OPENLANE, Inc. quarterly report, Q3 FY2011

Filing scope and business context

Important identity distinction: The supplied filing is KAR Auction Services, Inc.’s unaudited Form 10-Q for the quarter ended September 30, 2011—not an OPENLANE, Inc. 10-Q. OPENLANE is discussed because KAR completed its acquisition in October 2011; its results are not included in this quarter.

KAR operates ADESA whole-car auctions, IAAI salvage-vehicle auctions, and AFC dealer floorplan financing. At quarter-end it reported 70 ADESA auctions, 159 IAAI sites, and 89 AFC loan offices.

Financial results

Amounts are in millions of dollars except per-share data. Comparisons are with the corresponding 2010 period.

Q3 operating margin was approximately 17.4% versus 16.0%; nine-month operating margin was approximately 16.2% versus 16.1%. Nine-month gross profit, as defined in the filing before depreciation and amortization, was $638.7 million versus $624.4 million. The filing does not provide a single consolidated net interest coverage or net-debt metric.

Segment performance

• ADESA: Q3 revenue fell 10% to $241.3 million as vehicle sales declined 15%; higher revenue per vehicle partly offset lower volume. Operating profit was $32.7 million versus $45.9 million. For the first nine months, revenue declined 7% to $767.1 million and operating profit fell to $109.9 million from $142.0 million.
• IAAI: Q3 revenue rose 16% to $164.7 million, supported by higher unit volumes, selling prices, and non-insurance vehicles; operating profit increased to $28.0 million from $23.5 million. Nine-month revenue rose 12% to $513.8 million and operating profit to $103.6 million from $84.3 million.
• AFC: Q3 revenue rose 15% to $41.0 million and operating profit to $21.7 million from $17.1 million. Loan transactions increased 13% to 269,131. Nine-month revenue rose 27% to $119.4 million and operating profit to $62.4 million from $41.2 million.

Cash, liquidity, and debt

• Cash and cash equivalents were $203.6 million at September 30, 2011, up from $119.1 million at December 31, 2010; working capital was $330.6 million. The company reported $158.7 million of available cash excluding cash in transit.
• Nine-month operating cash flow was $205.5 million, down from $418.0 million. Investing outflow was $109.1 million versus $649.3 million, largely reflecting the prior-year finance-receivable accounting transition; capital expenditures were $64.2 million. Financing outflow was $8.8 million.
• Long-term debt was $1,820.8 million, with $17.0 million of current maturities; total debt before discount was $1,845.8 million. Separately, $542.7 million of obligations were collateralized by finance receivables. No borrowings were outstanding under the new $250 million revolver at quarter-end; $28.8 million of letters of credit reduced facility capacity. The MD&A liquidity table lists $250 million available under the credit facility.
• The May 2011 refinancing established a $1.7 billion term loan due 2017, bearing 5.0% at quarter-end, and a $250 million revolver. KAR repaid its prior term loan and, in June, redeemed $450 million of 8.75% notes and $131.1 million of 10% subordinated notes. Debt extinguishment charges totaled $53.5 million for the first nine months.
• AFC’s managed receivables were $802.9 million; $2.6 million were at least 31 days delinquent. KAR reported compliance with credit and securitization covenants at September 30. It stated liquidity was sufficient for foreseeable operating needs and the next 12 months.

Material changes, outlook, and risks

• Nine-month revenue increased 2%, but net income declined 7% and diluted EPS fell from $0.46 to $0.42. Results included the $53.5 million debt-extinguishment loss. The 2011 effective tax rate was 13.2%, benefiting from a $17.9 million release of uncertain-tax-position reserves; excluding this and other discrete effects, the filing gives a 40.2% rate. Management expected an approximately 25% effective tax rate for full-year 2011.
• Management cited continuing whole-car supply shortages and estimated North American used-vehicle auction volumes would be below 8 million units in both 2011 and 2012. ADESA’s lower volume and conversion rate pressured results; dealer consignment represented a larger share of sales. IAAI and AFC grew, with AFC’s managed portfolio more than 99% current.
• KAR completed the OPENLANE acquisition in October for stated cash consideration of $210 million plus approximately $35 million for OPENLANE excess cash. Funding included approximately $100 million of KAR cash and $145 million of revolver borrowings; approximately $35 million of acquired cash was used to repay part of the revolver borrowing. OPENLANE results were to be consolidated beginning in Q4. Full-year 2011 capital expenditures were expected to be approximately $85 million.
• Key risks identified include used- and salvage-vehicle supply and pricing, auction conversion and loan volumes, credit losses and recoveries, competition, interest rates and substantial debt, restrictive covenants, acquisition integration, foreign exchange, environmental obligations, litigation, and potential impairment of goodwill or intangible assets.
• IAAI faces potential environmental exposure relating to the Lower Duwamish Waterway Superfund site. The EPA had not demanded payment or action beyond an information response; discussions with Washington authorities addressed possible stormwater source-control work. Management reported no significant change in previously disclosed legal proceedings.

Most important facts for investors to verify

• Confirm the filing entity and period: this is KAR Auction Services’ Q3 2011 filing; OPENLANE’s acquisition occurred after quarter-end.
• Assess whether ADESA’s vehicle-volume and conversion declines persisted, and whether IAAI and AFC growth offset the pressure.
• Reconcile the stated revolver availability with letters of credit and post-quarter OPENLANE acquisition borrowings and repayment.
• Separate recurring earnings from debt-refinancing charges, tax-reserve releases, and contingent-consideration adjustments.
• Review covenant headroom, floating-rate exposure, AFC receivable quality and securitization terms, and the status and potential cost of the environmental matter.