Carmax Inc Q1 FY2023 Earnings Call

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 Lowenstein. Please go ahead, sir.

Thank you. Orlando. Good morning. Thank you for joining our fiscal 2023 first-quarter earnings conference call. I'm here today with Bill Nash, our President and CEO; Enrique Mayor-Mora, our Executive Vice President and CFO; and Jon Daniels, our Senior Vice President CarMax Auto Finance Operations. Let me remind you our statements today that are not statements of historical fact, including statements regarding the company's future business plans, prospects and financial performance are forward-looking statements we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on our current knowledge, expectations and assumptions and are subject to substantial risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, we disclaim any intent or obligation to update them. For additional information on important facts that could affect these expectations, please see our Form 8-K filed with the SEC this morning and our Annual Report on Form 10-K for the fiscal year ended February 28, 2022 previously filed with the SEC. Should you have any follow-up questions after the call, please feel free to contact our Investor Relations department at 804-747-0422, extension 7865. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow-ups. Bill?

Thank you, David. Good morning, everyone, and thanks for joining us. For the first quarter of FY'23, 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 427,000 cars in total during the first quarter, down 5.5% versus last year's period. In our retail business, total unit sales in the first quarter declined 11% and 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 material 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 the 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 remained strong. Based on external data, we gained share each month from January through April, the latest periods for which title data is available. We believe the 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 profitable market share gains in any environment. We reported first-quarter retail gross profit per used unit of $2,339, 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 2.7% 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-priced vehicles. We estimate that without these two factors, our wholesale unit growth would have been above 10%. Wholesale gross profit per unit was $1,029 in line with $1,025 a year ago. We are pleased that we continue to drive wholesale unit growth, even as we lapped last year's nationwide launch of our instant online appraisal offering on carmax.com 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 362,000 vehicles from consumers and dealers during the first quarter, up 6% versus last year's period. We continue to be the nation's largest buyer of vehicles from consumers purchasing approximately 345,000 cars in the quarter, up 3% versus last year's record results. This enabled our self-sufficiency to remain above 70% during the quarter. We also sourced approximately 17,000 vehicles through our Max offer, our digital appraisal product for dealers that we mentioned during our last call. This is up 183% versus last year's period. As a reminder, buying directly from consumers and dealers lowers our acquisition cost, enhances our inventory selection and provides profitable incremental wholesale volume. CarMax Auto Finance or 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. Jon will provide more detail on customer financing, the loan loss provision and CAF's 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. Enrique?

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 used sales was the key contributor, the comparison was also impacted by the following two items. First, as Jon will discuss, an $82 million 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. Wholesale 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 EPP profits. Service results declined $31 million as lower sales and secondarily impacts from inflationary pressures drove a deleverage in results. EPP gross profit decreased by $18 million or 13%, slightly more than the retail unit sales rate decline. While penetration was stable at approximately 61%, 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 favorability 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. 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 due to an increase in staffing costs and marketing, the continued investment in our strategic initiatives, growth costs related to the increase in appraisal buys and used stores and the consolidation of Edmunds. SG&A as a percent of gross profit deleveraged to 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 annualization 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 pressures and the 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, a $26 million increase in other overheads. 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 tight inventory position and robust customer demand. In addition, this quarter spent 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 CDCs 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 '22. In the first quarter, we repurchased approximately 1.6 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 at East Meadow, New York. We anticipate adding two more stores in this market next year. Now I'd like to turn the call over to Jon.

Thanks, Enrique, and good morning, everyone. Our CarMax Auto Finance business delivered solid results again this quarter despite the volatile broader lending environment. During the first quarter, CAF's net loans originated was over $2.4 billion. The weighted average contract rate charged to new customers was 9%, which was in line with the year-ago, but has significantly increased from 8.2% 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 credit. As the Fed clearly signaled interest rate hikes beginning of the calendar year, CAF 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, CAF's penetration in the first quarter, net of 3-day payoffs was 39.3% compared with 43.7% last year. Of importance, CAF saw its penetration level improved during the quarter as we observed banks and credit unions raising their own consumer rates during this period. Our Tier 2 partners continue to compete for the attractive CarMax business resulting in a penetration rate of 25.2% compared with 22.8% last year. Tier 3 accounted for 7.1% of used 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. CAF income for the quarter was $204 million, a decrease of 15% or $37 million from the same period last year. I want to take a moment to clarify the year-over-year swing in our loan loss provision. You will 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. CAF's loan loss provision this quarter 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 in 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 included a 5 basis point adjustment for the growth in Tier 2 and Tier 3 volume originated by CAF. We remain confident in both the resiliency of the CAF consumer and our ability to serve them well. While delinquency rates have increased, our Tier 1 credit losses remain comfortably within our historical operating range of 2% to 2.5%. 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, providing a full suite of personalized decisions available at the consumers' fingertips within carmax.com. During the month of March, we further enhanced this experience by testing a no impact on your credit score pre-qualification feature along with a streamlined application process that provides real-time credit decisions on our full inventory. We are extremely excited about the results thus far. It is currently available to approximately 25% of our online customers and we anticipate scaling nationwide during the rest of the year. Now I will turn the call back over to Bill.

Great, thank you, Jon, and 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'm 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 of 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 Omni 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 virtual, so 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 is 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 Jon 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 pre-qualification product once fully deployed will provide frictionless and seamless access to multi-lender credit terms on every car within our retail inventory on every car within our retail inventory whether the consumer chooses to browse and purchase from the comfort of their home, walk the lot on their own with their mobile device or shop alongside one of our exceptional sales consultants. Second area of focus is continuing to leverage data science, automation and AI to improve efficiency and effectiveness across our buying organizations, 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 Edmunds 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 in the white space adjacent to our existing capabilities. We are currently live in over 30 markets and anticipate launching additional markets throughout FY'23. Staying on Edmunds for a moment, I want to acknowledge that as of June 1, we reached the one-year anniversary of this acquisition. We are glad to have all of the talented Edmunds 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 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 future. With that, we'll be happy to take your questions. Orlando?

Thank you. All right, and we will take our first question from Brian Nagel with Oppenheimer. Please go ahead.

Good morning. Can you hear me?

Yes, good morning, Brian.

I'm sorry about that. I believe there was a transmission issue. Congratulations on the continued progress. From a broader perspective regarding sales trends, Bill, you mentioned in your prepared comments some of the persistent factors, including the challenging comparisons from last year, stimulus impacts, and high prices. As we move into FY'23, are you getting a clearer picture of consumer behavior, the underlying health of the consumer, and what is truly driving the business at this point? You noted a strengthening trend through fiscal Q1; is the consumer's health improving, or is this mainly due to comparison effects?

Yes, Brian, overall, the consumer is somewhat softer due to several factors I've mentioned. It's challenging to determine the exact impact of things like the end of stimulus payments, vehicle affordability issues, inflation, and rising interest rates. However, as we've distanced ourselves from the stimulus effects, we've seen improved performance, as I highlighted in my opening remarks. Our comparatives have shown a sequential improvement throughout the quarter, which is encouraging. While the consumer situation is softer, there remains some demand, and we are focused on maximizing that opportunity by implementing various strategies. This includes improving efficiencies and passing savings on to consumers to make vehicles more affordable. In my opening remarks, I mentioned increasing sales of older vehicles to meet consumer demand because many are looking for more affordable options. Historically, our ValueMax program, which included vehicles over six years old or with over 60,000 miles, accounted for about 22% to 25% of our sales. This quarter, it has risen to around 35%. This indicates that there is still demand in that segment. Additionally, we have a lending platform with great third-party lenders and CAF to ensure we offer competitive interest rates to our customers. These are some of the steps we're taking to navigate through these conditions. While the consumer is softer, there is still demand present.

No, that's very helpful. But if I could just slip one follow up into that. So, are you seeing, as you look at maybe across the different cohorts of your business, higher-priced vehicles, lower-priced vehicles, are you seeing now more significant demand dynamic across those cohorts?

On the vehicle prices?

Yes, just to get an idea of that.

What's interesting about it, Brian, is if you look back a year ago, 70% of our inventory was under $25,000. Fast forward to today, it's more like 43% to 45% and that's really a result of inflationary pressures, which again is one of the reasons why we're focused on getting more affordable inventory out there. So that's what our big push is right now. Now realizing some folks are interested in a higher model car and or an older car, but again, that's what our focus is right now.

Got it. I appreciate all the color. Thank you.

Yes.

Next question will come from John Healy with Northcoast Research. Please go ahead.

Thank you. Why don't we try to follow up on that first question maybe in a little bit different way. When I think about, Bill what you kind of talked about what's going on in the business, you re-merchandised, you've got investments into the sales and labor force, obviously, those mature at different rates. But if you look 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 that consumer might have paused and now they're realizing they have to make a transaction? Would just love to kind of hear how you and the team are attributing the sequential improvement and maybe to what initiatives are they more consumer-related?

Yes, it's a good question, John. I mean obviously, I'd love to tell you that it's because of our continued focus on improving the experience, getting the right inventory and they're improving prices and all that, while I do think that's a factor. I don't think you can ignore the fact that 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 $1,400 check went out to consumers during tax season and that did not happen this year. So, that absolutely had an impact. So I'm not going to sit here and say it's all 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.

I think 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, our percent of sales coming from older cars were not because the consumer demand is there. Those cars are not easy to buy in auction. So it's really a nod to 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. Will that revert? Will we pick that up in Q2? I was just curious how the timing impact might or that 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're very pleased with the auction performance, wholesale performance, in general. We're pleased with the fact that we actually grew it. 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 pickup. The other thing that I cited though was that we have made the decision to pull some what we normally run through the auctions and 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.

Yes.

Up next, we'll hear from Ms. 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 swaying from the, I guess, I would say fully reconditioned status that you've historically had and maybe leading from the scratches or whatever and marking it as is to further enhance the value proposition, I know that's been something you've been leery of in the past from a brand perspective. And then secondarily, obviously, there is a lot of concern that things are going to get worse before they get better, I mean how are you positioning from a controllable standpoint in the event that there is another leg down. I mean how should we think about SG&A, and what you can cut if you need to cut it?

Yes, I'll tackle both because I'm sure Enrique will have some comments on the kind of the concerns going forward. From your first question, as far as the older inventory. Sharon, if we're going to make it a CarMax car, it's going to be a CarMax car. And you know, you take these older cars, not all of them can make the cut. And we’ll end up trying to run some through retail, they won't make it, but we're bringing them up to the CarMax standards. 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'll continue to do that, we'll continue to bring 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, where the consumer is going, Sharon, we've been through this several times in the past and whether it's ’08, ‘09 recession, whether it's 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 they're expense levers and 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, your variable will adjust or if it's just you know if you want to secure cash, you can modify your stock buyback, you can start on some of your capital expenditures or delayed. So these are just some of the levers that you know that we pulled in the past and we're going to continue to monitor the conditions. But I'd tell you that it 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 what are going to 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.

Yes, I would just add that our objective is to ensure our expenses align with customer demand while also investing in key areas that will enable us to grow profitability and market share over time. As I mentioned in my prepared remarks, we're already aligning our cost structure to current demand through scheduling and natural attrition. We've taken these steps, and if a recession occurs, we are confident in our ability to weather it, as we are starting from a position of strength. We are profitable, have a strong balance sheet, and generate cash. As Bill mentioned, we've experienced these cycles before and feel confident we can manage through them effectively while also growing our market share.

Okay, thank you.

Thank you, Sharon.

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

Great, thanks for taking the questions. Nice execution on the retail gross profit per unit. Can you help us unpack that a little bit versus the prior quarter, what drove the sequential uptick there? Is it reconditioning saving? Is it just the sourcing mix? Is it pricing related? Curious if you could bucket those if possible and I have a follow-up.

Yes, thanks for the question, Rajat. Yes, the way I think about it and I talked about this in the opening remarks, we're really trying to walk upon balance here. We have some efficiencies, historically we've always passed our efficiencies along and the big efficiencies that we're working with right now are the fact that we've got self-sufficiency still at a high, but we also have this new dynamic where we're signed to more older cars. And as I talked about earlier, these older cars generally carry more margin. So that's also an opportunity to manage our margin and pass along efficiencies to the consumers. And this quarter, obviously, it's a little higher than last year and even our five-year average. And that's because with these efficiencies, we continue to pass along the price savings, but we also 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 bearing the other big changes and keep an eye on the testing, we feel good about the margins going forward as well.

Got it, got it. Relatedly, on the topic you're shifting to SG&A, I mean is there any of the slight change in the sourcing mix or trying to maintain that GPU coming in some way at the expense of more cost on the SG&A side. Now, you're not roughly $2,700 per unit and this is the seasonally strongest quarter typically every year, so curious like what takes us down further as the year progresses? What are the areas of opportunity? If you could just give us some puts and takes on that front on how the SG&A per unit should progress going forward?

Yes, I'll pass to Enrique in just a second, but just to be clear, like these, the margin improvements are not coming at the expense of SG&A and the way we think about margin when we were building the cars we've absolutely seen inflationary pressures in the build of cars, which goes to 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 if the costs go up, which everyone seeing 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 is also an efficiency on price as well.

Yes. To elaborate on that, there is some pressure on SG&A due to the volume of purchases we have experienced. We've had great success with the number of buys, which requires us to increase staffing to manage that demand, influencing our self-sufficiency rate. While there is some pressure on SG&A, it's important to highlight that the challenges in Q1 stem from a couple of factors compared to the previous year. First, we were understaffed during the first quarter last year, particularly coming out of the pandemic, and we spent the latter half of last year addressing that understaffing. Additionally, we spent less on marketing per unit last year in Q1 due to limited inventory. Despite strong demand, our marketing expenditure was lower, which creates some challenges when we look at performance this year. The second factor is our anticipation of a strong tax season, which led us to increase staffing in our stores and CDCs and raise our marketing spending. Although the expected sales did not materialize, we are adaptable and have started to reduce staffing accordingly in the CDCs and stores by using attrition and improved scheduling. It's crucial to understand what influenced the Q1 deleveraging.

Got it. Great, thanks for the color. I'll jump back in queue.

Thank you, Rajat.

Alright, up next, we'll hear from Daniel Imbro with Stephens Inc. Please go ahead.

Yes. Hey, good morning guys. Thanks for taking for our question. I wanted to ask on the competitive environment for CAF right now. I think last quarter we talked about how some of the other lenders were extending terms to 84 months. They weren't passing through higher cost of funds. It feels like you mentioned in your prepared remarks, if they were starting to pass through some of those higher cost of funds during the quarter. But just curious how the competitive backdrop is changing and obviously CAF penetration went down in the quarter. I mean, was that intentional on your part walking away from business? Or can you tell us what drove that? Thanks.

Sure. I appreciate the question, Daniel. Thank you for mentioning it in the prepared remarks. The main point regarding our penetration this quarter was really about our cash pricing adjustments. We are not stepping back from business at all. If you examine the average APR we charged our customers last quarter, it was 8.2% and this quarter it’s increased to 9%, primarily due to us passing along our higher costs to consumers. It’s always a challenging balance to maintain competitiveness for our customers. We are mostly up against credit unions and, to a lesser extent, external banks. We noticed that we adjusted our prices slightly earlier than our competitors, who tended to raise their rates throughout the quarter. Consequently, our penetration improved in the latter part of the quarter. I believe this trend will continue as we work to manage our penetration, our net interest margin, and remain highly competitive for our customers. It's a delicate balance that we will keep monitoring alongside our competitors' actions and the Fed's movements.

Our penetration decreased, while the number of consumers using their own financing increased.

Great, that's generally the offset. So in our space usually a customer sees the car, they want it, making either choose the financing from CAF, or again that's what's great about our program is 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 guys.

Thanks, Daniel.

All right. Up next, we will take a question from Seth Basham with Wedbush Securities. Please go ahead.

Yes, hi, this is Nathan Friedman on for Seth. Thanks for taking my questions. 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? And how should we be thinking about that?

Yes, Nathan. As I said earlier, we feel good about our margins. We've got some tailwinds there. I would tell you, we've navigated through times of depreciation before and 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 of 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 and sales elasticity competitors and all that.

Got it. Thanks for that. And my second question is focused on your strong net interest margin performance this quarter and the sequential increase here, despite your last ABS securitizations margins experiencing pretty large sequential margin declines. Can you provide more detail or quantify how much benefit you experienced from your hedging strategy this quarter? And how you're envisioning net interest margins going forward?

Sure. Enrique and I will address that. First, I want to highlight the growth in our net interest margin that we experienced this quarter. It's important to remember that our business model, along with our accounting processes, allows us to earn over time rather than relying on a gain on sale model. The assets contributing to our net interest margin this quarter are from one, two, even three years ago, during which spreads were very favorable. Therefore, the assets we acquired this quarter, particularly from our most recent ABS transaction, will effectively offset what we are maturing in our portfolio. Fortunately, the timing is right, and we still have robust margin assets in our portfolio, which we will continue to hold for a while. If we can maintain our high margins and manage them effectively, we may be able to reduce the rate of decline or at least slow it down. Regarding our hedging strategy, I'll let Enrique provide more insights on that.

Yes. And as Jon mentioned in his prepared remarks, we had and we experienced in the quarter a $9 million gain from a hedge benefit just to maybe explain that a little bit more. The 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 a 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 those receivables, they 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’d only expect us to be material to any degree in periods again with our sharp and material changes in the interest rate.

Well. That’s good. Thank you for the time and best of luck.

Thank you.

All right. And up next, we will take a question from John Murphy with Bank of America. Please go ahead.

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, the zero to six year old car population is likely to shrink pretty dramatically or not really recover much if that is what we're seeing on new vehicle sales side, I mean, the vehicles just don't exist in reality. So as you look at going older to beyond six years, it just seems like there's a real opportunity in the seven to 10 year old vehicles. Our high-quality products is very different than they were 10 to 20-years ago, so you can wrap them pretty well to the consumers, so they're good products for you to rep in sell. So just curious, as we think about this idea there and like you said you went from 25% Valuemax or Valuemax like vehicles to 35% this quarter. Could that be significantly higher over time? And just the kind of thing that could be not just sort of a move to offset some of the shortage of supply on zero to six year 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 store or in total?

Yes, good morning, John. It's a great question. The advantage of our business is that we adapt to whatever consumers are seeking. It is certainly becoming more challenging to locate and produce certain vehicles. We've encountered similar circumstances before. Back in 2008 and 2009, during the recession, the new car sales rate fell sharply. It was even more severe at that time, affecting about a 10-year supply of newer vehicles, as the sales rate dipped into very low double digits, and at times even lower. That situation created a surplus that eventually needed to be resolved. I anticipate a comparable situation now, but nothing as extreme as what we experienced in 2008 or 2009. The positive aspect now is our self-sufficiency. While we managed through the previous challenges, our current high level of self-sufficiency provides us with a significant source of inventory. I mentioned previously that vehicles over six years old make up about 66% of our sales, this quarter that percentage is closer to 50%. For five to seven-year-old vehicles, we’ve seen an increase to 30% to 35%, and for vehicles eight years and older, it’s around 15%. Overall, we have a better inventory source now, and we are enthusiastic about the opportunities that lie ahead.

Okay. To follow up on that, it seems like on the acquisition side, you’re doing well with self-sufficiency. However, if we consider consumers buying vehicles, it appears that buyers of older vehicles have a greater tendency to purchase online compared to those looking for newer vehicles. Regarding your omnichannel strategies and conversion rates based on age groups, is it accurate to say that buyers of vehicles over seven years old are more likely to buy online than those seeking one to three year old cars? I’m interested in your observations on this.

Yes, John. To be honest, off the top my head, I don't know if that's necessarily true, I mean what we're seeing from an online sales perspective is it's a wide swath of consumers looking for different merchandise. So I don't think that's necessarily true that it's the older stuff that selling online. There is some of it, I don't think it's disproportionate.

Okay. All right, thank you very much.

Thank you, John.

All right. Up next, we'll hear from Michael Montani 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 40k and below versus 100k plus households. But, but just talk about maybe what you saw there in the quarter? And then how that has evolved, if the sales have, kind of, stabilized it down low single-digit?

I don't have the specific household income data you're looking for. However, our online and in-store appraisal services have resonated well with a wide range of consumers. Interestingly, for the quarter, we saw an increase in purchases of larger SUV pickup trucks, which could be influenced by gas prices. On the flip side, we also noted that more consumers were willing to sell their vehicles if the pricing was right. While I don't currently have the household income data to provide specific details, I can say that our products have appealed to a broad audience.

Yes. I guess what I would add to that just some of the credit perspective trying to align maybe household income with the credit quality of the customer coming through the door. 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 markets 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 they're going to be able to get there. So again provided there is 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 the gross profit dollars we 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. Does add expense kind of step up here given the multi-channel has been initially rolled out, head count it sounds like it could moderate a bit? So, just help us to understand kind of how to think about the pace of SG&A dollars for the back half?

Yes. What we indicated in our last call is that for fiscal year 2023, we expect to exceed the historical range of high single-digit growth. We require more than that to leverage this upcoming year, primarily due to the annualization of our staffing success, with Q1 being the quarter where we see most of that impact. We are dedicated to aligning our expenses with customer demand, and we've already taken steps in that direction. Therefore, from a year-over-year leverage perspective, Q1 is indeed our most challenging quarter.

Thank you.

Thank you.

All right. 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 Maxoffer tool a little bit better. Can you give us a feel for the economics of that tool? And 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 sourced directly from the consumer or from auctions? Thanks.

Yes, Craig. As I mentioned earlier, we're excited about Maxoffer. It’s a product we've been developing, which took a bit of a back seat to the IO, but we're using similar algorithms. In terms of profitability, the Maxoffer purchases are definitely more profitable than purchasing offsite. When I evaluate this, the most profitable options are the IOs that draw consumers to bring us their cars for clear reasons, excluding logistics and such. However, Maxoffer isn't as profitable as consumer-sourced cars, yet it remains more profitable than offsite buying, mainly because we don't incur buying fees. As for why dealers opt to use it, many have inventory they aren't interested in or appraisals they struggle to value. This service is offered at no cost and has proven effective. As mentioned in the call, we operate in over 30 markets and see significant expansion opportunities. Edmunds works with thousands of dealers through their auctions, and we also collaborate with thousands of dealers, so we believe there's substantial potential here.

Can you shed any light on the fee structure? Are you getting a fee or they getting a fee?

So we make it worthwhile for our time, and the dealers actually earn some money from these, which is how we manage the process.

Perfect, thank you.

All right. And our next question will come from Evan Silverberg with Morgan Stanley. Please go ahead.

Good morning all. Evan Silverberg on for Adam Jonas. Recognizing there were some color in the prepared remarks on comps per month year-over-year. Curious if you could give any additional color on an absolute basis? How sales trended throughout the quarter? And what you're thinking in terms of exit rate into 2Q?

Yes. As I mentioned in my opening remarks, the performance improved steadily throughout the quarter, moving from double-digit declines to low single-digit negative comparisons by the end of the quarter. We are pleased with this trend. We will discuss June in the second quarter at that time, but overall, we feel satisfied as we concluded the quarter.

And even within the quarter are you seeing any trends within the tiers of the consumer or you think it's pretty steady throughout the different classes?

No. I think it's pretty steady through the different ones, as Jon pointed out earlier, I think that, that lower FICO customer is probably being impacted the most by vehicle affordability. But again that, that's the way it started out at the beginning of the quarter and that's the way it ended the quarter. So I think it's fairly consistent throughout the quarter.

Great. Thank you very much.

Thank you.

All right. 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 in the debt pay down. I was just curious on the roughly now I think about $1 billion then due two years from now. Is your goal to just get rid of that revolver through internal free cash flow generation before that time? Are you willing to do an five year, 10-year bond offering at some point?

Yes. Well we would. As you said, I mean, we are very pleased with our cash flow performance in the quarter. 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, will 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 30% to 45% adjusted debt-to-cap, and that's how we kind of manage the business we do that by taking on debt, we’re pulling down debt and also by our share repurchase program. So those are the levers that we use. So moving forward, you know, we’ll end up managing to that rate.

Okay. And on 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 in the past several quarters. Just curious, was your inventory decline here intentional to get some free cash flow generation? Or is it perhaps a function of buying more older vehicles?

Yes, it was a little bit more seasonal, you have this time of 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. It's a little bit of that. We also saw quarter-to-quarter just the average cost of our inventory went down a little bit too. So we did see that, and that helped us a little bit as well.

Okay, thank you.

All right. And moving on, we'll hear from Chris Bottiglieri with BNP Paribas. Please go ahead.

Hey, everyone. Thanks for taking the question. Just wanted to ask a follow-up question on kind, of CAF funding cost. So sort of I guess a few things like the interest rate hedge question, are you seeing that interest rates stay at these levels at the $9 million hedging benefit would unwind and trying to understand, like how long you said just last for? And then separately for the warehouse facility, kind of, in the K, like what's the benchmark rate for the warehouse facility is that like LIBOR or whatevere replace LIBOR or SIP number that’s called? And then, sorry, one last follow-on to this bigger picture, so I could tell you probably passed on that 50 bps of rate some of the customer. How much of that 300 basis point increase in benchmark rates do you ultimately think you’ll pass-through? And that's it from me.

I'll take the last one first, actually, yes, as you mentioned, we certainly have past along rates consumers. As I said previously, it's going to constantly be a test that assess right you recognize of 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 and it wasn't just a single move and then forget it, and then absorbed it, it was identified pockets of populations that we think are less elastic more elastic test, adjust, you know, look at what our competition is doing, and that's generally how we operate. So again we are not looking to absolutely lead the market in past in that great along. We want to make sure we remain highly competitive. Again, fortunately, we have that three-day payoff option. The customers may take advantage of to make sure we still sell the car. So I can't speculate exactly a much will pass along, but you understand how we're managing it.

Yes, regarding the other two questions, the cost basis in our warehouses is tied to LIBOR and increasingly to SOFR as it matures. Concerning the hedging question, it specifically relates to the $9 million, but we do not have an accounting hedge; we have a cash flow hedge. This will change and can be beneficial like this quarter, but could become a drawback only when interest rates change sharply. The adjustments depend on those rate changes because we have the hedge. The impact is only going to vary on a quarter-to-quarter basis, and it primarily relates to a much smaller pool of receivables with our banking partners for alternative funding. However, if interest rates don’t change sharply, there won’t be a significant impact from quarter to quarter.

That’s okay. And then bigger picture question, the GPUs, I mean, this feels like a two to three standard deviation move in the GPU, like you usually are pretty methodical about kind of past the amount of the consumer taking market share. Just kind of your taking that GPU in kind of letting your ASP’s in output. So I guess it cut us down like, when I could tell you're comfortable running at this higher GPU level like what's philosophically changing that's causing you to kind of shift towards GPU and maybe less than market share or help maybe I'm wrong here in understanding correctly, how would you frame it?

No, I think you're right, it is lumpy in any given quarter you can make $50 to $80 difference, this is always little bit more than and it was a conscious decision. But again, the way we approach is we really look for efficiencies first and foremost. And if we find the efficiencies then you have the decision to make. If 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 towards the price and just based on all the factors that we took some of these efficiency. 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 sub-sufficiency we continue to pass them and then we took a little bit more this quarter. So it was a conscious decision as far as going forward, we'll continue to monitor things and what competitors are doing and the elasticity and make decisions 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 in our market share.

Yes.

Thank you.

All right. And we'll take a follow-up from Chris Pierce with Needham. Please go ahead.

Good morning. You mentioned the importance of aligning expenses better and also the goal of growing market share. I'm curious about your views on advertising moving forward, especially given the competitive landscape and the current state of the market. How do you plan to approach advertising and advertising per vehicle in this context?

Yes. Thank you for the question, Chris. I believe our perspective on advertising remains consistent with what we’ve stated for the upcoming year. We expect to see an increase, and if you look back to the period before COVID, we were up 70%.

In total dollars and then on a per unit basis, most up 60%.

Yes. When I think about advertising, there's a lot of positive developments to mention. Although consumer demand is soft, many companies are investing in advertising. Our plan moving forward aligns with our original guidance, which we estimate to be around $350 per unit. It may be slightly higher this quarter, but it's a useful benchmark as we progress. We also have many new capabilities; for example, we expect to begin advertising online self progression later this year. As we do this, we'll adjust our spending, constantly shifting funds between acquisition and awareness efforts, whether for appraisal awareness or consumer awareness. So, you can expect to see some new messaging later this year.

Great. Thank you.

Thank you.

And we have no further questions at this time. I'll turn the conference back over to Bill for any closing remarks.

All right. 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 and each others and our communities. And even particularly the environment, we just recently published our 2022 responsibility report, if you haven't had a chance 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. And you may now disconnect.