Business context and reporting period
KAR Auction Services, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The company operates ADESA whole-car auctions, IAA salvage auctions, and AFC dealer floorplan financing. OPENLANE is identified as an ADESA subsidiary providing online remarketing technology; this filing reports KAR Auction Services on a consolidated basis, not OPENLANE as a standalone company.
Financial performance and position
Amounts are in millions of dollars except per-share data. Comparisons are with the same 2015 period unless otherwise noted.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $771.8 | $658.3 | $1,516.8 | $1,290.7 |
| Gross profit | $340.9 | $291.8 | $667.2 | $572.1 |
| Operating profit | $135.0 | $116.5 | $263.8 | $224.4 |
| Net income | $61.8 | $59.5 | $122.5 | $114.0 |
| Diluted EPS | $0.44 | $0.41 | $0.88 | $0.79 |
- Q2 revenue increased 17%; operating profit rose 16% and net income rose 4%. Revenue grew across ADESA, IAA, and AFC. Six-month revenue increased 18% and net income 7%.
- Q2 gross margin was approximately 44.2% versus 44.3%; operating margin was approximately 17.5% versus 17.7%. IAA’s margin declined, partly reflecting HBC’s purchase-contract mix; AFC’s gross margin improved.
- Interest expense increased 64% to $35.8 in Q2 and 51% to $64.5 for the six months, primarily due to refinancing and AFC’s larger financed portfolio. Six-month results included a $4.0 pretax debt-extinguishment charge.
- Six-month operating cash flow was $158.9, down from $200.5. Investing cash use was $531.1, including $353.3 for acquisitions and $75.5 in capital expenditures. Financing provided $526.4; cash increased $159.7 to $314.7.
- At June 30, cash was $314.7, working capital $636.0, and reported availability under the revolving credit facility $300.0, reduced by outstanding letters of credit. Management reported $243.3 of available cash excluding cash in transit.
- Gross long-term debt principal was $2,438.8; debt carrying value was $2,403.0, including $24.7 of current maturities. Separately, obligations collateralized by finance receivables were $1,231.2. The company reported a 3.16:1 senior secured leverage ratio and compliance with debt and securitization covenants.
Material changes and significant developments
- ADESA revenue rose 26% in Q2; vehicle sales volume increased 18% (9% excluding acquisitions), with revenue per vehicle up 6%. Online sales were about 41% of ADESA vehicle sales.
- IAA revenue increased 7% in Q2, with vehicle volume up about 6%; operating profit was nearly flat at $49.8 versus $49.2. AFC revenue increased 13%, supported by 10% growth in loan transactions; its credit-loss provision also increased.
- Completed acquisitions in 2016 included Brasher’s eight auctions, Sanford Auto Dealers Exchange, and U.K. online remarketer GRS. Aggregate purchase price, net of cash acquired, was approximately $354.6; acquisition pro forma impact was reported as immaterial. Purchase accounting remained preliminary.
- In March, KAR refinanced debt, issuing Term Loan B-3 and replacing its old revolving facility. Term Loan B-2 and B-3 balances were $1,092.2 and $1,346.6, respectively; their June 30 rates were 3.94% and 4.25%. The new facility extended approximately $1.35 billion of debt maturity to 2023 and increased the applicable interest costs.
Outlook, commentary, and risks
- No specific consolidated revenue or earnings guidance is provided. Management expected approximately $145 of 2016 capital expenditures and said available liquidity should cover operating needs, debt service, announced acquisitions, and dividends for the next 12 months.
- Management expected North American whole-car auction volumes to exceed 10 million units annually in 2016–2018, citing increased off-lease supply. The company also noted that lower salvage commodity and vehicle values can pressure IAA proceeds and margins.
- The company expected a quarterly dividend of $0.29 per share in 2016, subject to board approval and contractual restrictions; an August 2016 dividend declaration is also disclosed. Dividends declared were $0.58 per share for the first six months.
- Key risks include vehicle volumes and prices, auction competition, online-platform and cybersecurity risks, AFC dealer defaults and credit losses, variable interest rates, substantial debt and restrictive covenants, foreign exchange, acquisitions and integration, seasonality, weather, and environmental or legal liabilities.
- IAA received a notice concerning potential natural-resource damages related to the Lower Duwamish Waterway Superfund site. The company said it could not determine IAA’s responsibility or estimate any loss. Management stated ordinary-course litigation was not generally expected to have a material adverse effect.
- 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
- Confirm the acquisition contribution to ADESA growth and the final purchase accounting for the 2016 acquisitions.
- Track interest expense, variable-rate exposure, debt balances, leverage covenant headroom, and available revolver capacity following the refinancing.
- Assess AFC portfolio growth alongside delinquencies, credit losses, and recoveries; managed receivables were $1,738.6 and reported as over 99% current.
- Monitor IAA salvage values and margins, including the effect of commodity prices and purchase-contract vehicles.
- Review the eventual liability assessment and potential exposure concerning the Lower Duwamish Waterway matter.
- Check whether capital spending, dividends, and liquidity evolve as management expected; the filing’s cash-flow comparison is affected by timing of consignor collections and payments.