CARMAX INC (KMX) FY 2024 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 an integrated combination of both.

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 29, 2024, we operated 245 used car stores in 109 U.S. television markets.

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 42.9% of our retail used vehicle unit sales in fiscal 2024.  As of February 29, 2024, CAF serviced approximately 1.1 million customer accounts in its $17.39 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 2024 are as follows:

A high-level summary of our financial results for fiscal 2024 as compared to fiscal 2023 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, but not all, 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.

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Net earnings per diluted share during fiscal 2024 included a benefit of $0.32 in connection with the receipt of settlement proceeds in a class action lawsuit related to the economic loss associated with vehicles containing Takata airbags.

Refer to “Results of Operations” for further details on our revenues and profitability. A discussion regarding Results of Operations and Financial Condition for fiscal 2023 as compared to fiscal 2022 is included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended February 28, 2023, filed with the SEC on April 13, 2023.

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 has been used to fund the repurchase of common stock under our share repurchase program and our capital expenditures.

Our current capital allocation strategy is to focus on our core business. Given our recent performance and continued market uncertainties, we are taking a conservative approach to our capital structure in order to maintain the flexibility that allows us to efficiently access the capital markets for both CAF and CarMax as a whole. We have taken steps to better align our expenses to sales as well as slowed the rate of our store growth. We resumed our share repurchases during the third quarter of fiscal 2024 after a pause initiated during the third quarter of the prior fiscal year. For fiscal 2025, we intend to modestly accelerate the pace of our share repurchases above the pace that we implemented in the third quarter of fiscal 2024. 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 next twelve months and thereafter for the foreseeable future.

Strategic Update and Future Outlook

Our omni-channel experience provides 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, whether online, in-store or through an integrated combination of online and in-store experiences. While we expect our online and omni sales to grow over time, our goal is to provide the best experience whether in-store, online or a combination of the two. As a result, online, omni and in-person sales can vary from quarter to quarter depending on consumer preferences and how they choose to interact with us. We believe consumers in the used car industry will increasingly prefer to have the ability to shop and transact digitally. Approximately 70% of our customers leveraged some or all of our digital capabilities to complete their transactions during the current fiscal year, compared to approximately 40% when we completed our initial omni-channel roll-out at the end of fiscal 2020.

Our diversified business model, combined with our exceptional associates, national scale and unparalleled omni-channel experience, is a unique advantage in the used car industry that firmly positions us to drive profitable market share gains while creating shareholder value over the long-term. We continue to enhance our omni-channel capabilities, prioritize projects designed to optimize experiences for our associates and customers and drive operating efficiencies. Examples of the progress we made during fiscal 2024 include the following:

•Leveraged data science, automation, and artificial intelligence to make it even easier for retail customers to complete key transaction steps, such as vehicle transfers, on their own. We also enhanced digital checkout functionality for appraisal customers, enabling them to submit their documents remotely and unlocking their ability to participate in our 30-minute Express Drop Off experience, whether they receive their offer online or in-store.

•Expanded capabilities for Skye, our 24/7 virtual assistant, to include managing finance applications, vehicle transfers, appointment reservations and appraisal offers. Customer adoption of Skye has been strong, and this has not only created efficiencies but also widened bandwidth for our associates.

•Modernized our wholesale auction platform to offer new services, including single sign-on across all of our systems, artificial intelligence enhanced condition reports, early bidding capabilities and automated bills of sale. Additionally, we streamlined MaxOffer by rolling out our instant offer experience to all participating dealers.

•Added all of our lenders to our finance based shopping platform, expanding the options available to our customers.

•Launched several research and buy tools through Edmunds in support of their goal to be the leader in electric vehicles (“EV”) research.

We expect the impact of our omni-channel capabilities will continue to grow as consumers demand a more personalized car-buying experience. In fiscal 2025, we expect to continue to enhance our offerings in order to enable us to grow sales, profitable market share and buys while driving operational efficiencies. Examples of our initiatives for fiscal 2025 include the following:

•Launching an evolved hub within retail customers’ MyCarMax accounts that will make it even easier to seamlessly go back and forth between assisted help and self-progression. Customers will be able to see the steps they have taken on

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their shopping journey, whether on their own or with help from a CEC or store associate.

•Continuing to digitize work in order to build a leaner and higher value assistance model for our CECs and to support higher transaction volume. We plan to further integrate Skye into key communication channels and improve its ability to serve as the initial point of contact across many points in customers’ shopping journeys and seamlessly transition customers to a CEC associate via the customer’s channel of choice.

•Focusing on bringing even more wholesale vehicles into our ecosystem, leveraging our partnership with Edmunds to acquire vehicles from dealers.

•Optimizing our pre-qualification product by integrating our Instant Offer tool into the process. Additionally, we will remain opportunistic in CAF’s participation across the credit spectrum and pursue opportunities that enable us to provide outstanding offers for consumers while driving sales and economics for the business.

We purchased approximately 234,000 vehicles from consumers and dealers during the fourth quarter of fiscal 2024, down 10.8% from the prior year quarter. Approximately 21,000 vehicles were purchased through dealers, up 44.8% from the prior year quarter. We leverage the Edmunds sales team to open new markets and sign up new dealers for MaxOffer. We recently launched an appraisal tool for dealer websites that makes instant offers based on our algorithms, which are redeemable via MaxOffer. For fiscal 2024, our self-sufficiency rate remained above 70%. The success of our online instant appraisal offer continues to strengthen our leadership position as the largest used vehicle buyer from consumers.

Our SG&A expenses in fiscal 2024 decreased from the prior year, even when excluding the benefits of this year's legal settlement. We levered SG&A as a percentage of gross profit despite a 3.1% reduction in gross profit from the prior fiscal year. While SG&A as a percent of gross profit can fluctuate from quarter to quarter depending on variability in gross profit, our initial goal on the path to strengthening our SG&A to gross profit leverage over time is to achieve a rate in the mid-70% range on an annual basis. Achieving this annual rate will require continued efficiency gains in our operating model, gross profit growth and healthier consumer demand. In fiscal 2025, we expect to require low-single-digit gross profit growth to lever SG&A.

Other steps we have taken to support our business for both the short- and long-term include focusing on production efficiencies to align saleable inventory to sales, growing CAF’s penetration while raising CAF's consumer rates and tightening CAF's underwriting standards, and slowing our planned store growth to provide more capital flexibility. We resumed our share repurchases during the third quarter of fiscal 2024 after a pause initiated during the third quarter of the prior fiscal year.

We expect our diversified model, the scale of our operations, our investments and omni-channel strategy to provide a solid foundation for further growth. We have adjusted our long-term targets, which were disclosed in our Annual Report on Form 10-K for fiscal 2022, as follows:

•We are maintaining our goal to sell more than 2 million combined retail and wholesale units annually; however, we are extending the timeframe to between fiscal 2026 and fiscal 2030 due to uncertainty in the timing of market recovery and as we continue to focus on profitable market share growth. We intend to update the timeframe to achieve this goal when we have greater visibility into the industry’s pace of recovery.

•Given higher average selling prices, we expect to achieve the $33 billion in annual revenue target sooner than units.

•Similarly, we also expect to achieve more than 5% nationwide market share of age 0- to 10-year old used vehicles sooner than units, but given the recent volatility in vehicle values, we will provide an updated timeframe for our expected achievement at the end of fiscal 2025.

The achievement of these targets is dependent on macroeconomic factors that could result in ongoing volatility in consumer demand.

In calendar 2023, we estimate we sold approximately 3.7% of the age 0- to 10-year old vehicles sold on a nationwide basis, a decrease from 4.0% in calendar 2022. Market share performance in calendar 2023 was negatively impacted by sharp vehicle depreciation in the used car industry and our focus on profitable market share. Based on external data, we gained market share from December 2023 to January 2024, the latest period for which title data is available. 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.

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

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

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

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systems.

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

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

•Becoming the leading retailer of used EVs in the market. In support of this goal, Edmunds has launched several research and buying tools, which include providing data on the health and range of EV batteries as well as an evaluation of potential federal and state tax credits and incentives. This will support our business and help CarMax be part of the solution to reduce emissions.

As of February 29, 2024, we had used car stores located in 109 U.S. television markets, which covered approximately 85% 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 2024, we opened five stores and our first stand-alone reconditioning center in the Atlanta metro market. During fiscal 2025, we anticipate opening five stores, one stand-alone reconditioning center and one stand-alone auction facility.

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 policy discussed below is the one we consider critical to an understanding of our consolidated financial statements because its 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 method (“method”), 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 method 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 method 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 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

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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 $48.3 million as of February 29, 2024.

See Notes 1(H) and 4 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 19 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 less than 2% 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 2024, we opened 5 stores in existing television markets (Winchester, VA; Algonquin, IL; Victorville, CA; Green Brook, NJ; and Smithtown, NY).

Used Vehicle Sales

Fiscal 2024 Versus Fiscal 2023.  The 9.2% decrease in used vehicle revenues in fiscal 2024 was primarily driven by a 5.2% decrease in used unit sales and a 4.3% decrease in average retail selling price, or approximately $1,200. The decrease in used units included a 6.7% decrease in comparable store used unit sales. Online retail sales, as defined previously, accounted for 14% of used unit sales in fiscal 2024, compared with 12% in fiscal 2023.

During fiscal 2024, we believe persistent vehicle affordability challenges continued to impact our used unit sales performance, as headwinds remained due to widespread inflationary pressures, higher interest rates, tightened lending standards and prolonged low consumer confidence. While comparable store used unit sales declined 6.7% compared to the prior year, each quarter of the current fiscal year had year‐over‐year sequential improvement. For the first quarter of fiscal 2025, through mid-April, comparable store used unit sales experienced a mid single-digit decline.

The decrease in average retail selling price in fiscal 2024 reflected lower vehicle acquisition costs as well as shifts in the mix of our sales by vehicle age.

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.

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Fiscal 2024 Versus Fiscal 2023.  The 16.9% decrease in wholesale vehicle revenues in fiscal 2024 was primarily due to an 11.8% decrease in average selling price, or approximately $1,200, and a 6.6% decrease in unit sales.

The decrease in average selling price in fiscal 2024 was primarily due to shifts in the mix of our sales by vehicle age as well as decreased acquisition costs resulting from steep market depreciation.

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 (fees)/income, advertising and subscription revenues earned by our Edmunds business, and other revenues, which are predominantly comprised of service department 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 2024 Versus Fiscal 2023.  Other sales and revenues decreased 3.5% in fiscal 2024, reflecting a decline in EPP revenue and an unfavorable change in net third-party finance (fees)/income. EPP revenues decreased 4.9%, largely reflecting the decline in our retail unit sales, a decrease in profit sharing revenue recognized in the current year and decreased penetration, partially offset by increased margins and a favorable year-over-year return reserve adjustment. The change in net third-party finance (fees)/income was the result of lower Tier 2 volume, for which we generally receive a fee.

During the the fourth quarter of fiscal 2024, we raised MaxCare margins per contract sold, resulting in a slight decrease in EPP penetration while driving overall profitability. Our expectation is that this action will drive approximately $20 per retail unit of incremental EPP margin in fiscal 2025.

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 and dealers through our appraisal process.  Vehicles purchased directly from consumers and dealers 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. In any given period, our gross profit may also be impacted by the age mix of vehicles sold, as older vehicles are generally more profitable. 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 2024 Versus Fiscal 2023.  Used vehicle gross profit decreased 5.2% in fiscal 2024, driven by the 5.2% decrease in total used unit sales. Used vehicle gross profit per unit in fiscal 2024 was consistent with the prior fiscal year. We continue to focus on striking the right balance between covering cost increases, maintaining margin and passing along efficiencies to consumers to support vehicle affordability.

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 2024 Versus Fiscal 2023.  Wholesale vehicle gross profit decreased 5.6% in fiscal 2024, driven by the 6.6% decrease in wholesale unit sales. Wholesale vehicle gross profit per unit in fiscal 2024 was in line with the prior fiscal year.

Other Gross Profit

Other gross profit includes profits related to EPP revenues, net third-party finance (fees)/income, 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.  We have no cost of sales related to EPP revenues or net third-party finance (fees)/income, 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 2024 Versus Fiscal 2023.  Other gross profit increased 11.7% in fiscal 2024, primarily driven by a $75.3 million improvement in service department margins, partially offset by a decrease in EPP revenues and an unfavorable change in net third-party finance (fees)/income, as discussed above. The increase in service department profits was driven by efficiency and cost coverage measures that we have put in place. We expect to continue to see significant year-over-year favorability in service department profits in fiscal 2025. The extent of the improvement will be governed by sales performance given the leverage/deleverage nature of service.

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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)

(1)Amounts are net of intercompany eliminations.

(2)Excludes compensation and benefits related to reconditioning and vehicle repair service, which are included in cost of sales. See Note 13 for details of share-based compensation expense by grant type.

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

Fiscal 2024 Versus Fiscal 2023 (Decrease of $201.0 million or 8.1%). Factors contributing to the net decrease include the following:

•$155.9 million decrease in other overhead costs, which included a $67.2 million benefit in connection with the receipt of settlement proceeds in a class action lawsuit related to the economic loss associated with vehicles containing Takata airbags. Other overhead costs were also positively impacted by improvements in non-CAF uncollectable receivables that reflect improved execution at our stores and home office as well as external partners, a reduction in technology spend and favorability in staffing-related costs.

•$55.6 million decrease in compensation and benefits, excluding share-based compensation expense, driven by our continued focus in our stores and CECs on driving efficiency gains and aligning staffing levels to sales.

•$24.1 million decrease in advertising expense driven by our deliberate efforts to reduce marketing spend to align with sales. Advertising expense on a per retail unit basis was relatively consistent with the prior year. For fiscal 2025, we expect the full year spend on a per total unit basis to be consistent with fiscal 2024 at approximately $200.

•$30.5 million increase in stock-based compensation expense, primarily related to cash-settled restricted stock units, as the expense associated with these units was primarily driven by the change in the company's stock price during the relevant periods.

We anticipate that SG&A will be pressured in the first quarter of fiscal 2025 due to the receipt of $59 million in settlement proceeds during the first quarter of fiscal 2024 as well as the impact of stock-based compensation for certain retirement-eligible executives and the lapping of favorable reserve adjustments related to non-CAF uncollectable receivables, which amounts to approximately $25 million combined.

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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 2024 Versus Fiscal 2023.  Interest expense of $124.8 million in fiscal 2024 was relatively consistent compared with $120.4 million in fiscal 2023.

Other Income

Other income of $10.3 million in fiscal 2024 was relatively consistent compared with $9.4 million in fiscal 2023.

Income Taxes

The effective income tax rate was 25.3% in fiscal 2024 compared with 23.9% in fiscal 2023. The increase in the effective income tax rate was primarily driven by an increase in our state effective tax rate and a decrease in tax credits.

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 as well as changes in the mix of credit quality originated.

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 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 2 and Tier 3 finance providers, in order to better understand the performance of these loans, mitigate risk and add incremental profits. Historically, CAF has targeted originating approximately 5% of the total Tier 3 loan volume, which we increased to 10% during fiscal 2022 and throughout most of fiscal 2023. In response to the current environment, CAF adjusted its underwriting standards, including, towards the end of the fourth quarter of fiscal 2023, reducing its targeted percentage of Tier 3 volume from 10% to 5%. During the second quarter of fiscal 2024, CAF further adjusted its targeted percentage of Tier 3 volume to less than 5%. Within the Tier 2 space, CAF continues to originate loans on a test basis and we slightly increased our investment in this space starting in the second quarter of fiscal 2024. Any future adjustments in Tier 2 and Tier 3 will consider the broader lending environment, which includes funding availability, 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 3 for additional information on CAF income and Note 4 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 4.  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 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 2024 Versus Fiscal 2023.

•CAF income decreased $95.1 million, or 14.3%, reflecting a decrease in the net interest margin percentage, partially offset by an increase in average managed receivables and a decrease in the provision for loan losses.

•Total interest margin decreased as a percentage of average managed receivables to 6.0% in fiscal 2024 compared with 6.9% in fiscal 2023. The decrease was primarily driven by higher funding costs as well as an unfavorable impact of swaps not designated as hedges for accounting purposes, partially offset by higher customer rates. While total interest margin decreased year‐over‐year, it was relatively consistent each quarter throughout fiscal 2024.

•Provision for Loan Losses

◦The current year provision of $310.5 million decreased slightly from the prior year provision of $317.0 million.

◦The allowance for loan losses as a percentage of ending managed receivables was 2.78% as of February 29, 2024 compared with 3.02% as of February 28, 2023. The decrease in the allowance percentage from the prior year primarily reflects CAF's tightened underwriting standards in response to the current environment, partially offset by CAF's continued investment in the Tier 2 business as well as unfavorable loss performance.

•Loan Performance

◦The decline in net loan originations in fiscal 2024 resulted from decreases in used unit sales and the average amount financed, partially offset by an increase in the net penetration rate.

◦CAF net penetration for fiscal 2024 increased compared to the prior fiscal year, primarily reflecting changes in the underlying credit mix of customers applying for financing.

◦The weighted average contract rate increased to 11.2% in fiscal 2024, compared with 9.7% in the prior year. The increase was primarily due to higher rates charged to customers in response to the current interest rate environment.

◦The increase in past due accounts as a percentage of ending managed receivables for fiscal 2024 reflects an increase in delinquencies as well as our expansion of Tier 2 originations within CAF's portfolio. The increase in delinquencies primarily reflects customer hardship in the current economic environment.

PLANNED FUTURE ACTIVITIES

We anticipate opening a total of seven locations in fiscal 2025, including five stores, one stand-alone reconditioning center and one stand-alone auction facility. We currently estimate capital expenditures will total between $500 million and $550 million in fiscal 2025. Capital expenditures were $465.3 million in fiscal 2024. The year-over-year increase in planned spending is primarily related to the timing of spend for new stores. Planned capital spending in fiscal 2025 largely consists of spending to support our future long-term growth in stand-alone reconditioning and auction facilities, as well as our new stores.

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. Given our recent performance and continued market uncertainties, we are taking a conservative approach to our capital structure in order to maintain the flexibility that allows us to efficiently access the capital markets for both CAF and CarMax as a whole. We have taken steps to better align our expenses to sales as well as slowed the rate of our store growth. We resumed our share repurchases during the third quarter of fiscal 2024 after a pause initiated during the third quarter of the prior fiscal year. For fiscal 2025, we intend to modestly accelerate the pace of our share repurchases above the pace that we implemented in the third quarter of fiscal 2024. 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 next twelve months and thereafter for the foreseeable future.

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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 12 and 16 for amounts outstanding as of February 29, 2024 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 10 for information related to income taxes. Our contractual obligations related to defined benefit retirement plans represent the funded status recognized as of February 29, 2024. See Note 11 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 29, 2024, our purchase obligations and commitments were approximately $428.2 million, of which $213.3 million are due in fiscal 2025. The majority of the remaining purchase obligations and commitments are due within the next three years.

We have historically managed leverage based on a number of factors, including internal financial forecasts, consideration of CAF’s operational and capital needs, external peer benchmarking, requirements of our debt agreements and macroeconomic conditions. Generally, we expect to use our revolving credit facility and other financing sources, together with stock repurchases, to maintain a leverage profile that ensures operating flexibility while supporting continued investment in the business.

Operating Activities.  During fiscal 2024, net cash provided by operating activities totaled $458.6 million compared with $1.28 billion in fiscal 2023.

As of February 29, 2024, total inventory was $3.68 billion, representing a decrease of $48.1 million, or 1.3%, compared with the balance as of the start of the fiscal year. The decrease was primarily due to a decline in the average carrying cost of inventory driven by the net impacts of depreciation during the current fiscal year and shifts in the mix of vehicle units from non-saleable to saleable due to operational efficiencies.

Our operating cash flows are significantly impacted by changes in auto loans receivable, which increased $980.6 million in fiscal 2024 compared with $1.37 billion in fiscal 2023.  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 $506.9 million in fiscal 2024 compared with $893.3 million in fiscal 2023 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.

The change in net cash provided by operating activities for fiscal 2024 compared with fiscal 2023 reflected the decrease in inventory, as discussed above, combined with the prior year decrease in inventory, partially offset by the changes in auto loans receivable, as well as the net impact of volume and timing-related changes in accounts receivable and accounts payable.

Investing Activities.  Net cash used in investing activities totaled $467.0 million in fiscal 2024 compared with $425.8 million in fiscal 2023.  Capital expenditures were $465.3 million in fiscal 2024 versus $422.7 million in fiscal 2023. Capital expenditures primarily included land purchases and construction costs to support our growth capacity initiatives and new store openings as well as investments in technology.  We maintain a multi-year pipeline of sites to support our store and capacity growth, so portions of capital spending in one year may relate to locations that we open in subsequent fiscal years.

Financing Activities.  Net cash provided by financing activities was $307.8 million in fiscal 2024, compared with net cash used in financing activities of $710.2 million in fiscal 2023.  Included in these amounts were net issuances of non-recourse notes payable of $506.9 million in fiscal 2024 compared with $893.3 million in the prior year. Non-recourse notes payable are typically used to fund changes in auto loans receivable (see “Operating Activities”).

During fiscal 2024, cash provided by financing activities was impacted by stock repurchases of $94.1 million as well as net payments on our long-term debt of $111.5 million. During fiscal 2023, cash used in financing activities was impacted by stock repurchases of $333.9 million as well as net payments on our long-term debt of $1.25 billion.

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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 SOFR, the federal funds rate, or the prime rate, depending on the type of borrowing.

(3)Total debt excludes unamortized debt issuance costs. See Note 12 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 29, 2024, we were in compliance with these financial covenants.

See Note 12 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 29, 2024, $13.13 billion and $3.74 billion of non-recourse notes payable were outstanding related to asset-backed term funding transactions and our warehouse facilities, respectively.  During fiscal 2024, we funded a total of $6.63 billion in asset-backed term funding transactions. As of February 29, 2024, we had $2.06 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 12 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, as well as covenants and performance triggers related to events of default.  If these requirements are not met, we could be unable to continue to fund 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 29, 2024, a total of $4 billion of board authorizations for repurchases was outstanding, with no expiration date, of which $2.36 billion remained available for repurchase. During the third quarter of fiscal 2024, we resumed our share repurchases after a pause initiated during the third quarter of the prior fiscal year. See Note 13 for more information on share repurchase activity.

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Fair Value Measurements.  We recognize money market securities, mutual fund investments, certain equity investments and derivative instruments at fair value.  See Note 6 for more information on fair value measurements.