Americas Carmart Inc: Form 10-Q for the period ended Oct 31, 2023

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:

• operational infrastructure investments;
• same dealership sales and revenue growth;
• customer growth;
• gross profit margin percentages;
• gross profit per retail unit sold;
• business acquisitions;
• technological investments and initiatives;
• future revenue growth;
• receivables growth as related to revenue growth;
• new dealership openings;
• performance of new dealerships;
• interest rates;
• future credit losses;
• the Company’s collection results, including but not limited to collections during income tax refund periods;
• future supply, demand and affordability of used vehicles;
• availability of used vehicle financing;
• seasonality; and
• the Company’s business, operating and growth strategies and expectations.

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 and in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2023, as well as:

• 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 inflationary pressure on operating costs;
• the availability of quality used vehicles at prices that will be affordable to our customers, including the impacts of changes in new vehicle production and sales;
• the availability of credit facilities and access to capital through securitization financings or other sources on terms acceptable to us to support the Company’s business;
• the Company’s ability to underwrite and collect its contracts effectively;
• competition;
• dependence on existing management;
• ability to attract, develop, and retain qualified general managers;
• 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;
• the ability to keep pace with technological advances and changes in consumer behavior affecting our business;
• security breaches, cyber-attacks, or fraudulent activity;
• the ability to identify and obtain favorable locations for new or relocated dealerships at reasonable cost;
• the ability to successfully identify, complete and integrate new acquisitions; and
• potential business and economic disruptions and uncertainty that may result from any future public health crises and any efforts to mitigate the financial impact and health risks associated with such developments.

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 difficulties. As of October 31, 2023, the Company operated 153 dealerships located primarily in small cities throughout the South-Central United States.

The Company has grown its revenues between approximately 4% and 32% per year over the last ten fiscal years (average 12%). Growth results from same dealership revenue growth and the addition of new dealerships. Revenue increased 5.6% for the first six months of fiscal 2024 compared to the same period of fiscal 2023, due to a 25.1% increase in interest income and a 4.8% increase in the average retail sales price, partially offset by a 1.1% decrease in retail units sold. Our dealership volume productivity averaged 33.4 sales per month for the first six months of fiscal 2024, down from 34.0 during the same period last year.

The Company has been able to improve vehicle quality by bringing lower mileage and higher average model-year vehicles to our consumers. This will aid in driving down repair costs of the vehicles for our customers, as well as reduce service contract repair costs, and better recovery values in the event of repossession. These are material changes that will contribute to better gross margins. When combined with the inventory procurement and remarketing management processes implemented last year, the Company is delivering operating improvement for our customers.

Over the last five fiscal years, the Company’s provision for credit losses as a percentage of sales averaged 23.74%, with a pre-pandemic rate of 23.71% in fiscal 2019. During fiscal 2023, credit losses exceeded pre-pandemic levels, partially due to the inflationary pressure on customers and increasing interest rates from federal monetary policy. For the first six months of fiscal 2024, the provision for credit losses as a percentage of sales increased to 37.8% of which 4.6% was due to the $28 million increase in provision for credit losses during the three months ended October 31, 2023. Based on the Company’s current analysis of credit losses, the allowance for credit losses as a percentage of finance receivables, net of deferred revenue and pending APP claims, increased from 23.91% at April 30, 2023 to 26.04% at October 31, 2023.

Historically, credit losses, on a percentage basis, tend to be higher at new and developing dealerships than at mature dealerships. Generally, this is 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. Credit losses and charge-offs are impacted more by market and economic factors, including macro-economic conditions such as inflation in the price of gasoline, groceries and other staple items and overall unemployment levels, as well as the personal income levels of the Company’s customers.

The Company continuously looks for ways to operate more efficiently, improve its business practices and adjust underwriting and 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. Additionally, the Company has placed significant focus on the collection area as the Company’s training department continues to spend significant time and effort on collections improvements. The Company’s vice president of collections oversees the collections area and provides timely oversight and additional accountability on a consistent basis. The Company believes that the proper execution of its business practices is the single most important determinant of its long-term credit loss experience.

The Company’s gross profit dollars per retail unit sold increased by $475, or 7.5%, during the first six months of fiscal 2024 compared to the first six months of fiscal 2023, and gross margin as a percentage of sales for the first six months of fiscal 2024 increased to 34.4% of sales from 33.2% in the prior year period. The increase in gross profit dollars per retail unit sold was primarily related to the increase in average retail sales price of the vehicles sold during the respective periods. The Company’s gross margin is based upon the cost of the vehicle purchased, with higher-priced vehicles typically having higher gross margin dollars but lower gross margin percentages. Gross margin 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. The initiatives around inventory life cycle efficiencies and the decrease in wholesale losses also contributed to the increase in gross profit dollars. The Company plans to continue to focus on managing gross margin dollars in the near term, as demonstrated by the increases during fiscal 2024 as well as continuing to focus on improving wholesale results, cost controls, and operational improvement around the acquisition and disposal of vehicles.

The Company consistently focuses on collections. Each dealership is responsible for its own collections with supervisory involvement of the corporate office. Total collections of principal, interest, and late fees for the first six months of fiscal 2024 increased by $35.0 million, or 11.7%, over the prior year. Principal collections, as a percentage of average finance receivables, were in line with expectations at 15.2%, compared to 17.4% for the same period in prior year, reflecting an increase in the weighted average contract term compared to the prior year period.

Hiring, training and retaining qualified associates is critical to the Company’s success. The rate at which the Company adds new dealerships and is able to 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 landscape for hiring remains very competitive as the business activity and workforce participation continue to adjust post-pandemic. The Company has continued to add resources to recruit, train, and develop personnel, especially personnel targeted to fill dealership manager positions. The Company expects to continue to invest in the development of its workforce.

The Company will continue to prioritize its investments in areas that will allow it to improve its product and service, while operating more efficiently to support a larger, more profitable business over time.

Three months ended October 31, 2023 vs. Three months ended October 31, 2022

Consolidated Operations

(Operating Statement Dollars in Thousands)

Revenues increased by approximately $9.7 million, or 2.8%, for the three months ended October 31, 2023 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 the current and prior year quarter ($7.1 million) and revenue from dealerships opened after the prior year quarter ($2.6 million). Revenue growth was related to a 23.0% increase in interest income and a 5.6% increase in the average retail sales price, partially offset by a 4.6% decrease in retail units sold. Interest income increased approximately $11.1 million for the three months ended October 31, 2023, as compared to the same period in the prior fiscal year, due to the $239.2 million increase in average finance receivables.

Cost of sales, as a percentage of sales, decreased to 65.7% for the three months ended October 31, 2023 compared to 67.9% for the same period of the prior fiscal year, resulting in a gross margin as a percentage of sales of 34.3% for the current year period compared to 32.1% for the prior year period. The improvement in gross margin results from our continued focus on inventory efficiencies in procurement, remarketing, and repairs.

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 second quarter of fiscal 2024 was $19,035, a $1,010 increase over the prior year quarter. Approximately 40% of this increase was related to the vehicle selling price and 60% related to the ancillary products. As purchase costs increase, the margin between the purchase cost and the sales price of the vehicles we sell generally narrows on a percentage basis because the Company must offer affordable prices to its customers. We have implemented initiatives around reconditioning efforts and scaling that are expected to provide a better volume of affordable units.

Selling, general and administrative expenses, as a percentage of sales, were 14.8% for the three months ended October 31, 2023, an increase of 0.7% from the same period of the prior fiscal year, but was down sequentially by 3.4%, primarily due to a $3.2 million reduction in stock-based compensation, partially offset by increased costs in collection expenses and professional fees related to the implementation of our new technologies. 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 $1.9 million in the second quarter of fiscal 2024 compared to the same period of the prior fiscal year. Increased collections costs due primarily to the higher frequency of repossessions and professional fees related to the implementation of our new technologies contributed to the increase.

Provision for credit losses as a percentage of sales was 44.8%, which includes 9.3% due to $28 million increase in provision for the three months ended October 31, 2023 compared to 29.3% for the prior year period. The provision for credit losses as a percentage of sales was higher during the current year period primarily due to the growth in the balance of finance receivables, net of deferred revenue of $169.3 million, coupled with a decrease in sales of $1.4 million over the prior year period. An increase in net charge-offs also contributed to the higher provision. Net charge-offs as a percentage of average finance receivables increased to 7.2% for the three months ended October 31, 2023 compared to the prior year period of 5.8%. The Company experienced an increase in both the frequency and severity of losses. Structural changes to our portfolio driven by higher vehicle costs, longer contract terms, lower average down payments, and lower recovery values continue to drive an increase in the provision for credit losses. The Company increased the allowance for credit losses from 23.91% at April 30, 2023 to 26.04% in the second quarter of fiscal 2024, resulting in a $28 million increase to the provision for credit losses.

Interest expense as a percentage of sales increased to 5.5% for the three months ended October 31, 2023, compared to 2.8% for the prior year period. In dollar terms, interest expense increased $8.2 million due to increasing interest rates and an increase in the average borrowings of approximately $201.8 million during the three-month period ended October 31, 2023.

Six months ended October 31, 2023 vs. Six months ended October 31, 2022

Consolidated Operations

(Operating Statement Dollars in Thousands)

Revenues increased by approximately $38.9 million, or 5.6%, for the six months ended October 31, 2023 as compared to the same period in the prior fiscal year. The increase resulted from revenue growth at dealerships that operated a full six months in both the current and prior year period ($33.9 million) and revenue growth from dealerships opened during or after the prior year quarter ($5.0 million). Revenue growth was primarily related to a 25.1% increase in interest income and a 4.8% increase in the average retail sales price, partially offset by a 1.1% decrease in retail units sold. Interest income increased approximately $23.2 million for the six months ended October 31, 2023, as compared to the same period in the prior fiscal year, due to the $249.2 million increase in average finance receivables.

Cost of sales, as a percentage of sales, decreased to 65.6% for the six months ended October 31, 2023 compared to 66.8% for the same period of the prior fiscal year, resulting in a gross margin as a percentage of sales of 34.4% for the current year period compared to 33.2% for the prior year period. The primary driver of this decrease was a decrease in wholesale losses and our continued focus on inventory efficiencies in procurement, remarketing, and repairs. The average retail sales price for the six months ended October 31, 2023 was $18,914, an increase of $869 or 4.8% over the prior year period.

Selling, general and administrative expenses, as a percentage of sales, were 14.9% for the six months ended October 31, 2023, an increase of 0.5% from the same period of the prior fiscal year. In dollar terms, overall selling, general and administrative expenses increased approximately $5.2 million in the six months ended October 31, 2023, compared to the same period of the prior fiscal year. The Company has made increasing investments in several areas including senior management, inventory procurement and management, customer experience and digital efforts. Increased collections costs due primarily to the higher frequency of repossessions, the addition of new dealerships through acquisitions since last year and the continuing impact of general inflation contributed to the remaining increase. The Company continues to focus on controlling costs, while at the same time ensuring a solid infrastructure to support a growing customer base with a high level of support for its customers.

Provision for credit losses as a percentage of sales was 37.8% for the six months ended October 31, 2023 compared to 27.6% for the six months ended October 31, 2022. Net charge-offs as a percentage of average finance receivables were 13.1% for the six months ended October 31, 2022 and 11.0% for the prior year period. The frequency of losses accounted for over two-thirds of the credit loss increase. Severity was also higher than usual caused by the rapid vehicle depreciation exhibited last year that made some of the originations in the calendar year of 2021 and 2022 pools experience higher frequency and severity of loss. The Company increased the allowance for credit losses rate from 23.91% to 26.04%, sequentially, resulting in a $28.0 million charge to the provision for credit losses.

Interest expense as a percentage of sales increased to 5.0% for the six months ended October 31, 2023, compared to 2.6% for the prior year period. In dollar terms, interest expense increased $15.2 million due to increasing interest rates and an increase in the average borrowings of approximately $194.5 million during the six-month period ended October 31, 2023. Approximately 60% of the increase in interest expense was related to the increase in rates over 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):

Finance receivables, net, have increased 3.9% and 13.0% since April 30, 2023 and October 31, 2022, respectively, while revenues have grown 5.6% compared to the prior year period. 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. The Company’s percentage growth in finance receivables, net, since October 31, 2022, as compared to percentage growth in revenue has exceeded the norm due to higher used car prices, longer terms, and higher rate of past due balances. The growth rate of finance receivables, net has started to normalize and Management expects it to continue to normalize as the economic environment improves.

During the first six months of fiscal 2024, inventory increased by $4.6 million compared to inventory at April 30, 2023. The increase in inventory is due to the Company increasing its investment in inventory quantities to accommodate generally higher sales volumes and provide customers a quality mix of vehicles. Annualized inventory turns improved for the second quarter at 7.1 vs. the prior year’s second quarter turns of 6.7.

Property and equipment, net, decreased by $1.9 million at October 31, 2023 as compared to property and equipment, net, at April 30, 2023. The Company incurred $2.1 million in expenditures during the first six months of fiscal 2024 primarily related to remodeling or relocating existing locations in order to support growth. The Company incurred $3.4 million in depreciation expense during the first six months of fiscal 2024.

Accounts payable and accrued liabilities decreased by $4.5 million during the first six months of fiscal 2024 as compared to accounts payable and accrued liabilities at April 30, 2023, related primarily to the accident protection plan claims reserve reclass and reduction in accrued payables.

Income taxes receivable, net, was $3.4 million at October 31, 2023 compared to income taxes receivable, net, of $9.3 million at April 30, 2023, primarily due to the $8.6 million of net operating loss (Q1 2024 balance of $2.3 million and current year Q2 2024 of $6.3) reclass to deferred tax, offset by $3.6 million current tax liability.

Deferred revenue increased $5.3 million at October 31, 2023 as compared to April 30, 2023, primarily resulting from increased sales of the accident protection plan product and service contracts

Deferred income tax liabilities, net, decreased approximately $14.2 million at October 31, 2023 as compared to April 30, 2023, due primarily to a current year net operating loss.

On July 6, 2023, the Company completed an asset-backed securitization offering through which an indirect subsidiary of the Company issued two classes of non-recourse notes payable in an aggregate principal amount of $360.3 million, with a weighted average fixed coupon rate of 8.8% per annum and scheduled maturities through June 20, 2030. The notes are collateralized by installment sale contracts directly originated by the Company’s operating subsidiaries. Net proceeds from the offering (after deducting original issue discounts, the underwriting discount payable to the initial purchasers and other expenses) were approximately $356.4 million and were used to pay outstanding debt under the Company’s revolving credit facilities, provide additional operating liquidity, and make the initial deposits into collection and reserve accounts for the benefit of noteholders. See Note F for further details on these non-recourse notes payable.

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) funds available from asset-backed securitization offerings, (iv) income taxes, (v) capital expenditures, and (vi) 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. However, the Company has begun accessing the securitization market to increase its borrowing capacities, with issuances of asset-backed non-recourse notes in April 2022, January 2023 and July 2023. The increased borrowings during the second quarter of fiscal 2024 are primarily due to the Company’s July 2023 issuance of asset-backed non-recourse notes to support an increase in finance receivables, with longer terms, and a growing customer base. In the first six months of fiscal 2024, the Company funded finance receivables growth of $90 million, inventory growth of $4.6 million, and capital expenditures of $2.1 million with income from operations and a $79.5 million increase in total debt, net of cash. These investments reflect the Company’s commitment to providing the necessary inventory and facilities to support a growing customer base.

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):

The primary drivers of 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. Historically, most or all of the cash generated from operations has been used to fund finance receivables growth, capital expenditures, and common stock repurchases. To the extent finance receivables grow, capital expenditures and common stock repurchases exceed income from operations, we have historically increased our borrowings under our revolving credit facilities and more recently through the securitization market.

Cash flows used in operating activities for the six months ended October 31, 2023 compared to the same period in the prior fiscal year decreased primarily as a result of an increase in the provision for credit losses, an increase in finance receivable collections and an increase in inventory acquired in repossessions, partially offset by a decrease in deferred income taxes and a net loss. Finance receivables, net, increased by $41.8 million from April 30, 2023 to October 31, 2023.

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 generally 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.

Sustained macro-economic pressures affecting our customers have helped keep demand high in recent years for the types of vehicles we purchase. This strong demand, coupled with modest levels of new vehicle sales in recent years, have led to a generally ongoing tight supply of used vehicles available to the Company in both quality and quantity. Wholesale prices have begun to soften but remain high by historical standards. The Company expects the tight used vehicle supply and strong demand for the types of vehicles we purchase to continue to keep purchase costs and resulting sales prices elevated for the short-term but anticipates that continuing strong wage increases for our customers will cause affordability to improve gradually over the next couple of years.

The Company has devoted significant efforts to improving its purchasing processes to ensure adequate supply at appropriate prices, including expanding its purchasing territories to larger cities in close proximity to its dealerships and forming relationships with reconditioning partners to reduce purchasing costs. The Company has also increased the level of accountability for its purchasing agents including updates to sourcing and pricing guidelines. The Company continues to build relationships with national vendors that can supply a large quantity of high-quality vehicles. Even with these efforts, the Company expects gross margin percentages to remain under pressure over the near term.

The Company’s liquidity is also impacted by our credit losses. Macro-economic factors such as unemployment levels and general inflation can significantly affect our collection results and ultimately credit losses. The recent inflationary environment, with rising costs of non-discretionary items, such as groceries and gasoline, has negatively impacted our customers’ ability to make payments on their vehicles and resulted in increased charge-offs in recent periods and may continue to impact customers’ ability to make their car payments in the near term. The Company has made improvements to its business processes within the last few years to strengthen controls and provide stronger infrastructure to support its collections efforts. The Company continues to strive to reduce credit losses in spite of the current economic challenges and continued competitive pressures by improving deal structures. Management continues to focus on improved execution at the dealership level, specifically as related to working individually with customers concerning collection issues.

The Company has generally leased the majority of the properties where its dealerships are located. As of October 31, 2023, the Company leased approximately 86% 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 so long as either: (a) the aggregate amount of repurchases after September 30, 2021 does not exceed $50 million, net of proceeds received from the exercise of stock options and the total availability under the credit facilities is equal to or greater than 20% of the sum of the borrowing bases, in each case after giving effect to such repurchases (repurchases under this item are excluded from fixed charges for covenant calculations), or (b) the aggregate amount of such repurchases does not exceed 75% of the consolidated net income of the Company measured on a trailing twelve month basis; provided that 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 remains available. Thus, although the Company 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 October 31, 2023, the Company had approximately $4.3 million of cash on hand and approximately an additional $86.3 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 long-term basis, the Company expects its principal sources of liquidity to consist of income from operations, borrowings under revolving credit facilities or fixed interest term loans and proceeds from the issuance of non-recourse asset-backed notes. The Company’s revolving credit facilities mature in September 2024 and the Company expects that it will be able to renew or refinance its revolving credit facilities on or before the date they mature. The Company has recently accessed the securitization market with issuances of $400.0 million, $400.2 million and $360.3 million in aggregate principal amounts of non-recourse asset-backed notes in April 2022, January 2023 and July 2023, respectively. The Company expects that it will continue to access this market in diversifying and growing the business. Furthermore, while the Company has no other specific plans to issue further 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 fixed assets of approximately $12 million in the next 12 months as we complete facility updates and general fixed asset requirements, (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.

Off-Balance Sheet Arrangements

The Company has two standby letters of credit relating to insurance policies totaling $2.9 million at October 31, 2023.

Other than its letters 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 250 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 October 31, 2023.

Critical Accounting Estimates

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.

During the quarter ended October 31, 2023, the Company implemented third-party software to assist in calculating the Company’s allowance for credit losses. After implementing, the Company’s quantitative portion of the allowance for credit losses was measured using an undiscounted cash flow (“CF”) model. Whereby the undiscounted CF are adjusted by a prepayment rate and then the loss rate is applied and compared to the amortized cost basis of finance receivables to reflect management’s estimated of expected credit losses. The CF model is based on relevant installment sale contract level characteristics of the Company’s finance receivables, such as contract terms and interest rates, as well as the following assumptions:

• a historical loss period, which represents a full economic credit cycle utilizing loss experience, to calculate the historical loss rate; and
• expected prepayment rates based on our historical experience.

The Company’s allowance for credit losses also considers qualitative factors not captured within the CF modeled results such as changes in underwriting and collection practices, economic trends, changes in volume and terms of installment sales contracts, credit quality trends, installment sale contract review results, collateral trends, and concentrations of credit. The Company’s qualitative factors incorporate a macroeconomic variable forecast of inflation over a reasonable and supportable forecast period of one year that affects its customers’ non-discretionary income and ability to repay. The reasonable and supportable forecast period of one year is based on management’s current review of the reliability of extended forecasts and is applied as an adjustment to the historical loss rate.

The Company maintains an allowance for credit losses on an aggregate basis at a level it considers sufficient to cover estimated losses expected to be incurred on the portfolio at the measurement date in the collection of its finance receivables currently outstanding. At October 31, 2023, the weighted average contract term was 47.3 months with 36.5 months remaining. The allowance for credit losses at October 31, 2023 of $344.3 million, was 26.04% of the principal balance in finance receivables of $1.5 billion, less unearned accident protection plan revenue of $54.4 million and unearned service contract revenue of $71.4 million, less APP claims of $15.3 million.

Recent Accounting Pronouncements

Occasionally, new accounting pronouncements are issued by the 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.

Adopted in Current Period

In March 2022, the FASB issued an accounting pronouncement (ASU 2022-02) related to troubled debt restructurings (“TDRs”) and vintage disclosures for financing receivables. The amendments in this update eliminate the accounting guidance for TDRs by creditors while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors made to borrowers experiencing financial difficulty. The amendments also require disclosure of current period gross write-offs by year of origination for financing receivables. The amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. In regard to loan modifications, management notes that the Company primarily modifies a customer’s installment sale contract to allow for insignificant payment delays. This type of modification is generally done to account for payday changes for the customer and minor vehicle repairs.

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. The Company expects this pattern to continue in future years.

If conditions arise that impair vehicle sales during the first or fourth fiscal quarters, the adverse effect on the Company’s revenues and operating results for the year could be disproportionately large.

The Company is exposed to market risk on its financial instruments from changes in interest rates. In particular, the Company has historically had exposure to changes in the federal primary credit rate and has exposure to changes in the prime interest rate of its lender. The Company does not use financial instruments for trading purposes but has in the past entered into an interest rate swap agreement to manage interest rate risk.

Interest rate risk. The Company’s exposure to changes in interest rates relates primarily to its debt obligations. The Company is exposed to changes in interest rates as a result of its revolving credit facilities, and the interest rates charged to the Company under its credit facilities fluctuate based on its primary lender’s base rate of interest. The Company had an outstanding balance on its revolving line of credit of $165.5 million at October 31, 2023. The impact of a 1% increase in interest rates on this amount of debt would result in increased annual interest expense of approximately $1.7 million and a corresponding decrease in net income before income tax.

The Company’s earnings are impacted by its net interest income, which is the difference between the income earned on interest-bearing assets and the interest paid on interest-bearing notes payable. The Company’s finance receivables carry a fixed annual interest rate of 16.5% (prior to December 2022) to 18.0% (effective December 2022) for all states except Arkansas (which is subject to a usury cap of 17.0%) and Illinois (remains at 19.5% – 21.5%), and Smart Auto dealerships in Tennessee (which originate at up to 23.0%), based on the Company’s contract interest rate as of the contract origination date, while its revolving credit facilities contain variable interest rates that fluctuate with market interest rates.

a) Evaluation of Disclosure Controls and Procedures

Management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of October 31, 2023. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of October 31, 2023, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), to allow timely decisions regarding required disclosure.

b) Changes of Disclosure Controls and Procedures

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have been no material changes to the Company’s risk factors as previously disclosed in Item 1A to Part I of the Company’s Form 10-K for the fiscal year ended April 30, 2023.