CarMax 2008 Annual Report Download

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CARMAX, INC. ANNUAL REPORT
FISCAL YEAR 2008
BUILDING LOYALTY ONE CUSTOMER AT A TIME
BUILDING LOYALTY ONE CUSTOMER AT A TIME

Table of contents

  • Page 1
    CARMAX, INC. ANNUAL REPORT FISCAL YEAR 2008 BUILDING LOYALTY ONE CUSTOMER AT A TIME

  • Page 2
    ... CARMAX CAN GROW ORGANICALLY, UNRESTRAINED BY FRANCHISE LAWS OR MANUFACTURER RESTRICTIONS. THE AVERAGE CARMAX SUPERSTORE HAS BETWEEN 300 AND 400 VEHICLES IN INVENTORY AND SELLS APPROXIMATELY 420 CARS PER MONTH, WHICH IS MORE THAN 8 TIMES THE NUMBER OF USED CARS SOLD BY THE AVERAGE FRANCHISED DEALER...

  • Page 3
    ...OF IN-STORE CUSTOMERS VISIT OUR WEBSITE BEFORE COMING TO A CARMAX STORE, MAKING CARMAX.COM INTEGRAL TO OUR SUCCESS. IN FISCAL 2008, WE DRAMATICALLY EXPANDED OUR ONLINE VEHICLE SEARCH CAPABILITIES, PROVIDING CONSUMERS GREATER FLEXIBILITY AND THE ABILITY TO CUSTOMIZE THEIR ONLINE SHOPPING USING A WIDE...

  • Page 4
    ...this kind of environment that we originally CARMAX IS THE NATION'S LARGEST RETAILER OF USED CARS. OUR CONSUMER OFFER IS STRUCTURED AROUND FOUR CUSTOMER BENEFITS: LOW, NO-HAGGLE PRICES; A BROAD SELECTION; HIGH QUALITY VEHICLES; AND A CUSTOMER-FRIENDLY SALES PROCESS. conceived of CAF, to continue to...

  • Page 5
    ... of our consumer offer. The variety of awards we continue to win attest to the uniqueness of the CarMax culture and the engagement of our associates. For the fourth year in a row, we were named one of Fortune's "100 Best Companies to Work For," moving this year from a ranking in the high 80's into...

  • Page 6
    ... estimating reconditioning costs for vehicles by individual make, model and year. The new appraisal upgrade also includes printouts detailing information that help our customers better understand the factors that inï¬,uenced our offer. CarMax continues to earn a variety of external awards...

  • Page 7
    ... AND RETAINING QUALIFIED ASSOCIATES. ON AVERAGE, EACH STORE ASSOCIATE COMPLETED MORE THAN 75 HOURS OF TRAINING IN FISCAL 2008. CARMAX'S SUCCESS DEPENDS ON THE SKILLED AND DEDICATED ASSOCIATES WHO DELIVER OUR CONSUMER OFFER, EXECUTE OUR PROCESSES AND DEVELOP OUR SYSTEMS. VEHICLE RECONDITIONING IS...

  • Page 8
    ... is to make car buying as easy and transparent on carmax.com as it is in our stores, while also offering more in-depth information that can be accessed directly by our sales associates as they assist customers. We plan to become a one-stop shop for buyers at every stage of the process and continue...

  • Page 9
    SALES ASSOCIATE COMPENSATION IS GENERALLY BASED ON VOLUME INSTEAD OF PROFIT, WHICH ALLOWS ASSOCIATES TO FOCUS SOLELY ON MEETING CUSTOMER NEEDS. INFORMATION ON EACH OF THE MORE THAN 25,000 VEHICLES IN OUR NATIONWIDE INVENTORY IS AVAILABLE ON CARMAX.COM, AND CONSUMERS MAY TRANSFER VIRTUALLY ANY USED ...

  • Page 10
    ...ï¬,ected in the prices we receive weekly or bi-weekly at our auctions, currently held at 49 of our stores, and informs our appraisal offers. We Percentages represent breakdown of gross profit dollars continue to attract more bidding by auto dealers at our aucand CarMax Auto Finance income. tions by...

  • Page 11
    .... CARMAX MARKETS CARMAX USED CAR SUPERSTORES (As of February 29, 2008) Alabama Birmingham Arizona Tucson California Fresno Los Angeles (8) Sacramento San Diego Connecticut Hartford/ New Haven (2) Florida Jacksonville Miami (5) Orlando (2) Tampa (2) Georgia Atlanta (5) Illinois Chicago (8) Indiana...

  • Page 12
    ...the WTI Foundation, which supports vehicle technician training. This past year, the CarMax Foundation launched a new Regional Giving Program that allows each of our seven regions to make grants of $100,000 to nonprofit organization of their choice. Committees of store associates in each region chose...

  • Page 13
    ... PARKWAY, RICHMOND, VIRGINIA (Address of principal executive offices) 23238 (Zip Code) Registrant's telephone number, including area code: (804) 747-0422 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, par...

  • Page 14
    ... is a shell company (as defined in Rule 12b-2 of the Act). Yes No ⌧ The aggregate market value of the registrant' s common stock held by non-affiliates as of August 31, 2007, computed by reference to the closing price of the registrant' s common stock on the New York Stock Exchange on that date...

  • Page 15
    ... with Accountants on Accounting and Financial Disclosure ...Controls and Procedures...Other Information...PART III Item 10. Item 11. Item 12. Directors, Executive Officers and Corporate Governance ...Executive Compensation ...Security Ownership of Certain Beneficial Owners and Management and Related...

  • Page 16
    ... 89 used car superstores in 41 metropolitan markets. In addition, we sold 222,406 wholesale vehicles in fiscal 2008 through on-site auctions. We were the first used vehicle retailer to offer a large selection of high quality used vehicles at competitively low, "no-haggle" prices using a customer...

  • Page 17
    ...Vehicles purchased through our in-store appraisal process that do not meet our retail standards are sold to licensed dealers through on-site wholesale auctions. Our inventory management and pricing system tracks each vehicle throughout the sales process. Using the information provided by this system...

  • Page 18
    ... a part of the shopping and sales process online. The website offers complete inventory and pricing search capabilities. Information on the more than 25,000 cars available in our nationwide inventory is updated daily. Carmax.com includes detailed information, such as vehicle photos, prices, features...

  • Page 19
    ..., Florida, and we plan to open two more centers during fiscal 2009. We have replaced the traditional "trade-in" transaction with a process in which a CarMax-trained buyer appraises a customer' s vehicle and provides the owner with a written, guaranteed offer that is good for seven days. An appraisal...

  • Page 20
    ... The average auction sales rate was 97% in fiscal 2008. Dealers pay a fee to the company based on the sales price of the vehicles they purchase. Customer Credit. We offer customers a wide range of financing alternatives, which we believe enhances the CarMax consumer offer. Before the effect of 3-day...

  • Page 21
    ... management with real-time information about every aspect of store operations, such as inventory management, pricing, vehicle transfers, wholesale auctions and sales consultant productivity. In addition, our store system provides a direct link to our proprietary credit processing information system...

  • Page 22
    ... we conduct business, including advertising, sales, financing and employment practices. These laws include consumer protection laws, privacy laws, anti-money laundering laws and state franchise laws, as well as other laws and regulations applicable to new and used motor vehicle dealers. These laws...

  • Page 23
    ... sales revenue and results of operations and require a change in our operating strategies. Inventory. A reduction in the availability or access to sources of inventory would adversely affect our business. A failure to adjust appraisal offers to stay in line with broader market trade-in offer trends...

  • Page 24
    ...increased labor costs during periods of low unemployment. Information Systems. Our business is dependent upon the efficient operation of our information systems. In particular, we rely on our information systems to effectively manage sales, inventory, consumer financing and customer information. The...

  • Page 25
    ...used car superstores. We have financed the majority of our stores through sale-leaseback transactions. As of February 29, 2008, we leased 60 of our 92 retail stores and owned the remaining 32 stores. We also own our home office building in Richmond, Virginia, and land associated with planned future...

  • Page 26
    ...a real estate and an advertising/awareness building perspective and they are where we have generally experienced the fastest ramp-up in store sales and profitability. We also have resumed store growth in new large markets. For additional details on fiscal 2009 planned store openings, see "Operations...

  • Page 27
    ... II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Our common stock is listed and traded on the New York Stock Exchange under the ticker symbol KMX. As of February 29, 2008, there were approximately 7,000 CarMax shareholders of...

  • Page 28
    COMPARISON OF CUMULATIVE FIVE YEAR TOTAL RETURN 400 350 300 DOLLARS 250 200 150 100 50 0 2003 2004 2005 2006 2007 2008 CarMax S&P 500 Index S&P 500 Retailing Index CarMax ...S&P 500 Index ...S&P 500 Retailing Index ... 2003 $100.00 $100.00 $100.00 2004 $225.91 $138.52 $156.38 As of February ...

  • Page 29
    ... sold...New vehicle units sold ...Wholesale vehicle units sold...Percent changes in Comparable store used vehicle unit sales...Total used vehicle unit sales...Total net sales and operating revenues ...Net earnings...Diluted net earnings per share...Other year-end information Used car superstores...

  • Page 30
    ... vehicle financing, extended service plans ("ESPs") and vehicle repair service. A majority of the used vehicles we sell at retail are purchased directly from consumers. We also generate revenues, income and cash flows from the sale of vehicles purchased through our appraisal process that do not meet...

  • Page 31
    ... superstores, and they represented our entry into five new markets. Total wholesale vehicle unit sales increased 6%. Wholesale unit sales grew at a slower pace than our used vehicle unit sales, reflecting a decrease in our appraisal buy rate (defined as appraisal purchases as a percent of vehicles...

  • Page 32
    ... if future vehicle returns differ from historical averages. We also sell ESPs on behalf of unrelated third parties to customers who purchase a vehicle. Because these third parties are the primary obligors under these programs, we recognize commission revenue on the ESPs at the time of the sale, net...

  • Page 33
    ...) Used vehicle sales...New vehicle sales ...Wholesale vehicle sales...Other sales and revenues: Extended service plan revenues...Service department sales...Third-party finance fees, net ...Total other sales and revenues...Total net sales and operating revenues.. RETAIL VEHICLE SALES CHANGES 2008...

  • Page 34
    ... in the comparable store base. Our comparable store used unit sales growth benefited from strong store and Internet traffic and continued strong execution by our store teams. The increase in the average retail selling price was primarily the result of a shift in vehicle mix, as we experienced...

  • Page 35
    .... Wholesale Vehicle Sales Our operating strategy is to build customer satisfaction by offering high-quality vehicles. Fewer than half of the vehicles acquired from consumers through the appraisal purchase process meet our standards for reconditioning and subsequent retail sale. Those vehicles that...

  • Page 36
    ... the opening of buying centers in Raleigh, North Carolina, and Tampa, Florida, expanding the test we began in Atlanta, Georgia, in fiscal 2007. At these three locations, we conduct appraisals and purchase, but do not sell, vehicles. These test centers are part of our long-term plan to increase both...

  • Page 37
    ... our car-buying and auction processes. Other Gross Profit We have no cost of sales related to either extended service plan revenues or third-party finance fees, as these represent commissions paid to us by the third-party providers. Accordingly, changes in the mix of extended service plan revenues...

  • Page 38
    ... on average retail prices. However, increases in average vehicle selling prices will benefit the SG&A ratio and CAF income to the extent the average amount financed also increases. CarMax Auto Finance Income CAF provides financing for our used and new car sales. Because the purchase of a vehicle is...

  • Page 39
    ... growth in managed receivables during the year. Fiscal 2007 Versus Fiscal 2006. CAF income rose 27% to $132.6 million in fiscal 2007. CAF income benefited from the growth in retail vehicle unit sales, increases in the gain percentage, average amount financed and total managed receivables. The gain...

  • Page 40
    ... the average percentage of the outstanding principal balance we receive when a vehicle is repossessed and liquidated at wholesale auction. Historically, the annual recovery rate has ranged from a low of 42% to a high of 51%, and it is primarily affected by changes in the wholesale market pricing...

  • Page 41
    ...%, opening an estimated 14 used car superstores, including 7 production and 7 non-production stores. FISCAL 2009 PLANNED SUPERSTORE OPENINGS Location San Antonio, Texas (1)...Modesto, California (1) ...Phoenix, Arizona (1) ...Charleston, South Carolina (1) ...Huntsville, Alabama ...Colorado Springs...

  • Page 42
    ...model used cars. We expect total revenues to increase between 7% and 14%, reflecting our planned new store openings, the comparable store sales performance and anticipated declines in both used vehicle average selling prices and new car revenues. We are not anticipating any material change in credit...

  • Page 43
    ...with four, fiveyear renewal options. As of February 29, 2008, we owned 32 superstores currently in operation, as well as our home office in Richmond, Virginia. In addition, five superstores were accounted for as capital leases. Financing Activities. Net cash provided by financing activities was $171...

  • Page 44
    ... manage the interest rate exposure relating to floating-rate securitizations through the use of interest rate swaps. Disruptions in the credit markets may impact the effectiveness of our hedging strategies. Receivables held for investment or sale are financed with working capital. Generally, changes...

  • Page 45
    ...credit risk by dealing with highly rated bank counterparties. The market and credit risks associated with financial derivatives are similar to those relating to other types of financial instruments. Note 5 provides additional information on financial derivatives. COMPOSITION OF AUTO LOAN RECEIVABLES...

  • Page 46
    ..., the company's independent registered public accounting firm, has issued a report on our internal control over financial reporting. Their report is included herein. THOMAS J. FOLLIARD PRESIDENT AND CHIEF EXECUTIVE OFFICER KEITH D. BROWNING EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 34

  • Page 47
    ...28, 2007, and the results of their operations and their cash flows for each of the fiscal years in the threeyear period ended February 29, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal...

  • Page 48
    ...As discussed in Note 8(A) to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Pension and Other Postretirement Plans, effective February 28, 2007. Richmond, Virginia April 25, 2008 36

  • Page 49
    ...1.3 2.1 Cost of sales...GROSS PROFIT ...CARMAX AUTO FINANCE INCOME ... Selling, general and administrative expenses ...Gain on franchise disposition ...Interest expense ...Interest income ...Earnings before income taxes...Provision for income taxes ...NET EARNINGS ... Weighted average common shares...

  • Page 50
    ...Cash and cash equivalents ...Accounts receivable, net...Auto loan receivables held for sale...Retained interest in securitized receivables ...Inventory ...Prepaid expenses and other current assets ...TOTAL CURRENT ASSETS ...Property and equipment, net...Deferred income taxes...: Common stock, $0.50...

  • Page 51
    ...Excess tax benefits from share-based payment arrangements...(Decrease) increase in cash and cash equivalents...Cash and cash equivalents at beginning of year ...NET CASH PROVIDED BY FINANCING ACTIVITIES CASH AND CASH EQUIVALENTS AT END OF YEAR ...SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION 17...

  • Page 52
    ... No. 158, net of taxes of $11,858...Share-based compensation expense for stock options and restricted stock...Exercise of common stock options...Shares issued under stock incentive plans...Shares cancelled upon reacquisition ...Tax benefit from the exercise of common stock options...BALANCE AS OF...

  • Page 53
    ..., CarMax Auto Finance ("CAF"), and third-party lenders; the sale of extended service plans and accessories; the appraisal and purchase of vehicles directly from consumers; and vehicle repair service. Vehicles purchased through the appraisal process that do not meet our retail standards are sold to...

  • Page 54
    ... 12 months. The defined benefit retirement plan obligations are determined by independent actuaries using a number of assumptions provided by the company. Key assumptions used in measuring the plan obligations include the discount rate, expected rate of return on plan assets, rate of compensation...

  • Page 55
    ... 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 vehicles we sell with a 5-day, money-back guarantee. If a customer returns the vehicle purchased within the parameters...

  • Page 56
    ... on a direct basis to avoid making arbitrary decisions regarding the indirect benefit or costs that could be attributed to CAF. Examples of indirect costs not included are retail store expenses and corporate expenses such as human resources, administrative services, marketing, information systems...

  • Page 57
    ... over the life of the securitized receivables. The value of these receivables is determined by estimating the future cash flows using our assumptions of key factors, such as finance charge income, loss rates, prepayment rates, funding costs and discount rates appropriate for the type of asset and...

  • Page 58
    ...the credit quality of the receivables, economic factors and the performance history of similar receivables. Discount rate. The discount rate is the interest rate used for computing the present value of future cash flows and is determined based on the perceived market risk of the underlying auto loan...

  • Page 59
    ... ...Net credit losses as a percentage of average managed receivables...Recovery rate...SELECTED CASH FLOWS FROM SECURITIZED RECEIVABLES (In millions) Years Ended February 29 or 28 2008 2007 2006 $ 38.3 $ 20.7 $ 18.4 $3,608.4 $ 3,071.1 $ 2,657.7 1.06% 50% 0.67% 51% 0.69% 51% Proceeds from new...

  • Page 60
    ... used to match funding costs to the use of the funding. However, disruptions in the credit markets could impact the effectiveness of our hedging strategies. Credit risk is the exposure to nonperformance of another party to an agreement. We mitigate credit risk by dealing with highly rated bank...

  • Page 61
    ......34,191 24,282 Stock compensation ...1,636 - Capital loss carry forward ...Total gross deferred tax assets...Less: valuation allowance...Net gross deferred tax assets...Deferred tax liabilities: Securitized receivables...Prepaid expenses ...Inventory...Depreciation and amortization ...Other...

  • Page 62
    ... during the next 12 months; however, we do not expect the change to have a significant effect on our results of operations, financial condition or cash flows. Our continuing practice is to recognize interest and penalties related to income tax matters in selling, general and administrative expenses...

  • Page 63
    ... future service and increased compensation levels. ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS As of February 29 or 28 Pension Plan Restoration Plan 2008 2007 2008 2007 6.85% 5.75% 6.85% 5.75% 5.00% 5.00% 7.00% 7.00% Discount rate...Rate of compensation increase ... Plan Assets. The fair...

  • Page 64
    ... 446 $ 2,749 Our pension plan assets are held in trust and management sets the investment policies and strategies. Long-term strategic investment objectives include asset preservation and appropriately balancing risk and return. We oversee the investment allocation process, which includes selecting...

  • Page 65
    ... discount rate, expected rate of return on plan assets, rate of compensation increases and mortality rate. We evaluate these assumptions annually, at a minimum, and make changes as necessary. The discount rate used for retirement benefit plan accounting reflects the yields available on high-quality...

  • Page 66
    ... options. Nonemployee directors continue to receive awards of nonqualified stock options and stock grants. Stock options are awards that allow the recipient to purchase shares of our stock at a fixed price. Stock options are granted at an exercise price equal to the fair market value of our stock...

  • Page 67
    ... of the change to an estimated number of awards expected to vest was a $0.6 million reduction of selling, general and administrative expenses recorded in fiscal 2007. COMPOSITION OF SHARE-BASED COMPENSATION EXPENSE (In thousands) Cost of sales...CarMax Auto Finance income ...Selling, general and...

  • Page 68
    ... average expected volatility...Risk-free interest rate(2) ...Expected term (in years)(3) ...(1) Measured using historical daily price changes of our stock for a period corresponding to the term of the option and the implied volatility derived from the market prices of traded options on our stock...

  • Page 69
    ...compensation costs related to nonvested restricted stock awards totaled $19.1 million as of February 29, 2008. These costs are expected to be recognized over a weighted average period of 1.6 years. (D) Employee Stock Purchase Plan We sponsor an employee stock purchase plan for all associates meeting...

  • Page 70
    ...conduct a majority of our business in leased premises. Our lease obligations are based upon contractual minimum rates. Most leases provide that we pay taxes, maintenance, insurance and operating expenses applicable to the premises. The initial term of most real property leases will expire within the...

  • Page 71
    ... of our customer service strategy, we guarantee the used vehicles we retail with a 30-day limited warranty. A vehicle in need of repair within 30 days of the customer's purchase will be repaired free of charge. As a result, each vehicle sold has an implied liability associated with it. Accordingly...

  • Page 72
    ... 257,127 $ (962) Fiscal Year 2008 $ 8,199,571 $ 1,072,425 $ 85,865 Net sales and operating revenues ...Gross profit ...CarMax Auto Finance income (loss)...Selling, general and administrative expenses ...Net earnings ...Net earnings per share: Basic ...Diluted ...(In thousands except per share data...

  • Page 73
    ... the time periods specified in the U.S. Securities and Exchange Commission' s rules and forms. Disclosure controls are also designed to ensure that this information is accumulated and communicated to management, including the chief executive officer ("CEO") and the chief financial officer ("CFO...

  • Page 74
    ... President and Chief Administrative Officer 45 Senior Vice President, Marketing and Strategy 50 Senior Vice President and Chief Information Officer 54 Senior Vice President, General Counsel and Corporate Secretary Mr. Folliard joined CarMax in 1993 as senior buyer and became director of purchasing...

  • Page 75
    ... "Non-Employee Director Compensation in Fiscal 2008" in our 2008 Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information required by this Item is incorporated by reference to the section titled "CarMax Share Ownership...

  • Page 76
    .... All financial statements as set forth under Item 8 of this Form 10-K. Financial Statement Schedules. "Schedule II - Valuation and Qualifying Accounts and Reserves" and the accompanying Report of Independent Registered Public Accounting Firm on CarMax, Inc. Financial Statement Schedule for the...

  • Page 77
    ...Thomas J. Folliard President and Chief Executive Officer April 25, 2008 By: /s/ KEITH D. BROWNING Keith D. Browning Executive Vice President and Chief Financial Officer April 25, 2008 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following...

  • Page 78
    Schedule II CARMAX, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Balance at Beginning of Fiscal Year $3,580 $5,632 $7,083 Charged to Income $5,854 $5,856 $4,336 Charge-offs Less Recoveries $(3,802) $(4,405) $(2,738) Balance ...

  • Page 79
    ... * CarMax, Inc. Benefit Restoration Plan, as amended and restated effective as of January 1, 2008, filed as Exhibit 10.2 to CarMax' s Current Report on Form 8-K, filed June 29, 2007 (File No. 1-31420), is incorporated by this reference. * CarMax, Inc. 2002 Non-Employee Directors Stock Incentive Plan...

  • Page 80
    ... 2002 Employee Stock Purchase Plan, as amended and restated July 1, 2006, filed as Exhibit 10.1 to CarMax's Current Report on Form 8-K, filed June 22, 2006 (File No. 1-31420), is incorporated by this reference. Credit Agreement, dated August 24, 2005, among CarMax Auto Superstores, Inc., CarMax, Inc...

  • Page 81
    .... Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, filed herewith. Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, filed herewith. Indicates management contracts, compensatory plans or arrangements of the company required to be filed...

  • Page 82
    ... Systems Kim Ross Assistant Vice President Human Resources Marty Sberna Region Vice President Service Operations Atlanta Region Gary Sheehan Assistant Vice President Process Engineering Vaughn Sigmon Region Vice President General Manager Los Angeles Region Brian Stone Region Vice President Buyer...

  • Page 83
    ... superstore retailer) W. Robert Grafton Retired Managing Partner - Chief Executive Andersen Worldwide S.C. (an accounting and professional services firm) Edgar H. Grubb Retired Executive Vice President and Chief Financial Officer Transamerica Corporation (an insurance and financial services company...

  • Page 84
    ... information, financial reports, filings with the Securities and Exchange Commission (including Form 10-K), news releases and other investor information, please visit our investor website at: investor.carmax.com Information may also be obtained from the Investor Relations Department at: Email...

  • Page 85
    CARMAX, INC. 12800 TUCKAHOE CREEK PARKWAY, RICHMOND, VIRGINIA 23238 804-747-0422 WWW.CARMAX.COM