CARMAX INC (KMX) FY 2022 MD&A

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements and the accompanying notes presented in Item 8. Consolidated Financial Statements and Supplementary Data.  Note references are to the notes to consolidated financial statements included in Item 8.  Certain prior year amounts have been reclassified to conform to the current year’s presentation.  All references to net earnings per share are to diluted net earnings per share.  Amounts and percentages may not total due to rounding.

OVERVIEW

See Part I, Item 1 for a detailed description and discussion of the company’s business.

CarMax is the nation’s largest retailer of used vehicles.  We operate in two reportable segments:  CarMax Sales Operations and CarMax Auto Finance (“CAF”).  Our CarMax Sales Operations segment consists of all aspects of our auto merchandising and service operations, excluding financing provided by CAF.  Our CAF segment consists solely of our own finance operation that provides financing to customers buying retail vehicles from CarMax. Our consolidated financial statements include the financial results related to our Edmunds Holding Company (“Edmunds”) business, which does not meet the definition of a reportable segment. For purposes of our MD&A discussion, amounts related to that business are discussed in combination with our CarMax Sales Operations segment. Separate discussion of these amounts is not considered meaningful for the purpose of gaining an understanding of our business, as the significant drivers of these operations in total are consistent with those of our CarMax Sales Operations segment. Where appropriate, specific amounts related to non-reportable segments have been disclosed for informational purposes.

CarMax Sales Operations

Our sales operations segment consists of retail sales of used vehicles and related products and services, such as wholesale vehicle sales; the sale of extended protection plan (“EPP”) products, which include extended service plans (“ESPs”) and guaranteed asset protection (“GAP”); and vehicle repair service. We offer competitive, no-haggle prices; a broad selection of CarMax Quality Certified used vehicles; value-added EPP products; and superior customer service. Our omni-channel platform, which gives us the largest addressable market in the used car industry, empowers our retail customers to buy a car on their terms – online, in-store or a seamless combination of both. Customers can choose to complete the car-buying experience in-person at one of our stores; or buy the car online and receive delivery through express pickup, available nationwide, or home delivery, available to most customers.

Our customers finance the majority of the retail vehicles purchased from us, and availability of on-the-spot financing is a critical component of the sales process.  We provide financing to qualified retail customers through CAF and our arrangements with industry-leading third-party finance providers.  All of the finance offers, whether by CAF or our third-party providers, are backed by a 3-day payoff option.

As of February 28, 2022, we operated 230 used car stores in 107 U.S. television markets. As of that date, wholesale auctions previously held at many of our used car stores were being conducted virtually. During the third quarter of fiscal 2022, we sold our remaining new car franchise.

CarMax Auto Finance

In addition to third-party finance providers, we provide vehicle financing through CAF, which offers financing solely to customers buying retail vehicles from CarMax.  CAF allows us to manage our reliance on third-party finance providers and to leverage knowledge of our business to provide qualifying customers a competitive financing option.  As a result, we believe CAF enables us to capture additional profits, cash flows and sales.  CAF income primarily reflects the interest and fee income generated by the auto loans receivable less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct expenses. CAF income does not include any allocation of indirect costs. After the effect of 3-day payoffs and vehicle returns, CAF financed 42.6% of our retail used vehicle unit sales in fiscal 2022.  As of February 28, 2022, CAF serviced approximately 1.1 million customer accounts in its $15.65 billion portfolio of managed receivables.

Management regularly analyzes CAF’s operating results by assessing the competitiveness of our consumer offer, profitability, the performance of the auto loans receivable, including trends in credit losses and delinquencies, and CAF direct expenses.

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Revenues and Profitability

The sources of revenue and gross profit from the CarMax Sales Operations segment and other non-reportable segments for fiscal 2022 are as follows:

A high-level summary of our financial results for fiscal 2022 as compared to fiscal 2021 is as follows (1):

(1)    Where applicable, amounts are net of intercompany eliminations.

(2)     An online retail sale is defined as a sale where the customer completes all four of the following activities remotely: reserving the vehicle; financing the vehicle, if needed; trading-in or opting out of a trade-in; and creating an online sales order.

(3)    An omni sale is defined as a sale where customers complete at least one of the four activities listed above online.

(4)    Revenue from online transactions is defined as revenue from retail sales that qualify as an online retail sale, as well as any related EPP and third-party finance contribution, wholesale sales where the winning bid was taken from an online bid and all revenue earned by Edmunds.

(5)     Revenue from online transactions data is not available for the full year of fiscal 2021 as wholesale auctions were transitioned to a virtual format during the first quarter.

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Net earnings per diluted share during fiscal 2022 included a one-time benefit of $0.11 in connection with the receipt of settlement proceeds in November 2021 related to a class action lawsuit. Net earnings per diluted share in fiscal 2021 included a one-time benefit of $0.19 in connection with our receipt of settlement proceeds in April 2020 related to a previously disclosed class action lawsuit.

Refer to “Results of Operations” for further details on our revenues and profitability. A discussion regarding Results of Operations and Financial Condition for fiscal 2021 as compared to fiscal 2020 is included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended February 28, 2021, filed with the SEC on April 20, 2021.

In March 2020, the World Health Organization declared the outbreak of the novel coronavirus (“COVID-19”) as a global pandemic. Throughout fiscal 2021, many U.S. states and localities had shelter-in-place orders and occupancy restrictions, impacting the operations of our stores and consumer demand. As a result, our fiscal 2021 results were significantly impacted by the COVID-19 pandemic, primarily during the first quarter.

Although the effects of COVID-19 seem to have subsided, uncertainty continues. During fiscal 2022, states and localities conducted vaccine distribution programs and eased certain state-mandated restrictions; however, the continued spread and impact of COVID-19 persists, particularly as it relates to the emergence of new variants of the virus. We continue to actively monitor developments that may cause us to take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our associates, customers, communities and shareholders.

Liquidity

Our primary ongoing sources of liquidity include funds provided by operations, proceeds from non-recourse funding vehicles, and borrowings under our revolving credit facility or through other financing sources. In addition to funding our operations, this liquidity was used to fund the repurchase of common stock under our share repurchase program, our store growth and the Edmunds acquisition, which was completed during the second quarter of fiscal 2022.

Our current capital allocation strategy is to focus on our core business, including investing in digital capabilities and the strategic expansion of our store footprint, pursue new growth opportunities through investments, partnerships and acquisitions and return excess capital to shareholders. Given the year-over-year improvement in our business, the strength of the credit markets and our solid balance sheet, we believe we have the appropriate liquidity, access to capital and financial strength to support our operations and continue investing in our strategic initiatives for the foreseeable future.

Strategic Update and Future Outlook

Since completing our omni-channel rollout in the second quarter of fiscal 2021, we now have a common platform across all of CarMax that leverages our scale, nationwide footprint and infrastructure and empowers our customers to buy a vehicle on their terms. We recognize that there has been an accelerated shift in consumer buying behavior. Customers are seeking personalization, convenience and safety in how they shop for and buy a vehicle more than ever. Our omni-channel platform empowers customers to buy a car on their own terms, whether completely from home, in-store or through a seamlessly integrated combination of online and in-store experiences. Our diversified business model, combined with our omni-channel experience, is a unique advantage in the used car industry that firmly positions us to continue growing our market share while creating shareholder value over the long-term.

With the completion of our omni-channel platform rollout, we are now focusing our efforts on optimizing and enhancing the customer experience. In particular, we are focused on completing the roll out of our self-service experience. Currently, approximately 90% of our customers are eligible to complete an online retail sale independently if they choose. We expect to have this capability available to 100% of our customers by the end of the first quarter of fiscal 2023. In the fourth quarter of fiscal 2022, online retail sales accounted for 11% of retail unit sales, up from 9% in the previous quarter and 5% in the prior year quarter. Omni sales represented approximately 55% of retail sales in the fourth quarter of fiscal 2022, down from 57% in the previous quarter and up from 51% in the prior year quarter. The growing rate of customer adoption versus the prior year reinforces our belief in our omni-channel strategy.

Revenue from online transactions was $2.4 billion, or approximately 31% of net revenues in the fourth quarter of fiscal 2022, up from 30% in the previous quarter and 17% in the prior year quarter.

We continue to see success from our online instant appraisal offer, which quickly provides customers an offer on their vehicle. This innovative experience allowed us to purchase approximately 162,000 and 707,000 vehicles online from consumers during the fourth quarter and full year of fiscal 2022, respectively, representing approximately half of our total buys from consumers for both periods. As a result, our self-sufficiency has nearly doubled during the current year. Historically, our annual self-sufficiency rate has been between 36% and 41%. For the first quarter of fiscal 2022, our self-sufficiency rate was between 45%

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and 50%, and for the second through fourth quarters of fiscal 2022 we achieved record self-sufficiency rates above 70%. The success of these offerings strengthens our leadership position as the largest used vehicle buyer from consumers in the U.S.

Nearly two-thirds of our finance customers start their financing process online. With our financing offer product in our online checkout process, eligible customers can apply and accept finance offers without needing the assistance of an associate to submit a credit application over the phone or in store. In addition, our finance based shopping capability, available to most customers, enables our customers to see personalized finance terms from multiple lenders across the full inventory of vehicles on our website. During the month of March 2022, we further enhanced this experience and are testing additional capabilities, including enabling real-time decisioning as well as the ability for a customer to pre-qualify for financing with no impact to their credit score.

Our investments in the near term will focus on our customer experience, vehicle acquisition and marketing. Our plans to grow vehicle acquisition include attracting new customers and pursuing partnerships as we expand our appraisal offerings to dealers and other businesses. As we continue enhancing our online experience and offerings, we believe it is important to educate customers about our omni-channel platform and to differentiate and elevate our brand. During the fourth quarter of fiscal 2021, we introduced the next phase of our national multi-media marketing campaign. As a result, marketing spend increased in the current year. For fiscal 2023, we expect our marketing spend per unit to be at least as much as fiscal 2022. We believe we are well positioned to continue gaining market share through our marketing strategies, which are focused on driving customer growth through building awareness and affinity for the brand and acquiring in-market shoppers and sellers.

Our strategic investments include the acquisition of Edmunds, which we completed on June 1, 2021. The acquisition was the first in CarMax history, and added one of the most well established and trusted online guides for automotive information and a recognized industry leader in digital car shopping innovations to the CarMax family. With this acquisition, CarMax has enhanced its digital capabilities and further strengthened its role and reach across the used auto ecosystem while adding exceptional technology and creative talent. Edmunds continues to operate independently and remains focused on delivering confidence to consumers and excellent value to its dealer and OEM clients. Additionally, this acquisition allows both businesses to accelerate their respective capabilities to deliver an enhanced digital experience to our customers by leveraging Edmunds’ compelling content and technology, CarMax’s unparalleled national scale and infrastructure, and the combined talent of both businesses.

In order to execute our long-term strategy, we plan to continue investing in various strategic initiatives to increase innovation, specifically with regards to customer-facing and customer-enabling technologies, as well as marketing. We are also focused on ensuring we are efficient in our spend, targeting specific areas where we expect to achieve more efficiencies and leverage, such as our CECs and stores. Our use of data is a core component of these initiatives and continues to be a strategic asset for us as we leverage data to enhance the customer experience and increase operational efficiencies.

During fiscal 2022, we saw meaningful improvements in the service levels of our CECs related to web and phone lead response time while also handling a record level of volume. This improvement was due to a combination of staffing increases and ongoing utilization of our artificial intelligence and machine learning processes that drove the right work to the right associates. From an efficiency perspective, we continue to see gains in our buying organization. The combination of our instant appraisal offer program along with the investments we have made in data science, automation and artificial intelligence continue to reduce our costs per buy.

For fiscal 2023, we would expect to require an increase beyond the 5% to 8% range of gross profit growth to lever. This is primarily driven by the timing of strategic investments and growth-related costs, as well as heightened inflationary pressures. While we expect to remain in investment mode over the next few years, we expect our leverage point to be lower after fiscal 2023.

We expect our diversified model, the scale of our operations, our investments and omni-channel strategy to provide a solid foundation for further growth. In May 2021, we introduced 5-year financial targets, including: (i) selling 2 million vehicles through our combined retail and wholesale channels by fiscal 2026; (ii) generating $33 billion in revenue by fiscal 2026; and (iii) growing our nationwide share of the age 0-10 used vehicle market to more than 5% by the end of calendar 2025. Although we do not anticipate updating these targets annually, given our strong performance in fiscal 2022, we believe it is appropriate to provide the following update at this time:

•Sell between 2 million and 2.4 million vehicles through our combined retail and wholesale channels by fiscal 2026.

•Generate between $33 billion and $45 billion in revenue by fiscal 2026.

•Re-affirm the growth of our nationwide share of the age 0-10 used vehicle market to more than 5% by the end of calendar 2025.

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These ranges reflect macroeconomic factors that could result in ongoing volatility in consumer demand.

In calendar 2021, we estimate we sold approximately 4.0% of the age 0- to 10-year old vehicles sold on a nationwide basis, an increase from 3.5% in calendar 2020. We estimate we sold approximately 4.9% of the age 0- to 10-year old vehicles sold in the current comparable store markets in which we operate in calendar 2021, an increase from 4.3% in 2020. Comparing our results to published used vehicle SAAR data suggests that we continued to grow our market share during the fourth quarter of fiscal 2022, despite the sales decline we experienced. We believe we are well positioned to deliver profitable market share gains in any environment. Our strategy to increase our market share includes focusing on:

•Delivering a customer-driven, omni-channel buying and selling experience that is a unique and powerful integration of our in-store and online capabilities.

•Opening stores in new markets and expanding our presence in existing markets.

•Hiring, developing and retaining an engaged and skilled workforce.

•Improving efficiency in our stores and CECs and our logistics operations to reduce waste.

•Leveraging data and advanced analytics to continuously improve the customer experience as well as our processes and systems.

•Utilizing advertising to educate customers about our omni-channel platform and to differentiate and elevate our brand.

As of February 28, 2022, we had used car stores located in 107 U.S. television markets, which covered approximately 79% of the U.S. population.  The format and operating models utilized in our stores are continuously evaluated and may change or evolve over time based upon market and consumer expectations. During fiscal 2022, we opened ten stores, and we anticipate opening ten stores during fiscal 2023.

While we execute both our short- and long-term strategy, there are trends and factors that could impact our strategic approach or our results in the short and medium term. For additional information about risks and uncertainties facing our company, see “Risk Factors,” included in Part I, Item 1A of this Form 10-K.

CRITICAL ACCOUNTING ESTIMATES

Our results of operations and financial condition as reflected in the consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.  Preparation of financial statements requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues, expenses and the disclosures of contingent assets and liabilities.  We use our historical experience and other relevant factors when developing our estimates and assumptions.  We regularly evaluate these estimates and assumptions.  Note 1 includes a discussion of significant accounting policies.  The accounting policies discussed below are the ones we consider critical to an understanding of our consolidated financial statements because their application places the most significant demands on our judgment.  Our financial results might have been different if different assumptions had been used or other conditions had prevailed.

Allowance for Loan Losses

The allowance for loan losses represents the net credit losses expected over the remaining contractual life of our managed receivables.  Because net loss performance can vary substantially over time, estimating net losses requires assumptions about matters that are uncertain.

The allowance for loan losses is determined using a net loss timing curve, primarily based on the composition of the portfolio of managed receivables and historical gross loss and recovery trends. Due to the fact that losses for receivables with less than 18 months of performance history can be volatile, our net loss estimate weights both historical losses by credit grade at origination and actual loss data on the receivables to-date, along with forward loss curves, in estimating future performance. Once the receivables have 18 months of performance history, the net loss estimate reflects actual loss experience of those receivables to date, along with forward loss curves, to predict future performance. The forward loss curves are constructed using historical performance data and show the average timing of losses over the course of a receivable’s life. The net loss estimate is calculated by applying the loss rates developed using the methods described above to the amortized cost basis of the managed receivables.

The output of the net loss timing curve is adjusted to take into account reasonable and supportable forecasts about the future. Specifically, the change in U.S. unemployment rates and the National Automobile Dealers Association used vehicle price index are used to predict changes in gross loss and recovery rate, respectively. An economic adjustment factor, based upon a single macroeconomic scenario, is developed to capture the relationship between changes in these indices and changes in gross loss and recovery rates. This factor is applied to the output of the net loss timing curve for the reasonable and supportable forecast period of two years. After the end of this two-year period, we revert to historical experience on a straightline basis over a period of 12 months.  We periodically consider whether the use of alternative metrics would result in improved model

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performance and revise the model when appropriate.  We also consider whether qualitative adjustments are necessary for factors that are not reflected in the quantitative methods but impact the measurement of estimated credit losses. Such adjustments include the uncertainty of the impacts of recent economic trends on customer behavior. The change in the allowance for loan losses is recognized through an adjustment to the provision for loan losses.

Determining the appropriateness of the allowance for loan losses requires management to exercise judgment about matters that are inherently uncertain, including the timing and distribution of net losses that could materially affect the allowance for loan losses and, therefore, net earnings. To the extent that actual performance differs from our estimates, additional provision for credit losses may be required that would reduce net earnings. A 10% change in the estimated loss rates would have changed the allowance for loan losses by approximately $43.3 million as of February 28, 2022.

See Notes 1(H) and 5 for additional information on the allowance for loan losses.

RESULTS OF OPERATIONS – CARMAX SALES OPERATIONS AND OTHER NON-REPORTABLE SEGMENTS

NET SALES AND OPERATING REVENUES

(1)    Excludes intersegment sales and operating revenues that have been eliminated in consolidation. See Note 20 for further details.

UNIT SALES

AVERAGE SELLING PRICES

COMPARABLE STORE USED VEHICLE SALES CHANGES

(1)     Stores are added to the comparable store base beginning in their fourteenth full month of operation. We do not remove renovated stores from our comparable store base. Comparable store calculations include results for a set of stores that were included in our comparable store base in both the current and corresponding prior year periods.

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VEHICLE SALES CHANGES

USED VEHICLE FINANCING PENETRATION BY CHANNEL (BEFORE THE IMPACT OF 3-DAY PAYOFFS)

(1)     Calculated as used vehicle units financed for respective channel as a percentage of total used units sold.

(2)    Includes CAF’s Tier 2 and Tier 3 loan originations, which represent approximately 1% of total used units sold.

(3)     Third-party finance providers who generally pay us a fee or to whom no fee is paid.

(4)     Third-party finance providers to whom we pay a fee.

(5)     Represents customers arranging their own financing and customers that do not require financing.

CHANGE IN USED CAR STORE BASE

During fiscal 2022, we opened 10 stores (Miami, FL; Tampa, FL; Gainesville, FL; Los Angeles, CA; Greenville, NC; Springfield, MO; Tucson, AZ; Roanoke, VA; Cleveland, OH; and Orlando, FL).

Used Vehicle Sales

Fiscal 2022 Versus Fiscal 2021.  The 55.5% increase in used vehicle revenues in fiscal 2022 was primarily driven by a 22.9% increase in used unit sales and a 26.7% increase in average retail selling price. The increase in used units included a 21.9% increase in comparable store used unit sales. Online retail sales, as defined previously, accounted for 9% of used unit sales in fiscal 2022, compared with 4% in fiscal 2021.

We believe our strong comparable store used unit sales growth in fiscal 2022 was driven by solid execution, growing demand for our online offerings and strengthened marketing investments, as well as the continued success of vehicle sourcing directly from consumers. Sales also benefited from the net impact of macroeconomic factors, including federal government stimulus payments, the chip shortage and its impact on new vehicle availability, market prices and inflation. Our results for fiscal 2021 were significantly impacted by COVID-19, primarily during the first quarter.

During the fourth quarter of fiscal 2022, however, we believe a number of macroeconomic factors impacted our comparable store used unit sales performance, including declining consumer confidence, the COVID-19 Omicron variant, vehicle affordability, and the lapping of stimulus benefits paid in the prior year quarter.

The increase in average retail selling price in fiscal 2022 reflected higher vehicle acquisition costs driven by market appreciation.

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Wholesale Vehicle Sales

Vehicles sold at our wholesale auctions are, on average, approximately 10 years old with more than 100,000 miles and are primarily comprised of vehicles purchased through our appraisal process that do not meet our retail standards. Our wholesale auction prices usually reflect trends in the general wholesale market for the types of vehicles we sell, although they can also be affected by changes in vehicle mix or the average age, mileage or condition of the vehicles being sold. During fiscal 2021, our wholesale auctions were moved to an online format in response to COVID-19 and continue to operate completely online.

Fiscal 2022 Versus Fiscal 2021.  The 153.4% increase in wholesale vehicle revenues in fiscal 2022 was primarily due to a 65.7% increase in used unit sales as well as a 55.1% increase in average selling price. The wholesale unit growth in fiscal 2022 was largely driven by increased appraisal volume from online offerings as well as an increased buy rate, which was over 40% in fiscal 2022. During fiscal 2022, our strong appraisal offers, in response to the increase in market prices, contributed to our higher appraisal buy rate. The increase in average selling price was primarily due to increased acquisition costs driven by market appreciation.

Other Sales and Revenues

Other sales and revenues include revenue from the sale of ESPs and GAP (collectively reported in EPP revenues, net of a reserve for estimated contract cancellations), net third-party finance income/(fees), advertising and subscription revenues earned by our Edmunds business, and other revenues, which are predominantly comprised of service department and new vehicle sales. The fees we pay to the Tier 3 providers are reflected as an offset to finance fee revenues received from the Tier 2 providers. The mix of our retail vehicles financed by CAF, Tier 2 and Tier 3 providers, or customers that arrange their own financing, may vary from quarter to quarter depending on several factors including the credit quality of applicants, changes in providers’ credit decisioning and external market conditions. Changes in originations by one tier of credit providers may also affect the originations made by providers in other tiers.

Fiscal 2022 Versus Fiscal 2021.  Other sales and revenues increased 23.2% in fiscal 2022, reflecting the addition of Edmunds’ revenue of $101.8 million as well as growth in EPP revenues and net third-party finance income, partially offset by a decline in new vehicle sales. EPP revenues increased 15.9%, reflecting the increase in our retail unit volume partially offset by unfavorable year-over-year changes in cancellation reserves. Net third-party finance income improved as a result of favorable adjustments in the fee arrangements with our Tier 2 and Tier 3 providers made during the fourth quarter of fiscal 2021 as well as shifts in our sales mix by finance channel, partially offset by increased sales. The decline in new car sales was driven by the divestiture of our remaining new car franchises, as noted above.

GROSS PROFIT

(1)Amounts are net of intercompany eliminations.

GROSS PROFIT PER UNIT

(1)Amounts are net of intercompany eliminations. Those eliminations had the effect of increasing used vehicle gross profit per unit and wholesale vehicle gross profit per unit and decreasing other gross profit per unit by immaterial amounts.

(2)Calculated as category gross profit divided by its respective units sold, except the other category, which is divided by total used units sold.

(3)Calculated as a percentage of its respective sales or revenue.

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Used Vehicle Gross Profit

We target a dollar range of gross profit per used unit sold.  The gross profit dollar target for an individual vehicle is based on a variety of factors, including its probability of sale and its mileage relative to its age; however, it is not primarily based on the vehicle’s selling price.  Our ability to quickly adjust appraisal offers to be consistent with the broader market trade-in trends and the pace of our inventory turns reduce our exposure to the inherent continual fluctuation in used vehicle values and contribute to our ability to manage gross profit dollars per unit. Gross profit per used unit is consistent across our omni-channel platform.

We systematically adjust individual vehicle prices based on proprietary pricing algorithms in order to appropriately balance sales trends, inventory turns and gross profit achievement.  Other factors that may influence gross profit include the wholesale and retail vehicle pricing environments, vehicle reconditioning and logistics costs, and the percentage of vehicles sourced directly from consumers through our appraisal process.  Vehicles purchased directly from consumers generally have a lower cost per unit compared with vehicles purchased at auction or through other channels, which may generate more gross profit per unit. We monitor macroeconomic factors and pricing elasticity and adjust our pricing accordingly to optimize unit sales and profitability while also maintaining a competitively priced inventory.

Fiscal 2022 Versus Fiscal 2021.  Used vehicle gross profit increased 28.3% in fiscal 2022, driven by the 22.9% increase in total used unit sales as well as the $92 increase in used vehicle gross profit per unit. With used car prices at all-time highs during fiscal 2022, we chose to pass along some of our self-sufficiency driven acquisition cost savings to consumers by way of lower prices to make our vehicles more accessible, while balancing inflationary costs and target margin increases.

Wholesale Vehicle Gross Profit

Our wholesale gross profit per unit reflects the demand for older, higher mileage vehicles, which are the mainstay of our auctions, as well as strong dealer attendance and resulting high dealer-to-car ratios at our auctions.  The frequency of our auctions, which are generally held weekly or bi-weekly, minimizes the depreciation risk on these vehicles.  Our ability to adjust appraisal offers in response to the wholesale pricing environment is a key factor that influences wholesale gross profit.

Fiscal 2022 Versus Fiscal 2021.  Wholesale vehicle gross profit increased 80.6% in fiscal 2022, driven by the 65.7% increase in wholesale unit sales as well as a $90 increase in wholesale vehicle gross profit per unit.

Other Gross Profit

Other gross profit includes profits related to EPP revenues, net third-party finance income/(fees), advertising and subscription profits earned by our Edmunds business, and other revenues. Other revenues are predominantly comprised of service department operations, including used vehicle reconditioning, and new vehicle sales.  We have no cost of sales related to EPP revenues or net third-party finance income/(fees), as these represent revenues paid to us by certain third-party providers. Third-party finance income is reported net of the fees we pay to third-party Tier 3 finance providers.  Accordingly, changes in the relative mix of the components of other gross profit can affect the composition and amount of other gross profit.

Fiscal 2022 Versus Fiscal 2021.  Other gross profit increased 32.1% in fiscal 2022, reflecting the addition of Edmunds’ gross profit of $62.6 million as well as increases in EPP revenues and net third-party finance income, as discussed above, partially offset by a decline in service department profits. The decline in service department profits was primarily experienced in the fourth quarter of fiscal 2022, reflecting deleverage resulting from lower retail unit sales as well as the adverse effects on technician staffing and reconditioning efficiency from the COVID-19 Omicron variant. Additionally, prior to the fourth quarter, we experienced pressure from our efforts to support our higher level of retail sales, including growing technician staffing and shifting retail service capacity to support vehicle reconditioning.

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COMPONENTS OF SG&A EXPENSES AS A PERCENTAGE OF TOTAL SG&A EXPENSES

COMPONENTS OF SG&A EXPENSES COMPARED WITH PRIOR PERIODS (1) (2)

(1)Depreciation and amortization previously included in SG&A expenses is now separately presented and is excluded from this table. Prior period amounts have been reclassified to conform to the current period’s presentation.

(2)Amounts are net of intercompany eliminations.

(3)Excludes compensation and benefits related to reconditioning and vehicle repair service, which are included in cost of sales. See Note 14 for details of share-based compensation expense by grant type.

(4)Includes IT expenses, non-CAF bad debt, insurance, preopening and relocation costs, charitable contributions, travel and other administrative expenses.

Fiscal 2022 Versus Fiscal 2021 (Increase of $620.8 million or 36.4%). This increase reflected an increase in costs associated with our growth in sales volume, growth costs related to the increase in appraisal buys, new stores and customer support at our CECs and continued spending to advance our technology platforms and support strategic initiatives, as well as cost-reduction actions taken in response to the pandemic in the prior year. The increase also reflected the following:

•$314.6 million increase in compensation and benefits expense, excluding share-based compensation expense, driven by increased staffing, sales growth, a $26.2 million increase in our annual bonus compensation and a $24.5 million increase resulting from the addition of Edmunds during the current year, as well as cost-reduction actions taken in response to the pandemic in the prior year period.

•$108.4 million increase in advertising expense driven by our previously communicated investment in advertising spend.

•$182.3 million increase in other overhead costs, primarily reflecting investments to advance our technology platforms and support our strategic initiatives as well as cost-reduction actions taken in response to the pandemic in the prior year period. The current year included a $22.6 million one-time benefit related to the receipt of settlement proceeds in a class action lawsuit while the prior year included a one-time benefit of $40.3 million related to the receipt of settlement proceeds in a class action lawsuit.

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Interest Expense

Interest expense includes the interest related to short- and long-term debt, financing obligations and finance lease obligations. It does not include interest on the non-recourse notes payable, which is reflected within CAF income.

Fiscal 2022 Versus Fiscal 2021.  Interest expense increased to $94.1 million in fiscal 2022 versus $86.2 million in fiscal 2021. The increase primarily reflected an increase in finance lease obligations and higher outstanding debt levels in fiscal 2022.

Other (Income) Expense

Other income increased to $34.6 million in fiscal 2022 compared with $8.3 million in fiscal 2021. The increase was primarily due to net gains on an equity investment recorded during fiscal 2022.

Income Taxes

The effective income tax rate was 22.9% in fiscal 2022 compared with 22.6% in fiscal 2021.

RESULTS OF OPERATIONS – CARMAX AUTO FINANCE

CAF income primarily reflects interest and fee income generated by CAF’s portfolio of auto loans receivable less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct CAF expenses. Total interest margin reflects the spread between interest and fees charged to consumers and our funding costs. Changes in the interest margin on new originations affect CAF income over time. Increases in interest rates, which affect CAF’s funding costs, or other competitive pressures on consumer rates, could result in compression in the interest margin on new originations. Changes in the allowance for loan losses as a percentage of ending managed receivables reflect the effect of changes in loss and delinquency experience and economic factors on our outlook for net losses expected to occur over the remaining contractual life of the loans receivable.

CAF’s managed portfolio is composed primarily of loans originated over the past several years.  Trends in receivable growth and interest margins primarily reflect the cumulative effect of changes in the business over a multi-year period. Historically, we have sought to originate loans in our core portfolio, which excludes Tier 2 and Tier 3 originations, with an underlying risk profile that we believe will, in the aggregate, result in cumulative net losses in the 2% to 2.5% range (excluding CECL-required recovery costs) over the life of the loans.  Actual loss performance of the loans may fall outside of this range based on various factors, including intentional changes in the risk profile of originations, economic conditions (including the effects of COVID-19) and wholesale recovery rates.  Current period originations reflect current trends in both our retail sales and the CAF business, including the volume of loans originated, current interest rates charged to consumers, loan terms and average credit scores.  Loans originated in a given fiscal period impact CAF income over time, as we recognize income over the life of the underlying auto loan.

CAF also originates a small portion of auto loans to customers who typically would be financed by our Tier 3 finance providers, in order to better understand the performance of these loans, mitigate risk and add incremental profits.  Historically, CAF targeted originating approximately 5% of the total Tier 3 loan volume. During the first quarter of fiscal 2022, we began to increase our Tier 3 loan volume beyond our target of 5% of total Tier 3 loan volume to 10% by the end of the first quarter of fiscal 2022. Additionally, in the second quarter of fiscal 2022, CAF began to originate loans in the Tier 2 space on a test basis. Any future adjustments in Tier 2 and Tier 3 will consider the broader lending environment along with the long-term sustainability of the change. These loans have higher loss and delinquency rates than the remainder of the CAF portfolio, as well as higher contract rates.

CAF income does not include any allocation of indirect costs.  Although CAF benefits from certain indirect overhead expenditures, we have not allocated indirect costs to CAF to avoid making subjective allocation decisions.  Examples of indirect costs not allocated to CAF include retail store expenses and corporate expenses.

See Note 4 for additional information on CAF income and Note 5 for information on auto loans receivable, including credit quality.

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SELECTED CAF FINANCIAL INFORMATION

(1)Percent of total average managed receivables.

CAF ORIGINATION INFORMATION (AFTER THE IMPACT OF 3-DAY PAYOFFS)

(1)Vehicle units financed as a percentage of total used units sold.

(2)The credit scores represent FICO® scores and reflect only receivables with obligors that have a FICO® score at the time of application.  The FICO® score with respect to any receivable with co-obligors is calculated as the average of each obligor’s FICO® score at the time of application.  FICO® scores are not a significant factor in our primary scoring model, which relies on information from credit bureaus and other application information as discussed in Note 5.  FICO® is a federally registered servicemark of Fair Isaac Corporation.

(3)LTV represents the ratio of the amount financed to the total collateral value, which is measured as the vehicle selling price plus applicable taxes, title and fees.

LOAN PERFORMANCE INFORMATION

(1)    The allowance for loan losses as of February 28, 2021 includes a $202.0 million increase as a result of our adoption of CECL during the first quarter of fiscal 2021.

(2)    The average recovery rate represents the average percentage of the outstanding principal balance we receive when a vehicle is repossessed and liquidated, generally at our wholesale auctions. While in any individual period conditions may vary, over the past 10 fiscal years, the annual recovery rate has ranged from a low of 46% to a high of 71%, and it is primarily affected by the wholesale market environment.

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Fiscal 2022 Versus Fiscal 2021.

•CAF Income increased $238.7 million, or 42.4%, reflecting increases in the total interest margin percentage and average managed receivables as well as a decrease in the provision for loan losses.

•Provision for Loan Losses (Decreased to $141.7 million from $160.7 million)

◦The change in the provision was primarily driven by reserve increases during the first quarter of fiscal 2021 associated with deterioration in the macroeconomic environment resulting from the COVID-19 pandemic.

◦The allowance for loan losses as a percentage of ending managed receivables was 2.77% as of February 28, 2022 compared with 2.97% as of February 28, 2021.

•Total interest margin increased as a percentage of average managed receivables to 7.2% in fiscal 2022 compared with 6.1% in fiscal 2021 as a result of lower funding costs.

•Loan Performance

◦The increase in net loan originations in fiscal 2022 resulted from an increase in the average amount financed as well as our used unit sales growth.

◦CAF net penetration for fiscal 2022 was relatively consistent with the prior year. However, during the fourth quarter of fiscal 2022, CAF net penetration declined slightly, driven by an increase in the mix of customers utilizing outside financing. In the current environment, we seek to remain highly competitive in the marketplace while also maintaining the quality of CAF’s portfolio.

◦The increase in past due accounts as a percentage of ending managed receivables for fiscal 2022 primarily reflected a return to pre-pandemic delinquency levels as well as an increase, primarily in the 31-60 day past due bucket, resulting from the transition to CAF’s new auto loan receivable servicing system. During this transition, we continue to adjust resources as needed from early stage collection efforts to handling the increased volume of incoming phone calls we are receiving as customers get accustomed to the new platform. We ultimately expect this to normalize over time.

◦The annual recovery rate for fiscal 2022 was at the top of our range due to market appreciation experienced during the year.

PLANNED FUTURE ACTIVITIES

We anticipate opening ten stores in fiscal 2023, which will include our expected entry into the New York metro market. We currently estimate capital expenditures will total approximately $500 million in fiscal 2023, an increase from $308.5 million in fiscal 2022. The increase in planned capital spending in fiscal 2023 largely reflects long-term growth capacity initiatives for our auction, sales and production facilities in addition to continued investments in technology. We expect approximately 30% of our capital expenditures in fiscal 2023 will be focused on investments in technology.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1(X) to the consolidated financial statements for information on recent accounting pronouncements applicable to CarMax.

FINANCIAL CONDITION

Liquidity and Capital Resources

Our primary ongoing cash requirements are to fund our existing operations, store expansion and improvement, CAF and strategic growth initiatives. Since fiscal 2013, we have also elected to use cash for our share repurchase program.  Our primary ongoing sources of liquidity include funds provided by operations, proceeds from non-recourse funding vehicles and borrowings under our revolving credit facility or through other financing sources.

Our current capital allocation strategy is to focus on our core business, including investing in digital capabilities and the strategic expansion of our store footprint, pursue new growth opportunities through investments, partnerships and acquisitions and return excess capital to shareholders. Given the year-over-year improvement in our business, the strength of the credit markets and our solid balance sheet, we believe we have the appropriate liquidity, access to capital and financial strength to support our operations and continue investing in our strategic initiatives for the foreseeable future.

On June 1, 2021, we completed our acquisition of Edmunds for a total purchase price of $401.8 million, inclusive of our initial investment. The consideration paid at closing included a combination of cash and shares of CarMax common stock. See Note 2 for additional information.

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We are party to contractual obligations involving commitments to make payments to third parties. These obligations impact our liquidity and capital resource needs. Our contractual obligations primarily consist of long-term debt and related interest payments, leases, purchase obligations and commitments, income taxes and defined benefit retirement plans. See Notes 13 and 17 for amounts outstanding as of February 28, 2022 related to debt and leases, respectively.

Our contractual obligations related to income taxes represent the net unrecognized tax benefits related to uncertain tax positions. See Note 11 for information related to income taxes. Our contractual obligations related to defined benefit retirement plans represent the funded status recognized as of February 28, 2022. See Note 12 for information related to these plans.

Purchase obligations and commitments consist of certain enforceable and legally binding obligations related to real estate purchases, third-party outsourcing services and advertising. As of February 28, 2022, our purchase obligations and commitments were approximately $200.9 million, of which $108.0 million are due in fiscal 2023. The majority of the remaining purchase obligations and commitments are due within the next three years.

We currently target an adjusted debt-to-total capital ratio in a range of 35% to 45%. At the end of fiscal 2022, our adjusted debt to capital ratio, net of cash on hand, was at the higher end of our targeted range for the year. In calculating this ratio, we utilize total debt excluding non-recourse notes payable, finance lease liabilities, a multiple of eight times rent expense and total shareholders’ equity. Generally, we expect to use our revolving credit facility and other financing sources, together with stock repurchases, to maintain this targeted ratio; however, in any period, we may be outside this range due to seasonal, market, strategic or other factors.

Operating Activities.  During fiscal 2022, net cash used in operating activities totaled $2.55 billion, compared with net cash provided by operating activities of $667.8 million in fiscal 2021. Our operating cash flows are significantly impacted by changes in auto loans receivable, which increased $1.94 billion in fiscal 2022 compared with $300.8 million in fiscal 2021.

The majority of the changes in auto loans receivable are accompanied by changes in non-recourse notes payable, which are issued to fund auto loans originated by CAF. Net issuances of non-recourse notes payable were $1.70 billion in fiscal 2022 compared with $151.5 million in fiscal 2021 and are separately reflected as cash from financing activities. Due to the presentation differences between auto loans receivable and non-recourse notes payable on the consolidated statements of cash flows, fluctuations in these amounts can have a significant impact on our operating and financing cash flows without affecting our overall liquidity, working capital or cash flows.

As of February 28, 2022, total inventory was $5.12 billion, representing an increase of $1.97 billion, or 62.3%, compared with the balance as of the start of the fiscal year. The increase was primarily due to an increase in the average carrying cost of inventory as a result of higher acquisition costs, driven by market appreciation, as well as an increase in vehicle units. Saleable inventory levels have been below our targets throughout the current fiscal year as a result of temporary production slowdowns experienced in the fourth quarter of fiscal 2021 and strong demand experienced during fiscal 2022. We made substantial progress in building our inventory position during the second quarter of fiscal 2022, and we achieved sequential growth in saleable inventory each month during the third quarter. In the fourth quarter of fiscal 2022, we continued to build inventory for tax refund season, which typically has stronger demand. As of February 28, 2022, we believe our inventory is well positioned to support anticipated sales in the first quarter of fiscal 2023.

The change in net cash (used in) provided by operating activities for fiscal 2022 compared with fiscal 2021 reflected the changes in auto loans receivable and inventory, as discussed above, as well as accounts receivable, driven by increased sales and timing, partially offset by an increase in net earnings when excluding non-cash expenses, which include depreciation and amortization, share-based compensation expense and the provisions for loan losses and cancellation reserves. Our results for fiscal 2021 were significantly impacted by COVID-19, primarily during the first quarter. In response, we took proactive measures to strengthen our liquidity position, including reducing our inventory levels and aligning our costs to lower sales volume.

Investing Activities.  Net cash used in investing activities totaled $523.7 million in fiscal 2022 compared with $128.2 million in fiscal 2021.  For fiscal 2022, this included $241.6 million in cash paid in connection with the Edmunds acquisition, net of cash acquired. Capital expenditures were $308.5 million in fiscal 2022 versus $164.5 million in fiscal 2021. Capital expenditures primarily included store construction costs and store remodeling expenses, as well as investments in technology.  We maintain a multi-year pipeline of sites to support our store growth, so portions of capital spending in one year may relate to stores that we open in subsequent fiscal years.

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Financing Activities.  Net cash provided by financing activities was $3.10 billion in fiscal 2022, compared with net cash used in financing activities of $424.0 million in fiscal 2021.  Included in these amounts were net issuances of non-recourse notes payable of $1.70 billion compared with $151.5 million, respectively. Non-recourse notes payable are typically used to fund changes in auto loans receivable (see “Operating Activities”).

During fiscal 2022, cash provided by financing activities was impacted by stock repurchases of $576.5 million as well as net borrowings on our long-term debt of $1.93 billion, including a new $700 million term loan entered into during the third quarter of fiscal 2022. During fiscal 2021, cash used in financing activities was impacted by stock repurchases of $229.9 million as well as net payments on our long-term debt of $463.0 million.

TOTAL DEBT AND CASH AND CASH EQUIVALENTS

(1)Interest is payable monthly, with the exception of our senior notes, which are payable semi-annually.

(2)Borrowings accrue interest at variable rates based on the Eurodollar rate (LIBOR), or successor benchmark rate, the federal funds rate, or the prime rate, depending on the type of borrowing.

(3)Total debt excludes unamortized debt issuance costs. See Note 13 for additional information.

Borrowings under our $2.00 billion unsecured revolving credit facility are available for working capital and general corporate purposes, and the unused portion is fully available to us.  The credit facility, term loans and senior note agreements contain representations and warranties, conditions and covenants.  If these requirements are not met, all amounts outstanding or otherwise owed could become due and payable immediately and other limitations could be placed on our ability to use any available borrowing capacity. As of February 28, 2022, we were in compliance with these financial covenants.

See Note 13 for additional information on our revolving credit facility, term loans, senior notes and financing obligations.

CAF auto loans receivable are primarily funded through our warehouse facilities and asset-backed term funding transactions.  These non-recourse funding vehicles are structured to legally isolate the auto loans receivable, and we would not expect to be able to access the assets of our non-recourse funding vehicles, even in insolvency, receivership or conservatorship proceedings.  Similarly, the investors in the non-recourse notes payable have no recourse to our assets beyond the related receivables, the amounts on deposit in reserve accounts and the restricted cash from collections on auto loans receivable.  We do, however, continue to have the rights associated with the interest we retain in these non-recourse funding vehicles.

As of February 28, 2022, $12.18 billion and $3.29 billion of non-recourse notes payable were outstanding related to asset-backed term funding transactions and our warehouse facilities, respectively.  During fiscal 2022, we funded a total of $7.32 billion in asset-backed term funding transactions. As of February 28, 2022, we had $1.76 billion of unused capacity in our warehouse facilities.

We have periodically increased our warehouse facility limit over time, as our store base, sales and CAF loan originations have grown. See Notes 1(F) and 13 for additional information on the warehouse facilities.

We generally repurchase the receivables funded through our warehouse facilities when we enter into an asset-backed term funding transaction. If our counterparties were to refuse to permit these repurchases it could impact our ability to execute on our funding program. Additionally, the agreements related to the warehouse facilities include various representations and warranties, covenants and performance triggers.  If these requirements are not met, we could be unable to continue to fund

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receivables through the warehouse facilities.  In addition, warehouse facility investors could charge us a higher rate of interest and could have us replaced as servicer.  Further, we could be required to deposit collections on the related receivables with the warehouse facility agents on a daily basis and deliver executed lockbox agreements to the warehouse facility agents.

The timing and amount of stock repurchases are determined based on stock price, market conditions, legal requirements and other factors.  Shares repurchased are deemed authorized but unissued shares of common stock.  As of February 28, 2022, a total of $2 billion of board authorizations for repurchases was outstanding, with no expiration date, of which $774.5 million remained available for repurchase. In April 2022, our board of directors increased our share repurchase authorization by $2 billion. See Note 14 for more information on share repurchase activity.

Fair Value Measurements.  We recognize money market securities, mutual fund investments, certain equity investments and derivative instruments at fair value.  See Note 7 for more information on fair value measurements.