KAR Auction Services, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. The filing is for KAR Auction Services, Inc.; OPENLANE is identified as a wholly owned subsidiary within ADESA. It does not provide separate OPENLANE financial results.
Business context and financial results
KAR operated whole-car and salvage-vehicle auctions and provided floorplan financing through ADESA Auctions, IAA and AFC. At quarter-end, the company reported 67 ADESA auction sites, 163 IAA salvage sites and 104 AFC locations.
| Metric | Q2 2013 | Q2 2012 | H1 2013 | H1 2012 |
|---|---|---|---|---|
| Revenue | $541.4 million | $487.9 million | $1,099.0 million | $994.8 million |
| Operating profit | $81.3 million | $73.2 million | $159.4 million | $148.0 million |
| Net income | $33.4 million | $23.9 million | $62.5 million | $49.9 million |
| Diluted EPS | $0.24 | $0.17 | $0.45 | $0.36 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $223.0 million | $170.3 million |
Q2 revenue rose 11% year over year; operating profit rose 11% and net income rose 40%. H1 revenue increased 10%, operating profit 8% and net income 25%. Cost of services was $298.9 million in Q2 and $630.3 million in H1. Gross profit, defined in the filing as revenue less cost of services and exclusive of depreciation and amortization, was $242.5 million in Q2 and $468.7 million in H1. That equates to gross margins of approximately 44.8% and 42.7%, respectively, versus 46.1% and 46.5% in the comparable 2012 periods. Operating margins were approximately 15.0% in Q2 and 14.5% in H1.
Segments and material changes
- ADESA: Q2 revenue increased 8% to $285.3 million, principally on 10% higher vehicle sales; operating profit increased to $42.9 million from $30.0 million. Online sales were about 35% of volume, versus 31% a year earlier. H1 revenue increased 6% to $568.9 million and operating profit rose to $82.0 million.
- IAA: Q2 revenue grew 14% to $202.8 million, but operating profit declined to $34.6 million from $37.1 million. H1 revenue increased 16% to $424.4 million, while operating profit fell to $60.1 million from $78.3 million. Processing Superstorm Sandy vehicles generated a $13.5 million pretax loss in H1; Q2's portion was $2.7 million. Excluding Sandy effects, management said IAA gross margin would have been 37.9% for H1, compared with 32.1% reported.
- AFC: Q2 revenue rose 14% to $53.3 million and operating profit rose to $27.2 million. H1 revenue increased 13% to $105.7 million and operating profit to $56.6 million. Loan transactions increased 10% in H1; managed receivables were $1,067.7 million at June 30.
Q2 interest expense declined 17% to $24.5 million, and H1 expense declined 11% to $53.3 million, primarily reflecting lower Term Loan B interest rates. Debt-modification and extinguishment charges were $1.6 million in Q2 and $5.4 million in H1. The H1 effective tax rate was 39.0%, versus 43.6% in 2012.
Cash, debt and liquidity
Cash and cash equivalents were $168.1 million at June 30, 2013, versus $108.7 million at year-end 2012; working capital was $306.9 million. H1 operating cash flow was $223.0 million; investing cash use was $151.5 million and financing cash use was $6.4 million. Capital expenditures were $53.2 million in H1. The company expected approximately $95 million of capital expenditures for full-year 2013.
Long-term debt was $1,773.1 million, excluding $5.3 million of unamortized discount; $1,778.4 million principal was outstanding on Term Loan B. The $250 million revolver had no borrowings, with $23.6 million of letters of credit reducing availability. Term Loan B's stated rate was 3.75% at quarter-end. In March, KAR refinanced and increased the term loan, reducing its spread; proceeds were used to redeem $150 million of floating-rate notes. Management reported compliance with debt and securitization covenants and believed available liquidity sufficient for operating needs and debt service over the next 12 months. The reported senior secured leverage ratio was 3.3 to 1.0.
AFC's U.S. receivables facility was expanded from $650 million to $800 million and, along with the Canadian facility, extended to June 2016. The company declared dividends of $0.19 per share for each of Q1 and Q2 2013 and stated an expectation of quarterly $0.19 dividends during 2013, subject to board approval and contractual restrictions.
Outlook, risks and unusual items
- Management estimated North American used-vehicle auction volumes, including online-only sales, would exceed 8.5 million units in 2013 and 9 million by 2015. These are industry estimates, not company earnings guidance.
- Management cited vehicle supply and demand, auction volumes and conversion rates, used-vehicle pricing, interest rates, dealer credit quality, competition, regulation, acquisitions and integration, weather, and substantial debt as risks. The filing cautions that interim results may not indicate full-year results.
- The June acquisition of PWI Holdings, a vehicle service-contract provider, cost approximately $27.2 million net of cash. Preliminary purchase accounting included $22.3 million of goodwill, and the acquisition's reported income-statement impact was immaterial.
- IAA's Sandy-related vehicle processing involved unusually high towing, temporary-site and labor costs. Separately, IAA received EPA notices concerning the Lower Duwamish Waterway site; the company said it could not determine responsibility or estimate any loss. It reported no significant change in previously disclosed legal proceedings.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of IAA's revenue and profitability growth is sustainable after the temporary Sandy vehicle workload, and whether associated losses fully resolve.
- Whether auction volumes, online mix and ancillary revenue per vehicle support continued ADESA growth and margins.
- AFC receivable quality, delinquency and loss trends, funding-facility availability and compliance with facility covenants.
- Debt service capacity, floating-rate exposure, covenant headroom, and whether dividends and planned capital expenditures remain affordable.
- Final PWI purchase accounting and any developments in environmental or other legal contingencies.