Notes to Consolidated Financial Statements
(Unaudited)
1.Background
Business. CarMax, Inc. (“we,” “our,” “us,” “CarMax” and “the company”), including its wholly owned subsidiaries, 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. On June 1, 2021, we completed the acquisition of Edmunds Holding Company (“Edmunds”), which does not meet the quantitative thresholds to be considered a reportable segment. See Note 17 for additional information on our reportable segments and Note 2 for additional information regarding our acquisition of Edmunds.
We deliver an unrivaled customer experience by offering a broad selection of quality used vehicles and related products and services at competitive, no-haggle prices using a customer-friendly sales process. Our omni-channel platform, which gives us the largest addressable market in the used car industry, empowers our retail customers to buy a car on their terms – online, in-store or an integrated combination of both. Customers can choose to complete the car-buying experience in-person at one of our stores; or buy the car online and receive delivery through express pickup, available nationwide, or home delivery, available to most customers. We offer customers a range of related products and services, including the appraisal and purchase of vehicles directly from consumers; the financing of retail vehicle purchases through CAF and third-party finance 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 or virtual wholesale auctions.
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.
The accounting policies followed in the presentation of our interim financial results are consistent with those included in the company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2022 (the “2022 Annual Report”), with the exception of those related to recent accounting pronouncements adopted in the current fiscal year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in our 2022 Annual Report.
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. In particular, the novel coronavirus (“COVID-19”) pandemic and the resulting adverse impacts to global economic conditions, as well as our operations, may impact future estimates including, but not limited to, our allowance for loan losses, inventory valuations, fair value measurements, downward adjustments to investments in equity securities, asset impairment charges, the effectiveness of the company’s hedging instruments, deferred tax valuation allowances, cancellation reserves, actuarial losses on our retirement benefit plans and discount rate assumptions. Certain prior year amounts have been reclassified to conform to the current year’s presentation. Amounts and percentages may not total due to rounding.
Recent Accounting Pronouncements.
Adopted in the Current Period
In August 2020, the Financial Accounting Standards Board (“FASB”) issued an accounting pronouncement (ASU 2020-06) related to the measurement and disclosure requirements for convertible instruments and contracts in an entity's own equity. The pronouncement simplifies and adds disclosure requirements for the accounting and measurement of convertible instruments and the settlement assessment for contracts in an entity's own equity. We adopted this pronouncement for our fiscal year beginning March 1, 2022, and it did not have a material effect on our consolidated financial statements.
In July 2021, the FASB issued an accounting pronouncement (ASU 2021-05) related to accounting for sales-type leases with variable lease payments. This pronouncement is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. We adopted this pronouncement for our fiscal year beginning March 1, 2022, and it did not have a material effect on our consolidated financial statements.
In November 2021, the FASB issued an accounting pronouncement (ASU 2021-10) related to government assistance disclosures. The amendments in this update increase the transparency surrounding government assistance by requiring disclosure of 1) the types of assistance received, 2) an entity’s accounting for the assistance, and 3) the effect of the assistance on the entity’s financial statements. We adopted this pronouncement for our fiscal year beginning March 1, 2022, and it did not have a material effect on our consolidated financial statements.
2. Acquisition of Edmunds
On June 1, 2021, we completed the acquisition of Edmunds Holding Company, one of the most well established and trusted online guides for automotive information and a recognized leader in digital car shopping innovations. With this acquisition, CarMax has enhanced its digital capabilities and further strengthened its role and reach across the used auto ecosystem while adding exceptional technology and creative talent. Edmunds continues to operate independently and remains focused on delivering confidence to consumers and excellent value to its dealer and Original Equipment Manufacturer (“OEM”) clients. Additionally, this acquisition allows both businesses to accelerate their respective capabilities to deliver an enhanced digital experience to their customers by leveraging Edmunds’ compelling content and technology, CarMax’s unparalleled national scale and infrastructure, and the combined talent of both businesses.
The acquisition was accounted for in accordance with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, and, accordingly, Edmunds’ results of operations have been consolidated in our financial statements since the date of acquisition. We recorded a preliminary allocation of the purchase price to assets acquired and liabilities assumed based on their estimated fair values as of June 1, 2021. The transaction costs associated with the acquisition were approximately $8.0 million and were expensed as incurred within selling, general and administrative expenses.
The following table summarizes the total purchase consideration:
| | | | | |
| (In thousands) | |
| Total cash consideration for outstanding shares | $ | 251,047 | |
Fair value of common stock (1) | 90,571 | |
| Fair value of preexisting relationship | 60,200 | |
| Total | $ | 401,818 | |
(1) Represents the issuance of 776,097 shares of CarMax common stock to Edmunds equity holders, the fair value of which was based on the market value of CarMax common stock as of market close on the acquisition date (June 1, 2021).
In January 2020, we acquired a minority stake in Edmunds for $50 million. The noncontrolling equity investment in Edmunds was remeasured at a fair value of $60.2 million prior to the acquisition of the remaining ownership stake on June 1, 2021, which resulted in the recognition of a gain of $8.7 million. The gain was included in other income in the consolidated statements of earnings for the second quarter of fiscal 2022.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition:
| | | | | |
| (In thousands) | Fair Value |
| Cash | $ | 9,484 | |
| Accounts receivable, net | 33,719 | |
| Other current assets | 2,397 | |
| Property and equipment, net | 20,741 | |
Goodwill (1) | 141,258 | |
| Intangible assets | 218,000 | |
| Operating lease assets | 97,250 | |
| Other assets | 191 | |
| Total assets acquired | 523,040 | |
| |
| Accounts payable | 5,063 | |
| Accrued expenses and other current liabilities | 11,277 | |
| Current portion of operating lease liabilities | 12,795 | |
Deferred income taxes (1) | 3,823 | |
| Operating lease liabilities, excluding current portion | 88,264 | |
| Total liabilities assumed | 121,222 | |
| Net assets acquired | $ | 401,818 | |
(1) During the third quarter of fiscal 2022, we obtained new information about facts and circumstances that existed as of the acquisition date, which resulted in a change in the fair value of assets and liabilities recognized. The adjustments were primarily related to research and development tax credits, which resulted in a decrease in goodwill and a decrease in deferred income taxes of $8.4 million.
The excess of purchase consideration over the fair value of net identifiable assets acquired and liabilities assumed was recorded as goodwill, which is primarily attributed to expected synergies and the assembled workforce of the acquired business and is not deductible for tax purposes. The fair values assigned to the net identifiable assets and liabilities assumed are based on management’s estimates and assumptions.
Identifiable intangible assets were recognized at their estimated acquisition date fair values. The fair value of identifiable intangible assets was determined by using certain estimates and assumptions that are not observable in the market. The fair values of the trade name asset and the internally developed software asset were determined using the relief-from-royalty method, and the fair value of the customer relationships asset was determined using the excess earnings method. These income-based approaches included significant assumptions such as the amount and timing of projected cash flows, growth rates, customer attrition rates, discount rates, and the assessment of the asset’s life cycle. The estimated fair value and estimated remaining useful lives of identifiable intangible assets are as follows:
| | | | | | | | |
| (In thousands) | Useful Life (Years) | Fair Value |
| Trade name | Indefinite | $ | 31,900 | |
| Internally developed software | 7 | 52,900 | |
| Customer relationships | 17 | 133,200 | |
| Identifiable intangible assets | | $ | 218,000 | |
The operating results of Edmunds have been included in our consolidated financial statements since the date of the acquisition. Net sales and operating revenues and net earnings attributable to Edmunds were not material for the reporting periods presented. Our pro forma results as if the acquisition had taken place on the first day of fiscal 2021 would not be materially different from the amounts reflected in the accompanying consolidated financial statements, and therefore are not presented.
3. Revenue
We recognize revenue when control of the good or service has been transferred to the customer, generally either at the time of sale or upon delivery to a customer. Our contracts have a fixed contract price and revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. 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. We generally expense sales commissions when incurred because the amortization period would have been less than one year. These costs are recorded within selling, general and administrative expenses. We do not have any significant payment terms as payment is received at or shortly after the point of sale.
Disaggregation of Revenue
| | | | | | | | | | | | | | | |
| Three Months Ended May 31 | | |
| (In millions) | 2022 | | 2021 | | | | |
| Used vehicle sales | $ | 7,014.5 | | | $ | 6,157.3 | | | | | |
| Wholesale vehicle sales | 2,116.5 | | | 1,374.4 | | | | | |
| Other sales and revenues: | | | | | | | |
| Extended protection plan revenues | 116.5 | | | 134.2 | | | | | |
| Third-party finance income/(fees), net | 3.4 | | | (4.6) | | | | | |
Advertising & subscription revenues (1) | 34.4 | | | — | | | | | |
| Service revenues | 21.9 | | | 22.2 | | | | | |
| Other | 4.4 | | | 14.1 | | | | | |
| Total other sales and revenues | 180.6 | | | 165.9 | | | | | |
| Total net sales and operating revenues | $ | 9,311.6 | | | $ | 7,697.6 | | | | | |
(1) Excludes intersegment sales and operating revenues that have been eliminated in consolidation. See Note 17 for further details.
Used Vehicle Sales. Revenue from the sale of used vehicles is recognized upon transfer of control of the vehicle to the customer. As part of our customer service strategy, we guarantee the retail vehicles we sell with a 30-day/1,500 mile, money-back guarantee. We record a reserve for estimated returns based on historical experience and trends. The reserve for estimated returns is presented gross on the consolidated balance sheets, with a return asset recorded in other current assets and a refund liability recorded in accrued expenses and other current liabilities. We also guarantee the used vehicles we sell with a 90-day/4,000-mile limited warranty. These warranties are deemed assurance-type warranties and are accounted for as warranty obligations. See Note 16 for additional information on this warranty and its related obligation.
Wholesale Vehicle Sales. Wholesale vehicles are sold at our auctions, and revenue from the sale of these vehicles is recognized upon transfer of control of the vehicle to the customer. Dealers also pay a fee to us based on the sale price of the vehicles they purchase. This fee is recognized as revenue at the time of sale. While we provide condition disclosures on each wholesale vehicle sold, the vehicles are subject to a limited right of return. We record a reserve for estimated returns based on historical experience and trends. The reserve for estimated returns is presented gross on the consolidated balance sheets, with a return asset recorded in other current assets and a refund liability recorded in accrued expenses and other current liabilities.
EPP Revenues. We also sell ESP and GAP products on behalf of unrelated third parties, who are primarily responsible for fulfilling the contract, to customers who purchase a retail 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, on a net basis, at the time of sale. We also record a reserve, or refund liability, for estimated contract cancellations. 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 8 for additional information on cancellation reserves.
We are contractually entitled to receive profit-sharing revenues based on the performance of the ESPs administered by third parties. These revenues are a form of variable consideration included in EPP revenues to the extent that it is probable that it
will not result in a significant revenue reversal. An estimate of the amount to which we expect to be entitled, subject to various constraints, is recognized upon satisfying the performance obligation of selling the ESP. These constraints include factors that are outside of the company’s influence or control and the length of time until settlement. We apply the expected value method, utilizing historical claims and cancellation data from CarMax customers, as well as external data and other qualitative assumptions. This estimate is reassessed each reporting period with changes reflected in other sales and revenues on our consolidated statements of earnings and other assets on our consolidated balance sheets. As of May 31, 2022 and February 28, 2022, no current or long-term contract asset was recognized related to cumulative profit-sharing payments to which we expect to be entitled.
Third-Party Finance Income/(Fees). 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.
Advertising and Subscription Revenues. Advertising and subscription revenues consist of revenues earned by our Edmunds business. Advertising revenues are derived from advertising contracts with automotive manufacturers based on fixed fees per impression and fees for certain activities completed by customers on the manufacturers' websites. These fees are recognized in the period the impressions are delivered or certain activities occurred. Subscription revenues are derived from packages sold to automotive dealers that include car leads, inventory listings and enhanced placement in Edmunds' dealer locator and are recognized over the period that the services are made available to the dealers. Subscription revenues also include a digital marketing subscription service, which allows dealers to gain exposure on third party partner websites. Revenues for this service are recognized on a net basis.
Service Revenues. Service revenue consists of labor and parts income related to vehicle repair service, including repairs of vehicles covered under an ESP we sell or warranty program. Service revenue is recognized at the time the work is completed.
Other Revenues. Other revenues consist primarily of new vehicle sales and sales of accessories. Revenue in this category is recognized upon transfer of control to the customer.
4. 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 loans receivable, 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 or other funding arrangements to fund loans originated by CAF. CAF income primarily reflects the interest and fee income generated by the auto loans receivable less the interest expense associated with the debt issued to fund these receivables, a provision for estimated loan losses and direct 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 loans receivable, which are disclosed in Note 5, 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 May 31 | | |
| (In millions) | 2022 | | % (1) | | 2021 | | % (1) | | | | | | | | |
| Interest margin: | | | | | | | | | | | | | | | |
| Interest and fee income | $ | 346.7 | | | 8.8 | | | $ | 310.3 | | | 8.8 | | | | | | | | | |
| Interest expense | (48.8) | | | (1.2) | | | (65.8) | | | (1.9) | | | | | | | | | |
| Total interest margin | 297.9 | | | 7.5 | | | 244.5 | | | 6.9 | | | | | | | | | |
| Provision for loan losses | (57.8) | | | (1.5) | | | 24.4 | | | 0.7 | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Total interest margin after provision for loan losses | 240.1 | | | 6.1 | | | 268.9 | | | 7.6 | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Direct expenses: | | | | | | | | | | | | | | | |
| Payroll and fringe benefit expense | (14.7) | | | (0.4) | | | (12.6) | | | (0.4) | | | | | | | | | |
| Depreciation and amortization | (3.8) | | | (0.1) | | | (0.2) | | | — | | | | | | | | | |
| Other direct expenses | (17.1) | | | (0.4) | | | (14.4) | | | (0.4) | | | | | | | | | |
| Total direct expenses | (35.6) | | | (0.9) | | | (27.2) | | | (0.8) | | | | | | | | | |
| CarMax Auto Finance income | $ | 204.5 | | | 5.2 | | | $ | 241.7 | | | 6.8 | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Total average managed receivables | $ | 15,817.0 | | | | | $ | 14,148.7 | | | | | | | | | | | |
(1) Annualized percentage of total average managed receivables.
5. Auto Loans Receivable
Auto loans receivable include amounts due from customers related to retail vehicle sales financed through CAF and are presented net of an allowance for estimated loan losses. These auto loans represent a large group of smaller-balance homogeneous loans, which we consider to be part of one class of financing receivable and one portfolio segment for purposes of determining our allowance for loan losses. We generally use warehouse facilities to fund auto loans receivable originated by CAF until we elect to fund them through an asset-backed term funding transaction, such as a term securitization or alternative funding arrangement. We recognize transfers of auto loans receivable into the warehouse facilities and asset-backed term funding transactions (together, “non-recourse funding vehicles”) as secured borrowings, which result in recording the auto loans receivable and the related non-recourse notes payable on our consolidated balance sheets. The majority of the auto loans receivable serve as collateral for the related non-recourse notes payable of $15.76 billion as of May 31, 2022, and $15.47 billion as of February 28, 2022. See Note 10 for additional information on securitizations and non-recourse notes payable.
Interest income and expenses related to auto loans are included in CAF income. Interest income on auto loans receivable is recognized when earned based on contractual loan terms. All loans continue to accrue interest until repayment or charge-off. When a charge-off occurs, accrued interest is written off by reversing interest income. Direct costs associated with loan originations are not considered material, and thus, are expensed as incurred. See Note 4 for additional information on CAF income.
Auto Loans Receivable, Net
| | | | | | | | | | | |
| | As of May 31 | | As of February 28 |
| (In millions) | 2022 | | 2022 |
| Asset-backed term funding | $ | 11,613.3 | | | $ | 11,653.8 | |
| Warehouse facilities | 3,629.9 | | | 3,291.9 | |
Overcollateralization (1) | 565.1 | | | 489.1 | |
Other managed receivables (2) | 243.7 | | | 217.5 | |
| Total ending managed receivables | 16,052.0 | | | 15,652.3 | |
| Accrued interest and fees | 78.1 | | | 67.3 | |
| Other | 0.7 | | | 3.1 | |
| Less: allowance for loan losses | (458.2) | | | (433.0) | |
| Auto loans receivable, net | $ | 15,672.6 | | | $ | 15,289.7 | |
(1) Represents receivables restricted as excess collateral for the non-recourse funding vehicles.
(2) Other managed receivables includes receivables not funded through the non-recourse funding vehicles.
Credit Quality. When customers apply for financing, CAF’s proprietary scoring models utilize 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 with the highest probability of repayment are A-grade customers. 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. After origination, credit grades are generally not updated.
CAF uses a combination of the initial credit grades and historical performance to monitor the credit quality of the auto loans receivable 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 May 31, 2022 |
| Fiscal Year of Origination (1) | | | | |
| (In millions) | 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior to 2019 | | Total | | % (2) |
Core managed receivables (3): | | | | | | | | | | | | | | | |
| A | $ | 1,192.3 | | | $ | 3,447.1 | | | $ | 1,584.2 | | | $ | 1,088.7 | | | $ | 463.0 | | | $ | 158.3 | | | $ | 7,933.6 | | | 49.4 | |
| B | 869.9 | | | 2,495.0 | | | 1,139.0 | | | 743.6 | | | 393.8 | | | 183.0 | | | 5,824.3 | | | 36.3 | |
| C and other | 240.7 | | | 823.7 | | | 440.2 | | | 255.9 | | | 131.0 | | | 75.5 | | | 1,967.0 | | | 12.3 | |
| Total core managed receivables | 2,302.9 | | | 6,765.8 | | | 3,163.4 | | | 2,088.2 | | | 987.8 | | | 416.8 | | | 15,724.9 | | | 98.0 | |
Other managed receivables (4): | | | | | | | | | | | | | | | |
| C and other | 81.2 | | | 161.6 | | | 21.3 | | | 30.6 | | | 21.1 | | | 11.3 | | | 327.1 | | | 2.0 | |
| Total ending managed receivables | $ | 2,384.1 | | | $ | 6,927.4 | | | $ | 3,184.7 | | | $ | 2,118.8 | | | $ | 1,008.9 | | | $ | 428.1 | | | $ | 16,052.0 | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of February 28, 2022 |
| Fiscal Year of Origination (1) | | | | |
| (In millions) | 2022 | | 2021 | | 2020 | | 2019 | | 2018 | | Prior to 2018 | | Total | | % (2) |
Core managed receivables (3): | | | | | | | | | | | | | | | |
| A | $ | 3,885.5 | | | $ | 1,788.3 | | | $ | 1,266.1 | | | $ | 574.1 | | | $ | 203.4 | | | $ | 32.3 | | | $ | 7,749.7 | | | 49.5 | |
| B | 2,795.2 | | | 1,288.5 | | | 857.7 | | | 473.1 | | | 205.2 | | | 50.4 | | | 5,670.1 | | | 36.2 | |
| C and other | 919.1 | | | 496.2 | | | 294.8 | | | 156.7 | | | 73.8 | | | 29.6 | | | 1,970.2 | | | 12.6 | |
| Total core managed receivables | 7,599.8 | | | 3,573.0 | | | 2,418.6 | | | 1,203.9 | | | 482.4 | | | 112.3 | | | 15,390.0 | | | 98.3 | |
Other managed receivables (4): | | | | | | | | | | | | | | | |
| C and other | 165.2 | | | 23.9 | | | 34.7 | | | 23.8 | | | 10.0 | | | 4.7 | | | 262.3 | | | 1.7 | |
| Total ending managed receivables | $ | 7,765.0 | | | $ | 3,596.9 | | | $ | 2,453.3 | | | $ | 1,227.7 | | | $ | 492.4 | | | $ | 117.0 | | | $ | 15,652.3 | | | 100.0 | |
(1) Classified based on credit grade assigned when customers were initially approved for financing.
(2) Percent of total ending managed receivables.
(3) Represents CAF's Tier 1 originations.
(4) Represents CAF's Tier 2 and Tier 3 originations.
Allowance for Loan Losses. The allowance for loan losses at May 31, 2022 represents the net credit losses expected over the remaining contractual life of our managed receivables. The allowance for loan losses is determined using a net loss timing curve, primarily based on the composition of the portfolio of managed receivables and historical gross loss and recovery trends. Due to the fact that losses for receivables with less than 18 months of performance history can be volatile, our net loss estimate weights both historical losses by credit grade at origination and actual loss data on the receivables to-date, along with forward loss curves, in estimating future performance. Once the receivables have 18 months of performance history, the net loss estimate reflects actual loss experience of those receivables to date, along with forward loss curves, to predict future performance. The forward loss curves are constructed using historical performance data and show the average timing of losses over the course of a receivable’s life. The net loss estimate is calculated by applying the loss rates developed using the methods described above to the amortized cost basis of the managed receivables.
The output of the net loss timing curve is adjusted to take into account reasonable and supportable forecasts about the future. Specifically, the change in U.S. unemployment rates and the National Automobile Dealers Association used vehicle price index are used to predict changes in gross loss and recovery rate, respectively. An economic adjustment factor, based upon a single macroeconomic scenario, is developed to capture the relationship between changes in these forecasts and changes in gross loss and recovery rates. This factor is applied to the output of the net loss timing curve for the reasonable and supportable forecast period of two years. After the end of this two-year period, we revert to historical experience on a straight-line basis over a period of 12 months. We periodically consider whether the use of alternative metrics would result in improved model performance and revise the models when appropriate. We also consider whether qualitative adjustments are necessary for factors that are not reflected in the quantitative methods but impact the measurement of estimated credit losses. Such
adjustments include the uncertainty of the impacts of recent economic trends on customer behavior. The change in the allowance for loan losses is recognized through an adjustment to the provision for loan losses.
Allowance for Loan Losses
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended May 31, 2022 |
| (In millions) | Core | | Other | | Total | | % (1) |
| Balance as of beginning of period | $ | 377.5 | | | $ | 55.5 | | | $ | 433.0 | | | 2.77 | |
| Charge-offs | (61.4) | | | (6.8) | | | (68.2) | | | |
| Recoveries | 33.1 | | | 2.5 | | | 35.6 | | | |
| Provision for loan losses | 41.2 | | | 16.6 | | | 57.8 | | | |
| Balance as of end of period | $ | 390.4 | | | $ | 67.8 | | | $ | 458.2 | | | 2.85 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended May 31, 2021 |
| (In millions) | Core | | Other | | Total | | % (1) |
| Balance as of beginning of period | $ | 379.4 | | | $ | 31.7 | | | $ | 411.1 | | | 2.97 | |
| Charge-offs | (38.7) | | | (3.1) | | | (41.8) | | | |
| Recoveries | 32.2 | | | 2.4 | | | 34.6 | | | |
| Provision for loan losses | (24.8) | | | 0.4 | | | (24.4) | | | |
| Balance as of end of period | $ | 348.1 | | | $ | 31.4 | | | $ | 379.5 | | | 2.62 | |
(1) Percent of total ending managed receivables.
(2) Net of costs incurred to recover vehicle.
The allowance for loan losses increased $25.2 million from the prior quarter, primarily reflecting growth in receivables. During the quarter, the previously disclosed expansion of our Tier 2 and Tier 3 originations within CAF's portfolio resulted in a 5 basis point increase in the allowance as a percent of total ending managed receivables from the prior quarter. Loss performance was relatively consistent with the prior quarter. As a result, we determined that the quantitative loss rates should be kept consistent with the end of fiscal 2022. The allowance for loan losses as of May 31, 2022 reflects the historical loss performance experienced prior to the pandemic as well as increases for our Tier 3 expansion and growing Tier 2 portfolio.
Past Due Receivables. 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.
Past Due Receivables
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of May 31, 2022 |
| Core Receivables | | Other Receivables | | Total |
| (In millions) | A | | B | | C & Other | | Total | | C & Other | | $ | | % (1) |
| Current | $ | 7,901.3 | | | $ | 5,549.2 | | | $ | 1,692.5 | | | $ | 15,143.0 | | | $ | 256.7 | | | $ | 15,399.7 | | | 95.94 | |
| Delinquent loans: | | | | | | | | | | | | | |
| 31-60 days past due | 21.6 | | | 175.6 | | | 162.8 | | | 360.0 | | | 40.9 | | | 400.9 | | | 2.50 | |
| 61-90 days past due | 8.1 | | | 79.5 | | | 91.4 | | | 179.0 | | | 23.9 | | | 202.9 | | | 1.26 | |
| Greater than 90 days past due | 2.6 | | | 20.0 | | | 20.3 | | | 42.9 | | | 5.6 | | | 48.5 | | | 0.30 | |
| Total past due | 32.3 | | | 275.1 | | | 274.5 | | | 581.9 | | | 70.4 | | | 652.3 | | | 4.06 | |
| Total ending managed receivables | $ | 7,933.6 | | | $ | 5,824.3 | | | $ | 1,967.0 | | | $ | 15,724.9 | | | $ | 327.1 | | | $ | 16,052.0 | | | 100.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of February 28, 2022 |
| Core Receivables | | Other Receivables | | Total |
| (In millions) | A | | B | | C & Other | | Total | | C & Other | | $ | | % (1) |
| Current | $ | 7,711.9 | | | $ | 5,401.3 | | | $ | 1,702.7 | | | $ | 14,815.9 | | | $ | 206.4 | | | $ | 15,022.3 | | | 95.98 | |
| Delinquent loans: | | | | | | | | | | | | | |
| 31-60 days past due | 25.4 | | | 173.3 | | | 160.4 | | | 359.1 | | | 33.0 | | | 392.1 | | | 2.50 | |
| 61-90 days past due | 9.2 | | | 75.6 | | | 85.2 | | | 170.0 | | | 19.1 | | | 189.1 | | | 1.21 | |
| Greater than 90 days past due | 3.2 | | | 19.9 | | | 21.9 | | | 45.0 | | | 3.8 | | | 48.8 | | | 0.31 | |
| Total past due | 37.8 | | | 268.8 | | | 267.5 | | | 574.1 | | | 55.9 | | | 630.0 | | | 4.02 | |
| Total ending managed receivables | $ | 7,749.7 | | | $ | 5,670.1 | | | $ | 1,970.2 | | | $ | 15,390.0 | | | $ | 262.3 | | | $ | 15,652.3 | | | 100.00 | |
(1) Percent of total ending managed receivables.
6. 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 generally designate these derivative instruments as cash flow hedges for accounting purposes. In certain cases, we may choose not to designate a derivative instrument as a cash flow hedge for accounting purposes due to uncertainty around the probability that future hedged transactions will occur. 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 loans receivable, and (ii) exposure to variable interest rates associated with our term loans.
For the derivatives associated with our non-recourse funding vehicles that are designated as cash flow hedges, the changes in fair value are initially recorded in accumulated other comprehensive income (loss) (“AOCI”). 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 $26.2 million will be reclassified from AOCI as an increase to CAF income. Changes in fair value related to derivatives that have not been designated as cash flow hedges for accounting purposes are recognized in the income statement in the period in which the change occurs. For the three months ended May 31, 2022, we recognized income of $9.2 million in CAF income representing these changes in fair value.
As of May 31, 2022 and February 28, 2022, we had interest rate swaps outstanding with a combined notional amount of $4.11 billion and $3.64 billion, respectively, that were designated as cash flow hedges of interest rate risk. As of May 31, 2022 and February 28, 2022, we had interest rate swaps with a combined notional amount of $995.5 million and $578.3 million, respectively, outstanding that were not designated as cash flow hedges for accounting purposes.
See Note 7 for discussion of fair values of financial instruments and Note 13 for the effect on comprehensive income.
7. 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 loans receivable and 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 equity investments in large-, mid- and small-cap domestic and international companies or investment grade debt securities. 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.
Derivative Instruments. The fair values of our derivative instruments are included in either other current assets, other assets, accounts payable or other liabilities. 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 May 31, 2022 |
| (In thousands) | Level 1 | | Level 2 | | Total |
| Assets: | | | | | |
| Money market securities | $ | 687,599 | | | $ | — | | | $ | 687,599 | |
| Mutual fund investments | 24,593 | | | — | | | 24,593 | |
| | | | | |
| Derivative instruments designated as hedges | — | | | 70,215 | | | 70,215 | |
| Derivative instruments not designated as hedges | — | | | 18,546 | | | 18,546 | |
| Total assets at fair value | $ | 712,192 | | | $ | 88,761 | | | $ | 800,953 | |
| | | | | |
| Percent of total assets at fair value | 88.9 | % | | 11.1 | % | | 100.0 | % |
| Percent of total assets | 2.7 | % | | 0.3 | % | | 3.0 | % |
| | | | | |
| Liabilities: | | | | | |
| Derivative instruments designated as hedges | $ | — | | | $ | (1,518) | | | $ | (1,518) | |
| | | | | |
| | | | | |
| Total liabilities at fair value | $ | — | | | $ | (1,518) | | | $ | (1,518) | |
| | | | | |
| Percent of total liabilities | — | % | | — | % | | — | % |
| | | | | | | | | | | | | | | | | |
| | As of February 28, 2022 |
| (In thousands) | Level 1 | | Level 2 | | Total |
| Assets: | | | | | |
| Money market securities | $ | 701,865 | | | $ | — | | | $ | 701,865 | |
| Mutual fund investments | 24,022 | | | — | | | 24,022 | |
| Derivative instruments designated as hedges | — | | | 39,452 | | | 39,452 | |
| Derivative instruments not designated as hedges | — | | | 9,339 | | | 9,339 | |
| Total assets at fair value | $ | 725,887 | | | $ | 48,791 | | | $ | 774,678 | |
| | | | | |
| Percent of total assets at fair value | 93.7 | % | | 6.3 | % | | 100.0 | % |
| Percent of total assets | 2.8 | % | | 0.2 | % | | 2.9 | % |
| | | | | |
| Liabilities: | | | | | |
| Derivative instruments designated as hedges | $ | — | | | $ | (1,379) | | | $ | (1,379) | |
| Total liabilities at fair value | $ | — | | | $ | (1,379) | | | $ | (1,379) | |
| | | | | |
| Percent of total liabilities | — | % | | — | % | | — | % |
Fair Value of Financial Instruments
The carrying value of our cash and cash equivalents, accounts receivable, other restricted cash deposits and accounts payable approximates fair value due to the short-term nature and/or variable rates associated with these financial instruments. Auto loans receivable are presented net of an allowance for estimated loan losses, which we believe approximates fair value. We believe that the carrying value of our revolving credit facility and term loans approximates fair value due to the variable rates associated with these obligations. The fair value of our senior unsecured notes, which are not carried at fair value on our consolidated balance sheets, was determined using Level 2 inputs based on quoted market prices. The carrying value and fair value of the senior unsecured notes as of May 31, 2022 and February 28, 2022, respectively, are as follows:
| | | | | | | | | | | |
| (In thousands) | As of May 31, 2022 | | As of February 28, 2022 |
| Carrying value | $ | 500,000 | | | $ | 500,000 | |
| Fair value | $ | 491,085 | | | $ | 517,396 | |
8. Cancellation Reserves
We recognize revenue for EPP products, on a net basis, at the time of sale. We also record a reserve, or refund liability, 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 May 31 | | |
| (In millions) | 2022 | | 2021 | | | | |
| Balance as of beginning of period | $ | 144.7 | | | $ | 124.5 | | | | | |
| Cancellations | (27.7) | | | (20.2) | | | | | |
| Provision for future cancellations | 31.7 | | | 34.1 | | | | | |
| Balance as of end of period | $ | 148.7 | | | $ | 138.4 | | | | | |
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 May 31, 2022 and February 28, 2022, the current portion of cancellation reserves was $81.0 million and $78.7 million, respectively.
9. Income Taxes
We had $25.4 million of gross unrecognized tax benefits as of May 31, 2022, and $24.8 million as of February 28, 2022. There were no significant changes to the gross unrecognized tax benefits as reported for the fiscal year ended February 28, 2022.
10. Debt
| | | | | | | | | | | | | | |
| (In thousands) | | As of May 31 | | As of February 28 |
Debt Description (1) | Maturity Date | 2022 | | 2022 |
Revolving credit facility (2) | June 2024 | $ | 660,500 | | | $ | 1,243,500 | |
Term loan (2) | June 2024 | 300,000 | | | 300,000 | |
Term loan (2) | October 2026 | 699,388 | | | 699,352 | |
| 3.86% Senior notes | April 2023 | 100,000 | | | 100,000 | |
| 4.17% Senior notes | April 2026 | 200,000 | | | 200,000 | |
| 4.27% Senior notes | April 2028 | 200,000 | | | 200,000 | |
| Financing obligations | Various dates through February 2059 | 522,414 | | | 524,766 | |
| Non-recourse notes payable | Various dates through October 2028 | 15,764,161 | | | 15,466,799 | |
| Total debt | | 18,446,463 | | | 18,734,417 | |
| Less: current portion | | (632,461) | | | (532,272) | |
| Less: unamortized debt issuance costs | | (26,022) | | | (27,126) | |
| Long-term debt, net | | $ | 17,787,980 | | | $ | 18,175,019 | |
(1) Interest is payable monthly, with the exception of our senior notes, which are payable semi-annually.
(2) Borrowings accrue interest at variable rates based on the Eurodollar rate (LIBOR), or the successor benchmark rate, the federal funds rate, or the prime rate, depending on the type of borrowing.
Revolving Credit Facility. Borrowings under our $2.00 billion unsecured revolving credit facility (the “credit facility”) are available for working capital and general corporate purposes. 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. As of May 31, 2022, the unused capacity of $1.34 billion was fully available to us.
Term Loans. Borrowings under our $300 million and $700 million term loans are available for working capital and general corporate purposes. The interest rate on our term loans was 1.70% as of May 31, 2022, and the loans were classified as long-term debt as no repayments are scheduled to be made within the next 12 months.
Senior Notes. Borrowings under our unsecured senior notes totaling $500 million are available for working capital and general corporate purposes. The 3.86% senior note matures in April 2023 and is therefore classified as current. The remaining notes were classified as long-term debt as no repayments are scheduled to be made within the next 12 months.
Financing Obligations. Financing obligations relate to stores subject to sale-leaseback transactions that do not qualify for sale accounting. The financing obligations were structured at varying interest rates and generally have initial lease terms ranging from 15 to 20 years with payments made monthly. We have not entered into any new sale-leaseback transactions since fiscal 2009. In the event the agreements are modified or extended beyond their original term, the related obligation is adjusted based on the present value of the revised future payments, with a corresponding change to the assets subject to these transactions. Upon modification, the amortization of the obligation is reset, resulting in more of the payments being applied to interest expense in the initial years following the modification.
Non-Recourse Notes Payable. The non-recourse notes payable relate to auto loans receivable funded through non-recourse funding vehicles. The timing of principal payments on the non-recourse notes payable is based on the timing of principal collections and defaults on the related auto loans receivable. The current portion of non-recourse notes payable represents principal payments that are due to be distributed in the following period.
Notes payable related to our asset-backed term funding transactions accrue interest predominantly at fixed rates and have scheduled maturities through October 2028, but may mature earlier, depending upon the repayment rate of the underlying auto loans receivable.
Information on our funding vehicles of non-recourse notes payable as of May 31, 2022 are as follows:
| | | | | |
| (In billions) | Capacity |
| Warehouse facilities: | |
| August 2022 expiration | $ | 2.30 | |
| December 2022 expiration | 0.25 | |
| February 2023 expiration | 2.85 | |
| Combined warehouse facility limit | $ | 5.40 | |
| Unused capacity | $ | 1.77 | |
| |
| Non-recourse notes payable outstanding: | |
| Warehouse facilities | $ | 3.63 | |
| Asset-backed term funding transactions | 12.13 | |
| Non-recourse notes payable | $ | 15.76 | |
We generally enter into warehouse facility agreements for one-year terms and typically renew the agreements annually. 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 Note 5 for additional information on the related auto loans receivable.
Capitalized Interest. We capitalize interest in connection with the construction of certain facilities. For the three months ended May 31, 2022 and 2021, we capitalized interest of $0.8 million and $1.9 million, respectively.
Financial Covenants. The credit facility, term loans and senior note agreements contain representations and warranties, conditions and covenants. We must also meet financial covenants in conjunction with certain financing obligations. The agreements governing our non-recourse funding vehicles contain representations and warranties, financial covenants and performance triggers. As of May 31, 2022, we were in compliance with all financial covenants and our non-recourse funding vehicles were in compliance with the related performance triggers.
11. Stock and Stock-Based Incentive Plans
(A) Share Repurchase Program
In April 2022, our board of directors (“board”) increased our share repurchase authorization by $2.0 billion. As of May 31, 2022, a total of $4.0 billion of board authorizations for repurchases of our common stock was outstanding, with no expiration date, of which $2.6 billion remained available for repurchase.
Common Stock Repurchases
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | May 31 | | |
| | 2022 | | 2021 | | | | |
Number of shares repurchased (in thousands) | 1,644.4 | | | 997.6 | | | | | |
| Average cost per share | $ | 95.83 | | | $ | 124.83 | | | | | |
Available for repurchase, as of end of period (in millions) | $ | 2,616.9 | | | $ | 1,211.5 | | | | | |
(B)Stock Incentive Plans
We maintain long-term incentive plans for management, certain employees and the nonemployee members of our board. The plans allow for the granting 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 not awarded any incentive stock options.
The majority of associates who receive share-based compensation awards primarily receive cash-settled restricted stock units. Senior management and other key associates receive awards of nonqualified stock options, stock-settled restricted stock units and/or restricted stock awards. Nonemployee directors generally receive stock-settled deferred stock units. Excluding stock grants and stock-settled deferred stock units, all share-based compensation awards, including any associated dividend rights, are subject to forfeiture.
Nonqualified Stock Options. Nonqualified stock options are awards that allow the recipient to purchase shares of our common stock at a fixed price. Stock options are granted at an exercise price equal to the fair market value of our common stock on the grant date. The stock options generally vest annually in equal amounts over four years. These options expire seven years after the date of the grant.
Cash-Settled Restricted Stock Units. Also referred to as restricted stock units, or RSUs, these are awards that entitle the holder to a cash payment equal to the fair market value of a share of our common stock for each unit granted. For grants prior to fiscal 2021, conversion generally occurs at the end of a three-year vesting period. For RSUs granted during or after fiscal 2021, conversion generally occurs annually or in equal amounts over three years. However, the cash payment per RSU will not be greater than 200% or less than 75% of the fair market value of a share of our common stock on the grant date. The initial grant date fair values are based on the volume-weighted average prices or closing prices of our common stock on the grant dates. RSUs are liability-classified awards and do not have voting rights.
Stock-Settled Market Stock Units. Also referred to as market stock units, or MSUs, these are restricted stock unit awards with market conditions granted to eligible key associates that are converted into between zero and two shares of common stock for each unit granted. Conversion generally occurs at the end of a three-year vesting period. The conversion ratio is calculated by dividing the average closing price of our stock during the final 40 trading days of the three-year vesting period by our stock price on the grant date, with the resulting quotient capped at two. This quotient is then multiplied by the number of MSUs granted to yield the number of shares awarded. The grant date fair values are determined using a Monte-Carlo simulation and are based on the expected market price of our common stock on the vesting date and the expected number of converted common shares. MSUs do not have voting rights.
Other Share-Based Incentives
Stock-Settled Performance Stock Units. Also referred to as performance stock units, or PSUs, these are restricted stock unit awards with performance conditions granted to eligible key associates that are converted into between zero and two shares of common stock for each unit granted. Conversion generally occurs at the end of a three-year vesting period. For the fiscal 2020, fiscal 2022 and fiscal 2023 grants, the conversion ratio is based on the company reaching certain performance target levels set by the board of directors at the beginning of each one-year period, with the resulting quotients subject to meeting a minimum
25% threshold and capped at 200%. These quotients are then multiplied by the number of PSUs granted to yield the number of shares awarded.
For the first-year and third-year periods of the fiscal 2020 awards and the first-year of the fiscal 2022 awards, these targets were based on annual pretax diluted earnings per share excluding any unrealized gains or losses on equity investments in private companies; the board certified performance adjustment factors of 117%, 200% and 200%, respectively. For the second-year period of the fiscal 2020 awards, the performance goals included quantitative and qualitative metrics including covenant compliance, market share and COVID-19 recovery; the board certified a performance adjustment factor of 100%.
For the second-year period of the fiscal 2022 awards and the first-year period of the fiscal 2023 awards, the performance targets are based on annual pretax diluted earnings per share excluding any unrealized gains or losses on equity investments in private companies and market share. For the third-year period of the fiscal 2022 awards and the second- and third-year periods of the fiscal 2023 awards, the remaining awarded 48,658 PSUs do not qualify as grants under ASC 718 as mutual understanding of the target performance levels have not been set. The grant date fair values are based on the volume-weighted average prices or closing prices of our common stock on the grant dates. PSUs do not have voting rights. No PSUs were awarded in fiscal 2021. As of May 31, 2022, 43,364 granted units were outstanding at a weighted average grant date fair value per share of $109.02.
Stock-Settled Deferred Stock Units. Also referred to as deferred stock units, or DSUs, these are restricted stock unit awards granted to non-employee members of our board of directors that are converted into one share of common stock for each unit granted. Conversion occurs at the end of the one-year vesting period unless the director has exercised the option to defer conversion until separation of service to the company. The grant date fair values are based on the volume-weighted average prices or closing prices of our common stock on the grant dates. DSUs have no voting rights. As of May 31, 2022, 69,288 units were outstanding at a weighted average grant date fair value of $92.82.
Restricted Stock Awards. Restricted stock awards, or RSAs, are awards of our common stock that are subject to specified restrictions that generally lapse after a one- to three-year period from the date of the grant. The grant date fair values are based on the volume-weighted average prices or closing prices of our common stock on the grant dates. Participants holding restricted stock are entitled to vote on matters submitted to holders of our common stock for a vote. As of May 31, 2022, there were 24,171 shares outstanding at a grant date value of $119.96.
(C)Share-Based Compensation
Composition of Share-Based Compensation Expense
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | May 31 | | |
| (In thousands) | 2022 | | 2021 | | | | |
| Cost of sales | $ | 240 | | | $ | 1,729 | | | | | |
| CarMax Auto Finance income | 708 | | | 1,708 | | | | | |
| Selling, general and administrative expenses | 22,236 | | | 38,420 | | | | | |
| Share-based compensation expense, before income taxes | $ | 23,184 | | | $ | 41,857 | | | | | |
Composition of Share-Based Compensation Expense – By Grant Type
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | May 31 | | |
| (In thousands) | 2022 | | 2021 | | | | |
| Nonqualified stock options | $ | 11,212 | | | $ | 11,821 | | | | | |
| Cash-settled restricted stock units (RSUs) | 849 | | | 20,972 | | | | | |
| Stock-settled market stock units (MSUs) | 5,347 | | | 4,845 | | | | | |
| Other share-based incentives: | | | | | | | |
| Stock-settled performance stock units (PSUs) | 4,691 | | | 3,394 | | | | | |
| Restricted stock (RSAs) | 344 | | | 42 | | | | | |
| | | | | | | |
| Employee stock purchase plan | 741 | | | 783 | | | | | |
| Total other share-based incentives | $ | 5,776 | | | $ | 4,219 | | | | | |
| Share-based compensation expense, before income taxes | $ | 23,184 | | | $ | 41,857 | | | | | |
Unrecognized Share-Based Compensation Expense – By Grant Type
| | | | | | | | | | | |
| | As of May 31, 2022 |
| | | Weighted Average |
| Unrecognized | | Remaining |
| Compensation | | Recognition Life |
| (Costs in millions) | Costs | | (Years) |
| Nonqualified stock options | $ | 76.8 | | | 2.4 |
| Stock-settled market stock units | 24.5 | | | 1.8 |
| Other share-based incentives: | | | |
| Stock-settled performance stock units | 4.4 | | | 2.3 |
| | | |
| Restricted stock | 1.4 | | | 1.0 |
| Total other share-based incentives | 5.8 | | | 2.0 |
| Total | $ | 107.1 | | | 2.2 |
We recognize compensation expense for stock options, MSUs, PSUs, DSUs and RSAs on a straight-line basis (net of estimated forfeitures) over the requisite service period, which is generally the vesting period of the award. The PSU expense is adjusted for any change in management’s assessment of the performance target level that is probable of being achieved. The variable expense associated with RSUs is recognized over their vesting period (net of estimated forfeitures) and is calculated based on the volume-weighted average price or closing price of our common stock on the last trading day of each reporting period.
The total costs for matching contributions for our employee stock purchase plan are included in share-based compensation expense. There were no capitalized share-based compensation costs as of or for the three months ended May 31, 2022 or 2021.
Stock Option Activity
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | Weighted | | |
| | | | Weighted | | Average | | |
| | | | Average | | Remaining | | Aggregate |
| | Number of | | Exercise | | Contractual | | Intrinsic |
| (Shares and intrinsic value in thousands) | Shares | | Price | | Life (Years) | | Value |
| Outstanding as of February 28, 2022 | 5,796 | | | $ | 79.66 | | | | | |
| Options granted | 1,264 | | | $ | 91.14 | | | | | |
| Options exercised | (49) | | | $ | 70.25 | | | | | |
| Options forfeited or expired | (39) | | | $ | 95.00 | | | | | |
| Outstanding as of May 31, 2022 | 6,972 | | | $ | 81.72 | | | 4.5 | | $ | 155,771 | |
| | | | | | | |
| Exercisable as of May 31, 2022 | 4,134 | | | $ | 72.55 | | | 3.5 | | $ | 120,988 | |
Stock Option Information
| | | | | | | | | | | |
| Three Months Ended May 31 |
| 2022 | | 2021 |
| Options granted | 1,263,797 | | | 917,455 | |
| Weighted average grant date fair value per share | $ | 33.32 | | | $ | 42.33 | |
| Cash received from options exercised (in millions) | $ | 3.4 | | | $ | 21.6 | |
| Intrinsic value of options exercised (in millions) | $ | 1.2 | | | $ | 28.0 | |
| Realized tax benefits (in millions) | $ | 0.3 | | | $ | 6.9 | |
For stock options, 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 a closed-form valuation model (for example, 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 a closed-form 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.
Assumptions Used to Estimate Option Values
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended May 31 | | | | |
| | 2022 | | 2021 | | | | |
| Dividend yield | | | 0.0 | % | | | | 0.0 | % | | | | |
Expected volatility factor (1) | 38.7 | % | - | 45.4 | % | | 31.8 | % | - | 37.0 | % | | | | |
| Weighted average expected volatility | | | 39.4 | % | | | | 36.2 | % | | | | |
Risk-free interest rate (2) | 0.4 | % | - | 3.0 | % | | — | % | - | 1.3 | % | | | | |
Expected term (in years) (3) | | | 4.6 | | | | 4.6 | | | | |
(1)Measured using historical daily price changes of our stock for a period corresponding to the term of the options and the implied volatility derived from the market prices of traded options on our stock.
(2)Based on the U.S. Treasury yield curve at the time of grant.
(3)Represents the estimated number of years that options will be outstanding prior to exercise.
Cash-Settled Restricted Stock Unit Activity
| | | | | | | | | | | |
| | | | Weighted |
| | | | Average |
| | Number of | | Grant Date |
| (Units in thousands) | Units | | Fair Value |
| Outstanding as of February 28, 2022 | 1,163 | | | $ | 93.37 | |
| Stock units granted | 660 | | | $ | 91.14 | |
| Stock units vested and converted | (734) | | | $ | 85.33 | |
| Stock units cancelled | (23) | | | $ | 98.56 | |
| Outstanding as of May 31, 2022 | 1,066 | | | $ | 97.42 | |
Cash-Settled Restricted Stock Unit Information
| | | | | | | | | | | |
| Three Months Ended May 31 |
| 2022 | | 2021 |
| Stock units granted | 660,085 | | | 361,115 | |
| Initial weighted average grant date fair value per share | $ | 91.14 | | | $ | 136.94 | |
| Payments (before payroll tax withholdings) upon vesting (in millions) | $ | 65.2 | | | $ | 89.8 | |
| Realized tax benefits (in millions) | $ | 15.9 | | | $ | 24.6 | |
Expected Cash Settlement Range Upon Restricted Stock Unit Vesting
| | | | | | | | | | | |
| | As of May 31, 2022 |
| (In thousands) | Minimum (1) | | Maximum (1) |
| Fiscal 2024 | $ | 31,010 | | | $ | 82,692 | |
| Fiscal 2025 | 23,209 | | | 61,890 | |
| Fiscal 2026 | 12,724 | | | 33,930 | |
| Total expected cash settlements | $ | 66,943 | | | $ | 178,512 | |
(1)Net of estimated forfeitures.
Stock-Settled Market Stock Unit Activity
| | | | | | | | | | | |
| | | | Weighted |
| | | | Average |
| | Number of | | Grant Date |
| (Units in thousands) | Units | | Fair Value |
| Outstanding as of February 28, 2022 | 393 | | | $ | 112.17 | |
| Stock units granted | 132 | | | $ | 126.59 | |
| Stock units vested and converted | (119) | | | $ | 98.43 | |
| Stock units cancelled | (5) | | | $ | 124.75 | |
| Outstanding as of May 31, 2022 | 401 | | | $ | 120.80 | |
Stock-Settled Market Stock Unit Information
| | | | | | | | | | | |
| Three Months Ended May 31 |
| 2022 | | 2021 |
| Stock units granted | 131,701 | | | 80,910 | |
| Weighted average grant date fair value per share | $ | 126.59 | | | $ | 178.31 | |
Realized tax benefits (in millions) | $ | 3.0 | | | $ | 10.9 | |
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.
Basic and Dilutive Net Earnings Per Share Reconciliations
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | May 31 | | |
| (In thousands except per share data) | 2022 | | 2021 | | | | |
| Net earnings | $ | 252,265 | | | $ | 436,756 | | | | | |
| | | | | | | |
| Weighted average common shares outstanding | 160,298 | | | 163,151 | | | | | |
| Dilutive potential common shares: | | | | | | | |
| Stock options | 1,178 | | | 2,529 | | | | | |
| Stock-settled stock units and awards | 322 | | | 615 | | | | | |
| Weighted average common shares and dilutive potential common shares | 161,798 | | | 166,295 | | | | | |
| | | | | | | |
| Basic net earnings per share | $ | 1.57 | | | $ | 2.68 | | | | | |
| Diluted net earnings per share | $ | 1.56 | | | $ | 2.63 | | | | | |
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 May 31, 2022 and 2021, options to purchase 1,344,783 shares and 289,140 shares of common stock, respectively, were not included.
13. Accumulated Other Comprehensive Income (Loss)
Changes in Accumulated Other Comprehensive Income (Loss) By Component
| | | | | | | | | | | | | | | | | |
| | | | | | Total |
| | Net | | Net | | Accumulated |
| | Unrecognized | | Unrecognized | | Other |
| | Actuarial | | Hedge | | Comprehensive |
| (In thousands, net of income taxes) | Losses | | Gains | | Income (Loss) |
| Balance as of February 28, 2022 | $ | (73,001) | | | $ | 26,579 | | | $ | (46,422) | |
| Other comprehensive income before reclassifications | — | | | 52,055 | | | 52,055 | |
| Amounts reclassified from accumulated other comprehensive income (loss) | 481 | | | (222) | | | 259 | |
| Other comprehensive income | 481 | | | 51,833 | | | 52,314 | |
| Balance as of May 31, 2022 | $ | (72,520) | | | $ | 78,412 | | | $ | 5,892 | |
Changes In and Reclassifications Out of Accumulated Other Comprehensive Income (Loss)
| | | | | | | | | | | | | | | |
| | Three Months Ended May 31 | | |
| (In thousands) | 2022 | | 2021 | | | | |
| Retirement Benefit Plans: | | | | | | | |
| Actuarial loss amortization reclassifications recognized in net pension expense: | | | | | | | |
| Cost of sales | $ | 265 | | | $ | 357 | | | | | |
| CarMax Auto Finance income | 16 | | | 22 | | | | | |
| Selling, general and administrative expenses | 355 | | | 489 | | | | | |
| Total amortization reclassifications recognized in net pension expense | 636 | | | 868 | | | | | |
| Tax expense | (155) | | | (209) | | | | | |
| Amortization reclassifications recognized in net pension expense, net of tax | 481 | | | 659 | | | | | |
| Net change in retirement benefit plan unrecognized actuarial losses, net of tax | 481 | | | 659 | | | | | |
| | | | | | | |
| Cash Flow Hedges (Note 6): | | | | | | | |
| Changes in fair value | 70,042 | | | (2,006) | | | | | |
| Tax (expense) benefit | (17,987) | | | 528 | | | | | |
| Changes in fair value, net of tax | 52,055 | | | (1,478) | | | | | |
| Reclassifications to CarMax Auto Finance income | (299) | | | 5,098 | | | | | |
| Tax benefit (expense) | 77 | | | (1,342) | | | | | |
| Reclassification of hedge gains (losses), net of tax | (222) | | | 3,756 | | | | | |
| Net change in cash flow hedge unrecognized gains, net of tax | 51,833 | | | 2,278 | | | | | |
| Total other comprehensive income, net of tax | $ | 52,314 | | | $ | 2,937 | | | | | |
Changes in the funded status of our retirement plans and changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognized in accumulated other comprehensive income (loss). The cumulative balances are net of deferred taxes of $3.9 million as of May 31, 2022 and $14.2 million as of February 28, 2022.
14. Leases
Our leases primarily consist of operating and finance leases related to retail stores, office space, land and equipment. We also have stores subject to sale-leaseback transactions that do not qualify for sale accounting and are accounted for as financing obligations. For more information on these financing obligations see Note 10.
The initial term for real property leases is typically 5 to 20 years. For equipment leases, the initial term generally ranges from 3 to 8 years. Most leases include one or more options to renew, with renewal terms that can extend the lease term from 1 to 20 years or more. We include options to renew (or terminate) in our lease term, and as part of our right-of-use (“ROU”) assets and lease liabilities, when it is reasonably certain that we will exercise that option.
ROU assets and the related lease liabilities are initially measured at the present value of future lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our collateralized incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. We include variable lease payments in the initial measurement of ROU assets and lease liabilities only to the extent they depend on an index or rate. Changes in such indices or rates are accounted for in the period the change occurs, and do not result in the remeasurement of the ROU asset or liability. We are also responsible for payment of certain real estate taxes, insurance and other expenses on our leases. These amounts are generally considered to be variable and are not included in the measurement of the ROU asset and lease liability. We generally account for non-lease components, such as maintenance, separately from lease components. For certain equipment leases, we apply a portfolio approach to account for the lease assets and liabilities.
Our lease agreements do not contain any material residual value guarantees or material restricted covenants. Leases with a term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
The components of lease expense were as follows:
| | | | | | | | | | | | | | | |
| Three Months Ended May 31 | | |
| (In thousands) | 2022 | | 2021 | | | | |
Operating lease cost (1) | $ | 23,020 | | | $ | 14,352 | | | | | |
| Finance lease cost: | | | | | | | |
| Depreciation of lease assets | 3,494 | | | 3,142 | | | | | |
| Interest on lease liabilities | 4,930 | | | 4,107 | | | | | |
| Total finance lease cost | 8,424 | | | 7,249 | | | | | |
| Total lease cost | $ | 31,444 | | | $ | 21,601 | | | | | |
(1) Includes short-term leases and variable lease costs, which are immaterial.
Supplemental balance sheet information related to leases was as follows:
| | | | | | | | | | | | | | |
| | As of May 31 | | As of February 28 |
| (In thousands) | Classification | 2022 | | 2022 |
| Assets: | | | | |
| Operating lease assets | Operating lease assets | $ | 533,355 | | | $ | 537,357 | |
| Finance lease assets | Property and equipment, net (1) | 141,463 | | | 127,183 | |
| Total lease assets | | $ | 674,818 | | | $ | 664,540 | |
| Liabilities: | | | | |
| Current: | | | | |
| Operating leases | Current portion of operating lease liabilities | $ | 44,384 | | | $ | 44,197 | |
| Finance leases | Accrued expenses and other current liabilities | 12,327 | | | 10,290 | |
| Long-term: | | | | |
| Operating leases | Operating lease liabilities, excluding current portion | 519,818 | | | 523,269 | |
| Finance leases | Other liabilities | 158,988 | | | 145,179 | |
| Total lease liabilities | | $ | 735,517 | | | $ | 722,935 | |
(1) Finance lease assets are recorded net of accumulated depreciation of $34.2 million as of May 31, 2022 and $30.7 million as of February 28, 2022.
Lease term and discount rate information related to leases was as follows:
| | | | | | | | | | | |
| As of May 31 | | As of February 28 |
| Lease Term and Discount Rate | 2022 | | 2022 |
Weighted Average Remaining Lease Term (in years) | | | |
| Operating leases | 17.11 | | 17.31 |
| Finance leases | 11.58 | | 12.42 |
| | | |
| Weighted Average Discount Rate | | | |
| Operating leases | 4.80 | % | | 4.80 | % |
| Finance leases | 14.56 | % | | 14.35 | % |
Supplemental cash flow information related to leases was as follows:
| | | | | | | | | | | |
| Three Months Ended May 31 |
| (In thousands) | 2022 | | 2021 |
| Cash paid for amounts included in the measurement of lease liabilities: | | | |
| Operating cash flows from operating leases | $ | 22,282 | | | $ | 13,911 | |
| Operating cash flows from finance leases | $ | 3,935 | | | $ | 2,699 | |
| Financing cash flows from finance leases | $ | 2,925 | | | $ | 2,788 | |
| | | |
| Lease assets obtained in exchange for lease obligations: | | |
| Operating leases | $ | 7,871 | | | $ | 30,078 | |
| Finance leases | $ | 17,776 | | | $ | 10,107 | |
Maturities of lease liabilities were as follows:
| | | | | | | | | | | |
| As of May 31, 2022 |
| (In thousands) | Operating Leases (1) | | Finance Leases (1) |
| Fiscal 2023, remaining | $ | 53,792 | | | $ | 22,854 | |
| Fiscal 2024 | 71,516 | | | 36,850 | |
| Fiscal 2025 | 71,070 | | | 33,815 | |
| Fiscal 2026 | 65,566 | | | 34,875 | |
| Fiscal 2027 | 58,694 | | | 30,639 | |
| Thereafter | 572,583 | | | 195,344 | |
| Total lease payments | 893,221 | | | 354,377 | |
| Less: interest | (329,019) | | | (183,062) | |
| Present value of lease liabilities | $ | 564,202 | | | $ | 171,315 | |
(1) Lease payments exclude $28.8 million of legally binding minimum lease payments for leases signed but not yet commenced.
15. Supplemental Cash Flow Information
Supplemental disclosures of cash flow information:
| | | | | | | | | | | |
| Three Months Ended May 31 |
| (In thousands) | 2022 | | 2021 |
| Non-cash investing and financing activities: | | | |
| (Decrease) increase in accrued capital expenditures | $ | (2,457) | | | $ | 2,568 | |
| | | |
| | | |
See Note 14 for supplemental cash flow information related to leases.
16. Contingent Liabilities
Litigation. CarMax entities are defendants in three proceedings asserting wage and hour claims with respect to non-exempt CarMax employees in California. The asserted claims include failure to provide meal periods and rest breaks; pay statutory or contractual wages; reimburse for work-related expenses; and Private Attorneys General Act (“PAGA”) claims. On July 9, 2021, Daniel Bendure v. CarMax Auto Superstores California, LLC et al., a putative class action, was filed in the Superior Court of California, County of San Bernardino. The Bendure lawsuit seeks civil penalties for violation of the Labor Code, attorneys’ fees, costs, restitution of unpaid wages, interest, injunctive and equitable relief, general damages, and special damages. Bendure subsequently decided not to proceed with an individual or putative class claim, but rather filed and served a PAGA-only complaint in the Superior Court of California for the County of San Bernardino on December 7, 2021, based on the same allegations pled in the original complaint. CarMax filed a motion to compel arbitration. The Court has stayed all discovery until after it rules on CarMax’s motion to compel arbitration. On August 12, 2021, Jordon Miller v. CarMax Auto Superstores California, LLC et al., a putative class action, was filed in the Superior Court of California, County of Riverside. The Miller lawsuit also seeks civil penalties for violation of the Labor Code, attorneys’ fees, costs, restitution of unpaid wages, interest, injunctive and equitable relief, general damages, and special damages. On August 3, 2021, Charles Walker filed a
notice with the California Labor Workforce Development Agency, which is a prerequisite to filing a PAGA action in court. Walker filed his lawsuit on March 29, 2022.
On June 15, 2022, the United States Supreme Court issued its decision in Viking Cruise v. Moriana, holding that an individual who signs an arbitration agreement cannot circumvent that agreement by filing a related PAGA claim in court. In light of this decision, CarMax intends to move to compel arbitration of the individual PAGA claims noted above and will seek to dismiss any representative PAGA claims.
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 a 90-day/4,000 mile 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 $26.6 million as of May 31, 2022, and $18.5 million as of February 28, 2022, and is included in accrued expenses and other current liabilities.
17. Segment Information
We operate in two reportable segments: CarMax Sales Operations and 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 also have a non-reportable operating segment related to our recently acquired Edmunds business, which is reflected as “Other” in the segment tables below. Revenue generated by Edmunds primarily represents advertising and subscription revenues as discussed in Note 3. Edmunds also generates intersegment revenue as a result of transactions between Edmunds and CarMax Sales Operations, which represent arm’s length transactions at prevailing market prices. Such amounts are eliminated in consolidation.
The performance of our CarMax Sales Operations segment is reviewed by our chief operating decision maker at the gross profit level, the components of which are presented in the tables below. Required segment information related to our CAF segment is presented in Note 4. Additionally, asset information by segment is not utilized for purposes of assessing performance or allocating resources and, as a result, such information has not been presented.
Segment Information
| | | | | | | | | | | | | | |
| Three Months Ended May 31, 2022 |
| (In thousands) | CarMax Sales Operations | Other | Eliminations | Total |
| Sales and operating revenues | $ | 9,277,236 | | $ | 34,385 | | $ | — | | $ | 9,311,621 | |
| Intersegment sales and operating revenues | — | | 7,742 | | (7,742) | | — | |
| Total sales and operating revenues | $ | 9,277,236 | | $ | 42,127 | | $ | (7,742) | | $ | 9,311,621 | |
Depreciation and amortization (1) | $ | 312 | | $ | 3,074 | | $ | — | | $ | 3,386 | |
| Gross profit | $ | 849,290 | | $ | 27,727 | | $ | (1,626) | | $ | 875,391 | |
Reconciliation to Consolidated Earnings Before Taxes: | | | |
| CAF Income | | | | 204,473 | |
| Selling, general and administrative expenses | | | | (656,740) | |
Depreciation and amortization (2) | | | | (55,648) | |
| Interest expense | | | | (28,775) | |
| Other (expense) income | | | | (2,099) | |
| Earnings before income taxes | | | | $ | 336,602 | |
(1) Represents only the portion of depreciation and amortization recorded within Cost of sales, and thus included in the calculation of Gross profit.
(2) Exclusive of depreciation and amortization recorded within Cost of sales.
ITEM 2.