Business context and reporting period
This is KAR Auction Services, Inc.’s unaudited Form 10-Q for the three months ended March 31, 2019—not a standalone OPENLANE, Inc. filing. OPENLANE is identified as a subsidiary within ADESA. KAR operates ADESA whole-car auctions, IAA salvage auctions, and AFC dealer floorplan financing.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Revenue | $1,046.8 million | $950.5 million |
| Gross profit | $434.5 million | $415.5 million |
| Operating profit | $160.8 million | $157.8 million |
| Interest expense | $56.9 million | $41.5 million |
| Net income | $77.8 million | $90.0 million |
| Diluted EPS | $0.58 | $0.66 |
| Operating cash flow | $93.7 million | $152.3 million |
| Capital expenditures | $54.0 million | $38.7 million |
- Revenue rose 10%; gross profit increased about 5%. Gross margin, calculated on revenue less cost of services, was 41.5% versus 43.7%. Operating margin was 15.4% versus 16.6%.
- Net income declined 14%, despite higher revenue and operating profit, mainly alongside a 37% increase in interest expense. Management attributed higher interest expense primarily to higher average corporate borrowings and rates, plus increased AFC interest costs.
- Cash and cash equivalents were $265.6 million at March 31, down from $337.1 million at year-end; working capital was $514.6 million, versus $689.4 million at year-end. Cash, cash equivalents and restricted cash decreased $74.8 million during the quarter.
- Corporate debt totaled $2,794.7 million gross, including $93.5 million drawn on the revolving facility and $15.3 million on European lines. Separately, obligations collateralized by finance receivables were $1,360.6 million. The company reported covenant compliance and a senior secured leverage ratio of 1.96x against a 3.5x maximum.
- Adjusted EBITDA, a non-GAAP measure, was $230.8 million versus $229.4 million. The filing cautions that it is not a substitute for GAAP results.
Material changes and segment results
- ADESA: Revenue increased 14% to $599.7 million; vehicles sold rose 8% to 945,000. Operating profit fell to $67.4 million from $82.1 million. The filing cites higher acquisition and TradeRev costs, greater purchased-vehicle activity and a lower gross margin.
- IAA: Revenue increased 6% to $357.2 million; vehicles sold rose about 1% to 649,000. Operating profit increased to $85.7 million from $76.0 million. Same-store North American total-loss vehicle inventory was up about 10% year over year.
- AFC: Revenue increased 6% to $89.9 million and operating profit rose to $57.1 million from $47.0 million. Loan transactions were roughly flat at 461,000; revenue per transaction increased 7%, while provision for credit losses remained 1.6% of average managed receivables.
- Operating cash flow declined year over year, which management attributed primarily to the timing of collections and consignor payments near period-end and lower profitability. Investing cash outflow increased to $156.0 million, including $120.7 million of net cash paid for acquisitions.
Outlook, commentary and risks
- Management expected fiscal 2019 capital expenditures of approximately $200 million, about half for technology-related investments. It stated available liquidity was expected to meet operating needs, debt service, announced acquisitions and dividends for the next 12 months.
- The company expected the IAA spin-off to be completed in June 2019, subject to approvals and other conditions; it could be delayed, changed or abandoned. IAA Spinco was expected to have net debt of approximately 3.5x Adjusted EBITDA, subject to future financing and board approval.
- Management expected North American whole-car auction volumes to exceed 11 million units annually in 2019–2021 and estimated salvage auction industry volumes would grow 5%–7% annually. These are estimates, not guarantees.
- Management cited risks including vehicle supply and demand, auction volumes and conversion rates, used-vehicle and salvage-commodity prices, competition, technology and cybersecurity, acquisition integration, interest rates, foreign exchange, substantial debt and restrictive covenants, weather, and the proposed IAA separation.
- In January 2019, KAR acquired Dent-ology and CarsOnTheWeb. Aggregate purchase price was approximately $193.5 million, including contingent and deferred consideration; purchase accounting was preliminary. Acquisitions contributed $31.8 million to quarterly revenue and $160.5 million of goodwill.
- KAR adopted lease accounting Topic 842 in Q1: it recorded $942.5 million of operating lease right-of-use assets and $1,014.0 million of operating lease liabilities. The adoption added a $1.1 million net-of-tax adjustment to opening retained earnings.
- The company disclosed potential environmental liability involving IAA’s leased property adjacent to the Lower Duwamish Waterway Superfund site. It had no adequate information to determine IAA’s responsibility or estimate a loss. Management said ordinary-course legal matters were not generally expected to have a material adverse effect.
Important facts for investors to verify
- Whether the IAA spin-off closed on the expected timetable, its final debt allocation and tax treatment, and the resulting capital structures and dividend policies.
- Whether acquisition integration and ADESA/TradeRev growth improve segment profitability, given ADESA’s lower reported margin and operating profit.
- Whether working-capital timing normalizes and operating cash flow supports planned capital spending, dividends and debt service.
- Changes in gross corporate debt, AFC securitization obligations, borrowing costs, covenant headroom and credit losses.
- Any developments in the Lower Duwamish Waterway matter or other contingencies that could make exposure estimable or material.