CarMax, Inc. (KMX) Q2 2027 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter Fiscal Year 2027 CarMax Earnings Release Conference 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, David Lowenstein, VP, Investor Relations. Please go ahead.

Good morning. Thank you for joining our fiscal 2027 second quarter earnings conference call. 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 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 report on Form 10-Q previously filed with the SEC. Please note, in addition to our earnings release, we have also prepared a quarterly investor presentation, and both documents are 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. Lastly, let me thank you in advance for asking only 1 question and getting back in the queue for more follow-ups. Keith?

Thank you, David. Good morning, everyone, and thanks for joining us. As I reflect on my first 6 months at CarMax, I am proud of the progress we have made in strengthening the business. Last quarter, I introduced our strategy for growth built around 4 pillars that place the customer at the center of everything we do and that are designed to meaningfully improve how we operate at scale and support consistently strong performance. Our strong second quarter results reflect solid execution and the initial benefits we are seeing as we deliver on the strategy. Used unit comps grew 13%, driven largely by improved price competitiveness with total units across used and wholesale growing 15%. Earnings per share grew 81% year-over-year to $1.16, supported by robust comp growth, other gross profit expansion through the performance of our extended protection plan products, an increase in CAF contribution and continued SG&A leverage. I want to thank all of our associates for their hard work, which has underpinned these results. Enrique and Jon will speak to our second quarter performance in more detail in a few moments. Our improving performance has been driven by the speed and focus our teams have put into delivering our strategy. We have named our strategy for growth Shift into GEAR and have rolled it out across our corporate offices and entire field organization. Our associates are highly engaged with the steps we are taking to strengthen our core operations, which are designed to deliver robust financial results over the years to come. We have a lot to be proud of, and I want to highlight a few examples of the progress we made across each of our 4 pillars this quarter. While we speak to the pillars individually, like many aspects of our business, they are interconnected, and many overlapping benefits exist. As a reminder, Shift into GEAR starts with a great offering; we will give customers every reason to choose CarMax by offering a great car at the right price. During the second quarter, we further strengthened our price competitiveness to support retail sales growth. We did this by continuing to drive efficiencies in reconditioning, dynamically managing GPUs and then passing savings on to customers. In addition, we continue to improve our pricing algorithms to ensure we remain more competitive across demand cycles. We did this by incorporating local market insights more granularly and by expanding comparison points across a broader set of vehicles. These enhancements resulted in sharper pricing that resonated well with our customers and supported our sales. Our second pillar is easy experience; we will make it easy to do business with us, both online and in our stores. This quarter, we enhanced the customer experience to better support the purchase journey from digital to in-person. We scaled AI voice technology to 100% of both inbound store and customer experience center calls, which enables customers to quickly resolve their inquiries through our agentic AI tools or directly connect to the right associate for help. Additionally, we improved our digital experience by redesigning our car detail page to make it easier for customers to find and buy the right car for them. Recent updates include providing greater visibility into our inventory selection, incorporating personalized monthly payments and communicating next steps in the purchase process more clearly. The enhancements we made this quarter supported sales conversion, and we anticipate further gains over time. Our third pillar is add value. This pillar focuses on growing profitability by maximizing value across all aspects of our business. This will be done by connecting customers with valuable offerings and by capturing a larger portion of customer financing through CAF. During the second quarter, we grew our extended protection plan unit margins materially year-over-year as we continue to launch our redesigned offering. Additionally, we increased our Tier 2 penetration and recorded a gain on the residual sale related to our 2026-B non-prime securitization. Our final pillar is run lean; we will unlock efficiencies to enable a great offering, meaningfully improve how we operate at scale and support strong returns for our shareholders. During the second quarter, as I noted earlier, we continued taking costs out of our reconditioning operations and maintained our approach of passing savings on to customers through more competitive pricing to drive sales. Also, from an SG&A perspective, we took additional steps this quarter to solidify achieving our commitment of $200 million in fiscal year '27 exit rate savings. To support and advance Shift into GEAR, we are strengthening our leadership team. Today, I am pleased to announce 2 key appointments that will help us build on the momentum we are seeing as we begin to deliver on our strategic plan. First, effective October 5, Elizabeth Dirgins will join CarMax as Executive Vice President, Chief Digital and Customer Officer. In this newly created role, Elizabeth will own and unify the end-to-end customer experience, from customer acquisition through vehicle transaction. In this capacity, she will oversee our marketing, product and Edmunds team. With more than 2 decades of digital product and customer experience leadership, Elizabeth comes to us from Volkswagen Financial Services, where she served as Chief Digital Officer for the North American region. Second, Jeff Campbell, who has been with CarMax for over a decade, joined our senior leadership team in August as Senior Vice President, Strategy. Jeff is leading a newly centralized function designed to accelerate key decisions by bringing together all of our strategy, data science, AI and pricing teams. Jeff has held leadership roles at CarMax spanning product, strategy and transformation. Elizabeth and Jeff both bring the skills, experience and focus we need as we build a faster, more connected company that puts the customer at the center of everything we do. Both positions will report directly to me. Our customer promise is to deliver a great car at the right price with an online and in-store experience that our customers love. All the steps we have been taking are in service of that promise and to create confidence for the road ahead for our associates, customers and investors. We have a clear strategy, a solid foundation and a team that is committed to delivering strong unit and earnings growth that enables us to consistently reward our shareholders. Based on our second quarter performance, continued momentum and improving leverage, we intend to resume share repurchases at a modest level in the third quarter. Now I'd like to turn the call over to Enrique to discuss our second quarter financial performance in more detail. Enrique?

Thanks, Keith, and good morning, everyone. We are encouraged by the recent growth across the business as our Shift into GEAR strategy is yielding strong financial results, highlighted by the continued improvements in our year-over-year sales and earnings trends. During the second quarter, we delivered total sales of $7.9 billion, up 19% compared to last year. Across our retail and wholesale channels, we sold approximately 388,000 vehicles, up 15% versus the second quarter last year. In our retail business, used unit comps increased 13% and total used unit sales grew by 14%. Sales performance this quarter was primarily supported by more competitive pricing. As Keith discussed, we continue to realize efficiency gains in cost of sales, and we dynamically manage GPUs, passing those benefits on to customers. Together with the enhancements we are making to our pricing capabilities, these actions supported a significant improvement in our year-over-year sales trend. In addition, we benefited from enhanced FTC regulatory focus that has brought greater transparency to advertised vehicle pricing industry wide by requiring fees to be included. Given our long-standing commitment to transparent, no-haggle pricing, this brings more clarity to the strength of the CarMax consumer offer by enabling customers to make more direct price comparisons and is a tailwind to our business. Average selling price was $27,623, a year-over-year increase of $1,630 per unit. Wholesale unit sales were up 16% versus last year's second quarter. Average wholesale selling price increased by $145 per unit to $8,036. We bought approximately 310,000 vehicles during the quarter, up 6% from last year. We purchased approximately 262,000 vehicles from consumers, relatively flat to last year's second quarter. With the support of our Edmunds team, we sourced the remaining approximately 48,000 vehicles through dealers, which was up 54% from last year. Second quarter net earnings per diluted share was $1.16 versus $0.64 last year, an 81% increase, a strong positive change in year-over-year trend relative to the preceding 4 quarters. Total gross profit was $799 million, up 11% from last year's second quarter. Used retail margin of $479 million increased by 8%, driven by higher volume and partially offset by lower profit per used unit of $2,105, which was down $111 per unit from last year's second quarter. In managing margins more dynamically, we lowered GPUs by less than the full year $200 per retail unit outlook we provided previously as we balance demand, margins and efficiency gains in our reconditioning processes to support sales. We expect FY '27 full year retail margins will be down less than the $200 per unit as compared to FY '26. Wholesale vehicle margin of $138 million was flat to a year ago with higher volume offset by lower gross profit per unit of $858, which was down $135 per unit. Other gross profit was $183 million, an increase of $46 million or 33% from last year's second quarter. EPP margin dollars were up $27 million, driven by growth in both unit volume and unit margins, which were up $46 per unit in the second quarter. We have been encouraged with the impact from our EPP product redesign, focused on providing our customers with more affordable options and from our new wheel, tire and dent product offering. We remain on track to drive approximately $35 per unit in incremental EPP margin for the full fiscal year. Service margin increased by $22 million, driven primarily by efficiency gains in cost of sales and leverage from unit volume growth. CarMax Auto Finance income of $136 million was up 32% year-over-year. Jon will provide detail on CAF in a few moments. On the SG&A front, expenses for the second quarter were $629 million, up 4.6% from the prior year. SG&A levered robustly by $157 per total unit or 9% to $1,621. SG&A dollars for the second quarter versus last year were mainly impacted by 2 factors. First, compensation and benefits, excluding share-based compensation expense, increased by $11 million. This year-over-year comparison reflects materially lower corporate incentive compensation in the prior year and strong performance this year. Excluding this impact, compensation and benefits would have decreased by over $14 million, primarily reflecting lower field and corporate payroll, partially offset by variable costs associated with higher sales. We expect the year-over-year corporate incentive compensation dynamic to remain similar in the third quarter and to moderate in the fourth quarter. Second, share-based compensation increased by $7 million, driven by upward movement in our stock price. Regarding SG&A, we remain on track to deliver on our $200 million in identified savings as an FY '27 exit rate target, and we continue to drive toward expense efficiencies. As part of these efforts, we recently took additional actions to further streamline our corporate cost structure, which we expect will result in approximately $6 million in severance expense in the third quarter. Also worth noting, in this quarter's P&L, other income increased by $15 million compared to the same period last year, primarily reflecting unrealized gains on a small number of equity investments. As we have noted previously, we maintain a modest portfolio of investments across the used auto ecosystem. Separately, we are completing the termination of our legacy pension plan and expect it to be materially complete by the end of the fiscal year. As part of this process, we estimate approximately $50 million in total settlement-related noncash, nonrecurring charges will be recorded in other expense, with relatively similar amounts expected to be recognized in the third and fourth quarters of this fiscal year. Our expectation is that the assets in our pension trust will fully fund the settlement of the pension liabilities. Further, the planned termination will eliminate potential future corporate funding requirements. Regarding capital structure, as Keith mentioned, with a strong second quarter, a positive outlook on the balance of the year and traction on our strategy, we intend to restart our share repurchase program in the third quarter. We expect to begin our buybacks at a modest pace below the average quarterly pace prior to our pause. Our objective is to appropriately manage our net leverage to maintain financial flexibility and to efficiently access the capital markets for both CAF and CarMax as a whole, while also returning capital back to our shareholders. As of the end of the quarter, we had $1.31 billion of repurchase authorization remaining. I will now turn the call over to Jon to provide more detail on CarMax Auto Finance and our continuing focus on full credit spectrum expansion. Jon?

Thanks, Enrique, and good morning, everyone. During the second quarter, CarMax Auto Finance originated $2.3 billion, resulting in sales penetration of 40.9% net of 3-day payoffs versus 42.6% last year. The weighted average contract rate charged to new customers was 11.8%, up 60 basis points from the prior year. Third-party Tier 2 penetration was 15.9% versus 16.5% last year. And third-party Tier 3 was 7.6% versus 7.3% a year ago. We continue to make meaningful progress expanding across the credit spectrum. During the quarter, CAF was once again the largest Tier 2 lender, financing 22% of Tier 2 volume as compared to 10% a year ago. The observed credit performance in this space continues to be in line with our original expectations, reinforcing confidence in our decision to expand. Despite this growth in Tier 2, overall CAF penetration declined year-over-year, reflecting lower Tier 1 penetration. Increased funding costs driven by the interest rate environment resulted in CAF increasing rates in Tier 1, where customers have more funding alternatives, including cash or financing through credit unions. We view this as a normal response to the higher interest rate environment versus a structural change in behavior from CarMax customers. CAF income was $136 million, up 32% from the prior year's second quarter, driven by a $29 million decrease in the loan loss provision to $113 million. During the second quarter of the prior year, we recorded additional provision due to the worsening performance of older vintages at that time, whereas performance this year has been in line with expectations. This was partially offset by provisioning related to Tier 2 originations in the quarter from our full credit spectrum expansion. Additionally, CAF income benefited from a $17 million gain on sale recorded during the quarter and a $6 million increase in servicing fees year-over-year. This was partially offset by impacts from a $1.2 billion year-over-year reduction in outstanding receivables related to the combination of selling the residual interest for 2 non-prime securitizations and lower sales during fiscal 2026. Please note, the timing of our receivables sale differs from last year when we recorded a $27 million gain on our '25-B transaction during the third quarter. Our total reserve balance at the end of the quarter was $497 million or 3.07% of receivables held for investment. Net interest margin on the quarter was 6.6%, consistent year-over-year. As we reflect on another solid quarter, our multifaceted strategy to enable CAF income growth is hitting the mark. First and foremost, credit losses were within our expectations across both the Tier 1 and Tier 2 portfolios. Second, the refinement of our non-prime credit underwriting strategy continues to build momentum with origination volume up substantially compared to just a year ago. Third, we continue to benefit from flexibility in how we fund our receivables. Our ability to retain assets on our balance sheet when prioritizing attractive longer-term economics is now well complemented by our evolving method of utilizing off-balance sheet transactions to more quickly monetize cash flows and reduce future risk. This funding flexibility is an important advantage as we continue to grow CAF. The timing and mix of these transactions may create near-term variability in reported income and provision expense from quarter-to-quarter. However, as our evolving mix of funding strategies begins to mature and becomes more routine over the next 12 to 24 months, we would expect the variability to decrease. To provide a view into our near-term performance, we anticipate CAF's FY '27 income will be slightly lower than FY '26, all while planning to originate nearly $1 billion in Tier 2 by year-end. It is this disciplined scaling in Tier 2, along with an appropriately sized loss reserve, that should lead to significant CAF income growth over time. We plan to share more details during our upcoming strategic update. Now I'd like to turn the call back over to Keith. Keith?

Thank you, Jon. Before we open the line for questions, let me leave you with a few final thoughts. We are encouraged by our performance this quarter and the progress we are making across the business. While we're still early in our journey, the results we are seeing reinforce our confidence in our strategy and the opportunity ahead. Shift into GEAR is focused on strengthening our core business and getting CarMax back to sustained growth. We are steadfast in our focus on delivering the right cars at the right price, making it easier for our customers to do business with us, capturing more value from each transaction and operating more efficiently at scale. This quarter's strong unit and earnings growth reflects solid execution against these priorities. What encourages me most is that we are delivering these results while much of the work across our 4 GEAR pillars is still ahead of us. We have a solid foundation, an exceptional team, and we are adding leadership in key areas to accelerate our progress. I am confident in our ability to build on this early momentum, continue to improve our business and create long-term value for our shareholders. None of this happens without our associates, and I want to thank them again for their hard work and embracing our new strategy to create a stronger CarMax. I look forward to sharing more about our strategy, including key initiatives and milestones during our upcoming strategic update, which will take place virtually on November 3. Thank you for your continued interest in CarMax. Operator, we are ready to take questions.

[Operator Instructions] Your first question comes from the line of Daniela Haigian with Morgan Stanley.

So GPU, along with a lot of other areas of the business, came in really strong this quarter, and you're now trending better than that down $200 year-over-year full year guide. How would you characterize that strength? What was the impact from greater efficiencies in COGS per unit versus maybe some of this FTC uplift or retail wholesale spreads?

Daniela, thank you for being here. I'll let Enrique respond to that.

Yes, we've been really pleased that we've been able to come in better than our previous outlook on GPU, certainly now expecting the year to be below a $200 decrease year-over-year. And we've done that while maintaining strong sales as we've effectively balanced demand we're seeing in the marketplace for our cars, margins, as well as efficiency gains. And it's really the balance of all 3 of those things that has allowed us to come in better, if you will, on our GPU. And specifically around cost efficiencies that we're seeing in the business, the teams have done tremendous work around rolling out different tools for our operators. We have a new part selection tool that's benefiting the organization. We switched, as we've talked about before, from a 90-day warranty to a 30-day warranty for our customers and actually given that back in terms of lower pricing for our customers as well, and that supported our sales. But overall, really pleased that the demand we're seeing in the marketplace and our ability to, again, come in better than our GPU previous outlook.

And maybe the macro part, the impact of spreads or FTC?

Yes, the FTC impact definitely is a tailwind. When we take a look overall at like our comp performance, right, on the quarter, I would say it's evenly mixed between items we control directly, so COGS efficiencies, the GPU decrease, pricing algorithm improvements, customer experience improvements. So those items that we control directly, we think it's about half of the comp performance, while the other half is really coming from what we think is the FTC enforcement benefits that we're seeing.

Yes. Thanks. And just to build on that a little bit. I mean, I think there's 2 aspects, as Enrique said, having a really clear strategy that focuses on the core of this business is going to drive performance. And also really the strength of the CarMax brand, that price transparency, which we have been known for, disproportionately benefits us now going forward. So now that the FTC is focused on compliance to their guidelines. We've always had more transparency, and it's helping us with price competitiveness, too. So it's execution of strategy and also the strength of the CarMax customer value proposition.

That's really helpful. And then maybe, Keith, just a broader question for you. I know it's early days here, but how do you think about CarMax's omnichannel architecture and brand positioning in this future of agentic AI, right, where these agents are doing searching and comparing on the consumer's behalf? Maybe more to hear on this in November, but curious to hear how you think about it.

Sure. Yes. I mean, we'll talk a little bit about AI. Again, we have an AI center of excellence here at CarMax, which basically makes sure we responsibly use AI and look at all the different use cases here we implement. And so things like our agentic voice call center now, handling 100% of stores and our customer experience center calls and helping to do that. Your question is related to search. And I think that AI is going to be actually a real benefit to the consumer to be able to go out there and really understand different vehicles and how those vehicles meet their needs. In terms of actually getting down to transactions, I think that will be really difficult for the used car industry to be negatively impacted by it because every vehicle is an individual SKU. You can see how agentic AI e-commerce will impact more CPG faster. And we think it's a real benefit to our business here to drive us to become more efficient and deliver better customer experiences.

Our next question comes from Rajat Gupta with JPMorgan.

Congrats on the good execution here. I had a question on just comps for the rest of the year. If I look at normal seasonality in the business, based on the 13% comp in 2Q, normal seasonality would imply somewhere around mid-teens in the third quarter -- mid- to high teens in the third quarter. I'm curious, like, if you're seeing anything there in the macro or just the consumer backdrop that would deviate from that seasonality? That's question number 1. And then I have a follow-up.

Yes. Thanks, Rajat. I'll talk about the consumer. I mean, affordability is on everyone's mind. It seems like every single discussion is around that. And I think it speaks to the strength of the CarMax brand effectively and our focus on having incredibly competitive pricing. And the other word I would say about the consumer is resilient. At the end of the day, across all the different spectrums of the lower-end consumer to the higher-end consumer, we're definitely seeing resiliency there. I mean, the broader industry is down 1% -- or flat to 1%, and we posted comps of 13%. So I think having great cars, great vehicles at great pricing and making it easy to work with will drive continued growth and performance in the business.

In terms of an outlook for the back half of the year, look, we captured it in our prepared remarks. And you can see it in our bullishness around the business. We're turning our share repo back on. We're seeing continued momentum into the business. And so we're really pleased in terms of where we are and kind of what we're seeing in front of us.

Got it. And then once you lap -- you're going to lap the price cuts here in December, do you believe like the business has gotten to a place where there's enough efficiency you're able to drive to remain competitive on price to sustain the share gain? I'm curious how you feel about that based on what you've observed over the last 6 months.

Yes, absolutely. I mean, again, if you think about our strategy, Shift into GEAR, and running lean being that pillar and that running lean makes sure we can have a great offering and we've committed to saying we want to self-fund our price competitiveness moving forward to continue to find efficiencies in the business so that we can deliver great vehicles at exceptional prices, but not having to lower GPU moving forward. So that's the focus of the business, and I'm really confident in the team.

Yes. And I would say, certainly for FY '28, that is the intent, right? As we've talked about before, to self-fund any kind of GPU investments and lower price. I think, for this year, for the guidance we've given here, the outlook, we do expect to be lower, less than $200 year-over-year in a reduction in GPU. And I would expect some decrease in the third quarter and in the fourth quarter as well. We'll be comping over a record quarter in FY '25 in terms of GPU. So we are maintaining some flexibility in the business. We're running the business more dynamically, and that includes some flexibility. So I would expect GPUs for this year as a whole and by quarter to be down year-over-year in support of driving sales.

Our next question comes from Jeff Lick with Stephens.

Congrats on the great results. Enrique, maybe for you. The EPP gain was probably a little more than people were expecting. I was wondering if you could unpack that a little bit and just the dynamics of where that's coming from.

Yes. I would say that we were very pleased on the execution as a whole in terms of EPP and the incremental margin we're seeing from product redesign from our new product, wheel, tire and dent, all of that is in line with our expectations. And I would say our full year guidance of $35 in incremental EPP for the full year is pretty much in line, I would tell you, with where we ended this quarter being at $46 a unit, recognizing that in the first quarter, we are still rolling out nationally. We had a lot less than that. So I would tell you it's very much in line with what we had expected and where we expect to be for the year.

Yes, Jeff, this is Jon. I'll just add to that kind of qualitatively. Look, I think this is something we signaled. We knew that we could make progress here. We saw an opportunity to really refresh our product. We've gotten this in the stores. It will be nationally rolled out by end of the year. Just with getting in California, our stores have done an outstanding job at selling this product. It's a more affordable product for our customers. We've tacked on what we think is a fantastic cosmetic protection product, wheel, tire and dent. Like, we saw it come in. We knew that we could deliver, and the stores have done so.

And then just a quick 1 for Keith. Keith, on the last call, we talked about dynamic pricing that seems as it related to your previous career. And I'm just curious, I mean, the big question, as we get into the next year and we get through easy comps, is people are going to look at, okay, can they comp positive and they continue to hold GPU. Just any high-level thoughts as you've kind of been observing the data in the business on how you might give investors comfort that this just isn't an easy comp phenomenon?

Yes. No. Thanks, Jeff. And that's everything about Shift into GEAR is about making sure we have sustainable growth. And that's the complete focus of the team here right now is making sure that, again, we have the right level of saleable inventory. We can maintain competitive pricing. We can price dynamically depending upon where demand is and by segments. And we're continuing to evolve our pricing algorithms every single month, sharpening up, pulling in external data to make sure we have those local market pricing points, too. So we have a lot of confidence that this should be a growth business, and we should show positive comps and outperform the industry moving forward.

Our next question comes from Craig Kennison with Baird.

Keith, I'm wondering, could you provide examples of how you are taking friction out of the digital journey in order to impact conversion?

Yes, absolutely. Part of it is just really understanding what customers are looking for and making sure we're providing that information in the most easy way possible. And so a couple of examples we've used was like car details page, sharpening up like what consumers are doing in terms of search and making sure we're putting those pieces of information front and center, putting forward monthly payments, taking steps out of the purchase process and simplifying it. I think I mentioned previously, we had our EPP. We had a super complex matrix. And now the way that we're serving it up to customers, it's really self-driven by them, putting in a bit of information and serving up the exact right offerings to them, too. So it's really understanding everything from search all the way through transaction and then how we communicate with customers, just make it easier to do business with us. We're still early days in some parts of the journey. There's things that we can continue to sharpen up, and I'm really excited about having Elizabeth Dirgins join us as our new Chief Digital and Customer Officer. She's got 20-plus years in product, in financial services and in automotive. And so she's the perfect person to join our team here and really own the customer journey moving forward.

Our next question comes from David Bellinger with Mizuho.

I have a couple of strategic ones. Just following up on the GPU outlook being down less than $200 per unit for the year. That would put you at around $2,100 and still within, call it, the legacy guardrails that have governed the business for a while. Why not be more aggressive there? Or is there some optionality to further push GPU down beyond this fiscal year if you are seeing the proper payoff in terms of unit growth?

Yes. Look, I think we -- as we've talked about, we can largely self-fund those movements, right? So Shift into focus (sic) [ GEAR ] focus on sustainable comps, sustainable EPS growth. And we recognize at the same time, we need to self-fund and find efficiencies in the system. We believe there's efficiencies to be had in the system where we don't necessarily need to go down that route as the first selection, if you will. And we're going to focus on driving efficiencies in COGS and logistics business and so on and so forth in order to actually not have to go with margins lower than our initial guidance.

And I think in our November strategic update, we'll be walking through each one of the pillars of the strategy and understanding really the run lean piece and the great offering piece, how interconnected those are and talk about the initiatives we have that will deliver the self-funding, which will deliver the price competitiveness and protect GPU moving forward.

Got it. I also want to touch on inventory levels. So CarMax has been operating pretty consistently with about 80,000 to 90,000 vehicles in any given week. So is there an opportunity to compress that number and get some more efficiency out of the inventory base, maybe add some -- another source of GPU upside if you can bypass some of that natural depreciation from holding on to vehicles?

Yes. So that is a definite area of focus that we have. So like I was just talking about in terms of efficiencies in our COGS and our logistics, an area of focus for the teams are basically inventory, right? And how can we turn our inventory faster, how do we have less unproductive transfers, unproductive holds, things like that, that will slow down your WIP, that will actually drive -- slowing down your turns. Those are items that we think are ahead of us in terms of opportunity and are definitely part of the purview of Shift into GEAR. So absolutely on our list of opportunities.

And we're regularly testing, understanding how this impacts the consumer. So understanding if we -- how we handle holds, is that driving sales, but slowing down our inventory turns. Transfers. We transfer over 2 million -- close to 2.5 million vehicles a year, how do we make those transfers more productive and have fewer of them over time. So it's really understanding, again, how decisions we make on holds and transfers impact sales, but also impact inventory productivity. And we got a lot of work underway there right now as part of our strategy.

Our next question comes from Joe Spak with UBS.

I know you mentioned you're seeing resiliency across consumers of all income, but I was wondering if you could provide any detail if you had it in terms of either traffic or conversion, however you sort of tier your customers, whether that's deciles or quintiles. And I guess just if rates stay high, other macro pressures persist, I know the goal is eventually to sort of get to self-funding that growth. But, in a tougher macro environment, sort of how do you think about the strategic plan? Is GPU still a driver to help drive that growth in that tougher macro?

Yes. I mean, I'll talk about consumers because we look at our consumers by different cohorts effectively on income levels. And again, resilient is the word I would use. Even at our lowest income cohort, we basically have the same number of customers year-over-year. And then, as you move up the income cohorts, we had those growing year-over-year, too, which is how our inventory developed during the quarter as well, too. So we sold more newer vehicles, higher-priced vehicles in this quarter because of the strength of that cohort. Again, that was just for this quarter, and that could change in future quarters, and we can manage our inventory dynamically based upon where we're seeing demand come from, too. So again, across all the different spectrums, we saw basically either the same number of customers or a growing number of customers in a tougher macro environment. And again, I think our price transparency and our price competitiveness is a real, real strength of CarMax. In terms of GPU, moving forward, we believe we can find the efficiencies in the business to make sure we can protect our GPU. Again, it will go down a bit in Q3 and a bit in Q4, as we've already signaled. But going forward in future fiscal years, we'll fund the GPU savings that we need to find in this business.

Our next question comes from John Babcock with Barclays.

Just quickly on that last comment about the GPUs being down in 3Q and 4Q, and I know you also mentioned that earlier. Can you just talk about what's driving that?

Sorry, you broke up a little bit. Did you ask what's driving them?

Yes, yes. So why are you expecting GPUs to be down in 3Q and 4Q?

Yes. So consistent strategy this year, right, which we've communicated like in support of sales, we are lowering our GPUs for the year, right, in order to support our sales performance. We're driving efficiencies in the business. And as we talked about, we also have a tailwind from FTC. You mix all those things together, and we're, I believe, very effectively balancing demand, efficiencies and in order to support sales. So I mean, that's why it's very consistent with what we've said. I think the benefit has been really that we haven't had to lower our margins by as much as what we initially provided an outlook for because of that mix of benefits that we're actually seeing.

Got you. And then next question, I noticed in going back and looking at some of the historical data that the percentage of vehicles you've been buying from dealers has trended higher over the last couple of years, and you obviously had a pretty sizable increase this quarter. Just kind of curious like is that availability driving that? Or is there something else? And then also, can you talk about the profitability on those vehicles that you're buying directly from dealers versus if you buy a vehicle from customers?

Yes, absolutely. So we've been really pleased really since inception of our acquisition of Edmunds, and they have a sales force out there that partner with our organization, and they've been driving our MaxOffer, buying cars from dealers for a few years now. This quarter is just a continued testament to the strength of that product that we have out there, where you saw 54% growth year-over-year in the quarter. Now I will say in terms of profitability, the most profitable buy that we'll have is directly from a customer, right? That is the most profitable buy, as we've always talked about. The least profitable is going to an auction house. And buying a car in an auction house, all you know there is that you paid more than anybody else for the car, but you got the car. And in between there, I'd tell you is buying a car from a dealer. So kind of midway between buying a car from a customer and going to an auction. So definitely accretive to the organization is another contributor to -- that allows us to be more competitive on our pricing as well. So very pleased with our performance this quarter.

Okay. And then just my last question. Obviously, we've seen diesel and transportation costs rise up pretty sharply. I'm just kind of curious if you could talk a bit more about how that's impacting your business, how you're managing through that?

Yes, it's another component within our cost of sales. And -- but as we talked about this quarter, we effectively -- the teams have done a great job in driving efficiencies outside of that impact that have allowed us to be even more price competitive moving forward here, certainly in the quarter and our outlook moving forward. So we've been able to absorb it, the increase in price and diesel. But definitely, it's impacted our costs. But again, our efficiencies elsewhere have allowed us to offset it.

We'll go next to Scot Ciccarelli with Truist.

So I know you've cut it up a few different ways. But when you look at the sharply improved sales rate, can you help us better understand how much of it was driven more by what you guys have historically called top of the funnel, more people coming into your stores and the digital channels versus how much was driven by better conversion rates?

Yes. I would say that overall, in the quarter, our web traffic actually was down by a couple of points. So -- but what we absolutely saw was our sales opportunities being up and our engaged customers being up and our conversion of those engaged customers being up as well. So what we're seeing is better quality customers coming through, if you will, right? So web traffic down, but overall kind of quality customers coming through the digital door and the physical door is up, and our conversion of those customers are up as well.

Yes. I think our marketing team has done an exceptional job of really driving efficiencies in the marketing funnel. And so even though that the web traffic is down a bit, again, the quality of that traffic has significantly improved, which led to all of those factors as Enrique just pointed out, too. So again, a great job by the marketing team.

That's helpful. And then I know it's a little difficult to tease out, and there's obviously some substitutability. But do you think your Tier 2 CAF penetration were all incremental sales? Just trying to figure out if there's a sales impact, if any, as you guys have moved a little bit lower into the credit pool on a direct basis.

Yes. I appreciate the question. Yes, short answer is no. I would say it is not all incremental sales. There's always going to be some incrementality. I think we provided an outstanding offer out there. But no, this is really about us being opportunistic and moving down to the volume where -- again, our credit partners are great. They have always provided great offers to our customers. We're just taking the opportunity to take some of that volume for ourselves that's above and beyond what they would typically pay us. So no, not incremental largely at all.

[Operator Instructions] We'll move next to Alex Perry with Bank of America.

I just wanted to get your thoughts on how the FTC regulation could affect the GPU profiles longer term. Do you think that dealers start to alter their prices with now having to include the doc fees? And then how long should we expect the FTC tailwind to last for you? And what are you seeing sort of in terms of compliance in the overall market?

Sure. I mean, I can give you an example of the FTC benefit for CarMax. And I can't comment on specifically what other companies are going to do with their pricing. But when you think about our competitive pricing overall versus the broader industry, the percentage of vehicles rated great deals on Cars.com for CarMax more than doubled this quarter compared to Q2 of the previous year. So that's just significant, right? And so customers out there digitally shopping for vehicles and seeing the fact that, again, the number of great deals on third-party sites, like Cars.com, we've doubled there. So that's going to be a great, great tailwind for us for the remainder of this year. Compliance really started kind of in the May time frame. And so you probably think about it ramped up into May. So that's probably going to -- we'll lap that sometime...

Yes. And there was a bleed in naturally, not everybody complied certainly right away, and there's still some laggards, I'm sure. But really May is when we saw actually movement there. So again, we have until May and then certainly thereafter to benefit.

And I think the FTC sent out like 97 letters to different companies back in March telling that they're going to -- again, these aren't new guidelines. These guidelines have existed. This is basically saying they were going to enforce compliance. And so the vast majority of the industry is headed in that direction, again, which is just a tailwind for CarMax because we've already been more transparent.

And just a follow-up on that. What impact do you think that has on pricing longer term as dealers move to include this -- the doc fees into a sort of all-in more transparent pricing? What impact do you think that has on sort of GPUs and the overall pricing environment?

I think it's just going to continue to show how price competitive we are. I think, interestingly, the noncompliance by the broader industry actually was a disadvantage for CarMax. Our customer value proposition being no haggle and being transparent to customers, again, was exactly the right thing for CarMax to do in terms of building this brand. Now that people have to comply with this, it basically shows, again, how price competitive we're going to be and being able to maintain our pricing and our GPUs moving forward. And we'll see, again, how other people choose to price.

Our next question comes from Chris Pierce with Needham.

You kind of just hit on it. I really wanted to get a sense of these third-party sites. If we assume a lot of people start there, I'm just kind of curious, the tie-in between marketing and pricing. And does it really just come down to price? And I'd kind of love to get your thoughts on what you're seeing from those sites and the conversion of customers you're seeing from those sites. Then I just have one on the consumer.

I mean, again, we don't really talk about it in that level of detail. I mean, what we think about is our research shows that 90-plus percent of customers start their search for a vehicle online. I have to believe it's probably almost 100% in reality. And again, they're going to be searching at multiple sites. They're going to come to carmax.com, and they're going to look there. They're going to look at third-party sites. They're going to really understand kind of what vehicles are out there. And then, again, our marketing team does an exceptional job through SEO and GEO to be able to attract the right customers to our site and then convert them through the funnel, too. So again, it's making sure that you are priced competitively and that you're showing up in all the right channels, and that's how you maximize, again, customer acquisition to customer conversion.

Okay. Perfect. And I think you talked about rates up 60 bps on average maybe across the quarter and probably gone up through September here. I mean, how should we really think about the consumer being impacted here? Because it's just like you've got consumers dropping down from new car to used that are better credit quality because of new car prices, like a 1% move in rates, I think, is like -- cost hit is like $12 to $15 in monthly payments. So like, is this something investors are sort of overreacting to? Or what's sort of the right reaction? Or what level of rates is something that changes the dynamic for you guys? I just want to sort of kind of level set how investors -- how we should think about this?

Sure. Yes. I'll kind of initially answer that question. When I think about it from the credit lens, I think the consumer -- you're certainly going to have -- it will be bifurcated, the higher-end prime consumer, right? They have options. They're going to go to cash. The credit unions just have obviously an advantage there where they can keep rates low. So for CarMax, in particular, CAF, you're going to see probably some leakage from using the internal financing to those channels. Now CAF in particular, we have options there, right? We can choose, and that's the benefit of a captive. We can choose at any given point to keep the rate low or raise the rate as -- and protect our finance margin. So it happens this quarter, we chose to raise rates, and we saw great comps that were coming in place. So that's an option we have in any given quarter. But I think overall, in the prime consumer, they're just going to switch to a different financing mechanism. As you get further down the credit spectrum, that's where can that payment wall be $12, $15, that might mean a lot. Terms are already extended. Can they find a way to fit that into their budget, there can be a challenge there. Our goal here is to make sure that we have a great competitive front lot price, provide great credit offerings and make it as affordable for them as possible even in the face of macroeconomic changes.

We'll now take a follow-up from John Babcock with Barclays.

Sorry for the follow-up here. Just wanted clarification, though, on the GPUs because you said down 3Q and 4Q. Is that sequentially, or that's year-over-year?

Year-over-year.

Thank you. We don't have any further questions at this time. I'll hand the call back to Keith for any closing remarks.

Thank you, operator, and thanks, everyone, for joining the call today. And I appreciate all your questions and all your support, and we look forward to talking to you next quarter and then seeing you in November.

Thank you. Ladies and gentlemen, that concludes the Second Quarter Fiscal Year 2027 CarMax Earnings Release Conference Call. You may now disconnect.