Carmax Inc

NYSE:KMX

Earnings Call Transcript 2022-Q2

[Bill Nash, President, Chief Executive Officer]

Good morning and thank you for joining us.

As you read in our earnings release this morning, we delivered a record level of used sales for the second quarter and all-time record for wholesale vehicle sales, as well as robust CarMax auto finance income growth.

For the second quarter of FY22, our diversified business model delivered totaled sales of $8 billion, up 49% compared with the second quarter of FY21, driven by higher average selling prices and volume gains. Net earnings per diluted share was $1.72, down $0.07 from a year ago as we rolled over last year’s pandemic-driven expense reductions and also continued to invest in our growth.

Across our retail and wholesale channels, we sold approximately 420,000 cars in total, up 20% versus the second quarter last year. For the six months of FY22, we have sold approximately 872,000 retail and wholesale cars combined. We also bought 59% more cars from consumers in the second quarter this year versus last year and achieved record self sufficiency of approximately 70%.

Our omnichannel platform, unique customer offerings, solid execution and macro factors are driving performance across our company. In our retail business, total unit sales in the second quarter were up 6.7% and used unit comps were up 6.2% versus the second quarter last year despite headwinds from inventory levels, staffing, and overall used car valuations. Our teams made steady progress in building our saleable inventory during the quarter and we achieved sequential growth each month despite the strong retail demand that carried into the second quarter. While it remains below our targeted levels, we are on pace to grow our saleable inventory during the balance of the year.

In addition to strong unit sales, we reported $2,185 of retail gross profit per used unit, in line with our historical second quarter performance. For wholesale, units sold were up 41.4% from a record second quarter last year. Wholesale gross profit per unit was $1,005 compared with $1,086 for the same period last year. The strength in wholesale units was primarily driven by the ongoing success of our instant online appraisal offering that rolled out nationwide on carmax.com in February after launching on edmunds.com last year. We also benefited from still elevated valuations of used autos in the broader market.

CarMax auto finance, or CAF continued to deliver solid results with income of $200 million. In addition, CAF and our partner lenders delivered strong offers in all credit tiers, though we did see a sequential decline in Tier 3 volume relative to the first quarter. John will provide more details on customer financing and CAF contribution shortly.

Now I’d like to turn the call over to Enrique, who will provide more information on our second quarter financial performance, followed by John. After that, I’ll update you on the progress against our strategic priorities and then open up the call to Q&A.

Enrique?

[Enrique Mayor-Mora]

Thanks Bill and good morning everyone.

Total gross profit was $815 million, up 8% over last year’s second quarter. This was driven by wholesale vehicle margin of $189 million, which was up 31%, and used vehicle margin of $507 million, which was up 5% from last year’s second quarter. Other gross profit was $120 million, down $7 million from last year’s second quarter. Favorability in the quarter included $22 million of margin contribution from Edmunds since our June 1, 2021 acquisition. This was on revenues of $34.5 million, which is noted as advertising and subscription revenues in the earnings release.

Other gross profit also benefited from an $18 million improvement in third party finance fees with income of $3 million compared with $15 million in costs last year. This was driven by lower Tier 3 volume compared with last year and our renegotiated third party finance fees.

Offsetting this favorability, service was down $40 million, primarily the result of rolling over of favorable items from the prior year’s quarter and short term headwinds during this year’s quarter. Specifically, we comped over last year’s COVID-related cost reductions. Additionally, we experienced higher 90-day warranty cost timing stemming from the significant increase in sales during the first quarter of fiscal year ’22 compared to last year’s first quarter. We also realized lower retail service margin as production capacity was focused on reconditioning retail cars.

Also impacting other gross profit, EPP was down $6 million or 5.4%. While penetration was stable at above 60%, last year’s second quarter included a benefit of approximately $8 million in profit sharing revenues that was not recognized this year due to a timing shift in the performance period for one of our providers.

On the S&GA front, expenses for the second quarter increased to $574 million, up 30% from our COVID impacted quarter a year ago and as we continued to invest in our strategic initiatives and growth. As a reminder, last year during the pandemic, we took aggressive cost containment actions particularly during the first half of the year. SG&A as a percent of gross profit was 70.4% compared to 58.8% during the prior year second quarter.

The increase in SG&A dollars over last year was primarily driven by three main factors: first, a $55 million increase in total compensation and benefits driven by staffing and sales growth and by the inclusion of Edmunds payroll this quarter; second, a $41 million increase in other overhead due to investments to advance our technology platforms and strategic initiatives; third, a $35 million increase in advertising expense as previously communicated to amplify the CarMax brand, build awareness of our omnichannel offerings, and drive customer acquisition. We estimate that the COVID-related cost savings in SG&A in the prior year quarter was between $25 million to $30 million. For the first six months of FY22, SG&A as a percent of gross profit was 64.8%, leveraging five points over last year’s first half rate of 69.3%.

We remain committed to ensuring we are efficient in our spend and we expect that targeted areas of focus will continue to deliver improvements over time. We achieved an additional reduction year-over-year from our core CDC cost structure during the second quarter. Additionally, our omnichannel capabilities will unlock new opportunities as we leverage automation to reduce expenses and streamline operations. For example, our online instant offer program in resulting in more efficient buying organization as we continue to leverage the power of automation, AI and data science.

On capital allocation, our ongoing focus is to deploy capital in our business to grow market share and deliver long-term shareholder value. That includes investing in digital capabilities to enhance all aspects of our omnichannel experience, such as online vehicle acquisition which is already generating a strong ROI. We also continue to invest in the strategic expansion of our store footprint and look for additional paths to create incremental value.

In regard to our share repurchase program, we remain committed to returning excess capital to shareholders and repurchased approximately 1.8 million shares in the quarter for approximately $220 million.

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

[Jon Daniels, Senior Vice President, CarMax Auto Finance]

Thanks Enrique and good morning everybody.

Once again, our finance business has delivered outstanding results. For the second quarter, CAF’s penetration net of three-day payoffs was 43% compared with 42.6% a year ago. Tier 2 decreased to 21.6% of used unit sales compared with 22.3% last year. Tier 3 accounted for 7.2% compared with 11.1% a year ago. As a reminder, last year CAF decided to strategically route a portion of its Tier 1 volume and all of its allocated Tier 3 volume to partners to preserve the high quality of its portfolio during the start of the pandemic. These changes were rolled back by the end of Q2 last year.

During the quarter, we observed strong offers from our Tier 2 partners as they competed for additional volume within the CarMax channel. We also saw a decrease in application volume and conversion to sale for applications in the lower portion of the credit spectrum. We believe these decreases are due in large part to the higher average selling prices seen across the industry.

During this year’s second quarter on the strength of record used unit sales, CAF’s net loans originated was nearly $2.4 billion. The weighted average contract rate charged to new customers was 8.5%, up from 8.2% a year ago but down from 9% in the first quarter. Similar to the first quarter, this year-over-year difference in APR is a result of the change in credit mix of customers rather than an increase in the rate charged.

For our portfolio, overall interest margin increased to 7.2% versus 6% in the same period last year, resulting in a year-over-year increase of $65 million or 33%. This strong net interest margin highlights the strength of our ABS program and the favorable state of the capital markets. Given we recognize income over the life of our loans, we will benefit from this higher net interest margin across multiple years.

CAF’s income for the quarter was $200 million, up from $147 million a year ago. This significant year-over-year increase comes as a result of the stronger net interest margin and higher receivables. Our expense related to the provision in the second quarter was $35 million and resulted in an ending reserve balance of $398 million for the second quarter, or 2.66% of managed receivables. This is in line with the 2.62% at the end of the first quarter while also reflecting a modestly higher percentage of Tier 3 loans in the portfolio as a result of our decision to retain 10% of Tier 3 volume. We believe our future outlook on losses and corresponding reserve is appropriate given the current macroeconomic environment.

With regard to our lending platform and specifically where CAF participates across the credit spectrum, we are constantly evaluating the landscape and remain committed to making decisions that we believe are sustainable in the long term and in the best interests of our customers. During the second quarter in coordination with our business partners, we began a small test of CAF originating in the Tier 2 space. Much like when CAF entered Tier 3, this test will remain in place at low volumes for an extended period as we take the time to understand both the Tier 2 customer and how CAF’s participation in this space can best enhance the range of credit options, improve the customer experience, and drive profitability.

Now I’ll turn the call back over to Bill.

[Bill Nash, President, Chief Executive Officer]

Thank you Jon, thank you Enrique.

I’m very proud of how our teams have driven strong results this quarter across our diversified business model, and we’re excited about the incredible opportunity that lies ahead. We’ve intentionally built our omnichannel platform to give every customer the ability to progress to a sale or a buy, regardless of how they shop with us. We’ve found that most customers don’t want to shop for a car in a way that is tied solely to an in-store or digital experience. While we provide the ability for customers to buy a car 100% in-store or 100% online, our omnichannel capabilities really differentiate CarMax by enabling our customers to personalize their experience with a mix of digital and physical interactions to meet their needs.

In the second quarter, approximately 9% of our retail unit sales were online, consistent with our first quarter and up from the prior year’s quarter of 3%. As a reminder, we consider it an online retail sale when a customer completes all four of the major transactional activity remotely, so that’s reserving a car, financing the vehicle if that’s needed, trading in or opting out of a trade-in, and creating a sales order.

Our wholesale auctions remains virtual, so 100% of wholesale sales, which represents 21% of total revenue, are considered online transactions. Total revenues resulting from online transactions was 28%. This is up from 24% in the first quarter and up from 18% in last year’s second quarter.

Approximately 55% of retail unit sales were omni sales this quarter, flat to the first quarter and up from the prior year’s second quarter of 49%. Omni sales are those where our customers complete at least one of those major transactional activities remotely.

We’ve been focused on completing the rollout of our 100% self-service experience, where customers can independently complete the entire car buying process online if they so choose. Currently, a little more than 50% of our customers have access to a complete end-to-end, unaided online experience. We are on track to bring this capability to all of our retail consumers by the end of the fiscal year. Remember, while rolling out access to these capabilities will enable more customers to complete a 100% self-service online experience, all customers currently can buy a car online with assistance from an associate.

In the second quarter, we bought approximately 188,000 vehicles from customers through our online instant appraisal, which represents about half of our total buys from customers. That’s a 15% increase from our record first quarter number. This growth supports our belief that we’ve become and are further expanding our position as the largest online buyer of used autos from consumers in the U.S.

We are continuously enhancing our ecommerce offerings to exceed customer expectations and to seamlessly integrate with our best-in-class store experience. Let me share a few examples.

One of the areas we’ve enhanced is our financing process. Nearly 65% of our finance customers start their loan process online with a pre-approval application, and as of the second quarter 100% of those customers now receive a digital decision that includes customized loan terms. A majority of those customers through no additional time or effort are provided digital access to their personal financing terms on every care in our inventory, allowing them to shop with more confidence. In addition, what differentiates our experience is the ability to provide these inventory-wide credit offers using multiple finance partners, including CAF. This ensures we provide our customers with the most attractive rates and terms. We’re excited about our progress on this crucial part of the car buying journey.

We also continue to advance what we believe is industry-leading digital merchandising, which is critical to providing customer an immersive experience with our inventory as they shop remotely. This quarter, we added 360 degree interior views from the driver’s side and the back seat of the vehicle and continue to advance vehicle hotspots, which are call-outs to help the customer understand key vehicle features. We also continue to leverage artificial intelligence to ensure that our photos are consistently high quality to best represent our inventory. We’re hearing very positive feedback on these advancements that help customers understand and fall in love with our vehicles as they shop online.

In relation to our acquisition of Edmunds, we’re very pleased with our progress as our teams have hit the ground running on new innovations. We will continue to invest in the Edmunds brand and work together to unlock opportunities to compete across the larger used auto ecosystem.

We are really proud of the quarter and the significant progress we have made in advancing our omnichannel strategy. We are well positioned to deliver the most customer-centric experience in the used auto industry, which will enable sustainable growth and create meaningful long term shareholder value.

With that, we’ll be happy to take your questions, so Kevin?

[Operator]

[Operator instructions]

Our first question comes from Brian Nagel of Oppenheimer.

[Brian Nagel, Oppenheimer]

Hi, good morning.

[Bill Nash, President, Chief Executive Officer]

Good morning Brian.

[Brian Nagel, Oppenheimer]

David, congratulations on the new role.

[David Lowenstein, Assistant Vice President, Investor Relations]

Thank you.

[Brian Nagel, Oppenheimer]

I guess the question I want to ask, and I know you talked about this a bit in your comments, but as we look at this quarter and the 6.2% used unit comp, maybe you can help us better contextualize that. I mean, against that backdrop and clearly with COVID, coming out of the COVID crisis, a lot of the internal initiatives, is there a way to think about that number on a more normalized basis? How is it tracking versus what you view as the real health, the underlying health of your business?

Then as a follow-up, just from a positioning standpoint, you and your team are talking more and more now about used cars together with wholesale cars as a measure of overall sales. Does that reflect more a strategic shift on the part of CarMax? Thank you.

[Bill Nash, President, Chief Executive Officer]

Thank you for the questions, Brian. On the first question, look - we’re really pleased with the roughly 6% comps, and I say that because you also have to put a little context around the environment. We had several headwinds that we also faced during the quarter.

First of all, inventory - inventory is lower than where we want to be. It’s probably about 30% off of--at the end of the quarter, probably about 30% off of where we would normally target. In addition to the inventory headwind, we were understaffed and we still are understaffed, but not to the degree. We were understaffed pretty much across the board, and that’s important not only because it hinders our ability to hit our SLAs, but in some cases we just weren’t able to get back with customers, which is never a good thing, and so we’re working on that.

Then I think also just a broader macro thing is just the used car valuations. I mean, year-over-year the acquisition prices are up about $6,000, and I think Enrique talked about in his opening remarks--or Jon talked about in his opening remarks about how that may push some used car customers just out of the market. I think when you take the comp in that light with those headwinds, those headwinds when you add them all together are material headwinds, so we feel great about the comps for the quarter and we also feel great about the overall progress.

On your second question, how we talk about used and wholesale, yes - we do talk a little bit differently about that, but I think that really goes back to a little bit of what I talked about on analyst day, which is--you know, people always think about us as this used car retailer, and that is in fact great, but we’re much more than that. We’re a great retailer, a great wholesaler, a greater financier. We’ve added Edmunds, we’ve got dealer services, and it really goes to this broader used auto ecosystem, so that’s really kind of the change as to why we talk about both.

[Brian Nagel, Oppenheimer]

That’s helpful, Bill. Just a follow-up on the initial question, is there a way to quantify what that 6.2 would have been had you not faced these headwinds in the quarter?

[Bill Nash, President, Chief Executive Officer]

Yes I’ll tell you, Brian, it’s hard, and I’ll give you one example. The inventory being that down, that substantially down inventory would be just in itself a significant headwind. Now, I will tell you, I don’t think the normal elasticity applies right now because a lot of folks are under-inventoried; but what I will tell you is we feel like when you take all three of those things and add them up, they’re material headwinds, so again we’re pleased with how the quarter came out from a comp perspective and just overall.

[Operator]

Thank you. Our next question comes from Sharon Zackfia with William Blair.

[Sharon Zackfia, William Blair]

Hi, good morning. The inventory dynamic has been, I think, pretty obvious throughout the quarter for anyone kind of looking at your website. What is your line of sight into getting inventory back into kind of more normalized levels? I know you mentioned you expect it to continue to improve, as it did during the August quarter, but is this something where you’re three, six months out? To quantify, is it a staffing issue, is it the acquiring of vehicles that’s the issue? Help us understand where the pinch point is right now on the inventory side.

[Bill Nash, President, Chief Executive Officer]

Thank you Sharon. Well first of all, it’s not acquiring the vehicles. I talked in my opening remarks just about the fact that we’re approximately 70% self sufficient, so it’s definitely not the sourcing. As I talked about with Brian’s question, it certainly has been a headwind and it really all relates back to what happened in the fourth and the first quarter. The fourth quarter is typically a time when we build our inventory up - we weren’t able to do that because of COVID and some winter disruption production, then we had record sales in the first quarter, so we’re still digging out of that hole. Like I told Brian, we’re about 30% light to target, we’re about 15% year-over-year. If you look at last year’s second quarter to where we’re this second quarter, we’re about 15% light. We did make great progress sequentially every month. We grew our inventory, and look - we plan to continue to build inventory over the rest of the year, and I think the timing is really going to be--when we get back to where we want to be will really depend somewhat on the demand.

As far as staffing, yes - during the quarter, although we were able to build inventory, we did have some headwinds even on the staffing side; but again, I think staffing in general, we’re making great progress. We made great progress staffing across the board throughout the quarter and we continue to make great progress in this quarter as well.

[Sharon Zackfia, William Blair]

I know you mentioned to Brian that it’s kind of hard to quantify the impact of the inventory, but I’m curious if you’ve seen conversion go down, just because obviously every used car is like a snowflake and if you don’t have as broad an inventory, you have to be losing sales. Is there any way to look at conversion as a metric that might indicate what’s been left on the table?

[Bill Nash, President, Chief Executive Officer]

Yes, I think conversion was down a little bit. We look at conversion a couple different ways, both conversion from when they start top of funnel, but then also in the store. The store was fairly strong, but up top of the funnel we saw conversion go down, which we think is a great opportunity because we’ve always said--you know, one of the main reasons people don’t buy from us is because we don’t have the vehicle they’re looking for, and that certainly is magnified when your inventory is down.

[Operator]

Thank you. Our next question comes from Rick Nelson with Stephens.

[Rick Nelson, Stephens]

Thanks, good morning. Wanted to follow up on CAF and the strategy to more Tier 3 business at CAF. Can you compare the profitability of a Tier 3 unit sale to a third party lender, and what are the risks, I guess, with this strategy?

[Jon Daniels, Senior Vice President, CarMax Auto Finance]

Sure, yes. Appreciate your question, Rick. With regard to a Tier 3 unit, so Tier 3 sale from a finance perspective, obviously there is generally a higher cost to fund, there’s a higher risk customer there, but it’s going to be just a little south of maybe a more prime loan, if you will, so depending on the funding environment and obviously the APR we can charge, but say in that $2,000 to $2,100 range if you’re able to capture all the finance economics potentially. But there is higher risk there, so there’s a funding aspect there.

Now obviously with our partners, we were able to renegotiate fees. We’re currently paying $750 to those Tier 3 loans that our partners pick up, and obviously we mentioned beginning--over the course of Q1, we started taking about 10% of the volume within the Tier 3 space. We’re happy with that volume and we appreciate it, and we’ll continue to assess the mix that we should have. But ultimately for us, we want to make sure that whether we take more Tier 3, our partners take more Tier 3, we want to make sure that we are able to provide great credit offers to those customers. In our current credit platform construct, we feel we do that, so those are the economics at play that answers your question.

But again, we love the way it’s constructed today and we provide great offers to those customers.

[Bill Nash, President, Chief Executive Officer]

Yes, and Rick, the only thing I would add to that, whether it’s Tier 3 or Tier 2 for that matter, it really is about balancing the sustainability of the program, the profitability, and then the customer experience, so we take all that into consideration.

[Rick Nelson, Stephens]

Fair enough. Thanks and good luck.

[Bill Nash, President, Chief Executive Officer]

Thank you Rick.

[Operator]

Our next question comes from Craig Kennison with Baird.

[Craig Kennison, Baird]

Hey, good morning. Thanks for taking my question.

Bill, the surge in vehicles sourced from your online appraisal tool is really impressive. Do you have a feel for what those sellers would have done without the tool - would they have shown up at a CarMax store, would they have gone to another dealer, would they have sold through some person-to-person listing service? Where are they coming from?

[Bill Nash, President, Chief Executive Officer]

Craig, I think--look, we’re pleased with the online. I think we’re getting a lot of incremental units there, because even our traditional appraisal lane is still very strong. I’m not sure where they would have gone, but we absolutely feel there’s a tremendous incremental value there by the fact that we are offering this service, so maybe they would have gone and sold in other channels, I don’t know which channels, but we feel good about the incrementality.

[Craig Kennison, Baird]

And what percentage of online offers are you able to purchase, and does that tell you anything about the competitiveness of your offer?

[Bill Nash, President, Chief Executive Officer]

Yes, so our buy rate--you know, traditionally how we’ve talked about the buy rate is through our appraisal and our trade--appraisal lane buy rate is still--I mean, it’s very high, it’s in the low 30s. On the online offers, the way we really look at this at this point is if you get an online offer, because think about it, we’re putting millions of online offers out there each quarter. The way we think about it is, okay, once we’ve put an offer, of those customers how many show up at the store, and of those customers that show up at the store, how many of them actually sell? As you can imagine, that buy rate--the customers that show up with an online offer that actually sell is actually much higher than the traditional A-lane.

[Operator]

Thank you. Our next question comes from Rajat Gupta with JP Morgan.

[Rajat Gupta, JP Morgan]

Great, thanks for taking the questions.

Just had a question on some of the investments that you had made in the second quarter. Clearly advertising picked up, the other investments picked up, you’ve added more headcount. Could you give us any color on how much of this has started to benefit comps? Maybe if you could give us some color on how September is tracking, that would be useful.

Then just on GPU, given the rising used vehicle pricing environment you’re back in again, great August into September, likely into October-November as well, you’ve previously given us some color on [indiscernible] number for retail GPU. Any similar color you could provide us for fourth quarter as well? That’d be useful, and that will be all, thanks.

[Enrique Mayor-Mora]

Hey Rajat. With regard to SG&A, we firmly believe that now is the right time to invest in growing our business. We’re very bullish about our future, given the strength and trajectory of our business, and we’re going to continue to invest in our growth, we’re going to continue to invest in the omni and ecommerce functionality as we move forward. But we are on track by the end of this year to offer up to all of our retail customers 100% self sufficiency online, our self service online. We’re going to continue to invest in the acquisition of customers by marketing.

The investment in marketing is something that we had communicated last year, that we were going to step up our marketing advertising and other channels as well. Again, we believe we have a superior platform and we want to make sure that we’re communicating that in an effective way to our consumers, but at the same time there’s also a very targeted ROI opportunity in advertising as well that we’re investing in, and then lastly we’re going to continue to invest in the acquisition of vehicles. The instant offer program that we launched that has had tremendous success is just an example of one of those investments that just provides an outstanding ROI, so we’re going to continue to invest.

Now that being said, we do expect to lever over the longer term because at the same time that we’re investing, we also have cost efficiency plays, whether it’s the CECs or whether it’s the buying organization or whether it’s other channels as well. We have opportunities to get more efficient in how we work, and so we’ll continue to do that. But I think it is important to remember that we’re on track with our investments, we’re on track with our performance at this point.

[Bill Nash, President, Chief Executive Officer]

Yes, and Rajat, the only thing I would add to that is on the--like, the advertising for example, we’re really pleased with the performance of that. We saw about a 19% increase in web traffic. Our average flow to our website was about--it’s a little more than 34 million a month, so that’s another example where you feel like the investment’s paying off.

As far as the second part of your question, the GPU, it’s a great question. I kind of think about--we’re in a very similar situation today that we were last quarter when we talked about this. We’re constantly testing. A couple quarters ago we talked about doing some broader scale testing just because of some of the other factors, some of the other profit channels that were coming through the organization, and while those still exist, just like last quarter, we really wanted to make sure--you’ve got to monitor the macro factors and does it make sense. You’ve got to look at your inventory levels, you’ve got to understand the elasticity which, again, we’re still getting the read on elasticity with the tests that we always have going, you want to see what competitors are doing, and it just didn’t make sense to deviate more from that historical trend that we have on margins. At the end of the day, we want to have very, very competitive--competitively priced inventory. I think with the self sufficiency, that certainly helps.

I think going forward, how you should think about the third quarter is probably GPUs more in line with historical averages, just like the second quarter was.

[Operator]

Thank you. Again ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touchtone telephone.

Our next question comes from Michael Montani with Evercore.

[Michael Montani, Evercore]

Hi, thanks for taking the question. Just wanted to follow up on the cadence of the comps throughout the quarter and then to start the third quarter. From our work, it looked like the trends had accelerated nicely into August and basically could have been up double digits into September, so just wanted to see if you all would comment on that, if you could do it quantitatively, and if not that, if you could provide some color as to why trends may have strengthened, if it’s inventories or enhanced multi channel.

[Bill Nash, President, Chief Executive Officer]

Yes, good morning Michael. Obviously I’ve already said we’re pleased with overall comps for the quarter. We had positive comps every single month and we really continue to trend. It started since March. March was not only a record, all-time high record, but it was a record for the month. April-May-June-July-August have all in their respective been a record month for us, so we feel great about that.

To your point, we’re also very pleased with the start of the third quarter. Now, obviously we’ll talk more in detail about that at the end of the third quarter.

[Michael Montani, Evercore]

Okay, and then if I could, just on the margin front, two questions there. One was some folks had been anticipating a little upside on GPU due to pretty inelastic demand at the moment. Just wanted to understand if there’s something we need to also consider in terms of the volatility of the pricing in the environment, or if perhaps there’s more investment you all are making. Then the other one was just on advertising spend for the year and if there’s any kind of cost reductions to consider as we cycle 3Q and 4Q. What you called out in 2Q was helpful, $25 million, $30 million.

[Bill Nash, President, Chief Executive Officer]

Okay, yes. On the margins, look - we’re always looking at our margins, and I know we probably have some competitors where the big spike up in average selling prices, they’ll take more margin. You’ve followed us long enough to know that ASPs don’t really drive our margins. We feel very comfortable about where our margins are. For us, it’s about making sure we get a great margin but also having great prices, so again to the question I answered earlier, I think the third quarter, you can think about margins more in the historical trend. Could you have taken more margin? Yes, but again, we’re in this for the long haul and we want to make sure our prices are super competitive all the time, and we feel great about that.

I’ll let Enrique speak to the advertising.

[Enrique Mayor-Mora]

Yes, so two questions. On advertising, we had communicated earlier this year that our expectation for advertising on a per-unit basis for this year was going to be similar to what we spent in the back half of last year, so somewhere in the mid-300s per unit, and we’re on track so far this year and our expectation is that we’re going to meet that for the full year.

In regards to comping over COVID and the $25 million to $30 million that we estimate that last year was kind of one-time savings, that was really focused on the front half of the year. There still are some of those that will carry over into Q3, but not to the same level of materiality as what we saw certainly in the first two quarters of the year.

[Operator]

Thank you. Our next question comes from Seth Basham with Wedbush Securities.

[Seth Basham, Wedbush Securities]

Thanks a lot, and good morning. My question is around GPU and the pricing environment. Bill, maybe you can comment on what’s happening with wholesale price trends and retail price trends through the quarter and how that’s impacted your retail GPU.

[Bill Nash, President, Chief Executive Officer]

Yes, so obviously retail, if I look at it from a mix adjustment standpoint, retail pricing was up about--from an acquisition standpoint, was up about $6,000. Wholesale was up probably around $3,000, so both are--actually as long as I’ve been doing this, those are the biggest jumps I can remember ever seeing.

Now, I think the fact that self sufficiency is so high for us, I think that provides us a lot of opportunities as we go forward because that comes into play on not only a margin but your pricing structure. I think during the quarter, what we saw was--you know, we came out of the first quarter very high elevated prices. It hung in there for a little while. We then actually saw a little bit of depreciation take place, but surprisingly it started to appreciate again, so when we went back, I think we finished the quarter probably at the high that we finished the first quarter. It’s a very interesting dynamic.

I can only speculate - you know, maybe because of the chip shortages, it looks like it’s going to be longer than I think what people originally thought of for new cars. I think maybe there’s some folks out there buying more used cars to replenish their lots since they’re not going to have new cars, but it is an interesting dynamic that we’re seeing.

[Seth Basham, Wedbush Securities]

Yes, so the fact that prices started to appreciate again after the back half of your quarter unexpectedly should indicate that you could have captured incremental margin on those unit sales, so your GPU exiting the quarter was probably stronger than it was in the beginning of the quarter? Is that the right way to think about it?

[Bill Nash, President, Chief Executive Officer]

No, I would just think that pretty much--you know the way we manage our GPU really doesn’t--it doesn’t take into consideration the average selling prices. There’s other factors that go into that, so I would think it’s fairly consistent throughout the quarter is the way you should think about it.

[Operator]

Thank you. Our next question comes from Adam Jonas with Morgan Stanley.

[Adam Jonas, Morgan Stanley]

Why are you guys still buying back stock? I mean, you have such an unbelievable--once in a generation growth opportunity, you’re up against competitors that have a license to lose money and zero expectation to return cash. I understand the business spins off cash and everything, but isn’t it time to change the philosophy and just double down on the growth of the business and cut the buyback stuff?

[Enrique Mayor-Mora]

Like you said, we generate--we’re blessed with an operating model and a business model that generates a significant amount of cash, and we’re making the investments we think are the right investments at the right time, can generate our growth, and we still--still with that in mind, we believe we have excess cash to buy back stock and return it back to shareholders. We’re not holding back on our level of investments, and you can see that in our spend and in our capex, that we are investing aggressively. We’ll continue to do so and even in that scenario, we have enough cash to buy back shares. We are not holding back on our investments.

[Operator]

Thank you. Our next question comes from John Murphy with Bank of America.

[John Murphy, Bank of America]

Good morning guys. Just a question on two pressure points. First on inventory, it certainly seems--Bill, you just alluded to and based on what we know on the new vehicle side, that this inventory shortage on the new vehicle side is going to persist well into next year and certainly probably past mid next year, calendar year 2022. I’m just curious if you think the dynamics will be relieved until we get there, and then also as you think about the staffing levels, finding folks at reasonable prices is getting harder and harder, so that cost inflation on the SG&A side and staffing up might be difficult as well.

I’m just trying to understand if you can change strategy, alter strategy, or just change your growth strategy as you fight through these two macro factors, and when they’ll be relieved, because it’s kind of masking all the good stuff you’re doing and it’s muddling the story, but it’s not your fault and they’re macro issues that you’re just going to have to fight through.

[Bill Nash, President, Chief Executive Officer]

Yes, I think whatever I tell you on the chip situation, probably the only thing I can guarantee is I’ll be wrong; but I do agree with you, I think it’s going to persist throughout this year, which could keep used cars at an elevated--you know, it will persist through this year and, I think, pretty much through next year or a good part of next year, which will keep prices elevated. But it’s also the reason why I’m so excited about the investments we’ve made in vehicle acquisition and things like our instant offer, because that really helps to offset some of those headwinds and really gives us a lot of opportunity. Like I said earlier, we’re making strides, continuing to get our inventory up, so we feel good about that.

On the staffing, look - we’ve always invested in our associates. They’re the reason of our success, and during this time period, you know every employer is out there looking for staffing, and we’re no different. We’ve continued to invest more in this quarter in our associates, we’ve made pay changes that we feel really great about. We also--look, for 17 years in a row, we’ve been one of the best places to work, which is a great thing from an employer brand standpoint, so again even on the staffing side, we feel great about the trajectory that we’re going on.

So yes, there are some headwinds there, but we’re progressing both on the inventory side and both on the staffing, and feel great about some of the opportunities that we have that things like self sufficiency and IO give you.

[John Murphy, Bank of America]

Is it fair to say, or maybe just a follow-up, the SG&A leverage is going to be difficult to get through this period of macro pressure? It just seems like--I mean, you guys have executed incredibly well on same store sales and grosses despite these headwinds. I think some people are concerned about it, but then what you’ve done this quarter is pretty remarkable on the grosses and the volumes. Are you going to be able to get SG&A leverage until we get through the end of calendar year 2022? It just seems like it’s going to be hard to pull off. What’s your thought about that and where should we think about that inflection point?

[Enrique Mayor-Mora]

Yes, we certainly are in investment mode, as we’ve made clear, and you can go back to our analyst day. We’re really focused on driving our top line. We are focused on driving market share and meeting and exceeding our target that we laid out there, which is greater than 5% market share by FY26, and that does require investments like we’ve been talking about, the investments in the different areas that we mentioned, certainly.

Will it be harder to leverage? Well, in that kind of environment it is a little harder to leverage, right, and our expectation is that our gross profit will continue to grow, it will grow robustly, and on the back of that gross profit growth, there are opportunities to leverage specifically for this year for the entire year. Our expectation continues to be that we should be able to leverage for this year.

It’s hard to look quarter to quarter. You just can’t look in quarter to quarter just because there’s so many things that pop in and out of a quarter; but for the full year, we feel pretty good about that. Then moving forward, again we are in growth mode and we’re investing accordingly, and at the same time and as I speak to every quarter, we do look at opportunities to get more efficient. There are investments we’re making to drive the top line, there are investments we’re making to help pull out cost as well, and we always have a sharp eye to that, so we’ll continue to do our best on that. At the same time, we are focused on market share growth and the opportunities that lay ahead of us, and we’re really excited about them.

[Operator]

Thank you. Our next question comes from Ali Faghri with Guggenheim.

[Ali Faghri, Guggenheim Securities]

Good morning, thanks for taking my question. Sorry, but another question on retail GPU here. I recognize that retail prices don’t really drive CarMax’s GPU, but just the self sourcing improvement from sub-50% to 70% this quarter by itself should have been a big boost to GPU given the cost advantage from acquiring from consumers versus auction. I know you said you kept your prices competitive, but it also doesn’t seem, at least based on our work, that you are meaningfully outperforming peers on volumes either, so how do I tie that all together?

[Bill Nash, President, Chief Executive Officer]

Yes, well first of all, we feel really good about our pricing position, and we’ve been looking at this for a very long time, so we feel very good about where we are from a pricing standpoint. Look, this is one quarter. Some things have a longer tail, but I would also go back to the fact that, look, we had some major headwinds, and when you add them all up together, they were hard to overcome, which I’ve already talked about - you know, the inventory, just the pricing, the staffing. Those are headwinds over the self sufficiency.

I think what we’re most excited about is this self sufficiency and the opportunity that that gives us as we continue to move forward.

[Operator]

Thank you. Our next question comes from David Whiston with Morningstar.

[David Whiston, Morningstar]

Thanks, good morning. I hear you say you’re happy with pricing, but then when I look at Page 6 at the GPU, gross margin per unit there, it’s down considerably year-over-year and also down versus the quarter two years ago. It’s obviously a competitive marketplace though, too. Do you [indiscernible] to raise prices?

[Bill Nash, President, Chief Executive Officer]

Well David, just so we’re clear, the GPU, if you look at it--like, last year, second quarter was a record GPU and we’re only a little bit off of that, so I would say if you look at our historical average, we’re on the higher end of GPU. I think there might be a little disconnect there.

Could we raise GPUs? Absolutely, and look - we’re going to continue to monitor the macro factors to see what makes sense. Self sufficiency gives us a lot of opportunities as we go forward, but I think at the same time, we are in this for the long term and we want to make sure customers are getting great value every day, and so we’re going to continue to weigh all factors as we go forward.

[David Whiston, Morningstar]

Okay. Just to be clear, I was talking about the 8.3% versus the 11%, and then the 10.5% two years ago. That’s why I asked about pricing.

[Bill Nash, President, Chief Executive Officer]

Oh, I’m sorry. You were talking more as it relates to ASP? Yes, and again, I’d just throw that out--

[Enrique Mayor-Mora]

If you look at it on a per-unit basis, it’s going to be skewed, artificially skewed as a percent of revenue just because retail prices are just up, like, 30% since the beginning of the year, so it’s hard to look at as a percent of revenue. We really look at the business on a per-unit basis.

[Bill Nash, President, Chief Executive Officer]

Yes, and we manage it differently than a lot of the other publicly traded auto retailers.

[Operator]

Thank you. Our next question comes from Chris Bottiglieri with Exane BNP Paribas.

[Chris Bottiglieri, Exane BNP Paribas]

Hey, thanks for taking the question. Just had two quick ones on other gross profit. I guess just first, trying to understand the service gross profit seemingly went negative this quarter because of the warranty issue. Next quarter or whenever, does this go back to the 20% to 30% gross margin rate you’ve historically had, or is there something, like some kind of a lag, to all this warranty stuff that we should be thinking about?

[Enrique Mayor-Mora]

Yes, service this quarter, we were upside down $40 million year-over-year on the quarter, and we estimate that a material amount of that were headwinds we faced in the quarter, that were really shorter term in nature. The two largest ones I’d tell you, number one was the 90-day warranty that you mentioned, and when you think about it, right, our comps this year in the first quarter were 99%. Last year in the first quarter, they were negative 42%, and so you’re looking at a lot more volume from a 90-day perspective warranty work that carries over into the subsequent quarter, so that very much is a timing play right there.

Then the second piece is, similar to SG&A, we just had prior year one-time COVID-related savings in support pay and the employee retention credit plan as well, that are more shorter term in nature. The material amount of that is really shorter term.

What I’d say is historically we’ve run service as a positive margin contributor. The exception was last year - certainly during COVID it was not, but prior years it had been a positive margin contributor, and as we move forward on an annual basis, we do expect that to continue to be a positive margin contributor as well. But this quarter, certainly those two headwinds made it a little bit harder.

[Operator]

Thank you. Again ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touchtone telephone.

Our next question is a follow-up question from Rajat Gupta with JP Morgan.

[Rajat Gupta, JP Morgan]

Thanks for letting me get back in the queue here. I just wanted to follow up in terms of a housekeeping question around SG&A. How much of the quarter-over-quarter pick-up in SG&A was due to the Edmunds acquisition, and if you could say what are some of the buckets in SG&A also, that might be very helpful. Thank you.

[Enrique Mayor-Mora]

Yes, as regards to Edmunds, I spoke in my prepared remarks that from a gross profit standpoint, Edmunds contributed about $20 million. You’re going to see that in the 10-Q tomorrow when we file. Overall, so it’s an operating segment, Edmunds is-we’re going to be reporting on it as an operating segment, not a reporting segment, so we’re going to be reporting moving forward on their revenues, on their gross profit, but that’s the extent to which we’re going to report on them.

What I could tell you, though Rajat, is that overall, they were slightly accretive to CarMax, so you can kind of back into their SG&A using that kind of approach.

[Operator]

I’m not showing any further questions at this time. I’d like to turn the call back to Bill Nash for any closing comments.

[Bill Nash, President, Chief Executive Officer]

Great, thank you Kevin.

Well listen, thanks for joining us today, for your questions and your continued support. We’re confident in our ability to seamlessly merge our world-class in-person and online experiences, add to that our diversified business model and we’ll be able to continue to drive growth and market share gains as we move forward.

As always, I want to thank our more than 27,000 associates for your continued dedication, to living our values each day, taking care of each other, the customers and our communities. You all are the reason that we remain a positive disruptive force within the used car industry.

Again, thanks for everyone’s time today, and we will talk again next quarter.

[Operator]

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.