Americas Carmart Inc: Form 10-Q for the period ended Jul 31, 2024

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 may include, but are not limited to:

• operational infrastructure investments;
• same dealership sales and revenue growth;
• customer growth and engagement;
• gross profit margin percentages;
• gross profit per retail unit sold;
• business acquisitions;
• inventory acquisition, reconditioning, transportation and remarketing;
• 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, 2024, 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, and any increase in the cost of capital, to support the Company’s business;
• the Company’s ability to underwrite and collect its contracts effectively, including whether anticipated benefits from the Company’s recently implemented loan origination system are achieved as expected or at all;
• 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;
• the occurrence and impact of any adverse weather events or other natural disasters affecting the Company’s dealerships or customers; 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. Readers and investors 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 July 31, 2024, the Company operated 156 dealerships located primarily in small cities throughout the South-Central United States.

Over the last ten fiscal years, the Company’s revenue growth averaged 11.4%. Revenue for the first three months of fiscal 2025 declined 5.2% compared to the same period of fiscal 2024, primarily due to a 9.6% decrease in retail units sold. The decrease was partially offset by a 2.4% increase in the average retail sales price and a 7.2% increase in interest income. Our dealership volume productivity averaged 30.9 sales per month for the first three months of fiscal 2025, down from 34.2 during the same period last year.

The Company has been focused on improving vehicle quality by bringing lower mileage and on average newer model-year vehicles to our consumers, while balancing this with affordability. The Company believes this will aid in driving down our customers’ vehicle repair costs, reduce our service contract repair expenses, and lead to better recovery values in the event of repossession. When combined with inventory procurement efficiencies, these changes are expected to drive improved customer experience and contribute to better gross margins.

In the fourth quarter of fiscal year 2024, the Company entered into a strategic partnership with a leading automotive services and technology provider, to improve the efficiencies within the Company’s inventory supply chain process. This partnership is allowing the Company to utilize reconditioning and auction facilities, which the Company expects will improve the Company’s vehicle quality.

Over the last five fiscal years, the Company’s provision for credit losses as a percentage of sales averaged 26.36%, with a pre-pandemic rate of 23.71% in fiscal 2019. During fiscal 2024, 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 three months of fiscal 2025, the provision for credit losses as a percentage of sales decreased slightly sequentially to 33.2%, compared to 33.3% for the fourth quarter of fiscal 2024 as lower sales in the first quarter of fiscal 2025 largely offset improvements in the provision. Based on the Company’s current analysis of credit losses, the allowance for credit losses at July 31, 2024 was 25.0% of finance receivables, net of deferred revenue and pending APP claims.

The Company’s credit losses and charge-offs are impacted by market and economic factors, including macro-economic conditions such as inflation in the cost of vehicle insurance, rent, groceries, the price of gasoline, childcare, and other staple items, and overall unemployment levels, as well as the personal income levels of the Company’s customers. Historically, credit losses, on a percentage basis, also tend to be higher at new and developing dealerships than at longer tenure locations with experienced management. 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.

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’s training department continuously strengthens its training for collections. The Company’s collections department and support staff oversee collections and provide 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 $228, or 3.4%, during the first three months of fiscal 2025 compared to the first three months of fiscal 2024, and gross margin as a percentage of sales for the first three months of fiscal 2025 increased to 35.0% of sales from 34.7% in the prior year period. The increase in gross profit dollars per retail unit sold was related to an increase in the average retail sales price of the vehicles sold during the respective periods. The Company’s initiatives around pricing discipline, reduced transportation costs and lower vehicle repair costs also contributed to the increase in gross profit dollars. 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 Company plans to continue to focus on managing gross margin dollars in the near term, as demonstrated by the increase during the first quarter of fiscal 2025, 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 and oversight from the corporate office. Total collections of principal, interest, and late fees for the first three months of fiscal 2025 increased by $7.1 million, or 4.3%, over the prior year period. Principal collections, as a percentage of average finance receivables, however, stayed consistent at 7.8%, compared to the same period in prior year.

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. 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 continues to prioritize investments to improve its products and services and operate more efficiently over time. One of the Company’s largest recent investments has been improving its processes and technology for credit applications and decision-making through a new loan origination system (“LOS”). This online loan application system allows the consumer to apply for credit faster in anticipation of their vehicle purchase, authorize a soft credit pull during the application process, and receive a response via text message on the status of their application, as well as have access to centralized appointment-setting. At the end of July 2024 the Company had implemented the LOS in 147 of its 156 dealerships, with centralized decision-making on approvals of applications submitted via the online platform. The remaining nine dealerships, which were acquired, are still in their earn-out period or have yet to be integrated. Through the LOS, the Company has tightened its credit approval standards, primarily by requiring a higher down payment and shorter terms from certain customers.

Three months ended July 31, 2024 vs. Three months ended July 31, 2023

Consolidated Operations

(Operating Statement Dollars in Thousands)

Revenues decreased by approximately $19.0 million, or 5.2%, for the three months ended July 31, 2024 as compared to the same period in the prior fiscal year. The decrease resulted from a decline in revenue at dealerships that operated a full three months in both the current and prior year quarter ($31.9 million decrease) and by dealerships that were closed during the prior year quarter ($3.6 million decrease); partially offset by revenue growth from dealerships opened or acquired after the prior year quarter ($15.9 million). The decline in revenue was related to a 9.6% decrease in retail units sold, largely reflecting the challenging macroeconomic environment for our customers, partially offset by a 7.2% increase in interest income and a 2.4% increase in the average retail sales price. Interest income increased approximately $4.1 million for the three months ended July 31, 2024, as compared to the same period in the prior fiscal year, due to the $45.9 million increase in average finance receivables.

Cost of sales, as a percentage of sales, decreased to 65.0% for the three months ended July 31, 2024 compared to 65.3% for the same period of the prior fiscal year, resulting in a gross margin as a percentage of sales of 35.0% for the current year period compared to 34.7% for the prior year period. The improvement in gross margin resulted from better operational execution in pricing discipline and our continued focus on inventory efficiencies in procurement, remarketing, and repairs as well as an improvement in APP claims.

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 and includes the price of ancillary products sold with the vehicle, such as the APP and vehicle repair plans. As purchase costs increase, the margin between the purchase cost and the sales price of the vehicles the Company sells generally narrows on a percentage basis because the Company must offer affordable prices to its customers. The average retail sales price for the first quarter of fiscal 2025 was $19,250, a $451 increase over the prior year quarter. This increase was due to the increase in the average price of ancillary products rather than an increase in the Company’s purchase cost. The Company continues to focus on gross margin improvement through pricing discipline, reduced transportation costs and lower vehicle repair costs.

Selling, general and administrative expenses, as a percentage of sales, were 16.3% for the three months ended July 31, 2024, an increase of 1.3% 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 $241,000 in the first quarter of fiscal 2025 compared to the same period of the prior fiscal year. Although the Company had favorable declines in payroll and related costs as a result of prior cost cutting measures, this was offset by increases in the licensing and expenses related to technology implementations, along with the increased selling, general and administrative expenses related to the acquisitions.

Provision for credit losses as a percentage of sales was 33.2% for the three months ended July 31, 2024 compared to 31.0% 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 $28.5 million, as well as being amplified with a decrease in sales of $23.1 million compared to the prior year period. In overall dollars, the provision for credit losses decreased 0.9% in the first quarter of fiscal 2025 compared to the same period of the prior fiscal year due to the improved experience of contracts underwritten in the Company’s new loan origination system.

Interest expense as a percentage of sales increased to 6.4% for the three months ended July 31, 2024, compared to 4.6% for the prior year period. In dollar terms, interest expense increased $4.0 million due to increasing interest rates and an increase in the average borrowings of approximately $91.8 million during the three-month period ended July 31, 2024.

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 2.5% and 1.0% since April 30, 2024 and July 31, 2023, respectively, while revenues decreased 5.2% compared to the prior year period. The Company currently anticipates that the growth in finance receivables will generally be slightly higher than overall revenue growth on an annual basis due to overall term length increases in our installment sale contracts, partially offset by improvements in underwriting and collection procedures in an effort to reduce credit losses.

During the first three months of fiscal 2025, inventory increased by $7.1 million compared to inventory at April 30, 2024, primarily due to the most recent acquisition which added $5.0 million to the inventory balance. Annualized inventory turns decreased for the current year quarter at 6.7 versus the prior year’s first quarter at 7.2. The Company strives to improve the quality of the inventory and maintain adequate turns while maintaining inventory levels to ensure an adequate supply of vehicles in volume and mix, and to meet sales demand.

Property and equipment, net, decreased by $568,000 at July 31, 2024 as compared to property and equipment, net, at April 30, 2024. The Company incurred $986,000 in expenditures during the first three months of fiscal 2025 primarily related to remodeling existing locations in order to support growth. The Company incurred $1.9 million in depreciation expense during the first three months of fiscal 2025.

Accounts payable and accrued liabilities increased by $18.9 million during the first three months of fiscal 2025 as compared to accounts payable and accrued liabilities at April 30, 2024, related primarily to invoice management and vendor efficiencies.

Income taxes receivable, net, was $938,000 at July 31, 2024 compared to income taxes receivable, net, of $3.0 million at April 30, 2024, primarily due applying overpayments of taxes towards current year tax liabilities and refunds of overpaid taxes on prior year returns.

Deferred revenue increased $911,000 at July 31, 2024 as compared to April 30, 2024, primarily resulting from the increase in average retail sales price as well as the increased terms on the service contracts, partially offset by the decrease in units sold.

Deferred income tax liabilities, net, decreased approximately $942,000 at July 31, 2024 as compared to April 30, 2024, due primarily to a current year net operating loss.

The Company had $448.7 million and $553.6 million of notes payable outstanding related to asset-backed term funding transactions as of July 31, 2024 and April 30, 2024, respectively. These non-recourse notes issued by the Company accrue interest at fixed rates with a weighted average rate of 9.0% as of July 31, 2024. The Company’s warehouse loan facility accrues interest at a rate equal to the term SOFR plus 350 basis points. See Note F for further details on the non-recourse notes payable, warehouse loan facility and the revolving line of credit.

Borrowings on the Company’s revolving credit facilities fluctuate based upon a number of factors including (i) net income, (ii) finance receivables changes, (iii) funds available from asset-backed securitization offerings, warehouse facilities and/or other capital financing sources, (iv) income taxes, (v) capital expenditures, and if applicable, (vi) common stock repurchases. Historically, income from operations, as well as borrowings on the revolving credit facilities and securitized debt, have funded the Company’s finance receivables growth, capital asset purchases and common stock repurchases. The overall increase in total borrowings during the first quarter of fiscal 2025 was made to support an increase in finance receivables, with longer terms, and a growing customer base. During the first three months of fiscal 2025, the Company funded finance receivables growth of $29.9 million, increased inventory by $7.1 million, invested $13.5 million in dealership acquisitions, and purchased fixed assets of $986,000, with income from operations and increased total debt of $28 million, or a $23.7 million increase in total debt, net of cash.

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 as applicable, common stock repurchases. To the extent finance receivables growth, capital expenditures and common stock repurchases have exceeded income from operations, the Company has increased borrowings under our revolving credit facilities and secured additional funding through the issuance of asset-backed non-recourse notes.

Cash flows used in operating activities for the three months ended July 31, 2024 compared to the same period in the prior fiscal year decreased primarily as a result of a decrease in finance receivable originations and an increase in accounts payable and accrued liabilities. Finance receivables, net, increased by $27.7 million from April 30, 2024 to July 31, 2024.

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 higher 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 vehicle 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 vehicle sales, particularly domestic brands, lead to decreased supply in the used vehicle 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 for used vehicles, 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 for used vehicles, 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 continue to soften in calendar year 2024 but remain high compared to the last several years. 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 an increase in marketplace wages for our customers could enhance affordability.

The Company has devoted significant efforts to improving its purchasing processes to ensure adequate supply at appropriate prices which includes the new partnership with an industry leader, 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.

The Company’s liquidity is also impacted by our credit losses. Macro-economic factors such as unemployment levels and general inflation on core and discretionary items can significantly affect our collection results and ultimately credit losses. Currently, as our customers look to cover rising costs of non-discretionary items, such as childcare, insurance, groceries and gasoline, it may impact our customers’ ability to make their vehicle payments. The Company has made improvements to its business processes via the implementation of the loan origination system during the last two years to strengthen controls and provide stronger infrastructure to support its collections efforts. Management continues to focus on improved execution at the dealership level, specifically as related to working individually with customers concerning collection issues.

The Company’s business model relies on leasing the majority of the properties where its dealerships are located. As of July 31, 2024, 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 principal sources of liquidity include income from operations, proceeds from non-recourse notes payable issued under asset-back securitization transactions, warehouse facilities, borrowings under its revolving credit facilities, and other potential debt or equity financing sources. At July 31, 2024, the Company had approximately $4.7 million of cash on hand and approximately an additional $33.5 million of availability under its revolving credit facilities (see Note F to the Condensed Consolidated Financial Statements). The revolving credit facility has a scheduled maturity date of September 30, 2025, with total permitted borrowings of $340 million at July 31, 2024. In July 2024, the Company entered into Amendment No. 7 to its revolving credit agreement to allow for, among other things, the entry into an amortizing warehouse agreement and to amend the fixed charge coverage ratio under the credit agreement. On September 16, 2024, the Company entered into Amendment No. 8 to its revolving credit agreement that, among other things, reduces the total permitted borrowings under the revolving line of credit by $20 million to $320 million. Under the amendment, the Company will be required, after October 15, 2024, to maintain a minimum amount available to be drawn under the credit facilities, based on eligible finance receivables and inventory, of $20 million. If the outstanding principal balance under the line of credit equals or exceeds $300 million, the Company will be required tomaintain a minimum availability of $50 million. The amendment provides that the Company will use the net proceeds of any junior capital raise of $50 million or more to pay down the then outstanding principal balance of the line of credit and will pay a fee to the lenders of 0.10% of the total permitted borrowings under the line of credit if the Company has not completed such a capital raise by October 31, 2024. The amendment also makes certain modifications to the fixed charge coverage ratio covenant under the credit agreement and restricts the Company from making future repurchases of its common stock, along with the agreement’s existing restrictions on other distributions to the Company’s shareholders. Thus, 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.

In July 2024, the Company entered into a $150 million amortizing warehouse agreement backed by a portion of its finance receivables. The warehouse facility accrues interest at a rate of SOFR plus 350 basis points, with payments of principal and interest due monthly and a scheduled maturity date of July 12, 2026. The Company primarily used the funds from the warehouse facility to pay down the current revolving loan balance. On September 16, 2024, the Company entered into an amendment to the warehouse agreement that amends the fixed charge coverage ratio covenant consistent with Amendment No. 8 to the revolving credit agreement and modifies certain other financial covenants under the warehouse agreement.

The Company expects to use cash from operations and other financing sources to (i) pay down the outstanding principal balance of the revolving line of credit, (ii) grow its finance receivables portfolio, (iii) purchase fixed assets of approximately $8 million in the next 12 months as we complete facility updates and general fixed asset requirements, (iv) fund dealership acquisitions as opportunities arise on terms acceptable to the Company, and (v) reduce the Company’s remaining 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 at least one year from the financial statement issuance date through expected financing sources such as additional securitized borrowings or public registered offerings.

Off-Balance Sheet Arrangements

The Company has two standby letters of credit relating to insurance policies totaling $3.9 million at July 31, 2024.

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 July 31, 2024.

Critical Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) 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 expected to be incurred on the portfolio at the measurement date in the collection of its finance receivables currently outstanding. At July 31, 2024, the weighted average contract term was 48.1 months with 36.1 months remaining. The allowance for credit losses at July 31, 2024 of $334.4 million, was 25.0% of the principal balance in finance receivables of $1.5 billion, less unearned accident protection plan revenue of $52.0 million and unearned service contract revenue of $69.7 million, less APP claims of $5.4 million.

The allowance for credit losses is a critical accounting estimate for the following reasons:

• estimates relating to the allowance for credit losses require management to project future loan performance, including cash flows, prepayments, and charge-offs;
• the allowance for credit losses is influenced by factors outside of management’s control such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions including, but not limited to, inflation; and
• judgment is required to determine whether the model used to generate the allowance for credit losses produces results that appropriately reflect a current estimate of lifetime expected credit losses.

Because management’s estimate of the allowance for credit losses involves a high degree of judgment, such as the subjectivity of the assumptions used, there is uncertainty inherent in such estimates. Changes in these estimates could significantly impact the allowance and provision for credit losses.

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.

In March 2022, the FASB issued Accounting Standards Update (“ASU”) 2022-02, Financial Instruments – Credit Losses. The guidance changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. This guidance will affect the Company’s vintage disclosures related to 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. The Company adopted this standard on May 1, 2023, under a prospective basis. In regard to installment sale contract 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.

In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which sets forth improvements to the current segment disclosure requirements in accordance with Topic 280 “Segment Reporting,” including clarifying that entities with a single reportable segment are subject to both new and existing segment reporting requirements. ASU 2023-07 will be effective retrospectively for fiscal years beginning after December 15, 2023 and interim periods beginning after December 15, 2024. Early adoption is permitted. Adoption of this ASU will result in additional disclosure, but will not impact the Company’s consolidated financial position, results of operations or cash flows.

In December 2023, the FASB issued an accounting pronouncement (ASU 2023-09) related to income tax disclosures. The amendments in this update are intended to enhance the transparency and decision usefulness of income tax disclosures primarily through changes to the rate reconciliation and income taxes paid information. This update is effective for annual periods beginning after December 15, 2024, though early adoption is permitted. We plan to adopt this pronouncement for our fiscal year beginning May 1, 2025, and we do not expect it to have a material effect on our consolidated financial statements.

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 $184.8 million at July 31, 2024. The impact of a 1% increase in interest rates would result in increased annual interest expense of approximately $18.5 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 based on the Company’s contract interest rate as of the origination date of the installment sales contract, while its revolving credit facilities contain variable interest rates that fluctuate with market interest rates. During the third quarter of fiscal 2024, the Company increased the interest rate by 0.25%. The Company’s finance receivables now carry a fixed annual interest rate of 18.25% (up from 18.0%) for all states, except Arkansas at 16.75% (which is subject to a usury cap of 17.0%), Illinois (remains at 19.5% – 21.5%), and acquired dealerships in Tennessee (which originate at up to 23.0%). The interest rate on the Company’s revolving credit facilities is generally SOFR plus 3.50%, or for non-SOFR amounts the base rate of 8.50% plus 1% at July 31, 2024.

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 July 31, 2024. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of July 31, 2024. The Company’s disclosure controls and procedures are designed to ensure 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 in Internal Control over Financial Reporting

There were improvements to the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended July 31, 2024, that have positively impacted, the Company’s internal control over financial reporting.

During the first quarter of fiscal year 2025, the Company commenced the implementation of a new core accounting platform, which included changes to the Company’s general ledger, accounts payable, and fixed assets accounting processes. Management continues to review and enhance the design and documentation of the Company’s internal control over financial reporting. To date, the implementation, integration, and transition have not materially affected the Company’s internal control over financial reporting. As each phase of the implementation occurs, management will reassess the Company’s processes and procedures, which may result in changes to the Company’s internal control over financial reporting. There have been no other changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the three month period ending July 31, 2024 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, 2024.