Edgar Filing: CARMAX INC

Document

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, 2016

[ ] 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 x		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 30, 2016
Common Stock, par value $0.50		187,116,434

Page 1

CARMAX, INC. AND SUBSIDIARIES

TABLE OF CONTENTS



			Page No.
PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements:

		Consolidated Statements of Earnings (Unaudited) –
		Three and Nine Months Ended November 30, 2016 and 2015	3

		Consolidated Statements of Comprehensive Income (Unaudited) –
		Three and Nine Months Ended November 30, 2016 and 2015	4

		Consolidated Balance Sheets (Unaudited) –
		November 30, 2016 and February 29, 2016	5

		Consolidated Statements of Cash Flows (Unaudited) –
		Nine Months Ended November 30, 2016 and 2015	6

		Notes to Consolidated Financial Statements (Unaudited)	7

	Item 2.	Management's Discussion and Analysis of Financial Condition and
		Results of Operations	22

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36

	Item 4.	Controls and Procedures	36

PART II.	OTHER INFORMATION

	Item 1.	Legal Proceedings	37

	Item 1A.	Risk Factors	37

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37

	Item 5.	Other Information	38

	Item 6.	Exhibits	39

SIGNATURES			40

EXHIBIT INDEX			41

Page 2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARMAX, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)



	Three Months Ended November 30						Nine Months Ended November 30
(In thousands except per share data)	2016		%⁽¹⁾	2015		%⁽¹⁾	2016			%⁽¹⁾	2015		%⁽¹⁾
SALES AND OPERATING REVENUES:
Used vehicle sales	$	3,090,613	83.5	$	2,908,963	82.1	$	9,820,401		83.0	$	9,351,841	81.7
Wholesale vehicle sales	488,385		13.2	513,796		14.5	1,616,528			13.7	1,682,195		14.7
Other sales and revenues	122,526		3.3	121,310		3.4	388,229			3.3	409,834		3.6
NET SALES AND OPERATING REVENUES	3,701,524		100.0	3,544,069		100.0	11,825,158			100.0	11,443,870		100.0
Cost of sales	3,198,389		86.4	3,079,738		86.9	10,204,024			86.3	9,914,375		86.6
GROSS PROFIT	503,135		13.6	464,331		13.1	1,621,134			13.7	1,529,495		13.4
CARMAX AUTO FINANCE INCOME	89,359		2.4	92,316		2.6	286,086			2.4	299,703		2.6
Selling, general and administrative expenses	356,735		9.6	337,512		9.5	1,103,091			9.3	1,018,075		8.9
Interest expense	15,071		0.4	10,021		0.3	40,063			0.3	24,574		0.2
Other expense (income)	1,027		—	1,157		—	(24		)	—	2,791		—
Earnings before income taxes	219,661		5.9	207,957		5.9	764,090			6.5	783,758		6.8
Income tax provision	83,016		2.2	79,758		2.3	289,723			2.5	301,357		2.6
NET EARNINGS	$	136,645	3.7	$	128,199	3.6	$	474,367		4.0	$	482,401	4.2
WEIGHTED AVERAGE COMMON SHARES:
Basic	189,200			201,291			191,431				205,760
Diluted	190,818			203,383			193,239				208,242
NET EARNINGS PER SHARE:
Basic	$	0.72		$	0.64		$	2.48			$	2.34
Diluted	$	0.72		$	0.63		$	2.45			$	2.32

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

See accompanying notes to consolidated financial statements.

Page 3

CARMAX, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)



	Three Months Ended November 30					Nine Months Ended November 30
(In thousands)	2016		2015			2016		2015
NET EARNINGS	$	136,645	$	128,199		$	474,367	$	482,401
Other comprehensive income (loss), net of taxes:
Net change in retirement benefit plan unrecognized actuarial losses	247		322			744		967

Net change in cash flow hedge unrecognized losses	6,200		(837		)	9,317		(2,240		)

Other comprehensive income (loss), net of taxes	6,447		(515		)	10,061		(1,273		)
TOTAL COMPREHENSIVE INCOME	$	143,092	$	127,684		$	484,428	$	481,128

See accompanying notes to consolidated financial statements.

Page 4

CARMAX, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)



	As of November 30			As of February 29
(In thousands except share data)	2016			2016
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	23,713		$	37,394
Restricted cash from collections on auto loan receivables	357,040			343,829
Accounts receivable, net	92,003			132,171
Inventory	2,170,175			1,932,029
Other current assets	41,347			26,358
TOTAL CURRENT ASSETS	2,684,278			2,471,781
Auto loan receivables, net	10,333,318			9,536,892
Property and equipment, net	2,449,343			2,161,698
Deferred income taxes	155,995			161,862
Other assets	137,133			127,678
TOTAL ASSETS	$	15,760,067		$	14,459,911
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	476,757		$	441,746
Accrued expenses and other current liabilities	224,585			245,909
Accrued income taxes	2,071			2,029
Short-term debt	880			428
Current portion of finance and capital lease obligations	10,566			14,331
Current portion of non-recourse notes payable	312,858			300,750
TOTAL CURRENT LIABILITIES	1,027,717			1,005,193
Long-term debt, excluding current portion	888,161			713,910
Finance and capital lease obligations, excluding current portion	466,965			400,323
Non-recourse notes payable, excluding current portion	10,129,401			9,206,425
Other liabilities	232,439			229,274
TOTAL LIABILITIES	12,744,683			11,555,125

Commitments and contingent liabilities
SHAREHOLDERS’ EQUITY:
Common stock, $0.50 par value; 350,000,000 shares authorized; 187,351,060 and 194,712,234 shares issued and outstanding as of November 30, 2016 and February 29, 2016, respectively	93,676			97,356
Capital in excess of par value	1,160,484			1,130,822
Accumulated other comprehensive loss	(60,135		)	(70,196		)
Retained earnings	1,821,359			1,746,804
TOTAL SHAREHOLDERS’ EQUITY	3,015,384			2,904,786
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	15,760,067		$	14,459,911

See accompanying notes to consolidated financial statements.

Page 5

CARMAX, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)



	Nine Months Ended November 30
(In thousands)	2016			2015
OPERATING ACTIVITIES:
Net earnings	$	474,367		$	482,401
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization	125,654			100,504
Share-based compensation expense	72,026			45,284
Provision for loan losses	104,249			70,165
Provision for cancellation reserves	51,768			61,048
Deferred income tax benefit	(584		)	(8,322		)
Other	2,118			3,007
Net decrease (increase) in:
Accounts receivable, net	40,168			49,160
Inventory	(238,146		)	(66,396		)
Other current assets	(5,802		)	12,397
Auto loan receivables, net	(900,675		)	(952,974		)
Other assets	1,193			268
Net decrease in:
Accounts Payable, accrued expenses and other
current liabilities and accrued income taxes	(5,240		)	(109,243		)
Other liabilities	(64,222		)	(68,878		)
NET CASH USED IN OPERATING ACTIVITIES	(343,126		)	(381,579		)
INVESTING ACTIVITIES:
Capital expenditures	(315,543		)	(240,835		)
Proceeds from sales of assets	728			1,520
Increase in restricted cash from collections on auto loan receivables	(13,211		)	(22,064		)
Increase in restricted cash in reserve accounts	(11,663		)	(8,383		)
Release of restricted cash from reserve accounts	8,083			5,907
Purchases of money market securities, net	(3,482		)	(6,106		)
Purchases of trading securities	(3,442		)	(4,759		)
Sales of trading securities	318			101
NET CASH USED IN INVESTING ACTIVITIES	(338,212		)	(274,619		)
FINANCING ACTIVITIES:
Increase (decrease) in short-term debt, net	452			(749		)
Proceeds from issuances of long-term debt	1,660,600			1,137,300
Payments on long-term debt	(1,484,900		)	(583,300		)
Cash paid for debt issuance costs	(12,568		)	(3,104		)
Payments on finance and capital lease obligations	(8,407		)	(13,310		)
Issuances of non-recourse notes payable	7,235,000			7,430,805
Payments on non-recourse notes payable	(6,299,802		)	(6,565,516		)
Repurchase and retirement of common stock	(464,352		)	(816,181		)
Equity issuances	34,554			44,855
Excess tax benefits from share-based payment arrangements	7,080			31,138
NET CASH PROVIDED BY FINANCING ACTIVITIES	667,657			661,938
(Decrease) increase in cash and cash equivalents	(13,681		)	5,740
Cash and cash equivalents at beginning of year	37,394			27,606
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	23,713		$	33,346

See accompanying notes to consolidated financial statements.

Page 6

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 operate in two reportable segments: CarMax Sales Operations and CarMax Auto Finance (“CAF”). Our CarMax Sales Operations segment consists of all aspects of our auto merchandising and service operations, excluding financing provided by CAF. Our CAF segment consists solely of our own finance operation that provides financing to customers buying retail vehicles from CarMax.

We seek to deliver an unrivaled customer experience by offering a broad selection of high quality used vehicles and related products and services at low, no-haggle prices using a customer-friendly sales process in an attractive, modern sales facility, as well as through carmax.com and our mobile apps. We provide customers with a full range of related products and services, including the appraisal and purchase of vehicles directly from consumers; the financing of vehicle purchases through CAF and third-party financing providers; the sale of extended protection plan (“EPP”) products, which include extended service plans (“ESPs”) and guaranteed asset protection (“GAP”); 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. These consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP 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. 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 29, 2016.

The preparation of financial statements in conformity with U.S. GAAP 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. Certain prior year amounts have been reclassified to conform to the current year’s presentation. Amounts and percentages may not total due to rounding.

In connection with our adoption of ASU 2015-03 in fiscal 2017, we have presented all debt issuance costs, with the exception of those related to our revolving credit facility, as a reduction of the carrying amount of the related debt liability. Prior period amounts have been reclassified to conform to the current year's presentation.

In the fourth quarter of fiscal 2016, we reclassified New Vehicle Sales to Other Sales and Revenues and no longer separately present New Vehicle Sales. All periods presented have been revised for this new presentation.

Cash and Cash Equivalents. Cash equivalents of approximately $272,000 as of November 30, 2016, and $109,000 as of February 29, 2016, consisted of highly liquid investments with original maturities of three months or less.

Restricted Cash from Collections on Auto Loan Receivables. Cash equivalents totaling $357.0 million as of November 30, 2016, and $343.8 million as of February 29, 2016, consisted of collections of principal, interest and fee payments on securitized auto loan receivables that are restricted for payment to the securitization investors pursuant to the applicable securitization agreements.

Securitizations. We maintain a revolving securitization program composed of three warehouse facilities (“warehouse facilities”) that we use to fund auto loan receivables originated by CAF. We typically elect to fund these receivables through a term securitization or alternative funding arrangement at a later date. We sell the auto loan receivables to one of three wholly owned, bankruptcy-remote, special purpose entities that transfer an undivided percentage ownership interest in the receivables, but not the receivables themselves, to entities formed by third-party investors. These entities issue asset-backed commercial paper or utilize other funding sources supported by the transferred receivables, and the proceeds are used to finance the securitized receivables.

Page 7

We typically use term securitizations to provide long-term funding for most of the auto loan receivables initially securitized through the warehouse facilities. 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 asset-backed securities are used to finance the securitized receivables.

We are required to evaluate term securitization trusts for consolidation. In our capacity as servicer, we have the power to direct the activities of the trusts that most significantly impact the economic performance of the trusts. In addition, we have the obligation to absorb losses (subject to limitations) and the rights to receive any returns of the trusts, which could be significant. Accordingly, we are the primary beneficiary of the trusts and are required to consolidate them.

We recognize transfers of auto loan receivables into the warehouse facilities and term securitizations (“securitization vehicles”) as secured borrowings, which result in recording the auto loan receivables and the related non-recourse notes payable on our consolidated balance sheets.

The securitized receivables can only be used as collateral to settle obligations of the securitization vehicles. The securitization vehicles and investors have no recourse to our assets beyond the securitized receivables, the amounts on deposit in reserve accounts and the restricted cash from collections on auto loan receivables. We have not provided financial or other support to the securitization vehicles that was not previously contractually required, and there are no additional arrangements, guarantees or other commitments that could require us to provide financial support to the securitization vehicles.

See Notes 4 and 10 for additional information on auto loan receivables and non-recourse notes payable.

Auto Loan Receivables, Net. Auto loan receivables include amounts due from customers related to retail vehicle sales financed through CAF. The receivables are presented net of an allowance for estimated loan losses. The allowance for loan losses represents an estimate of the amount of net losses inherent in our portfolio of managed receivables as of the applicable reporting date and anticipated to occur during the following 12 months. The allowance is primarily based on the credit quality of the underlying receivables, historical loss trends and forecasted forward loss curves. We also take into account recent trends in delinquencies and defaults, recovery rates and the economic environment. The provision for loan losses is the periodic expense of maintaining an adequate allowance.

An account is considered delinquent when the related customer fails to make a substantial portion of a scheduled payment on or before the due date. In general, accounts are charged-off on the last business day of the month during which the earliest of the following occurs: the receivable is 120 days or more delinquent as of the last business day of the month, the related vehicle is repossessed and liquidated, or the receivable is otherwise deemed uncollectible. For purposes of determining impairment, auto loans are evaluated collectively, as they represent a large group of smaller-balance homogeneous loans, and therefore, are not individually evaluated for impairment. See Note 4 for additional information on auto loan receivables.

Interest income and expenses related to auto loans are included in CAF income. Interest income on auto loan receivables is recognized when earned based on contractual loan terms. All loans continue to accrue interest until repayment or charge-off. Direct costs associated with loan originations are not considered material, and thus, are expensed as incurred. See Note 3 for additional information on CAF income.

Property and Equipment. Property and equipment is stated at cost less accumulated depreciation and amortization of $1.01 billion and $925.3 million as of November 30, 2016 and February 29, 2016, respectively.

Other Assets. Other assets includes amounts classified as restricted cash on deposit in reserve accounts and restricted investments. The restricted cash on deposit in reserve accounts is for the benefit of holders of non-recourse notes payable, and these funds are not expected to be available to the company or its creditors. 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. Restricted cash on deposit in reserve accounts is invested in money market securities and was $50.2 million as of November 30, 2016, and $46.6 million as of February 29, 2016.

Restricted investments includes money market securities primarily held to satisfy certain insurance program requirements, as well as mutual funds held in a rabbi trust established to fund informally our executive deferred compensation plan. Restricted investments totaled $70.7 million as of November 30, 2016, and $63.0 million as of February 29, 2016.

Page 8

Revenue Recognition. We recognize revenue when the earnings process is complete, generally either at the time of sale to a customer or upon delivery to a customer. As part of our customer service strategy, we guarantee the retail vehicles we sell with a 5-day, money-back guarantee. We record a reserve for estimated returns based on historical experience and trends.

We also sell ESP and GAP products on behalf of unrelated third parties, who are the primary obligors, to customers who purchase a vehicle. The ESPs we currently offer on all used vehicles provide coverage up to 60 months (subject to mileage limitations), while GAP covers the customer for the term of their finance contract. We recognize revenue at the time of sale, net of a reserve for estimated contract cancellations. Periodically, we may receive additional revenue based upon the level of underwriting profits of the third parties who administer the products. These additional amounts are recognized as revenue when received. The reserve for cancellations is evaluated for each product, and is based on forecasted forward cancellation curves utilizing historical experience, recent trends and credit mix of the customer base. Our risk related to contract cancellations is limited to the revenue that we receive. Cancellations fluctuate depending on the volume of EPP sales, customer financing default or prepayment rates, and shifts in customer behavior, including those related to changes in the coverage or term of the product. The current portion of estimated cancellation reserves is recognized as a component of accrued expenses and other current liabilities with the remaining amount recognized in other liabilities. See Note 7 for additional information on cancellation reserves.

Customers applying for financing who are not approved or are conditionally approved by CAF are generally evaluated by other third-party finance providers. These providers generally either pay us or are paid a fixed, pre-negotiated fee per contract. We recognize these fees at the time of sale.

We collect sales taxes and other taxes from customers on behalf of governmental authorities at the time of sale. These taxes are accounted for on a net basis and are not included in net sales and operating revenues or cost of sales.

Derivative Instruments and Hedging Activities. We enter into derivative instruments to manage certain risks arising from both our business operations and economic conditions that result in the future known receipt or payment of uncertain cash amounts, the values of which are impacted by interest rates. We recognize the derivatives at fair value as either current assets or current liabilities on the consolidated balance sheets, and where applicable, such contracts covered by master netting agreements are reported net. Gross positive fair values are netted with gross negative fair values by counterparty. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. We may enter into derivative contracts that are intended to economically hedge certain risks, even though hedge accounting may not apply or we do not elect to apply hedge accounting. See Note 5 for additional information on derivative instruments and hedging activities.

Recent Accounting Pronouncements.

Effective in Future Periods. In October 2016, the Financial Accounting Standards Board (“FASB”) issued an accounting pronouncement (FASB ASU 2016-16) related to the income tax effects of intra-entity transfers of assets other than inventory. The pronouncement requires that entities recognize the income tax effects of intra-entity transfers of assets other than inventory when the transfer occurs. Current GAAP prohibits the recognition of those tax effects until the asset has been sold to an outside party. The pronouncement is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. We plan to adopt this pronouncement for our fiscal year beginning March 1, 2018, and are currently evaluating the effect on our consolidated financial statements.

In November 2016, the FASB issued an accounting pronouncement (FASB ASU 2016-18) related to the presentation of restricted cash in the statement of cash flows. The pronouncement requires that a statement of cash flows explain the change during the period in cash, cash equivalents, and amounts generally described as restricted cash. Amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The pronouncement is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. We plan to adopt this pronouncement for our fiscal year beginning March 1, 2018, and the pronouncement will result in changes to our consolidated statements of cash flows such that restricted cash amounts will be included in the beginning-of-period and end-of-period cash and cash equivalents totals.

Page 9

3. CarMax Auto Finance

CAF provides financing to qualified retail customers purchasing vehicles from CarMax. CAF provides us the opportunity to capture additional profits, cash flows and sales while managing our reliance on third-party finance sources. Management regularly analyzes CAF's operating results by assessing profitability, the performance of the auto loan receivables including trends in credit losses and delinquencies, and CAF direct expenses. This information is used to assess CAF's performance and make operating decisions, including resource allocation.

We typically use securitizations to fund loans originated by CAF, as discussed in Note 2. CAF income primarily reflects the interest and fee income generated by the auto loan receivables less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct CAF expenses.

CAF income does not include any allocation of indirect costs. Although CAF benefits from certain indirect overhead expenditures, we have not allocated indirect costs to CAF to avoid making subjective allocation decisions. Examples of indirect costs not allocated to CAF include retail store expenses and corporate expenses. In addition, except for auto loan receivables, which are disclosed in Note 4, CAF assets are not separately reported nor do we allocate assets to CAF because such allocation would not be useful to management in making operating decisions.

Components of CAF Income



	Three Months Ended November 30										Nine Months Ended November 30
(In millions)	2016			% ⁽¹⁾		2015			% ⁽¹⁾		2016			% ⁽¹⁾		2015			% ⁽¹⁾
Interest margin:
Interest and fee income	$	192.7		7.5		$	172.3		7.4		$	567.0		7.5		$	507.0		7.5
Interest expense	(44.1		)	(1.7	)	(33.0		)	(1.4	)	(125.3		)	(1.7	)	(91.9		)	(1.4	)
Total interest margin	148.6			5.8		139.3			6.0		441.7			5.9		415.1			6.2
Provision for loan losses	(41.9		)	(1.6	)	(30.9		)	(1.3	)	(104.2		)	(1.4	)	(70.2		)	(1.0	)
Total interest margin after provision for loan losses	106.7			4.1		108.4			4.7		337.5			4.5		344.9			5.1

Total other expense	—			—		(0.3		)	—		—			—		(0.4		)	—

Direct expenses:
Payroll and fringe benefit expense	(7.5		)	(0.3	)	(7.1		)	(0.3	)	(22.9		)	(0.3	)	(21.0		)	(0.3	)
Other direct expenses	(9.8		)	(0.4	)	(8.7		)	(0.4	)	(28.5		)	(0.4	)	(23.8		)	(0.4	)
Total direct expenses	(17.3		)	(0.7	)	(15.8		)	(0.7	)	(51.4		)	(0.7	)	(44.8		)	(0.7	)
CarMax Auto Finance income	$	89.4		3.5		$	92.3		4.0		$	286.1		3.8		$	299.7		4.5

Total average managed receivables	$	10,297.8				$	9,261.4				$	10,030.9				$	8,973.3


⁽¹⁾	Annualized percentage of total average managed receivables.

Page 10

4. Auto Loan Receivables

Auto loan receivables include amounts due from customers related to retail vehicle sales financed through CAF and are presented net of an allowance for estimated loan losses. We generally use warehouse facilities to fund auto loan receivables originated by CAF until we elect to fund them through a term securitization or alternative funding arrangement. The majority of the auto loan receivables serve as collateral for the related non-recourse notes payable of $10.46 billion as of November 30, 2016 and $9.53 billion as of February 29, 2016.

Auto Loan Receivables, Net



	As of November 30			As of February 29
(In millions)	2016			2016
Term securitizations	$	8,473.1		$	7,828.0
Warehouse facilities	1,677.0			1,399.0
Other receivables⁽¹⁾	257.6			366.6
Total ending managed receivables	10,407.7			9,593.6
Accrued interest and fees	41.8			35.0
Other	(1.4		)	3.2
Less allowance for loan losses	(114.8		)	(94.9		)
Auto loan receivables, net	$	10,333.3		$	9,536.9


⁽¹⁾	Other receivables includes receivables not funded through the warehouse facilities or term securitizations, including receivables restricted as excess collateral for those funding arrangements.

During fiscal 2017, we entered into a new $100 million warehouse facility to fund managed receivables associated with a portion of CAF's Tier 3 loan origination activity. These receivables have historically been included in other receivables, within managed receivables. Amounts securitized within this facility are now included within warehouse facilities. See Notes 2 and 10 for additional information on securitizations and non-recourse notes payable.

Credit Quality. When customers apply for financing, CAF’s proprietary scoring models rely on the customers’ credit history and certain application information to evaluate and rank their risk. We obtain credit histories and other credit data that includes information such as number, age, type of and payment history for prior or existing credit accounts. The application information that is used includes income, collateral value and down payment. The scoring models yield credit grades that represent the relative likelihood of repayment. Customers assigned a grade of “A” are determined to have the highest probability of repayment, and customers assigned a lower grade are determined to have a lower probability of repayment. For loans that are approved, the credit grade influences the terms of the agreement, such as the required loan-to-value ratio and interest rate.

CAF uses a combination of the initial credit grades and historical performance to monitor the credit quality of the auto loan receivables on an ongoing basis. We validate the accuracy of the scoring models periodically. Loan performance is reviewed on a recurring basis to identify whether the assigned grades adequately reflect the customers’ likelihood of repayment.

Ending Managed Receivables by Major Credit Grade



	As of November 30			As of February 29
(In millions)	2016⁽¹⁾		% ⁽²⁾	2016⁽¹⁾		% ⁽²⁾
A	$	5,068.7	48.7	$	4,666.6	48.6
B	3,643.9		35.0	3,400.1		35.4
C and other	1,695.1		16.3	1,526.9		16.0
Total ending managed receivables	$	10,407.7	100.0	$	9,593.6	100.0


⁽¹⁾	Classified based on credit grade assigned when customers were initially approved for financing.


⁽²⁾	Percent of total ending managed receivables.

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Allowance for Loan Losses



	Three Months Ended November 30								Nine Months Ended November 30
(In millions)	2016			%⁽¹⁾	2015			%⁽¹⁾	2016			%⁽¹⁾	2015			%⁽¹⁾
Balance as of beginning of period	$	109.7		1.08	$	87.8		0.96	$	94.9		0.99	$	81.7		0.97
Charge-offs	(62.9		)		(51.9		)		(164.6		)		(128.7		)
Recoveries	26.1				24.1				80.3				67.7
Provision for loan losses	41.9				30.9				104.2				70.2
Balance as of end of period	$	114.8		1.10	$	90.9		0.97	$	114.8		1.10	$	90.9		0.97


⁽¹⁾	Percent of total ending managed receivables.

The allowance for loan losses represents an estimate of the amount of net losses inherent in our portfolio of managed receivables as of the applicable reporting date and anticipated to occur during the following 12 months. The allowance is primarily based on the credit quality of the underlying receivables, historical loss trends and forecasted forward loss curves. We also take into account recent trends in delinquencies and defaults, recovery rates and the economic environment. The provision for loan losses is the periodic expense of maintaining an adequate allowance.

Past Due Receivables



	As of November 30			As of February 29
(In millions)	2016		%⁽¹⁾	2016		%⁽¹⁾
Total ending managed receivables	$	10,407.7	100.0	$	9,593.6	100.0
Delinquent loans:
31-60 days past due	$	228.8	2.2	$	171.0	1.8
61-90 days past due	101.9		1.0	69.1		0.7
Greater than 90 days past due	29.0		0.3	22.7		0.2
Total past due	$	359.7	3.5	$	262.8	2.7


⁽¹⁾	Percent of total ending managed receivables.

5. Derivative Instruments and Hedging Activities

We use derivatives to manage certain risks arising from both our business operations and economic conditions, particularly with regard to issuances of debt. Primary exposures include LIBOR and other rates used as benchmarks in our securitizations and other debt financing. We enter into derivative instruments to manage exposures related to the future known receipt or payment of uncertain cash amounts, the values of which are impacted by interest rates, and designate these derivative instruments as cash flow hedges for accounting purposes. Our derivative instruments are used to manage (i) differences in the amount of our known or expected cash receipts and our known or expected cash payments principally related to the funding of our auto loan receivables, and (ii) exposure to variable interest rates associated with our term loan, as further discussed in Note 10.

For the derivatives associated with our securitization program, the effective portion of changes in the fair value is initially recorded in accumulated other comprehensive loss (“AOCL”). For the majority of these derivatives, the amounts are subsequently reclassified into CAF income in the period that the hedged forecasted transaction affects earnings, which occurs as interest expense is recognized on those future issuances of debt. During the next 12 months, we estimate that an additional $5.5 million will be reclassified from AOCL as a decrease to CAF income.

As of November 30, 2016 and February 29, 2016, we had interest rate swaps outstanding with a combined notional amount of $2.32 billion and $2.42 billion, respectively, that were designated as cash flow hedges of interest rate risk.

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Fair Values of Derivative Instruments



	As of November 30, 2016					As of February 29, 2016
(In thousands)	Assets ⁽¹⁾		Liabilities ⁽²⁾			Assets⁽¹⁾		Liabilities⁽²⁾
Derivatives designated as accounting hedges:
Interest rate swaps	$	8,778	$	(318	)	$	587	$	(8,024	)


⁽¹⁾	Reported in other current assets on the consolidated balance sheets.


⁽²⁾	Reported in accounts payable on the consolidated balance sheets.

Effect of Derivative Instruments on Comprehensive Income



	Three Months Ended						Nine Months Ended
	November 30						November 30
(In thousands)	2016			2015			2016			2015
Derivatives designated as accounting hedges:
Gain (loss) recognized in AOCL ⁽¹⁾	$	7,282		$	(3,325	)	$	6,484		$	(9,596	)
Loss reclassified from AOCL into CAF income⁽¹⁾	$	(2,935	)	$	(1,944	)	$	(8,868	)	$	(5,902	)
Loss recognized in CAF income ⁽²⁾	$	—		$	(336	)	$	—		$	(438	)


⁽¹⁾	Represents the effective portion.


⁽²⁾	Represents the ineffective portion.

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. 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 cash and cash equivalents, restricted cash from collections on auto loan receivables or other assets. They consist of highly liquid investments with original maturities of three months or less and are classified as Level 1.

Mutual Fund Investments. Mutual fund investments consist of publicly traded mutual funds that primarily include diversified investments in large-, mid- and small-cap domestic and international companies. The investments, which are included in other assets, are held in a rabbi trust established to fund informally our executive deferred compensation plan and are classified as Level 1.

Page 13

Derivative Instruments. The fair values of our derivative instruments are included in either other current assets or accounts payable. As described in Note 5, as part of our risk management strategy, we utilize derivative instruments to manage differences in the amount of our known or expected cash receipts and our known or expected cash payments principally related to the funding of our auto loan receivables as well as to manage exposure to variable interest rates on our term loan. 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 and third-party valuation services. Quotes from third-party valuation services 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. The models do not require significant judgment and model inputs can typically be observed in a liquid market; however, because the models include inputs other than quoted prices in active markets, all 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, 2016
(In thousands)	Level 1			Level 2			Total
Assets:
Money market securities	$	460,379		$	—		$	460,379
Mutual fund investments	17,861			—			17,861
Derivative instruments	—			8,778			8,778
Total assets at fair value	$	478,240		$	8,778		$	487,018

Percent of total assets at fair value	98.2		%	1.8		%	100.0		%
Percent of total assets	3.0		%	0.1		%	3.1		%

Liabilities:
Derivative instruments	$	—		$	(318	)	$	(318	)
Total liabilities at fair value	$	—		$	(318	)	$	(318	)

Percent of total liabilities	—		%	—		%	—		%



	As of February 29, 2016
(In thousands)	Level 1			Level 2			Total
Assets:
Money market securities	$	439,943		$	—		$	439,943
Mutual fund investments	13,622			—			13,622
Derivative instruments	—			587			587
Total assets at fair value	$	453,565		$	587		$	454,152

Percent of total assets at fair value	99.9		%	0.1		%	100.0		%
Percent of total assets	3.1		%	—		%	3.1		%

Liabilities:
Derivative instruments	$	—		$	(8,024	)	$	(8,024	)
Total liabilities at fair value	$	—		$	(8,024	)	$	(8,024	)

Percent of total liabilities	—		%	0.1		%	0.1		%

Page 14

There were no transfers between Levels 1 and 2 for the three and nine months ended November 30, 2016. As of November 30, 2016 and February 29, 2016 we had no Level 3 assets.

7. Cancellation Reserves

We recognize revenue for EPP products at the time of sale, net of a reserve for estimated contract cancellations. Cancellations of these services may result from early termination by the customer, or default or prepayment on the finance contract. The reserve for cancellations is evaluated for each product, and is based on forecasted forward cancellation curves utilizing historical experience, recent trends and credit mix of the customer base.

Cancellation Reserves



	Three Months Ended November 30						Nine Months Ended November 30
(In millions)	2016			2015			2016			2015
Balance as of beginning of period	$	113.3		$	108.1		$	110.2		$	94.4
Cancellations	(16.8		)	(16.9		)	(49.6		)	(45.6		)
Provision for future cancellations	15.9			18.6			51.8			61.0
Balance as of end of period	$	112.4		$	109.8		$	112.4		$	109.8

The current portion of estimated cancellation reserves is recognized as a component of accrued expenses and other current liabilities with the remaining amount recognized in other liabilities. As of November 30, 2016 and February 29, 2016, the current portion of cancellation reserves was $57.1 million and $54.4 million, respectively.

8. Income Taxes

We had $30.4 million of gross unrecognized tax benefits as of November 30, 2016, and $26.8 million as of February 29, 2016. There were no significant changes to the gross unrecognized tax benefits as reported for the year ended February 29, 2016, as all activity was related to positions taken on tax returns filed or intended to be filed in the current fiscal year.

9. Retirement Plans

We have two frozen noncontributory defined benefit plans: our pension plan (the “pension plan”) and our unfunded, nonqualified plan (the “restoration plan”), which restores retirement benefits for certain associates who are affected by Internal Revenue Code limitations on benefits provided under the pension plan. No additional benefits have accrued under these plans since they were frozen; however, we have a continuing obligation to fund the pension plan and will continue to recognize net periodic pension expense for both plans for benefits earned prior to being frozen. We use a fiscal year end measurement date for both the pension plan and the restoration plan.

Net Pension Expense



	Three Months Ended November 30
	Pension Plan				Restoration Plan				Total
(In thousands)	2016		2015		2016		2015		2016		2015
Net pension expense	$	82	$	212	$	120	$	114	$	202	$	326



	Nine Months Ended November 30
	Pension Plan				Restoration Plan				Total
(In thousands)	2016		2015		2016		2015		2016		2015
Net pension expense	$	248	$	636	$	360	$	342	$	608	$	978

Net pension expense includes actuarial loss amortization of $0.4 million and $0.5 million for the three months ended November 30, 2016 and 2015, respectively, and $1.2 million and $1.5 million for the nine months ended November 30, 2016 and 2015, respectively. We made no contributions to the pension plan during the nine months ended November 30, 2016, and do not anticipate making

Page 15

any contributions during the remainder of fiscal 2017; however, conditions may change where we may elect to make contributions. The expected long-term rate of return on plan assets for the pension plan was 7.75% as of February 29, 2016.

10. Debt



	As of November 30			As of February 29
(In thousands)	2016			2016
Revolving credit facility	$	91,580		$	415,428
Term loan	300,000			300,000
3.86% Senior notes due 2023	100,000			—
4.17% Senior notes due 2026	200,000			—
4.27% Senior notes due 2028	200,000			—
Finance and capital lease obligations	477,531			414,654
Non-recourse notes payable	10,462,947			9,527,750
Total debt	11,832,058			10,657,832
Less: current portion	(324,304		)	(315,509		)
Less: unamortized debt issuance costs	(23,227		)	(21,665		)
Long-term debt, net	$	11,484,527		$	10,320,658

Revolving Credit Facility. We have a $1.20 billion unsecured revolving credit facility (the “credit facility”) with various financial institutions that expires in August 2020. Borrowings under the credit facility are available for working capital and general corporate purposes. Borrowings accrue interest at variable rates based on LIBOR, the federal funds rate, or the prime rate, depending on the type of borrowing, and we pay a commitment fee on the unused portions of the available funds. Borrowings under the credit facility are either due “on demand” or at maturity depending on the type of borrowing. Borrowings with “on demand” repayment terms are presented as short-term debt, while amounts due at maturity are presented as long-term debt with expected repayments within the next 12 months presented as a component of current portion of long-term debt. As of November 30, 2016, the unused capacity of $1.11 billion was fully available to us.

Term Loan. We have a $300 million term loan that expires in August 2020. The term loan accrues interest at variable rates based on the LIBOR rate, the federal funds rate, or the prime rate, and interest is payable monthly. As of November 30, 2016, $300 million remained outstanding and was classified as long-term debt, as no repayments are scheduled to be made within the next 12 months. Borrowings under the term loan are available for working capital and general corporate purposes. We have entered into an interest rate derivative contract to manage our exposure to variable interest rates associated with this term loan.

Senior Notes. During the first quarter of fiscal 2017, we entered into a note purchase agreement to issue and sell an aggregate of $500 million principal amount of senior unsecured notes, due 2023, 2026 and 2028, in a private placement to certain accredited investors. As of November 30, 2016, $500 million of senior unsecured notes were outstanding. Borrowings under these notes are available for working capital and general corporate purposes. Interest on the notes is payable semi-annually.

Finance and Capital Lease Obligations. Finance and capital lease obligations relate primarily to stores subject to sale-leaseback transactions that did not qualify for sale accounting, and therefore, are accounted for as financings. The leases were structured at varying interest rates and generally have initial lease terms ranging from 15 to 20 years with payments made monthly. Payments on the leases are recognized as interest expense and a reduction of the obligations. We have not entered into any new sale-leaseback transactions since fiscal 2009. In the event the leases are modified or extended beyond their original lease term, the related obligation is increased based on the present value of the revised future lease payments, with a corresponding increase to the assets subject to these transactions. Upon modification, the amortization of the obligation is reset, resulting in more of the lease payments being applied to interest expense in the initial years following the modification. See Note 14 for additional information on finance and capital lease obligations.

Non-Recourse Notes Payable. The non-recourse notes payable relate to auto loan receivables funded through term securitizations and our warehouse facilities. The timing of principal payments on the non-recourse notes payable is based on the timing of

Page 16

principal collections and defaults on the securitized auto loan receivables. The current portion of non-recourse notes payable represents principal payments that are due to be distributed in the following period.

As of November 30, 2016, $8.79 billion of non-recourse notes payable was outstanding related to term securitizations. These notes payable accrue interest predominantly at fixed rates and have scheduled maturities through April 2023, but may mature earlier, depending upon the repayment rate of the underlying auto loan receivables.

As of November 30, 2016, $1.68 billion of non-recourse notes payable was outstanding related to our warehouse facilities. In fiscal 2017, we increased the combined limit of our warehouse facilities by $300 million. As of November 30, 2016, the combined warehouse facility limit was $2.80 billion, and the unused warehouse capacity totaled $1.12 billion. Of the combined warehouse facility limit, $1.50 billion will expire in February 2017 and $1.30 billion will expire in August 2017. The return requirements of warehouse facility investors could fluctuate significantly depending on market conditions. At renewal, the cost, structure and capacity of the facilities could change. These changes could have a significant impact on our funding costs.

See Notes 2 and 4 for additional information on the related securitized auto loan receivables.

Capitalized Interest. We capitalize interest in connection with the construction of certain facilities. For the nine months ended November 30, 2016 and 2015, we capitalized interest of $8.4 million and $7.6 million, respectively.

Financial Covenants. The credit facility, term loan and senior note agreements contain representations and warranties, conditions and covenants. We must also meet financial covenants in conjunction with certain of the sale-leaseback transactions. Our securitization agreements contain representations and warranties, financial covenants and performance triggers. As of November 30, 2016, we were in compliance with all financial covenants and our securitized receivables were in compliance with the related performance triggers.

11. Stock and Stock-Based Incentive Plans

(A) Share Repurchase Program

As of November 30, 2016, our board of directors has authorized the repurchase of up to $4.55 billion of our common stock. At that date, $1.69 billion was available for repurchase under the board's outstanding authorization, which includes an additional $750 million authorized during fiscal 2017. Also during fiscal 2017, the board removed the expiration date of the outstanding repurchase authorizations.

Common Stock Repurchases



	Three Months Ended				Nine Months Ended
	November 30				November 30
	2016		2015		2016		2015
Number of shares repurchased (in thousands)	3,780.5		7,680.8		8,715.2		13,336.1
Average cost per share	$	52.56	$	58.03	$	52.38	$	61.14
Available for repurchase, as of end of period (in millions)	$	1,691.5	$	1,553.8	$	1,691.5	$	1,553.8

(B) Share-Based Compensation

Composition of Share-Based Compensation Expense



	Three Months Ended				Nine Months Ended
	November 30				November 30
(In thousands)	2016		2015		2016		2015
Cost of sales	$	584	$	394	$	2,998	$	1,459
CarMax Auto Finance income	663		502		2,314		1,100
Selling, general and administrative expenses	10,522		11,178		67,784		43,728
Share-based compensation expense, before income taxes	$	11,769	$	12,074	$	73,096	$	46,287

Page 17

Composition of Share-Based Compensation Expense – By Grant Type



	Three Months Ended					Nine Months Ended
	November 30					November 30
(In thousands)	2016			2015		2016		2015
Nonqualified stock options	$	4,756		$	5,794	$	32,977	$	20,064
Cash-settled restricted stock units (RSUs)	4,490			2,960		25,951		14,358
Stock-settled market stock units (MSUs)	2,463			2,586		9,811		8,123
Stock-settled performance stock units (PSUs)	(488		)	341		1,844		1,579
Employee stock purchase plan	305			296		1,070		1,003
Restricted stock awards (RSAs)	243			97		1,443		1,160
Share-based compensation expense, before income taxes	$	11,769		$	12,074	$	73,096	$	46,287

Share/Unit Activity



	Nine Months Ended November 30, 2016
	Equity Classified											Liability Classified
(Shares/units in thousands)	Options			MSUs			PSUs		RSAs			RSUs
Outstanding as of February 29, 2016	7,322			543			66		17			1,320
Granted	2,310			171			83		49			632
Exercised or vested and converted	(1,144		)	(210		)	—		(17		)	(436		)
Cancelled	(4		)	(1		)	—		—			(89		)
Outstanding as of November 30, 2016	8,484			503			149		49			1,427

Weighted average grant date fair value per share/unit:

Granted	$	14.19		$	63.96		$	51.63	$	50.65		$	51.63
Ending outstanding	$	14.99		$	65.66		$	60.94	$	50.65		$	55.04

	As of November 30, 2016
Unrecognized compensation (in millions)	$	37.4		$	13.6		$	2.5	$	1.2

In the second quarter of fiscal 2017, in connection with the retirement of our former CEO, Thomas J. Folliard, the board of directors modified certain equity awards previously granted to him. This modification effectively provided Mr. Folliard retirement treatment under the terms of the awards, notwithstanding that he was younger than 55 years old. The modification resulted in the recognition of additional share-based compensation expense of $10.9 million. In addition, the awards granted to Mr. Folliard in April 2016 effectively provided him retirement treatment, thus full expense recognition of $3.5 million occurred at the grant date.

12. Net Earnings Per Share

Basic net earnings per share is computed by dividing net earnings available for basic common shares by the weighted average number of shares of common stock outstanding. Diluted net earnings per share is computed by dividing net earnings available for diluted common shares by the sum of weighted average number of shares of common stock outstanding and dilutive potential common stock. Diluted net earnings per share is calculated using the “if-converted” treasury stock method.

Page 18

Basic and Dilutive Net Earnings Per Share Reconciliations



	Three Months Ended				Nine Months Ended
	November 30				November 30
(In thousands except per share data)	2016		2015		2016		2015
Net earnings	$	136,645	$	128,199	$	474,367	$	482,401

Weighted average common shares outstanding	189,200		201,291		191,431		205,760
Dilutive potential common shares:
Stock options	1,191		1,552		1,346		1,853
Stock-settled stock units and awards	427		540		462		629
Weighted average common shares and dilutive potential common shares	190,818		203,383		193,239		208,242

Basic net earnings per share	$	0.72	$	0.64	$	2.48	$	2.34
Diluted net earnings per share	$	0.72	$	0.63	$	2.45	$	2.32

Certain options to purchase shares of common stock were outstanding and not included in the calculation of diluted net earnings per share because their inclusion would have been antidilutive. On a weighted average basis, for the three months ended November 30, 2016 and 2015, options to purchase 3,104,720 shares and 1,383,861 shares of common stock, respectively, were not included. For the nine months ended November 30, 2016 and 2015, weighted average options to purchase 3,253,237 shares and 1,195,011 shares, respectively, were not included.

13. Accumulated Other Comprehensive Loss

Changes in Accumulated Other Comprehensive Loss By Component



							Total
	Net						Accumulated
	Unrecognized			Net			Other
	Actuarial			Unrecognized			Comprehensive
(In thousands, net of income taxes)	Losses			Hedge Losses			Loss
Balance as of February 29, 2016	$	(56,470	)	$	(13,726	)	$	(70,196	)
Other comprehensive income before reclassifications	—			3,936			3,936
Amounts reclassified from accumulated other comprehensive loss	744			5,381			6,125
Other comprehensive income	744			9,317			10,061
Balance as of November 30, 2016	$	(55,726	)	$	(4,409	)	$	(60,135	)

Page 19

Changes In and Reclassifications Out of Accumulated Other Comprehensive Loss



	Three Months Ended November 30						Nine Months Ended November 30
(In thousands)	2016			2015			2016			2015
Retirement Benefit Plans (Note 9):
Actuarial loss amortization reclassifications recognized in net pension expense:
Cost of sales	$	160		$	212		$	477		$	628
CarMax Auto Finance income	10			13			28			37
Selling, general and administrative expenses	217			289			655			878
Total amortization reclassifications recognized in net pension expense	387			514			1,160			1,543
Tax expense	(140		)	(192		)	(416		)	(576		)
Amortization reclassifications recognized in net pension expense, net of tax	247			322			744			967
Net change in retirement benefit plan unrecognized actuarial losses, net of tax	247			322			744			967

Cash Flow Hedges (Note 5):
Effective portion of changes in fair value	7,282			(3,325		)	6,484			(9,596		)
Tax (expense) benefit	(2,863		)	1,308			(2,548		)	3,775
Effective portion of changes in fair value, net of tax	4,419			(2,017		)	3,936			(5,821		)
Reclassifications to CarMax Auto Finance income	2,935			1,944			8,868			5,902
Tax expense	(1,154		)	(764		)	(3,487		)	(2,321		)
Reclassification of hedge losses, net of tax	1,781			1,180			5,381			3,581
Net change in cash flow hedge unrecognized losses, net of tax	6,200			(837		)	9,317			(2,240		)
Total other comprehensive income (loss), net of tax	$	6,447		$	(515	)	$	10,061		$	(1,273	)

Changes in the funded status of our retirement plans and the effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognized in accumulated other comprehensive loss. The cumulative balances are net of deferred taxes of $36.0 million as of November 30, 2016, and $42.4 million as of February 29, 2016.

14. Supplemental Cash Flow Information

Supplemental disclosures of cash flow information:



	Nine Months Ended November 30
(In thousands)	2016		2015
Non-cash investing and financing activities:
Increase in accrued capital expenditures	$	8,629	$	6,563
Increase in finance and capital lease obligations	$	70,072	$	92,001

15. Contingent Liabilities

Litigation. 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 wage and hour claims with respect to a putative class consisting of sales consultants, sales managers, and other hourly employees who worked for the company in California from April 2, 2004, to the present. The court dismissed certain of the initial claims so that, by June 16, 2009, the remaining claims regarded the sales consultant putative class and were: (1) failure to provide meal breaks or compensation in lieu thereof; (2) failure to pay wages of terminated or resigned employees related to meal breaks; (3) unfair competition; and (4) claims under the California Labor Code Private Attorney General Act (the "Private Attorney General Act"). On

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March 30, 2016, the remaining claims asserted by Fowler were settled for an immaterial amount. On August 30, 2016, the remaining claims asserted by Areso were settled for an immaterial amount.

CarMax entities are defendants in three additional proceedings asserting wage and hour claims with respect to CarMax sales consultants in California. The asserted claims include failure to pay minimum wage, provide meal periods and rest breaks, pay statutory/contractual wages, reimburse for work-related expenses, provide accurate itemized wage statements; unfair competition; and Private Attorney General Act claims. On September 4, 2015, Craig Weiss v. CarMax Auto Superstores California, LLC, and CarMax Auto Superstores West Coast, Inc., a putative class action, was filed in the Superior Court of California, County of Placer. The Weiss lawsuit seeks civil penalties, fines, cost of suit, and the recovery of attorneys’ fees. On June 29, 2016, Ryan Gomez et al. v. CarMax Superstores California, LLC, and CarMax Auto Superstores West Coast, Inc., a putative class action, was filed in the Superior Court of the State of California, Los Angeles. The Gomez lawsuit seeks declaratory relief, unspecified damages, restitution, statutory penalties, interest, cost and attorneys’ fees. On September 7, 2016, James Rowland v. CarMax Superstores California, LLC, and CarMax Auto Superstores West Coast, Inc., a putative class action, was filed in the U.S. District Court, Eastern District of California, Sacramento Division. The Rowland lawsuit seeks unspecified damages, restitution, statutory penalties, interest, cost and 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, results of operations or cash flows.

Other Matters. In accordance with the terms of real estate lease agreements, we generally agree to indemnify the lessor from certain liabilities arising as a result of the use of the leased premises, including environmental liabilities and repairs to leased property upon termination of the lease. Additionally, in accordance with the terms of agreements entered into for the sale of properties, we generally agree to indemnify the buyer from certain liabilities and costs arising subsequent to the date of the sale, including environmental liabilities and liabilities resulting from the breach of representations or warranties made in accordance with the agreements. We do not have any known material environmental commitments, contingencies or other indemnification issues arising from these arrangements.

As part of our customer service strategy, we guarantee the used vehicles we retail with at least a 30-day limited warranty. A vehicle in need of repair within this period will be repaired free of charge. As a result, each vehicle sold has an implied liability associated with it. Accordingly, based on historical trends, we record a provision for estimated future repairs during the guarantee period for each vehicle sold. The liability for this guarantee was $5.7 million as of November 30, 2016, and $6.1 million as of February 29, 2016, and is included in accrued expenses and other current liabilities.

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ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements, the accompanying notes and the MD&A included in our Annual Report on Form 10-K for the fiscal year ended February 29, 2016 (“fiscal 2016”), as well as our consolidated financial statements and the accompanying notes included in Item 1 of this Form 10-Q. Note references are to the notes to consolidated financial statements included in Item 1. All references to net earnings per share are to diluted net earnings per share. Certain prior year amounts have been reclassified to conform to the current year’s presentation. Amounts and percentages may not total due to rounding.

OVERVIEW

CarMax is the nation’s largest retailer of used vehicles. We operate in two reportable segments: CarMax Sales Operations and CarMax Auto Finance (“CAF”). Our CarMax Sales Operations segment consists of all aspects of our auto merchandising and service operations, excluding financing provided by CAF. Our CAF segment consists solely of our own finance operation that provides financing to customers buying retail vehicles from CarMax.

CarMax Sales Operations

Our sales operations segment consists of retail sales of used vehicles and related products and services, such as wholesale vehicle sales; the sale of extended protection plan (“EPP”) products, which include extended service plans (“ESPs”) and guaranteed asset protection (“GAP”); and vehicle repair service. We focus on addressing the major sources of customer dissatisfaction with traditional auto retailers while maximizing operating efficiencies. We offer low, no-haggle prices; a broad selection of CarMax Quality Certified used vehicles; value-added EPP products; and superior customer service. Our website and related mobile apps are tools for communicating the CarMax consumer offer in detail, sophisticated search engines for finding the right vehicle and sales channels for customers who prefer to initiate the shopping and sales process online.

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

As of November 30, 2016, we operated 169 used car stores in 84 U.S. markets, covering 55 mid-sized markets, 23 large markets and 6 small markets. We define mid-sized markets as those with television viewing populations generally between 600,000 and 3 million people. As of that date, we also conducted wholesale auctions at 71 used car stores and we operated 2 new car franchises.

CarMax Auto Finance

In addition to third-party financing providers, we provide vehicle financing through CAF, which offers financing solely to customers buying retail vehicles from CarMax. CAF allows us to manage our reliance on third-party financing providers and to leverage knowledge of our business to provide qualifying customers a competitive financing option. As a result, we believe CAF enables us to capture additional profits, cash flows and sales. CAF income primarily reflects the interest and fee income generated by the auto loan receivables less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct expenses. CAF income does not include any allocation of indirect costs. After the effect of 3-day payoffs and vehicle returns, CAF financed 44.7% of our retail used vehicle unit sales in the first nine months of fiscal 2017. As of November 30, 2016, CAF serviced approximately 783,000 customer accounts in its $10.41 billion portfolio of managed receivables.

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

Revenues and Profitability -- Three and Nine Months Ended November 30, 2016

During the third quarter of fiscal 2017, net sales and operating revenues increased 4.4% and net earnings increased 6.6%. The 14.3% increase in earnings per share reflected the increase in net earnings and the effect of our ongoing share repurchase program.

Our primary source of revenue and net income is the retail sale of used vehicles. During the third quarter of fiscal 2017, we sold 156,789 used vehicles, representing 83.5% of our net sales and operating revenues and 67.1% of our gross profit. Compared to the prior year period, used vehicle revenues grew 6.2% and used vehicle gross profits improved 8.8% in the third quarter primarily due to a 9.1% increase in total used unit sales, which included a 5.4% increase in comparable store used units.

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Wholesale sales are also a significant contributor to our revenues and net income. During the third quarter of fiscal 2017, we sold 91,973 wholesale vehicles, representing 13.2% of our net sales and operating revenues and 16.4% of our gross profit. Compared to the prior year period, wholesale vehicle revenues fell 4.9% and wholesale vehicle gross profits declined 7.3% in the third quarter primarily due to a 2.2% reduction in unit sales and a 5.2% decrease in wholesale vehicle gross profit per unit.

During the third quarter of fiscal 2017, other sales and revenues, which include revenue earned on the sale of EPP products, net third-party finance fees, and service department and new vehicle sales, represented 3.3% of our net sales and operating revenues and 16.4% of our gross profit. Compared to the prior year period, other sales and revenues increased 1.0% and other gross profit rose 27.7% in the third quarter, primarily reflecting the improvements in EPP revenues and net third-party finance fees.

Income from our CAF segment totaled $89.4 million in the third quarter of fiscal 2017, down 3.2% compared with the prior year period. The decline in CAF income was primarily due to an increase in the provision for loan losses and a lower total interest margin percentage.

Selling, general and administrative ("SG&A") expenses increased 5.7% to $356.7 million, primarily reflecting the 12% increase in our store base since the beginning of the third quarter of fiscal 2016, as well as higher variable costs associated with our comparable store unit growth.

During the first nine months of fiscal 2017, net sales and operating revenues increased 3.3%, net earnings declined 1.7% and net earnings per share increased 5.6%. Net earnings for the first nine months of the current year were reduced by $0.04 per diluted share related to the modification of certain equity awards held by our recently retired chief executive officer.

Liquidity

Our primary ongoing sources of liquidity include funds provided by operations, proceeds from securitization transactions, and borrowings under our revolving credit facility or through other financing sources. During the first nine months of fiscal 2017, net cash used in operations totaled $343.1 million. This amount, combined with $935.2 million of net issuances of non-recourse notes payable, resulted in $592.1 million of adjusted net cash provided by operating activities (a non-GAAP measure). This liquidity, together with a $175.7 million increase in the long-term debt, was primarily used to fund the increase in CAF auto loan receivables, the 8.7 million common shares repurchased under our share repurchase program and our store growth.

When considering cash provided by operating activities, management does not include increases in auto loan receivables that have been securitized with non-recourse notes payable, which are separately reflected as cash provided by financing activities. For a reconciliation of adjusted net cash provided by operating activities to net cash used in operating activities, the most directly comparable GAAP financial measure, see “Reconciliation of Adjusted Net Cash from Operating Activities” included in “Financial Condition – Liquidity and Capital Resources.”

Future Outlook

Over the long term, we believe the primary driver for earnings growth will be vehicle unit sales growth from both new stores and stores included in our comparable store base. We also believe that increased used vehicle unit sales will drive increased sales of wholesale vehicles and ancillary products and, over time, increased CAF income. To expand our vehicle unit sales at new and existing stores, we will need to continue delivering an unrivaled customer experience in stores and online, which will require investments in our information technology infrastructure and other strategic initiatives. We also will need to continue hiring and developing the associates necessary to drive our success, while managing the risks posed by an evolving competitive environment. In addition, to support our store growth plans, we will need to continue procuring suitable real estate at favorable terms. While in any individual period conditions may vary, over the long term we would expect to begin leveraging our SG&A expenses when comparable store used unit sales growth reaches the mid-single digit range.

We are continuing the national rollout of our retail concept, and as of November 30, 2016, we had used car stores located in markets that represented approximately 69% of the U.S. population. During the first nine months of fiscal 2017, we opened 11 stores, and during the remainder of the fiscal year, we plan to open 4 stores. In fiscal 2018, we plan to open between 13 and 16 stores. For a detailed list of stores we plan to open in the 12 months following November 30, 2016, see the table included in “Planned Future Activities.”

A significant portion of our used vehicle inventory is sourced from local, regional and online wholesale auto auctions. Wholesale vehicle prices are influenced by a variety of factors, including the supply of vehicles available at auction relative to dealer demand. Industry sources predict that there will be a continued influx in off-lease vehicles in coming years, which has and could continue to increase the volume of late-model vehicles available at auction relative to dealer demand. This has and could continue to reduce wholesale auction prices and our vehicle acquisition costs. It could also impact CAF recovery rates.

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For additional information about risks and uncertainties facing our Company, see “Risk Factors,” included in Part I. Item 1A of the Annual Report on Form 10-K for the fiscal year ended February 29, 2016.

CRITICAL ACCOUNTING POLICIES

For information on critical accounting policies, see “Critical Accounting Policies” in MD&A included in Item 7 of the Annual Report on Form 10-K for the fiscal year ended February 29, 2016. These policies relate to financing and securitization transactions, revenue recognition and income taxes.

RESULTS OF OPERATIONS – CARMAX SALES OPERATIONS

NET SALES AND OPERATING REVENUES



	Three Months Ended November 30								Nine Months Ended November 30
(In millions)	2016			2015			Change		2016			2015			Change
Used vehicle sales	$	3,090.6		$	2,909.0		6.2	%	$	9,820.4		$	9,351.8		5.0	%
Wholesale vehicle sales	488.4			513.8			(4.9	)%	1,616.5			1,682.2			(3.9	)%
Other sales and revenues:
Extended protection plan revenues	70.2			61.6			14.0	%	221.5			197.4			12.2	%
Third-party finance fees, net	(9.1		)	(13.6		)	32.9	%	(29.3		)	(45.1		)	35.1	%
Other ⁽¹⁾	61.4			73.3			(16.2	)%	196.0			257.5			(23.9	)%
Total other sales and revenues	122.5			121.3			1.0	%	388.2			409.8			(5.3	)%
Total net sales and operating revenues	$	3,701.5		$	3,544.1		4.4	%	$	11,825.2		$	11,443.9		3.3	%


⁽¹⁾	Includes service department and new vehicle sales. In the fourth quarter of fiscal 2016, we reclassified new vehicle sales to other sales and revenues and no longer separately present new vehicle sales. Prior period amounts have been revised for this presentation.

UNIT SALES



	Three Months Ended November 30				Nine Months Ended November 30
	2016	2015	Change		2016	2015	Change
Used vehicles	156,789	143,673	9.1	%	495,277	464,699	6.6	%
Wholesale vehicles	91,973	94,066	(2.2	)%	300,543	302,218	(0.6	)%

AVERAGE SELLING PRICES



	Three Months Ended November 30						Nine Months Ended November 30
	2016		2015		Change		2016		2015		Change
Used vehicles	$	19,520	$	20,094	(2.9	)%	$	19,640	$	19,970	(1.7	)%
Wholesale vehicles	$	5,103	$	5,243	(2.7	)%	$	5,165	$	5,345	(3.4	)%

COMPARABLE STORE USED VEHICLE SALES CHANGES



	Three Months Ended November 30				Nine Months Ended November 30
	2016		2015		2016		2015
Used vehicle units	5.4	%	(0.8	)%	2.8	%	3.0	%
Used vehicle revenues	2.5	%	0.0	%	1.2	%