off top my head I don't.
I don't know if thats necessarily true I mean, what we're seeing from an online.
Sales perspective is it's a it's a wide swath of consumers looking for different merchandise I don't think I don't think thats necessarily true that the older stuff thats selling online.
Some of it but I don't think is disproportionate.
Okay, Alright, thank you very much.
Thank you John .
Alright up next we'll hear from Michael Montana with Evercore ISI. Please go ahead.
Great. Thanks for taking the question good morning.
Just wanted to ask first if I could if you all could share some incremental color around the buying trends you're seeing I don't know if you can segment. It out by income cohort kind of 40, K and below versus 100, K plus households, but but just talk about maybe what you saw there in the quarter and then how that has evolved if I'm the sales have kind of stabilized.
The download single digit.
Michael I don't have the cohort that youre looking for as far as household income.
Both are online in store appraisal lane has really resonated.
Rodley with all consumers.
Interestingly for the quarter.
We bought it may not be a total surprise, we bought more what I would call larger Suvs and pickup trucks.
From consumers that may be because of gas prices, but on the flip side. We also saw more of that that would consumers. You know I think if you pay the right and you have a price right that they'll sell in we actually.
We saw that but you know I don't I don't have the data in front of me to tell you. Okay household income what does that look like on a sale, but I will tell you. It's it's.
The product that we have out there has really appealed across the spectrum.
Yeah, I guess, what I would add to that just from a credit perspective.
Going to align maybe household income with the credit quality of the customer coming through the door and I think we mentioned before I think there is demand out there you see the lower credit quality customer who is still shopping still applying for credit. They just seem to be maybe priced out of the market at times because of the price of the vehicle and ultimately the monthly payments. So I think the demand is there I think as inventory comes down.
We're going to be able to get there. So again provided theres some correlation between that consumer and the lower income consumer.
I think the demand is there.
And if I could just follow up on the profit front.
Earlier. This year you all had mentioned in the gross profit dollars would need to grow kind of high single digits to leverage given some of the investments underway. So just wanted to think about that into the back half of the year. You know does add expense kind of step up here given the multichannel has been initially rolled out head count it sounds like it could.
Moderate a bit so just help us understand kind of how to think about the pace of SG&A dollars for the back half.
Yes, and so what we said last call was we expect in fiscal year 'twenty three actually we're going to need in excess of that historical range of high single digit right. So we need more than that to leverage this coming year because of what I talked about earlier largely that annualized <unk> of the success in staffing and again Q1 really in the quarter, what we see.
Of that impact.
We are committed to ensuring that our expenses are in line with customer demand and again I talked about that what we've already the steps we've already undertaken several Q1 really from a year over year leverage perspective is our toughest quarter.
Thank you.
Thank you.
Alright up next we will take a question from Craig Kennison with Baird. Please go ahead.
Hey, good morning, Thanks for taking my question as well I wanted to dig into your sourcing mode and really understand your Max after tool a little bit better can you give us a feel for the economics of that tool and you know why do dealers choose to use it given you're also competitors in that local market.
And then are those cars as profitable as cars you source directly from the consumer or from auctions.
Thanks.
Yeah, Craig Yeah, we're like I said earlier, we are excited about Max offer it's been a product that we've been working on it took a little bit of a back seat to the Io, but we're leveraging.
Similar algorithms when I think about the profitability obviously the.
Well first of all the Max offer buys are absolutely more profitable than buying off site.
As I ran comment I think the most profitable or certainly the <unk> that our consumers are bringing us the cars for obvious reasons, we're not planning logistics that kind of thing, but for the Max offer there, they're not as profitable as a consumer but theres still more profitable than buying off site, which again makes sense, because we're not having to pay to pay biopsies as far as why dealers we choose to use.
Look theres lots of deals out there that have inventory that they're not interested in or they have appraisals that theyre looking at that they really don't know how to value. It and so this is a service that can be provided at.
No cost with our backing on it and it's.
It has proven to resonate like I said in the call were a little over 30 in 30 markets. We have plenty of opportunity to continue to expand it Edmonds has thousands of dealers that they work with our auctions. We have thousands of dealers. So we think theres a lot of potential here.
Can you shed any light on the fee structure or you're getting a fee or are they getting a fee.
Yes, so we do they actually we make it a little bit where we make it worth our time, so they actually do do make some money on these.
And that's kind of how we work it.
Perfect. Thank you.
Yep.
Alright, our next question will come from Evan Silverberg with Morgan Stanley . Please go ahead.
Good morning, Evan Silverberg on for Adam Jonas recognizing there was some color in the prepared remarks on our comps per month year over year curious if you could give any additional color on an absolute basis, how are sales trended throughout the quarter and what youre thinking in terms of exit rate into <unk>.
Yeah like I said in my opening remarks, I got better progressively throughout the quarter from double digits too.
You know low single digit negative comp for the end of the quarter. So we've been pleased with that that that trend.
And obviously, we'll talk about June and second quarter at that time, but again, we've we feel pleased as we exited the quarter.
And even within the quarter or are you seeing any trends within the tiers of the consumer or you think its pretty steady throughout the different classes.
No I think it's pretty steady through the different ones as John pointed out earlier, I think that that lower FICO customer is probably being impacted the most by vehicle affordability.
But you know again.
That's the way it started out the beginning of the quarter and that's the way. It ended ended the quarter. So I think it's fairly consistent throughout the quarter.
Great. Thank you very much.
Thank you.
Alright, our next question will come from David Whiston with Morningstar. Please go ahead.
Thanks, Good morning.
It's great to see free cash flow generation, along with buybacks and.
Debt pay down I was just curious on the roughly now I think about 1 billion due two years from now.
Is your goal to just get rid of that revolver through internal free cash flow generation before that time or are you willing to do in five year 10 year bond offering at some point.
Yeah.
As you said I mean, we were very pleased with our cash flow performance in the in a corner you know despite a challenging sales quarter, certainly where our business model is able to generate cash and we're really pleased that allowed us to pay down a fair chunk on our revolver almost $600 million and accelerate our share repurchase program. So in terms of what we're going to do moving forward.
I think the way to think about it is we'll be nimble to the environment, we're going to do what's right for our shareholders and while taking a look at how we're performing and kind of what the options are for US I think the way to think about it is we intend on managing within our capital structure at 35% to 45% adjusted debt to cap and that's how we kind of manage the busy.
We do that by taking on debt with pulling down debt and also by our share repurchase program. So those are the levers that we use so so moving forward, we will end up managing to that rate.
Okay and on the.
The free cash flow generation it looks like you've got a lot of help from inventory reductions, which you hadn't gotten that help in working capital the past several quarters.
Just curious what's your inventory decline here intentional to get some free cash flow generation or is it perhaps a function of buying more older vehicles.
Yeah. It was a little bit more seasonal this time of the year in the first quarter and leading into the first half of the year, we ramped down their inventory as we work through tax season, and a little bit of that we also saw quarter to quarter. Just the average cost of our inventory went down a little bit too.
We did see that and that that helped us a little bit as well.
Okay. Thank you.
Okay.
Alright, and moving on we'll hear from Chris both the Leary with BNP Paribas. Please go ahead.
Hi, everyone. Thanks for take the question just wanted to ask a follow up question on the kind of Caf funding cost. So that's what are other I guess, a few things like the interest rate hedge question are you, saying that interest rates stay at these levels that the 9 million hedging benefit would unwind I'm trying to understand like how long these hedges last score.
And then separately for the warehouse facility I can't find it in the K like what's the what's the benchmark rate for the warehouse facilities at LIBOR or whatever replace LIBOR sits over to adult.
And then sorry, one last follow on to this bigger picture. So I could tell you probably pass on about 50 bps of rates out of the customer.
How much of that 300 basis point increase in benchmark rates do you ultimately think you'll pass through.
Brian .
Okay.
I'll take the last one first actually yeah as.
You mentioned, we certainly are pass long rates to consumers.
As I said previously it's going to constantly be a test and assess right you recognize what we're trying to manage penetration margin customer experience all of those things.
So we're going to watch it very carefully what I was very pleased with this quarter was it wasn't just a single move and then forget it and then absorbed but it was identified pockets of populations that we think are less elastic more elastic test adjust.
Look at what our competition is doing and that's generally how we operate so again, we are not looking to absolute lead the market in passing that right along.
We want to make sure we remain highly competitive again, Fortunately, we have that three day payoff option. The customers may take advantage up to make sure we still sell the car. So I can't speculate exactly how much will pass along but you understand how we're managing it.
And for the other two questions in terms of the cost basis in our warehouses. It really is LIBOR and more and more so far as that as that tool kind of matures somewhat.
In terms of the hedging question very specifically the $9 million, but we do not have an accounting hedge we have a cash flow hedge again that really is going to change that.
Benefit like it was this quarter it could be a detriment only when interest rates are going up.
Change sharply and materially that's when they're going to change because we have that hedge.
The hedges over the life of the loan that we have right, but again, it's only really going to change from quarter to quarter, when there's a sharp and material change in those interest rates and that's why we see a benefit.
And then and again and Thats on that's on as I mentioned in the earlier the vast majority of our receivables are a few of the securitization market will not be impacted on a quarter to quarter basis with that it's really it is very small at much smaller pool of receivables that we have through our banking partners through alternative funding, where we'll see that again.
And those that those interest rates don't change sharply or materially you're really not going to see anything impactful quarter to quarter.
Okay, and then bigger picture question. The Gpus I mean, this feels like a two three standard deviation move in the GPU like usually you're pretty methodical about kind of past the amount of the consumer.
Any market share or just kind of.
Pegging that GPU and kind of letting it go.
Tease me now, but so I guess it kind of sounds like when I could tell you are comfortable running at those higher GPU level like what's philosophically changing that's causing you to kind of shift towards the pea with maybe less about market share or maybe.
Maybe I'm wrong here understanding that correctly, how would you frame it.
I think you are right. It is a lumpy in any given quarter you can be 50 to $80 differences will obviously, a little bit more than that and it was a it was a conscious decision, but again the way. We approach. It is we really look for efficiencies first and foremost and if we find the efficiencies. Then you have the decision to make do you take a little bit more to margin you have to look at a lot of factors in order to determine that and how much do you put two.
<unk>.
Price and just based on all the factors we took some of these efficiencies. So it's really not on the backs of the consumer what they're paying before we're actually passing some of the efficiencies. Some of these additional ones from the older vehicles and the self sufficiency, we continue to pass them and then we took a little bit more this quarter. So it was a it was a conscious decision as far as going forward.
We will continue to monitor things and what competitors are doing and the elasticity and make decisions as we as we always do during the quarter.
And we've been able to do that while growing our market share within the quarter right. So that's the market and our market share yeah, that's right.
Thank you.
Okay.
Alright, and we will take a follow up from Chris appears with Needham. Please go ahead.
Hey, Good morning, you guys have talked about better aligning expenses, we've also talked about growing market share.
That last question the GPU comfort you have with this higher level. Just curious how you think about advertising going forward, you've kind of got a hobbled competitor out there, but I know the end market isn't really.
On fire, either some kind of curious how you're thinking about advertising and advertising per vehicles going forward.
Yeah. Thank you for the question, Chris look I think our stance on advertising is still what we would spend as we've said for this upcoming year, we expected to have a step up I mean keep in mind. If you go back pre Covid I think Enrique were 70% up in total dollars and on a per unit basis, most up 60% yes.
Think about advertising, we had a lot of good things to say it.
Even though obviously the consumer soft there's a lot of advertising dollars being put in by everybody and I think the way that we will continue to go forward is.
With the guidance that we originally gave which was really more in the ballpark of let's call. It the $3 50 per $3 50 per unit, a little bit a little bit higher this quarter, but I think that's a good kind of a good thing to good way to think about it as we go forward and then we've got lots of new capabilities. When you think about online self progression. We do anticipate at some point later in the year that will start.
Advertise that and when we do that we'll we'll shift some dollars around you know, we're always moving things between acquisition and awareness and whether it's appraisal.
Awareness, whether it's consumer retail consumer awareness, we're always moving things around on any given quarter. So you know I would look for some some new messaging later on this year.
Alright, thank you.
Thank you.
And we have no further questions at this time I will turn the conference back over to Bill for any closing remarks.
Alright, well great well. Thank you all for joining the call today and as always for your questions and your support as always do I want to thank our associates for everything they do and their commitment to making a positive impact on the customers in each others in our communities and even particularly the environment. We just recently published our 2022 responsibility report if you haven't had a chance to look at it I would highly encourage you.
To take a look at it we're really proud of the values that we live every day and our ongoing commitment to all of our stakeholders to drive long term sustainable value creation. So again. Thank you for your time today, and we'll talk again next quarter.
And ladies and gentlemen. This concludes today's call. We thank you again for your participation you may now disconnect.
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