CARMAX, INC.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is provided as a supplement to, and should be
read in conjunction with, our audited consolidated financial statements, the
accompanying notes and the MD&A included in our Annual Report on Form 10-K for
the fiscal year ended February 28, 2022 ("fiscal 2022"), as well as our
consolidated financial statements and the accompanying notes included in Item 1
of this Form 10-Q. Note references are to the notes to consolidated financial
statements included in Item 1. All references to net earnings per share are to
diluted net earnings per share. Certain prior year amounts have been
reclassified to conform to the current year's presentation. Amounts and
percentages may not total due to rounding.
OVERVIEW
CarMax is the nation's largest retailer of used vehicles. We operate in two
reportable segments: CarMax Sales Operations and CarMax Auto Finance
("CAF"). Our CarMax Sales Operations segment consists of all aspects of our auto
merchandising and service operations, excluding financing provided by CAF. Our
CAF segment consists solely of our own finance operation that provides financing
to customers buying retail vehicles from CarMax. Our consolidated financial
statements include the financial results related to our Edmunds Holding Company
("Edmunds") business, which does not meet the definition of a reportable
segment. For purposes of our MD&A discussion, amounts related to that business
are discussed in combination with our CarMax Sales Operations segment. Separate
discussion of these amounts is not considered meaningful for the purpose of
gaining an understanding of our business, as the significant drivers of these
operations in total are consistent with those of our CarMax Sales Operations
segment. Where appropriate, specific amounts related to non-reportable segments
have been disclosed for informational purposes.
CarMax Sales Operations
Our sales operations segment consists of retail sales of used vehicles and
related products and services, such as wholesale vehicle sales; the sale of
extended protection plan ("EPP") products, which include extended service plans
("ESPs") and guaranteed asset protection ("GAP"); and vehicle repair service. We
offer competitive, no-haggle prices; a broad selection of CarMax Quality
Certified used vehicles; value-added EPP products; and superior customer
service. Our omni-channel platform, which gives us the largest addressable
market in the used car industry, empowers our retail customers to buy a car on
their terms - online, in-store or an integrated combination of both. Customers
can choose to complete the car-buying experience in-person at one of our stores;
or buy the car online and receive delivery through express pickup, available
nationwide, or home delivery, available to most customers.
Our customers finance the majority of the retail vehicles purchased from us, and
availability of on-the-spot financing is a critical component of the sales
process. We provide financing to qualified retail customers through CAF and our
arrangements with industry-leading third-party finance providers. All of the
finance offers, whether by CAF or our third-party providers, are backed by a
3-day payoff option.
As of
CarMax Auto Finance In addition to third-party finance providers, we provide vehicle financing through CAF, which offers financing solely to customers buying retail vehicles from CarMax. CAF allows us to manage our reliance on third-party finance providers and to leverage knowledge of our business to provide qualifying customers a competitive financing option. As a result, we believe CAF enables us to capture additional profits, cash flows and sales. CAF income primarily reflects the interest and fee income generated by the auto loans receivable less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct expenses. CAF income does not include any allocation of indirect costs. After the effect of 3-day payoffs and vehicle returns, CAF financed 39.3% of our retail used vehicle unit sales in the first three months of fiscal 2023. As ofMay 31, 2022 , CAF serviced approximately 1.1 million customer accounts in its$16.05 billion portfolio of managed receivables. Management regularly analyzes CAF's operating results by assessing the competitiveness of our consumer offer, profitability, the performance of the auto loans receivable, including trends in credit losses and delinquencies, and CAF direct expenses. Page 33 -------------------------------------------------------------------------------- Revenues and Profitability The sources of revenue and gross profit from the CarMax Sales Operations segment and other non-reportable segments for the first three months of fiscal 2023 are as follows: Net Sales and Gross Profit Operating Revenues [[Image Removed: kmx-20220531_g1.jpg]][[Image Removed: kmx-20220531_g2.jpg]] A high-level summary of our financial results for the first quarter of fiscal 2023 as compared to the first quarter of fiscal 2022 is as follows (1): Change from Three Three Months Ended Months Ended May (Dollars in millions except per share or per unit data) May 31, 2022 31, 2021
Income statement information
Net sales and operating revenues$ 9,311.6 21.0 % Gross profit$ 875.4 (5.3) % CAF income$ 204.5 (15.4) % Selling, general and administrative expenses$ 656.7 18.5 % Net earnings$ 252.3 (42.2) % Unit sales information Used unit sales 240,950 (11.0) % Change in used unit sales in comparable stores (12.7) % N/A Wholesale unit sales 186,307 2.7 %
Per unit information
Used gross profit per unit$ 2,339 6.1 % Wholesale gross profit per unit$ 1,029 0.4 % SG&A as a % of gross profit 75.0 % 15.1 %
Per share information
Net earnings per diluted share $ 1.56 (40.7) % Online sales metrics Online retail sales (2) 11 % 3 % Omni sales (3) 54 % (2) % Revenue from online transactions (4) 31 % 7 % (1) Where applicable, amounts are net of intercompany eliminations. (2) An online retail sale is defined as a sale where the customer completes all four of the following activities remotely: reserving the vehicle; financing the vehicle, if needed; trading-in or opting out of a trade-in; and creating an online sales order. Page 34 -------------------------------------------------------------------------------- (3) An omni sale is defined as a sale where customers complete at least one of the four activities listed above online. (4) Where applicable, amounts are net of intercompany eliminations. Revenue from online transactions is defined as revenue from retail sales that qualify as an online retail sale, as well as any related EPP and third-party finance contribution, wholesale sales where the winning bid was taken from an online bid and all revenue earned by Edmunds.
Refer to "Results of Operations" for further details on our revenues and profitability.
Liquidity
Our primary ongoing sources of liquidity include funds provided by operations, proceeds from non-recourse funding vehicles, and borrowings under our revolving credit facility or through other financing sources. In addition to funding our operations, this liquidity was used to fund the repurchase of common stock under our share repurchase program, our store growth and the Edmunds acquisition, which was completed during the second quarter of fiscal 2022. Our current capital allocation strategy is to focus on our core business, including investing in digital capabilities and the strategic expansion of our store footprint, pursue new growth opportunities through investments, partnerships and acquisitions and return excess capital to shareholders. Given our continued strong business results, the strength of the credit markets and our solid balance sheet, we believe we have the appropriate liquidity, access to capital and financial strength to support our operations and continue investing in our strategic initiatives for the foreseeable future. Strategic Update and Future Outlook Our omni-channel experience provides a common platform across all of CarMax that leverages our scale, nationwide footprint and infrastructure and empowers our customers to buy a vehicle on their terms. We recognize that there has been an accelerated shift in consumer buying behavior. Customers are seeking personalization, convenience and safety in how they shop for and buy a vehicle more than ever. Our omni-channel platform empowers customers to buy a car on their own terms, whether completely from home, in-store or through an integrated combination of online and in-store experiences. Our diversified business model, combined with our omni-channel experience, is a unique advantage in the used car industry that firmly positions us to continue growing our market share while creating shareholder value over the long-term. We continue to focus our efforts on optimizing and enhancing the customer experience. During the first quarter of fiscal 2023, we enabled online self-progression for all of our retail customers. All customers are now eligible to complete an online retail sale independently if they choose. In the first quarter of fiscal 2023, online retail sales accounted for 11% of retail unit sales, consistent with the previous quarter and up from 8% in the prior year quarter. Omni sales represented approximately 54% of retail sales, down slightly from 55% in the previous quarter and 56% in the prior year 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 in-store, online or a combination of the two.
Revenue from online transactions was
We purchased approximately 362,000 vehicles from consumers and dealers during the first quarter of fiscal 2023, up 6% from the prior year quarter. This includes approximately 17,000 vehicles through MaxOffer, our digital appraisal product for dealers. We leverage the Edmunds sales team to open new markets and sign up new dealers for MaxOffer. For the first quarter of fiscal 2023, our self-sufficiency rate remained above 70%. The success of our online instant appraisal offer continues to strengthen our leadership position as the largest used vehicle buyer from consumers. Nearly two-thirds of our finance customers start their financing process online. With our financing offer product in our online checkout process, eligible customers can apply and accept finance offers without needing the assistance of an associate to submit a credit application over the phone or in store. In addition, our finance based shopping capability, available to most customers, enables our customers to see personalized finance terms from multiple lenders across the full inventory of vehicles on our website. During the first quarter of fiscal 2023, we further enhanced this experience by testing additional capabilities, including enabling real-time decisioning as well as the ability for a customer to pre-qualify for financing with no impact to their credit score. These enhancements are currently available to approximately 25% of our online customers, and we anticipate scaling nationwide during the rest of the year. Our investments in the near term will focus on our customer experience, vehicle acquisition and marketing. Our plans to grow vehicle acquisition include attracting new customers and pursuing partnerships as we expand our appraisal offerings to dealers. As we continue enhancing our online experience and offerings, we believe it is important to educate customers about our omni-channel platform and to differentiate and elevate our brand. For fiscal 2023, we expect our marketing spend per unit to be at least as much as fiscal 2022. We believe we are well positioned to continue gaining market share through our marketing Page 35 --------------------------------------------------------------------------------
strategies, which are focused on driving customer growth through building awareness and affinity for the brand and acquiring in-market shoppers and sellers.
In order to execute our long-term strategy, we plan to continue investing in various strategic initiatives to increase innovation, specifically with regards to customer-facing and customer-enabling technologies, as well as marketing. We are also focused on ensuring we are efficient in our spend, targeting specific areas where we expect to achieve more efficiencies and leverage, such as our CECs and stores. Our use of data is a core component of these initiatives and continues to be a strategic asset for us as we leverage data to enhance the customer experience and increase operational efficiencies. For fiscal 2023, we would expect to require an increase beyond the 5% to 8% range of gross profit growth to lever SG&A as a percentage of gross profit. This is primarily driven by the timing of strategic investments and growth-related costs, as well as heightened inflationary pressures. While we expect to remain in investment mode over the next few years, we expect our leverage point to be lower after fiscal 2023. We expect our diversified model, the scale of our operations, our investments and omni-channel strategy to provide a solid foundation for further growth. As a result, we have set the following long-term targets, which were disclosed in our Annual Report on Form 10-K for fiscal 2022: •Sell between 2 million and 2.4 million vehicles through our combined retail and wholesale channels by fiscal 2026. •Generate between$33 billion and$45 billion in revenue by fiscal 2026. •Grow our nationwide share of the age 0- to 10 used vehicle market to more than 5% by the end of calendar 2025.
These ranges include our assessment of macroeconomic factors that could result in ongoing volatility in consumer demand.
In calendar 2021, we estimate we sold approximately 4.0% of the age 0- to 10-year old vehicles sold on a nationwide basis, an increase from 3.5% in calendar 2020. We estimate we sold approximately 4.9% of the age 0- to 10-year old vehicles sold in the current comparable store markets in which we operate in calendar 2021, an increase from 4.3% in 2020. Based on external data, we gained market share from January through April, the latest period for which title data is available. We believe we are well positioned to deliver profitable market share gains in any environment. Our strategy to increase our market share includes focusing on: •Delivering a customer-driven, omni-channel buying and selling experience that is a unique and powerful integration of our in-store and online capabilities. •Opening stores in new markets and expanding our presence in existing markets. •Hiring, developing and retaining an engaged and skilled workforce. •Improving efficiency in our stores and CECs and our logistics operations to reduce waste. •Leveraging data and advanced analytics to continuously improve the customer experience as well as our processes and systems. •Utilizing advertising to drive customer growth, educate customers about our omni-channel platform and to differentiate and elevate our brand. As ofMay 31, 2022 , we had used car stores located in 108 U.S. television markets, which covered approximately 86% of theU.S. population. The format and operating models utilized in our stores are continuously evaluated and may change or evolve over time based upon market and consumer expectations. During the first three months of fiscal 2023, we opened one store, and during the remainder of the fiscal year we plan to open nine stores. While we execute both our short- and long-term strategy, there are trends and factors that could impact our strategic approach or our results in the short and medium term. For additional information about risks and uncertainties facing our company, see "Risk Factors," included in Part I. Item 1A of the Annual Report on Form 10-K for the fiscal year endedFebruary 28, 2022 .
CRITICAL ACCOUNTING ESTIMATES
For information on critical accounting policies, see "Critical Accounting
Estimates" in the MD&A included in Item 7 of the Annual Report on Form 10-K for
the fiscal year ended
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RESULTS OF OPERATIONS - CARMAX SALES OPERATIONS AND OTHER NON-REPORTABLE SEGMENTS
NET SALES AND OPERATING REVENUES
Three Months Ended May 31
(In millions) 2022 2021 Change
Used vehicle sales $ 7,014.5 $ 6,157.3 13.9 %
Wholesale vehicle sales 2,116.5 1,374.4 54.0 %
Other sales and revenues:
Extended protection plan revenues 116.5 134.2 (13.2) %
Third-party finance income/(fees), net 3.4 (4.6) 173.9 %
Advertising & subscription revenues (1) 34.4 - 100.0 %
Other 26.3 36.3 (27.3) %
Total other sales and revenues 180.6 165.9 8.9 %
Total net sales and operating revenues $ 9,311.6 $ 7,697.6 21.0 %
(1) Excludes intersegment sales and operating revenues that have been eliminated in consolidation. See Note 17 for further details.
UNIT SALES
Three Months Ended May 31
2022 2021 Change
Used vehicles 240,950 270,799 (11.0) %
Wholesale vehicles 186,307 181,389 2.7 %
AVERAGE SELLING PRICES
Three Months Ended May 31
2022 2021 Change
Used vehicles $ 28,844 $ 22,533 28.0 %
Wholesale vehicles $ 10,996 $ 7,266 51.3 %
COMPARABLE STORE USED VEHICLE SALES CHANGES
Three Months Ended May 31 (1)
2022 2021
Used vehicle units (12.7) % 99.1 %
Used vehicle revenues 11.6 % 120.6 %
(1) Stores are added to the comparable store base beginning in their fourteenth
full month of operation. We do not remove renovated stores from our comparable
store base. Comparable store calculations include results for a set of stores
that were included in our comparable store base in both the current and
corresponding prior year periods.
VEHICLE SALES CHANGES
Three Months Ended May 31
2022 2021
Used vehicle units (11.0) % 100.6 %
Used vehicle revenues 13.9 % 121.0 %
Wholesale vehicle units 2.7 % 186.6 %
Wholesale vehicle revenues 54.0 % 300.9 %
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USED VEHICLE FINANCING PENETRATION BY CHANNEL (BEFORE THE IMPACT OF 3-DAY
PAYOFFS)
Three Months Ended May 31 (1)
2022 2021
CAF (2) 43.3 % 46.7 %
Tier 2 (3) 25.2 % 22.8 %
Tier 3 (4) 7.1 % 10.0 %
Other (5) 24.4 % 20.5 %
Total 100.0 % 100.0 %
(1) Calculated as used vehicle units financed for respective channel as a
percentage of total used units sold.
(2) Includes CAF's Tier 2 and Tier 3 loan originations, which represent
approximately 1% of total used units sold.
(3) Third-party finance providers who generally pay us a fee or to whom no fee
is paid.
(4) Third-party finance providers to whom we pay a fee.
(5) Represents customers arranging their own financing and customers that do
not require financing.
CHANGE IN USED CAR STORE BASE
Three Months Ended May 31
2022 2021
Used car stores, beginning of period 230 220
Store openings 1 2
Used car stores, end of period 231 222
During the first three months of fiscal 2023, we opened one store, representing
our entry into the
Used Vehicle Sales. The 13.9% increase in used vehicle revenues in the first quarter of fiscal 2023 was primarily driven by a 28.0% increase in average retail selling price, partially offset by an 11.0% decrease in used unit sales. The decrease in used units included a 12.7% decrease in comparable store used unit sales. Online retail sales, as defined previously, accounted for 11% of used unit sales for the first quarter of fiscal 2023, compared with 8% for the first quarter of fiscal 2022. During the first quarter of fiscal 2023, we believe a number of macroeconomic factors impacted our used unit sales performance, including the lapping of stimulus benefits paid in the prior year period, widespread inflationary pressures, including challenges to vehicle affordability, and declining consumer confidence. Comparable store used unit sales improved sequentially during the quarter from a double-digit decline in March to a low single-digit decline in May.
The increase in average retail selling price in the first quarter of fiscal 2023 reflected higher vehicle acquisition costs resulting from strong wholesale industry valuations.
Wholesale Vehicle Sales. Vehicles sold at our wholesale auctions are, on
average, approximately 10 years old with more than 100,000 miles and are
primarily comprised of vehicles purchased through our appraisal process that do
not meet our retail standards. Our wholesale auction prices usually reflect
trends in the general wholesale market for the types of vehicles we sell,
although they can also be affected by changes in vehicle mix or the average age,
mileage or condition of the vehicles being sold. During fiscal 2021, our
wholesale auctions were moved to an online format in response to COVID-19 and
continue to operate completely online.
The 54.0% increase in wholesale vehicle revenues in the first quarter of fiscal
2023 was primarily due to a 51.3% increase in average selling price as well as a
2.7% increase in unit sales. Wholesale volume was impacted by an unfavorable
calendar shift in the quarter compared to the prior year quarter as well as our
decision to shift units from wholesale to retail to meet consumer demand for
lower priced vehicles. We estimate that without these two factors, our wholesale
unit growth would have been above 10%. The increase in average selling price in
the first quarter of fiscal 2023 was primarily due to increased acquisition
costs resulting from continued strong industry valuations.
Other Sales and Revenues. Other sales and revenues include revenue from the
sale of ESPs and GAP (collectively reported in EPP revenues, net of a reserve
for estimated contract cancellations), net third-party finance income/(fees),
advertising and subscription revenues earned by our Edmunds business, and other
revenues, which are predominantly comprised of service
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department sales. The fees we pay to the Tier 3 providers are reflected as an
offset to finance fee revenues received from the Tier 2 providers. The mix of
our retail vehicles financed by CAF, Tier 2 and Tier 3 providers, or customers
that arrange their own financing, may vary from quarter to quarter depending on
several factors, including the credit quality of applicants, changes in
providers' credit decisioning and external market conditions. Changes in
originations by one tier of credit providers may also affect the originations
made by providers in other tiers.
Other sales and revenues increased 8.9% in the first quarter of fiscal 2023,
reflecting the addition of Edmunds' revenue and an improvement in net
third-party finance income, partially offset by a decrease in EPP revenue and a
decline in new vehicle sales. Net third-party finance income improved as a
result of lower Tier 3 originations. The decline in new car sales was driven by
the divestiture of our remaining new car franchise in fiscal 2022. EPP revenues
decreased 13.2%, reflecting the decline in our retail unit volume.
Seasonality. Historically, our business has been seasonal. Our stores
typically experience their strongest traffic and sales in the spring and summer,
with an increase in traffic and sales in February and March, coinciding with
federal income tax refund season. Sales are typically slowest in the fall.
GROSS PROFIT
Three Months Ended May 31 (1)
(In millions) 2022 2021 Change
Used vehicle gross profit $ 563.5 $ 597.0 (5.6) %
Wholesale vehicle gross profit 191.7 185.8 3.1 %
Other gross profit 120.2 141.7 (15.1) %
Total $ 875.4 $ 924.5 (5.3) %
(1) Amounts are net of intercompany eliminations.
GROSS PROFIT PER UNIT
Three Months Ended May 31 (1)
2022 2021
$ per $ per
unit(2) %(3) unit(2) %(3)
Used vehicle gross profit $ 2,339 8.0 $ 2,205 9.7
Wholesale vehicle gross profit $ 1,029 9.1 $ 1,025 13.5
Other gross profit $ 499 66.6 $ 523 85.4
(1) Amounts are net of intercompany eliminations. Those eliminations had the
effect of increasing used vehicle gross profit per unit and wholesale vehicle
gross profit per unit and decreasing other gross profit per unit by immaterial
amounts.
(2) Calculated as category gross profit divided by its respective units sold,
except the other category, which is divided by total used units sold.
(3) Calculated as a percentage of its respective sales or revenue.
Used Vehicle Gross Profit. We target a dollar range of gross profit per used
unit sold. The gross profit dollar target for an individual vehicle is based on
a variety of factors, including its probability of sale and its mileage relative
to its age; however, it is not primarily based on the vehicle's selling
price. Our ability to quickly adjust appraisal offers to be consistent with the
broader market trade-in trends and the pace of our inventory turns reduce our
exposure to the inherent continual fluctuation in used vehicle values and
contribute to our ability to manage gross profit dollars per unit. Gross profit
per used unit is consistent across our omni-channel platform.
We systematically adjust individual vehicle prices based on proprietary pricing
algorithms in order to appropriately balance sales trends, inventory turns and
gross profit achievement. Other factors that may influence gross profit include
the wholesale and retail vehicle pricing environments, vehicle reconditioning
and logistics costs, and the percentage of vehicles sourced directly from
consumers through our appraisal process. Vehicles purchased directly from
consumers generally have a lower cost per unit compared with vehicles purchased
at auction or through other channels, which may generate more gross profit per
unit. In any given period, our gross profit may also be impacted by the age mix
of vehicles sold, as older vehicles are generally more profitable. We monitor
macroeconomic factors and pricing elasticity and adjust our pricing accordingly
to optimize unit sales and profitability while also maintaining a competitively
priced inventory.
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Used vehicle gross profit decreased 5.6% in the first quarter of fiscal 2023,
driven by the 11.0% decrease in total used unit sales, partially offset by the
$134 increase in used vehicle gross profit per unit. 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 Vehicle Gross Profit. Our wholesale gross profit per unit reflects the
demand for older, higher mileage vehicles, which are the mainstay of our
auctions, as well as strong dealer attendance and resulting high dealer-to-car
ratios at our auctions. The frequency of our auctions, which are generally held
weekly or bi-weekly, minimizes the depreciation risk on these vehicles. Our
ability to adjust appraisal offers in response to the wholesale pricing
environment is a key factor that influences wholesale gross profit.
Wholesale vehicle gross profit increased 3.1% in the first quarter of fiscal 2023, primarily driven by the 2.7% increase in wholesale unit sales.
Other Gross Profit. Other gross profit includes profits related to EPP revenues, net third-party finance income/(fees), advertising and subscription profits earned by our Edmunds business, and other revenues. Other revenues are predominantly comprised of service department operations, including used vehicle reconditioning. We have no cost of sales related to EPP revenues or net third-party finance income/(fees), as these represent revenues paid to us by certain third-party providers. Third-party finance income is reported net of the fees we pay to third-party Tier 3 finance providers. Accordingly, changes in the relative mix of the components of other gross profit can affect the composition and amount of other gross profit. Other gross profit decreased 15.1% in the first quarter of fiscal 2023, primarily driven by a decline in service department margins as well as a decrease in EPP revenues, as discussed above, partially offset by the addition of Edmunds' gross profit of$20.0 million and improvement in net third-party finance income, as discussed above. The$30.9 million decline in service department profits was driven by deleverage resulting from the decline in retail unit sales as well as inflationary pressure. Page 40 --------------------------------------------------------------------------------
SG&A Expenses
COMPONENTS OF SG&A EXPENSES AS A PERCENTAGE OF TOTAL SG&A EXPENSES
Three Months Ended May 31, 2022
[[Image Removed: kmx-20220531_g3.jpg]]COMPONENTS OF SG&A EXPENSES COMPARED WITH PRIOR PERIOD (1)
Three Months Ended May 31
(In millions except per unit data) 2022 2021 Change
Compensation and benefits: Compensation and benefits, excluding share-based compensation expense
$ 345.3 $ 284.2 21.5 % Share-based compensation expense 22.2 38.4 (42.1) % Total compensation and benefits (2)$ 367.5 $ 322.6 13.9 % Occupancy costs 65.8 50.6 30.2 % Advertising expense 88.9 72.5 22.7 % Other overhead costs (3) 134.5 108.4 24.0 % Total SG&A expenses$ 656.7 $ 554.1 18.5 % SG&A as % of gross profit 75.0 % 59.9 % 15.1 % (1) Amounts are net of intercompany eliminations. (2) Excludes compensation and benefits related to reconditioning and vehicle repair service, which are included in cost of sales. See Note 11 for details of share-based compensation expense by grant type. (3) Includes IT expenses, non-CAF bad debt, insurance, preopening and relocation costs, charitable contributions, travel and other administrative expenses. SG&A expenses increased 18.5% in the first quarter of fiscal 2023. Factors contributing to the net increase include the following: •$61.1 million increase in compensation and benefits expense, excluding share-based compensation expense, driven by increased staffing and wage pressures as well as the inclusion of Edmunds in the current quarter. •$26.1 million increase in other overhead costs, driven by investments to advance our technology platforms and support our strategic initiatives, as well as growth related costs. •$16.4 million increase in advertising expense driven by our previously communicated investment in advertising spend as well as last year's lower level of spend in the first quarter given our tight inventory position and robust consumer demand. •$16.2 million decrease in stock-based compensation expense, primarily related to cash-settled restricted stock units, as the expense associated with these units was primarily driven by the change in the company's stock price during the relevant periods. Page 41 -------------------------------------------------------------------------------- Interest Expense. Interest expense includes the interest related to short- and long-term debt, financing obligations and finance lease obligations. It does not include interest on the non-recourse notes payable, which is reflected within CAF income. Interest expense increased to$28.8 million in the first quarter of fiscal 2023 compared with$20.5 million in the first quarter of fiscal 2022. The increase primarily reflected higher outstanding debt balances in the current quarter, including the$700 million term loan issued inOctober 2021 and a higher outstanding revolver balance, as well as higher interest rates. Other Expense (Income). Other expense was$2.1 million in the first quarter of fiscal 2023 compared with income of$25.6 million in the first quarter of fiscal 2022. The decrease was primarily due to net gains on an equity investment recorded during fiscal 2022. Income Taxes. The effective income tax rate was 25.1% in the first quarter of fiscal 2023 versus 23.0% in the first quarter of fiscal 2022. The increase in the effective income tax rate was primarily driven by the difference in excess tax benefit related to settlements of share-based awards.
RESULTS OF OPERATIONS - CARMAX AUTO FINANCE
CAF income primarily reflects interest and fee income generated by CAF's portfolio of auto loans receivable less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct CAF expenses. Total interest margin reflects the spread between interest and fees charged to consumers and our funding costs. Changes in the interest margin on new originations affect CAF income over time. Increases in interest rates, which affect CAF's funding costs, or other competitive pressures on consumer rates, could result in compression in the interest margin on new originations. Changes in the allowance for loan losses as a percentage of ending managed receivables reflect the effect of changes in loss and delinquency experience and economic factors on our outlook for net losses expected to occur over the remaining contractual life of the loans receivable. CAF's managed portfolio is composed primarily of loans originated over the past several years. Trends in receivable growth and interest margins primarily reflect the cumulative effect of changes in the business over a multi-year period. Historically, we have sought to originate loans in our core portfolio, which excludes Tier 2 and Tier 3 origination, with an underlying risk profile that we believe will, in the aggregate result in cumulative net losses in the 2% to 2.5% range (excluding CECL-required recovery costs) over the life of the loans. Actual loss performance of the loans may fall outside of this range based on various factors, including intentional changes in the risk profile of originations, economic conditions (including the effects of COVID-19) and wholesale recovery rates. Current period originations reflect current trends in both our retail sales and the CAF business, including the volume of loans originated, current interest rates charged to consumers, loan terms and average credit scores. Loans originated in a given fiscal period impact CAF income over time, as we recognize income over the life of the underlying auto loan. CAF also originates a small portion of auto loans to customers who typically would be financed by our Tier 3 finance providers, in order to better understand the performance of these loans, mitigate risk and add incremental profits. Historically, CAF targeted originating approximately 5% of the total Tier 3 loan volume. During the first quarter of fiscal 2022, we increased our Tier 3 loan volume beyond our target of 5% of total Tier 3 loan volume to 10% by the end of the first quarter of fiscal 2022. Additionally, in the second quarter of fiscal 2022, CAF began to originate loans in the Tier 2 space on a test basis. Any future adjustments in Tier 2 and Tier 3 will consider the broader lending environment along with the long-term sustainability of the change. These loans have higher loss and delinquency rates than the remainder of the CAF portfolio, as well as higher contract rates.
CAF income does not include any allocation of indirect costs. Although CAF benefits from certain indirect overhead expenditures, we have not allocated indirect costs to CAF to avoid making subjective allocation decisions. Examples of indirect costs not allocated to CAF include retail store expenses and corporate expenses.
See Note 4 for additional information on CAF income and Note 5 for information on auto loans receivable, including credit quality.
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SELECTED CAF FINANCIAL INFORMATION
Three Months Ended May 31
(In millions) 2022 % (1) 2021 % (1)
Interest margin:
Interest and fee income $ 346.7 8.8 $ 310.3 8.8
Interest expense (48.8) (1.2) (65.8) (1.9)
Total interest margin $ 297.9 7.5 $ 244.5 6.9
Provision for loan losses $ (57.8) (1.5) $ 24.4 0.7
CarMax Auto Finance income $ 204.5 5.2 $ 241.7 6.8
(1) Annualized percentage of total average managed receivables.
CAF ORIGINATION INFORMATION (AFTER THE IMPACT OF 3-DAY PAYOFFS)
Three Months Ended May 31
2022 2021
Net loans originated (in millions)$ 2,446.8 $ 2,483.4 Vehicle units financed 94,663 118,363 Net penetration rate (1) 39.3 % 43.7 % Weighted average contract rate 9.0 % 9.0 % Weighted average credit score (2) 704
695
Weighted average loan-to-value (LTV) (3) 87.6 % 90.2 %
Weighted average term (in months) 66.3 66.3
(1) Vehicle units financed as a percentage of total used units sold.
(2) The credit scores represent FICO® scores and reflect only receivables with
obligors that have a FICO® score at the time of application. The FICO® score
with respect to any receivable with co-obligors is calculated as the average of
each obligor's FICO® score at the time of application. FICO® scores are not a
significant factor in our primary scoring model, which relies on information
from credit bureaus and other application information as discussed in Note
5. FICO® is a federally registered servicemark of Fair Isaac Corporation.
(3) LTV represents the ratio of the amount financed to the total collateral
value, which is measured as the vehicle selling price plus applicable taxes,
title and fees.
LOAN PERFORMANCE INFORMATION
As of and for the Three Months Ended
May 31
(In millions) 2022 2021
Total ending managed receivables $ 16,052.0 $ 14,465.9
Total average managed receivables $ 15,817.0 $ 14,148.7
Allowance for loan losses $ 458.2 $ 379.5 Allowance for loan losses as a percentage of ending managed receivables
2.85 % 2.62 %
Net credit losses on managed receivables $ 32.6 $ 7.2 Annualized net credit losses as a percentage of total average managed receivables
0.83 % 0.21 %
Past due accounts as a percentage of ending managed receivables 4.06 % 2.10 %
Average recovery rate (1) 73.7 % 64.7 %
(1) The average recovery rate represents the average percentage of the
outstanding principal balance we receive when a vehicle is repossessed and
liquidated, generally at our wholesale auctions. While in any individual period
conditions may vary, over the past 10 fiscal years, the annual recovery rate has
ranged from a low of 46% to a high of 71%, and it is primarily affected by the
wholesale market environment.
Page 43
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•CAF Income (Decrease of $37.3 million , or 15.4% in the first quarter of fiscal
2023)
•The decrease in CAF income for the first quarter of fiscal 2023 reflects a
year-over-year swing in the provision for loan losses as discussed below.
•The increase in the provision for loan losses was partially offset by increases
in the total interest margin and average managed receivables.
•Provision for Loan Losses
•The provision for loan losses resulted in expense of $57.8 million in the first
quarter of fiscal 2023 compared with income of $24.4 million in the first
quarter of fiscal 2022.
•The current quarter provision primarily reflected the expected lifetime losses
on loans originated during the quarter, while the prior year quarter provision
reflected the continued reduction of the reserve that was established at the
start of the COVID-19 pandemic, reflecting favorable loan loss performance.
•The allowance for loan losses as a percentage of ending managed receivables was
2.85% as of May 31, 2022 , compared with 2.62% as of May 31, 2021 and 2.77% as of
February 28, 2022 . The increase in the allowance percentage from February
primarily reflected the effect of the previously disclosed expansion of Tier 2
and Tier 3 originations within CAF's portfolio.
•Total Interest Margin (Increased to 7.5% in the first quarter of fiscal 2023
from 6.9% in the first quarter of fiscal 2022)
•The increase in the total interest margin percentage was primarily the result
of lower funding costs as well as a $9.2 million benefit related to swaps not
designated as hedges for accounting purposes.
•Loan Origination and Performance
•The decrease in net loan originations in the first quarter of fiscal 2023
resulted from a decrease in used unit sales and the net penetration rate,
partially offset by an increase in the average amount financed.
•CAF net penetration in the first quarter of fiscal 2023 declined from the prior
year period, largely reflecting an increase in the mix of customers utilizing
outside financing.
•The weighted average contract rate for the first quarter of fiscal 2023 was
consistent with the prior year at 9.0% but increased significantly from 8.2% in
the prior quarter. This increase was primarily due to higher rates charged to
customers in response to the current interest rate environment.
•The increase in past due accounts as a percentage of ending managed receivables
for fiscal 2023 primarily reflected a return to pre-pandemic delinquency levels
as well as impacts from our new system implementation in the prior year, which
are expected to normalize during the current fiscal year.
•The recovery rate in the first quarter of fiscal 2023 was above our historical
range due to market appreciation.
PLANNED FUTURE ACTIVITIES
We anticipate opening a total of ten stores in fiscal 2023. During the first quarter of fiscal 2023, we entered theNew York City metro market. We anticipate opening two more stores in this market in the second quarter, as well as in the next fiscal year. We currently estimate capital expenditures will total approximately$500 million in fiscal 2023, an increase from$308.5 million in fiscal 2022. The increase in planned capital spending in fiscal 2023 largely reflects long-term growth capacity initiatives for our auction, sales and production facilities in addition to continued investments in technology. We expect approximately 30% of our capital expenditures in fiscal 2023 will be focused on investments in technology.
FINANCIAL CONDITION
Liquidity and Capital Resources Our primary ongoing cash requirements are to fund our existing operations, store expansion and improvement, CAF and strategic growth initiatives. Since fiscal 2013, we have also elected to use cash for our share repurchase program. Our primary ongoing sources of liquidity include funds provided by operations, proceeds from non-recourse funding vehicles and borrowings under our revolving credit facility or through other financing sources. Our current capital allocation strategy is to focus on our core business, including investing in digital capabilities and the strategic expansion of our store footprint, pursue new growth opportunities through investments, partnerships and acquisitions and return excess capital to shareholders. Given our continued strong business results, the strength of the credit markets and our solid balance sheet, we believe we have the appropriate liquidity, access to capital and financial strength to support our operations and continue investing in our strategic initiatives for the foreseeable future. Page 44 -------------------------------------------------------------------------------- We currently target an adjusted debt-to-total capital ratio in a range of 35% to 45%. Our adjusted debt to capital ratio, net of cash on hand, was at the middle of our targeted range for the first quarter of fiscal 2023. In calculating this ratio, we utilize total debt excluding non-recourse notes payable, finance lease liabilities, a multiple of eight times rent expense and total shareholders' equity. Generally, we expect to use our revolving credit facility and other financing sources, together with stock repurchases, to maintain this targeted ratio; however, in any period, we may be outside this range due to seasonal, market, strategic or other factors. Operating Activities. During the first three months of fiscal 2023, net cash provided by operating activities totaled$531.0 million , compared with cash used in operating activities of$111.9 million in the prior year period. Our operating cash flows are significantly impacted by changes in auto loans receivable, which increased$440.7 million in the current year period compared with$644.9 million in the prior year period. The majority of the changes in auto loans receivable are accompanied by changes in non-recourse notes payable, which are issued to fund auto loans originated by CAF. Net issuances of non-recourse notes payable were$297.4 million in the current year period compared with$596.7 million in the prior year period and are separately reflected as cash from financing activities. Due to the presentation differences between auto loans receivable and non-recourse notes payable on the consolidated statements of cash flows, fluctuations in these amounts can have a significant impact on our operating and financing cash flows without affecting our overall liquidity, working capital or cash flows. As ofMay 31, 2022 , total inventory was$4.69 billion , representing a decrease of$433.5 million compared with the balance as of the start of the fiscal year. The decrease was primarily due to a decrease in vehicle units as well as a decrease in the average carrying cost of inventory as a result of a decline in acquisition costs. The change in net cash provided by (used in) operating activities for the first three months of the current fiscal year compared with the prior year period reflected the changes in inventory and auto loans receivable, as discussed above, as well as changes in accounts receivable, partially offset by changes in accounts payable as well as a decrease in net earnings when excluding non-cash expenses, which include depreciation and amortization, share-based compensation expense and the provisions for loan losses and cancellation reserves. Investing Activities. During the first three months of fiscal 2023, net cash used in investing activities totaled$99.0 million compared with$63.1 million in fiscal 2022. Capital expenditures were$94.8 million in the current year period versus$59.1 million in the prior year period. Capital expenditures primarily included store construction costs and store remodeling expenses as well as investments in technology. We maintain a multi-year pipeline of sites to support our store growth, so portions of capital spending in one year may relate to stores that we open in subsequent fiscal years. As ofMay 31, 2022 , 151 of our 231 used car stores were located on owned sites and 80 were located on leased sites, including 24 land-only leases and 56 land and building leases. Financing Activities. During the first three months of fiscal 2023, net cash used in financing activities totaled$455.0 million compared with net cash provided by financing activities of$475.1 million in the prior year period. Included in these amounts were net issuances of non-recourse notes payable of$297.4 million compared with$596.7 million in the prior year period. Non-recourse notes payable are typically used to fund changes in auto loans receivable (see "Operating Activities"). During the first three months of fiscal 2023, cash used in financing activities was impacted by stock repurchases of$163.0 million as well as net payments on our long-term debt of$585.9 million . During the first three months of fiscal 2022, cash provided by financing activities was impacted by stock repurchases of$133.8 million as well as net payments on our long-term debt of$2.6 million . Page 45 --------------------------------------------------------------------------------
TOTAL DEBT AND CASH AND CASH EQUIVALENTS
(In thousands) As of May 31 As of February 28
Debt Description (1) Maturity Date 2022 2022
Revolving credit facility (2) June 2024 $ 660,500 $ 1,243,500
Term loan (2) June 2024 300,000 300,000
Term loan (2) October 2026 699,388 699,352
3.86% Senior notes April 2023 100,000 100,000
4.17% Senior notes April 2026 200,000 200,000
4.27% Senior notes April 2028 200,000 200,000
Various dates through February
Financing obligations 2059 522,414 524,766
Various dates through October
Non-recourse notes payable 2028 15,764,161 15,466,799
Total debt (3) $ 18,446,463 $ 18,734,417
Cash and cash equivalents $ 95,313 $ 102,716
(1) Interest is payable monthly, with the exception of our senior notes, which are payable semi-annually.
(2) Borrowings accrue interest at variable rates based on the Eurodollar rate (LIBOR), or successor benchmark rate, the federal funds rate, or the prime rate, depending on the type of borrowing. (3) Total debt excludes unamortized debt issuance costs. See Note 10 for additional information. Borrowings under our$2.00 billion unsecured revolving credit facility are available for working capital and general corporate purposes, and the unused portion is fully available to us. The credit facility, term loans and senior note agreements contain representations and warranties, conditions and covenants. If these requirements are not met, all amounts outstanding or otherwise owed could become due and payable immediately and other limitations could be placed on our ability to use any available borrowing capacity. As ofMay 31, 2022 , we were in compliance with these financial covenants.
See Note 10 for additional information on our revolving credit facility, term loans, senior notes and financing obligations.
CAF auto loans receivable are primarily funded through our warehouse facilities and asset-backed term funding transactions. These non-recourse funding vehicles are structured to legally isolate the auto loans receivable, and we would not expect to be able to access the assets of our non-recourse funding vehicles, even in insolvency, receivership or conservatorship proceedings. Similarly, the investors in the non-recourse notes payable have no recourse to our assets beyond the related receivables, the amounts on deposit in reserve accounts and the restricted cash from collections on auto loans receivable. We do, however, continue to have the rights associated with the interest we retain in these non-recourse funding vehicles. As ofMay 31, 2022 ,$12.13 billion and$3.63 billion of non-recourse notes payable were outstanding related to asset-backed term funding transactions and our warehouse facilities, respectively. During the first three months of fiscal 2023, we funded a total of$1.75 billion in asset-backed term funding transactions. As ofMay 31, 2022 , we had$1.77 billion of unused capacity in our warehouse facilities.
We have periodically increased our warehouse facility limit over time, as our store base, sales and CAF loan originations have grown. See Note 10 for additional information on the warehouse facilities.
We generally repurchase the receivables funded through our warehouse facilities when we enter into an asset-backed term funding transaction. If our counterparties were to refuse to permit these repurchases it could impact our ability to execute on our funding program. Additionally, the agreements related to the warehouse facilities include various representations and warranties, covenants and performance triggers. If these requirements are not met, we could be unable to continue to fund receivables through the warehouse facilities. In addition, warehouse facility investors could charge us a higher rate of interest and could have us replaced as servicer. Further, we could be required to deposit collections on the related receivables with the warehouse facility agents on a daily basis and deliver executed lockbox agreements to the warehouse facility agents. The timing and amount of stock repurchases are determined based on stock price, market conditions, legal requirements and other factors. Shares repurchased are deemed authorized but unissued shares of common stock. InApril 2022 , our board of directors increased our share repurchase authorization by$2 billion . As ofMay 31, 2022 , a total of$4 billion of board authorizations for repurchases was outstanding, with no expiration date, of which$2.62 billion remained available for repurchase. See Note 11 for more information on share repurchase activity. Page 46 -------------------------------------------------------------------------------- Fair Value Measurements We recognize money market securities, mutual fund investments, certain equity investments and derivative instruments at fair value. See Note 7 for more information on fair value measurements.
FORWARD-LOOKING STATEMENTS
We caution readers that the statements contained in this report that are not statements of historical fact, including statements about our future business plans, operations, capital structure, opportunities, or prospects, including without limitation any statements or factors regarding expected operating capacity, sales, inventory, market share, online purchases of vehicles from consumers, gross profit per used unit, revenue, margins, expenditures, liquidity, loan originations, CAF income, stock repurchases, indebtedness, earnings, market conditions or expectations with regards to the continued impact of the COVID-19 pandemic, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by the use of words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "outlook," "plan," "positioned," "predict," "target," "should," "will" and other similar expressions, whether in the negative or affirmative. Such forward-looking statements are based upon management's current knowledge, expectations and assumptions and involve risks and uncertainties and assumptions about future events and involve risks and uncertainties that could cause actual results to differ materially from anticipated results. We disclaim any intent or obligation to update these statements. Among the factors that could cause actual results and outcomes to differ materially from those contained in the forward-looking statements are the following: •The effect and consequences of the Coronavirus public health crisis on matters includingU.S. and local economies; our business operations and continuity; the availability of corporate and consumer financing; the health and productivity of our associates; the ability of third-party providers to continue uninterrupted service; and the regulatory environment in which we operate.
•Changes in general or regional
•Changes in the availability or cost of capital and working capital financing, including changes related to the asset-backed securitization market.
•Changes in the competitive landscape and/or our failure to successfully adjust to such changes.
•Events that damage our reputation or harm the perception of the quality of our brand.
•Our inability to realize the benefits associated with our omni-channel initiatives and strategic investments.
•Our inability to recruit, develop and retain associates and maintain positive associate relations.
•The loss of key associates from our store, regional or corporate management teams or a significant increase in labor costs.
•Security breaches or other events that result in the misappropriation, loss or other unauthorized disclosure of confidential customer, associate or corporate information.
•Significant changes in prices of new and used vehicles.
•Changes in economic conditions or other factors that result in greater credit losses for CAF's portfolio of auto loans receivable than anticipated.
•A reduction in the availability of or access to sources of inventory or a failure to expeditiously liquidate inventory.
•Changes in consumer credit availability provided by our third-party finance providers.
•Changes in the availability of extended protection plan products from third-party providers.
•Factors related to the regulatory and legislative environment in which we operate.
•Factors related to geographic and sales growth, including the inability to effectively manage our growth.
•The failure of or inability to sufficiently enhance key information systems.
•The performance of the third-party vendors we rely on for key components of our business.
•The effect of various litigation matters.
•Adverse conditions affecting one or more automotive manufacturers, and manufacturer recalls.
Page 47 --------------------------------------------------------------------------------
•The failure or inability to realize the benefits associated with our strategic transactions.
•The inaccuracy of estimates and assumptions used in the preparation of our financial statements, or the effect of new accounting requirements or changes toU.S. generally accepted accounting principles.
•The volatility in the market price for our common stock.
•The failure or inability to adequately protect our intellectual property.
•The occurrence of severe weather events.
•Factors related to the geographic concentration of our stores.
For more details on factors that could affect expectations, see Part II, Item 1A, "Risk Factors" on Page 50 of this report, our Annual Report on Form 10-K for the fiscal year endedFebruary 28, 2022 , and our quarterly or current reports as filed with or furnished to theU.S. Securities and Exchange Commission ("SEC"). Our filings are publicly available on our investor information home page at investors.carmax.com. Requests for information may also be made to our Investor Relations Department by email to investor_relations@carmax.com or by calling 1-804-747-0422, ext. 7865. We undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise. Page 48 --------------------------------------------------------------------------------
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