Business Context and Reporting Period
Company: KAR Auction Services, Inc. (formerly KAR Holdings, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Business Overview: KAR is a leading provider of vehicle auction services in North America, operating through three segments: ADESA (whole car auctions), IAAI (salvage auctions), and AFC (floorplan financing). The company facilitates the sale of used and salvage vehicles through physical and online venues without taking title to the vehicles. In December 2009, the company completed its Initial Public Offering (IPO).
Key Financial Metrics (Year Ended Dec 31, 2009)
| Metric | 2009 | 2008 |
|---|---|---|
| Total Operating Revenues | $1,729.6 million | $1,771.4 million |
| Operating Profit | $195.3 million | ($12.5 million) |
| Net Income | $23.2 million | ($216.2 million) |
| Diluted EPS | $0.21 | ($2.02) |
| Cash Flow from Operations | $250.8 million | $224.9 million |
| Total Debt | $2,272.9 million | $2,527.4 million |
| Working Capital | $299.5 million | $304.3 million |
| Capital Expenditures | $65.6 million | $129.6 million |
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased 2% to $1,729.6 million. ADESA revenue fell 3% due to lower ancillary service fees and a weaker Canadian dollar, partially offset by higher vehicle values. IAAI revenue increased 1% driven by higher salvage volumes. AFC revenue dropped 10% due to a 30% decrease in loan transactions, though revenue per loan increased 29%.
- Profitability Turnaround: The company returned to profitability with $23.2 million in net income, compared to a $216.2 million net loss in 2008. The 2008 loss was significantly impacted by a $164.4 million non-cash goodwill and tradename impairment charge in the AFC segment, which did not recur in 2009.
- Debt Reduction: Total debt decreased by approximately $254.5 million. The company utilized $310.3 million in net proceeds from its December 2009 IPO to prepay $250.0 million of its Term Loan B and $225.6 million of its 10% senior subordinated notes (completed in January 2010).
- Interest Expense: Interest expense decreased 20% to $172.6 million, driven by lower interest rates on variable debt and principal repayments.
Guidance, Outlook, and Risks
Management Commentary & Strategy: Management plans to utilize excess cash flow primarily for debt reduction. Strategic initiatives include growing market share in whole car and salvage businesses, increasing revenue per vehicle through ancillary services, and improving operating efficiency via "Project PRIDE" at ADESA. The company expects to expand its salvage operations by operating additional sites at existing ADESA facilities.
Outlook & Risks:
- Economic Sensitivity: The business is highly sensitive to economic downturns, which affect consumer demand for used vehicles, dealer financing availability, and the supply of off-lease vehicles.
- Goodwill Impairment: The company holds approximately $1.5 billion in goodwill. Future declines in profitability or market valuation could trigger additional impairment charges.
- Accounting Changes: New FASB guidance (ASC 860) effective January 1, 2010, requires the company to bring $367 million of securitized loans back onto the balance sheet, expected to reduce pretax income by approximately $3 million in Q1 2010.
- Environmental Liability: The EPA is investigating IAAI's potential liability regarding contamination at the Lower Duwamish Waterway Superfund Site in Seattle; the potential liability cannot be estimated at this time.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with the senior secured credit facility leverage ratios, especially given the high debt load ($2.27 billion).
- Goodwill Valuation: Monitor the fair value of the AFC reporting unit, which previously suffered a significant impairment, to assess risk of future write-downs.
- Accounting Impact: Confirm the financial impact of the new ASC 860 guidance on securitized receivables in the first quarter of 2010 filings.
- Environmental Contingency: Track developments regarding the Lower Duwamish Waterway Superfund Site investigation for potential material liabilities.
- Off-Lease Vehicle Supply: Monitor trends in new vehicle lease originations, as declines in 2008-2009 are expected to reduce the supply of off-lease vehicles at auction starting in 2011.