tenq.htm




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

[ X ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended November 30, 2009

OR

 [    ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number:  1-31420

CARMAX, INC.
(Exact name of registrant as specified in its charter)

VIRGINIA
54-1821055
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

12800 TUCKAHOE CREEK PARKWAY, RICHMOND, VIRGINIA
23238
(Address of principal executive offices)
(Zip Code)

 (804) 747-0422
(Registrant's telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  X
No          

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ___
No          

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer X
Accelerated filer _
Non-accelerated filer _
Smaller reporting company _

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes         
No  X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding as of December 31, 2009
Common Stock, par value $0.50
 
222,858,781
     
A Table of Contents is included on Page 2 and a separate Exhibit Index is included on Page 43.

 
 
 

 

CARMAX, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 
Page
No.
PART I.
FINANCIAL INFORMATION
 
       
 
Item 1.    Financial Statements:
 
   
Consolidated Statements of Earnings -
Three Months and Nine Months Ended November 30, 2009 and 2008
 
3
       
   
Consolidated Balance Sheets -
November 30, 2009, and February 28, 2009
 
4
       
   
Consolidated Statements of Cash Flows -
Nine Months Ended November 30, 2009 and 2008
 
5
       
   
Notes to Consolidated Financial Statements
6
       
 
Item 2.    Management's Discussion and Analysis of Financial Condition and
               Results of Operations
 
23
     
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
39
     
 
Item 4.    Controls and Procedures
40
     
PART II.
OTHER INFORMATION
 
     
 
Item 1.    Legal Proceedings
41
     
 
Item 1A.  Risk Factors
41
     
 
Item 6.    Exhibits
41
     
     
SIGNATURES 
42
     
EXHIBIT INDEX 
43











Page 2 of 43
 
 

 


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



CARMAX, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
(Unaudited)
(In thousands except per share data)



   
Three Months Ended November 30
   
Nine Months Ended November 30
 
   
2009
      % (1)     2008       % (1)     2009       % (1)     2008       % (1)
                                                               
Sales and operating revenues:
                                                             
Used vehicle sales
  $ 1,407,077       81.5     $ 1,168,804       80.3     $ 4,662,968       82.7     $ 4,461,969       81.1  
New vehicle sales
    38,158       2.2       57,508       4.0       149,917       2.7       217,396       4.0  
Wholesale vehicle sales
    226,907       13.1       176,956       12.2       635,394       11.3       642,552       11.7  
Other sales and revenues
    53,835       3.1       52,364       3.6       188,669       3.3       181,532       3.3  
Net sales and operating revenues
    1,725,977       100.0       1,455,632       100.0       5,636,948       100.0       5,503,449       100.0  
Cost of sales
    1,483,114       85.9       1,256,396       86.3       4,803,299       85.2       4,765,586       86.6  
Gross profit
    242,863       14.1       199,236       13.7       833,649       14.8       737,863       13.4  
CarMax Auto Finance income (loss)
    65,806       3.8       (15,360 )     (1.1 )     116,300       2.1       (12,682 )     (0.2 )
Selling, general and administrative
                                                               
expenses
    192,140       11.1       217,482       14.9       616,487       10.9       685,614       12.5  
Interest expense
    674             1,525       0.1       3,088       0.1       5,060       0.1  
Interest income
    45             735       0.1       418             1,353        
Earnings (loss) before income taxes
    115,900       6.7       (34,396 )     (2.4 )     330,792       5.9       35,860       0.7  
Income tax provision (benefit)
    41,311       2.4       (12,522 )     (0.9 )     124,484       2.2       14,170       0.3  
Net earnings (loss)
  $ 74,589       4.3     $ (21,874 )     (1.5 )   $ 206,308       3.7     $ 21,690       0.4  
                                                                 
Weighted average common shares: (2)
                                                         
Basic
    220,204               217,712               218,980               217,468          
Diluted
    223,879               217,712               221,346               219,678          
                                                                 
Net earnings (loss) per share: (2)
                                                               
Basic
  $ 0.34             $ (0.10 )           $ 0.93             $ 0.10          
Diluted
  $ 0.33             $ (0.10 )           $ 0.92             $ 0.10          

 (1)
Percents are calculated as a percentage of net sales and operating revenues and may not equal totals due to rounding.

(2)
Reflects the implementation of the accounting pronouncement related to participating securities.  See Note 11 for additional information.







See accompanying notes to consolidated financial statements.

Page 3 of 43
 
 

 

CARMAX, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
(In thousands except share data)


     
November 30, 2009
 
February 28, 2009
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
    $
15,212
    $
140,597
 
Accounts receivable, net
     
       68,314
     
       75,876
 
Auto loan receivables held for sale
     
       18,822
     
         9,748
 
Retained interest in securitized receivables
     
      521,283
     
      348,262
 
Inventory
     
      751,297
     
      703,157
 
Deferred income taxes
     
         7,085
     
                   ―
 
Prepaid expenses and other current assets
     
       10,328
     
       10,112
 
                   
Total current assets
     
   1,392,341
     
   1,287,752
 
                   
Property and equipment, net
     
      905,564
     
      938,259
 
Deferred income taxes
     
       63,643
     
      103,163
 
Other assets
     
       48,719
     
       50,013
 
                   
TOTAL ASSETS
    $
2,410,267
    $
2,379,187
 
                   
LIABILITIES AND SHAREHOLDERS’ EQUITY
                 
Current liabilities:
                 
Accounts payable
    $
191,170
    $
237,312
 
Accrued expenses and other current liabilities
     
      100,575
     
       55,793
 
Accrued income taxes
     
       16,504
     
       26,551
 
Deferred income taxes
     
              ―
     
       12,129
 
Short-term debt
     
            190
     
            878
 
Current portion of long-term debt
     
      119,201
     
      158,107
 
                   
Total current liabilities
     
      427,640
     
      490,770
 
                   
Long-term debt, excluding current portion
     
       27,533
     
      178,062
 
Deferred revenue and other liabilities
     
      109,120
     
      117,288
 
                   
TOTAL LIABILITIES
     
      564,293
     
      786,120
 
                   
Commitments and contingent liabilities
                 
                   
Shareholders’ equity:
                 
Common stock, $0.50 par value; 350,000,000 shares authorized;
                 
222,451,921 and 220,392,014 shares issued and outstanding
                 
as of November 30, 2009, and February 28, 2009, respectively
     
      111,226
     
      110,196
 
Capital in excess of par value
     
      731,501
     
      685,938
 
Accumulated other comprehensive loss
     
      (16,854)
     
      (16,860)
 
Retained earnings
     
   1,020,101
     
      813,793
 
                   
TOTAL SHAREHOLDERS’ EQUITY
     
   1,845,974
     
   1,593,067
 
                   
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
    $
2,410,267
    $
2,379,187
 





See accompanying notes to consolidated financial statements.


Page 4 of 43
 
 

 

CARMAX, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)


   
Nine Months Ended November 30
   
2009
2008
             
Operating Activities:
           
Net earnings
  $ 206,308     $ 21,690  
Adjustments to reconcile net earnings to net cash provided by operating activities:
               
Depreciation and amortization
    43,947       41,379  
Share-based compensation expense
    30,697       27,038  
Loss on disposition of assets
    359       8,263  
Deferred income tax provision (benefit)
    20,312       (34,604 )
Net decrease (increase) in:
               
Accounts receivable, net
    7,562       27,412  
Auto loan receivables held for sale, net
    (9,074 )     (15,926 )
Retained interest in securitized receivables
    (173,021 )     (44,234 )
Inventory
    (48,140 )     374,271  
Prepaid expenses and other current assets
    (216 )     10,317  
Other assets
    1,290       177  
Net decrease in:
               
Accounts payable, accrued expenses and other current
               
liabilities and accrued income taxes
    (10,969 )     (104,495 )
Deferred revenue and other liabilities
    (12,578 )     (4,660 )
Net cash provided by operating activities
    56,477       306,628  
                 
Investing Activities:
               
Capital expenditures
    (18,372 )     (163,964 )
Proceeds from sales of assets
    79       28,355  
Insurance proceeds related to damaged property
    447        
Purchases of money market securities
    (2,196 )     (4,009 )
Sales of investments available for sale
    2,200        
Net cash used in investing activities
    (17,842 )     (139,618 )
                 
Financing Activities:
               
Decrease in short-term debt, net
    (688 )     (8,944 )
Issuances of long-term debt
    441,000       487,800  
Payments on long-term debt
    (630,435 )     (531,036 )
Equity issuances, net
    23,318       9,962  
Excess tax benefits from share-based payment arrangements
    2,785       387  
Net cash used in financing activities
    (164,020 )     (41,831 )
                 
(Decrease) increase in cash and cash equivalents
    (125,385 )     125,179  
Cash and cash equivalents at beginning of year
    140,597       12,965  
Cash and cash equivalents at end of period
  $ 15,212     $ 138,144  






See accompanying notes to consolidated financial statements.

Page 5 of 43
 
 

 

CARMAX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1.  
Background
 
CarMax, Inc. (“we”, “our”, “us”, “CarMax” and “the company”), including its wholly owned subsidiaries, is the largest retailer of used vehicles in the United States.  We were the first used vehicle retailer to offer a large selection of high quality used vehicles at competitively low, no-haggle prices using a customer-friendly sales process in an attractive, modern sales facility.  At select locations we also sell new vehicles under various franchise agreements.  We provide customers with a full range of related products and services, including the financing of vehicle purchases through our own finance operation, CarMax Auto Finance (“CAF”), and third-party lenders; the sale of extended service plans and accessories; the appraisal and purchase of vehicles directly from consumers; and vehicle repair service.  Vehicles purchased through the appraisal process that do not meet our retail standards are sold to licensed dealers through on-site wholesale auctions.
 
2.  
Accounting Policies
 
Basis of Presentation and Use of Estimates.  The accompanying interim unaudited consolidated financial statements include the accounts of CarMax and our wholly owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.  The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities.  Actual results could differ from those estimates.  Amounts and percentages may not total due to rounding.
 
 
These consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, such interim consolidated financial statements reflect all normal recurring adjustments considered necessary to present fairly the financial position and the results of operations and cash flows for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year.  We have evaluated subsequent events for potential recognition and/or disclosure through January 8, 2010, the date the consolidated financial statements included in this Quarterly Report on Form 10-Q were filed.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2009.

Cash and Cash Equivalents.  Cash equivalents of $0.5 million as of November 30, 2009, and $128.3 million as of February 28, 2009, consisted of highly liquid investments with original maturities of three months or less.
 

Page 6 of 43
 
 

 

3.  
CarMax Auto Finance Income (Loss)  
 
   
Three Months Ended
   
Nine Months Ended
 
   
November 30
   
November 30
 
(In millions)
 
2009
   
%
   
2008
   
%
   
2009
   
%
   
2008
   
%
 
Gain on sales of loans originated and sold (1)(2)
  $ 17.0       3.6     $ 11.3       2.8     $ 54.7       3.9     $ 32.5       2.1  
Other gains (losses) (1)
    31.6               (39.8 )             12.6               (82.6 )        
Total gain (loss)
    48.6               (28.5 )             67.3               (50.1 )        
Other CAF income: (3)
                                                               
Servicing fee income
    10.6       1.0       10.4       1.0       31.4       1.0       31.1       1.0  
Interest income
    17.6       1.7       12.6       1.2       50.4       1.7       34.8       1.2  
Total other CAF income
    28.2       2.7       23.0       2.3       81.8       2.7       65.9       2.2  
Direct CAF expenses: (3)
                                                               
CAF payroll and fringe benefit expense
    4.9       0.5       4.8       0.5       15.1       0.5       14.0       0.5  
Other direct CAF expenses
    6.1       0.6       5.1       0.5       17.7       0.6       14.5       0.5  
Total direct CAF expenses
    11.0       1.1       9.9       1.0       32.8       1.1       28.4       0.9  
CarMax Auto Finance income (loss) (4)
  $ 65.8       3.8     $ (15.4 )     (1.1 )   $ 116.3       2.1     $ (12.7 )     (0.2 )
                                                                 
Total loans originated and sold
  $ 474.8             $ 407.0             $ 1,410.4             $ 1,560.4          
Average managed receivables
  $ 4,106.9             $ 4,076.3             $ 4,066.0             $ 4,019.0          
Ending managed receivables
  $ 4,097.4             $ 4,027.3             $ 4,097.4             $ 4,027.3          
                                                                 
Total net sales and operating revenues
  $ 1,726.0             $ 1,455.6             $ 5,636.9             $ 5,503.4          

 
(1)
To the extent we recognize valuation or other adjustments related to loans originated and sold during previous quarters of the same fiscal year, the sum of amounts reported for the individual quarters may not equal the year-to-date total.
 
 
Percent columns indicate:
 
(2)
Percent of loans originated and sold.
 
(3)
Annualized percent of average managed receivables.
 
(4)
Percent of total net sales and operating revenues.

CAF provides financing for qualified customers at competitive market rates of interest.  Throughout each month, we sell substantially all of the loans originated by CAF in securitization transactions as discussed in Note 4.  The majority of CAF income has typically been generated by the spread between the interest rates charged to customers and the related cost of funds.  A gain, recorded at the time of securitization, results from recording a receivable approximately equal to the present value of the expected residual cash flows generated by the securitized receivables.  The cash flows are calculated taking into account expected prepayments, losses and funding costs.

The gain on sales of loans originated and sold includes both the gain income recorded at the time of securitization and the effect of any subsequent changes in valuation assumptions or funding costs that are incurred in the same fiscal period that the loans were originated.  Other gains or losses include the effects of changes in valuation assumptions or funding costs related to loans originated and sold during previous fiscal periods.  In addition, other gains or losses could include the effects of new term securitizations, changes in the valuation of retained subordinated bonds and the repurchase and resale of receivables in existing term securitizations, as applicable.

CAF income or loss does not include any allocation of indirect costs or income.  We present this information on a direct basis to avoid making arbitrary decisions regarding the indirect benefits or costs that could be attributed to CAF.  Examples of indirect costs not included are retail store expenses and corporate expenses such as human resources, administrative services, marketing, information systems, accounting, legal, treasury and executive payroll.
 
Page 7 of 43


4.  
Securitizations

We maintain a revolving securitization program (“warehouse facility”) that currently provides financing of up to $1.2 billion to fund substantially all of the auto loan receivables originated by CAF until they can be funded through a term securitization or alternative funding arrangement.  We sell the auto loan receivables to a wholly owned, bankruptcy-remote, special purpose entity that transfers an undivided interest in the receivables to entities formed by third-party investors (“bank conduits”).  The bank conduits issue asset-backed commercial paper supported by the transferred receivables, and the proceeds from the sale of the commercial paper are used to pay for the securitized receivables.  The return requirements of investors in the bank conduits could fluctuate significantly depending on market conditions.  The warehouse facility has a 364-day term ending in August 2010.  At renewal, the cost, structure and capacity of the facility could change.  These changes could have a significant impact on our funding costs.

The bank conduits may be considered variable interest entities, but are not consolidated because we are not the primary beneficiary and our interest does not constitute a variable interest in the entities.  We hold a variable interest in specified assets transferred to the entities rather than interests in the entities themselves.

Historically, we have used term securitizations to refinance the receivables previously securitized through the warehouse facility.  The purpose of term securitizations is to provide permanent funding for these receivables.  In these transactions, a pool of auto loan receivables is sold to a bankruptcy-remote, special purpose entity that, in turn, transfers the receivables to a special purpose securitization trust.  The securitization trust issues asset-backed securities, secured or otherwise supported by the transferred receivables, and the proceeds from the sale of the securities are used to pay for the securitized receivables.  Refinancing receivables in a term securitization could have a significant impact on our results of operations depending on the transaction structure and market conditions.

The warehouse facility and each term securitization are governed by various legal documents that limit and specify the activities of the special purpose entities and securitization trusts (collectively, “securitization vehicles”) used to facilitate the securitizations.  The securitization vehicles are generally allowed to acquire the receivables being sold to them, issue asset-backed securities to investors to fund the acquisition of the receivables and enter into passive derivatives or other yield maintenance contracts to hedge or mitigate certain risks related to the pool of receivables or asset-backed securities.  Additionally, the securitization vehicles are required to service the receivables they hold and the securities they have issued.  These servicing functions are performed by CarMax as appointed within the underlying legal documents.  Servicing functions include, but are not limited to, collecting payments from borrowers, monitoring delinquencies, liquidating assets, investing funds until distribution, remitting payments to the trustee who in turn remits payments to the investors, and accounting for and reporting information to investors.

ENDING MANAGED RECEIVABLES
 
   
As of November 30
   
As of February 28 or 29
 
(In millions)
 
2009
   
2008
   
2009
   
2008
 
Warehouse facility
  $ 416.0     $ 907.0     $ 1,215.0     $ 854.5  
Term securitizations
    3,528.6       2,978.7       2,616.9       2,910.0  
Loans held for investment
    134.0       120.7       145.1       69.0  
Loans held for sale
    18.8       20.9       9.7       5.0  
Total ending managed receivables
  $ 4,097.4     $ 4,027.3     $ 3,986.7     $ 3,838.5  

The special purpose entities and investors have no recourse to our assets.  Our risk under these arrangements is limited to the retained interest.  We have not provided financial or other support to the special purpose entities or investors that was not previously contractually required.  There are no additional arrangements, guarantees or other commitments
 
 
Page 8 of 43

 
that could require us to provide financial support or that would affect the fair value of our retained interest.  All transfers of receivables are accounted for as sales (See Note 14).  When the receivables are securitized, we recognize a gain or loss on the sale of the receivables as described in Note 3.

Retained Interest.  We retain an interest in the auto loan receivables that we securitize.  The retained interest includes the present value of the expected residual cash flows generated by the securitized receivables, or “interest-only strip receivables,” various reserve accounts, required excess receivables and retained subordinated bonds, as described below.  As of November 30, 2009, on a combined basis, the reserve accounts and required excess receivables were 4.1% of ending managed receivables.  The interest-only strip receivables, reserve accounts and required excess receivables serve as a credit enhancement for the benefit of the investors in the securitized receivables.

The fair value of the retained interest was $521.3 million as of November 30, 2009, and $348.3 million as of February 28, 2009.  Additional information on fair value measurements is included in Note 6.  The receivables underlying the retained interest had a weighted average life of 1.5 years as of November 30, 2009, and February 28, 2009.  The weighted average life in periods (for example, months or years) of prepayable assets is calculated by multiplying the principal collections expected in each future period by the number of periods until that future period, summing those products and dividing the sum by the initial principal balance.
 
Interest-only strip receivables. Interest-only strip receivables represent the present value of residual cash flows we expect to receive over the life of the securitized receivables.  The value of these receivables is determined by estimating the future cash flows using our assumptions of key factors, such as finance charge income, loss rates, prepayment rates, funding costs and discount rates appropriate for the type of asset and risk.  The value of interest-only strip receivables could be affected by external factors, such as changes in the behavior patterns of customers, changes in the strength of the economy and developments in the interest rate and credit markets; therefore, actual performance could differ from these assumptions.  We evaluate the performance of the receivables relative to these assumptions on a regular basis.  Any financial impact resulting from a change in performance is recognized in earnings in the period in which it occurs.

Reserve accounts.  We are required to fund various reserve accounts established for the benefit of the securitization investors.  In the event that the cash generated by the securitized receivables in a given period was insufficient to pay the interest, principal and other required payments, the balances on deposit in the reserve accounts would be used to pay those amounts.  In general, each of our term securitizations requires that an amount equal to a specified percentage of the original balance of the securitized receivables be deposited in a reserve account on the closing date.  An amount equal to a specified percentage of funded receivables is also required in our warehouse facility.  Any excess cash generated by the receivables must be used to fund the reserve account to the extent necessary to maintain the required amount.  If the amount on deposit in the reserve account exceeds the required amount, the excess is released through the special purpose entity to us.  In the term securitizations, the amount required to be on deposit in the reserve account must equal or exceed a specified floor amount.  The reserve account remains funded until the investors are paid in full, at which time the remaining balance is released through the special purpose entity to us.  The amount on deposit in reserve accounts was $43.1 million as of November 30, 2009, and $41.4 million as of February 28, 2009.

Required excess receivables.  The total value of the securitized receivables must exceed the principal amount owed to the investors by a specified amount.  The required excess receivables balance represents this specified amount.  Any cash flows generated by the required excess receivables are used, if needed, to make payments to the investors.  Any remaining cash flows from the required excess receivables are released through the special purpose entity to us.  The unpaid principal balance related to the required excess receivables was $125.3 million as of November 30, 2009, and $139.1 million as of February 28, 2009.
 
 
Page 9 of 43

 
Retained subordinated bonds. Between January 2008 and April 2009, we retained some or all of the subordinated bonds associated with our term securitizations.  We receive periodic interest payments on certain bonds.  The bonds are carried at fair value and changes in fair value are included in earnings as a component of CAF income.  We base our valuation on observable market prices of the same or similar securities when available; however, observable market prices are not consistently available for these assets.  Our current valuations are primarily based on an average of three non-binding, current market spread quotes from third-party investment banks.  By applying these average spreads to current bond benchmarks, as determined through the use of a widely accepted third-party bond pricing model, we have measured a current fair value.  The fair value of retained subordinated bonds was $241.4 million as of November 30, 2009, and $87.4 million as of February 28, 2009.

Key Assumptions Used in Measuring the Fair Value of the Retained Interest and Sensitivity Analysis.  The following table shows the key economic assumptions used in measuring the fair value of the retained interest as of November 30, 2009, and a sensitivity analysis showing the hypothetical effect on the retained interest if there were unfavorable variations from the assumptions used.  These sensitivity analyses are hypothetical and should be used with caution.  In this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in actual circumstances, changes in one factor could result in changes in another, which might magnify or counteract the sensitivities.

KEY ASSUMPTIONS

 
(In millions)
 
Assumptions Used
   
Impact on Fair Value of 10% Adverse Change
   
Impact on Fair Value of 20% Adverse Change
 
Prepayment rate
    1.20% - 1.40 %   $ 8.0     $ 16.2  
Cumulative net loss rate
    1.94% - 4.00 %   $ 9.3     $ 18.6  
Annual discount rate
    17.25% - 19.00 %   $ 6.5     $ 12.8  
Warehouse facility costs (1)
    2.68 %   $ 1.8     $ 3.6  
 
(1)
Expressed as a spread above appropriate benchmark rates.  Applies only to retained interest in receivables securitized through the warehouse facility. As of November 30, 2009, there were receivables of $416.0 million funded in the warehouse facility.

Prepayment rate.  We use the Absolute Prepayment Model or “ABS” to estimate prepayments.  This model assumes a rate of prepayment each month relative to the original number of receivables in a pool of receivables.  ABS further assumes that all the receivables are the same size and amortize at the same rate and that each receivable in each month of its life will either be paid as scheduled or prepaid in full.  For example, in a pool of receivables originally containing 10,000 receivables, a 1% ABS rate means that 100 receivables prepay each month.

Cumulative net loss rate.  The cumulative net loss rate, or “static pool” net losses, is calculated by dividing the total projected credit losses of a pool of receivables, net of recoveries, by the original pool balance.  Projected net credit losses are estimated using the losses experienced to date, the credit quality of the receivables, economic factors and the performance history of similar receivables.

Annual discount rate.  The annual discount rate is the interest rate used for computing the present value of future cash flows and is determined based on the perceived market risk of the underlying auto loan receivables and current market conditions.

Warehouse facility costs.  While receivables are securitized in the warehouse facility, our retained interest is exposed to changes in credit spreads and other variable funding costs.  The warehouse facility costs are expressed as a spread above applicable benchmark rates.

Continuing Involvement with Securitized Receivables.  We continue to manage the auto loan receivables that we securitize.  We receive servicing fees of approximately 1% of the outstanding principal balance of the securitized receivables.  We believe that the servicing fees specified in the securitization agreements adequately compensate us for servicing
 
Page 10 of 43

 
the securitized receivables.  No servicing asset or liability has been recorded.  We are at risk for the retained interest in the securitized receivables and, if the securitized receivables do not perform as originally projected, the value of the retained interest would be impacted.
 
PAST DUE ACCOUNT INFORMATION

   
As of November 30
   
As of February 28 or 29
 
(In millions)
 
2009
   
2008
   
2009
   
2008
 
Accounts 31+ days past due
  $ 166.5     $ 136.1     $ 118.1     $ 86.1  
Ending managed receivables
  $ 4,097.4     $ 4,027.3     $ 3,986.7     $ 3,838.5  
Past due accounts as a percentage of ending managed receivables
    4.06 %     3.38  %     2.96 %     2.24
 
CREDIT LOSS INFORMATION

   
Three Months Ended
   
Nine Months Ended
 
   
November 30
   
November 30
 
(In millions)
 
2009
   
2008
   
2009
   
2008
 
Net credit losses on managed receivables
  $ 20.4     $ 21.6     $ 51.8     $ 48.5  
Average managed receivables
  $ 4,106.9     $ 4,076.3     $ 4,066.0     $ 4,019.0  
Annualized net credit losses as a percentage of average managed receivables
    1.99 %     2.11 %     1.70 %     1.61 %
Average recovery rate
    50.2 %     42.4 %     49.4 %     44.4 %

SELECTED CASH FLOWS FROM SECURITIZED RECEIVABLES
 
   
Three Months Ended
   
Nine Months Ended
 
   
November 30
   
November 30
 
(In millions)
 
2009
   
2008
   
2009
   
2008
 
Proceeds from new securitizations
  $ 432.0     $ 307.0     $ 1,262.0     $ 1,314.8  
Proceeds from collections
  $ 195.9     $ 176.7     $ 596.1     $ 664.9  
Servicing fees received
  $ 10.5     $ 10.5     $ 31.2     $ 30.9  
Other cash flows received from the retained interest:
                               
Interest-only strip receivables
  $ 32.5     $ 16.3     $ 99.4     $ 72.7  
Reserve account releases
  $ 4.3     $ 0.1     $ 16.6     $ 3.2  
Interest on retained subordinated bonds
  $ 2.4     $ 2.4     $ 7.2     $ 5.1  
 
Proceeds from new securitizations.  Proceeds from new securitizations include proceeds from receivables that are newly securitized in or refinanced through the warehouse facility during the indicated period.  Balances previously outstanding in term securitizations that were refinanced through the warehouse facility totaled $76.0 million in the first nine months of fiscal 2010 and $48.4 million in the first nine months of fiscal 2009.  Proceeds received when we refinance receivables from the warehouse facility are excluded from this table as they are not considered new securitizations.

Proceeds from collections.  Proceeds from collections represent principal amounts collected on receivables securitized through the warehouse facility that are used to fund new originations.

Servicing fees received.  Servicing fees received represent cash fees paid to us to service the securitized receivables.

Other cash flows received from the retained interest.  Other cash flows received from the retained interest represents cash that we receive from the securitized receivables other than servicing fees.  It includes cash collected on interest-only strip receivables, amounts released to us from reserve accounts and interest on retained subordinated bonds.
 
 
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Financial Covenants and Performance Triggers.  The securitization agreement related to the warehouse facility includes various financial covenants and performance triggers.  The financial covenants include a maximum total liabilities to tangible net worth ratio and a minimum fixed charge coverage ratio.  Performance triggers require that the pool of securitized receivables in the warehouse facility achieve specified thresholds related to portfolio yield, loss rate and delinquency rate.  If these financial covenants and/or thresholds are not met, we could be unable to continue to securitize receivables through the warehouse facility.  In addition, the warehouse facility investors would charge us a higher rate of interest and could have us replaced as servicer.  Further, we could be required to deposit collections on the securitized receivables with the warehouse agent on a daily basis, and deliver executed lockbox agreements to the warehouse facility agent.  As of November 30, 2009, we were in compliance with the financial covenants and the securitized receivables were in compliance with the performance triggers.
 
5.  
Financial Derivatives
 
We utilize derivatives relating to our auto loan receivable securitizations and our investment in certain retained subordinated bonds.  Interest rate swaps are used to better match funding costs to the interest on the fixed-rate receivables being securitized and the retained subordinated bonds, and to minimize the funding costs related to certain of our securitization trusts.  Swaps related to receivables funded in the warehouse facility are unwound when those receivables are refinanced in a term securitization.  During the third quarter of fiscal 2010, we entered into 19 interest rate swaps with initial notional amounts totaling $474.4 million and terms ranging from 15 to 41 months.  The notional amounts of outstanding swaps totaled $578.6 million as of November 30, 2009, and $1.36 billion as of February 28, 2009.  Interest rate caps are used to limit risk for investors in our warehouse facility.  During the quarter, we entered into two interest rate caps, with terms ranging from 48 to 52 months.  As of November 30, 2009, we were party to six interest rate caps, three of which were assets and three were liabilities, and as a result the net effect on the consolidated balance sheet was not material.

FAIR VALUE OF DERIVATIVE INSTRUMENTS (1)

 
 
 
As of November 30
   
As of February 28 or 29
 
(In thousands)
  Consolidated Balance Sheets  
2009
   
2008
   
2009
   
2008
 
Asset derivatives:
                         
Interest rate swaps
Retained interest in securitized receivables
  $ 138     $ 27     $ 33     $  
Interest rate swaps
Accounts payable
                52        
Interest rate caps
Other assets
    3,184                    
Liability derivatives:
                                 
Interest rate swaps
Accounts payable
    (8,477 )     (23,396 )     (30,590 )     (15,130 )
Interest rate caps
Other assets
    (3,171 )                  
Total
 
  $ (8,326 )   $ (23,369 )   $ (30,505 )   $ (15,130 )
 
CHANGES IN FAIR VALUE OF DERIVATIVE INSTRUMENTS (1)
 
 
 
 
Three Months Ended
   
Nine Months Ended
 
     
November 30
   
November 30
 
(In thousands)
  Consolidated Statements of Earnings  
2009
   
2008
   
2009
   
2008
 
Loss on interest rate swaps
CarMax Auto Finance income (loss)
  $ (4,404 )   $ (20,341 )   $ (9,197 )   $ (10,153 )
 
 
(1)
Additional information on fair value measurements is included in Note 6.
 
The market and credit risks associated with interest rate swaps and caps are similar to those relating to other types of financial instruments.  Market risk is the exposure created by potential fluctuations in interest rates.  We do not anticipate significant market risk from swaps as they are predominantly used to match funding costs to the use of the funding.  
 
 
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However, disruptions in the credit markets could impact the effectiveness of our hedging strategies.  Credit risk is the exposure to nonperformance of another party to an agreement.  We mitigate credit risk by dealing with highly rated bank counterparties.
 
6.  
Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market or, if none exists, the most advantageous market, for the specific asset or liability at the measurement date (referred to as the “exit price”).  The fair value should be based on assumptions that market participants would use, including a consideration of nonperformance risk.

We assess the inputs used to measure fair value using the three-tier hierarchy and as disclosed in the tables below.  The hierarchy indicates the extent to which inputs used in measuring fair value are observable in the market.

 
Level 1
Inputs include unadjusted quoted prices in active markets for identical assets or liabilities that we can access at the measurement date.

 
Level 2
Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets in active markets, quoted prices from identical or similar assets in inactive markets and observable inputs such as interest rates and yield curves.

 
Level 3
Inputs that are significant to the measurement that are not observable in the market and include management's judgments about the assumptions market participants would use in pricing the asset or liability (including assumptions about risk).  

Our fair value processes include controls that are designed to ensure that fair values are appropriate.  Such controls include model validation, review of key model inputs, analysis of period-over-period fluctuations and reviews by senior management.

VALUATION METHODOLOGIES

Money market securities. Money market securities are cash equivalents, which are included in either cash and cash equivalents or other assets, and consist of highly liquid investments with original maturities of three months or less.  We use quoted market prices for identical assets to measure fair value.  Therefore, all money market securities are classified as Level 1.

Retained interest in securitized receivables.  We retain an interest in the auto loan receivables that we securitize, including interest-only strip receivables, various reserve accounts, required excess receivables and retained subordinated bonds.  Excluding the retained subordinated bonds, we estimate the fair value of the retained interest using internal valuation models.  These models include a combination of market inputs and our own assumptions as described in Note 4.  As the valuation models include significant unobservable inputs, we classified the retained interest as Level 3.

For the retained subordinated bonds, we base our valuation on observable market prices for similar assets when available.  Otherwise, our valuations are based on input from independent third parties and internal valuation models, as described in Note 4.  As the key assumption used in the valuation is currently based on unobservable inputs, we classified the retained subordinated bonds as Level 3.

Financial derivatives.  Financial derivatives are included in either prepaid expenses and other current assets or accounts payable.  As part of our risk management strategy, we utilize derivatives relating to our auto loan receivable securitizations and our investment in retained subordinated bonds.  Interest rate swaps are used to better match funding costs to the interest on the fixed-rate receivables being securitized and the retained subordinated bonds and to minimize the funding costs related to certain of our securitization trusts.  Interest rate caps are used to limit risk for investors in our warehouse facility.  Our derivatives are not exchange-traded and are over-the-counter customized derivative instruments.  All of our derivative exposures are with highly rated bank counterparties.

We measure derivative fair values assuming that the unit of account is an individual derivative instrument and that derivatives are sold or transferred on a stand-alone basis.  We estimate the fair value of our derivatives using quotes determined by the derivative counterparties.  We validate these quotes using our own internal model.  Both our internal
 
 
Page 13 of 43

 
model and quotes received from bank counterparties project future cash flows and discount the future amounts to a present value using market-based expectations for interest rates and the contractual terms of the derivative instruments.  Because model inputs can typically be observed in the liquid market and the models do not require significant judgment, these derivatives are classified as Level 2.

Our derivative fair value measurements consider assumptions about counterparty and our own nonperformance risk.  We monitor counterparty and our own nonperformance risk and, in the event that we determine that a party is unlikely to perform under terms of the contract, we would adjust the derivative fair value to reflect the nonperformance risk.

ITEMS MEASURED AT FAIR VALUE ON A RECURRING BASIS

 
As of November 30, 2009
 
(In millions)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
ASSETS
                       
Money market securities
  $ 31.2     $     $     $ 31.2  
Retained interest in securitized receivables
           ―              
Total assets at fair value
  $ 31.2     $     $ 521.3     $ 552.5  
                                 
Percent of total assets at fair value
    5.7 %     %     94.3 %     100.0 %
Percent of total assets
    1.3 %     %     21.6 %     22.9 %
                                 
LIABILITIES
                               
Financial derivatives
  $     $ 8.5     $     $ 8.5  
Total liabilities at fair value
  $     $ 8.5     $     $ 8.5  
                                 
Percent of total liabilities
    %     1.5 %     %     1.5 %

CHANGES IN THE LEVEL 3 ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

(In millions)
 
Retained interest in
securitized receivables
 
Balance as of February 28, 2009
  $ 348.3  
Total realized/unrealized gains (1)
    67.7  
Purchases, sales, issuances and settlements, net
    105.3  
Balance as of November 30, 2009
  $ 521.3  
         
Change in unrealized gains on assets still held (1)
  $ 61.1  
 
(1)
Reported in CarMax Auto Finance income (loss) on the consolidated statements of earnings.
 
 
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7.  
Income Taxes

We had $17.0 million of gross unrecognized tax benefits as of November 30, 2009, and $25.6 million as of February 28, 2009.  During the first nine months of fiscal 2010, we settled federal and state liabilities of $9.5 million related to the Internal Revenue Service audit of fiscal years 2005 through 2007 and various other prior year tax audits.  There were no other significant changes to the unrecognized tax benefits as reported for the year ended February 28, 2009, as all other activity was related to positions taken on tax returns filed or intended to be filed in the current fiscal year.

8.  
Retirement Plans

Effective December 31, 2008, we froze both our noncontributory defined benefit pension plan (the “pension plan”) and our unfunded nonqualified plan (the “restoration plan”).  No additional benefits accrue after that date for either plan.  The pension plan covers the majority of full-time employees.  The restoration plan restores retirement benefits for certain senior executives who are affected by Internal Revenue Code limitations on benefits provided under the pension plan.  We use a fiscal year end measurement date for both the pension plan and the restoration plan.

COMPONENTS OF NET PENSION EXPENSE
 
   
Three Months Ended November 30
 
   
Pension Plan
   
Restoration Plan
   
Total
 
(In thousands)
 
2009
   
2008
   
2009
   
2008
   
2009
   
2008
 
Service cost
  $     $ 2,368     $     $ 203     $     $ 2,571  
Interest cost
    1,428       1,526       152       177       1,580       1,703  
Expected return on plan assets
    (1,622 )     (1,408 )                 (1,622 )     (1,408 )
Amortization of prior service cost
          5             14             19  
Recognized actuarial (gain) loss
          (463 )           49             (414
Pension (benefit) expense
    (194 )     2,028       152       443       (42 )     2,471  
Curtailment (gain) loss
          (8,229 )           800             (7,429 )
Net pension (benefit) expense
  $ (194 )   $ (6,201 )   $ 152     $ 1,243     $ (42 )   $ (4,958


   
Nine Months Ended November 30
 
   
Pension Plan
   
Restoration Plan
   
Total
 
(In thousands)
 
2009
   
2008
   
2009
   
2008
   
2009
   
2008
 
Service cost
  $     $ 9,252     $     $ 631     $     $ 9,883  
Interest cost
    4,284       5,056       454       593       4,738       5,649  
Expected return on plan assets
    (4,866 )     (4,098 )                 (4,866 )     (4,098 )
Amortization of prior service cost
          23             74             97  
Recognized actuarial (gain) loss
          (175 )           247             72  
Pension (benefit) expense
    (582 )     10,058       454       1,545       (128 )     11,603  
Curtailment (gain) loss
          (8,229 )           800             (7,429 )
Net pension (benefit) expense
  $ (582   $ 1,829     $ 454     $ 2,345     $ (128   $ 4,174  
 

We made contributions to the pension plan totaling $15.0 million during the first nine months of fiscal 2010.  We do not anticipate making a contribution to the pension plan in the fourth quarter of fiscal 2010.
 
9.  
Debt

Our $700 million revolving credit facility (the “credit facility”) expires in December 2011 and is secured by vehicle inventory.  Borrowings under this credit facility are limited to 80% of qualifying inventory, and they are available for working capital and general corporate purposes.  As of November 30, 2009, $118.7 million was outstanding under the credit facility
 
 
Page 15 of 43

 
and $461.3 million of the remaining borrowing limit was available to us.  The outstanding balance included $0.2 million classified as short-term debt and $118.5 million classified as current portion of long-term debt.  We classified $118.5 million as current portion of long-term debt based on our expectation that this balance will not remain outstanding for more than one year.

Obligations under capital leases as of November 30, 2009, consisted of $0.7 million classified as current portion of long-term debt and $27.5 million classified as long-term debt.
 
10.  
Share-Based Compensation

We maintain long-term incentive plans for management, key employees and the nonemployee members of our board of directors.  The plans allow for the grant of equity-based compensation awards, including nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock awards, stock- and cash-settled restricted stock units, stock grants or a combination of awards.  To date, we have awarded no incentive stock options.

Stock options are awards that allow the recipient to purchase shares of our stock at a fixed price.  Stock options are granted at an exercise price equal to the fair market value of our stock on the grant date.  Substantially all of the stock options vest annually in equal amounts over periods of three to four years.  These options expire no later than ten years after the date of the grant.  Restricted stock awards and restricted stock units are subject to specified restrictions and a risk of forfeiture.  The restrictions typically lapse three years from the grant date.

COMPOSITION OF SHARE-BASED COMPENSATION EXPENSE

   
Three Months Ended
   
Nine Months Ended
 
   
November 30
   
November 30
 
(In thousands)
 
2009
   
2008
   
2009
   
2008
 
Cost of sales
  $ 727     $ 582     $ 1,651     $ 1,585  
CarMax Auto Finance income (loss)
    356       355       987       784  
Selling, general and administrative expenses
    7,175       7,227       28,798       25,494  
Share-based compensation expense, before income taxes
  $ 8,258     $ 8,164     $ 31,436     $ 27,863  

We recognize compensation expense for stock options, restricted stock and stock-settled restricted stock units on a straight-line basis (net of estimated forfeitures) over the requisite service period, which is generally the vesting period of the award.  Our employee stock purchase plan is considered a liability-classified compensatory plan; the associated costs included in share-based compensation expense in the third quarter of fiscal 2010 and fiscal 2009 were $0.2 million.  The associated costs for the employee stock purchase plan included in share-based compensation expense in the first nine months of fiscal 2010 and fiscal 2009 were $0.7 million and $0.8 million, respectively.  Cash-settled restricted stock units granted in April 2009 are also classified as liability awards and the associated costs of $1.8 million in the third quarter and $4.4 million in the first nine months of fiscal 2010 are included in share-based compensation expense.  There were no capitalized share-based compensation costs as of November 30, 2009 and 2008.
 
 

 
Page 16 of 43

 
STOCK OPTION ACTIVITY
 
 
 
(Shares and intrinsic value in thousands)
 
 
Number of Shares
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Life (Years)
   
 
Aggregate Intrinsic Value
 
Outstanding as of March 1, 2009
    14,844     $ 15.40              
Options granted
    2,948     $ 11.52              
Options exercised
    (2,447 )   $ 11.12              
Options forfeited or expired
    (963 )   $ 13.66              
Outstanding as of November 30, 2009
    14,382     $ 15.45       4.9     $ 72,413  
Exercisable as of November 30, 2009
    8,510     $ 14.95       4.4     $ 46,374  

For the nine months ended November 30, 2009 and 2008, we granted nonqualified options to purchase 2,948,150 and 2,219,857 shares of common stock, respectively.  The total cash received as a result of stock option exercises was $27.2 million in the first nine months of fiscal 2010 and $10.0 million in the first nine months of fiscal 2009.  We settle stock option exercises with authorized but unissued shares of CarMax common stock.  The total intrinsic value of options exercised was $18.7 million for the first nine months of fiscal 2010 and $5.6 million for the first nine months of fiscal 2009.  We realized related tax benefits of $7.6 million in the first nine months of fiscal 2010 and $2.2 million in the first nine months of fiscal 2009.

OUTSTANDING STOCK OPTIONS
 
As of November 30, 2009
   
Options Outstanding
   
Options Exercisable
 
(Shares in thousands)
Range of Exercise Prices
   
 
Number of Shares
   
Weighted Average Remaining Contractual Life (Years)
   
Weighted Average Exercise Price
   
 
Number of Shares
   
Weighted Average Exercise Price
 
                                 
$ 7.02 to $ 9.30       1,122       3.2     $ 7.16       1,122     $ 7.16  
$ 10.74 to $11.43       2,888       6.3     $ 11.41       64     $ 10.75  
$ 13.19       2,361       5.5     $ 13.19       2,361     $ 13.19  
$ 14.13 to $14.86       2,478       4.5     $ 14.67       2,327     $ 14.67  
$ 15.17 to $17.44       1,713       3.4     $ 17.07       1,271     $ 17.08  
$ 19.36 to $19.82       2,143       5.3     $ 19.80       512     $ 19.80  
$ 22.28 to $25.79       1,677       4.4     $ 25.03       853     $ 25.03  
Total
      14,382       4.9     $ 15.45       8,510     $ 14.95  

For all stock options granted prior to March 1, 2006, the fair value was estimated as of the date of grant using a Black-Scholes option-pricing model.  For stock options granted to employees on or after March 1, 2006, the fair value of each award is estimated as of the date of grant using a binomial valuation model.  In computing the value of the option, the binomial model considers characteristics of fair-value option pricing that are not available for consideration under the Black-Scholes model, such as the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life and the probability of termination or retirement of the option holder.  For this reason, we believe that the binomial model provides a fair value that is more representative of actual experience and future expected experience than the value calculated using the Black-Scholes model.  For grants to nonemployee directors prior to fiscal 2009, we used the Black-Scholes model to estimate the fair value of stock option awards.  Beginning in fiscal 2009, we used the binomial model.  Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the recipients of share-based awards.
 
 
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The weighted average fair values at the date of grant for options granted during the nine-month periods ended November 30, 2009 and 2008, were $5.30 and $7.16 per share, respectively.  The unrecognized compensation costs related to nonvested options totaled $21.8 million as of November 30, 2009.  These costs are expected to be recognized over a weighted average period of 2.5 years.

ASSUMPTIONS USED TO ESTIMATE OPTION VALUES

   
Nine Months Ended November 30
 
   
2009
   
2008
 
Dividend yield
    0.0 %     0.0 %
Expected volatility factor(1)
    52.2% – 73.4 %     34.8% – 60.9 %
Weighted average expected volatility
    57.3 %     44.1 %
Risk-free interest rate(2) 
    0.2% – 3.2 %     1.5% – 3.7 %
Expected term (in years)(3)
    5.2 – 5.5       4.8 – 5.2  
 
 
(1)
Measured using historical daily price changes of our stock for a period corresponding to the term of the option and the implied volatility derived from the market prices of traded options on our stock.
 
(2)
Based on the U.S. Treasury yield curve in effect at the time of grant.
 
(3)
Represents the estimated number of years that options will be outstanding prior to exercise.

RESTRICTED STOCK ACTIVITY
 
(In thousands)
 
Number of Shares
   
Weighted Average Grant Date Fair Value
 
Outstanding as of March 1, 2009
    2,633     $ 20.55  
Restricted stock vested
    (816 )   $ 17.23  
Restricted stock cancelled
    (126 )   $ 21.56  
Outstanding as of November 30, 2009
    1,691     $ 22.08  


For the nine months ended November 30, 2009, no shares of restricted stock were granted.  The fair value of a restricted stock award is determined and fixed based on the fair market value of our stock on the grant date.  We realized related tax benefits of $4.2 million from the vesting of restricted stock in the first nine months of fiscal 2010. The unrecognized compensation costs related to nonvested restricted stock awards totaled $9.6 million as of November 30, 2009.  These costs are expected to be recognized over a weighted average period of 0.9 years.
 
Stock-Settled Restricted Stock Units.  In April 2009, we granted stock-settled restricted stock units, which we refer to as market stock units, or MSUs, to eligible key employees.  Generally, at the end of the three-year vesting period, each MSU will be converted into between zero and two shares of CarMax common stock.  The share conversion is dependent on the performance of the company’s common stock during the last 40 trading days prior to the vesting date.  The expense associated with outstanding MSUs is recorded over their life.  The fixed fair value per share was determined to be $16.34 at the grant date using a Monte-Carlo simulation and was based on the expected market price on the vesting date and the expected number of converted common shares.  The compensation expense for the three months and nine months ended November 30, 2009, was $0.4 million and $2.1 million, respectively.  The unrecognized compensation costs related to these nonvested MSUs totaled $4.1 million as of November 30, 2009.  These costs are expected to be recognized over a weighted average period of 2.3 years.
 
 
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STOCK-SETTLED RESTRICTED STOCK UNIT ACTIVITY
 
(In thousands)  
Number of Shares
   
Weighted Average Grant Date Fair Value
 
Outstanding as of March 1, 2009
        $  
Stock units granted
    406     $ 16.34  
Stock units vested and converted
    (6 )   $ 16.34  
Stock units cancelled
    (5 )   $ 16.34  
Outstanding as of November 30, 2009
    395     $ 16.34  
 
Cash-Settled Restricted Stock Units.   Additionally in April 2009, we granted cash-settled restricted stock units to other eligible employees.  These restricted stock units, or RSUs, are classified as liability awards.  At the end of the three-year vesting period, each RSU will entitle its holder to a cash payment equal to the fair market value of CarMax common stock on the vesting date.  However, the cash payment will be no greater than 200%, or less than 75%, of the fair market value of CarMax common stock on the RSUs grant date.  The variable expense associated with these outstanding RSUs is recorded over their life and is calculated based on the company’s closing stock price at the end of each reporting period.  The compensation expense for the third quarter of fiscal year 2010 was $1.8 million and $4.4 million in the first nine months of fiscal year 2010.  As of November 30, 2009, we expect the total cash settlement upon vesting to range between $7.2 million to $19.1 million.
 
11.  
Net Earnings per Share

On March 1, 2009, the company adopted the accounting pronouncement related to participating securities,  with retrospective application, which was subsequently integrated into the FASB Accounting Standards Codification (“FASB ASC”) Topic 260, “Earnings Per Share.”  This pronouncement addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, and therefore need to be included in the earnings allocation in computing earnings per share under the two-class method, as described in this pronouncement.  Nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and should be included in the computation of earnings per share pursuant to the two-class method.  Our restricted stock awards are considered “participating securities” because they contain nonforfeitable rights to dividends.  Nonvested MSUs and RSUs granted after February 28, 2009, do not receive nonforfeitable dividend equivalent rights and are therefore not considered participating securities.  The adoption of this pronouncement had no impact on previously reported basic or diluted net earnings per share for the three months and nine months ended November 30, 2008.
 
 
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BASIC AND DILUTIVE NET EARNINGS PER SHARE RECONCILIATIONS
 
   
Three Months Ended
   
Nine Months Ended
 
   
November 30
   
November 30
 
(In thousands except per share data)
 
2009
   
2008
   
2009
   
2008
 
Net earnings (loss)
  $ 74,589     $ (21,874 )   $ 206,308     $ 21,690  
Less net earnings (loss) allocable to restricted stock
    574       (268 )     1,804       256  
Net earnings (loss) available for basic common shares
    74,015       (21,606 )     204,504       21,434  
Adjustment for dilutive potential common shares
    10             19       2  
Net earnings (loss) available for diluted common shares
  $ 74,025     $ (21,606 )   $ 204,523     $ 21,436  
                                 
Weighted average common shares outstanding
    220,204       217,712       218,980       217,468  
Dilutive potential common shares:
                               
Stock options
    3,236             2,141       2,210  
Stock-settled restricted stock units
    439             225        
Weighted average common shares and dilutive potential common shares
    223,879       217,712       221,346       219,678  
Basic net earnings (loss) per share
  $ 0.34     $ (0.10 )   $ 0.93     $ 0.10  
Diluted net earnings (loss) per share
  $ 0.33     $ (0.10 )   $ 0.92     $ 0.10  
 
For the quarters ended November 30, 2009 and 2008, weighted-average options to purchase 3,484,685 shares and 14,934,460 shares, respectively, of common stock were outstanding and not included in the calculations of diluted net earnings per share because their inclusion would be antidilutive.  For the nine months ended November 30, 2009 and 2008, weighted-average options to purchase 7,787,984 shares and 5,508,301 shares, respectively, of common stock were outstanding and not included in the calculations.
 
12.  
Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss relates entirely to unrecognized actuarial losses on our retirement plans.  The total accumulated other comprehensive loss was $16.9 million as of November 30, 2009, and February 28, 2009.  The cumulative balance was net of deferred tax of $9.9 million as of November 30, 2009, and February 28, 2009.

13.  
Contingent Liabilities

On April 2, 2008, Mr. John Fowler filed a putative class action lawsuit against CarMax Auto Superstores California, LLC and CarMax Auto Superstores West Coast, Inc. in the Superior Court of California, County of Los Angeles.  Subsequently, two other lawsuits, Leena Areso et al. v.  CarMax Auto Superstores California, LLC and Justin Weaver v. CarMax Auto Superstores California, LLC, were consolidated as part of the Fowler case.  The allegations in the consolidated case involved: (1) failure to provide meal and rest breaks or compensation in lieu thereof; (2) failure to pay wages of terminated or resigned employees related to meal and rest breaks and overtime; (3) failure to pay overtime; (4) failure to comply with itemized employee wage statement provisions; and (5) unfair competition.  The putative class consisted of sales consultants, sales managers, and other hourly employees who worked for the company in California from April 2, 2004, to the present.  On May 12, 2009, the court dismissed all of the class claims with respect to the sales
 
 
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manager putative class.  On June 16, 2009, the court dismissed all claims related to the failure to comply with the itemized employee wage statement provisions.  The court also granted CarMax's motion for summary adjudication with regard to CarMax's alleged failure to pay overtime to the sales consultant putative class.  The plaintiffs have appealed the court's ruling regarding the sales consultant overtime claim.  In addition to the plaintiffs' appeal of the overtime claim, the claims currently remaining in the lawsuit regarding the sales consultant putative class are: (1) failure to provide meal and rest breaks or compensation in lieu thereof; (2) failure to pay wages of terminated or resigned employees related to meal and rest breaks; and (3) unfair competition.  On June 16, 2009, the court entered a stay of these claims pending the outcome of a California Supreme Court case involving related legal issues.  The lawsuit seeks compensatory and special damages, wages, interest, civil and statutory penalties, restitution, injunctive relief and the recovery of attorneys’ fees.  We are unable to make a reasonable estimate of the amount or range of loss that could result from an unfavorable outcome in these matters.

We are involved in various other legal proceedings in the normal course of business.  Based upon our evaluation of information currently available, we believe that the ultimate resolution of any such proceedings will not have a material adverse effect, either individually or in the aggregate, on our financial condition or results of operations.

14.  
Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168, “The ‘FASB Accounting Standards Codification’ and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”) and integrated it into the FASB ASC Topic 105, “Generally Accepted Accounting Principles,” (“Topic 105"),  as subsequently updated by FASB Accounting Standards Updates (“ASUs”) Nos. 2009-01 through 2010-03.  Topic 105 establishes the FASB ASC, which officially launched July 1, 2009, as the source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants.  The subsequent issuances of new standards will be in the form of FASB ASUs that will be included in the FASB ASC.  Generally, the FASB ASC is not expected to change U.S. GAAP.  All other accounting literature excluded from the FASB ASC will be considered nonauthoritative.  Topic 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009.  We have adopted this pronouncement for our quarter ended November 30, 2009.  Beginning this quarter, references to authoritative accounting literature will be in accordance with the FASB ASC.

In December 2008, the FASB issued an accounting pronouncement related to employers’ disclosures about postretirement benefit plan assets (FASB ASC Topic 715), which will require employers to disclose information about how investment allocation decisions are made, the fair value of each major category of plan assets and information about the inputs and valuation techniques used to develop the fair value measurements of plan assets.  This pronouncement is effective for fiscal years ending after December 15, 2009.  We will include the newly required disclosures in our annual consolidated financial statements and notes for the fiscal year ending February 28, 2010.

In April 2009, the FASB issued an accounting pronouncement related to fair value measurements (FASB ASC Topic 820), which provides guidance on estimating fair value when market activity has decreased and on identifying transactions that are not orderly.  Additionally, entities are required to disclose in interim and annual periods the inputs and valuation techniques used to measure fair value.  This pronouncement is effective for interim and annual periods ending after June 15, 2009.  As the requirements are consistent with our previous practice, its implementation did not have an impact on our consolidated financial statements.

In May 2009, the FASB issued an accounting pronouncement related to subsequent events (FASB ASC Topic 855), which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before the date the financial statements are issued or available to be issued.  This pronouncement requires companies to reflect in their financial statements the effects of subsequent events that provide additional evidence about conditions at the balance-sheet date.  Subsequent events that provide evidence about conditions that arose after the balance-sheet date should be disclosed if the financial statements would otherwise be misleading.  Disclosures should
 
 
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