Business context and reporting period
This is KAR Auction Services, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2018. The filing identifies Openlane, Inc. as a wholly owned subsidiary within ADESA; the financial results below are for KAR Auction Services on a consolidated basis, not Openlane alone.
KAR operates ADESA whole-car auctions and related services, IAA salvage-vehicle auctions, and AFC dealer floorplan financing. It generally acts as an agent in vehicle auctions and records fees and services rather than the full selling price of consigned vehicles.
Financial results and key metrics
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Revenue | $956.6 million | $858.0 million | +11% |
| Gross profit | $425.3 million | $376.3 million | +13% |
| Operating profit | $175.6 million | $157.2 million | +12% |
| Net income | $93.2 million | $57.2 million | +63% |
| Diluted EPS | $0.69 | $0.41 | Up $0.28 |
| Operating margin | 18.4% | 18.3% | Up 0.1 percentage point |
For the six months ended June 30, 2018, revenue was $1,907.1 million (+11%), operating profit was $333.4 million (+11%), net income was $183.2 million (+45%), and diluted EPS was $1.35 versus $0.91. The prior-year comparison included a $27.5 million debt-extinguishment charge; no such charge was recorded in 2018. Effective tax rates were lower in 2018, primarily reflecting the Tax Cuts and Jobs Act.
Q2 revenue grew across all segments: ADESA $538.3 million (+10%), IAA $333.2 million (+12%), and AFC $85.1 million (+21%). Segment operating profit was $91.5 million for ADESA (down from $98.4 million), $78.7 million for IAA (up from $66.8 million), and $51.1 million for AFC (up from $33.5 million). ADESA’s higher SG&A, including acquisition-related costs and TradeRev rollout spending, weighed on its operating profit.
For the first six months, operating cash flow was $386.7 million, compared with $373.9 million. Investing cash outflow was $165.5 million, including $80.2 million in property, equipment and software purchases and $23.3 million for the STRATIM acquisition. Financing cash outflow was $157.5 million, including $94.2 million of dividends and $50.0 million of share repurchases. Cash, cash equivalents and restricted cash ended the period at $390.5 million.
At June 30, 2018, cash and cash equivalents were $369.8 million, working capital was $797.1 million, and $350.0 million was available under the revolving credit facility before considering letters of credit. Long-term debt, including current maturities and before unamortized issuance costs, was $2,699.3 million; separate obligations collateralized by finance receivables were $1,358.0 million. The company reported compliance with debt and securitization covenants. Its consolidated senior secured leverage ratio was 1.91 to 1.0, against a 3.5-to-1.0 maximum applicable when revolving loans are outstanding.
Material changes versus the prior comparable period
- ADESA sales volume rose 9% in Q2, with online-only vehicle sales increasing to 346,000 from 245,000; physical-auction sales declined 4%. ADESA’s operating profit fell despite higher revenue, largely reflecting higher SG&A.
- IAA Q2 vehicles sold increased approximately 7%; operating profit rose to $78.7 million. Its same-store North American total-loss vehicle inventory was up approximately 2% year over year.
- AFC Q2 loan transactions increased 5%, and revenue per loan transaction (excluding other service revenue) rose 20% to $177. Its credit-loss provision fell to 1.5% of average managed receivables from 2.6%.
- Interest expense increased 21% in Q2 to $48.5 million, driven by higher average corporate debt and interest rates, as well as higher AFC interest costs.
- ADESA online activity continued to grow: online sales represented approximately 54% of ADESA total Q2 vehicle sales, versus approximately 46% a year earlier.
Outlook, management commentary, risks and unusual items
- Management expected 2018 capital expenditures of approximately $185 million, including an IAA Florida property for catastrophic-event use; approximately half was expected to be technology-related.
- Management expected quarterly dividends of $0.35 per share in 2018, subject to board approval. The filing reports the August 2018 declaration of a $0.35 dividend payable in October.
- The company projected North American whole-car auction volumes above 11 million units annually in 2018–2020 and expected salvage auction industry volume growth of 5%–7% annually. These are management estimates, not guarantees.
- TradeRev incurred operating losses of $22.4 million in the first half of 2018; management expected similar losses in the second half, primarily from rollout-related SG&A.
- KAR was pursuing a spin-off of IAA, initially expected within 12 months of its February 2018 announcement, but disclosed that completion could occur after Q1 2019. The transaction remained subject to approvals, agreements, tax-related conditions and other customary matters; delay or failure, costs, disruption and potential tax liability were identified risks.
- Interest-rate exposure remains relevant because the term loans are variable-rate. Interest-rate caps covered $1.2 billion of variable-rate debt, and the filing estimated that a hypothetical 100-basis-point rate increase would add about $1.3 million to quarterly and $3.3 million to six-month interest expense, taking caps into account.
- Other stated risks include vehicle volumes and pricing, competition, dealer credit losses and collateral recoveries, technology and cybersecurity, weather and catastrophe-related costs, foreign exchange, substantial debt and restrictive covenants.
- IAA had received EPA notices concerning potential responsibility at the Lower Duwamish Waterway Superfund site. The company said it could not determine IAA’s responsibility or estimate a loss; no payment demand had been made. Management generally did not expect ordinary-course litigation to materially affect the company, but actual losses above accruals could adversely affect results.
- The 2018 adoption of revenue-recognition guidance reduced opening retained earnings by $3.0 million; prior periods were not restated. STRATIM was acquired for approximately $23.3 million net of cash acquired, with preliminary purchase accounting and $22.0 million of goodwill; its reported impact was immaterial.
Most important facts for investors to verify
- Confirm the reporting entity and scope: this filing is KAR Auction Services’ consolidated 10-Q, while Openlane is described as an ADESA subsidiary.
- Assess whether ADESA’s online-volume growth and higher revenue per vehicle can offset physical-auction declines and continued TradeRev rollout losses and SG&A growth.
- Monitor AFC credit performance, delinquency trends, allowance adequacy and the sustainability of the lower reported credit-loss provision.
- Review debt service, variable-rate exposure, covenant headroom and the capacity of AFC securitization facilities to fund receivables.
- Track the IAA spin-off timeline, transaction costs, tax-free treatment conditions and potential impact on customers, employees and shareholders.
- Check subsequent developments in the Lower Duwamish Waterway matter and any new estimate, accrual or demand relating to potential environmental liability.