Business context and reporting period
This is KAR Auction Services, Inc.’s unaudited Form 10-Q for the quarter ended March 31, 2020, filed May 7, 2020. The filing identifies Openlane, Inc. as a wholly owned subsidiary within ADESA; it is not a standalone Openlane 10-Q. KAR’s continuing operations comprise ADESA Auctions, which provides wholesale vehicle auction and remarketing services, and AFC, which provides dealer floorplan financing. The former salvage auction business, IAA, was spun off in June 2019 and is presented as discontinued operations in the 2019 comparison.
Key financial results
Amounts are in millions except per-share data. Comparisons are with Q1 2019 unless otherwise stated.
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Total revenue | $645.5 | $689.6 |
| Gross profit | $250.9 | $295.7 |
| Operating profit | $40.8 | $76.2 |
| Continuing-operations income | $2.8 | $15.3 |
| Continuing-operations diluted EPS | $0.02 | $0.11 |
| Net income, including discontinued operations | $2.8 | $77.8 |
| Cash flow from continuing operating activities | $(49.2) | $50.0 |
| Capital expenditures | $29.6 | $32.3 |
- Total revenue declined 6%; gross profit fell about 15%, and operating profit fell about 46%. Operating margin was approximately 6.3%, compared with 11.0% a year earlier.
- Interest expense declined 33% to $38.0, primarily reflecting lower average corporate debt and interest rates following the IAA spin-off debt repayment and subsequent refinancing.
- ADESA revenue declined 5% to $567.0; vehicles sold fell 9% to 862,000. Online sales represented 63% of volume, up from 57%. ADESA operating profit decreased to $34.4 from $67.4.
- AFC revenue fell 13% to $78.5 and operating profit fell to $45.4 from $57.1. Loan transactions declined 3% to 448,000; the provision for credit losses rose to $16.9 from $8.2.
- Q1 2019 included $62.5 of after-tax income from IAA discontinued operations; therefore, total net income is not directly comparable. Continuing-operations income is the more relevant comparison.
Balance sheet, debt and liquidity
- At March 31, 2020, cash and cash equivalents were $293.1 and restricted cash was $114.4. Working capital was $694.1. The company reported $325.0 of availability under its $325 million revolving facility; outstanding letters of credit reduce borrowing availability.
- Corporate debt was $1.913 billion, including $945.2 of Term Loan B-6, $950.0 of 5.125% senior notes, and $17.5 of European line borrowings. Separately, obligations collateralized by finance receivables were $1.350 billion.
- The company reported no revolver borrowings and stated it was in compliance with applicable debt and securitization covenants. Its secured net leverage ratio was 1.8; the stated maximum of 3.5 applies when revolver loans are outstanding.
- Operating cash flow was negative $49.2, while investing activities provided $116.7, including a net decrease in finance receivables held for investment. Financing activities used $197.2. Cash, cash equivalents and restricted cash decreased by $153.4 during the quarter.
- Finance receivables managed by AFC were $1.955 billion; the allowance for credit losses was $25.0, up from $15.0 at year-end. The company adopted the current expected credit-loss standard in Q1, increasing the opening allowance by $5.0.
Material changes, outlook and risks
- COVID-19 sharply disrupted operations late in the quarter. North American volumes excluding TradeRev were down 12%, 45% and 87% year over year in the second, third and fourth weeks of March, respectively. Physical auction operations were suspended March 20; select Simulcast-only auctions reopened April 6, but volumes remained significantly below normal.
- Management expected 2020 whole-car auction volumes and AFC loan transaction volumes to be significantly lower than in 2019, but said it could not estimate future volumes or the duration and financial impact of the pandemic. The filing provides no specific earnings or revenue guidance.
- Liquidity and cost actions included furloughing approximately 11,000 employees in April, temporary salary reductions, delaying or canceling auction-site capital projects, deferring some rent, and suspending the quarterly dividend. The company also intended to use certain CARES Act tax relief. Management said available liquidity was expected to meet needs for the foreseeable future, while warning that continued disruption or deteriorating conditions could materially affect liquidity.
- AFC introduced a customer relief program allowing eligible dealers to defer certain curtailment payments through May 31, 2020, and reduced or restricted unused portions of some customer floorplan lines. Reduced retail activity and lower wholesale vehicle prices could raise defaults and losses on recovered collateral.
- In January, KAR entered into $500 million of five-year pay-fixed interest rate swaps, fixing the hedged borrowing rate at a total 3.69%. The swaps generated a $19.0 after-tax unrealized loss in other comprehensive income in Q1. Foreign currency translation also contributed to a $35.9 loss; total comprehensive loss was $52.1.
- The $0.19-per-share dividend declared in February was paid April 3; the company subsequently temporarily suspended its quarterly dividend. The $300 million share-repurchase authorization remained unused during Q1.
- Other risks include auction and dealer demand, vehicle pricing and credit losses, debt and covenant restrictions, cybersecurity exposure from increased remote access, litigation, and possible impairment of goodwill or intangible assets. Management said ordinary-course litigation was not expected to have a material adverse effect; actual losses could exceed accrued amounts.
Important facts for investors to verify
- Whether post-quarter auction volumes and Simulcast activity recovered, and how reopening restrictions affected revenue, margins and costs.
- Whether AFC’s dealer relief measures, delinquencies, charge-offs and allowance for credit losses adequately reflect deteriorating dealer and vehicle-market conditions.
- Cash generation and liquidity after the reported operating cash outflow, including usable cash versus restricted cash and actual revolver availability.
- Debt covenant headroom, securitization facility compliance and the effect of reduced receivables or customer payment deferrals.
- The duration of the dividend suspension and any changes to planned capital expenditures, staffing or the share-repurchase authorization.