KAR Auction Services, Inc. 10-Q — Quarter ended September 30, 2012
Entity context: The provided filing is for KAR Auction Services, Inc., not a standalone OPENLANE, Inc. filing. OPENLANE is included within KAR’s ADESA Auctions segment, following its acquisition in the fourth quarter of 2011. Figures below are consolidated unless stated otherwise; dollar amounts are in millions except per-share data.
Business context and reporting period
KAR operates whole-car auctions through ADESA, salvage vehicle auctions through IAA, and dealer floorplan financing through AFC. This unaudited quarterly report covers the three and nine months ended September 30, 2012, compared with the same periods in 2011. KAR reported 68 ADESA whole-car auction sites, 161 IAA salvage sites, and 104 AFC locations at quarter-end.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $474.9 | $449.1 | $1,469.7 | $1,406.5 |
| Gross profit | $210.8 | $201.8 | $673.0 | $640.3 |
| Operating profit | $61.7 | $77.6 | $209.7 | $226.3 |
| Net income | $19.2 | $32.2 | $69.1 | $57.7 |
| Diluted earnings per share | $0.14 | $0.23 | $0.50 | $0.42 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $238.0 | $205.5 |
Gross margin was approximately 44.4% in Q3 2012 versus 44.9% in Q3 2011, and 45.8% for the first nine months of 2012 versus 45.5% in 2011. Operating margin was approximately 13.0% versus 17.3% in Q3, and 14.3% versus 16.1% for the nine-month periods. Management reported Adjusted EBITDA of $117.3 for Q3 2012 versus $115.7, and $380.3 for the first nine months versus $375.1; this is a non-GAAP measure.
At September 30, cash and cash equivalents were $163.7, working capital was $319.4, and current assets and current liabilities were $1,587.7 and $1,268.3. Long-term debt was $1,805.2, with $17.0 of current maturities; total debt before unamortized discount was $1,828.7. AFC’s separate obligations collateralized by finance receivables were $633.5. The $250 million revolving facility had no borrowings, with $22.8 of letters of credit reducing availability. The filing reports $250 million available under the facility.
For the first nine months, investing cash outflow was $112.5 and financing cash outflow was $62.3; cash increased by $66.3 to $163.7. Capital expenditures were $60.8. Management estimated full-year 2012 capital expenditures of approximately $90 million.
Material changes versus prior comparable periods
- Q3 revenue increased 6%, but operating profit fell 20% and net income fell 40%. SG&A rose $21.9, including increased corporate stock-based compensation and OPENLANE-related costs; Q3 2011 had a $12.9 credit from remeasurement of KAR LLC and Axle LLC profit interests, versus $5.0 of expense in Q3 2012.
- Nine-month revenue increased 4%, while operating profit declined 7%. Net income rose 20%, in part because 2011 included a $53.5 debt-extinguishment loss; interest expense also declined $22.5, partly reflecting 2011 debt refinancing and swap termination costs.
- ADESA revenue grew 7% in Q3 and 3% year to date, with OPENLANE contributing $22.8 and $65.4, respectively. ADESA vehicle volumes rose, but revenue per vehicle fell and same-store volumes declined.
- IAA revenue rose 2% in Q3 and 4% year to date. Higher processing and towing costs, including costs associated with more vehicles sold under purchase agreements, pressured gross margin.
- AFC revenue rose 17% in Q3 and 15% year to date, supported by higher loan transaction volumes and a larger managed receivables portfolio. Managed receivables were $938.5 at September 30, 2012, up from $802.9 a year earlier; management stated more than 99% of the portfolio was current.
Outlook, commentary, risks and contingencies
- Management said available cash, operating cash flow, working capital and revolving-credit availability were sufficient for expected operating needs, capital requirements and debt service for the next 12 months. The company was in compliance with debt and securitization covenants at quarter-end; its reported senior secured leverage ratio was 3.2 to 1.0.
- Management estimated North American whole-car auction volumes, including online sales, at approximately 8 million units in 2012, approaching 8.4 million in 2013 and nearly 9 million by 2015. The filing cautions that off-lease supply could remain weak into 2013 and that lower used-vehicle or commodity prices could reduce salvage auction proceeds and profitability.
- Key risks include auction supply and conversion rates, vehicle values, credit losses and dealer defaults, competition and pricing, interest and foreign exchange movements, regulatory and environmental matters, substantial debt and restrictive covenants, execution of growth and technology initiatives, and seasonality. Management noted that Q4 typically has lower auction volume and additional holiday and winter-weather costs.
- The company had purchased interest-rate caps covering $925 million of variable-rate debt when one-month LIBOR exceeds 1.25%; the caps mature in August 2013. A hypothetical 100-basis-point rate increase would have increased interest expense by approximately $0.4 for Q3 and $1.5 for the nine-month period.
- Ordinary-course litigation and disputes were disclosed. For the Lower Duwamish Waterway Superfund site, the EPA had identified IAA as a potentially responsible party, but had not demanded payment or action beyond an information response. The company said it could not determine IAA’s responsibility or estimate any loss.
- The filing identifies no separate company earnings guidance. The stated $90 million 2012 capital expenditure estimate and industry-volume projections are management estimates, not earnings guidance.
Most important facts for investors to verify
- Confirm the intended issuer: this document reports KAR Auction Services, Inc.; OPENLANE is consolidated within ADESA rather than reported as a standalone issuer or segment.
- Assess whether the Q3 decline in operating profit and earnings reflects recurring cost growth or nonrecurring stock-compensation comparisons and integration costs.
- Track ADESA same-store auction volumes, revenue per vehicle, conversion rates and OPENLANE integration economics.
- Review AFC receivables growth, portfolio aging, credit losses, securitization capacity and covenant compliance.
- Verify debt-service capacity, availability under the revolving facility, covenant thresholds and exposure to variable interest rates.
- Follow the Lower Duwamish environmental matter and any change in the company’s ability to estimate or accrue a potential loss.