Business context and reporting period
This is KAR Auction Services, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The request identifies OPENLANE, Inc.; in the filing, Openlane is described as a wholly owned ADESA subsidiary and technology provider, not the registrant. KAR reported two continuing segments: ADESA Auctions and AFC, which provides floorplan financing to independent used-car dealers.
KAR completed the spin-off of its salvage-auction business, IAA, on June 28, 2019. IAA is presented as discontinued operations for all periods; comparisons below refer to continuing operations unless noted.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $701.9m | $612.4m | $2,110.6m | $1,849.0m |
| Operating profit | $85.7m | $85.6m | $252.5m | $269.9m |
| Continuing-operations income | $34.4m | $30.9m | $77.1m | $102.5m |
| Net income, including discontinued operations | $35.3m | $77.5m | $168.7m | $260.7m |
| Diluted continuing EPS | $0.26 | $0.23 | $0.58 | $0.76 |
- Revenue grew 15% in Q3 and 14% for the nine months. Acquisitions contributed $54.8m and $137.9m, respectively; excluding purchased-vehicle revenue, growth was 7% in both periods.
- Operating margin was approximately 12.2% in Q3 versus 14.0% a year earlier; for the nine months it was 12.0% versus 14.6%. Revenue growth did not translate into higher operating profit.
- Q3 continuing income increased year over year, but nine-month continuing income declined. Total net income fell substantially, chiefly reflecting lower IAA discontinued-operations income after the spin-off: $0.9m versus $46.6m in Q3 and $91.6m versus $158.2m for nine months.
- Q3 ADESA revenue rose 16% to $613.6m; vehicles sold increased 9% to 957,000. ADESA operating profit declined to $68.5m from $75.5m. Its gross margin fell to 37.1% from 41.6%, reflecting more purchased vehicles and lower-margin ancillary services. Nine-month ADESA operating profit was $215.5m versus $249.1m.
- Q3 AFC revenue increased 3% to $88.3m and operating profit rose to $55.1m from $52.1m. Loan transactions were up 2%; credit-loss provision was 1.7% of average managed receivables versus 1.5%. Management said it expected the annual provision to be below 2%, while noting quarterly losses may vary.
- Continuing operating cash flow was $291.1m for nine months, down from $326.9m. Continuing investing cash use was $367.3m, including $127.6m in capital expenditures and acquisition spending. Management expected full-year 2019 capital expenditures of approximately $160m.
- At September 30, cash and cash equivalents were $508.6m, working capital $741.5m, and stated availability under the credit facility $325m. Continuing-operations cash flow is not the same as total cash movement: financing included the IAA separation and substantial debt repayment.
- Long-term debt was $1.863bn, with $27.0m current maturities; gross debt was $1.918bn. Separately, AFC had $1.428bn of obligations collateralized by finance receivables. The reported senior secured net leverage ratio was 1.74; the 3.5 maximum covenant applies when revolving loans are outstanding. The company reported covenant compliance.
Material changes, outlook, risks and unusual items
- IAA distributed approximately $1.278bn to KAR in connection with the spin-off; KAR used the proceeds to prepay about $1.3bn of term loans. In September, KAR refinanced prior term loans with a $950m Term Loan B-6 due 2026 and established a $325m revolving facility due 2024. The new term loan rate was 4.31% at quarter-end. The refinancing generated a $2.2m noncash debt-extinguishment loss.
- January 2019 acquisitions included Dent-ology and CarsOnTheWeb (COTW), expanding reconditioning services and European online auctions. Management said their consolidated financial impact was immaterial for the nine-month period. The filing reports up to approximately $77m of undiscounted deferred and contingent acquisition payments.
- ADESA subsidiary High Tech Locksmiths recorded an approximately $5.4m inventory loss in the first nine months; KAR was pursuing recovery but cautioned it might not recover all or any of it. TradeRev reported operating losses of $51.6m for nine months, versus $37.3m a year earlier.
- Management expected North American whole-car auction volumes, including online and mobile sales, to exceed 11 million units in 2019, 2020 and 2021. It gave no consolidated earnings guidance in the provided filing text. It cited seasonality, with typically lower auction volume in the fourth quarter.
- Key disclosed risks include competition and pricing pressure; used-vehicle supply, demand, and auction volumes; AFC dealer defaults and collateral values; interest-rate and foreign-exchange movements; technology and cybersecurity; acquisition integration; substantial debt and restrictive covenants; environmental matters; and litigation. The filing says ordinary-course legal matters were not expected by management to have a material adverse effect.
- Other items: KAR adopted lease accounting in 2019, recording operating-lease right-of-use assets of $366.4m and lease liabilities of $394.8m at quarter-end. In October 2019, the board authorized a new stock-repurchase program of up to $300m through October 2021; repurchases are discretionary. The company also announced a $0.19-per-share dividend payable in January 2020.
Important facts for investors to verify
- Confirm whether the intended subject is KAR Auction Services or OPENLANE; this filing is KAR’s, and identifies Openlane as a subsidiary.
- Assess continuing-operations earnings and margins separately from IAA discontinued results and acquisition-related revenue, purchased vehicles, and other mix effects.
- Track TradeRev losses, ADESA’s margin and vehicle volumes, and AFC credit-loss rates against management’s stated expectations.
- Review debt, AFC securitization obligations, facility availability, covenant conditions, and refinancing terms; distinguish these debt categories when assessing leverage and liquidity.
- Monitor the recoverability of the $5.4m inventory loss, acquisition contingent payments, capital spending, and execution of the new repurchase authorization.