10.Stock and Stock-Based Incentive Plans

(A)Share Repurchase Program

In fiscal 2013, our board of directors authorized the repurchase of up to $800 million of our common stock. Purchases may be made in open market or privately negotiated transactions at management’s discretion and the timing and amount of repurchases are determined based on share price, market conditions, legal requirements and other factors. Shares repurchased are deemed authorized but unissued shares of common stock.

For the three months ended November 30, 2013, we repurchased 313,042 shares of common stock at an average purchase price of $47.39 per share. For the nine months ended November 30, 2013, we repurchased 4,305,293 shares of common stock at an average purchase price of $43.69 per share. For the three and nine months ended November 30, 2012, we repurchased 1,744,300 shares of common stock at an average purchase price of $34.53 per share. As of November 30, 2013, $400.0 million was available for repurchase under the authorization, which expires on December 31, 2014.

(B)Stock Incentive Plans

We maintain long-term incentive plans for management, key employees and the nonemployee members of our board of directors. 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 and stock-settled restricted stock units. Nonemployee directors receive awards of nonqualified stock options and stock grants.

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 periods of one to four years. These options are subject to forfeiture and expire no later than ten 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. Conversion generally occurs at the end of a three-year vesting period. 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. RSUs are liability awards that are subject to forfeiture and do not have voting rights.

Stock-Settled Restricted Stock Units. Also referred to as market stock units, or MSUs, these are awards 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 forty 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. MSUs are subject to forfeiture and do not have voting rights.

(C)Share-Based Compensation

Composition of Share-Based Compensation Expense


	Three Months Ended				Nine Months Ended
	November 30				November 30
(In thousands)	2013		2012		2013		2012
Cost of sales	$	1,037	$	1,111	$	2,896	$	2,208
CarMax Auto Finance income		790		716		2,302		1,845
Selling, general and administrative expenses		15,371		14,821		50,608		43,304
Share-based compensation expense, before income taxes	$	17,198	$	16,648	$	55,806	$	47,357

Composition of Share-Based Compensation Expense – By Grant Type


	Three Months Ended				Nine Months Ended
	November 30				November 30
(In thousands)	2013		2012		2013		2012
Nonqualified stock options	$	5,946	$	4,564	$	18,765	$	18,805
Cash-settled restricted stock units		8,014		9,238		25,986		17,630
Stock-settled restricted stock units		2,986		2,589		9,697		9,612
Employee stock purchase plan		252		257		858		760
Stock grants to non-employee directors		―		―		500		550
Share-based compensation expense, before income taxes	$	17,198	$	16,648	$	55,806	$	47,357

We recognize compensation expense for stock options and MSUs on a straight-line basis (net of estimated forfeitures) over the requisite service period, which is generally the vesting period of the award. 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 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 nine months ended November 30, 2013 or 2012.

Stock Option Activity


					Weighted
					Average
			Weighted		Remaining		Aggregate
	Number of		Average		Contractual		Intrinsic
(Shares and intrinsic value in thousands)	Shares		Exercise Price		Life (Years)		Value
Outstanding as of February 28, 2013		10,771	$	23.00
Options granted		1,605		42.77
Options exercised		(1,328)		19.60
Options forfeited or expired		(19)		26.25
Outstanding as of November 30, 2013		11,029	$	26.29		3.7	$	272,568
Exercisable as of November 30, 2013		6,854	$	20.68		2.7	$	207,819

For the nine months ended November 30, 2013 and 2012, we granted nonqualified options to purchase 1,605,149 and 2,252,124 shares of common stock, respectively. The total cash received as a result of stock option exercises for the nine months ended November 30, 2013 and 2012, was $26.0 million and $37.8 million, respectively. We settle stock option exercises with authorized but unissued shares of our common stock. The total intrinsic value of options exercised for the nine months ended November 30, 2013 and 2012, was $34.7 million and $37.7 million, respectively. We realized related tax benefits of $13.9 million and $15.1 million during the nine months ended November 30, 2013 and 2012, respectively.

Outstanding Stock Options


					As of November 30, 2013
					Options Outstanding						Options Exercisable
							Weighted
							Average		Weighted				Weighted
							Remaining		Average				Average
(Shares in thousands)					Number of		Contractual		Exercise		Number of		Exercise
Range of Exercise Prices					Shares		Life (Years)		Price		Shares		Price
$	11.43					1,627		2.4	$	11.43		1,627	$	11.43
$	13.19	-	$	19.82		2,268		1.3	$	16.35		2,268	$	16.35
$	19.98	-	$	25.39		1,677		3.2	$	25.19		1,318	$	25.13
$	25.67	-	$	32.05		2,147		5.2	$	31.60		657	$	31.39
$	32.69	-	$	49.25		3,310		5.3	$	37.50		984	$	32.82
Total						11,029		3.7	$	26.29		6,854	$	20.68

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.

The weighted average fair value per share at the date of grant for options granted during the nine months ended November 30, 2013 and 2012, was $15.59 and $12.67, respectively. The unrecognized compensation costs related to nonvested options totaled $37.8 million as of November 30, 2013. These costs are expected to be recognized on a straight-line basis over a weighted average period of 2.2 years.

Assumptions Used to Estimate Option Values


	Nine Months Ended November 30
	2013					2012
Dividend yield				0.0	%				0.0	%
Expected volatility factor (1)	27.9	%	-	46.8	%	31.1	%	-	51.4	%
Weighted average expected volatility				44.7	%				49.4	%
Risk-free interest rate (2)	0.02	%	-	2.6	%	0.02	%	-	2.0	%
Expected term (in years) (3)				4.7					4.7

(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 in effect 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, 2013	1,651	$	29.90
Stock units granted	542	$	42.68
Stock units vested and converted	(564)	$	25.62
Stock units cancelled	(78)	$	34.76
Outstanding as of November 30, 2013	1,551	$	35.68

For the nine months ended November 30, 2013 and 2012, we granted RSUs of 541,819 units and 644,232 units, respectively. The initial weighted average fair market value per unit at the date of grant for the RSUs granted during the nine months ended November 30, 2013 and 2012, was $42.68 and $31.76, respectively. The RSUs are cash-settled upon vesting. For the nine months ended November 30, 2013 and 2012, we paid $23.3 million and $18.0 million, respectively (before payroll tax withholdings), to RSU holders upon the vesting of RSUs. We realized tax benefits of $9.3 million and $7.2 million during the nine months ended November 30, 2013 and 2012, respectively.

Expected Cash Settlement Range Upon Restricted Stock Unit Vesting


	As of November 30, 2013
(In thousands)	Minimum (1)		Maximum (1)
Fiscal 2015	$	11,276	$	30,069
Fiscal 2016		12,422		33,126
Fiscal 2017		14,159		37,757
Total expected cash settlements	$	37,857	$	100,952

(1)Net of estimated forfeitures.

Stock-Settled Restricted Stock Unit Activity


		Weighted
		Average
	Number of	Grant Date
(Units in thousands)	Units	Fair Value
Outstanding as of February 28, 2013	904	$	40.78
Stock units granted	238	$	52.02
Stock units vested and converted	(282)	$	36.56
Stock units cancelled	(4)	$	46.14
Outstanding as of November 30, 2013	856	$	45.26

For the nine months ended November 30, 2013 and 2012, we granted MSUs of 237,660 units and 348,551 units, respectively. The weighted average fair value per unit at the date of grant for MSUs granted during the nine months ended November 30, 2013 and 2012, was $52.02 and $40.33, respectively. The fair values were determined using a Monte-Carlo simulation and were based on the expected market price of our common stock on the vesting date and the expected number of converted common shares. We realized related tax benefits of $6.7 million and $9.5 million for the nine months ended November 30, 2013 and 2012, respectively, from the vesting of market stock units. The unrecognized compensation costs related to nonvested MSUs totaled $16.2 million as of November 30, 2013. These costs are expected to be recognized on a straight-line basis over a weighted average period of 1.3 years.