Business context and reporting period
This is KAR Auction Services, Inc.’s unaudited Form 10-Q for the three months ended March 31, 2016. The filing describes OPENLANE as a wholly owned ADESA subsidiary providing online remarketing technology; it is not a standalone OPENLANE filing. KAR operates ADESA whole-car auctions, IAA salvage auctions and AFC dealer floorplan financing.
Financial performance and liquidity
Amounts are in millions of U.S. dollars, except per-share data. Results compare Q1 2016 with Q1 2015.
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Revenue | $745.0 | $632.4 |
| Gross profit | $326.3 | $280.3 |
| Operating profit | $128.8 | $107.9 |
| Interest expense | $28.7 | $21.0 |
| Net income | $60.7 | $54.5 |
| Diluted EPS | $0.44 | $0.38 |
| Operating cash flow | $69.5 | $86.1 |
| Capital expenditures | $36.0 | $25.1 |
Revenue grew 18%; operating profit rose 19% and net income rose 11%. Gross margin was approximately 43.8% versus 44.3%; operating margin was approximately 17.3% versus 17.1%. Interest expense increased 37%, and Q1 included a $4.0 million pretax, noncash debt-extinguishment charge. The effective tax rate was 37.7% versus 38.8%.
Segment revenue was ADESA $401.5 million (+22%), IAA $269.6 million (+13%) and AFC $73.9 million (+11%). Operating profit was ADESA $77.3 million (up from $52.2 million), IAA $49.1 million (down from $49.7 million) and AFC $38.6 million (up from $33.1 million). ADESA’s vehicle sales volume rose 17%; IAA’s rose approximately 14%; AFC loan transactions increased 10% to 453,550. IAA’s gross margin declined to 35.6% from 38.4%, partly reflecting purchase-contract vehicle mix, including HBC.
Cash and cash equivalents were $676.3 million at March 31, versus $155.0 million at year-end; working capital was $950.0 million. The cash increase primarily reflected debt refinancing, not operating cash generation: operating cash flow fell year over year, and investing used $100.3 million. Long-term debt, including current maturities, was approximately $2.410 billion, compared with approximately $1.865 billion at year-end. The company had no borrowings on its new $300 million revolving facility and $28.0 million of outstanding letters of credit. AFC’s obligations collateralized by finance receivables were $1.203 billion. Management reported compliance with debt and securitization covenants.
Material changes, outlook and risks
- In March, KAR refinanced debt, issuing a $1.35 billion seven-year Term Loan B-3, repaying Term Loan B-1 and the old revolving-credit borrowings, and replacing the prior revolver with a $300 million five-year facility. Term Loan B-2 and B-3 rates were 3.94% and 4.25%, respectively, at quarter-end. The transaction increased debt and interest costs and extended $1.35 billion of debt maturity to 2023.
- Management expected 2016 capital expenditures of approximately $145 million. It expected a $0.29 quarterly dividend in 2016, subject to board approval and contractual restrictions. Management stated that available liquidity was expected to meet operating needs, debt service, announced acquisitions and dividends for the next 12 months; no earnings guidance was provided.
- ADESA completed the acquisition of eight Brasher’s auctions on April 1, 2016, for $275 million cash; Brasher’s 2015 revenue was approximately $140 million. Results are to be included beginning in Q2. A proposed SADE acquisition, expanding ADESA in central Florida, was expected to close in Q2 subject to customary conditions.
- Management identified lower scrap and commodity prices as a pressure on IAA salvage proceeds and profitability. Other key exposures include auction volumes and conversion rates, used-vehicle pricing and supply, competition, AFC credit losses and dealer defaults, variable interest rates, foreign exchange, cyber and technology risks, acquisition integration, weather, environmental matters and substantial debt and restrictive covenants. Canadian currency translation reduced Q1 revenue by $8.2 million, operating profit by $2.7 million and net income by $1.4 million.
- IAA faces potential liability related to the Lower Duwamish Waterway Superfund site. The EPA had not demanded payment or specified the basis for IAA’s potential responsibility; the company said it could not estimate any loss. Ordinary-course litigation was not considered likely to materially affect results, according to management.
- Management estimated North American whole-car auction volumes at approximately 10 million units in 2016 and more than 10 million in 2017 and 2018. These are industry estimates, not company revenue or earnings guidance. The filing also discusses seasonality, including generally lower auction volume in the fourth quarter.
Important facts for investors to verify
- Confirm the issuer and scope: the filing is for KAR Auction Services, Inc.; OPENLANE is identified as an ADESA subsidiary.
- Reconcile the stated $300 million revolving-facility availability with the $28.0 million of letters of credit that the filing says reduce borrowing availability.
- Assess the refinancing’s effect on ongoing interest expense, leverage and covenant headroom; the reported senior secured leverage ratio was 2.75 to 1.0.
- Track IAA salvage margins and commodity prices, as well as whether higher auction volumes translate into durable per-vehicle revenue and profit.
- Review the cash and debt impact of the Brasher’s acquisition, the pending SADE transaction, and the unquantified environmental contingency.