Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion should be read in conjunction
with the Company's Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this report.
Forward-Looking Information
This Quarterly Report on Form 10-Q contains
“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements address the Company’s future objectives, plans and goals, as well as the Company’s intent, beliefs and current
expectations regarding future operating performance, and can generally be identified by words such as “may,” “will,”
“should,” “could,” “believe,” “expect,” “anticipate,” “intend,”
“plan,” “foresee,” and other similar words or phrases. Specific events addressed by these forward-looking
statements include, but are not limited to:
|
•
|
new dealership openings;
|
|
•
|
performance of new dealerships;
|
|
•
|
same dealership revenue growth;
|
|
•
|
receivables growth as related to revenue growth;
|
|
•
|
gross margin percentages;
|
|
•
|
the Company’s collection results, including, but not limited to, collections during income tax refund periods;
|
|
•
|
compliance with tax regulations;
|
|
•
|
the Company’s business and growth strategies;
|
|
•
|
financing the majority of growth from profits; and
|
|
•
|
having adequate liquidity to satisfy its capital needs.
|
These forward-looking statements are based
on the Company’s current estimates and assumptions and involve various risks and uncertainties. As a result, you are cautioned
that these forward-looking statements are not guarantees of future performance, and that actual results could differ materially
from those projected in these forward-looking statements. Factors that may cause actual results to differ materially from the Company’s
projections include those risks described elsewhere in this report, as well as:
|
•
|
the availability of credit facilities to support the Company’s business;
|
|
•
|
the Company’s ability to underwrite and collect its contracts effectively;
|
|
•
|
dependence on existing management;
|
|
•
|
ability to attract, develop and retain qualified general managers;
|
|
•
|
availability of quality vehicles at prices that will be affordable to customers;
|
|
•
|
changes in consumer finance laws or regulations, including, but not limited to, rules and regulations that have recently been
enacted or could be enacted by federal and state governments;
|
|
•
|
general economic conditions in the markets in which the Company operates, including, but not limited to, fluctuations in gas
prices, grocery prices and employment levels; and
|
|
•
|
security breaches, cyber-attacks, or fraudulent activity.
|
The Company undertakes no obligation to update
or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned
not to place undue reliance on these forward-looking statements, which speak only as of the dates on which they are made.
Overview
America’s Car-Mart, Inc., a Texas corporation
initially formed in 1981 (the “Company”), is one of the largest publicly held automotive retailers in the United States
focused exclusively on the “Integrated Auto Sales and Finance” segment of the used car market. The Company’s
operations are principally conducted through its two operating subsidiaries, America’s Car Mart, Inc., an Arkansas corporation
(“Car-Mart of Arkansas”), and Colonial Auto Finance, Inc., an Arkansas corporation (“Colonial”). References
to the Company include the Company’s consolidated subsidiaries. The Company primarily sells older model used vehicles and
provides financing for substantially all of its customers. Many of the Company’s customers have limited financial resources
and would not qualify for conventional financing as a result of limited credit histories or past credit problems. As of July 31,
2019, the Company operated 145 dealerships located primarily in small cities throughout the South-Central United States.
The Company has grown its revenues between
3% and 13% per year over the last ten fiscal years (8% on average). Growth results from same dealership revenue growth and the
addition of new dealerships. Revenue increased 4.8% for the first three months of fiscal 2020 compared to the same period of fiscal
2019 due to a 9.5% increase in interest income and a 3.6% increase in the average retail sales price.
The Company’s primary focus is on collections.
Each dealership is responsible for its own collections with supervisory involvement of the corporate office. Over the last five
fiscal years, the Company’s credit losses as a percentage of sales have ranged from approximately 25% in fiscal 2019 to 28.7%
in fiscal 2017 (average of 27.7%). Credit losses as a percentage of sales increased in recent years prior to 2018, primarily due
to increased contract term lengths and lower down payments resulting from increased competitive pressures as well as higher charge-offs
caused, to an extent, by negative macro-economic factors affecting the Company’s customer base. For the first three months
of fiscal 2020, credit losses as a percentage of sales were 21.0%, compared to 26.1% for the first three months of fiscal 2019.
The decrease in the provision for credit losses as a percentage of sales is primarily due to a higher percentage of collections
of finance receivables, due to the improved and consistent efforts in the collections process. A decrease to the allowance for
credit losses from 25% to 24.5% was made in the first quarter of fiscal 2020, which resulted in a $2.6 million (1.7% of sales)
credit to the provision for credit losses.
Historically, credit losses, on a percentage basis,
tend to be higher at new and developing dealerships than at mature dealerships. Generally, this is the case because the management
at new and developing dealerships tends to be less experienced in making credit decisions and collecting customer accounts and
the customer base is less seasoned. Normally more mature dealerships have more repeat customers and, on average, repeat customers
are a better credit risk than non-repeat customers. Negative macro-economic issues do not always lead to higher credit loss results
for the Company because the Company provides basic affordable transportation which in many cases is not a discretionary expenditure
for customers. The Company does believe, however, that general inflation, particularly within staple items such as groceries and
gasoline, as well as overall unemployment levels and potentially lower or stagnant personal income levels affecting customers can
have, and have had in recent years, a negative impact on collections. Additionally, increased competition for used vehicle financing
in recent years has had a negative effect on collections and charge-offs.
In an ongoing effort to reduce credit losses,
improve collection levels and operate more efficiently, the Company continues to look for improvements to its business practices,
including better underwriting and better collection procedures. The Company has a proprietary credit scoring system which enables
the Company to monitor the quality of contracts. Corporate office personnel monitor proprietary credit scores and work with dealerships
when the distribution of scores falls outside of prescribed thresholds. The Company has implemented credit reporting and the use
of GPS units on vehicles. Additionally, the Company places significant focus on the collection area; the Company’s training
department continues to spend significant time and effort on collections improvements. The field operations officer oversees the
collections department and provides timely oversight and additional accountability on a consistent basis. In addition, the Company
has a director of collection services who assists with managing the Company’s servicing and collections practices and provides
additional monitoring and training. The Company believes that the proper execution of its business practices is the single most
important determinant of its long-term credit loss experience.
Historically, the Company’s gross margin
as a percentage of sales has been fairly consistent from year to year. Over the previous five fiscal years, the Company’s
gross margins as a percentage of sales ranged between approximately 40% and 42%. The Company’s gross margin is based upon
the cost of the vehicle purchased, with lower-priced vehicles typically having higher gross margin percentages, and is also affected
by the percentage of wholesale sales to retail sales, which relates for the most part to repossessed vehicles sold at or near cost.
Gross margin in recent years has been negatively affected by the increase in the average retail sales price (a function of a higher
purchase price) and higher operating costs, mostly related to increased vehicle repair costs and higher fuel costs. After decreasing
to a five-year low of 39.8% of sales during fiscal 2016, gross margin for fiscal 2017 improved to 41.4%, primarily as a result
of lower repair expenses and a decrease in losses on wholesales, and remained relatively flat for fiscal 2018 and 2019, compared
to 2017. For the first three months of fiscal 2020 the gross margin was 40.7% of sales compared to 41.6% for the first three months
of fiscal 2019. Gross profit dollars per retail unit sold increased $104, or 2.2%, to $4,886 for the three months ended July 31,
2019, compared to July 31, 2018. The Company expects that its gross margin percentage will continue to remain in the historical
range over the near term.
Hiring, training and retaining qualified associates
is critical to the Company’s success. The extent to which the Company is able to add new dealerships and implement operating
initiatives is limited by the number of trained managers and support personnel the Company has at its disposal. Excessive turnover,
particularly at the dealership manager level, could impact the Company’s ability to add new dealerships and to meet operational
initiatives. The Company has added resources to recruit, train, and develop personnel, especially personnel targeted for dealership
manager positions. The Company expects to continue to invest in the development of its workforce.
Three months ended July 31, 2019 vs. Three months ended July 31, 2018
Consolidated Operations
(Operating Statement Dollars in Thousands)
|
|
|
|
|
|
% Change
|
|
As a % of Sales
|
|
|
Three Months Ended
July 31,
|
|
2019
vs.
|
|
Three Months Ended
July 31,
|
|
|
2019
|
|
2018
|
|
2018
|
|
2019
|
|
2018
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
150,074
|
|
|
$
|
144,101
|
|
|
|
4.1
|
%
|
|
|
100.0
|
|
|
|
100.0
|
|
Interest income
|
|
|
21,804
|
|
|
|
19,914
|
|
|
|
9.5
|
|
|
|
14.5
|
|
|
|
13.8
|
|
Total
|
|
|
171,878
|
|
|
|
164,015
|
|
|
|
4.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales, excluding depreciation shown below
|
|
|
88,885
|
|
|
|
84,168
|
|
|
|
5.6
|
|
|
|
59.2
|
|
|
|
58.4
|
|
Selling, general and administrative
|
|
|
28,671
|
|
|
|
26,382
|
|
|
|
8.7
|
|
|
|
19.1
|
|
|
|
18.3
|
|
Provision for credit losses
|
|
|
31,475
|
|
|
|
37,543
|
|
|
|
(16.2
|
)
|
|
|
21.0
|
|
|
|
26.1
|
|
Interest expense
|
|
|
2,004
|
|
|
|
1,804
|
|
|
|
11.1
|
|
|
|
1.3
|
|
|
|
1.3
|
|
Depreciation and amortization
|
|
|
967
|
|
|
|
985
|
|
|
|
(1.8
|
)
|
|
|
0.6
|
|
|
|
0.7
|
|
Loss on disposal of property and equipment
|
|
|
37
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
152,039
|
|
|
|
150,882
|
|
|
|
0.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pretax income
|
|
$
|
19,839
|
|
|
$
|
13,133
|
|
|
|
|
|
|
|
13.2
|
|
|
|
9.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail units sold
|
|
|
12,523
|
|
|
|
12,533
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average stores in operation
|
|
|
144
|
|
|
|
140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average units sold per store per month
|
|
|
29.0
|
|
|
|
29.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average retail sales price
|
|
$
|
11,410
|
|
|
$
|
11,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit per retail unit
|
|
$
|
4,886
|
|
|
$
|
4,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Same store revenue change
|
|
|
3.3
|
%
|
|
|
12.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period End Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stores open
|
|
|
145
|
|
|
|
140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts over 30 days past due
|
|
|
3.8
|
%
|
|
|
3.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues increased by approximately $7.9 million,
or 4.8%, for the three months ended July 31, 2019 as compared to the same period in the prior fiscal year. The increase resulted
from revenue growth at dealerships that operated a full three months in both current and prior year quarter ($5.5 million) and
revenue growth from dealerships opened after the prior year quarter ($3.3 million), partially offset by the loss of revenues from
dealerships closed during or after the quarter ended July 31, 2018 ($889,000). Interest income increased approximately $1.9 million
for the three months ended July 31, 2019, as compared to the same period in the prior fiscal year due to the $41.5 million increase
in average finance receivables.
Cost of sales, as a percentage of sales, increased
to 59.2% for the three months ended July 31, 2019 compared to 58.4% for the same period of the prior fiscal year, resulting in
a gross margin as a percentage of sales of 40.8% for the current year period compared to 41.6% for the prior year period. The lower
gross margin percentage primarily relates to the increase in average retail sales price.
Gross margin as a percentage of sales is significantly
impacted by the average retail sales price of the vehicles the Company sells, which is largely a function of the Company’s
purchase cost. The average retail sales price for the first quarter of fiscal 2020 was $11,410 a $395 increase over the prior year
quarter. The Company’s purchase costs remain relatively high from a combination of consumer demand for the types of vehicles
the Company purchases for resale and a strategic management decision to purchase higher quality vehicles for our customers. When
purchase costs increase, the margin between the purchase cost and the sales price of the vehicles we sell narrows as a percentage
because the Company must offer affordable prices to our customers. Therefore, we continue to focus efforts on minimizing the average
retail sales price of our vehicles in order to help keep contract terms shorter, which helps customers maintain appropriate equity
in their vehicles and reduces credit losses and resulting wholesale volumes.
Selling,
general and administrative expenses, as a percentage of sales, were 19.1% for the three months ended July 31, 2019, an increase
of 0.8% from the same period of the prior fiscal year. Selling, general and administrative expenses are, for the most part, more
fixed in nature. In dollar terms, overall selling, general and administrative expenses increased approximately $2.3 million in
the first quarter of fiscal 2020 compared to the same period of the prior fiscal year. The majority of this increase is in the
payroll and benefits area, including stock-based compensation, as we continue to invest in our associates as we train, develop
and recruit qualified associates, all in an effort to provide excellent customer service. This includes additional bonus and commissions
related to the higher net income levels as several of our associates (especially the general managers) are compensated on net income.
The Company continues to focus on controlling costs, while at the same time ensuring a solid infrastructure to ensure a high level
of support for our customers.
Provision for credit losses as a percentage
of sales was 21.0% for the three months ended July 31, 2019 compared to 26.1% for the three months ended July 31, 2018. Net charge-offs
as a percentage of average finance receivables were 5.4% for the three months ended July 31, 2019 and 6.4% for the prior year period.
The decrease in the provision for credit losses as a percentage of sales is primarily due to a higher percentage of collections
of finance receivables, a lower level of modifications, increased early payoffs and improved and consistent collections practices.
As a result of the improved credit results, a decrease to the allowance for credit losses from 25% to 24.5% was made in the first
quarter of fiscal 2020, which resulted in a $2.6 million (1.7% of sales) credit to the provision for credit losses. The Company
believes that the proper execution of its business practices remains the single most important determinant of its long-term credit
loss experience.
Interest expense as a percentage of sales remained
flat at 1.3% for the three months ended July 31, 2019 and the same period of the prior fiscal year.
Financial Condition
The following table sets forth the major balance
sheet accounts of the Company as of the dates specified (in thousands):
|
|
July 31, 2019
|
|
April 30, 2019
|
Assets:
|
|
|
|
|
|
|
|
|
Finance receivables, net
|
|
$
|
431,610
|
|
|
$
|
415,486
|
|
Inventory
|
|
|
44,651
|
|
|
|
37,483
|
|
Income taxes receivable, net
|
|
|
-
|
|
|
|
1,947
|
|
Property and equipment, net
|
|
|
28,571
|
|
|
|
28,537
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
|
31,011
|
|
|
|
32,496
|
|
Deferred revenue
|
|
|
32,558
|
|
|
|
31,959
|
|
Deferred tax liabilities, net
|
|
|
15,132
|
|
|
|
14,259
|
|
Debt facilities
|
|
|
158,677
|
|
|
|
152,918
|
|
Since April 30, 2019, finance receivables have
increased 3.9%, while revenues have grown 4.8% compared to the prior year quarter. Historically, the growth in finance receivables
has been slightly higher than overall revenue growth on an annual basis due to overall term length increases partially offset by
improvements in underwriting and collection procedures in an effort to reduce credit losses. However, during the three months ended
July 31, 2019, revenue have grown faster than finance receivables due to the increasing retail price and increased finance receivables
collections.
During the first three months of fiscal 2019,
inventory increased by $7.2 million compared to inventory at April 30, 2019. The Company strives to improve the quality of the
inventory while maintaining inventory levels to ensure adequate supply of vehicles, in volume and mix, and to meet sales demand.
Income taxes payable, net, was $1.4 million at
July 31, 2019 as compared to income taxes receivable, net of $1.9 million at April 30, 2019, primarily due to the timing of quarterly
tax payments and the tax benefit of stock option exercises.
Property and equipment, net, increased by $34,000
at July 31, 2019 as compared to property and equipment, net, at April 30, 2019. The Company incurred $967,000 of depreciation expense,
partially offset by $1.0 million in expenditures to open new dealerships, refurbish and expand existing locations.
Accounts payable and accrued liabilities decreased
by $1.5 million during the first three months of fiscal 2020 as compared to accounts payable and accrued liabilities at April 30,
2019, related primarily to the adoption of ASU 2016-02, Leases, as deferred rent is no longer included in accrued liabilities,
but is included in the lease liability.
Deferred revenue increased $599,000 at July 31,
2019 as compared to April 30, 2019, primarily resulting from increased sales of the payment protection plan product and service
contracts.
Deferred income tax liabilities, net, increased
approximately $873,000 at July 31, 2019 as compared to April 30, 2019, due primarily to the increase in finance receivables.
Borrowings on the Company’s revolving
credit facilities fluctuate primarily based upon a number of factors including (i) net income, (ii) finance receivables changes,
(iii) income taxes, (iv) capital expenditures, and (v) common stock repurchases. Historically, income from operations,
as well as borrowings on the revolving credit facilities, have funded the Company’s finance receivables growth, capital asset
purchases and common stock repurchases. In the first three months of fiscal 2020, the Company funded finance receivables growth
of $17.8 million, inventory growth of $7.2 million, capital expenditures of $1.0 million, and common stock repurchases of $4.7
million with income from operations and a $5.8 million increase in total debt.
Liquidity and Capital Resources
The following table sets forth certain summarized
historical information with respect to the Company’s Condensed Consolidated Statements of Cash Flows (in thousands):
|
|
Three Months Ended
July 31,
|
|
|
2019
|
|
2018
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
15,511
|
|
|
$
|
10,884
|
|
Provision for credit losses
|
|
|
31,475
|
|
|
|
37,543
|
|
Losses on claims for payment protection plan
|
|
|
4,230
|
|
|
|
4,069
|
|
Depreciation and amortization
|
|
|
967
|
|
|
|
985
|
|
Stock based compensation
|
|
|
1,620
|
|
|
|
1,094
|
|
Finance receivable originations
|
|
|
(137,855
|
)
|
|
|
(134,261
|
)
|
Finance receivable collections
|
|
|
74,355
|
|
|
|
66,740
|
|
Inventory
|
|
|
4,503
|
|
|
|
7,251
|
|
Accounts payable and accrued liabilities
|
|
|
(1,387
|
)
|
|
|
3,032
|
|
Deferred payment protection plan revenue
|
|
|
464
|
|
|
|
606
|
|
Deferred service contract revenue
|
|
|
135
|
|
|
|
272
|
|
Income taxes, net
|
|
|
3,100
|
|
|
|
486
|
|
Deferred income taxes
|
|
|
873
|
|
|
|
871
|
|
Accrued interest on finance receivables
|
|
|
(240
|
)
|
|
|
(143
|
)
|
Other
|
|
|
157
|
|
|
|
985
|
|
Total
|
|
|
(2,092
|
)
|
|
|
414
|
|
|
|
|
|
|
|
|
|
|
Investing activities:
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(1,010
|
)
|
|
|
(685
|
)
|
Total
|
|
|
(1,010
|
)
|
|
|
(685
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities:
|
|
|
|
|
|
|
|
|
Revolving credit facilities, net
|
|
|
5,830
|
|
|
|
2,793
|
|
Payments on note payable
|
|
|
(125
|
)
|
|
|
(94
|
)
|
Change in cash overdrafts
|
|
|
1,890
|
|
|
|
2,036
|
|
Purchase of common stock
|
|
|
(4,715
|
)
|
|
|
(7,377
|
)
|
Dividend payments
|
|
|
(10
|
)
|
|
|
(10
|
)
|
Exercise of stock options and issuance of common stock
|
|
|
120
|
|
|
|
2,742
|
|
Total
|
|
|
2,990
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
Decrease in cash
|
|
$
|
(112
|
)
|
|
$
|
(181
|
)
|
The primary drivers of operating profits and
cash flows include (i) top line sales (ii) interest income on finance receivables, (iii) gross margin percentages on vehicle sales,
and (iv) credit losses, a significant portion of which relates to the collection of principal on finance receivables. The Company
generates cash flow from operations. Historically, most or all of this cash is used to fund finance receivables growth,
capital expenditures, and common stock repurchases. To the extent finance receivables growth, capital expenditures and
common stock repurchases exceed income from operations, generally the Company increases its borrowings under its revolving credit
facilities. The majority of the Company’s growth has been self-funded.
Cash flows from operations for the three months
ended July 31, 2019 compared to the same period in the prior fiscal year were increased primarily as a result of (i) larger finance
receivables collections, (ii) increase in net income, and (iii) a larger increase in income taxes payable, partially offset by
(i) less provision for credit losses, (ii) smaller increase in accounts payable and accrued liabilities, as compared to the prior
year period (iii) larger finance receivable originations, and (iv) a smaller increase in inventory, as compared to the prior year
period. Finance receivables, net, increased by $16.1 million from April 30, 2019 to July 31, 2019.
The purchase price the Company pays for a vehicle
has a significant effect on liquidity and capital resources. Because the Company bases its selling price on the purchase cost for
the vehicle, increases in purchase costs result in increased selling prices. As the selling price increases, it becomes more difficult
to keep the gross margin percentage and contract term in line with historical results because the Company’s customers have
limited incomes and their car payments must remain affordable within their individual budgets. Several external factors can negatively
affect the purchase cost of vehicles. Decreases in the overall volume of new car sales, particularly domestic brands, lead to decreased
supply in the used car market. Also, constrictions in consumer credit, as well as general economic conditions, can increase overall
demand for the types of vehicles the Company purchases for resale as used vehicles become more attractive than new vehicles in
times of economic instability. A negative shift in used vehicle supply, combined with strong demand, results in increased used
vehicle prices and thus higher purchase costs for the Company. These factors have caused purchase costs to increase generally over
the last five years. The higher vehicle purchase costs resulted in an increase in the average sales price of $395, or 3.6%, during
the first three months of fiscal 2020 compared to the same period in the prior fiscal year. Management expects the supply of vehicles
to remain tight during the near term and to result in further modest increases in vehicle purchase costs, with strong new car sales
levels in recent years helping to provide additional supply and mitigate expected cost increases.
The Company believes that the amount of credit
available for the sub-prime auto industry has increased in recent years, and management expects the availability of consumer credit
within the automotive industry to be higher over the near term when compared to historical levels. This is expected to contribute
to continued strong overall demand for most, if not all, of the vehicles the Company purchases for resale. Increased
competition resulting from availability of funding to the sub-prime auto industry can result in lower down payments and longer
terms, which can have a negative effect on collection percentages, liquidity and credit losses. In the most recent quarter competitive
pressures may have eased modestly, contributing to increased traffic at our dealerships.
Macro-economic factors such as inflation within
groceries and other staple items, as well as overall unemployment levels, can also affect the Company’s collection results,
credit losses and resulting liquidity. The Company anticipates that, despite generally positive overall economic trends, the challenges
facing the Company’s customer base, coupled with the extended terms and decreased recovery rates, will contribute to credit
losses remaining elevated in the near term compared to historical ranges. Management continues to focus on improved execution at
the dealership level, specifically as related to working individually with customers to address collection issues.
The Company has generally leased the majority
of the properties where its dealerships are located. As of July 31, 2019, the Company leased approximately 82% of its dealership
properties. The Company expects to continue to lease the majority of the properties where its dealerships are located.
The Company’s revolving credit facilities
generally restrict distributions by the Company to its shareholders. The distribution limitations under the credit facilities allow
the Company to repurchase shares of its common stock up to certain limits. Under the current limits, the aggregate amount of repurchases
after October 25, 2017 cannot exceed the greater of: (a) $50 million, net of proceeds received from the exercise of stock options
(plus any repurchases made during the first six months after October 25, 2017, in an aggregate amount up to the remaining availability
under the $40 million repurchase limit in effect immediately prior to October 25, 2017, net of proceeds received from the exercise
of stock options), provided that the sum of the borrowing bases combined minus the principal balances of all revolver loans after
giving effect to such repurchases is equal to or greater than 20% of the sum of the borrowing bases; or (b) 75% of the consolidated
net income of the Company measured on a trailing twelve month basis. In addition, immediately before and after giving effect to
the Company’s stock repurchases, at least 12.5% of the aggregate funds committed under the credit facilities must remain
available. Thus, although the Company currently does routinely repurchase stock, the Company is limited in its ability to pay dividends
or make other distributions to its shareholders without the consent of the Company’s lenders.
At July 31, 2019, the Company had approximately
$1.6 million of cash on hand and approximately an additional $56 million of availability under its revolving credit facilities
(see Note F to the Condensed Consolidated Financial Statements). On a short-term basis, the Company’s principal
sources of liquidity include income from operations and borrowings under its revolving credit facilities. On a longer-term basis,
the Company expects its principal sources of liquidity to consist of income from operations and borrowings under revolving credit
facilities or fixed interest term loans. The Company’s revolving credit facilities mature in December 2021. Furthermore,
while the Company has no specific plans to issue debt or equity securities, the Company believes, if necessary, it could raise
additional capital through the issuance of such securities.
The Company expects to use cash from operations
and borrowings to (i) grow its finance receivables portfolio, (ii) purchase property and equipment of approximately $6.5 million
in the next 12 months in connection with refurbishing existing dealerships and adding new dealerships, (iii) repurchase shares
of common stock when favorable conditions exist, and (iv) reduce debt to the extent excess cash is available.
The Company believes it will have adequate liquidity
to continue to grow its revenues and to satisfy its capital needs for the foreseeable future.
Contractual Payment Obligations
There have been no material changes outside of
the ordinary course of business in the Company’s contractual payment obligations from those reported at April 30, 2019 in
the Company’s Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
The Company has entered into operating leases for approximately
82% of its dealerships and office facilities. Generally, these leases are for periods of three to five years and usually contain
multiple renewal options. The Company uses leasing arrangements to maintain flexibility in its dealership locations and to preserve
capital. The Company expects to continue to lease the majority of its dealerships and office facilities under arrangements substantially
consistent with the past.
The Company has a standby letter of credit
relating to an insurance policy totaling $250,000 at July 31, 2019.
Other than its operating leases and the letter of credit, the Company
is not a party to any off-balance sheet arrangement that management believes is reasonably likely to have a current or future effect
on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources that are material to investors.
Related Finance Company Contingency
Car-Mart of Arkansas and Colonial do not meet
the affiliation standard for filing consolidated income tax returns, and as such they file separate federal and state income tax
returns. Car-Mart of Arkansas routinely sells its finance receivables to Colonial at what the Company believes to be fair market
value and is able to take a tax deduction at the time of sale for the difference between the tax basis of the receivables sold
and the sales price. These types of transactions, based upon facts and circumstances, have been permissible under the provisions
of the Internal Revenue Code as described in the Treasury Regulations. For financial accounting purposes, these transactions are
eliminated in consolidation and a deferred income tax liability has been recorded for this timing difference. The sale of finance
receivables from Car-Mart of Arkansas to Colonial provides certain legal protection for the Company’s finance receivables
and, principally because of certain state apportionment characteristics of Colonial, also has the effect of reducing the Company’s
overall effective state income tax rate by approximately 274 basis points. The actual interpretation of the Regulations is in part
a facts and circumstances matter. The Company believes it satisfies the material provisions of the Regulations. Failure to satisfy
those provisions could result in the loss of a tax deduction at the time the receivables are sold and have the effect of increasing
the Company’s overall effective income tax rate as well as the timing of required tax payments.
The Company’s policy is to recognize
accrued interest related to unrecognized tax benefits in interest expense and penalties in operating expenses. The Company had
no accrued penalties or interest as of July 31, 2019.
Critical Accounting Policies
The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America requires the Company to make estimates and assumptions
in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ
from the Company’s estimates. The Company believes the most significant estimate made in the preparation of the accompanying
Condensed Consolidated Financial Statements relates to the determination of its allowance for credit losses, which is discussed
below. The Company’s accounting policies are discussed in Note B to the Condensed Consolidated Financial Statements.
The Company maintains an allowance for credit
losses on an aggregate basis at a level it considers sufficient to cover estimated losses inherent in the portfolio at the balance
sheet date in the collection of its finance receivables currently outstanding. At July 31, 2019, the weighted average
total contract term was 32.1 months with 23.1 months remaining. The reserve amount in the allowance for credit losses at July 31,
2019, $129.5 million, was 24.5% of the principal balance in finance receivables of $561.1 million, less unearned payment protection
plan revenue of $21.8 million and unearned service contract revenue of $10.7 million.
The estimated reserve amount is the Company’s
anticipated future net charge-offs for losses incurred through the balance sheet date. The allowance takes into account historical
credit loss experience (both timing and severity of losses), with consideration given to recent credit loss trends and changes
in contract characteristics (i.e., average amount financed, months outstanding at loss date, term and age of portfolio), delinquency
levels, collateral values, economic conditions and underwriting and collection practices. The allowance for credit losses is reviewed
at least quarterly by management with any changes reflected in current operations. The calculation of the allowance for credit
losses uses the following primary factors:
|
•
|
The number of units repossessed or charged-off as a percentage of total units financed over specific
historical periods of time from one year to five years.
|
|
•
|
The average net repossession and charge-off loss per unit during the last eighteen months segregated
by the number of months since the contract origination date and adjusted for the expected future average net charge-off loss per
unit. About 50% of the charge-offs that will ultimately occur in the portfolio are expected to occur within 10-11 months
following the balance sheet date. The average age of an account at charge-off date for the eighteen-month period ended
July 31, 2019 was 12.5 months.
|
|
•
|
The timing of repossession and charge-off losses relative to the date of sale (i.e., how long it
takes for a repossession or charge-off to occur) for repossessions and charge-offs occurring during the last eighteen months.
|
A point estimate is produced by this analysis
which is then supplemented by any positive or negative subjective factors to arrive at an overall reserve amount that management
considers to be a reasonable estimate of losses inherent in the portfolio at the balance sheet date that will be realized via actual
charge-offs in the future. Although it is at least reasonably possible that events or circumstances could occur in the future that
are not presently foreseen which could cause actual credit losses to be materially different from the recorded allowance for credit
losses, the Company believes that it has given appropriate consideration to all relevant factors and has made reasonable assumptions
in determining the allowance for credit losses. While challenging economic conditions can negatively impact credit losses, the
effectiveness of the execution of internal policies and procedures within the collections area and the competitive environment
on the funding side have historically had a more significant effect on collection results than macro-economic issues. A 1% change,
as a percentage of finance receivables, in the allowance for credit losses would equate to an approximate pre-tax adjustment of
$5.3 million.
As a result of the improvements in our net
charge-offs as a percentage of average receivables, the quality of the portfolio and our allowance analysis, a decrease to the
allowance for credit losses from 25% to 24.5% was made in the first quarter of fiscal 2020, which resulted in a $2.6 million credit
to the provision for credit losses, a $2.0 million after tax increase to net income, or $0.29 per diluted share.
Recent Accounting Pronouncements
Occasionally, new accounting pronouncements
are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies, which the Company
will adopt as of the specified effective date. Unless otherwise discussed, the Company believes the implementation of recently
issued standards which are not yet effective will not have a material impact on its consolidated financial statements upon adoption.
Leases. In February 2016, the FASB issued
ASU 2016-02, Leases. The new guidance requires that lessees recognize all leases, including operating leases, with a term
greater than 12 months on-balance sheet and also requires disclosure of key information about leasing transactions. The guidance
in ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within
those years. The Company adopted this ASU and related amendments for its fiscal year beginning May 1, 2019 and elected certain
practical expedients permitted under the transition guidance, including to retain the historical lease classification as well as
relief from reviewing expired or existing contracts to determine if they contain leases. The adoption of this ASU and related amendments
resulted in total assets and liabilities increasing $34.5 million. The Company’s Consolidated Statements of Income and Consolidated
Statements of Cash Flows were not materially impacted.
Credit Losses. In June 2016, the FASB
issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326). ASU 2016-13 requires financial assets
such as loans to be presented net of an allowance for credit losses that reduces the cost basis to the amount expected to be collected
over the estimated life. Expected credit losses will be measured based on historical experience and current conditions, as well
as forecasts of future conditions that affect the collectability of the reported amount. ASU 2016-13 is effective for annual reporting
periods beginning after December 15, 2019, and interim reporting periods within those years using a modified retrospective approach.
The Company is currently evaluating the potential effects of the adoption of this guidance on the consolidated financial statements
but does not expect such impact to be material.
Cloud Computing Arrangement. In August
2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40).
ASU 2018-15 aligns the requirements for capitalizing implementation costs in a cloud computing arrangement with the requirements
for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for annual
reporting periods beginning after December 15, 2019, and interim reporting periods within those years. The Company is currently
evaluating the potential effects of the adoption of this guidance on the consolidated financial statements but does not expect
such impact to be material.
Seasonality
Historically, the Company’s third fiscal
quarter (November through January) has been the slowest period for vehicle sales. Conversely, the Company’s first and fourth
fiscal quarters (May through July and February through April) have historically been the busiest times for vehicle sales. Therefore,
the Company generally realizes a higher proportion of its revenue and operating profit during the first and fourth fiscal quarters.
Tax refund anticipation sales efforts during the Company’s third fiscal quarter have increased sales levels during the third
fiscal quarter in some past years; however, due to the timing of actual tax refund dollars in the Company’s markets, these
sales and collections have primarily occurred in the fourth quarter in each of the last four fiscal years. The Company expects
this pattern to continue in future years.
If conditions arise that impair vehicle sales
during the first, third or fourth fiscal quarters, the adverse effect on the Company’s revenues and operating results for
the year could be disproportionately large.