Business context and reporting period
Issuer: KAR Auction Services, Inc. (NYSE: KAR), not OPENLANE, Inc. This is KAR’s Form 10-K for the fiscal year ended December 31, 2011; the filing also reports unaudited fourth-quarter results. OPENLANE became a wholly owned ADESA subsidiary in October 2011.
KAR operates three segments: ADESA whole-car auctions, IAA salvage auctions, and AFC dealer floorplan financing. At year-end, the network included 69 whole-car and 159 salvage auction locations. The company facilitated sales of more than 3.1 million vehicles during 2011.
Financial results and liquidity
Dollar amounts are in millions, except per-share data. Gross profit below is revenue less cost of services and excludes depreciation and amortization.
| Metric | FY 2011 | FY 2010 | Change |
|---|---|---|---|
| Revenue | $1,886.3 | $1,822.6 | +3% |
| Gross profit | $851.1 | $815.3 | +4% |
| Gross margin | 45.1% | 44.7% | +0.4 percentage points |
| Operating profit | $281.9 | $268.8 | +5% |
| Net income | $72.2 | $69.6 | +4% |
| Diluted EPS | $0.52 | $0.51 | +$0.01 |
| Cash from operations | $305.8 | $467.6 | -35% |
Operating margin was approximately 14.9%, compared with 14.8% in 2010. Net income growth was modest despite higher operating profit, reflecting a $53.5 million 2011 debt-extinguishment loss and higher interest expense; 2010 also included a $32.7 million extinguishment loss. The 2011 effective tax rate was 19.8%, including an $18.6 million tax-reserve release; excluding specified discrete tax items, management reported a 40.2% effective rate.
| Fourth-quarter metric | Q4 2011 | Q4 2010 |
|---|---|---|
| Revenue | $479.8 | $443.2 |
| Operating profit | $55.6 | $47.9 |
| Net income | $14.5 | $7.3 |
| Diluted EPS | $0.11 | $0.05 |
At December 31, 2011, cash and cash equivalents were $97.4 million, working capital was $177.0 million (down from $287.9 million), and $181.1 million was available under the revolving credit facility after outstanding letters of credit. Management cited $52.7 million of available cash excluding cash in transit; $26.8 million was held by foreign subsidiaries and considered permanently reinvested.
Reported total debt was $1,910.4 million before a $7.6 million unamortized discount and current maturities; balance-sheet debt, net of discount, was $1,902.8 million. These figures exclude $610.3 million of obligations collateralized by finance receivables. The company reported covenant compliance and a 3.6x consolidated senior secured leverage ratio at year-end. Operating cash flow fell to $305.8 million; investing cash outflow was $419.8 million, including $214.6 million for acquisitions and $85.8 million of capital expenditures.
Material changes versus the prior comparable period
- ADESA: Revenue declined 5% to $1,017.4 million as vehicles sold fell 7%; revenue per vehicle rose 2% to approximately $585. Dealer consignment units increased 13% on a same-store basis, but lower conversion and volumes reduced operating profit to $127.4 million from $165.9 million.
- IAA: Revenue rose 15% to $700.1 million, supported by 9% more vehicles sold and higher average selling prices. Operating profit increased to $136.7 million from $110.6 million; gross margin remained 40.7%.
- AFC: Revenue increased 24% to $168.8 million; loan transactions rose 14% to approximately 1.065 million, and managed receivables grew to $883.2 million from $771.6 million. Operating profit increased to $84.4 million from $56.6 million. Its managed portfolio was approximately 99% current at year-end.
- In October, KAR acquired OPENLANE for $208.4 million cash consideration plus approximately $35 million for excess cash at closing. OPENLANE contributed $16.4 million of fourth-quarter revenue and a $2.7 million net loss.
- KAR refinanced its prior credit facility in May and used new term-loan proceeds and cash to repay $450.0 million of fixed-rate notes and $131.1 million of subordinated notes in June. The refinancing and note repurchases contributed to $53.5 million of 2011 debt-extinguishment charges.
Outlook, risks and unusual items
- Management estimated North American whole-car auction volumes at approximately 8 million units in 2012, about 8.4 million in 2013, and nearly 9 million by 2015, including online-only volumes. It expected 2012 industry volumes to be broadly consistent with 2011 in its business discussion, while also describing a gradual recovery thereafter.
- Capital expenditures were expected to be approximately $90 million in 2012, principally for information systems, OPENLANE integration, facility upkeep and capacity projects. Management said cash, operating cash flow, working capital and available credit should fund near- and longer-term needs, and stated that excess cash would be directed substantially toward debt reduction.
- Key risks include reduced whole-car supply—particularly off-lease and repossessed vehicles—volume and pricing changes, competition from online platforms, and execution of OPENLANE integration. A shift toward virtual auctions could pressure revenue per vehicle while fixed facility costs remain.
- Other material exposures include substantial debt and variable interest rates, AFC securitization funding and credit losses, foreign-exchange movements, auction settlement risk, regulatory and environmental liabilities, and self-insurance. A 100-basis-point increase in short-term rates was estimated to add about $5 million to annual interest expense. KAR had purchased $925 million notional interest-rate caps effective through August 2013.
- IAA’s potential liability relating to the Lower Duwamish Waterway Superfund site could not be estimated; the EPA had not demanded payment or action beyond an information response. Recorded environmental liabilities for other matters were $0.1 million at year-end.
- The $18.6 million reversal of uncertain-tax-position reserves and $4.6 million reversal of acquisition-related contingent consideration benefited reported 2011 results. Prior-year AFC fee presentation was also revised, increasing revenue and corresponding expenses; comparisons should use the revised figures.
Most important facts for investors to verify
- Reconcile debt and liquidity, including the separate $610.3 million of securitization obligations, debt maturities, variable-rate exposure and covenant headroom.
- Assess whether ADESA’s lower unit volumes and conversion rates stabilize, and whether IAA’s growth and AFC’s improved credit performance persist.
- Review OPENLANE’s integration progress, profitability after the reported fourth-quarter loss, and the returns expected on acquisition spending.
- Separate recurring earnings and cash generation from debt-refinancing charges, tax-reserve releases, contingent-consideration reversals and accounting-presentation changes.
- Monitor whole-car industry supply, online-auction economics, AFC funding and loss metrics, and developments in the Lower Duwamish environmental matter.