Carmax Inc: Form 10-Q for the period ended Nov 30, 2024

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, the accompanying notes and the MD&A included in our Annual Report on Form 10-K for the fiscal year ended February 29, 2024 (“fiscal 2024”), as well as our unaudited interim consolidated financial statements and the accompanying notes included in Item 1 of this Form 10-Q. Note references are to the notes to unaudited interim consolidated financial statements included in Item 1. All references to net earnings per share are to diluted net earnings per share. Certain prior year amounts have been reclassified to conform to the current year’s presentation. Amounts and percentages may not total due to rounding.

OVERVIEW

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.

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”); advertising and subscription revenues; 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 November 30, 2024, we operated 248 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 42.8% of our retail used vehicle unit sales in the first nine months of fiscal 2025. As of November 30, 2024, CAF serviced approximately 1.1 million customer accounts in its $17.76 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.

Revenues and Profitability

The sources of revenue and gross profit from the CarMax Sales Operations segment for the first nine months of fiscal 2025 are as follows:

Net Sales and Operating Revenues Gross Profit

A high-level summary of our financial results for the third quarter and first nine months of fiscal 2025 as compared to the third quarter and first nine months of fiscal 2024 is as follows (1):

(Dollars in millions except per share or per unit data)

(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.

Net earnings per diluted share during the first nine months of the prior fiscal year 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.

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 our capital expenditures and the repurchase of common stock under our share repurchase program.

Our current capital allocation strategy is to focus on our core business. Given 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. During the first nine months of fiscal 2025, we accelerated 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 business for the next 12 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 fiscal 2024, 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 expect the impact of our omni-channel capabilities will continue to grow as consumers demand a more personalized car-buying experience. Some examples of our focus on refining the experience for customers and associates and supporting future growth across our diversified business include:

• We completed the nationwide rollout of our customer shopping accounts, which make it easier for customers to see the steps they have taken on their shopping journey, whether on their own or with help from an associate. These accounts also guide next steps and create operational efficiencies by empowering associates to seamlessly search and update customer records regardless of where they were originated.
• We are creating operational efficiencies and assisting customers with tools such as Skye, our AI virtual assistant, which have allowed customers to complete more remote steps year over year and improved conversion across all of our channels: online, in-store, and through our Customer Experience Centers (“CECs”).
• We continue to add helpful shopping information and tools to our website, including vehicle-specific battery health information on most EVs. We also highlight and allow customers to filter searches for cars that are eligible for the used EV tax credit.
• We enhanced our industry-leading online appraisal experience and are now able to give digital offers to approximately 99% of the customers who visit carmax.com for an appraisal.
• We began initial testing of our new Tier 3 origination model. We are now testing credit scoring models and the corresponding strategies across the full credit spectrum, which positions us to continue to grow CAF income over time.
• We are focusing on cost efficiencies by expanding our test of a new transportation management process that leverages data science algorithms and AI to provide new planning and execution capabilities. The process centrally dispatches moves and automates communication between drivers and stores.

In addition to these actions, we are focused on driving down our cost of sales by pursuing incremental efficiency opportunities that we have identified across our logistics network and reconditioning operations. We believe these initiatives focused on our logistics network and reconditioning operations will drive savings of approximately $200 per retail unit, approximately half of which have been realized to-date with the remainder to be realized in the upcoming quarters.

We purchased approximately 270,000 vehicles from consumers and dealers during the third quarter of fiscal 2025, up 7.9% from the prior year quarter. Of the approximately 237,000 vehicles purchased from consumers, more than half were purchased through our online instant appraisal experience. Approximately 33,000 vehicles were purchased through dealers, up 46.7% from the prior year quarter. We leverage the Edmunds sales team to open new markets and sign up new dealers for MaxOffer. Our MaxOffer active dealers have increased approximately 40% from the prior year quarter.

While SG&A as a percent of gross profit can fluctuate from quarter to quarter depending on variability in gross profit and the timing of SG&A spending, 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.

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 our Annual Report on Form 10-K for fiscal 2024, we disclosed the following long-term targets:

• We are maintaining our goal to sell more than 2 million combined retail and wholesale units annually; however, we extended 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 the current fiscal year.

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. 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 systems.
• Improving efficiency in our stores and CECs as well as 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.

As of November 30, 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 the first nine months of fiscal 2025, we opened three stores and our second stand-alone reconditioning center in Richland, Mississippi. During the remainder of the fiscal year, we plan to open two stores and one stand-alone auction facility. We are utilizing our stand-alone reconditioning and auction locations to balance capacity and drive efficiencies across the network.

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 the Annual Report on Form 10-K for the fiscal year ended February 29, 2024.

CRITICAL ACCOUNTING ESTIMATES

For information on critical accounting policies, see "Critical Accounting Estimates" in the MD&A included in Item 7 of the Annual Report on Form 10-K for the fiscal year ended February 29, 2024.

RESULTS OF OPERATIONS – CARMAX SALES OPERATIONS

NET SALES AND OPERATING REVENUES

(In millions)

(1) Excludes intercompany sales and operating revenues that have been eliminated in consolidation.

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.

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 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 the first nine months of fiscal 2025, we opened three stores in existing television markets (El Paso, TX; Gainesville, GA; and Alliance, TX).

Used Vehicle Sales. The 1.2% increase in used vehicle revenues in the third quarter of fiscal 2025 was driven by a 5.4% increase in used unit sales, partially offset by a 3.9% decrease in average retail selling price, or approximately $1,100. The increase in used units included a 4.3% increase in comparable store used unit sales, supported by conversion. For the first nine months of fiscal 2025, used vehicle revenues decreased 1.1%, driven by a 3.7% decrease in average selling price, or approximately $1,000, partially offset by a 2.2% increase in used unit sales. The increase in used units included a 1.3% increase in comparable store used unit sales. Online retail sales, as defined previously, accounted for 15% of used unit sales for both the third quarter and first nine months of fiscal 2025 compared with 14% for both the third quarter and first nine months of fiscal 2024. Comparable store used unit sales improved sequentially during the third quarter. Our December comparable store used unit sales have further improved from the third quarter and we anticipate our fourth quarter fiscal 2025 results will exceed those of the third quarter.

The decrease in average retail selling price in the third quarter of fiscal 2025 primarily reflected lower vehicle acquisition costs. The decrease in average retail selling price in the first nine months of fiscal 2025 reflected lower vehicle acquisition costs, partially offset by shifts in the mix of our sales by vehicle age and class.

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.

The 0.3% increase in wholesale vehicle revenues in the third quarter of fiscal 2025 was driven by a 6.3% increase in unit sales, partially offset by a 5.7% decrease in average selling price, or approximately $500. For the first nine months of fiscal 2025, wholesale vehicle revenues decreased 10.5%, driven by a decrease in average selling price of 9.8%, or approximately $900, and a 1.3% decrease in unit sales.

The decrease in average selling price during both the third quarter and first nine months of fiscal 2025 was primarily due to decreased acquisition costs and shifts in the mix of our sales by vehicle age.

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 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.

Other sales and revenues increased 9.7% and 9.1% in the third quarter and first nine months of fiscal 2025, respectively, reflecting increases in EPP revenues. EPP revenues increased 16.1% and 13.8% in the third quarter and first nine months of fiscal 2025, respectively, largely reflecting increased margins, partially offset by decreased penetration.

Seasonality. Historically, our business has been seasonal. Our stores typically experience their strongest traffic and sales in the spring and summer, with an increase in traffic and sales in February and March, coinciding with federal income tax refund season. Sales are typically slowest in the fall.

GROSS PROFIT

(In millions)

(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.

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 trends in the broader trade-in market 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 competitively priced inventory.

Used vehicle gross profit increased 6.8% in the third quarter of fiscal 2025, primarily driven by the 5.4% increase in total used unit sales. Used vehicle gross profit increased 2.5% in the first nine months of fiscal 2025, primarily driven by the 2.2% increase in total used unit sales. Used vehicle gross profit per unit was in line with the prior year period for both the third quarter and first nine months of fiscal 2025. 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.

Wholesale vehicle gross profit increased 12.3% in the third quarter of fiscal 2025, driven by a 6.3% increase in wholesale unit sales and a $54 increase in wholesale vehicle gross profit per unit. Wholesale vehicle gross profit increased 1.3% in the first nine months of fiscal 2025, driven by a $27 increase in wholesale vehicle gross profit per unit, partially offset by a 1.3% decrease in wholesale unit sales.

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. 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.

Other gross profit increased 24.6% and 18.7% in the third quarter and first nine months of fiscal 2025, respectively, primarily driven by increases in EPP revenues, as discussed above, as well as improvements in service department margins. The increase in service department profits for both the third quarter and first nine months of fiscal 2025 was driven by cost coverage measures that we have implemented, increased efficiencies and the increase in used unit sales. We expect to continue to see significant year-over-year favorability in service department profits in the fourth quarter of fiscal 2025 and for the full year, as governed by sales performance given the leverage/deleverage nature of service. We also expect EPP margin per unit to increase slightly year over year in the fourth quarter of fiscal 2025 but to a lesser degree than the increase in the first nine months of fiscal 2025.

SG&A Expenses

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

Three Months Ended November 30, 2024 Nine Months Ended November 30, 2024

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

(In millions except per unit data)

(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 10 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.

SG&A expenses increased $15.8 million, or 2.8%, in the third quarter of fiscal 2025. Factors contributing to the net increase include the following:

• $25.5 million increase in compensation and benefits, excluding share-based compensation expense, driven by an increase in the corporate bonus accrual, which was reduced in the prior year quarter.
• $9.5 million decrease in advertising expense driven by the timing of our spend.

Advertising expense on a per total unit basis for the third quarter of fiscal 2025 was lower than our previously disclosed annual target; however, we expect the per total unit spend in the fourth quarter will be higher than in the first nine months of fiscal 2025 and the prior year fourth quarter. We continue to expect the full-year advertising spend for fiscal 2025 to be consistent with fiscal 2024 at approximately $200 per total unit.

SG&A leveraged by 640 basis points during the third quarter of fiscal 2025, driven by the growth in gross profit and continued expense efficiency actions.

SG&A expenses increased $119.4 million, or 7.0%, in the first nine months of fiscal 2025. Factors contributing to the net increase include the following:

• $64.3 million increase in other overhead costs driven by the $67.2 million benefit in the prior year period in connection with the receipt of settlement proceeds in a class action lawsuit related to the economic loss associated with vehicles containing Takata airbags.
• $38.4 million increase in compensation and benefits, excluding share-based compensation expense, driven by an increase in the corporate bonus accrual, which was reduced in the prior year period.
• $15.0 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, as well as the retirement eligibility of certain senior executives.
• $14.6 million increase in occupancy costs driven by store maintenance spend and inflationary pressures on utilities.
• $12.9 million decrease in advertising expense driven by the timing of our spend.

Excluding the legal settlement in the prior year period, SG&A expenses in the first nine months of fiscal 2025 increased 2.9%, or $52.2 million.

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.

Interest expense decreased to $25.4 million and $83.8 million in the third quarter and first nine months of fiscal 2025, respectively, compared with $31.3 million and $93.3 million in the third quarter and first nine months of fiscal 2024, respectively. The decrease for both periods primarily reflected lower outstanding debt balances in the current fiscal year resulting from the payoff of the $300 million term loan in May 2024.

Other Expense (Income). Other expense was $5.4 million in the third quarter of fiscal 2025 compared with income of $0.9 million in the third quarter of fiscal 2024. Other expense was $2.5 million in the first nine months of fiscal 2025 compared with income of $4.7 million in the first nine months of fiscal 2024. The change for both periods was primarily driven by a one-time charge of approximately $5 million related to equipment and leasing arrangements in our logistics operations.

Income Taxes. The effective income tax rate was 24.6% in the third quarter of fiscal 2025 and 25.5% in the first nine months of fiscal 2025 versus 25.8% in the third quarter of fiscal 2024 and 25.5% in the first nine months of fiscal 2024. The decrease in the effective income tax rate for the third quarter of fiscal 2025 was primarily driven by the favorable impact of amended state tax returns.

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. The range was established to provide consistent performance for CAF’s previous prime asset-backed securitization program. As discussed below, CAF has expanded its securitization program to include higher prime and non-prime issuances, both of which are expected to perform differently from the historical range.

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. The targeted percentage of Tier 2 and Tier 3 originations has fluctuated over the past several years. CAF currently targets originating less than 5% of the total Tier 3 loan volume. Within the Tier 2 space, CAF continues to originate loans on a test basis and we slightly increased our investment in this space during the prior fiscal year. 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 has expanded its asset-backed securitization program to allow for distinct higher prime and non-prime issuances, with higher prime generally representing FICO scores greater than 650 and non-prime generally representing FICO scores below 650. We believe this strategy will enable CAF to efficiently fund incremental originations and support future CAF growth across the credit spectrum by creating additional funding capacity, driving additional finance income for the business over time. In June 2024, CAF closed on its first non-prime securitization deal. In July and November 2024, CAF closed on its first and second higher prime securitization deals under this expanded funding strategy.

During the second quarter of fiscal 2025, CAF began testing its new full-spectrum credit scoring models and corresponding strategies across both the Tier 1 and Tier 2 spaces. CAF began its testing of the new model in the Tier 3 space during the third quarter of fiscal 2025. We would expect each additional percentage point of CAF penetration to generate $10 million to $12 million in lifetime pre-tax income per year of origination, net of the impact to finance partner participation fees. Our pre-tax income expectations will be impacted by the volume of loans originated, interest rates charged to customers, loan terms, loss rates, average credit scores and the broader macroeconomic and lending environments. While this income is earned over time, the provision for lifetime losses is recognized at the time of origination. We believe our unique finance platform with a full-spectrum in-house lending operation, coupled with a robust network of partner lenders, will strengthen our competitive advantage.

We are continuously exploring opportunities to help our customers through adjustments in our account servicing strategies. One such example is with payment extensions, which have historically impacted less than 1% of our portfolio on an account basis in any given month and been below industry levels. We believe this tool has proven successful in helping customers navigate temporary challenges. During the third quarter of fiscal 2025, we began testing an enhancement to our policy that further empowers delinquent customers to take advantage of a payment extension and more aligns with industry levels. This testing has brought payment extensions to slightly above 1% of our portfolio on an account basis in a given month. While early performance results are encouraging and similar to those witnessed under the existing policy, we recognize that some customers will eventually return to delinquency and result in a charge-off. We believe our estimate of the allowance for loan losses appropriately incorporates the impact of our enhanced extension policy.

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.

SELECTED CAF FINANCIAL INFORMATION

(In millions)

(1) Annualized percentage 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

(In millions)

(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.

• CAF Income (Increases of $11.2 million, or 7.6%, and $1.4 million, or 0.3%, in the third quarter and first nine months of fiscal 2025, respectively)
• The increase in CAF income for both the third quarter and first nine months of fiscal 2025 reflects an increase in net interest margin percentage and an increase in average managed receivables, partially offset by an increase in the provision for loan losses.
• Total Interest Margin (Increased to 6.2% in both the third quarter and first nine months of fiscal 2025 from 5.9% and 6.0% in the third quarter and first nine months of fiscal 2024, respectively)
• The increase in total interest margin for both the third quarter and first nine months of fiscal 2025 was driven by higher customer rates, partially offset by higher funding costs. While total interest margin for the third quarter increased year-over-year, it was relatively consistent with the second quarter total interest margin of 6.1%.
• Provision for Loan Losses
• The provision for loan losses resulted in expense of $72.6 million and $266.4 million in the third quarter and first nine months of fiscal 2025, respectively, compared with expense of $68.3 million and $239.0 million in the third quarter and first nine months of fiscal 2024, respectively.
• The increase in the provision for loan losses for the first nine months of fiscal 2025 was primarily driven by unfavorable loss performance. We experienced higher losses for receivables originated in 2022 and 2023, when average selling prices were elevated and these customers were later challenged with the macro-inflationary environment. In addition, we experienced higher losses pertaining to a segment of customers generally concentrated at the lower end of Tier 1, which we addressed through further tightening in April 2024. While the loan loss reserve was adjusted for these receivables during the first quarter of fiscal 2025, further deterioration was observed during the second quarter, resulting in an additional adjustment to the reserve. In the third quarter, losses were relatively in line with our expectations.
• The allowance for loan losses as a percentage of ending managed receivables was 2.70% as of November 30, 2024, compared with 2.92% as of November 30, 2023 and 2.78% as of February 29, 2024. The allowance percentage decreased from February primarily due to the previously implemented tightened underwriting standards, partially offset by unfavorable loss performance in CAF’s portfolio of core receivables as well as expanded investment in Tier 2.
• Loan Performance
• The decline in net loan originations in both the third quarter and first nine months of fiscal 2025 resulted from decreases in the average amount financed and the net penetration rate, partially offset by an increase in used unit sales.
• CAF net penetration decreased in the third quarter and first nine months of fiscal 2025 compared to the prior year periods, primarily reflecting shifts in the mix of customers utilizing outside financing.
• The weighted average contract rate decreased to 11.2% from 11.3% in the third quarter of fiscal 2025 compared to the prior year quarter. The decrease was primarily due to a lower rates charged to customers, partially offset by the expansion of Tier 2 originations within CAF’s portfolio.
• The weighted average contract rate increased to 11.3% from 11.1% in the first nine months of fiscal 2025 compared with the prior year period. The increase was primarily due to our expansion of Tier 2 originations within CAF’s portfolio as well as higher rates charged to customers, partially offset by a reduction in Tier 3 originations.
• The year-over-year decrease in past due accounts as a percentage of ending managed receivables in the third quarter and first nine months of fiscal 2025 primarily reflects the impact of enhancements to our payment extension policy, as discussed above.

PLANNED FUTURE ACTIVITIES

During the first nine months of fiscal 2025, we opened three stores as well as one stand-alone reconditioning center. For the remainder of fiscal 2025, we anticipate opening two new store locations 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. 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.

FINANCIAL CONDITION

Liquidity and Capital Resources

Our primary ongoing cash requirements are to fund our existing operations, store and capacity expansion, store 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 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. During the first nine months of fiscal 2025, we accelerated 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 business for the next 12 months and thereafter for the foreseeable future.

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 the first nine months of fiscal 2025, net cash provided by operating activities totaled $478.1 million compared with $149.0 million in the prior year period.

As of November 30, 2024, total inventory was $3.67 billion, representing a decrease of $12.9 million compared with the balance as of the start of the fiscal year. The decrease was primarily due to a decrease in volume driven by our strategy to mitigate depreciation in the current market.

Our operating cash flows are significantly impacted by changes in auto loans receivable, which increased $667.5 million in the current year period compared with $979.1 million in the prior year period. 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 $229.3 million in the current year period compared with $669.3 million in the prior year period 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 increase in net cash provided by operating activities for the first nine months of the current fiscal year compared with the prior year period primarily reflected the change in auto loans receivable, as discussed above, and 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. This increase was partially offset by the change in inventory, as discussed above.

Investing Activities. During the first nine months of fiscal 2025, net cash used in investing activities totaled $347.9 million compared with $357.2 million in fiscal 2024. Capital expenditures were $340.3 million in the current year period versus $355.4 million in the prior year period. Capital expenditures primarily included land purchases and construction costs to support our growth capacity initiatives and new store openings. 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.

As of November 30, 2024, 165 of our 248 used car stores were located on owned sites and 83 were located on leased sites, including 27 land-only leases and 56 land and building leases.

Financing Activities. During the first nine months of fiscal 2025, net cash used in financing activities totaled $404.7 million compared with net cash provided by financing activities of $517.3 million in the prior year period. Included in these amounts were net issuances of non-recourse notes payable of $229.3 million compared with $669.3 million in the prior year period. Non-recourse notes payable are typically used to fund changes in auto loans receivable (see “Operating Activities”).

During the first nine months of fiscal 2025, cash used in financing activities was impacted by net payments on our long-term debt of $309.8 million as well as stock repurchases of $329.6 million. During the first nine months of fiscal 2024, cash provided by financing activities was impacted by net payments on our long-term debt of $108.4 million as well as stock repurchases of $44.3 million.

TOTAL DEBT AND CASH AND CASH EQUIVALENTS

(In thousands)

(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 9 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 loan 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 November 30, 2024, we were in compliance with these financial covenants.

See Note 9 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 November 30, 2024, $13.16 billion and $3.94 billion of non-recourse notes payable were outstanding related to asset-backed term funding transactions and our warehouse facilities, respectively. During the first nine months of fiscal 2025, we funded a total of $5.03 billion in asset-backed term funding transactions. As of November 30, 2024, we had $2.16 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 Note 9 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 November 30, 2024, a total of $4 billion of board authorizations for repurchases was outstanding, with no expiration date, of which $2.04 billion remained available for repurchase. See Note 10 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 6 for more information on fair value measurements.

FORWARD-LOOKING STATEMENTS

We caution readers that the statements contained in this report that are not statements of historical fact, including statements about our future business plans, operations, challenges, opportunities or prospects, including without limitation any statements or factors regarding expected operating capacity, sales, inventory, market share, financial targets, revenue, margins, expenses, liquidity, loan originations, capital expenditures, share repurchase plans, debt obligations or earnings, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by the use of words such as “anticipate,” “believe,” “could,” “enable,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “positioned,” “predict,” “should,” “target,” “will” and other similar expressions, whether in the negative or affirmative. Such forward-looking statements are based upon management’s current knowledge, expectations and assumptions and involve risks and uncertainties that could cause actual results to differ materially from anticipated results. We disclaim any intent or obligation to update these statements. Among the factors that could cause actual results and outcomes to differ materially from those contained in the forward-looking statements are the following:

• Changes in the competitive landscape and/or our failure to successfully adjust to such changes.
• Changes in general or regional U.S. economic conditions, including inflationary pressures, fluctuating interest rates and the potential impact of international events.
• Changes in the availability or cost of capital and working capital financing, including changes related to the asset-backed securitization market.
• Events that damage our reputation or harm the perception of the quality of our brand.
• Significant changes in prices of new and used vehicles.
• A reduction in the availability of or access to sources of inventory or a failure to expeditiously liquidate inventory.
• Our inability to realize the benefits associated with our omni-channel platform.
• Factors related to geographic and sales growth, including the inability to effectively manage our growth.
• Our inability to recruit, develop and retain associates and maintain positive associate relations.
• The loss of key associates from our store, regional or corporate management teams or a significant increase in labor costs.
• Changes in economic conditions or other factors that result in greater credit losses for CAF’s portfolio of auto loans receivable than anticipated.
• The failure or inability to realize the benefits associated with our strategic investments.
• Changes in consumer credit availability provided by our third-party finance providers.
• Changes in the availability of extended protection plan products from third-party providers.
• The performance of the third-party vendors we rely on for key components of our business.
• Adverse conditions affecting one or more automotive manufacturers, and manufacturer recalls.
• The inaccuracy of estimates and assumptions used in the preparation of our financial statements, or the effect of new accounting requirements or changes to U.S. generally accepted accounting principles.
• The failure or inability to adequately protect our intellectual property.
• The occurrence of severe weather events.
• The failure or inability to meet our environmental goals or satisfy related disclosure requirements.
• Factors related to the geographic concentration of our stores.
• Security breaches or other events that result in the misappropriation, loss or other unauthorized disclosure of confidential customer, associate or corporate information.
• The failure of or inability to sufficiently enhance key information systems.
• Factors related to the regulatory and legislative environment in which we operate.
• The effect of various litigation matters.
• The volatility in the market price for our common stock.

For more details on factors that could affect expectations, see Part II, Item 1A, “Risk Factors” on Page 44 of this report, our Annual Report on Form 10-K for the fiscal year ended February 29, 2024, and our quarterly or current reports as filed with or furnished to the U.S. Securities and Exchange Commission (“SEC”). Our filings are publicly available on our investor information home page at investors.carmax.com. Requests for information may also be made to our Investor Relations Department by email to investor_relations@carmax.com (mailto:relations@carmax.com) or by calling 1-804-747-0422, ext. 7865. We undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

There have been no material changes to our market risk since February 29, 2024. For information on our exposure to market risk, refer to Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” contained in our Annual Report on Form 10-K for the fiscal year ended February 29, 2024.

Disclosure. We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures are also designed to ensure that this information is accumulated and communicated to management, including the chief executive officer (“CEO”) and the chief financial officer (“CFO”), as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, with the participation of the CEO and CFO, we evaluated the effectiveness of our disclosure controls and procedures. Based upon that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period.

Internal Control over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended November 30, 2024, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In connection with information set forth in this Form 10-Q, the factors discussed under “Risk Factors” in our Form 10-K for fiscal year ended February 29, 2024, should be considered. These risks could materially and adversely affect our business, financial condition, and results of operations. There have been no material changes to the factors discussed in our Form 10‑K.