Earnings Call Transcript - KMX Q3 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Third Quarter Fiscal year 2023 CarMax Earnings Release Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, David Lowenstein, AVP Investor Relations. Please go ahead.

David Lowenstein, AVP Investor Relations

Thank you, Ashley. Good morning, everyone. Thank you for joining our fiscal 2023 third quarter earnings conference call. I'm here today with Bill Nash, our President and CEO; Enrique Mayor-Mora, our Executive Vice President and CFO; and Jon Daniels, our Senior Vice President, CarMax Auto Finance Operations. Let me remind you, our statements today that are not statements of historical fact, including statements regarding the company's future business plans, prospects and financial performance are forward-looking statements we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on our current knowledge, expectations, and assumptions, and are subject to substantial risks and uncertainties that could cause the actual results to differ materially from our expectations. In providing projections and other forward-looking statements, we disclaim any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our Form 8-K, filed with the SEC, this morning, and our annual report on Form 10-K for the fiscal year ended February 28, 2022, previously filed with the SEC. Should you have any follow-up questions after the call, please feel free to contact our Investor Relations department at 804-747-0422 extension 7865. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow-ups. Bill?

Bill Nash, President and CEO

Great, thank you, David. Good morning, everyone, and thanks for joining us. Our third quarter results reflect the continuation of widespread pressures across the used car industry. Vehicle affordability remains challenging due to macro factors stemming from broad inflation, climbing interest rates, and continued low consumer confidence. In addition, persistent and steep depreciation impacted wholesale values throughout the quarter. In response, we have been taking deliberate steps to support our business for both the short-term and for the long run. We are leveraging our strongest assets, our associates, our experience and our culture to manage through this cycle. Actions that we took during the quarter include further reducing SG&A, selling a higher mix of older lower-priced vehicles, slowing buys in light of the steep market depreciation, maintaining used saleable inventory units while driving down total inventory dollars more than 25% year-over-year, raising caps consumer rates to help offset rising cost of funds, pausing share buyback to give us capital flexibility and slowing our planned store growth for next fiscal year to five locations while maintaining our ability to open more locations if market conditions change. In the near-term, we are prioritizing initiatives that unlock operational efficiencies and create better experiences for our associates and our customers. While we continue to selectively invest in initiatives that have the potential to activate new capabilities, we have slowed the pace of those investments. We believe these steps will enable us to come out of this cycle leaner and more effective while positioning us for future growth. We will provide more details on these actions later during today's call. And now on to our results. For the third quarter of FY ‘23, our diversified business model delivered total sales of $6.5 billion, down 24% compared with last year's third quarter, driven by lower retail and wholesale volume. In our retail business, total unit sales in the third quarter declined 20.8% and used unit comps were down 22.4% versus the third quarter last year, when we achieved a 15.8% used unit comp. In addition to the macro factors that I mentioned previously, we believe our performance was impacted by transitory competitive responses to the current environment. External title data indicates that we gained market share on a year-to-date basis through October, though we've seen some recent loss of share. As we have said before, we are focused on profitable market share gains that can be sustained for the long-term. Through expansive price elasticity testing, we determined that holding margins during the quarter was the right profitability play. Third quarter retail gross profit per used unit was $2,237, which is consistent with last year's third quarter. Also, unit sales were down 36.7% versus the third quarter last year, driven by rapidly changing market conditions, which included about $2,000 of depreciation. This is incremental to approximately $2,500 of depreciation experienced during the second quarter. Wholesale performance was also impacted as we continued to reallocate some older vehicles from wholesale to retail to meet consumer demand for lower-priced vehicles. Also, gross profit per unit was $966, down from a third quarter record of $1,131 a year ago. Recall, last year prices appreciated approximately $2,500 during the quarter, which was a margin tailwind. Just as we were doing in retail, we will continue to focus on maximizing total wholesale margin profitability. We bought approximately 238,000 vehicles from consumers and dealers during the third quarter, down 40% versus last year's period. Our volume was impacted by steep depreciation and our deliberate decision to slow buys in reaction to the depreciation. We purchased approximately 224,000 cars from consumers in the quarter with about half of those buys coming through our online instant appraisal experience. We also sourced about 14,000 vehicles through Max offer, our digital appraisal product for dealers, up 16% from last year's third quarter. Our self-sufficiency remained above 70% during the quarter. In regard to our third quarter online metrics, approximately 12% of retail unit sales were online, up from 9% in the prior year's quarter. Approximately 52% of retail unit sales were Omni sales this quarter, down from 57% in the prior year's quarter. Our wholesale auctions remained virtual, so 100% wholesale sales, which represent 18% of total revenue, are considered online transactions. Total revenue resulting from online transactions was approximately 28%, down from 30% during last year's third quarter. CarMax Auto Finance delivered income of $152 million, down from $166 million during the same period last year. John will provide more detail on consumer financing, the loan loss provision, and cash contribution in a few moments. At this point, I'd like to turn the call over to Enrique, who will provide more information on our third quarter financial performance and the steps we've taken to further align our business to the current sales environment. Enrique?

Enrique Mayor-Mora, Executive Vice President and CFO

Thanks, Bill. Good morning, everyone. Third quarter net earnings per diluted share was $0.24, down from $1.63 a year ago. Total gross profit was $577 million, down 31% from last year's third quarter. Used retail margin of $403 million and wholesale vehicle margin of $115 million declined 21% and 46%, respectively. The year-over-year decreases were driven by lower volume across used and wholesale and lower wholesale margin per unit. As Bill noted, we continue to face depreciation and have been adjusting accordingly to better position ourselves to manage through the current environment. Other gross profit was $59 million, down 49% from last year's third quarter. This decrease was driven primarily by the effect of lower retail unit sales on service and EPP. Service results declined $37 million as lower sales and secondarily, our decision to maintain technician staffing levels drove some deleveraging. Technicians are among the most in-demand associates in the industry, and their retention will position us strongly to quickly grow inventory when we exit the current cycle. EPP fell by 14% or $15 million, reflecting the decline in sales that was partially offset by stronger margins and a favorable year-over-year return reserve adjustment. Penetration was stable at approximately 60%. Third-party finance fees were relatively flat over last year's third quarter with lower volume and fee generating Tier-2 offset by lower Tier-3 volumes for which we pay a fee. On the SG&A front, expenses for the third quarter were $592 million, up 3% from the prior year's quarter, reflecting a slowdown from the year-over-year increases of 19% during the first quarter and 16% during the second quarter of this year. In the prior year's third quarter, we received a $23 million settlement from a class action lawsuit. Adjusting for that settlement, SG&A actually would have declined 1% year-over-year this quarter. SG&A as a percent of gross profit was materially pressured as compared to the third quarter last year, due primarily to the 31% decrease in total gross margin dollars compared to last year's quarter. The change in SG&A dollars over last year was mainly due to the following factors. First, a $41 million increase in other overhead primarily driven by cycling over last year's legal settlement. We also continue to invest, although at a reduced pace in our technology platforms and strategic and growth initiatives. Second, an $18 million reduction in compensation and benefits, including a $16 million decrease in share-based compensation, and third, a $17 million reduction in advertising. During the quarter, we continue to take steps to better align our expenses to our sales. This included further reducing staffing through attrition in our stores and CECs, limiting hiring and contractor utilization in our corporate offices, and continuing to align our marketing spend to sales. While our advertising expense was lower year-over-year, our investment on a per unit basis remains consistent with last year's third quarter. We remain focused on reducing expenses and anticipate continued progress in the fourth quarter. Regarding capital structure, our first priority is to fund the business. Given third quarter performance and continued market uncertainties, we are taking a conservative approach to our capital structure. While our adjusted debt-to-capital ratio was below 35% to 45% targeted range. We are managing our net leverage to maintain the flexibility that allows us to efficiently access the capital markets for both CAF and CarMax as a whole. In keeping with this goal of maintaining flexibility, we took the following steps this quarter in addition to the SG&A actions I spoke to. First, we paused our share buybacks. Our $2.45 billion authorization remains in place, as does our commitment to return capital back to shareholders over time. Second, we slowed the velocity of our CapEx spend, we expect CapEx will end the fiscal year at approximately $450 million versus our previous $500 million estimate. As Bill mentioned, we have also conservatively planned store growth of five new locations in fiscal year 2024. Our liquidity remains very strong. We ended the quarter with over $680 million in cash on the balance sheet and no draw on our $2 billion revolver. Now I'd like to turn the call over to Jon.

Jon Daniels, Senior Vice President, CarMax Auto Finance Operations

Thanks, Enrique, and good morning, everyone. In the third quarter, the strength and stability of our credit platform provided approvals to over 95% of the consumers who applied for credit during their shopping journey. CarMax Auto Finance originated $2.1 billion within the quarter, resulting in a penetration of 44.4% net three-day payoffs up from 42.2% realized in the same quarter last year and 41.2% in Q2. The weighted average contract rate charged to new customers was 9.8%, which was higher than the 8.3% in last year's third quarter and a 9.4% seen in Q2. We continue to leverage our scalable testing environments and nimble underwriting infrastructure to strategically pass along a portion of the increased funding costs to consumers while still increasing share of the finance contracts. Tier-2 penetration in the quarter was 20.5% in line with historical levels, but down from last year's 22.2%. Tier-3 financed 6.1% of used unit sales compared to 6.5% a year ago. Our lenders continued to make their own independent lending decisions in this challenging environment, and we remain pleased with the competitive offers they are collectively able to provide to our customers. CAF income for the quarter was $152 million, a decrease of 8.3% or $14 million from the same period last year. Our loan loss provision was $86 million, resulting in an ending reserve balance of $491 million. This is compared to a provision of $76 million in last year's Q3. The current quarter's reserve of $491 million is 2.95% of managed receivables up slightly from 2.92% at the end of this year second quarter. This sequential three-basis-point adjustment in reserves to receivables ratio, comes primarily from the continued addition of Tier-2 and Tier-3 receivables to the overall portfolio as seen in previous quarters. All in all, we were pleased with the credit performance within our portfolio during the quarter, we believe we are appropriately reserved for future losses. Further, we continue to be in a strong position to leverage our unique credit platforms to operate our Tier-1 business within our targeted loss range up 2% to 2.5%. Within the quarter, total interest margin dollars were flat to last year at $277 million modestly supported by a $5 million benefit from our hedging strategy. The corresponding margin to receivables rate 6.7% was down 54 basis points year-over-year as receivables with historically low funding costs are offset by the receivables impacted by the more recent Fed moves. Regarding advancements in our broader credit technology, during the third quarter, we successfully completed the nationwide rollout of finance-based shopping, our multilinear pre-qualification product, and we continue to see a high level of engagement with this experience. As a reminder, this gives customers the ability to digitally receive quick credit decisions across our entire inventory via our simple online application with no impact to credit scores. This also allows consumers to quickly and easily secure financing at any point in their shopping journey. Like the rest of the business, CAF is also focused on driving efficiencies. We are already seeing benefits from the modern, more nimble receivable servicing system that we launched a year ago. Consumer finance is a highly regulated and everchanging space. And our new system allows us to adapt more easily to these necessary changes. A recent example is California's upcoming regulatory change that requires added disclosure and refund requirements related to the cancellation of the GAP waiver product. With our old system, the implementation would have been lengthy and onerous, and we likely would have temporarily suspended the product in the state while we made the changes. However, with our new, more agile technology, we are able to incorporate these requirements without interrupting. This is just one example of our early wins resulting from our new system, and we have a clear line of sight to many more in the near and mid-term. Now I'll turn the call back over to Bill.

Bill Nash, President and CEO

Thank you, Jon, and thank you, Enrique. As I mentioned at the start of today's call, we're taking steps to support our business by prioritizing projects that unlock operating efficiencies and create better experiences for our associates and customers. It starts with making our omni-channel experience faster, simpler and more seamless. Some examples include, we're enhancing online features to help customers feel more confident in completing key transaction steps on their own and make it easier to go back and forth between assisted help and self-progression. We're also making it simple for consumers to opt into express pickup through self-progression. This delivery option offers customers the ability to complete their transaction at one of our stores in as little as 30 minutes and represents a win-win opportunity. Our research shows that customers love this experience when utilized and it will enable us to lower our costs over time. Our final example is that we are working to seamlessly integrate our finance-based shopping product into our stores and customer experience centers so that all consumers can enjoy this experience, not just those who shop online. At the same time, we are adding additional lenders to the platform to expand the breadth and depth of offers available to our customers. As we evolve our omni-channel experience, we are also updating our operating models to drive efficiency gains in our stores. For example, in our business offices, we have launched self-check-in capabilities for appraisal customers and have also enhanced e-sign functionality to better enable self-progression. Additionally, we are testing an improved digital customer queue to better manage appointments, as well as new software to improve title speed and visibility. We anticipate these tools will enable us to reduce associate time spent per customer and shorten customer transaction times. Our associates are key to providing an exceptional customer experience and we are focused on leveraging their skills in the most value-added manner. We will also continue to selectively invest in key projects that have the potential to deliver new capabilities while lowering our costs. Examples include first, we're updating Max offer our appraisal product for dealers, which is available in approximately 50 markets. Many of our dealers are still on the initial version, which does not provide instant offers and requires them to take and send us vehicle pictures. We are rolling out a new product which offers a fully digital instant offer experience to all dealers. We believe this will well position us to grow our dealer buys more efficiently and support higher volume over time. Second, we are leveraging technology to enhance our logistics capability. We move approximately 2 million vehicles each year. We estimate that our internal logistics operation drives about a 20% cost advantage over third-party providers and improves our speed, predictability and control of moves. Enhancements to our transportation management system will enable us to consolidate loads, increase our mix of full loads and reduce the truck volume in and out of our stores. This will support our ability to keep our costs low as we complete moves even faster and more efficiently. Third, we're continuing to upgrade our auction experience. During the third quarter, we scaled our modernized vehicle detail page to 50% of dealers. This page is mobile-friendly, provides more relevant data to our dealers, and improved search and filter functionality. It is also the springboard that we will use to launch capabilities we believe will further enhance our wholesale business, including AI enhanced condition reports and proxy bidding. We are confident that our focus initiatives will drive efficiencies and grow our business over the long-term. In closing, we have spent almost 30 years building a diversified business that can profitably navigate the ups and downs of the used car industry. We have a strong balance sheet and access to capital. Our experience in inventory and margin management is a strength and we will continue to be thoughtful and manage our expenses pulling levers as necessary. While we're not able to predict how long the industry will remain challenged, we believe the pressures are transitory and that we are well positioned to manage through them and emerge an even stronger company. I want to thank our associates for everything that they're doing to support each other, our customers, and our business. Our foundation remains strong, and we're excited about the future of our diversified business model. With that, we'll be happy to take your questions. Ashley?

Operator, Operator

And your first question comes from the line of Brian Nagel with Oppenheimer. Your line is open.

Brian Nagel, Analyst

I have a question regarding sales trends over the quarters. Bill, could you provide more details on how the business is performing in this area? You mentioned earlier that there were market share declines towards the end of the period, which seems to be due to competitors taking more aggressive pricing actions. Can you elaborate on which competitors are doing this and how long you expect this trend to continue? Additionally, considering CarMax's historical strength in inventory management, are there potential issues within your inventory given that others are now acting more aggressively on price while you have maintained wider margins?

Bill Nash, President and CEO

There's a lot to unpack here. Let me begin with sales during the quarter. The last time we spoke in mid to late September, we noted that sales were down in the mid-teens. By the end of September, it softened further, and this trend continued into October and November. To save you from asking, December is tracking similarly to the average performance of the third quarter, showing slight improvement over November. However, it’s important to remember that we’ll be comparing against easier performance from the previous third quarter as we move into the fourth quarter. Regarding market share, we still have year-to-date gains even though we observed declines in September and October, based on the most recent title data available. I want to caution about discussing market share based on short-term fluctuations since there are often temporary pressures at play. We noticed competitors reducing prices and margins to clear inventory, which isn't unexpected; we experienced similar behavior during the 2008-2009 recession. This prompted us to conduct comprehensive pricing elasticity tests. Those tests showed that while we could have sold more cars by lowering prices, it would have negatively impacted our profits. As I mentioned in my opening remarks, our focus is on achieving profitable long-term market share growth, and we have a strong track record in that area. Regarding who is currently active in this space, it’s a diverse market with many players, and I can’t single any out. I can say, however, that there are widespread pressures among competitors trying to sell off their inventory.

Operator, Operator

We'll take our next question from Rajat Gupta with JPMorgan. Please go ahead.

Rajat Gupta, Analyst

First, regarding retail GPUs, it's clear that the management has been effective this quarter. You've mentioned that you aren't discounting as heavily as some competitors. However, there comes a time when you need to clear out your inventory, which appears to be aging on the shelves. What are your thoughts on possibly having to consider discounts to move that inventory, whether this quarter or next? How do you plan to handle that transition? Additionally, how should we view the impact on retail GPUs in the coming quarters based on your pricing strategy? I have a follow-up as well. Thank you.

Bill Nash, President and CEO

So, Rajat great question. This is where I think we really shine when it comes to inventory management, I'm really pleased. If you notice, I talked about how much our total inventory has gone down, but we were able to maintain saleable units. And that's because the team did a phenomenal job, really cleaning up stuff that we had, whether we’re waiting on parts, missing titles, we really worked hard to clean up a lot. So to your point, the aging inventory, it's one of the reasons why you didn't see more movement in our ASPs. Our average selling price is given the depreciation, the team did a phenomenal job working through that getting it out there. And then with our sophisticated price testing, we just realized, look, there's no sense in giving this away. And so again, we feel like we put ourselves in really good position going forward. And I think what you'll see going forward is, your retail average selling prices are going to come down a lot more than what you've seen up to this point. So we feel good about retail GPU. Obviously, we will continue to test the elasticity as we go forward. But if elasticity holds, I think you'll see us continue to have robust retail GPUs.

Rajat Gupta, Analyst

Got it. And maybe like, the other gross profit line, if I look at the volume that you did three years ago, very similar to the volumes that you have today, really slightly lower today. And that other gross profit was $94 million and now $59 million, despite your third-party financing fee is actually better. So why is that down almost 50% on a similar level of volume? I mean, is there any opportunity to reduce the cost there? And I know, you mentioned that you want to retain the technicians, but how long are we going to see this kind of run rate before it can recouple to what you had in the past? And thanks for taking the question.

Enrique Mayor-Mora, Executive Vice President and CFO

Yes, specifically with the other margin, what you really need to do is look within the service business, and this quarter a couple of things. Number one was just with sales volumes being where they were down 20% year-over-year, that places a fair bit of deleverage pressure on the service business. That's number one. But number two, have almost equal importance this quarter, about $15 million year-over-year was our decision, the correct decision is to hold on to technicians. It's a very difficult position to staff, it is that most important that we retain, and we recruit the technicians because when we come out of this cycle, we want to be in a position where we can actually ramp up our inventory quickly, faster than our competitors. But that being said, it is an investment that flows through that service line. And again, this quarter was roughly $15 million given the current sales levels, but it's absolutely the right decision for the medium-term and definitely for the longer-term. That was the biggest pressure this quarter, Rajat.

Bill Nash, President and CEO

Yes. Rajat, the only thing I would add is, obviously, you're comparing it to a few years ago, we have a lot more production capacity now because we have more technicians, we have more space. So that's feeding into it as well.

Rajat Gupta, Analyst

Sorry, just a follow-up. What's your view on the cycle recovery? I mean, like, are you anticipating things like rebound at some point next year? Or I mean, what kind of conviction do you have on that like, just so that you might have to take some of these kind of actions more aggressively? Just curious on the thought process there.

Bill Nash, President and CEO

Yes. Look Rajat, your guess as far as what's going to happen next year is as good as mine. I think what we're trying to do is put ourselves in a position that regardless of what happens in the upcoming quarters, we will flex up or if we need to pull additional levers, we will pull additional levers. So we're just trying to give ourselves flexibility at this point.

Enrique Mayor-Mora, Executive Vice President and CFO

Yes, we are focused on what we can control, and that's where we're taking action. You can see how we've improved our SG&A. Service costs have increased, but that's due to our investment in technicians because we believe that we'll get through this cycle. When we come out on the other side, we want to be well-positioned to quickly reduce our inventory.

Rajat Gupta, Analyst

Got it. Great. Thanks for taking the question.

Operator, Operator

We will take our next question from John Healy with Northcoast Research. Please go ahead.

John Healy, Analyst

Just wanted to ask for a little bit more color on the SG&A cadence. I appreciate the comp cadence, but I was just wondering if you could help us think about the actions you took in Q3. And maybe the run rates and really, I don't know if we can think about an SG&A to gross kind of level for the next couple of quarters, or just help us understand kind of, what might be reasonable for you guys, just because there's been a lot of growth SG&A. And now it sounds like you're calibrating that. So anything you could provide there would be helpful?

Enrique Mayor-Mora, Executive Vice President and CFO

Thank you, John. As I mentioned in my prepared remarks, we have made significant progress in managing our SG&A expenses. In the first half of the year, we saw an increase of 16% to 17% year-over-year, but we've reduced that growth to just 3% in this quarter. However, if we exclude the $23 million settlement from last year’s third quarter, we actually observed a slight decrease in overall SG&A. This is a substantial change, and we expect it to continue into the fourth quarter and next year. The reason for this is the actions we've discussed, which fall into two main categories. Firstly, we've focused on reducing our headcount through attrition in our stores. This takes time, as it’s managed through natural turnover, but we feel this is essential for maintaining our company culture. We started this initiative in the second quarter and expect it to persist into the fourth quarter and beyond. Secondly, we are actively managing our fixed costs. I’ve mentioned our reduced use of contractors at the corporate office, and we have also paused hiring for new positions there. While we are still filling key and strategic roles, we have significantly slowed down our corporate overhead hiring. We believe these actions are suitable for the current market environment, and we are ready to take additional measures if necessary. Regarding the fourth quarter, I anticipate it will be similar to the third quarter when adjusted for the previous year's settlement.

John Healy, Analyst

And when you say relatively similar to the Q3, would that be in terms of dollars, or would that be in terms of SG&A to gross?

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. The focus is on the year-over-year changes in SG&A and its growth. The key issue with the leverage ratio of SG&A to gross profit lies in our control over SG&A, which I believe we have managed effectively. The difficulty arises from the gross profit number, which can vary significantly from quarter to quarter, complicating the management of that leverage ratio. As I mentioned earlier, we will concentrate on areas within our control, particularly the SG&A line. My comments are specifically related to the year-over-year growth of SG&A and the current quarter.

John Healy, Analyst

Perfect, thank you. And just one follow up question just about the gross profit per unit levels. I feel like you've kind of already answered this, but just want to ask it maybe in a different way. Hypothetically, if ASPs fall another 5% to 10% over the next couple of quarters either given market conditions or just changing of mix? Are you guys still confident that the $2200 GPU level is achievable? And even in that scenario, so I just wanted to ask that more directly.

Bill Nash, President and CEO

Yes. Look, I think we feel very comfortable where we're running the retail GPUs. We'll continue to monitor the test. But look, I expect ASPs to continue to fall, which I think overall for the industry is a good thing to help drop some gap between new and late model use. So we feel comfortable with where our GPUs are and will continue to test.

Operator, Operator

We will take our next question from Daniel Imbro with Stephens Inc. Please go ahead.

Daniel Imbro, Analyst

I want to follow up on John's question on expenses. Enrique, can you just provide some more color around really what the biggest inflationary drivers are in that other overhead costs fine? I think you pulled back, you said on some of the labor end of the season, and it's still up, $40 million year-over-year. So is any of that one-time increase? And then just taking a step back on expenses, I think even last quarter, we talked about, one of the reasons that you don't want to reduce headcount too quickly, is the need to hire back. And that gets harder next year. But now it sounds like we're expecting a softer backdrop for the next 12 plus months. So I guess why not reduce expenses or headcount more quickly across other parts of the enterprise? Thanks.

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. And what I'd say there is that, we did, and so as sales got more challenged in the third quarter, we went deeper into the staffing levels in the field. And so, it's still through attrition. So it does take a little bit longer. But at the same time, we did lower our staffing targets to reflect the current sales environments, I tell you, we did go deeper into managing those expenses. And in regards to your first question, I think you're asking about the other expense line, and what goes in there, because it was a 41% increase, if you just look at the release, right? That is primarily because we're comping over the $23 million settlement that we had last year, if you back that out, you're looking at less than half of that as an increase. And what that really is attributed to is our investments in technology and product, right. And that's what that's attributed to. What I will tell you, though, as well, if you compare it to prior quarters, there is a reduction in the pace of that investment from a year-over-year standpoint. And so we've been pulling back there as well. You also see that manifested in our CapEx guidance for this year. We've taken that down from 500 to 450, the largest chunk of that decrease, really comes from slowing down some of those projects, in addition to just slowing down some of the capacity initiatives that we have out there in terms of growing our capacity with lower volume, we're just slowing down some of those investments.

Bill Nash, President and CEO

And Daniel the only thing I would add there is, look, our culture is one that's a people-first mindset, our people are the reason for our success. And that's the reason we chosen to allow attrition to get us to where we need to be. We will obviously continue to monitor the situation, but we're very comfortable with allowing attrition to get us to where we need to be.

Daniel Imbro, Analyst

Got it. I'll stick with one question. And I'll hop back in the queue for follow up. Thanks.

Operator, Operator

We'll take our next question from John Murphy with Bank of America. Please go ahead.

John Murphy, Analyst

I want to take a moment to focus on the supply side. Considering the one- to six-year-old car fleet, it is likely to continue shrinking over the next few years. Competition seems to be more concentrated on dealers, which may result in a decline in the available one- to six-year-old cars. You've mentioned an approach to target lower price segments to boost volume, and you've demonstrated a good capability in managing that. I'm interested in how quickly you can implement this strategy to potentially increase volume while maintaining lower price points, achieving higher gross profits and possibly better returns on the capital invested.

Bill Nash, President and CEO

Yes. Thanks for the question, John. It's interesting, because we're kind of living a very similar life to what we did after the '08, '09 recession, you remember where you come out of that you have less newer cars, and it kind of has to work its way through. I tell you, we're in a better position today than we were back there just because our self-sufficiency is so high. And we'll be able to sell what consumers are looking for. And we're going to be able to get that really in a better way than we could after 08, 09 because our self-sufficiency is so high. In my opening comments, one of the reasons our buyers were down so far, obviously, depreciation was the biggest lever, but there's also we made some decision just to slow down buys. And so there were retail cars that we purposely did not buy because of the risk of those cars in a highly depreciating type of market. So, again, I'm very comfortable with where we are and I think we're better positioned than we were in 08, 09. And I think we did a phenomenal job in 08 and 09 navigating that period.

John Murphy, Analyst

But maybe a follow-up, Bill, I mean, how fast can you move on this to drive comps positive? I mean, we understand that kind of the headwinds in sort of what was traditionally your core. I mean, it is obvious, you know it. I mean, you're going after it. I mean, when do you kind of just push and just increase, maybe materially the penetration of these older vehicles to drive the volumes higher? Because, I mean, the one thing that, it's very admirable is that the variable, GPU or the focus on GPUs, which is a variable cost analysis, but you do have these fixed costs that are high, particularly as Enrique was talking about these technicians. So you got to cover these costs at some point not, I mean when can you do this? I mean, something you are stating to do and but you're not doing it?

Bill Nash, President and CEO

When discussing the penetration of older vehicles, it's important to note that the level of penetration and the amount we offer is influenced by consumer demand. Not everyone is interested in older, high-mileage vehicles that tend to be less expensive. Therefore, our actions are driven by demand, and as long as consumers continue to show interest, we will keep providing those options. However, it's also true that not everyone is seeking that type of vehicle.

Operator, Operator

Thank you. Our next question comes from Seth Basham with Wedbush Securities. Please go ahead.

Seth Basham, Analyst

Just to clarify for this sales environment where comps continuing to trend down 20%, you still expect SG&A to be flat to up year-over-year in the fourth quarter and going forward?

Enrique Mayor-Mora, Executive Vice President and CFO

No, I mentioned that you need to back out the $23 million we got last year in the third quarter. And so we would expect to be down year-over-year in the fourth quarter. It gets a little bit tricky Seth is like quarter-to-quarter things can happen. But our expectation is that we would be down year-over-year in the fourth quarter.

Seth Basham, Analyst

Okay. And again, how much down and when you think about the 20% decline persisting when you decide to get more aggressive on SG&A?

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. We won't be providing specific guidance on how much we expect to decline in the fourth quarter due to some variability from quarter to quarter, but we anticipate a year-over-year decrease. Looking at the trend we've been managing, our focus has been on SG&A, and we believe we've taken the right actions so far. If the business doesn’t improve and continues to decline, we do have other options we can explore. However, for now, we feel confident in our current approach and will continue to manage the business responsibly as we always have.

Bill Nash, President and CEO

No, I consider this what you would see in a highly depreciating market. When prices are going down a lot like they have been. And consumers have been told for the last year that this is the best time to sell their car, they can get more than they could ever gotten before. There's a disconnect there. And so as prices come down, it always drives our buy rate down. The other thing I would just add to that is that we stepped back, our appraisal advertising just given the volatility of the market. So no, I don't consider this the new norm.

Seth Basham, Analyst

Thank you, guys.

Operator, Operator

And our next question comes from Sharon Zackfia with William Blair. Please go ahead.

Sharon Zackfia, Analyst

Following up on the SG&A question. I guess is there a way to contextualize how much you've taken out year-to-date of SG&A. And what that run rate is now in the fourth quarter because I'm assuming that those initiatives continued in the third quarter and into the fourth quarter.

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. I think the better way to think about it Sharon, or the best way to think about it is just the cadence, the year-over-year cadence that we've had, because there's always seasonality that occurs right quarter-to-quarter in our business, and that also impacts SG&A. But if you again, if you go back to the first half of the year, Q1, we grew SG&A 19% up year-over-year in the first quarter. In the second quarter, it was up 16% year-over-year. This quarter, if you back out the legal settlement that we got last year, we're down 1%. So that's a significant decrease in the pace of SG&A. And so we are focused on it, we are managing to the current environment. And we think we're doing so appropriately. Now, if the business continues to be challenged, there's other things we can do. But for the time being, we've taken some pretty material steps to manage our SG&A.

Sharon Zackfia, Analyst

Yes. I think part of the confusion is, it sounds as if you're expecting SG&A to be down. Similarly, like down 1% in the fiscal fourth quarter year-over-year, but it also sounds as if you're continuing to proactively manage SG&A. And I think a lot of us are trying to reconcile that in our heads as to why we wouldn't see SG&A down a bit more year-over-year than what you saw in the third quarter, if that makes sense.

Enrique Mayor-Mora, Executive Vice President and CFO

We expect to continue to see SG&A kind of to go down. I think coming into individual quarter, it gets a little bit challenging to give you a number that we're managing too, many things can happen on a quarter. But what I tell you is thematically and practically we expect to continue to manage our SG&A down from a year-over-year basis.

Sharon Zackfia, Analyst

Okay. Maybe separately? I mean, how should we think about SG&A on a full year basis for next year? So you've got a lot of moving parts, you kind of have to keep your muscle intact for a potential rebound. But at the same time, you're dealing with a very difficult macro climate. So as we think about next year, particularly with the curtailment in the opening, I mean how are you viewing SG&A dollar growth?

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. The way we're looking at SG&A is, we've given guidance in the past, like, hey, we need 5% to 8% gross profit go to lever, I think in this kind of environment, right? In this kind of macro backdrop, that kind of guidance is less important than what I'm about to say. So we are actually managing, and our goal is to get to kind of the mid 7%, 8% SG&A to gross profit, right, that is our first step on the way to improving our SG&A. Now we're going to need gross profit growth there, right. But that is our first step. Over time, we have talked about having an operating model that's more efficient than what it used to be. And we still expect that that's going to be over time, though, how many transformations and you can take a look at other retailers that have gone through it, it takes time to get to a better and more efficient operating model. But we expect to get back to where we used to be, it's just going to take time. Our first step is to get to kind of the mid 7%, 8% SG&A to gross profit, right. But again, we're going to need gross profit support to get there. In the meantime, we're going to continue to manage our SG&A appropriately for the market. And that's what we do. And you can see that's exactly what we did in the third quarter. We expect to carry that forward into the fourth quarter and into next year.

Bill Nash, President and CEO

And I think Sharon, we will also have a lot more visibility after the fourth quarter to really be able to tell you more depending on how the business does between now and then.

Sharon Zackfia, Analyst

Thank you.

Operator, Operator

We will go next to Craig Kennison with Baird. Please go ahead.

Craig Kennison, Analyst

I want to address the topic of SG&A from a different angle. There has been a shift in the competitive landscape that seems to benefit you. I'm curious if you might consider adjusting your approach to SG&A, given that succeeding in this market may require a long-term strategy rather than a short-term focus, which could mean implementing more significant reductions than just low single-digit percentage cuts.

Enrique Mayor-Mora, Executive Vice President and CFO

Yes, Craig. I think it about a little bit differently. I think similar to you, but we have competitors that are, obviously struggling. I don't think now is the time where, given our financial strength where we should be pulling back a whole bunch on SG&A. We have pulled considerably back. But at the same time, as I talked in my opening remarks, we also want to make sure that we're continuing to build for the future. And I think what everybody needs to remember is, we don't operate this business on a quarter-to-quarter basis, we operate the business for the success over the long term. And there are some things that we're spending on that will absolutely help us longer term. Does it give us a headwind for EPS right now? Absolutely. But is it the right decision for the company long-term? Absolutely. So again, I think, really, my thoughts are on your questions, we're going to continue to walk this fine line. We want to continue to build out the muscle. We want to continue to find near-term efficiencies, which we will do. And we'll continue to manage the business with a long-term view versus just a quarter-to-quarter view.

Craig Kennison, Analyst

And maybe just to follow up, I mean, obviously, the stocks under significant pressure, and it feels like you have the long-term philosophy, but not enough shareholders are on board with it, is there something you can do to improve the messaging, or the guidance provided to maybe reduce the amount of surprise with which your results are met?

Bill Nash, President and CEO

I think the surprise is coming from macro factors to Enrique's point that we really, those are things that you can't control. And so what you need to focus on is what you can control and obviously, I think our long-term messaging is still more intact than ever. Yes, we've got some pain here in the short-term. But guess what we've seen pain before in the short-term. We've seen, if you look at market share, for example, which is a proxy for how I think success is going, if you look at market share, we've historically gained market shares. I mean, even in the time we are at 08, 09, we lost a little market share in the near-term, but then we quickly got it back. And then some more. Even if you look in the last few years, when you look back at like FY 20, when we started really rolling out our online capabilities, we saw a step up in market share gains. Unfortunately, we went into COVID, we gave a little bit back, but the following year, we got that back plus more. Now we're in a recessionary period. So again, I think everybody just needs to kind of keep a perspective of what we're going after long term. And yes, the short-term can be a little noisy, but the long-term message is still intact.

Craig Kennison, Analyst

Great. Thanks so much.

Operator, Operator

We'll take our next question from Michael Montani with Evercore. Please go ahead.

Michael Montani, Analyst

Just wanted to ask a little bit more on the credit side for John, if you could give us some incremental color you had mentioned 2 to 2.5 is kind of normal for Tier-1. So what were the equivalent kind of loss ratio expectations be for Tier-2 and Tier-3? And then by way of follow up would be, can you give some incremental color around delinquency trends and roll rates, if possible, at all, by tier would be very helpful?

Jon Daniels, Senior Vice President, CarMax Auto Finance Operations

Sure. Yes, right on. Thanks for the question. The 2% to 2.5% is, again, our targeted range. I think we've done a great job staying within there. We've been in the Tier-3 business for since 2014, I think we've historically quoted, it's basically, you know, 1% of our receivables initially, it's now 2%. And obviously, substantially higher loss rates, I think we've put it's often 10% of our losses when it was 1%. So you're seeing maybe a 10x, 10-fold loss rate difference there in the Tier-3. Tier-2 is somewhere in between depends on where we choose to play there, there's obviously a wide spectrum. So hopefully that gives us some color on how to expect losses, provisioning, whatever, around the different buckets, overall macro factors and delinquencies and losses, impacting our portfolio. I think it’s very clear delinquencies are on the rise in the industry, there's no doubt, you can see that within our ABS deals, we've mentioned that historically, there's certainly think pressure in the consumer. I think we've done a really, really strong job at working with that consumer. And while they might go 30, 35 days past due, helping them find solutions, such that it doesn't go into a charge off status. So we continue to fight that good fight and work with our consumers. As Bill mentioned, obviously, monthly payments are up, I think we've done a nice job of being responsible in our lending to our consumers and helping them through it. And ultimately, we reserve accordingly expecting all of this. So I think we're in a good position from a reserve standpoint, we'll watch the credit environment and the consumer very carefully. And hopefully that answers your questions.

Michael Montani, Analyst

And maybe can you just contrast a little bit the current delinquency experience, you're seeing vis-à-vis, what was happening in 07 and 08?

Jon Daniels, Senior Vice President, CarMax Auto Finance Operations

Sure. Yes, I think what you're seeing historically is, I would say, 07 and 08 you absolutely saw an impact across the entire credit spectrum substantially. I think what we've identified is, we're seeing a little more pressure on maybe the lower credit consumer, the Tier-3 into the Tier-2, maybe even a lower side of our Tier-1 space. So I see that definitely different. And again, I think that we're seeing delinquency pressure that that hint of a challenge for the consumer, but it really is not manifesting itself into loss. Again, we're going to watch it carefully. And we'll see what happens. But you absolutely saw more of an impact across the credit spectrum and into the loss side in 08, 09. And again, I think that's a very different environment. We can all agree with that, the labor pressure is back then versus now income for the worker. So we'll see where it translates. But I think those are the fundamental differences we've seen.

Operator, Operator

We'll take our next question from Chris Bottiglieri with BNP. Please go ahead. Your line is open.

Chris Bottiglieri, Analyst

I want to talk about your path to your target SG&A gross. It sounds like it's gross profit dependent on some level, but some of the gross profit levels like service and use volumes that are out of your control. I think it's probably fair to say the wholesalers took a pretty big step down this quarter. But you've driven significant improvement there. So I guess my point is like, where do you see the gross profit coming from? Is there any reason I think that wholesale could read on evidently.

Bill Nash, President and CEO

I agree with Enrique's earlier point that it's a two-part equation. We're managing expenses on the gross profit side, but we really need the business to bounce back. We definitely need that recovery. Wholesale gross profit has shown some good improvements, and both wholesale and retail gross profit margins are looking strong. The focus now is on regaining some of the lost volume. I'm optimistic that we can grow the wholesale segment a bit more. As I mentioned, some decisions we made this quarter may have slowed that growth, but I believe that's where we stand, which will carry significant weight.

Chris Bottiglieri, Analyst

Got you. Okay. Then, question on CAF quickly, the penetration jumped a ton, despite like a pretty large rate hike. And imagine like you've been more in terms of quicker to raise rates. And Bring Your Own Financing jumped a bit, too, as well. And Tier-2 and Tier-3 declined. You're also adding new partners onto the Tier-2, Tier-3 network, if I heard that correctly. So you can talk about you're seeing there in aggregate or the Tier-2 and Tier-3 tightening credit at the margin. Does your new instant appraisal tool that you've added? It sounds like it includes the partners more. Will that help drive penetration of Tier-2, 3. Just any thoughts there would be helpful?

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. Let me address your points one by one. Regarding overall penetration, we noted in our prepared remarks that CAF penetration is increasing alongside our rate hikes, which we're very pleased about. Typically, there tends to be a lag behind the market, especially as we compete with credit unions at the higher end. However, we believe we have effectively raised rates by 40 basis points sequentially and 150 basis points year-over-year while maintaining that penetration. We're satisfied with those results. It’s evident that Tier-2 and Tier-3 penetration has decreased compared to last year, which I attribute to two factors. There are certainly consumer challenges, as Bill pointed out, and ongoing affordability issues. Additionally, it's clear that lenders are adjusting their operations independently and making necessary pullbacks. The advantage of our platform is that while individual lenders work together to determine the best approach for themselves, they collectively create strong credit offers in the long term. Thus, the pullback is noticeable. Regarding your final question about our pre-quarter tool, we have been consistently adding lenders to that platform. We believe it is a top-tier tool, requiring flexibility from our lenders, all of whom are coming on board. Are we seeing engagement? Yes, although I can't say it is significantly impacting the penetration directly, it does attract higher quality credit consumers to the application process. Does that address your questions? What else might I have overlooked?

Chris Bottiglieri, Analyst

Nothing. You got my laundry list. And thanks for correcting my misspoken. Yes, that's why that was the insert. Sorry, I said began the financing penetration tool. Thank you.

Operator, Operator

We'll take our final question from Chris Pierce with Needham. Please go ahead.

Chris Pierce, Analyst

I just wanted to kind of get some color around. You talked about competitors acting aggressively to preference units versus price where you guys kind of do the opposite. Is that positive because it means the industry is moving back to normal, but or is it a short-term negative because they're going to have fresher inventory that's going to lower your unit numbers and just kind of want to know how to think about that and how that's kind of trended in the past. You've talked about seeing this before?

Bill Nash, President and CEO

Yes, Chris. It sounds like you're noting that some competitors are struggling to move their inventory and are facing significant depreciation. As a result, they're trying to sell off some of that inventory. Historically, this approach has not proven sustainable in the long run, as it doesn't generate the necessary profits, despite the effort to move units. This situation is part of the reason we implemented our price strategy; we aimed to assess price elasticity. We tested prices both upward and downward to gain a clearer understanding, which ultimately reinforces our confidence that we made the right decision for our profitability.

Operator, Operator

Thank you. And our next question comes from David Whiston with Morningstar. Please go ahead.

David Whiston, Analyst

It looks like you had a really great free cash flow generation quarter from an inventory reduction. And I'm just curious, I guess, wanting you, how much longer can you reduce your inventory to get that free cash flow benefit yet still have adequate vehicle inventory to sell? And then, you paid off the revolver with some of that free cash flow? Do you also want to pay off that June 24 term loan to get some more balance sheet health, would you rather have that cash on hand?

Enrique Mayor-Mora, Executive Vice President and CFO

Yes. I think in this kind of environment, I think having some cash on hand isn't a bad thing. And we absolutely used the really effective management of inventory like Bill talked about. We decreased overall inventory year-over-year, but we actually increased our sellable inventory. So that's some impressive work by the teams to work through our WIP. And so that was really good news. We used that cash basically to, as you mentioned, to pay down the revolver, this quarter take it down to zero, that would be of no tap on our revolver. And at the same time, sit on some cash, I just think, David in this kind of environment, it's not a bad thing to have some cash as well. So it gives us ultimately the flexibility to manage through this kind of environment. And, we have a really strong balance sheet. We're proud of it. And we have flexibility that others don't have in the industry. And I think that puts us in a position of strength.

David Whiston, Analyst

And somewhat related, the buyback pause. I do understand wanting to be prudent. But should we interpret this to mean you guys are less optimistic about maybe the short to mid-term than you were three months ago?

Enrique Mayor-Mora, Executive Vice President and CFO

Well, it's important that we run a conservative balance sheet in this kind of environment. And as I mentioned, in my prepared remarks, we do look at our net leverage ratios in terms of something to manage to carefully to make sure we have ultimate flexibility when it comes to having funds and managing CAF. We do have a very large cap to finance organization. And that's just a key consideration that goes into it. So I think until the business kind of improves, and just as importantly, the macro backdrop improves, I expect that we will pause the share buyback. That being said, we remain fully committed to the share repurchase program, and we'll get back into it at the appropriate time when things improve, and the outlook improves.

Bill Nash, President and CEO

Yes, David, that's about our views have changed on, things are going to get worse. It's just more about the uncertainty.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes the third quarter fiscal year 2023 CarMax earnings release conference call. You may now disconnect.