CarMax, Inc. (KMX) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to the CarMax Strategic Update call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. David Lowenstein, Vice President, Investor Relations. Please go ahead, sir.

Good morning. Thank you for joining our strategic update webcast. I'm here today with Keith Barr, President and CEO; Enrique Mayor-Mora, Executive Vice President and CFO, and Jon Daniels, Executive Vice President, CarMax Auto Finance. Let me remind you our statements today that are not statements of historical fact, including but not limited to, statements regarding the company's future business plans, prospects and financial performance are forward-looking statements we make pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on our current knowledge, expectations and assumptions and are subject to substantial risks and uncertainties and that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, we disclaim any intent or obligation to update them. For additional information on important factors and risks that could affect these expectations, please see our Form 8-K filed with the SEC this morning our annual report on Form 10-K for fiscal year 2026 and our quarterly reports on Form 10-Q previously filed with the SEC. Please note the presentation from today's webcast is available on the Investor Relations section of our website. Our commentary today may include non-GAAP financial measures. Reconciliations of these measures to the comparable GAAP measures are available in the investor presentation. Should you have any follow-up questions after the call, please feel free to contact our Investor Relations department at 804 747-0422 extension 7865. Keith will start today's webcast with a brief overview of the used auto market and how CarMax is structurally positioned to deliver sustained growth. He will then frame our shift into gear growth strategy and John will highlight Cash competitive differentiation and full credit spectrum strategy. Finally, Enrique will detail the financial targets we have set through fiscal year 2030 and our capital allocation approach. We'll save plenty of time after our presentation to take your questions. With that, I'll pass it over to Keith. Keith?

Good morning, everyone, and thank you for joining us. I want to start today by sharing again why I came to CarMax. Looking at CarMax from the outside, I saw a very strong foundation, an iconic brand, an award-winning culture a differentiated business model with unmatched scale and an irreplaceable platform. I believe these assets could be leveraged better to drive consistent growth, gain market share and generate strong return for shareholders. A little more than 7 months in, I'm more confident than ever in our ability to capture the tremendous opportunity ahead of us. In order to do this, we need to have a clear strategy, and I've spent meaningful time across our business, engaging with our associates, listening to our customers and working with our leadership team to develop our strategy for growth, shift to gear. The work in front of us is focused on turning our advantages into stronger performance. Our second quarter results showed that when our pricing is right, customers choose CarMax at a rate that outperforms the industry. We are building on this early momentum with our Shift into GEAR strategy, which is designed to strengthen the core of our operations by focusing on the fundamentals of what we do every day at CarMax, helping our customers buy, sell and finance cars with ease and confidence. However, they choose to do it. Shift into GEAR is a clear actionable plan to drive sustainable market share gains and earnings growth enabling us to consistently reward our shareholders. But it will do more than just drive our near-term results. It will establish the foundation for accelerated growth in the long term. Let me start with talking a little bit about the market we are competing in and the strength of our platform. The used car industry is 1 of the largest consumer markets in America, a roughly $1 trillion market that is incredibly fragmented. The 10 largest retailers together hold only about 10% share of the total market with CarMax having only a 4% share today of the aged 0 to 10 market. The opportunity in front of us is substantial, and we are well positioned to leverage our national and unique scale to win customers and grow faster than the market. In this industry, a company with the right operating model and customer offer has a tremendous opportunity to take share, and we have both. The hallmark of our market position is that the operating model CarMax has built over the last 30 years aligns with the way customers actually shop for and buy vehicles. Industry research as well as our own shows that customers want digital convenience combined with an in-store connection. While most customers intend to utilize both online and in-store steps in their car buying journey, the vast majority consistently choose to complete their purchase in store. We can meet the customer however and wherever they want to be met. This is why CarMax is strategically advantaged. We start from a position strength since we've already built the combined digital and physical scale to deliver that experience nationwide. Our digital offering is backed by a store network that reaches 85% of the U.S. population. Customers can see and test drive the car they are considering, explore a wide selection in 1 place trading their vehicle, obtained financing and received knowledgeable guidance along with the personal connection our associates offer. Additionally, our offering is underpinned by a national logistics network scale reconditioning operations and exceptional awareness. The key advantage we see is not just any one of these things, but how they work together to drive growth inside 1 platform. These capabilities took decades and significant capital to build and our long-term differentiators when we deliver on the fundamentals. This is where the pieces come together to create our competitive advantage. First, customers know and trust the CarMax brand, which is backed by 30-plus years of bringing transparency to the car buying process. Second, we delivered the best of both worlds, the convenience of digital backed by a network of over 255 stores and 28,000 associates. Third, we have structural advantages built over decades. Our scale and capabilities are nearly impossible to replicate. Fourth, we have a leadership team and a culture built to execute. I've seen that firsthand both in our corporate offices and with our associates in the field, and I continue to be impressed by the capability and commitment of our associates. Fifth, the largest opportunities in front of us are within our control, and our growth is not dependent upon market acceleration. I'll share examples a bit later in the presentation. And most importantly, we have a clear plan to strengthen the core of our operations, shifting to gears how we convert these advantages into stronger growth and financial returns. Now I'm going to talk to you in more detail about our shift into GEAR strategy. Our strategy is built around 4 fundamental pillars: great offerings about giving customers every reason to choose Carmax; easy experience is about making it easy to do business with us; add values about maximizing the value we create on each transaction; and run lean is about unlocking efficiencies so we can fund a better offer and generate stronger returns. These 4 pillars do not work in silos, but it's 1 system. Let me walk through each beginning with great offering. Great offering is built around 2 things that matter most when a customer is buying a used car, price and selection. On price, our objective is straightforward: deliver highly competitive prices to customers and use that advantage to take share. We intend to take hundreds of dollars of costs out of each car across reconditioning and logistics over the coming years, and we intend to reinvest those savings back into price. That gives us a sustainable way to compete harder for the sale without structurally sacrificing retail margins. At the same time, we are getting more precise about how we price. Each year, we priced more than $20 billion of retail vehicles and have augmented our pricing models to use more local and real-time market signals with the goal of pricing more dynamically. So we can win the sale while earning the right margin. Selection is the other half of the offering. We're adding more inventory while continuing to ensure our mix matches the cars customers want to buy. But just as importantly, we're unlocking the inventory we already own. Saleable inventory is up materially from a year ago, driven in part by freeing up more of our existing inventory for customers to purchase through better management of local holds and transfers. We know that having more saleable inventory leads to more sales. But having the right car is only part of the equation. We also have to get it to the customer quickly. Further results have been encouraging in the markets where we have tested faster delivery. In those markets, we are making more cars available to customers faster within days, and this is driving more sales. Customer feedback is validating our efforts, and we see this as a meaningful lever to drive more share gains. We plan to scale it up in a disciplined way in step with what the results and the economics tell us. In addition to having the right car at the right price, making it easy to complete the purchase journey, drive stronger conversion. We are focused on the end-to-end customer journey. When I joined, I saw a clear opportunity to bring our digital capabilities and stores closer together. And that is where we're putting our energy. Let me walk you through our progress. It starts with finding the right car. We have improved search and made car pages more intuitive with clear highlights and more personalization, so shoppers find the right car faster. The new experience is already outperforming our prior pages with more upside as we optimize. And as AI changes how consumers research and show, we will be ready with a robust generative engine optimization strategy and digital properties that support gentex commerce. Once they find the car, we're making it easier for customers to move forward. Our redesigned reservation flow puts financing and trade information upfront, so customers are better prepared and more reservations convert to sales. Next is the handoff to the store. Today, a customer might hear from the store, our customer experience center and our automated systems, which can sometimes be confusing. We are testing a model where the store owns the relationship from the moment of the reservation supported by our customer experience center and by automated communication. It simplifies the experience and draws on a real advantage, associates who know the customer, know the car and understand local dynamics. The test is underway in a handful of stores, and we are encouraged by the early results. AI runs through every step of the journey. Our digital and voice agents work alongside our associates online, by phone and in-store. Early tests show improved conversion and efficiency. And our agents free up associates to spend more time on the moments that matter and where they can add the most value. The goal is 1 easy connected CarMax experience from the customer's first search to the moment they purchased their car. We have multiple paths to create more value for the customer and capture more economics for CarMax. CAF has a proven prime lending platform, and we've been extending our platform across the credit spectrum in disciplined stages, with a focus on Tier 2. CAF financed 10% of CarMax's Tier 2 volume in Q2 fiscal year 2026. In Q2 fiscal year 2027, that number has more than doubled our goal is to reach 40% by fiscal year 2030. As that expansion continues, it provides meaningful runway to capture more of the financing economics from our customers CarMax is already serving. In tandem, we are broadening the way we fund CAF so we can grow responsibly, implementing the structure that gives us the best balance of return and risk. Our second residual sale which included selling roughly $600 million of receivables in the second quarter is 1 example of that flexibility. John will go deeper on our funding efforts in a few minutes. Another opportunity to grow profitability is with our extended protection plan products. We reinvented Max Care over the last year with more term and deductible options as well as optional wheel tire and dent production. That updated product suite is now available nationwide. Our objective going forward is to grow EPP profit per retail unit by more than 20% through fiscal year 2030, while putting relevant protection in more customers' hands. As we sell more cars, finance more customers and leverage expanded protection plan products, we create more profit from every customer we win. The fourth pillar is Rune. -- unlocking efficiencies that fund a great offering and experience by taking cost and complexity out of the business. Our first focus area is on reconditioning. Much of that work still runs on a legacy store-based system, supported by paper checklists and white boards. We are replacing it with a modern end-to-end best-in-class third-party software-as-a-service digital platform that will standardize processes across every store and centralize decisions on what work to do, where to do it and which parts to use. It will also enable better data and analytics that show us what is working and help us improve. Specifically, we plan to optimize our reconditioning processes with several key enhancements, including digital inspections to efficiently capture an accurate profile of each car's condition, digitized repair order management, to enable smart and consistent decisions on what to repair. Work management systems that improve productivity by refining how we route work to our associates, part entire selection tool upgrades that broaden automated order, sublet management to improve decisioning on when and what repairs facilitate across our partner network. The result is that we deliver the high-quality cars our customers know us for, and we do so with more efficient operations, more work done in-house and a lower cost embedded in every car. We expect to begin piloting next year and will scale from there. Our second focus area is on logistics. Our model today is largely point-to-point, connecting our 255-plus stores. To better leverage our national scale, we are reengineering the network toward a hub-and-spoke design with plans to expand that model over time, fewer, smarter moves, should lower cost and get cars to customers faster. We're also putting a modern technology foundation underneath the network so we can make better decisions and continuously improve cost and experience. Across reconditioning logistics, we have a clear line of sight to hundreds of dollars per car savings through fiscal year '23, allowing us to self-fund sales growth through competitive pricing. Our third focus area is acquisition, buying directly from consumers is the lowest cost source of inventory, and we see a very tangible opportunity to do more of it. Today, more than 20% of customers who come to us to sell their vehicle cannot receive a truly instant offer online and instead are sent to a more time-consuming process. Our goal is to increase incident offer eligibility to over 95%, so almost all customers can get an instant appraisal on their car through CarMax. We plan to begin testing changes in December that will move us toward that goal over time. The fourth focus area within run Lean is SG&A. We remain on track for $200 million of run rate savings exiting fiscal year 2027. We will continue to look for more efficiencies in the business and maintain this cost discipline moving forward. We expect to build significant leverage into how we operate every year. This is the simplest way to think about what we expect to shift into gear to deliver, 4 pillars, 1 system, driving sustained market share growth. Each pillar has its own work, but the value comes from the way they compound and create a flywheel of continuous growth and every turn of the flywheel as durable earnings growth, better price, selection and experience brings more customers to CarMax and drives more sales, each sale earns more with CAF and protection products adding profit. More volume runs through our stores, reconditioning centers and logistics network, which creates scale efficiencies and lowers our cost base. Those savings go back into the offer and into the operating leverage so we can compete harder to the next customer. Then the cycle repeats, and we keep taking share and building durable earnings. CAF is a big part of that cycle, and it scales with every customer we win. I will now turn it over to John to walk you through how it works and where we are expanding. Jon?

Thanks, Keith. Good morning, everyone. As Keith discussed, the key part of our shift into gear strategy is finding ways to add more value on each transaction. CarMax Auto Finance is central to that opportunity, and I'd like to spend a few minutes discussing the role CAF plays in our business or opportunities to expand and how all of that translates into earnings. Pat is 1 of the advantages that makes the CarMax model unique. Having such a well-established captive lender provides additional sales, a significant source of earnings and a sizable opportunity for added growth. CAF diversifies CarMax's earnings. It creates an additional profit engine beyond the economics of the vehicle sale and generates earnings over the multiyear life of the loan, helping to complement the immediate income recognition of that sale. A captive lending business not only provides an opportunity to maximize finance income but it is also fundamentally more integrated into the broader business ecosystem, both tactically and strategically. Unlike what occurs inside a more traditional third-party financial institution half lending decisions are made with direct consideration for our customers and CarMax as a whole. We have a strong, long-standing track record of more than 30 years of underwriting, funding and servicing auto loans. That experience across multiple economic cycles gives us a deep base of lending knowledge and operational know-how specific to CarMax customers. We have always run the business with discipline. We balance growth, credit risk and financial return and make decisions that are sustainable and in the best long-term interest of CarMax. This model is scalable. We see significant volume runway inside the customer base CarMax already serves and our funding capabilities continue to expand giving us more ways to capture attractive economics while managing risk. Together, these traits make CAF a differentiated and integral part of the CarMax business model, positioning it to play an increasingly important role in driving growth and earnings over time. Historically, CAF's core has been the more prime Tier 1 credit space, and that remains a strong proven business platform that continues to anchor our $16 billion portfolio. Full Spectrum is about extending that proven platform into the Tier 2 nonprime lending space. where we see a compelling opportunity within customers CarMax is already serving. Tier 3 is not a near-term priority for cash, and at this point remains primarily a partner opportunity that drives incremental sales. Slide Tier 2, we have been successfully serving these customers through our retail business for decades, but much of the financing is captured by our long-term third-party lenders. By expanding CAF's participation in this segment, we have an opportunity to finance more of these transactions and retain more of the economics associated with these loans. As Keith mentioned, CAF continues to grow its volume, doubling our Tier 2 penetration in the second quarter versus last year. And the credit performance of the originated volume to date continues to track in line with our expectations. We are confident in our ability to succeed in this space. Over 30 years, we've demonstrated proficiency at adapting and refining how we underwrite and service CarMax customers. Paired with our newly enhanced funding capabilities and backed by our own customer and credit data, we can generate sizable income growth from Tier 2 segments that will provide us highly attractive risk-adjusted economics. We also believe it is valuable to keep the financing and servicing relationship inside CarMax for years after vehicle sale, providing a meaningful customer loyalty benefit. The opportunity is both economic and strategic serve more CarMax customers directly and capture more of the value created by the transaction. In short, full spectrum builds on CAF's proven foundation, extending our capabilities to more customers, strengthening our relationships and creating a meaningful opportunity for long-term earnings growth. As we expand into Tier 2, it's important to understand the mechanics of how lifetime earnings will change and ultimately grow. When we originate a loan that we hold for investment, we are required to reserve for lifetime expected credit losses upfront, but we earn the income on that loan over time. That timing impact is more pronounced in Tier 2 because expected losses and therefore, the upfront provision are higher. As a result, as we meaningfully grow Tier 2 volume and retain a portion as held for investment, CA income will initially be pressured by the provision associated with these new loans. However, on a per loan basis, Tier 2 is expected to carry a higher return than Tier 1 and to deliver sizable income over the life of the loan. This results in CarMax capturing substantially more cumulative value than the fee historically received when the customer financing was given to a partner lender. In the case where we fund our growth through off-balance sheet transactions, we avoid this upfront provision, but instead receive a gain on the sale of the loan, ongoing servicing fees and retain the net interest margin up until the point at which the loan sale takes place. While the full lifetime value earned is less than had we held the loan for investment, there is substantially more value versus the current partner fee structure while also derisking the remaining portfolio. We believe that for each point of sales attributed to Tier 2 that we retain, there is between $8 million and $20 million of additional lifetime pretax income to be captured beyond the partner fees provided today, depending on our funding approach and corresponding terms of a deal. We see the potential of our blended held-for-sale and held-for-investment strategies generating in excess of $100 million of lifetime pretax income annually from the Tier 2 space as CAF pushes towards financing 40% of this volume or roughly 8 points of total sales by fiscal year 2030. Two factors squarely within our control will be the keys to realizing the full potential of this growth effort. First, we will be growing in stages. Rather than scaling originations all at once, we will methodically originate and evaluate each segment within the Tier 2 space. and use those results to inform our next phase of growth. This allows us to refine our underwriting and servicing approach and maintain the discipline that has been fundamental to CAP success. Second, we will continue to refine and leverage our new funding capabilities, having the flexibility to retain loans on our balance sheet or utilize off-balance sheet funding channels allows us to balance risk, capital requirements and the opportunity to capture attractive lifetime economics as we grow. Ultimately, we are focused on building a larger, more profitable CAF business over time and are doing so in a controlled and thoughtful manner. With that, I will turn it over to Enrique. Enrique?

Thanks, John. I'm going to bring the operating strategy into the financial framework. The goal is to show you what we expect shift into gear to produce through fiscal year 2030, the key building blocks underneath those targets and how we will allocate capital as performance improves. Using fiscal year 2026 as the base period and assuming a stable operating environment, we expect to deliver mid-single-digit compound annual growth in used retail units through fiscal year 2030 and as we strengthen the core of our operations. At the earnings level, we expect to deliver mid-teens compound annual growth in adjusted EPS over the same period. These targets are grounded in the word Keith and John just described. Great offering and easy experience drive share gains. At value increases the economics of each transaction, run lean lowers the cost structure, funds a stronger offering and enhances operating leverage. When those pieces work together, we are confident CarMax can sustainably outperform the industry. I want to highlight the 5 key drivers of achieving our financial targets. First, as I just mentioned, we are targeting a mid-single-digit CAGR through fiscal year 2030 for used retail units. We expect the work we are doing under great offering and easy experience along with greater industry price transparency that helps customers see the value of our offer more clearly will drive market share gains. We are assuming retail GPU stays generally consistent from fiscal year 2027, with some expected fluctuations from quarter-to-quarter while hundreds of dollars of per unit savings and reconditioning and logistics costs are reinvested in price. Our recent trends have proven that when our pricing is right, we gained market share. Second, we are targeting low double-digit EPP margin dollar CAGR led by unit growth and increased per unit margins. The increase in unit margins will be driven by the rollout of new and enhanced products, heightened focus on store execution and improved provider economics through a redesigned profit-sharing arrangement. Third, expanding Tier 2 originations drives higher loss provisioning upfront, which will impact the growth trajectory of CAF income. We therefore expect CAF income to be down slightly in fiscal year 2027 and flattish year-over-year in fiscal year 2028. From the fiscal year 2028 base, we are targeting an accelerating high single-digit growth through fiscal year 2030 as more of the lifetime economics flow through reported income. Fourth, we are targeting low single-digit SG&A growth over the plan period while units grow at mid-single-digit rate. We are on track for a $200 million run rate savings target exiting fiscal year 2027. We will reallocate savings to self-fund growth, and we will continue to look for additional efficiencies. The combination of controlled spending and higher volume creates strong operating leverage. Finally, when you add up unit growth, EPP acceleration, CAP growth over time, SG&A leverage and disciplined share repurchases, we expect to deliver mid-teens adjusted EPS growth. We expect share repurchases to contribute low single-digit EPS growth within that framework with the majority of the growth driven by our operating performance. That brings me to capital allocation. Our framework has 3 priorities: First, maintain financial strength. We plan to preserve a strong balance sheet and manage within our long-term leverage target of 1.5 to 2x. That gives us the flexibility to operate through cycles and supports efficient access to capital for CAF and the broader business. Second, investing to grow the core business. Our current viewpoint is that we will allocate approximately $500 million per year for capital expenditures starting in fiscal year 2028 to fund the areas that increase long-term earnings power and strengthen the customer proposition. The 2 largest buckets of these expenditures are expanding physical locations, including stand-alone reconditioning and auction centers and investing in technology modernization and AI capabilities to enhance operational effectiveness and efficiencies. We will also take a measured approach to funding CAF expansion as we grow into Tier 2 credit. Third, we plan to continue to return excess capital to shareholders. Disciplined share repurchases remain an important part of the framework. We will continue to balance those returns against the needs of the business and the relative returns available across other uses of capital. Overall, Shift into GEAR built a strong financial framework, that we expect will deliver a mid-teens EPS CAGR and increase our capacity to return capital to our shareholders, which we will utilize to compound growth over time. With that, I will turn it back to Keith for a few closing thoughts. Keith?

Thanks, Enrique. Let me close by bringing the story back to why I joined CarMax and where we are headed. I came to CarMax 7 months ago because I saw a great company with assets that are nearly impossible to replicate and a growth opportunity much larger than recent results reflected. The time I've spent with our associates, customers and inside the business has only increased that conviction. We are operating in a large fragmented market with a long runway for growth. The largest players hold a small share. We have roughly 4% of it, and we intend to take more. We are starting from a position of strength, a truly trusted brand. a national physical footprint larger than the competition, scale digital capabilities and an integrated retail, wholesale and cat model. We know that customers want digital convenience paired with an in-store experience. we are built to deliver both at scale. Shift into GEAR puts all of our advantages to work. We are strengthening our price position and broadening our selection. We are making the experience of buying and selling a car easier for our customers. We're expanding CAF and our protection products and taking out structural costs so we can reinvest in the offering and create leverage as we grow. This strategy will also deliver strong financial results. Through fiscal year 2030, we are targeting mid-single-digit retail unit growth and mid-teens adjusted EPS growth. Most importantly, the work is already producing results. We are seeing how sharper prices drive share gains, how greater inventory availability and access improved conversion and sales. and now extending proven capabilities like CAF creates new earning opportunities for the long term. Those early results give us confidence in the strategy, our ability to execute and the opportunity ahead. When we execute on the shift into gear growth strategy, and we will, we strengthened the core of our operations, grow market share and create value for shareholders. But this is only the starting point. We have confidence that the foundation we are building today will unlock even more growth in the future. We are moving with focus and at pace. We are holding ourselves accountable and we'll be transparent about our progress. We know what we need to do, and we have the assets and the team to do it. Thank you for your time and continued interest in CarMax. With that, we're happy to take your questions. Operator?

[Operator Instructions] We'll go first this morning to Sharon Zackfia with William Blair.

I was hoping you could talk about maybe what your longer-term market share opportunity is maybe framing that in terms of what you see in some of your oldest markets and where you are now? And then secondarily, it's encouraging to hear about all of the opportunities for more consistent earnings growth. But the margins are down significantly from where they were pre-pandemic. Do you think there is an opportunity over time to recapture pre-pandemic margins more in the mid- to high single-digit range? Or are there structural elements that make that more difficult to achieve?

Thanks, Sharon. Really appreciate your questions. Yes, in terms of market share, like I said earlier, we have a 4% market share of the 0 and 10 market today. And we basically see the opportunity for us to continue to gain market share every single year moving forward when our pricing is correct. If you look at Q2, market was just broadly flat, and we had a 13% comp. We see that momentum continuing for the remainder of the year into future fiscal year too. So we will gain market share every single year by posting this mid-single-digit comp growth going forward, too. So I'm really excited about the opportunity. And we'll talk more about it as the call goes on, but how we're going to go ahead and do that. In terms of margin, it's an excellent question. I think one of the challenges of CarMax when I got here was we protected margin at the expense of sales over a number of years. Right now, we're focusing on how do we make sure that we take cost out of the business from things like reconditioning and logistics, reinvest that back into price then have sustainable comparable sales growth and continue to find more efficiencies and leverage SG&A. Not saying that there isn't margin opportunity potentially in the future. But right now, we're making sure that we're protecting our existing margins so we can drive comparable sales growth going forward.

Ms. Zackfia, did you have anything further man?

Sorry, I thought I did my 2 one. Can I ask some 1 follow-up then. On the pricing, so you talked about taking hundreds of dollars of reconditioning out, is there a linearity there? Or is there a lumpiness? Like how should we think about that ability to reinvest back in pricing going forward?

Yes. So we talked a little bit about both of those areas and reconditioning and logistics. And so we are in the design phase right now of the new reconditioning system. We'll be piloting that early next year. and then we'll be scaling that up over fiscal year '28 and; 29. And so that would create reconditioning savings, which we're going to reinvest back into price to make sure we can continue to drive comparable sales. Additionally, we just finished a 16-week engagement, redesigning our logistics network, rolling that out in terms of piloting later on this year, early next year and then you're scaling up that new hub-and-spoke design logistics network over coming years, too. So we'll take cost out probably quarter after quarter, year after year and reinvest that back into price but you won't be seeing it coming through margin because we're going to again reinvest it back into price to make sure we can protect sales and have those comfortable sales growth.

And Sharon, I'd say, well, those bleed into next year, there are specific examples of digitizing, reconditioning and logistics savings as well in the nearer term, so kind of like in the here and now and in the near term, we have taken costs out as we talked about last quarter, going from a 90-day warranty to a 30-day warranty, improvements in sublet and also by accelerating part of that digitization of our reconditioning through a part selection tool that we've already rolled out there are some near-term opportunities that we're executing on. But as Keith mentioned, certainly, as we look out over the scope of these 4 years, we do think that there is a material opportunity to drive down costs and then give first and foremost, to back to consumers to drive sales.

We'll go next now to Rajat Gupta at JPMorgan. .

Great. I just want to follow up just on the previous question. I'm clearly you've seen really nice elasticity this year with the initial price cuts. With some of these savings that you expect within the hundreds of dollars pocket around Recon logistics, is there a way to think about how the vast should look like because your -- the way I see it is you're looking to maintain your retail but you can still remain price competitive with those -- investing those savings into price. I'm curious if anything has changed in terms of how you do elasticity why wouldn't you see higher growth with those savings? And I have a follow-up.

Sure. It's a great question, and I'll let Enrique chime in as well to you. But Again, we're going to continue to find cost taking out of the business over time to reinvest back into price. And again, we're seeing, again, Q2, 13% comp gets to flat industry, that momentum continuing on for the rest of the year into following fiscal year. So we think there's more opportunity. And again, when I think about chips into gear, this is about strengthening the core of our operations. It is about modernizing parts of our business and leveraging some of our core competitive advantages. -- to take a solid foundation and then continue to accelerate growth over time. So again, we see this as a starting point for the next few years, which gives us an incredibly strong business that can deliver comparable sales growth mid-teens EPS growth and then continue to accelerate going on from there. So Enrique?

Yes, I think what I'd add is like the elasticity versus what we saw in the past is very similar. So it's not like the elasticity has changed. And in our second quarter call, what we did talk about in terms of driving our comp performance of 13% comes kind of the split tethering that we control directly. That was pulling cost out of reconditioning, right, as well as lowering GPUs, but then also supported by the FTC enforcement. So it's roughly half split between what Joe our comps and we had talked about last quarter. But overall, the elasticity hasn't really changed versus what we had seen before.

Understood. Got it. And just on CAF, I appreciate all the color around increasing the Tier 2 penetration, it all makes sense. I didn't see anything on like total cap penetration. It took a bit of a step back last quarter. But I'm curious No. Is that 40% based on maintaining the current level of total cash penetration? Or is that going to drive also drive incremental total gas penetration. Just curious to get an update there.

Yes, Rajat, this is John. Thanks for the question. Yes, I think total GAAP penetration still remains a focus. We said we wanted to target 50% by authority. That is still absolutely the cars. We wanted to highlight the specific percentage of Tier 2 metric because we really think it just shines a spotlight on really what we're focusing on and what we're going after, capturing an appropriate share of the Tier 2 percentage. And clearly, you've seen we've made great strides there, and we'll continue to do so into FY '30. We highlighted during the Q2 call that for while we absolutely can control how much we take, it is cyclical and a function of the economic environment with interest rates going up, you will lose some to cash, you will lose some to credit unions. So we didn't want that to really not hide how much we're taking in Tier 2. So we will absolutely highlight both metrics going forward but we really want to localize it on the Tier 2. We think that's important to track our progress on the growth.

We'll go next now to Brian Nagel of Oppenheimer.

So the first question I want to ask, just within the, I guess, the context of the new longer-term financial plan you're outlining today. And how should we think about, I guess, the linearity of that plan. And the reason I'm asking is having followed CarMax for a while. There have been -- in the past, there have been other algorithms have been put forth. But it's -- there's been a lot of choppiness within those algorithms, meaning that the company has only really operate on Algo in a very short amount of time. So as you're looking about this new financial plan, do you think there's -- should we think about this as more linear? Is there going to be more consistent growth in CarMax going forward?

Yes. Thanks, Brian. That is absolutely our focus. And that's why we positioned the algorithm where it is. We believe fundamentally, we can have sustainable, consistent levels of comparable sales growth going forward. by maintaining our pricing correctly and by taking cost out of the business. And what gives us confidence in that, Brian is, and as Enrique commented on earlier, every year, we see opportunities to take cost out of our business in terms of logistics and reconditioning finding ways making us more and more efficient and just keep our pricing, again, competitive within the broader marketplace, too. And also going back on the FTC piece earlier, that clearly is a tailwind for us for the foreseeable future. I also see it as a longer-term structural tailwind for CarMax because really, the lack of compliance to FTC guidelines was a bit of a headwind for CarMax. We were always being transparent in our pricing when the industry wasn't and it's going to reaffirm to our customers the strength of the CarMax value proposition in the CarMax brand. And two, so again, to your point earlier, we expect to have a much higher level of consistent growth going forward and less variability. Again, assuming that there's a generally stable macroeconomic environment and no major exogenous events.

That's helpful. And then my follow-up question, in the presentation, you talked about the 250 or so stores you currently operate. Question I want to ask is as you look at the operating model today, I mean -- and to get to the financial goals we're talking about today, a, is there any needed investment or then, or b, is there any type of restructuring? Do you have the right number of stores or the stores configured correctly, et cetera?

Yes. It's an excellent question, Brian. And I think I would call this as an evolution, not necessarily a revolution for CarMax. We have an amazing geographic footprint, but the model is going to need to evolve to have consistent delivery of comparable sales growth and higher efficiencies. And so we are building stand-alone reconditioning centers. We're moving to a hub-and-spoke logistics network with digitizing reconditioning. We've guided from a capital perspective, about $500 million a year to reinvest in those technologies and in that physical footprint, and we'll evolve and change it every year to deliver consistent levels of performance. So I wouldn't say there has to be a massive transformation overnight. It will be an evolution of the model in the most efficient way possible as we kind of roll out reconditioning centers as we roll out the new logistics network. That makes sense.

We'll go next now to Jeff Lick with Stephens.

I'll echo what Brian said Keith, now that you've been there for a little while, and obviously, you were new to the used car business, but not new to running businesses. I'm just curious if you could maybe just talk about where some of the lowest hanging fruit is that you've seen or where you see the biggest changes to kind of how the key bar regime will run CarMax versus how it was run previously.

Yes. Thanks, Jeff. I'll say this. The car business is a very simple business and a very complex business. It's very simple. It's like if you get your pricing right and understand how that flywheel works, you will drive sales and you will drive EPS. And so I understand that really, really well. How you do that consistently is the hard part about this business. How do you consistently take cost out. And I think the biggest thing I'd say, Jeff, what's different is I think about leveraging our scale, centralization, digitization, just becoming a more efficient business. for 30-plus years, this was built as a fairly decentralized business. Logistics was point-to-point. Stores were doing reconditioning and doing it different ways, still using cook boards, still using white boards. There's so much opportunity here, Jeff, to leverage technology, data, analytics, AI, centralization and leverage scale just drive performance and scale is what wins at the end of the day. So we're well positioned from a physical footprint perspective. And we have the financial capacity to invest in things that will help us win in the longer term. And actually, that's the upside opportunity for CarMax, right? There's a lot of things that we haven't invested in to the degree that we needed to, and we're going to do that now within our capital guidance and really that will drive sustainable performance. And so digitization, centralization and just how we leverage scale in a very different way and moving away from being such a decentralized business.

And as a follow-up, I wanted to ask this question kind of in a respectful intellectual curiosity way as opposed to a solid in Smart Pass way. But with respect to the -- when you highlight that customers want a store connection with digital convenience. I'm just curious, your theory as to if that's the case, why has Carvana's growth rate on a big base now, they're not growing high percentages on small units anymore, why do you think that's the case? I'm just wondering if it's possible that there's a subsector of used car buyers that don't want don't really care about the store and if that subsector has vastly different kind of psychographic and economic characteristics attached to it.

Yes. It's a great question. I'll preach it 2 ways. I think there are going to be 3 types of customer journeys going forward, and I'll talk a little bit about the competitive landscape. I believe there are a subset of customers who will be end-to-end digital, who want to start digitally and want to complete digitally and don't want to come to the store. There are a set of customers who actually just kind of almost start at the store, and there's ones that are in between where they progress digitally, and then they want to complete in a store. I was just looking at some of the most recent consumer insight data we have. What was interesting to me was how many customers, even though they complete digitally, actually test drive either at an OEM or a CarMax or at another used retail dealer. So customers, even though they say they're digital, the truth is the vast majority of them are still going to a store to test drive, even then they may complete it digitally too. And so I think that's why CarMax is so advantaged right? We can do the complete in store. We can do the end-to-end digital and we can do the combination of the best of both worlds, too. So we have to improve. We're going to get better in a lot of those areas but we are structurally advantaged to be able to take advantage of the growth opportunities here continued success.

We'll go next now to Daniela Haigian with Morgan Stanley.

Great. I think my first 1 is kind of digging into this reconditioning theme. Keith, you made a very clear connection between having more salable inventory and the ability to grow market share. So if you think about how you're adding more reconditioning or stand-alone reconditioning centers. You're kind of reorienting some of your stores moving to this more in store? How do you -- what are some numbers you can share around that in terms of annual throughput at your stand-alone reconditioning centers, the number that you want to add, the percentage you want to in-source or any other kind of goals internally around that initiative?

I think when thinking about sellable inventory, there's multiple ways to increase the cell polymer, right? So there is adding off-site production and auction centers, -- and think about those as like the largest of our large reconditioning centers. So think of like a Marietta and San Diego, you're looking at about 500 a week. And so you're looking at a very strong capacity to conditions. But there's also taking a look at our hold policy, taking a look at our transfer policies, right, and making sure that for the inventory that we do have that we're being as efficient and we're maximizing the speed at which they're moving. And so we're taking a look at all 3 of those different items. And that's part of the journey as well, right, which is how to make sure it's not only adding off-site production capacity, but it's also maximizing again the efficiency of the inventory that we have.

Yes. And just to expand on that a little bit. I mean we're looking at how long should it hold be allowed? Should we be doing free transfers, should be paid transfers, understanding which vehicle should be able to be held, which vehicles should be able to be transferred. I think we were doing a lot of things that were great for our customers, but we're actually making us less productive as a business sometimes and not having the payback that we need to. And so we're really encouraged by the early tests we're seeing on faster transfers. We're really encouraged by how we're seeing the impact of paid transfers and shorter holds. All these things effectively just give us more saleable inventory without having to just buy more vehicles. So more and more efficient. I talked to the team about making our existing assets just work harder for us day in and day out.

Got it. That's really helpful. My second 1 is on CAF. You had a really helpful slide, Slide 22, where you kind of show the unit economics or profitability of held for investment versus held for sale versus kind of these origination fees for third parties. Your target is for 40% penetration in Tier 2. What -- is there some reason that that's kind of an optimal number? Would you prefer to have more penetration? Is that a better economic outcome for you? Or is there some benefit to kind of leaving some Tier 2 originations for third-party lenders?

Yes, Daniela, I appreciate the question. So the reason we offered 40% is, again, time-bound exercise here, we're giving you FY '30. So we feel like we stated this on the prepared remarks, we want to have disciplined structured growth here. We're growing our funding capabilities. We're learning about our underwriting. We're continuing to iterate. So that's just the trajectory that it takes us and wanted to time down that on FY '30. But yes, beyond that, we absolutely believe there's more value to gain. Now what I will say is our partner -- our overall credit platform that includes our long-term partners that we value tremendously they will always be a part of our platform. The question will be what's the optimal amount for cash to take versus the partners and how much we have. That is something that we will continue to evolve. But 40% is FY '30. But beyond that, we definitely see there's more opportunity.

We'll go next now to Alex Perry with Bank of America.

I just wanted to see if you could sort of contextualize the level of price investment we should expect like maybe sort of benchmark us, how much did you sort of take like-for-like pricing down this year? What would be the expectation moving forward? And then what is the price gap you see versus some of the other franchise players and digital players? Like how much price needs to be taken to be more in line or to drive that higher volume?

Yes. Thanks, Alex. I mean, I think the team has done an exceptional job, I think, about how we think evolving our pricing. So first, it was, yes, we did lower GPU a year ago. Then we're also taking more cost out to be able to price competitively. We've also updated our algorithms now. We're bringing more local market data and we're going to continue to iterate those algorithms to be more dynamic in our pricing and really understanding how we compete at the unit level at the market level, too. And so -- it's not like there's a set number, hey, we have to reduce price by another $100. It's really understanding how do we price the individual vehicle sharper and smarter in individual markets based upon what's happening there, then continue to take cost out every single year. So as inflation comes in, we take cost out to make sure we can maintain our relative price positioning. So CarMax's are to premium. We provide just an exceptional experience, a great trusted brand and so forth. But we have to make sure that there's a sensitivity to how much of a premium we should charge. And we're quite clear about that. Actually, we don't publicly disclose it, but we actually really understand exactly where we need to be positioned in the market. And I think you're seeing that flow through in our results.

And then I just wanted to ask about the algo and the timing of the algo on the unit side. I guess, does the mid-single-digit growth rate hold into next year? It sounds like some of the more chunkier significant initiatives won't come online until next year. So I just wanted to make sure that sort of mid- digit rate would hold through next year, especially when you have some of the difficult comps from the initial price investments and FTC tailwinds as well.

Yes. As Keith mentioned, our goal is to drive sustainable and kind of predictable performance, right, year-over-year-over-year. And so I would say that quarter-to-quarter, there can be some variation, right, certainly within the span of 3 months. But from a year-over-year over year standpoint, we are looking to drive kind of predictable, sustainable performance. So I would think about our guidance kind of within that context. SP29412103 Really helpful.

We'll go next to now to Craig Kennison with Baird.

In the past, you've talked about online sales penetration, which has been a metric that really has been stuck in the 14% range. Is that a number you focus on? And is it something you can move the needle?