KAR Auction Services, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013. The filing is KAR Auction Services’ consolidated, unaudited report; OPENLANE is identified as a wholly owned subsidiary within the ADESA business, not the reporting company. The business operates whole-car auctions (ADESA), salvage auctions (IAA), and dealer floorplan financing (AFC).
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $533.7 million | $474.9 million | $1,632.7 million | $1,469.7 million |
| Operating profit | $67.6 million | $61.7 million | $227.0 million | $209.7 million |
| Net income | $22.8 million | $19.2 million | $85.3 million | $69.1 million |
| Diluted earnings per share | $0.16 | $0.14 | $0.61 | $0.50 |
| Operating margin | 12.7% | 13.0% | 13.9% | 14.3% |
Q3 revenue increased 12% and net income 19% year over year. For the nine-month period, revenue increased 11% and net income 23%. Revenue grew across all three segments. IAA’s nine-month operating performance was pressured by Superstorm Sandy-related processing costs.
Cash flow: Nine-month operating cash flow was $318.4 million, versus $238.0 million in 2012. Investing used $180.7 million, including $75.3 million for property, equipment and software, acquisition spending, and growth in finance receivables. Financing used $46.5 million. Cash and cash equivalents ended the period at $196.0 million, up from $108.7 million at year-end 2012.
Liquidity and debt: Working capital was $363.1 million. Long-term debt was $1,770.3 million, with no borrowings on the $250 million revolving facility; $23.6 million of letters of credit reduce revolving availability. Separately, $742.4 million of obligations collateralized by finance receivables were current liabilities. The company reported compliance with debt and securitization covenants and a 3.2-to-1.0 senior secured leverage ratio. Management said available liquidity should meet operating, capital and debt-service needs for the next twelve months.
Margins and segment trends: ADESA Q3 revenue rose 7%, supported by 13% more vehicles sold, while revenue per vehicle fell 5%; its gross margin improved to 44.8% from 42.7%. IAA Q3 revenue rose 19% with vehicle volume up approximately 16%, but gross margin declined to 35.6% from 36.7% as service costs increased. AFC Q3 revenue rose 18%, including $5.1 million from the acquired service-contract business; loan transactions increased 9%.
Material changes, outlook and unusual items
- Debt refinancing: In March, the company increased Term Loan B by $150 million and reduced its spread to adjusted LIBOR plus 2.75%; the rate was 3.75% at quarter-end. Proceeds funded redemption of $150 million of floating-rate notes. Nine-month results included a $5.4 million debt modification/extinguishment loss.
- Superstorm Sandy: IAA sold more than 45,000 related vehicles during the first nine months, generating about $29.7 million revenue and $43.2 million cost of services, for a $13.5 million pretax loss. The filing says this reduced IAA’s reported margin; excluding Sandy, IAA’s nine-month gross margin would have been 37.1%. This adjustment is excluded from the company’s Adjusted EBITDA under its credit agreement.
- Acquisition: KAR acquired PWI Holdings in June for approximately $27.3 million net of cash, expanding AFC’s vehicle service-contract offering. Its income-statement impact was described as immaterial for the periods reported.
- Capital spending and dividends: Management expected fiscal 2013 capital expenditures of approximately $95 million, compared with $75.3 million spent in the first nine months. The company declared three 2013 quarterly dividends of $0.19 per share and announced a $0.25 dividend payable in January 2014. Management expected, subject to board approval, a $0.25 quarterly dividend in 2014; future dividends remain subject to financial and contractual constraints.
- Industry outlook and risks: The company estimated North American whole-car auction volumes would exceed 8.5 million units in 2013 and 9 million by 2015. These are industry estimates, not company earnings guidance. Key risks include vehicle supply and demand, used-vehicle prices, competition from online platforms, AFC credit losses and funding costs, variable interest rates, substantial debt and restrictive covenants, severe weather, foreign exchange, and environmental or legal liabilities. The Lower Duwamish Waterway matter remains unresolved; the company said it could not estimate IAA’s potential liability.
- Controls: Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether auction volume growth and revenue per vehicle trends persist, particularly ADESA’s lower revenue per vehicle and IAA’s higher service costs.
- IAA’s remaining Sandy-related vehicle volume, costs and any further effect on margins; compare GAAP results with Adjusted EBITDA adjustments.
- Actual revolving-credit availability after letters of credit, covenant headroom, variable-rate exposure and the terms of the receivables securitization facilities.
- Whether cash generation supports planned capital spending, debt reduction and the indicated dividend, given covenant limits and substantial debt.
- Progress and potential exposure in the Lower Duwamish Waterway proceeding and other environmental or legal contingencies.