Business context and reporting period
KAR Auction Services, Inc. (the registrant; the filing identifies OPENLANE as a wholly owned ADESA subsidiary) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Its businesses comprise ADESA whole-car auctions, IAA salvage auctions, and AFC dealer floorplan financing. The company reported 68 ADESA auction sites, 161 IAA sites, and 104 AFC locations.
Financial performance and position
Amounts are in millions of dollars except per-share data. Comparisons are with the same 2011 period unless indicated otherwise.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $487.9 | $472.7 | $994.8 | $957.4 |
| Operating profit | $73.2 | $75.3 | $148.0 | $148.7 |
| Net income (loss) | $23.9 | $(14.3) | $49.9 | $25.5 |
| Diluted EPS | $0.17 | $(0.11) | $0.36 | $0.19 |
| Interest expense | $29.6 | $49.7 | $59.9 | $82.9 |
- Operating margin was approximately 15.0% in Q2 2012 versus 15.9% in Q2 2011, and 14.9% for the first half versus 15.5% in the prior-year first half. Gross profit, defined as revenue less cost of services, was $224.7 million in Q2 and $462.2 million for the first half.
- Revenue growth was led by AFC and IAA. Q2 segment revenue: ADESA $263.8 million, IAA $177.3 million, and AFC $46.8 million. First-half segment revenue: $534.4 million, $366.7 million, and $93.7 million, respectively.
- Q2 segment operating profit was ADESA $30.0 million, IAA $37.1 million, and AFC $24.8 million; corporate/holding-company operating loss was $18.7 million. ADESA operating profit declined despite higher revenue, while IAA was flat and AFC improved.
- Operating cash flow for the first half was $170.3 million, versus $157.5 million. Investing cash outflow was $95.1 million and financing cash outflow was $55.1 million; cash increased $19.7 million to $117.1 million.
- At June 30, cash was $117.1 million, working capital $274.9 million, and total assets $4.869 billion. Available cash excluding cash in transit was $83.9 million, including $43.5 million held by foreign subsidiaries and considered permanently reinvested.
- Debt consisted of $1.683 billion of Term Loan B and $150 million of floating-rate senior notes, or $1.833 billion gross debt before unamortized discount and current maturities. There were no revolver borrowings; $23.8 million of letters of credit reduced availability under the $250 million facility. Separately, AFC had $634.1 million of obligations collateralized by finance receivables.
- Non-GAAP Adjusted EBITDA was $128.1 million for Q2 and $263.0 million for the first half, compared with $132.1 million and $259.4 million, respectively, in 2011. Trailing-twelve-month Adjusted EBITDA was $490.8 million. These are supplemental measures, not GAAP results.
Material changes versus the prior comparable period
- Q2 revenue increased 3%, but operating profit fell by $2.1 million as operating expenses rose faster than revenue. First-half revenue increased 4%, while operating profit was nearly unchanged.
- Net income improved substantially in Q2 from a prior-year loss, largely because Q2 2011 included a $53.5 million debt-extinguishment loss. First-half 2012 net income also benefited from lower interest expense; the prior-year first half included the same debt-extinguishment charge.
- Interest expense fell $20.1 million in Q2 and $23.0 million for the first half. The filing attributes much of the decline to 2011 swap termination/prepayment-related costs and refinancing, partly offset by current debt costs and higher AFC funding costs.
- ADESA vehicle sales rose 11% in Q2 and 10% in the first half, including OPENLANE; excluding OPENLANE, same-store units sold declined 6% in both periods. ADESA revenue per vehicle fell 8%, and conversion rates also declined.
- IAA revenue increased 2% in Q2 and 5% for the first half on higher units sold, but costs associated with towing, processing, reconditioning, and purchase-agreement vehicles pressured gross margin.
- AFC revenue increased 11% in Q2 and 14% for the first half, with loan transactions up 16% and 17%, respectively. Revenue per loan transaction declined 4% and 3%, respectively, partly reflecting higher credit-loss provisions and lower average loan values.
- Cash from operations rose, while investing outflow increased as finance receivables grew. The company repaid the $68.9 million revolver balance outstanding at year-end 2011.
Outlook, commentary, risks, and unusual items
- Management estimated North American used-vehicle auction volumes, including OPENLANE, at approximately 8 million units in 2012, 8.4 million in 2013, and nearly 9 million by 2015. It noted that reduced off-lease supply could continue to affect volumes into 2013.
- Fiscal 2012 capital expenditures were expected to be approximately $90 million, compared with $85.8 million in 2011, primarily for information systems, OPENLANE/ADESA integration, facility upkeep and expansion, and relocation projects.
- Management said existing cash, operating cash flow, working capital, and credit availability should fund operating needs, capital requirements, and debt service for the next twelve months. It reported compliance with credit and securitization covenants; actual senior secured leverage was 3.3x at June 30. The leverage covenant applies when revolver loans are outstanding and becomes more restrictive over time.
- Key risks include auction supply and demand, vehicle prices and conversion rates, customer credit and collections, competition, interest and foreign-exchange movements, substantial indebtedness and restrictive covenants, acquisition integration, technology investment, weather, environmental obligations, litigation, and impairment of goodwill or intangibles. The business is seasonal, with typically lower fourth-quarter volumes.
- Variable-rate debt is partly hedged by $925 million notional interest-rate caps through August 2013. A hypothetical 100-basis-point increase in short-term rates would have increased first-half 2012 interest expense by approximately $1.1 million.
- Ordinary-course litigation was reported. For IAA’s Lower Duwamish Waterway matter, the company could not determine responsibility or estimate potential loss; the EPA had not demanded payment or action beyond an information request. IAA denied allegations in a Carteret, New Jersey, environmental case, which management did not expect to have a material adverse effect.
- Other notable items include $1.0 million of contingent-consideration expense recorded in the first half of 2012, versus a $5.9 million reversal in Q2 2011, and 2011 tax benefits from the release of $14.4 million of uncertain-tax-position reserves. The filing says 2011 AFC presentation was revised to gross up certain revenues and related expenses, with no net-income impact.
Important facts for investors to verify
- Confirm that the filing is KAR Auction Services’ consolidated report, not a standalone OPENLANE 10-Q; assess OPENLANE’s contribution and integration costs within ADESA.
- Track ADESA’s same-store unit trends, revenue per vehicle, and conversion rates, distinguishing acquired online volume from underlying auction performance.
- Assess whether AFC’s portfolio growth and higher loan transactions can offset falling revenue per transaction and rising credit-loss provisions; verify delinquency and loss trends.
- Review debt service, floating-rate exposure, covenant headroom, and the availability and renewal terms of the AFC securitization facilities.
- Monitor the Lower Duwamish potential environmental liability and other litigation, for which the filing does not provide a clear loss estimate.
- Compare future capital spending and integration progress with management’s approximately $90 million 2012 capex outlook and stated liquidity expectations.