11. Share-Based Compensation

We maintain long-term incentive plans for management, key employees and the nonemployee members of our board of directors. The plans allow for the 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. Substantially all of the stock options vest annually in equal amounts over periods of three to four years. These options are subject to forfeiture and expire no later than 10 years after the date of the grant.

Restricted Stock. Restricted stock awards are awards of our common stock that are subject to specified restrictions and a risk of forfeiture. The restrictions typically lapse three years from the grant date. Participants holding restricted stock are entitled to vote on matters submitted to holders of our common stock for a vote. No restricted stock awards have been granted since fiscal 2009.

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.

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.

COMPOSITION OF SHARE-BASED COMPENSATION EXPENSE



		Three Months Ended				Nine Months Ended
		November 30				November 30
(In thousands)		2011		2010		2011		2010
Cost of sales	$	604	$	789	$	1,293	$	1,393
CarMax Auto Finance income		526		488		1,388		1,150
Selling, general and administrative expenses		9,929		10,581		35,170		31,819
Share-based compensation expense, before income taxes	$	11,059	$	11,858	$	37,851	$	34,362

COMPOSITION OF SHARE-BASED COMPENSATION EXPENSE – BY GRANT TYPE



		Three Months Ended				Nine Months Ended
		November 30				November 30
(In thousands)		2011		2010		2011		2010
Nonqualified stock options	$	4,571	$	3,490	$	17,456	$	13,650
Restricted stock		0		1,372		163		4,463
Stock-settled restricted stock units		2,291		1,207		8,129		4,626
Cash-settled restricted stock units		3,982		5,574		10,849		10,386
Stock grants to non-employee directors		0		0		550		475
Employee stock purchase plan		215		215		704		762
Share-based compensation expense, before income taxes	$	11,059	$	11,858	$	37,851	$	34,362

We recognize compensation expense for stock options, restricted stock 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 expected 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, 2011 or 2010.


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 March 1, 2011	12,444		$	17.31
Options granted	1,934		$	32.70
Options exercised	(874	)	$	16.84
Options forfeited or expired	(98	)	$	22.52
Outstanding as of November 30, 2011	13,406		$	19.52	3.8	$	131,365
Exercisable as of November 30, 2011	8,508		$	17.07	2.9	$	99,918

For the nine months ended November 30, 2011 and 2010, we granted nonqualified options to purchase 1,933,690 and 1,879,111 shares of common stock, respectively. The total cash received as a result of stock option exercises for the nine months ended November 30, 2011 and 2010, was $14.7 million and $39.1 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, 2011 and 2010, was $13.9 million and $34.7 million, respectively. We realized related tax benefits of $5.5 million and $14.0 million during the nine months ended November 30, 2011 and 2010, respectively.

OUTSTANDING STOCK OPTIONS



					As of November 30, 2011
		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
$	7.14 to $10.75	574	1.3	$	7.39	574	$	7.39
$	11.43	2,359	4.4	$	11.43	1,082	$	11.43
$	13.19 to $14.13	1,729	3.0	$	13.42	1,729	$	13.42
$	14.49 to $19.36	1,932	2.0	$	15.91	1,880	$	15.89
$	19.82	1,717	3.4	$	19.82	1,253	$	19.82
$	19.98 to $24.99	1,354	2.5	$	24.78	1,319	$	24.91
$	25.39	1,750	5.4	$	25.39	488	$	25.39
$	25.67 to $33.11	1,991	6.2	$	32.43	183	$	29.83
	Total	13,406	3.8	$	19.52	8,508	$	17.07

For all stock options granted prior to March 1, 2006, the fair value was estimated as of the date of grant using a Black-Scholes option-pricing model. For stock options granted to associates on or after March 1, 2006, the fair value of each award is estimated as of the date of grant using a binomial valuation model. In computing the value of the option, the binomial model considers characteristics of fair-value option pricing that are not available for consideration under the Black-Scholes model, such as the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life and the probability of termination or retirement of the option holder. For this reason, we believe that the binomial model provides a fair value that is more representative of actual experience and future expected experience than the value calculated using the Black-Scholes model. For grants to nonemployee directors prior to fiscal 2009, we used the Black-Scholes model to estimate the fair value of stock option awards. Beginning in fiscal 2009, we used the binomial model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the recipients of share-based awards.

The weighted average fair values at the date of grant for options granted during the nine months ended November 30, 2011 and 2010, were $13.84 and $10.80 per share, respectively. The unrecognized compensation costs related to nonvested options totaled $27.3 million as of November 30, 2011. These costs are expected to be recognized on a straight-line basis over a weighted average period of 2.1 years.

ASSUMPTIONS USED TO ESTIMATE OPTION VALUES



	Nine Months Ended November 30
	2011		2010
Dividend yield	0.0	%	0.0	%
Expected volatility factor ⁽¹⁾	34.8% - 51.0%		34.6% - 50.2%
Weighted average expected volatility	49.3	%	48.2	%
Risk-free interest rate ⁽²⁾	0.01% - 3.5%		0.2% - 4.0%
Expected term (in years) ⁽³⁾	4.6		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.

RESTRICTED STOCK ACTIVITY



				Weighted
				Average
	Number of			Grant Date
(Shares in thousands)	Shares			Fair Value
Outstanding as of March 1, 2011	863		$	19.81
Restricted stock vested	(856	)	$	19.81
Restricted stock cancelled	(7	)	$	19.82
Outstanding as of November 30, 2011	0		$	0

We realized related tax benefits of $10.9 million and $7.7 million from the vesting of restricted stock in the nine months ended November 30, 2011 and 2010, respectively.

STOCK-SETTLED RESTRICTED STOCK UNIT ACTIVITY



				Weighted
				Average
	Number of			Grant Date
(Units in thousands)	Units			Fair Value
Outstanding as of March 1, 2011	666		$	24.66
Stock units granted	293		$	45.58
Stock units vested and converted	(2	)	$	24.19
Stock units cancelled	(13	)	$	30.24
Outstanding as of November 30, 2011	944		$	31.07

For the nine months ended November 30, 2011 and 2010, we granted MSUs of 292,946 units and 277,066 units, respectively. The fixed fair values per share at the date of grant for MSUs granted during the nine months ended November 30, 2011 and 2010, were $45.58 and $36.24, 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. The unrecognized compensation costs related to nonvested MSUs totaled $14.4 million as of November 30, 2011. These costs are expected to be recognized on a straight-line basis over a weighted average period of 1.2 years.

CASH-SETTLED RESTRICTED STOCK UNIT ACTIVITY



				Weighted
				Average
	Number of			Grant Date
(Units in thousands)	Units			Fair Value
Outstanding as of March 1, 2011	1,501		$	17.49
Stock units granted	575		$	32.69
Stock units vested and converted	(14	)	$	20.74
Stock units cancelled	(110	)	$	20.83
Outstanding as of November 30, 2011	1,952		$	21.76

For the nine months ended November 30, 2011 and 2010, we granted RSUs of 575,380 units and 688,880 units, respectively. The initial fair market values per share for the liability-classified RSUs granted during the nine months ended November 30, 2011 and 2010, were $32.69 and $25.39, respectively. The RSUs will be cash-settled upon vesting.

EXPECTED CASH SETTLEMENT RANGE UPON RESTRICTED STOCK UNIT VESTING


		As of November 30, 2011
(In thousands)		Minimum ⁽¹⁾		Maximum ⁽¹⁾
Fiscal 2013	$	6,871	$	18,323
Fiscal 2014		10,528		28,074
Fiscal 2015		11,422		30,460
Total expected cash settlements	$	28,821	$	76,857

⁽¹⁾Net of estimated forfeitures.