Business context and reporting period
KAR Auction Services, Inc. (the registrant; OPENLANE, Inc. is a wholly owned ADESA subsidiary) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. KAR operates ADESA whole-car auctions, IAA salvage auctions, and AFC dealer floorplan financing. ADESA’s online services include technology powered by OPENLANE.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $585.6 million | $541.4 million | $1,169.4 million | $1,099.0 million |
| Operating profit | $100.9 million | $81.3 million | $185.3 million | $159.4 million |
| Net income | $50.8 million | $33.4 million | $71.5 million | $62.5 million |
| Diluted EPS | $0.36 | $0.24 | $0.51 | $0.45 |
- Q2 revenue rose 8%, operating profit 24%, and net income 52% year over year. Six-month revenue rose 6%, operating profit 16%, and net income 14%. Q2 operating margin was approximately 17.2% versus 15.0%; six-month operating margin was 15.8% versus 14.5%.
- Q2 segment revenue grew at ADESA 6% to $301.8 million, IAA 10% to $223.8 million, and AFC 13% to $60.0 million. For the six months, growth was 5%, 6%, and 14%, respectively. IAA’s 2013 comparison includes Superstorm Sandy activity and associated costs.
- Six-month operating cash flow was $231.4 million, compared with $223.0 million. Investing used $114.5 million and financing used $23.1 million; cash increased $93.7 million to $285.3 million.
- At June 30, cash was $285.3 million, working capital $449.5 million, and reported availability under the revolving facility $250 million before $26.4 million of letters of credit. Long-term debt was $1,745.2 million plus $17.7 million current maturities. AFC obligations collateralized by finance receivables were $800.4 million.
- ADESA and IAA generally act as agents and earn fees; AFC had $1,170.3 million of managed receivables. The filing reports AFC’s portfolio was over 99% current.
Material changes and unusual items
- On March 11, 2014, KAR refinanced its prior credit agreement with $648.4 million of Term Loan B-1, $1,117.2 million of Term Loan B-2, and a $250 million revolving facility with no borrowings at quarter-end. The refinancing reduced borrowing rates and extended approximately $1.1 billion of debt maturity to March 2021, but resulted in a $30.3 million non-cash extinguishment charge in the first half.
- Six-month interest expense declined to $45.0 million from $53.3 million. The refinancing charge contributed to reported net income growing more slowly than operating profit; 2013 also included $5.4 million of debt modification/extinguishment charges.
- IAA’s first-half 2013 results included a $13.5 million pretax net loss processing Superstorm Sandy vehicles. The comparison therefore benefited from the absence of that unusual loss in 2014.
- Stock-based compensation expense increased to $20.8 million for the first half from $4.4 million, largely due to exit-option expense. AFC revenue included PWI service-contract revenue following its 2013 acquisition.
Outlook, commentary, and risks
- Management expects approximately $105 million of 2014 capital expenditures, primarily for information systems, facility upkeep and auction-site capacity expansion. It expects, subject to board approval, quarterly dividends of $0.25 per share during 2014; an October 2014 payment had been announced.
- Management estimated North American used-vehicle auction volumes of approximately 9.1 million units in 2014, 9.5 million in 2015, and 9.7 million in 2016. These are industry estimates, not company revenue guidance. Management noted that moderating used-vehicle and commodity prices could pressure salvage-auction proceeds, revenue, and gross profit.
- Management said available cash, operating cash flow, working capital, and credit availability should fund operating needs, capital requirements, and debt service for the next 12 months. The actual consolidated senior secured leverage ratio was 2.81-to-1.0 at June 30; the covenant maximum was 4.0-to-1.0 when revolving loans are outstanding. KAR reported compliance with its credit and securitization covenants.
- Key risks include vehicle supply and demand, auction volumes and pricing, competition and online-channel shifts, AFC dealer defaults and credit losses, variable interest rates, substantial debt and restrictive covenants, foreign exchange, severe weather, environmental exposure, and litigation.
- IAA faces potential liability relating to the Lower Duwamish Waterway Superfund site. The EPA had not demanded payment or action beyond an information response, and the company said it could not determine responsibility or estimate potential loss.
- The filing identifies ASU 2014-09 revenue-recognition requirements, effective for annual periods beginning after December 15, 2016; KAR was evaluating the impact and had not selected a transition method.
Important facts for investors to verify
- Confirm the issuer/entity scope: this filing is for KAR Auction Services, not a standalone OPENLANE filing; OPENLANE is identified as an ADESA subsidiary.
- Assess recurring earnings separately from the $30.3 million refinancing charge, stock-based compensation increase, and the prior-year Sandy-related IAA loss.
- Review debt maturities, variable-rate exposure, covenant headroom, and the availability of the revolving facility after letters of credit; the company’s rate sensitivity and interest-rate caps are described in the filing.
- Track auction volumes, online-only mix and revenue per vehicle, salvage pricing, AFC delinquencies and credit losses, and PWI’s contribution and costs.
- Verify the assumptions behind capital spending and dividend plans, and monitor the Superfund matter and other contingencies for new estimates or developments.