Filing summary: KAR Auction Services, Inc. (Q1 2017)
Entity note: The supplied filing is KAR Auction Services, Inc.’s Form 10-Q, not a standalone OPENLANE, Inc. filing. The filing identifies Openlane as an ADESA subsidiary. Reporting period: three months ended March 31, 2017; filed May 10, 2017. Dollar amounts are in millions unless noted.
Business context and results
KAR operates whole-car auctions through ADESA, salvage-vehicle auctions through IAA, and dealer floorplan financing through AFC. At quarter-end, it reported 77 ADESA auction sites, 173 IAA sites, and 128 AFC locations.
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $866.6 | $758.3 | +14% |
| Gross profit | $365.4 | $326.3 | +12% |
| Gross margin | 42.2% | 43.0% | Down 0.8 percentage points |
| Operating profit | $143.5 | $128.8 | +11% |
| Operating margin | 16.6% | 17.0% | Down 0.4 percentage points |
| Net income | $69.2 | $60.7 | +14% |
| Diluted EPS | $0.50 | $0.44 | +14% |
| Operating cash flow | $142.0 | $70.1 | More than doubled |
| Capital expenditures | $37.2 | $36.0 | +$1.2 |
Interest expense increased 40% to $40.3, primarily reflecting Term Loan B-3, higher Term Loan B-2 rates, revolver borrowing and increased AFC portfolio financing. The effective tax rate declined to 33.0% from 37.7%, including $4.1 of excess stock-compensation tax benefits recognized under newly adopted accounting guidance.
Segments and material period-over-period changes
- ADESA: Revenue rose 20% to $498.0; vehicles sold increased 16% to 818,000, including acquisitions. Operating profit rose to $92.7. Gross margin declined to 41.6% from 42.5%.
- IAA: Revenue increased 10% to $297.4, with vehicles sold up 11% to 592,000. Operating profit rose to $59.2 and gross margin improved to 36.4% from 35.6%.
- AFC: Revenue fell 4% to $71.2 and operating profit fell to $34.3 from $38.6. The credit-loss provision increased to 2.5% of average managed receivables from 1.3%; loan transactions were nearly flat at 456,000.
- Businesses acquired in the prior 12 months contributed $48.4 of revenue growth. Holding-company operating loss widened to $42.7 from $36.2, partly reflecting higher compensation, professional fees and technology costs.
Liquidity, debt and capital allocation
At March 31, cash and cash equivalents were $188.0, working capital was $554.0, and reported availability under the credit facility was $286.7. Net cash decreased $13.8 during the quarter. Operating cash flow benefited from timing of collections and payments to auction consignors; management cautioned that working capital varies with period-end timing.
Debt included $2,429.8 of gross long-term debt before unamortized issuance costs and discounts, plus $1,241.8 of obligations collateralized by finance receivables. The secured term loans bore rates of 4.19% and 4.50%. The company reported a 3.08-to-1.0 senior secured leverage ratio against a 3.75-to-1.0 limit for the quarter and said it was in compliance with credit and securitization covenants. It reported no off-balance-sheet arrangements.
The company declared dividends of $0.32 per share and expected, subject to board approval, to pay $0.32 quarterly during 2017. No shares were repurchased in Q1 under its $500 million authorization. Fiscal 2017 capital expenditures were expected to be approximately $145 million.
Outlook, risks and unusual items
- Management expected North American whole-car auction volumes to exceed 10.6 million units annually in 2017–2019, citing anticipated growth in off-lease and repossessed vehicles. This is an industry estimate, not company-specific guidance.
- AFC management expected annual credit-loss provision expense of approximately 1.75%–2.25% of average managed receivables, but anticipated a higher rate in the first half of 2017 and improvement in the second half.
- In April 2017, KAR acquired DRIVIN for $43 million cash; results were to be included beginning in Q2, and purchase accounting was incomplete.
- Interest-rate exposure remains material: a hypothetical 100-basis-point increase in short-term rates was estimated to increase quarterly interest expense by approximately $5.3 million after considering caps. Management also cited competition, vehicle volumes and values, AFC credit losses, substantial debt, covenant restrictions, cyber and technology risks, weather, and regulatory and environmental matters.
- IAA is a potentially responsible party concerning the Lower Duwamish Waterway Superfund site. The EPA had not specified the factual basis or demanded payment or action beyond an information response; the company said it could not estimate its responsibility or potential loss. Management did not expect ordinary-course litigation generally to materially affect the company.
- New lease accounting was expected to significantly affect the balance sheet because of the company’s substantial operating leases. The company also noted that revenue-recognition changes could accelerate recognition for certain services, including towing and vehicle inspection reports; the impact remained under evaluation.
Important facts for investors to verify
- Confirm the issuer and reporting scope: this summary is based on KAR Auction Services’ consolidated filing, with Openlane described as an ADESA subsidiary.
- Assess whether auction volume and revenue growth excluding acquisitions are sustainable, and monitor segment margins.
- Track AFC credit-loss provisions, delinquencies and recoveries, particularly against management’s expected first-half and full-year ranges.
- Review debt service, revolver availability, covenant headroom, variable-rate exposure and the effect of lease accounting on reported leverage.
- Monitor the DRIVIN acquisition, planned capital spending, dividends and any share repurchases, as well as developments in the Lower Duwamish matter.