2.Accounting Policies

 

Basis of Presentation and Use of Estimates.  The accompanying interim unaudited consolidated financial statements include the accounts of CarMax and our wholly owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.  These consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  In the opinion of management, such interim consolidated financial statements reflect all normal recurring adjustments considered necessary to present fairly the financial position and the results of operations and cash flows for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2014.

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities.  Actual results could differ from those estimates.  Certain prior year amounts have been reclassified to conform to current year’s presentation.  Amounts and percentages may not total due to rounding.

 

Cash and Cash Equivalents.  Cash equivalents of $514.7 million as of May 31, 2014, and $607.0 million as of      February 28, 2014, consisted of highly liquid investments with original maturities of three months or less.

 

Restricted Cash from Collections on Auto Loan Receivables.  Cash accounts totaling $290.7 million as of May 31, 2014, and $259.3 million as of February 28, 2014, consisted of collections of principal and interest payments on securitized auto loan receivables that are restricted for payment to the securitization investors pursuant to the applicable securitization agreements.

 

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

 

We typically use term securitizations to provide long-term funding for most of the auto loan receivables initially securitized through the warehouse facilities.  In these transactions, a pool of auto loan receivables is sold to a bankruptcy-remote, special purpose entity that, in turn, transfers the receivables to a special purpose securitization trust.  The securitization trust issues asset-backed securities, secured or otherwise supported by the transferred receivables, and the proceeds from the sale of the asset-backed securities are used to finance the securitized receivables.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Property and Equipment, Net.  Property and equipment is reported net of accumulated depreciation and amortization of $754.2 million and $730.6 million as of May 31, 2014 and February 28, 2014, respectively.

 

Other Assets.  Other assets includes amounts classified as restricted cash on deposit in reserve accounts and restricted investments.  The restricted cash on deposit in reserve accounts is for the benefit of holders of non-recourse notes payable, and these funds are not expected to be available to the company or its creditors.  In the event that the cash generated by the securitized receivables in a given period was insufficient to pay the interest, principal and other required payments, the balances on deposit in the reserve accounts would be used to pay those amounts.  Restricted cash on deposit in reserve accounts was $35.8 million as of May 31, 2014, and $32.5 million as of February 28, 2014.

 

Restricted investments includes money market securities primarily held to satisfy certain insurance program requirements, as well as investments held in a rabbi trust established to fund informally our executive deferred compensation plan.  The rabbi trust investments are classified as trading securities with realized and unrealized gains and losses reflected as a component of other (expense) income.  Restricted investments was $43.2 million as of May 31, 2014, and $40.2 million as of February 28, 2014.

 

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

   

We sell EPP products on behalf of unrelated third parties to customers who purchase a vehicle.  In May 2014, the ESPs we offer on all used vehicles were modified to provide coverage of 60 months (subject to mileage limitations).  Prior to this modification, the ESPs we offered provided coverage up to 72 months.  GAP covers the customer for the term of their finance contract. We recognize commission revenue at the time of sale, net of a reserve for estimated customer cancellations.  Periodically, we may receive additional commissions based upon the level of underwriting profits of the third parties who administer the products.  These additional commissions are recognized as revenue when received.  The reserve for cancellations is evaluated for each product, and is based on forecasted forward cancellation curves utilizing historical experience, recent trends and credit mix of the customer base.  Our risk related to customer cancellations is limited to the commissions 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 other current liabilities with the remaining amount recognized in other liabilities.  See Note 7 for additional information on cancellation reserves. 

   

Customers applying for financing who are not approved by CAF may be evaluated by other financial institutions.  Depending on the credit profile of the customer, third-party finance providers generally either pay us or are paid a fixed, pre-negotiated fee per contract.  We recognize these fees at the time of sale.

   

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

 

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

 

Recent Accounting Pronouncements.    

Effective in the Current Quarter.    In February 2013, the Financial Accounting Standards Board (“FASB”) issued an accounting pronouncement related to liabilities (FASB ASC Topic 405).  The amendments provide guidance on the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements, including debt arrangements, other contractual obligations, and settled litigation and judicial rulings.  This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  We adopted this pronouncement for our fiscal year beginning March 1, 2014, and there was no effect on our consolidated financial statements.

 

In July 2013, the FASB issued an accounting pronouncement related to income taxes (FASB ASC Topic 740), which provides guidance regarding the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar loss or a tax credit carryforward exists.  Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward.  This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted.  We adopted this pronouncement for our fiscal year beginning March 1, 2014, and there was no effect on our consolidated financial statements.

 

Effective in Future Periods.  In May 2014, the FASB issued an accounting pronouncement related to revenue recognition (FASB ASC Topic 606), which amends the guidance in former ASC Topic 605, Revenue Recognition, and provides a single, comprehensive revenue recognition model for all contracts with customers.  This standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized.  The entity will recognize revenue to reflect the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.  This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted.  We will adopt the provisions of ASC Topic 606 for our fiscal year beginning March 1, 2017, and are currently evaluating the impact on our consolidated financial statements.