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
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.
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 website and related mobile apps serve as sales channels for
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 36.1% of our retail used vehicle unit sales in the
first three months of fiscal 2021. As of
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.
Impact of COVID-19
In
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As shelter-in-place orders are being phased out and we have begun to reopen
stores and auctions, we have implemented robust plans to reduce the risk of
exposure and further spread of the virus in our stores and continue to follow
the mandates of public health officials and government agencies. We are adhering
to occupancy restrictions at our stores where required. We also launched
contactless curbside pickup to better serve our customers in alignment with
enhanced safety practices. In addition, we quickly shifted our wholesale
business from in-person to online auctions, and we continue to keep our
appraisal lanes open where possible for customers
These developments have caused significant disruption to our business and had a significant impact on our financial position, results of operations and cash flows in the first quarter of fiscal 2021. Sales performance in the first quarter of fiscal 2021 was significantly impacted by the COVID-19 pandemic. At the peak of the COVID-19 pandemic to date, in early April, due to the mandates of public health officials and government agencies, approximately half of our stores were closed or under limited operations. Limited operations means the stores could sell cars but were limited to appointment-only, curbside pickup, home delivery or some combination of all three. As a result, used vehicle sales were down more than 75% during that period. Further, pricing and margin was pressured by sharp declines in industry wholesale valuations due to a steep depreciation environment.
Since hitting a trough in early April, we have seen our sales progressively
improve as stores reopen, occupancy restrictions start to ease and customers
begin to re-engage in car buying. As of
As a result of the improvement in sales in May and June, we have begun increasing production to raise our inventory levels. We expect there to be service inefficiencies in the second quarter as it takes time to return production to a normalized operating state.
The impact of COVID-19 on CAF loan origination volume has been consistent with our retail and wholesale sales performance noted above. As the pandemic escalated, we saw an increase in delinquencies and greater demand for payment extensions. In response, we implemented a variety of measures to support our customers through this difficult time and to maximize the long-term collectability of the portfolio. This included suspending repossessions, waiving late fees, and providing loan payment extensions where appropriate. In addition to pausing our in-house Tier 3 lending, we also made temporary underwriting adjustments focused on preserving our high-quality portfolio and tested certain loan routing to our third-party providers.
Payment extensions spiked in April and have declined significantly in recent weeks as customers have exhibited the ability and willingness to pay. During the first quarter of fiscal 2021, delinquency rates were lower year-over-year. However, this was largely due to payment extensions that were granted during the quarter. We plan to continue supporting our customers with a focus on providing appropriate relief while at the same time protecting our portfolio.
In response to COVID-19, we took several measures in the first quarter of fiscal 2021 to enhance our liquidity position and provide additional financial flexibility. This included drawing down additional funds on our revolving credit facility, pausing our stock repurchase program, pausing our store expansion strategy and remodels, reducing inventory levels and aligning other operating expenses to the lower sales volume. In addition to the temporary furlough mentioned above, we also implemented a hiring freeze, reduced advertising spending and reduced labor hours.
At the same time, we took advantage of our financial strength to continue making investments in our omni-channel experience and other digital initiatives that provide us with a competitive advantage. We implemented the most pertinent parts of the omni-channel experience in the first quarter, including launching a new initiative, contactless curbside pickup, to 200 stores nationwide. We expect to complete the rollout of our omni-channel experience in the second quarter of fiscal 2021.
As a result of these measures, we had
During the first quarter of fiscal 2021, new legislation was enacted, and new
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The COVID-19 pandemic remains a rapidly evolving situation. We continue to actively monitor developments that may cause us to take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our associates, customers and shareholders. The duration and severity of the COVID-19 outbreak are uncertain, and we are unable to determine the full impact that social distancing protocols, or potential subsequent outbreaks, will have on our operations or consumer demand. As such, the full impact on our revenues, profitability, financial position and liquidity remains uncertain at this time.
Revenues and Profitability The sources of revenue and gross profit from the CarMax Sales Operations segment for the first three months of fiscal 2021 are as follows:
Operating Revenues
[[Image Removed: chart-41964b4c37425108a0c.jpg]][[Image Removed: chart-11daf93103ac5e7eb94.jpg]] A high-level summary of our financial results for the first quarter of fiscal 2021 as compared to the first quarter of fiscal 2020 is as follows:
Change from
(Dollars in millions except per share or per Three Months Ended Three Months Ended unit data)
May 31, 2020 May 31, 2019
Income statement information
Net sales and operating revenues $ 3,228.8 (39.8 )% Gross profit $ 354.2 (52.3 )% CAF income $ 51.0 (56.1 )% Selling, general and administrative expenses $ 373.7 (23.7 )% Net earnings $ 5.0 (98.1 )%
Unit sales information
Used unit sales 135,028 (39.8 )% Change in used unit sales in comparable stores (41.8 )% N/A Wholesale unit sales 63,295 (47.6 )%
Per unit information
Used gross profit per unit $ 1,937 (12.6 )% Wholesale gross profit per unit $ 978 (6.2 )% SG&A per used vehicle unit $ 2,768 26.8 %
Per share information
Net earnings per diluted share $ 0.03 (98.1 )% Page 31 --------------------------------------------------------------------------------
Revenues and profitability for the first quarter of fiscal 2021 were
significantly impacted by COVID-19, as previously discussed. The results for the
first quarter of fiscal 2021 included
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. During the first three
months of fiscal 2021, net cash provided by operations totaled
When considering cash from operating activities, management does not include
changes in auto loans receivable that have been funded with non-recourse notes
payable, which are separately reflected as cash (used in) provided by financing
activities. For a reconciliation of adjusted net cash provided by operating
activities to net cash provided by (used in) operating activities, the most
directly comparable GAAP financial measure, see "Reconciliation of Adjusted
As noted above, in response to the COVID-19 situation, we took certain measures to enhance our liquidity position and provide additional financial flexibility, including drawing down additional funds on our revolving credit facility, pausing our stock repurchase program, pausing our store expansion strategy and remodels and actively aligning operating expenses to the current state of the business, including the previously discussed furlough. As a result of these measures, we strengthened our overall financial position by selling through inventory and quickly aligning costs to lower sales volumes. We exited the first quarter of fiscal 2021 in a stronger liquidity position than we entered. We believe we have sufficient liquidity and financial strength to support our operations and continue investing in our omni and digital initiatives for the foreseeable future.
Future Outlook The COVID-19 situation has created an unprecedented and challenging time. Our current focus is on positioning the company for a strong recovery as we emerge from this crisis. As discussed above, we have taken several steps to ensure a strong liquidity position and enable our stores to operate amidst the current health and safety concerns. We will continue to monitor the COVID-19 situation and make any further decisions around preserving cash and reducing our operating expenses as appropriate.
We recognize the current environment has accelerated a shift in consumer buying behavior. Customers are seeking safety, personalization and convenience more than ever in how they shop for and buy a vehicle. Our omni-channel experience empowers customers to buy a car on their own terms, whether completely from home, in-store or through a seamlessly integrated combination of online and in-store experiences. The current environment creates a unique opportunity for us to accelerate our omni-channel experience and other digitally driven investments, which are significant competitive advantages for us. We expect to complete our omni-channel rollout in the second quarter of fiscal 2021 and are focusing our efforts on optimizing this customer experience with new enhancements.
In the near term, our strategic investments will focus on our customer experience, vehicle acquisition and our wholesale business. This includes a continued focus on driving effectiveness through our centralized CECs, improving our core buying channels and opening new buying channels and modernizing our wholesale auction platforms. As we complete the roll out of our omni-channel experience, we do not expect to realize the full extent of efficiencies gained from the CECs during this fiscal year. We will continue to assess opportunities to become leaner, more agile and a more cost-effective organization over the long term.
Our long-term strategy continues to be focused on completing the rollout of our retail concept, including our omni-channel experience, and increasing our share of used vehicle unit sales in each of the markets in which we operate. We believe, over the long term, used vehicle unit sales are the primary driver for earnings growth. We also believe increased used vehicle unit sales will drive increased sales of wholesale vehicles and ancillary products and, over time, increased CAF income.
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In calendar 2019, we estimate we sold approximately 4.7% of the age 0- to 10-year old vehicles sold in the comparable store markets in which we were operating and approximately 3.5% of the age 0- to 10-year old vehicles sold on a nationwide basis. 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 and developing an engaged and skilled workforce.
• Improving efficiency in our stores and our logistics operations to drive out waste. • Leveraging data and advanced analytics to continuously improve the customer experience as well as our processes and systems.
In order to execute our long-term strategy, we have invested in various strategic initiatives to increase innovation, specifically with regards to customer-facing and customer-enabling technologies. We continue to make improvements to our website and enhance customer experiences, such as finance pre-approval, online appraisal, home delivery and curbside pick-up. We are also developing and implementing tools that help our associates be more efficient and effective. Additionally, we have centralized customer support in our CECs, which we believe provides a more seamless integration between the online and in-store experience for our customers. 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.
As of
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 ended
CRITICAL ACCOUNTING POLICIES
As a result of our adoption of the new accounting standard related to the
measurement of credit losses on financial instruments ("CECL") on
Allowance for Loan Losses. The allowance for loan losses represents the net credit losses expected over the remaining contractual life of our managed receivables. Because net loss performance can vary substantially over time, estimating net losses requires assumptions about matters that are uncertain.
The allowance for loan losses is determined using a net loss timing curve,
primarily based on the composition of the portfolio of managed receivables and
historical gross loss and recovery trends. For receivables that have less than
18 months of performance history, the net loss estimate takes into account the
credit grades of the receivables and historical losses by credit grade to
supplement actual loss data in estimating future performance. Once the
receivables have 18 months of performance history, the net loss estimate
reflects actual loss experience of those receivables to date along with forward
loss curves to predict future performance. The forward loss curves are
constructed using historical performance data and show the average timing of
losses over the course of a receivable's life.
The output of the net loss timing curve is adjusted to take into account
reasonable and supportable forecasts about the future. Specifically, the change
in
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Determining the appropriateness of the allowance for loan losses requires
management to exercise judgment about matters that are inherently uncertain,
including the timing and distribution of net losses that could materially affect
the allowance for loan losses and, therefore, net earnings. To the extent that
actual performance differs from our estimates, additional provision for credit
losses may be required that would reduce net earnings. A 10% change in the
estimated loss rates would have changed the allowance for loan losses by
approximately
See Note 4 for additional information on the allowance for loan losses.
There have been no additional changes to our critical accounting policies during
the three months ended
RESULTS OF OPERATIONS - CARMAX SALES OPERATIONS
NET SALES AND OPERATING REVENUES
Three Months Ended May 31 (In millions) 2020 2019 Change Used vehicle sales$ 2,786.2 $ 4,540.7 (38.6 )% Wholesale vehicle sales 342.9 662.4 (48.2 )% Other sales and revenues: Extended protection plan revenues 73.4 111.3 (34.1 )% Third-party finance fees, net (10.7 ) (15.5 ) 30.7 % Other 37.0 67.4 (45.0 )% Total other sales and revenues 99.7 163.2 (38.9 )%
Total net sales and operating revenues
UNIT SALES Three Months Ended May 31 2020 2019 Change
Used vehicles 135,028 224,268 (39.8 )% Wholesale vehicles 63,295 120,768 (47.6 )%
AVERAGE SELLING PRICES
Three Months Ended May 31 2020 2019 Change
Used vehicles
COMPARABLE STORE USED VEHICLE SALES CHANGES
Three Months Ended May 31 (1) 2020 2019 Used vehicle units (41.8 )% 9.5 % Used vehicle revenues (40.8 )% 9.4 %
(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. Page 34 -------------------------------------------------------------------------------- VEHICLE SALES CHANGES Three Months Ended May 31 2020 2019 Used vehicle units (39.8 )% 13.0 % Used vehicle revenues (38.6 )% 12.9 % Wholesale vehicle units (47.6 )% 6.6 % Wholesale vehicle revenues (48.2 )% 7.3 % USED VEHICLE FINANCING PENETRATION BY CHANNEL (BEFORE THE IMPACT OF 3-DAY PAYOFFS) Three Months Ended May 31 (1) 2020 2019 CAF (2) 38.2 % 46.2 % Tier 2 (3) 28.5 % 20.3 % Tier 3 (4) 14.5 % 11.5 % Other (5) 18.8 % 22.0 % 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 3 loan originations, which represent less than 1% of
total used units sold.
(3) Third-party finance providers
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 2020 2019 Used car stores, beginning of period 216 203 Store openings 4 3 Used car stores, end of period 220 206
During the first three months of fiscal 2021, we opened four stores, all in
existing television markets (
Used Vehicle Sales. The 38.6% decrease in used vehicle revenues in the first quarter of fiscal 2021 was primarily due to a 39.8% decline in used unit sales. The decrease in used units included a 41.8% decrease in comparable store used unit sales. The comparable store used unit sales performance reflected the combined effects of COVID-19 related store closures and restrictions on operations, as well as reduced customer traffic resulting from the economic impact of the pandemic and nationwide shelter-in-place orders. More than 80% of the days in the first quarter of fiscal 2021 were negatively impacted by a mix of store closures, limited operations and occupancy restrictions.
The increase in average retail selling price in the first quarter of fiscal 2021 reflected higher vehicle acquisition costs, primarily related to inventory acquired prior to the steep depreciation environment experienced during the quarter, as well as shifts in the mix of our sales by both vehicle age and class.
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 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.
The 48.2% decrease in wholesale vehicle revenues in the first quarter of fiscal 2021 was primarily due to a 47.6% decrease in unit sales as well as a 2.0% decline in average selling price. The wholesale unit decline reflected both lower appraisal traffic and a reduction in our appraisal buy rate, partially offset by the shift in our wholesale business from in-person to online auctions. Our
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buy rate typically declines during periods of weaker wholesale industry pricing as we adjust our appraisal offers in response to the wholesale pricing environment. Our auction sales rate for the first quarter of fiscal 2021 was consistent with our historical rate of approximately 95%.
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 fees, and other revenues, which are predominantly comprised of service department and new vehicle 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 declined 38.9% in the first quarter of fiscal 2021,
reflecting decreases in EPP revenues, new car sales and service department
sales. EPP revenues declined 34.1%, largely reflecting the reduction in our used
unit sales. EPP revenue for the first quarter of fiscal 2021 included a
year-over-year benefit of
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 (In millions) 2020 2019 Change Used vehicle gross profit$ 261.5 $ 496.8 (47.4 )% Wholesale vehicle gross profit 61.9 126.0 (50.8 )% Other gross profit 30.8 119.6 (74.3 )% Total$ 354.2 $ 742.4 (52.3 )% GROSS PROFIT PER UNIT Three Months Ended May 31 2020 2019 $ per unit(1) %(2) $ per unit(1) %(2)
Used vehicle gross profit $ 1,937 9.4 $ 2,215 10.9 Wholesale vehicle gross profit $
978 18.1 $ 1,043 19.0 Other gross profit $ 228 30.8 $ 533 73.3 Total gross profit $ 2,623 11.0 $ 3,310 13.8
(1) Calculated as category gross profit divided by its respective units sold,
except the other and total categories, which are divided by total used
units sold.
(2) 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.
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 typically generate more gross profit per unit compared with vehicles purchased at auction or through other channels.
Page 36 --------------------------------------------------------------------------------
Used vehicle gross profit declined 47.4% in the first quarter of fiscal 2021,
reflecting the 39.8% decline in total used unit sales as well as the
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 decreased 50.8% in the first quarter of fiscal
2021, driven by both the 47.6% reduction in wholesale unit sales and a
Other Gross Profit. Other gross profit includes profits related to EPP revenues, net third-party finance fees and other revenues. Other revenues are predominantly comprised of service department operations, including used vehicle reconditioning, and new vehicle sales. We have no cost of sales related to EPP revenues or net third-party finance fees, as these represent revenues paid to us by certain third-party providers. Third-party finance fees are 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 declined 74.3% in the first quarter of fiscal 2021 due to a
Impact of Inflation. Historically, inflation has not had a significant impact on results. Profitability is primarily affected by our ability to achieve targeted unit sales and gross profit dollars per vehicle rather than by changes in average retail prices. However, we believe higher vehicle acquisition prices have adversely impacted, and could impact in the future, our comparable store used unit sales growth. Changes in average vehicle selling prices can also impact CAF income, to the extent the average amount financed also changes.
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SG&A Expenses
COMPONENTS OF SG&A EXPENSES AS A PERCENTAGE OF TOTAL SG&A EXPENSES [[Image Removed: chart-d9fed172b898519f847.jpg]] COMPONENTS OF SG&A EXPENSES COMPARED WITH PRIOR PERIOD
Three Months Ended May 31 (In millions except per unit data) 2020 2019 Change Compensation and benefits: Compensation and benefits, excluding share-based compensation expense$ 191.2 $ 230.0 (16.8 )% Share-based compensation expense 23.7 40.9 (42.2 )% Total compensation and benefits (1)$ 214.9 $ 270.9 (20.7 )% Store occupancy costs 94.6 96.6 (2.1 )% Advertising expense 34.5 41.9 (17.6 )% Other overhead costs (2) 29.7 80.3 (63.0 )% Total SG&A expenses$ 373.7 $ 489.7 (23.7 )% SG&A per used vehicle unit (3)$ 2,768 $ 2,183 $ 585
(1) Excludes compensation and benefits related to reconditioning and vehicle
repair service, which are included in cost of sales. See Note 10 for
details of share-based compensation expense by grant type.
(2) Includes IT expenses, preopening and relocation costs, insurance, non-CAF
bad debt, travel, charitable contributions and other administrative
expenses.
(3) Calculated as total SG&A expenses divided by total used vehicle units.
SG&A expenses decreased 23.7% in the first quarter of fiscal 2021. This decrease reflected a reduction in costs associated with our decline in sales volume, the furlough of associates and the alignment of other costs to the state of the business, partially offset by an increase in costs as a result of the 8% growth in our store base since the beginning of fiscal 2020 (representing the addition of 17 stores). The net decrease also included the following: •$40.3 million one-time benefit, representing our receipt of settlement proceeds in a class action lawsuit related to the economic loss associated with vehicles containing Takata airbags. •$17.2 million decrease in share-based compensation expense. The decrease in share-based compensation expense was 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. •$7.4 million decrease in advertising expense in response to COVID-19. We expect that our advertising expense for the remainder of the year, on a per unit basis, will be comparable to the per unit expense in fiscal 2020, dependent on sales performance. Page 38 --------------------------------------------------------------------------------
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
Income Taxes. The effective income tax rate was (19.5)% in the first quarter of
fiscal 2021 versus 24.1% in the first quarter of fiscal 2020. During the first
quarter of fiscal 2021, our provision for income taxes and effective tax rate
were positively impacted by
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 strived to originate loans with an underlying risk profile that we believe will, in the aggregate and excluding CAF's Tier 3 originations, result in cumulative net losses in the 2% to 2.5% range 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 possible effects of the COVID-19 outbreak) and wholesale recovery rates. Based on underwriting adjustments made during the first quarter of fiscal 2021, in response to higher anticipated losses related to COVID-19, we are currently targeting new loans toward the higher end of this range. 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 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 3 for additional information on CAF income and Note 4 for information on auto loans receivable, including credit quality. SELECTED CAF FINANCIAL INFORMATION
Three Months Ended May 31 (In millions) 2020 % (1) 2019 % (1) Interest margin: Interest and fee income$ 282.5 8.4$ 266.2 8.4 Interest expense (84.6 ) (2.5 ) (87.4 ) (2.8 )
Total interest margin
(1) Annualized percentage of total average managed receivables.
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CAF ORIGINATION INFORMATION (AFTER THE IMPACT OF 3-DAY PAYOFFS)
Three Months EndedMay 31 2020 2019
Net loans originated (in millions)
48,696 92,958 Net penetration rate (1) 36.1 % 41.4 % Weighted average contract rate 8.4 % 8.9 % Weighted average credit score (2) 707 704 Weighted average loan-to-value (LTV) (3) 93.1 % 94.4 % Weighted average term (in months) 66.1 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 4. 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) 2020 2019 Total ending managed receivables$ 13,171.9 $ 12,859.4 Total average managed receivables$ 13,408.5 $ 12,707.3 Allowance for loan losses (1)$ 437.2 $ 147.0
Allowance for loan losses as a percentage of ending managed receivables
3.32 % 1.14 % Net credit losses on managed receivables$ 44.6 $ 29.4
Annualized net credit losses as a percentage of total average managed receivables
1.33 % 0.93 % Past due accounts as a percentage of ending managed receivables 2.48 % 3.36 % Average recovery rate (2) 47.3 % 49.2 %
(1) The allowance for loan losses as of
increase as a result of our adoption of CECL during the first quarter of
fiscal 2021.
(2) 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 60%, and it is primarily affected by the wholesale market environment.
• CAF Income (Decrease of
• The decrease in CAF income for the first quarter of fiscal 2021 reflects an increase in the provision for loan losses, partially offset by improvement in the total interest margin percentage. • The decline in net loan originations in the first quarter of fiscal 2021 resulted from our used vehicle sales decline as well as a decline in CAF's penetration rate. • The decrease in CAF's penetration rate reflected the combined effects of a shift in customer credit mix, adjustments to CAF's credit policies made in response to COVID-19 and testing of loan routing to our third-party providers. Page 40 --------------------------------------------------------------------------------
• Provision for Loan Losses (Increased to
• The increase in the provision for loan losses included an increase of$84.0 million in our estimate of lifetime losses on existing loans, which was an approximately 25% increase in our loss expectations, largely resulting from COVID-19 turmoil and worsening economic factors. • The remaining$38.0 million largely reflected our estimate of lifetime losses on originations in the first quarter of fiscal 2021. • In connection with our adoption of CECL during the first quarter of fiscal 2021, we recorded a$202.0 million increase in the allowance for loan losses on the first quarter opening balance sheet, with a corresponding decrease of$153.3 million , net of tax, in retained earnings. • Total interest margin (Increased to 5.9% of average managed receivables from
5.6%)
• The increase in the total interest margin percentage was the result of lower funding costs.
Tier 3 Loan Originations. CAF also originates a small portion of auto loans to
customers
PLANNED FUTURE ACTIVITIES
During the first quarter of fiscal 2021, we opened four stores, all in an
existing markets (
FINANCIAL CONDITION
Liquidity and Capital Resources Historically, our primary ongoing cash requirements have been to fund our existing operations, store expansion and improvement and CAF. 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.
During the first quarter of fiscal 2021, in response to the COVID-19 crisis, we
took immediate and proactive measures to bolster our liquidity position and
provide additional financial flexibility to improve our ability to meet our
short-term liquidity needs. Those measures included drawing down additional
funds on our revolving credit facility, pausing our stock repurchase program,
pausing our store expansion strategy and actively aligning operating expenses to
the current state of the business, including the temporary furlough of over
15,000 associates in
Operating Activities. During the first three months of fiscal 2021, net cash
provided by operating activities totaled
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loans receivable are accompanied by changes in non-recourse notes payable, which are separately reflected as cash from financing activities.
As of
When considering cash from operating activities, management uses an adjusted measure of net cash from operating activities that offsets the changes in auto loans receivable with the corresponding changes in non-recourse notes payable. This is achieved by adding back the cash from the net (payments on) issuances of non-recourse notes payable, which represents the change in auto loans receivable that were funded through the net (payments on) issuance of non-recourse notes payable during the period. The resulting financial measure, adjusted net cash from operating activities, is a non-GAAP financial measure. We believe adjusted net cash from operating activities is a meaningful metric for investors because it provides better visibility into the cash generated from operations. Including the changes in non-recourse notes payable, net cash provided by operating activities would have been as follows:
RECONCILIATION OF ADJUSTED NET CASH FROM OPERATING ACTIVITIES
Three Months Ended May 31 (In millions) 2020 2019
Net cash provided by operating activities
(438.3 ) 358.2
Adjusted net cash provided by operating activities $ 811.3 $ 401.4
(1) Calculated using the gross issuances less payments on non-recourse notes payable as disclosed on the consolidated statements of cash flows.
Adjusted net cash provided by operating activities for the first three months of the current fiscal year increased compared with the prior year period primarily due to the changes in inventory discussed above, partially offset by timing-related changes to accounts receivable and 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 the fiscal year, net cash
used in investing activities totaled
As of
Financing Activities. During the first three months of fiscal 2021, net cash
used in financing activities totaled
During the first three months of fiscal 2021, cash used in financing activities
was impacted by stock repurchases of
Page 42 -------------------------------------------------------------------------------- TOTAL DEBT AND CASH AND CASH EQUIVALENTS (In thousands) As of May 31 As of February 29 Debt Description (1) Maturity Date 2020 2020 Revolving credit facility (2) June 2024$ 370,086 $ 452,740 Term loan June 2024 300,000 300,000 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 Financing obligations February 2059 535,078 536,739 Various dates through May Non-recourse notes payable 2027 13,174,982 13,613,272 Total debt (3) 14,880,146 15,402,751 Cash and cash equivalents$ 658,022 $ 58,211
(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), the federal funds rate, or the prime rate, depending on the type
of borrowing.
(3) Total debt excludes unamortized debt issuance costs. See Note 9 for
additional information.
Borrowings under our
See Note 9 for additional information on our revolving credit facility, term loan, 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 of
We have periodically increased our warehouse facility limit over time, as our store base, sales and CAF loan originations have grown. See Note 9 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. As of
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Fair Value Measurements We recognize money market securities, mutual fund investments and derivative instruments at fair value. See Note 6 for more information on fair value measurements.
FORWARD-LOOKING STATEMENTS We caution readers that the statements contained in this report about our future business plans, operations, capital structure, opportunities, or prospects, including without limitation any statements or factors regarding expected operating capacity, sales, margins, expenditures, CAF income, stock repurchases, indebtedness, tax rates, earnings, or market conditions 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," "predict," "should," "will" and other similar expressions, whether in the negative or affirmative. Such forward-looking statements are based upon management's current knowledge 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 COVID-19 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. • 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 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. • The failure or inability to realize the benefits associated with our strategic investments. • 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.
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• 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 47 of this report, our Annual Report on Form 10-K for
the fiscal year ended
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