10-Q 1 karq1201710-q.htm 10-Q - MARCH 31, 2017 Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34568
________________________________________________________
karlogoa01.jpg
KAR Auction Services, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or
organization)
 
20-8744739
(I.R.S. Employer
Identification No.)
13085 Hamilton Crossing Boulevard
Carmel, Indiana 46032
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (800) 923-3725
________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 (Do not check if a
smaller reporting company)
 
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý
As of April 30, 2017, 137,149,840 shares of the registrant's common stock, par value $0.01 per share, were outstanding.
 



KAR Auction Services, Inc.
Table of Contents

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I
FINANCIAL INFORMATION
Item 1.    Financial Statements
KAR Auction Services, Inc.
Consolidated Statements of Income
(In millions, except per share data)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2017
 
2016
Operating revenues
 
 
 
ADESA Auction Services
$
498.0

 
$
414.8

IAA Salvage Services
297.4

 
269.6

AFC
71.2

 
73.9

Total operating revenues
866.6

 
758.3

Operating expenses
 
 
 
Cost of services (exclusive of depreciation and amortization)
501.2

 
432.0

Selling, general and administrative
157.4

 
141.1

Depreciation and amortization
64.5

 
56.4

Total operating expenses
723.1

 
629.5

Operating profit
143.5

 
128.8

Interest expense
40.3

 
28.7

Other income, net
(0.1
)
 
(1.3
)
Loss on extinguishment of debt

 
4.0

Income before income taxes
103.3

 
97.4

Income taxes
34.1

 
36.7

Net income
$
69.2

 
$
60.7

Net income per share
 
 
 
Basic
$
0.51

 
$
0.44

Diluted
$
0.50

 
$
0.44

Dividends declared per common share
$
0.32

 
$
0.29

   










See accompanying notes to consolidated financial statements

3


KAR Auction Services, Inc.
Consolidated Statements of Comprehensive Income
(In millions)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2017
 
2016
Net income
$
69.2

 
$
60.7

Other comprehensive income
 
 
 
Foreign currency translation gain
3.4

 
8.7

Comprehensive income
$
72.6

 
$
69.4

   

























See accompanying notes to consolidated financial statements

4


KAR Auction Services, Inc.
Consolidated Balance Sheets
(In millions)
(Unaudited)
 
March 31, 2017
 
December 31, 2016
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
188.0

 
$
201.8

Restricted cash
18.4

 
17.9

Trade receivables, net of allowances of $9.4 and $13.0
773.0

 
682.9

Finance receivables, net of allowances of $12.3 and $12.0
1,748.4

 
1,780.2

Other current assets
159.8

 
158.4

Total current assets
2,887.6

 
2,841.2

Other assets
 
 
 
Goodwill
2,058.3

 
2,057.0

Customer relationships, net of accumulated amortization of $731.6 and $707.8
438.6

 
461.0

Other intangible assets, net of accumulated amortization of $303.1 and $301.6
317.3

 
320.1

Other assets
40.9

 
35.8

Total other assets
2,855.1

 
2,873.9

Property and equipment, net of accumulated depreciation of $678.9 and $655.6
837.5

 
842.5

Total assets
$
6,580.2

 
$
6,557.6

   

















See accompanying notes to consolidated financial statements

5


KAR Auction Services, Inc.
Consolidated Balance Sheets
(In millions, except share and per share data)
(Unaudited)
 
March 31, 2017
 
December 31, 2016
Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
786.5

 
$
648.5

Accrued employee benefits and compensation expenses
72.3

 
100.7

Accrued interest
1.5

 
2.2

Other accrued expenses
147.6

 
149.4

Income taxes payable
2.0

 
5.0

Dividends payable
43.9

 
43.7

Obligations collateralized by finance receivables
1,241.8

 
1,280.3

Current maturities of long-term debt
38.0

 
105.2

Total current liabilities
2,333.6

 
2,335.0

Non-current liabilities
 
 
 
Long-term debt
2,360.5

 
2,365.1

Deferred income tax liabilities
288.7

 
291.7

Other liabilities
167.0

 
168.5

Total non-current liabilities
2,816.2

 
2,825.3

Commitments and contingencies (Note 8)

 

Stockholders' equity
 
 
 
Preferred stock, $0.01 par value:
 
 
 
Authorized shares: 100,000,000
 

 
 

Issued shares: none

 

Common stock, $0.01 par value:
 
 
 
Authorized shares: 400,000,000
 

 
 

Issued and outstanding shares:
 

 
 

March 31, 2017: 137,129,155
 

 
 

December 31, 2016: 136,639,217
1.4

 
1.4

Additional paid-in capital
1,376.3

 
1,371.1

Retained earnings
98.6

 
74.1

Accumulated other comprehensive loss
(45.9
)
 
(49.3
)
Total stockholders' equity
1,430.4

 
1,397.3

Total liabilities and stockholders' equity
$
6,580.2

 
$
6,557.6








See accompanying notes to consolidated financial statements

6


KAR Auction Services, Inc.
Consolidated Statements of Stockholders' Equity
(In millions)
(Unaudited)
 
Common
Stock
Shares
 
Common
Stock
Amount
 
Additional
Paid-In
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Balance at Balance at December 31, 2016
136.6

 
$
1.4

 
$
1,371.1

 
$
74.1

 
$
(49.3
)
 
$
1,397.3

Net income
 

 
 
 
 
 
69.2

 
 
 
69.2

Other comprehensive income
 

 
 
 
 
 
 
 
3.4

 
3.4

Issuance of common stock under stock plans
0.6

 
 
 
4.3

 
 
 
 
 
4.3

Surrender of RSUs for taxes
(0.1
)
 
 
 
(5.7
)
 
 
 
 
 
(5.7
)
Stock-based compensation expense
 

 
 
 
5.8

 
 
 
 
 
5.8

Dividends earned under stock plans
 
 
 
 
0.8

 
(0.8
)
 
 
 

Cash dividends declared to stockholders ($0.32 per share)
 

 
 
 
 
 
(43.9
)
 
 
 
(43.9
)
Balance at March 31, 2017
137.1

 
$
1.4

 
$
1,376.3

 
$
98.6

 
$
(45.9
)
 
$
1,430.4

   





















See accompanying notes to consolidated financial statements

7


KAR Auction Services, Inc.
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2017
 
2016
Operating activities
 
 
 
Net income
$
69.2

 
$
60.7

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
64.5

 
56.4

Provision for credit losses
11.6

 
6.9

Deferred income taxes
(3.1
)
 
(3.5
)
Amortization of debt issuance costs
2.5

 
2.0

Stock-based compensation
5.8

 
5.2

(Gain) loss on disposal of fixed assets
(0.3
)
 
0.1

Loss on extinguishment of debt

 
4.0

Other non-cash, net
2.9

 
2.0

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Trade receivables and other assets
(94.3
)
 
(152.4
)
Accounts payable and accrued expenses
83.2

 
88.7

Net cash provided by operating activities
142.0

 
70.1

Investing activities
 
 
 
Net decrease (increase) in finance receivables held for investment
21.4

 
(65.6
)
Purchases of property, equipment and computer software
(37.2
)
 
(36.0
)
Advance to equity method investee
(5.0
)
 

Proceeds from the sale of property and equipment
0.1

 

(Increase) decrease in restricted cash
(0.5
)
 
1.3

Net cash used by investing activities
(21.2
)
 
(100.3
)
Financing activities
 
 
 
Net increase in book overdrafts
31.4

 
41.7

Net decrease in borrowings from lines of credit
(67.2
)
 
(140.0
)
Net (decrease) increase in obligations collateralized by finance receivables
(41.0
)
 
8.1

Proceeds from long-term debt

 
1,336.5

Payments for debt issuance costs/amendments
(0.1
)
 
(19.5
)
Payments on long-term debt
(6.1
)
 
(637.6
)
Payments on capital leases
(7.4
)
 
(6.2
)
Payments of contingent consideration and deferred acquisition costs
(3.0
)
 
(2.0
)
Issuance of common stock under stock plans
4.3

 
3.1

Tax withholding payments for vested RSUs
(3.6
)
 
(0.9
)
Dividends paid to stockholders
(43.7
)
 
(37.2
)
Net cash (used by) provided by financing activities
(136.4
)
 
546.0

Effect of exchange rate changes on cash
1.8

 
5.5

Net (decrease) increase in cash and cash equivalents
(13.8
)
 
521.3

Cash and cash equivalents at beginning of period
201.8

 
155.0

Cash and cash equivalents at end of period
$
188.0

 
$
676.3

Cash paid for interest
$
37.1

 
$
25.4

Cash paid for taxes, net of refunds
$
39.3

 
$
32.9




See accompanying notes to consolidated financial statements

8


KAR Auction Services, Inc.
Notes to Consolidated Financial Statements
March 31, 2017 (Unaudited)
Note 1—Basis of Presentation and Nature of Operations
Defined Terms
Unless otherwise indicated or unless the context otherwise requires, the following terms used herein shall have the following meanings:
"we," "us," "our" and "the Company" refer, collectively, to KAR Auction Services, Inc. and all of its subsidiaries;
"ADESA" or "ADESA Auctions" refer, collectively, to ADESA, Inc., a wholly-owned subsidiary of KAR Auction Services, and ADESA, Inc.'s subsidiaries, including Openlane, Inc. (together with Openlane, Inc.'s subsidiaries, "Openlane") and ADESA Remarketing Limited (formerly known as GRS Remarketing Limited ("GRS" or "ADESA Remarketing Limited"));
"AFC" refers, collectively, to Automotive Finance Corporation, a wholly-owned subsidiary of ADESA, and Automotive Finance Corporation's subsidiaries and other related entities, including PWI Holdings, Inc.;
"Credit Agreement" refers to the Amended and Restated Credit Agreement, dated March 11, 2014, as amended on March 9, 2016, among KAR Auction Services, as the borrower, the several banks and other financial institutions or entities from time to time parties thereto and the administrative agent;
"Credit Facility" refers to the three-year senior secured term loan B-1 facility ("Term Loan B-1"), the seven-year senior secured term loan B-2 facility ("Term Loan B-2"), the seven-year senior secured term loan B-3 facility ("Term Loan B-3"), the $300 million, five-year senior secured revolving credit facility (the "revolving credit facility") and the $250 million, five-year senior secured revolving credit facility (the "old revolving credit facility"), the terms of which are set forth in the Credit Agreement. Term Loan B-1 and the old revolving credit facility were extinguished in March 2016 with proceeds received from Term Loan B-3;
"IAA" refers, collectively, to Insurance Auto Auctions, Inc., a wholly-owned subsidiary of KAR Auction Services, and Insurance Auto Auctions, Inc.'s subsidiaries and other related entities, including HBC Vehicle Services Limited ("HBC"); and
"KAR Auction Services" refers to KAR Auction Services, Inc. and not to its subsidiaries.
Business and Nature of Operations
As of March 31, 2017, we have a North American network of 77 ADESA whole car auction sites and 173 IAA salvage vehicle auction sites; in addition, we offer online auctions for both whole car and salvage vehicles. ADESA also includes ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom. IAA also includes HBC Vehicle Services Limited, which operates from 11 locations in the United Kingdom. Our auctions facilitate the sale of used and salvage vehicles through physical, online or hybrid auctions, which permit Internet buyers to participate in physical auctions. ADESA and IAA are leading, national providers of wholesale and salvage vehicle auctions and related vehicle remarketing services for the automotive industry in North America. ADESA's online service offerings include customized private label solutions powered with software developed by its wholly-owned subsidiary, Openlane, that allow our institutional consignors (automobile manufacturers, captive finance companies and other institutions) to offer vehicles via the Internet prior to arrival at the physical auction. Remarketing services include a variety of activities designed to transfer used and salvage vehicles between sellers and buyers throughout the vehicle life cycle. ADESA and IAA facilitate the exchange of these vehicles through an auction marketplace, which aligns sellers and buyers. As an agent for customers, the Company generally does not take title to or ownership of vehicles sold at the auctions. Generally, fees are earned from the seller and buyer on each successful auction transaction in addition to fees earned for ancillary services.
ADESA has the second largest used vehicle auction network in North America, based upon the number of used vehicles sold through auctions annually, and also provides services such as inbound and outbound transportation logistics, reconditioning, vehicle inspection and certification, titling, administrative and collateral recovery services. ADESA is able to serve the diverse and multi-faceted needs of its customers through the wide range of services offered.
IAA is one of the leading providers of salvage vehicle auctions and related services. The salvage auctions facilitate the remarketing of damaged vehicles that are designated as total losses by insurance companies, recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made, purchased vehicles and older model vehicles donated to charity or sold by dealers in salvage auctions. The salvage auction business specializes in providing services such as

9

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


inbound transportation logistics, inspections, evaluations, salvage recovery services, titling and settlement administrative services.
AFC is a leading provider of floorplan financing to independent used vehicle dealers and this financing is provided through 128 locations throughout the United States and Canada as of March 31, 2017. Floorplan financing supports independent used vehicle dealers in North America who purchase vehicles at ADESA, IAA, other used vehicle and salvage auctions and non-auction purchases. In addition to floorplan financing, AFC also provides independent used vehicle dealers with other related services and products, such as vehicle service contracts.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for annual financial statements. Operating results for interim periods are not necessarily indicative of results that may be expected for the year as a whole. In the opinion of management, the consolidated financial statements reflect all adjustments, generally consisting of normal recurring accruals, necessary for a fair statement of our results of operations, cash flows and financial position for the periods presented. These consolidated financial statements and condensed notes to consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on February 24, 2017. The 2016 year-end consolidated balance sheet data included in this Form 10-Q was derived from the audited financial statements referenced above and does not include all disclosures required by U.S. GAAP for annual financial statements.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation under ASC 718, Compensation-Stock Compensation. We recognize all stock-based compensation as expense in the financial statements and that cost is measured as the fair value of the award at the grant date for equity-classified awards.

We adopted ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, in the first quarter of 2017. As a result of the adoption, the Company elected to recognize the impact of forfeitures as they occur. In addition, the Company now recognizes excess tax benefits and tax deficiencies related to employee stock-based compensation within income tax expense. As a result, on a prospective basis, we recognized $4.1 million of excess tax benefits from stock-based compensation as a discrete item in our income tax expense for the three months ended March 31, 2017. Historically, these amounts were recorded as additional paid-in capital. We have also retrospectively applied ASU 2016-09 to our consolidated statements of cash flows for the three months ended March 31, 2016, which resulted in a reclassification of excess tax benefits from stock-based compensation of $0.6 million from cash flows provided by financing activities to cash flows provided by operating activities.
New Accounting Standards
In January 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the test for goodwill impairment by eliminating Step 2 (implied fair value measurement). Instead goodwill impairment would be measured as the amount by which a reporting unit's carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2017-04 will have a material impact on the consolidated financial statements.


10

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which addresses diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2016-18 will have a material impact on the consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance on the statement of cash flows presentation of certain transactions where diversity in practice exists. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-15 will have on the consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted beginning in annual periods beginning after December 15, 2018, including interim periods within those fiscal years. We do not expect the adoption of ASU 2016-13 will have a material impact on the consolidated financial statements based on the short-term nature of AFC's loans.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which replaces existing lease guidance. The ASU is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet, with an exception for leases that meet the definition of a short-term lease. The new guidance will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted and the ASU is required to be applied with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on the consolidated financial statements and anticipates that the new guidance will significantly impact its consolidated financial statements, as the Company has a significant number of leases. Our current minimum commitments under non-cancelable operating leases are disclosed in the "Contractual Obligations" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016 and in Note 13 to the Consolidated Financial Statements of the same report. In addition, the recognition of these leases on our consolidated balance sheet would increase our net debt calculation which is included in the determination of our Consolidated Senior Secured Leverage Ratio. In this event, our Credit Agreement specifies that the covenant shall continue to be calculated as if the accounting standard had not occurred and that we could enter into negotiations to amend such provisions in the Credit Agreement so as to equitably reflect such changes with the desired result that the criteria for evaluating our financial condition would be the same after the change as if such change had not been made. We plan to amend the applicable provision in our Credit Agreement upon the adoption of ASU 2016-02.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which superseded the revenue recognition requirements in ASC 605, Revenue Recognition. The new guidance provides clarification on the recognition of revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosures to help financial statement users better understand the nature, amount, timing and uncertainty of revenue that is recognized. In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 by one year. In accordance with the agreed upon delay, the new guidance is effective for the first annual reporting period and interim periods beginning after December 15, 2017, and will require either retrospective application to each prior reporting period presented or retrospective application with the cumulative effect of initially applying the standard recognized at the date of adoption. The Company expects to use retrospective application with the cumulative effect as its transition method. The Company is currently evaluating the impact the adoption of ASU 2014-09 will have on the consolidated financial statements and related disclosures. However, we have identified services such as towing, vehicle inspection reports and other pre-sale services which could result in the acceleration of revenue recognition.

11

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 2—Stock and Stock-Based Compensation Plans
The KAR Auction Services, Inc. 2009 Omnibus Stock and Incentive Plan ("Omnibus Plan") is intended to provide equity or cash-based awards to our employees. Our stock-based compensation expense includes expense associated with KAR Auction Services, Inc. performance-based restricted stock units ("PRSUs"), service-based restricted stock units ("RSUs") and service options. We have classified the KAR Auction Services, Inc. PRSUs, RSUs and service options as equity awards.
The following table summarizes our stock-based compensation expense by type of award (in millions):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
PRSUs
 
$
3.1

 
$
3.1

RSUs
 
2.2

 
1.5

Service options
 
0.5

 
0.6

Total stock-based compensation expense
 
$
5.8

 
$
5.2

PRSUs and RSUs
In the first quarter of 2017, we granted a target amount of approximately 0.2 million PRSUs to certain executive officers and management of the Company. The PRSUs vest if and to the extent that the Company's three-year operating adjusted earnings per share attains certain specified goals. In addition, approximately 0.2 million RSUs were granted to certain executive officers and management of the Company. The RSUs are contingent upon continued employment and vest in three equal annual installments. The weighted average grant date fair value of the PRSUs and the RSUs was $44.51 per share, which was determined using the closing price of the Company's common stock on the dates of grant.
Share Repurchase Program
In October 2016, the board of directors authorized a repurchase of up to $500 million of the Company’s outstanding common stock, par value $0.01 per share, through October 26, 2019. Repurchases may be made in the open market or through privately negotiated transactions, in accordance with applicable securities laws and regulations, including pursuant to repurchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing and amount of any repurchases is subject to market and other conditions. No shares of common stock were repurchased during the first quarter of 2017. In 2016 we repurchased and retired a total of 1,931,200 shares of common stock in the open market at a weighted average price of $41.61 per share under the October 2016 authorization.

12

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 3—Net Income Per Share
The following table sets forth the computation of net income per share (in millions except per share amounts):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net income
 
$
69.2

 
$
60.7

Weighted average common shares outstanding
 
136.8

 
137.2

Effect of dilutive stock options and restricted stock awards
 
1.5

 
1.8

Weighted average common shares outstanding and potential common shares
 
138.3

 
139.0

Net income per share
 
 
 
 
Basic
 
$
0.51

 
$
0.44

Diluted
 
$
0.50

 
$
0.44

Basic net income per share was calculated by dividing net income by the weighted average number of outstanding common shares for the period. Diluted net income per share was calculated consistent with basic net income per share including the effect of dilutive unissued common shares related to our stock-based employee compensation program. The effect of stock options and restricted stock on net income per share-diluted is determined through the application of the treasury stock method, whereby net proceeds received by the Company based on assumed exercises are hypothetically used to repurchase our common stock at the average market price during the period. Stock options that would have an anti-dilutive effect on net income per diluted share and PRSUs subject to performance conditions which have not yet been satisfied are excluded from the calculations. No options were excluded from the calculation of diluted net income per share for the three months ended March 31, 2017 and 2016. In addition, approximately 0.7 million and approximately 0.5 million PRSUs were excluded from the calculation of diluted net income per share for the three months ended March 31, 2017 and 2016, respectively. Total options outstanding at March 31, 2017 and 2016 were 2.4 million and 3.7 million, respectively.
Note 4—Equity Method Investment
In August 2014, ADESA acquired a 50% interest in Nth Gen Software Inc. ("TradeRev") and its online vehicle remarketing system for approximately $30 million in cash. TradeRev is an online automotive remarketing system where dealers can launch and participate in real-time vehicle auctions at any time from their mobile devices or desktop. In addition, ADESA also entered into a joint marketing agreement with TradeRev to assist in expanding its footprint in the dealer-to-dealer online space in the U.S. and Canadian markets.

In the first quarter of 2017, TradeRev signed a promissory note with ADESA. The promissory note created a line of credit for term loans up to $15 million, with a minimum of $5 million to be drawn at a time. At March 31, 2017, there was $5 million outstanding on the promissory note and the initial maturity date is January 5, 2020. This amount is recorded in “Other assets” on the consolidated balance sheet.

The Company will continue to account for TradeRev as an equity method investment because we have the ability to exercise significant influence over operating and financial policies but do not have a controlling financial interest. At March 31, 2017, the carrying amount of the investment was $20.6 million. The Company’s share in the net losses of TradeRev for the three months ended March 31, 2017 and 2016 was $1.7 million and $0.6 million, respectively. This amount was recorded to “Other income, net” in the consolidated statements of income.


13

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 5—Finance Receivables and Obligations Collateralized by Finance Receivables
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to a wholly-owned, bankruptcy remote, consolidated, special purpose subsidiary ("AFC Funding Corporation"), established for the purpose of purchasing AFC's finance receivables. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires on January 31, 2020. AFC Funding Corporation had committed liquidity of $1.50 billion for U.S. finance receivables at March 31, 2017.
We also have an agreement for the securitization of Automotive Finance Canada Inc.'s ("AFCI") receivables which expires on January 31, 2020. AFCI's committed facility is provided through a third party conduit (separate from the U.S. facility) and was C$125 million at March 31, 2017. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.
The following tables present quantitative information about delinquencies, credit losses less recoveries ("net credit losses") and components of securitized financial assets and other related assets managed. For purposes of this illustration, delinquent receivables are defined as receivables 31 days or more past due.
 
March 31, 2017
 
Net Credit Losses
Three Months Ended March 31, 2017
 
Principal Amount of:
 
(in millions)
Receivables
 
Receivables
Delinquent
 
Floorplan receivables
$
1,748.0

 
$
15.6

 
$
10.9

Other loans
12.7

 

 

Total receivables managed
$
1,760.7

 
$
15.6

 
$
10.9


 
December 31, 2016
 
Net Credit Losses
Three Months Ended March 31, 2016
 
Principal Amount of:
 
(in millions)
Receivables
 
Receivables
Delinquent
 
Floorplan receivables
$
1,781.1

 
$
12.0

 
$
5.3

Other loans
11.1

 

 

Total receivables managed
$
1,792.2

 
$
12.0

 
$
5.3

AFC's allowance for losses was $12.3 million and $12.0 million at March 31, 2017 and December 31, 2016, respectively.
As of March 31, 2017 and December 31, 2016, $1,738.2 million and $1,774.8 million, respectively, of finance receivables and a cash reserve of 1 percent of the obligations collateralized by finance receivables served as security for the obligations collateralized by finance receivables. Obligations collateralized by finance receivables consisted of the following:
 
March 31,
2017
 
December 31,
2016
Obligations collateralized by finance receivables, gross
$
1,259.9

 
$
1,300.0

Unamortized securitization issuance costs
(18.1
)
 
(19.7
)
Obligations collateralized by finance receivables
$
1,241.8

 
$
1,280.3

Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At March 31, 2017, we were in compliance with the covenants in the securitization agreements.

14

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 6—Long-Term Debt
Long-term debt consisted of the following (in millions):
 
Interest Rate*
 
Maturity
 
March 31, 2017
 
December 31, 2016
Term Loan B-2
Adjusted LIBOR
 
+ 3.1875%
 
March 11, 2021
 
$
1,080.0

 
$
1,082.7

Term Loan B-3
Adjusted LIBOR
 
+ 3.50%
 
March 9, 2023
 
1,336.5

 
1,339.9

Revolving credit facility
Adjusted LIBOR
 
+ 2.50%
 
March 9, 2021
 
13.3

 
80.5

Canadian line of credit
CAD Prime
 
+ 0.50%
 
Repayable upon demand
 

 

Total debt
 
 
 
 
 
 
2,429.8

 
2,503.1

Unamortized debt issuance costs/discounts
 
 
 
 
 
(31.3
)
 
(32.8
)
Current portion of long-term debt
 
 
 
 
 
 
(38.0
)
 
(105.2
)
Long-term debt
 
 
 
 
 
 
$
2,360.5

 
$
2,365.1

*The interest rates presented in the table above represent the rates in place at March 31, 2017.
Credit Facility
On March 9, 2016, we entered into an Incremental Commitment Agreement and First Amendment (the "First Amendment") to the Credit Agreement. The First Amendment provided for, among other things, (i) a new seven-year senior secured term loan facility ("Term Loan B-3") and (ii) a $300 million, five-year senior secured revolving credit facility (the "revolving credit facility"), which replaced the previously existing revolving credit facility (the "old revolving credit facility").
The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate purposes. The Company also pays a commitment fee of 40 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility. The rates on Term Loan B-2 and Term Loan B-3 were 4.19% and 4.50% at March 31, 2017, respectively.
The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in 100% of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and 65% of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions. The Credit Agreement contains affirmative and negative covenants that we believe are usual and customary for a senior secured credit agreement. The negative covenants include, among other things, limitations on asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with our affiliates. The Credit Agreement also requires us to maintain a maximum leverage ratio, provided there are revolving loans outstanding. We were in compliance with the covenants in the Credit Agreement at March 31, 2017.
On March 31, 2017, $13.3 million was drawn on the revolving credit facility and $80.5 million was drawn on the revolving credit facility at December 31, 2016. In addition, we had related outstanding letters of credit in the aggregate amount of $35.9 million and $29.7 million at March 31, 2017 and December 31, 2016, respectively, which reduce the amount available for borrowings under the revolving credit facility. The $13.3 million of outstanding borrowings under the revolving credit facility have been classified as current debt as the Company intends to repay the outstanding borrowings within the next twelve months.
Fair Value of Debt

As of March 31, 2017, the estimated fair value of our long-term debt amounted to $2,452.7 million. The estimates of fair value were based on broker-dealer quotes for our debt as of March 31, 2017. The estimates presented on long-term financial instruments are not necessarily indicative of the amounts that would be realized in a current market exchange.

15

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 7—Derivatives
We are exposed to interest rate risk on our variable rate borrowings. Accordingly, interest rate fluctuations affect the amount of interest expense we are obligated to pay. We use interest rate derivatives with the objective of managing exposure to interest rate movements, thereby reducing the effect of interest rate changes and the effect they could have on future cash flows. Currently, interest rate cap agreements are used to accomplish this objective.
In March 2017, we entered into two interest rate caps with an aggregate notional amount of $400 million to manage our exposure to interest rate movements on our variable rate Credit Facility when three-month LIBOR exceeds 2.0%. The interest rate cap agreements each had an effective date of March 31, 2017 and each mature on March 31, 2019. We paid an aggregate amount of approximately $0.7 million for the caps in April 2017.
In August 2015, we purchased three interest rate caps for an aggregate amount of approximately $1.5 million with an aggregate notional amount of $800 million to manage our exposure to interest rate movements on our variable rate Credit Facility if/when three-month LIBOR (i) exceeded 2.0% between August 19, 2015 (the effective date) and September 29, 2016 and (ii) exceeds 1.75% between September 30, 2016 and August 19, 2017 (the maturity date).
In April 2015, we purchased two interest rate caps for an aggregate amount of approximately $0.7 million with an aggregate notional amount of $400 million to manage our exposure to interest rate movements on our variable rate Credit Facility when three-month LIBOR exceeded 1.5%. The interest rate cap agreements each had an effective date of April 16, 2015 and each matured on March 31, 2017.
We are exposed to credit loss in the event of non-performance by the counterparties; however, non-performance is not anticipated. ASC 815, Derivatives and Hedging, requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. The fair values of the interest rate derivatives are based on quoted market prices for similar instruments from commercial banks. The following table presents the fair value of our interest rate derivatives included in the consolidated balance sheets for the periods presented (in millions):
 
 
Asset Derivatives
 
 
March 31, 2017
 
December 31, 2016
Derivatives Not Designated as Hedging Instruments
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
2017 Interest rate caps
 
Other assets
 
$
0.7

 
Other assets
 
N/A

2015 Interest rate caps
 
Other assets
 
$

 
Other assets
 
$

We have not designated any of the interest rate caps as hedges for accounting purposes. Accordingly, changes in the fair value of the interest rate caps are recognized as "Interest expense" in the consolidated statement of income. The following table presents the effect of the interest rate derivatives on our consolidated statements of income for the periods presented (in millions):
 
 
Location of Gain / (Loss) Recognized in Income on Derivatives
 
Amount of Gain / (Loss)
Recognized in Income on Derivatives
 
 
 
Three Months Ended 
 March 31,
Derivatives Not Designated as Hedging Instruments
 
 
2017
 
2016
2017 Interest rate caps
 
Interest expense
 
$
(0.1
)
 
N/A

2015 Interest rate caps
 
Interest expense
 
$

 
$
(0.6
)

16

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 8—Commitments and Contingencies
We are involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries; property damage; handling, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Management considers the likelihood of loss or the incurrence of a liability, as well as the ability to reasonably estimate the amount of loss, in determining loss contingencies. We accrue an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss (or range of possible losses) can be reasonably estimated. Management regularly evaluates current information available to determine whether accrual amounts should be adjusted. Accruals for contingencies including litigation and environmental matters are included in "Other accrued expenses" at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. These accruals are adjusted periodically as assessment and remediation efforts progress, or as additional technical or legal information becomes available. If the amount of an actual loss is greater than the amount accrued, this could have an adverse impact on our operating results in that period. Such matters are generally not, in the opinion of management, likely to have a material adverse effect on our financial condition, results of operations or cash flows. Legal fees are expensed as incurred. There has been no significant change in the legal and regulatory proceedings which were disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.
Note 9—Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following (in millions):
 
March 31, 2017
 
December 31, 2016
Foreign currency translation loss
$
(46.0
)
 
$
(49.4
)
Unrealized gain on postretirement benefit obligation, net of tax
0.1

 
0.1

Accumulated other comprehensive loss
$
(45.9
)
 
$
(49.3
)

Note 10—Segment Information
ASC 280, Segment Reporting, requires reporting of segment information that is consistent with the manner in which the chief operating decision maker operates and views the Company. Our operations are grouped into three operating segments: ADESA Auctions, IAA and AFC, which also serve as our reportable business segments. These reportable business segments offer different services and have fundamental differences in their operations.
The holding company is maintained separately from the three reportable segments and includes expenses associated with the corporate offices, such as salaries, benefits and travel costs for the corporate management team, certain human resources, information technology and accounting costs, and certain insurance, treasury, legal and risk management costs. Holding company interest expense includes the interest expense incurred on capital leases and the corporate debt structure. Intercompany charges relate primarily to interest on intercompany debt or receivables and certain administrative costs allocated by the holding company.

17

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Financial information regarding our reportable segments is set forth below for the three months ended March 31, 2017 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
498.0

 
$
297.4

 
$
71.2

 
$

 
$
866.6

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
290.9

 
189.1

 
21.2

 

 
501.2

Selling, general and administrative
87.3

 
25.9

 
7.9

 
36.3

 
157.4

Depreciation and amortization          
27.1

 
23.2

 
7.8

 
6.4

 
64.5

Total operating expenses
405.3

 
238.2

 
36.9

 
42.7

 
723.1

Operating profit (loss)
92.7

 
59.2

 
34.3

 
(42.7
)
 
143.5

Interest expense
0.2

 

 
10.3

 
29.8

 
40.3

Other (income) expense, net
0.4

 
(0.4
)
 

 
(0.1
)
 
(0.1
)
Intercompany expense (income)
11.8

 
9.4

 
(8.7
)
 
(12.5
)
 

Income (loss) before income taxes
80.3

 
50.2

 
32.7

 
(59.9
)
 
103.3

Income taxes
29.0

 
18.0

 
11.8

 
(24.7
)
 
34.1

Net income (loss)
$
51.3

 
$
32.2

 
$
20.9

 
$
(35.2
)
 
$
69.2

Total assets
$
2,994.7

 
$
1,328.9

 
$
2,171.4

 
$
85.2

 
$
6,580.2

Financial information regarding our reportable segments is set forth below for the three months ended March 31, 2016 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
414.8

 
$
269.6

 
$
73.9

 
$

 
$
758.3

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
238.4

 
173.5

 
20.1

 

 
432.0

Selling, general and administrative
76.6

 
25.7

 
7.5

 
31.3

 
141.1

Depreciation and amortization          
22.5

 
21.3

 
7.7

 
4.9

 
56.4

Total operating expenses
337.5

 
220.5

 
35.3

 
36.2

 
629.5

Operating profit (loss)
77.3

 
49.1

 
38.6

 
(36.2
)
 
128.8

Interest expense
0.1

 

 
7.8

 
20.8

 
28.7

Other (income) expense, net
(0.6
)
 
(0.3
)
 

 
(0.4
)
 
(1.3
)
Loss on extinguishment of debt

 

 

 
4.0

 
4.0

Intercompany expense (income)
15.2

 
9.6

 
(7.8
)
 
(17.0
)
 

Income (loss) before income taxes
62.6

 
39.8

 
38.6

 
(43.6
)
 
97.4

Income taxes
23.3

 
14.9

 
14.6

 
(16.1
)
 
36.7

Net income (loss)
$
39.3

 
$
24.9

 
$
24.0

 
$
(27.5
)
 
$
60.7

Total assets
$
3,085.4

 
$
1,265.0

 
$
2,068.6

 
$
71.1

 
$
6,490.1


18

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2017 (Unaudited)


Note 11—Subsequent Event
In April 2017, KAR purchased all of the stock of CarCo Technologies, Inc. (“DRIVIN”) for $43 million in cash. DRIVIN aggregates automotive retail, pricing, registration and other market and economic data from a variety of public and proprietary sources. The insights generated from that data are deployed through predictive pricing, inventory management and vehicle matching tools that help customers buy, sell and source vehicles. The purchase accounting related to this acquisition is incomplete. Financial results for DRIVIN will be included in our consolidated financial statements beginning in the second quarter of 2017.


19


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and which are subject to certain risks, trends and uncertainties. In particular, statements made in this report on Form 10-Q that are not historical facts (including, but not limited to, expectations, estimates, assumptions and projections regarding the industry, business, future operating results, potential acquisitions and anticipated cash requirements) may be forward-looking statements. Words such as "should," "may," "will," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and similar expressions identify forward-looking statements. Such statements, including statements regarding our future growth; anticipated cost savings, revenue increases, credit losses and capital expenditures; dividend declarations and payments; common stock repurchases; strategic initiatives, greenfields and acquisitions; our competitive position and retention of customers; and our continued investment in information technology, are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results projected, expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016, filed on February 24, 2017. Some of these factors include:
our ability to successfully implement our business strategies or realize expected cost savings and revenue enhancements;
our ability to effectively maintain or update information and technology systems;
our ability to implement and maintain measures to protect against cyber-attacks;
significant current competition and the introduction of new competitors;
competitive pricing pressures;
any losses of key personnel;
our ability to meet or exceed customers' expectations, as well as develop and implement information systems responsive to customer needs;
business development activities, including greenfields, acquisitions and integration of acquired businesses;
costs associated with the acquisition of businesses or technologies;
fluctuations in consumer demand for and in the supply of used, leased and salvage vehicles and the resulting impact on auction sales volumes, conversion rates and loan transaction volumes;
our ability to obtain land or renew/enter into new leases at commercially reasonable rates;
decreases in the number of used vehicles sold at physical auctions;
changes in the market value of vehicles auctioned, including changes in the actual cash value of salvage vehicles;
trends in new and used vehicle sales and incentives, including wholesale used vehicle pricing;
the ability of consumers to lease or finance the purchase of new and/or used vehicles;
the ability to recover or collect from delinquent or bankrupt customers;
economic conditions including fuel prices, commodity prices, foreign exchange rates and interest rate fluctuations;
trends in the vehicle remarketing industry;
trends in the number of commercial vehicles being brought to auction, in particular off-lease volumes;
changes in the volume of vehicle production, including capacity reductions at the major original equipment manufacturers;
laws, regulations and industry standards, including changes in regulations governing the sale of used vehicles, the processing of salvage vehicles and commercial lending activities;
our ability to maintain our brand and protect our intellectual property;

20


the costs of environmental compliance and/or the imposition of liabilities under environmental laws and regulations;
weather, including increased expenses as a result of catastrophic events;
general business conditions;
our substantial amount of debt;
restrictive covenants in our debt agreements;
our assumption of the settlement risk for vehicles sold;
litigation developments;
our self-insurance for certain risks;
interruptions to service from our workforce;
any impairment to our goodwill or other intangible assets;
changes in effective tax rates;
changes to accounting standards; and
other risks described from time to time in our filings with the SEC.
Many of these risk factors are outside of our control, and as such, they involve risks which are not currently known that could cause actual results to differ materially from those discussed or implied herein. The forward-looking statements in this document are made as of the date on which they are made and we do not undertake to update our forward-looking statements.
Our future growth depends on a variety of factors, including our ability to increase vehicle sold volumes and loan transaction volumes, expand our product and service offerings, including information systems development, acquire and integrate additional business entities, manage expansion, control costs in our operations, introduce fee increases, and retain our executive officers and key employees. We cannot predict whether our growth strategy will be successful. In addition, we cannot predict what portion of overall sales will be conducted through online auctions or other remarketing methods in the future and what impact this may have on our auction business.
Overview
We provide whole car auction services and salvage auction services in North America and the United Kingdom. Our business is divided into three reportable business segments, each of which is an integral part of the vehicle remarketing industry: ADESA Auctions, IAA and AFC.
The ADESA Auctions segment serves a domestic and international customer base through live and online auctions and through 77 whole car auction facilities in North America that are developed and strategically located to draw professional sellers and buyers together and allow the buyers to inspect and compare vehicles remotely or in person. Through ADESA.com, powered by Openlane technology, ADESA offers comprehensive private label remarketing solutions to automobile manufacturers, captive finance companies and other institutions to offer vehicles via the Internet prior to arrival at the physical auction. Vehicles at ADESA's auctions are typically sold by commercial fleet operators, financial institutions, rental car companies, new and used vehicle dealers and vehicle manufacturers and their captive finance companies to franchise and independent used vehicle dealers. ADESA also provides value-added ancillary services including inbound and outbound transportation logistics, reconditioning, vehicle inspection and certification, titling, administrative and collateral recovery services. ADESA also includes ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom.
The IAA segment serves a domestic and international customer base through live and online auctions and through 173 salvage vehicle auction sites in the United States and Canada at March 31, 2017. IAA also includes HBC, which operates from 11 locations in the United Kingdom. The salvage auctions facilitate the remarketing of damaged vehicles designated as total losses by insurance companies, charity donation vehicles, recovered stolen (or theft) vehicles and low value used vehicles. The salvage auction business specializes in providing services such as inbound transportation, titling, salvage recovery and claims settlement administrative services.

21


The AFC segment provides short-term, inventory-secured financing, known as floorplan financing, primarily to independent used vehicle dealers. At March 31, 2017, AFC conducted business at 128 locations in the United States and Canada. The Company also sells vehicle service contracts through Preferred Warranties, Inc. ("PWI").
The holding company is maintained separately from the three reportable segments and includes expenses associated with the corporate offices, such as salaries, benefits and travel costs for our management team, certain human resources, information technology and accounting costs, and certain insurance, treasury, legal and risk management costs. Holding company interest expense includes the interest expense incurred on capital leases and the corporate debt structure. Intercompany charges relate primarily to interest on intercompany debt or receivables and certain administrative costs allocated by the holding company.
Industry Trends
Whole Car
Used vehicles sold in North America through whole car auctions, including online only sales, were approximately 9.2 million, 9.9 million and an estimated 10.6 million in 2014, 2015 and 2016, respectively. We expect that used vehicle auction volumes in North America, including online only volumes, will be over 10.6 million units in 2017, 2018 and 2019. Our estimates are based on information from the Bureau of Economic Analysis, IHS Automotive, Kontos Total Market Estimates, NAAA's 2015 Annual Review and management estimates. A primary driver of the anticipated improvement is more off-lease and repossessed vehicles entering the market over the next three years.
Salvage
Vehicles deemed a total loss by automobile insurance companies represent the largest category of vehicles sold in the salvage vehicle auction industry. The percentage of claims resulting in total losses was approximately 17% in 2016, 16% in 2015 and 14% in 2014. There is no central reporting system for the salvage vehicle auction industry that tracks the number of salvage vehicle auction volumes in any given year, which makes estimating industry volumes difficult.
Fluctuations in used vehicle and commodity pricing (aluminum, steel, etc.) have an impact on proceeds received in the salvage vehicle auction industry. In times of rising prices, revenue and gross profit are positively impacted. If used vehicle and commodity prices decrease, as the industry has recently experienced, proceeds, revenue and gross profit at salvage auctions may be negatively impacted, which could adversely affect the level of profitability. For example, the average price per ton of crushed auto bodies in North America decreased from $312 in December 2013 to $198 in December 2014 to $115 in December 2015, before rebounding to $136 in December 2016. This reduction in the price of crushed auto bodies has had an adverse impact on the value of salvage vehicles being sold in the salvage auction industry and resulted in reduced revenue per vehicle sold and gross profit. In the first quarter of 2017, the price per ton of crushed auto bodies in North America has ranged from $156 to $175 and finished March 2017 at $175, as compared to $112 at March 31, 2016.
Automotive Finance
AFC works with independent used vehicle dealers to improve their results by providing a comprehensive set of business and financial solutions that leverages its local branches, industry experience and scale, as well as KAR affiliations. Over the last few years AFC's North American dealer base grew from over 9,700 dealers in 2009 to approximately 15,700 dealers in 2016 and loan transactions, which includes both loans paid off and loans curtailed, grew from approximately 800,000 in 2009 to approximately 1,718,000 in 2016. As a result of this increased activity, AFC is experiencing increased competition.
Key challenges for the independent used vehicle dealer include demand for used vehicles, disruptions in pricing of used vehicle inventory and lack of access to consumer financing. These same challenges, to the extent they occur, could result in a material negative impact on AFC's results of operations. A significant decline in used vehicle sales would result in a decrease in consumer auto loan originations and an increased number of dealers defaulting on their loans. In addition, volatility in wholesale vehicle pricing impacts the value of recovered collateral on defaulted loans and the resulting severity of credit losses at AFC.

22


Seasonality
The volume of vehicles sold through our auctions generally fluctuates from quarter-to-quarter. This seasonality is caused by several factors including weather, the timing of used vehicles available for sale from selling customers, the availability and quality of salvage vehicles, holidays, and the seasonality of the retail market for used vehicles, which affects the demand side of the auction industry. Used vehicle auction volumes tend to decline during prolonged periods of winter weather conditions. In addition, mild weather conditions and decreases in traffic volume can each lead to a decline in the available supply of salvage vehicles because fewer traffic accidents occur, resulting in fewer damaged vehicles overall. As a result, revenues and operating expenses related to volume will fluctuate accordingly on a quarterly basis. The fourth calendar quarter typically experiences lower used vehicle auction volume as well as additional costs associated with the holidays and winter weather.
Sources of Revenues and Expenses
Our revenue is derived from auction fees and related services associated with our whole car and salvage auctions, and from dealer financing fees, interest income and other service revenue at AFC. Although auction revenues primarily include the auction services and related fees, our related receivables and payables include the gross value of the vehicles sold.
Our operating expenses consist of cost of services, selling, general and administrative and depreciation and amortization. Cost of services is composed of payroll and related costs, subcontract services, the cost of vehicles purchased, supplies, insurance, property taxes, utilities, service contract claims, maintenance and lease expense related to the auction sites and loan offices. Cost of services excludes depreciation and amortization. Selling, general and administrative expenses are composed of payroll and related costs, sales and marketing, information technology services and professional fees.

23


Results of Operations
Overview of Results of KAR Auction Services, Inc. for the Three Months Ended March 31, 2017 and 2016:
 
Three Months Ended 
 March 31,
(Dollars in millions except per share amounts)
2017
 
2016
Revenues
 
 
 
ADESA
$
498.0

 
$
414.8

IAA
297.4

 
269.6

AFC
71.2

 
73.9

Total revenues
866.6

 
758.3

Cost of services*
501.2

 
432.0

Gross profit*
365.4

 
326.3

Selling, general and administrative
157.4

 
141.1

Depreciation and amortization
64.5

 
56.4

Operating profit
143.5

 
128.8

Interest expense
40.3

 
28.7

Other income, net
(0.1
)
 
(1.3
)
Loss on extinguishment of debt

 
4.0

Income before income taxes
103.3

 
97.4

Income taxes
34.1

 
36.7

Net income
$
69.2

 
$
60.7

Net income per share
 
 
 
Basic
$
0.51

 
$
0.44

Diluted
$
0.50

 
$
0.44


* Exclusive of depreciation and amortization
Overview
For the three months ended March 31, 2017, we had revenue of $866.6 million compared with revenue of $758.3 million for the three months ended March 31, 2016, an increase of 14%. Businesses acquired in the last 12 months accounted for an increase in revenue of $48.4 million. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below.
Depreciation and Amortization
Depreciation and amortization increased $8.1 million, or 14%, to $64.5 million for the three months ended March 31, 2017, compared with $56.4 million for the three months ended March 31, 2016. The increase in depreciation and amortization was primarily the result of certain assets placed in service over the last twelve months and depreciation and amortization for the assets of businesses acquired in 2016.
Interest Expense
Interest expense increased $11.6 million, or 40%, to $40.3 million for the three months ended March 31, 2017, compared with $28.7 million for the three months ended March 31, 2016. The increase was primarily attributable to the interest associated with Term Loan B-3, the increase in interest rate on Term Loan B-2, as well as the interest associated with outstanding revolver borrowings. In addition, there was an increase in interest expense at AFC of $2.5 million, which resulted from an increase in the average portfolio financed in the three months ended March 31, 2017 as compared with the three months ended March 31, 2016.
Loss on Extinguishment of Debt
In March 2016, we amended our Credit Agreement and recorded a $4.0 million pretax charge resulting from the write-off of unamortized debt issue costs associated with Term Loan B-1 and unamortized debt issue costs associated with the old revolving credit facility.

24



Income Taxes
We had an effective tax rate of 33.0% for the three months ended March 31, 2017, compared with an effective tax rate of 37.7% for the three months ended March 31, 2016. Our effective tax rate was lower in the first quarter of 2017 primarily as a result of the adoption of ASU 2016-09 in the first quarter of 2017. We recognized $4.1 million of excess tax benefits from employee stock-based compensation as a discrete item in our income tax expense for the three months ended March 31, 2017. These amounts were previously recorded to additional paid-in capital.
Impact of Foreign Currency
The weakening of the U.S. dollar has impacted the reporting of our Canadian operations in U.S. dollars. For the three months ended March 31, 2017, fluctuations in the Canadian exchange rate increased revenue by $2.9 million, operating profit by $1.0 million, net income by $0.6 million and net income per diluted share by less than $0.01.
ADESA Results
 
Three Months Ended 
 March 31,
(Dollars in millions except per vehicle amounts)
2017
 
2016
ADESA revenue
$
498.0

 
$
414.8

Cost of services*
290.9

 
238.4

Gross profit*
207.1

 
176.4

Selling, general and administrative
87.3

 
76.6

Depreciation and amortization
27.1

 
22.5

Operating profit
$
92.7

 
$
77.3

Vehicles sold
818,000

 
703,000

   Physical auction vehicles sold
603,000

 
515,000

   Online only vehicles sold
215,000

 
188,000

   Dealer consignment mix at physical auctions
44
%
 
47
%
   Conversion rate at North American physical auctions
61.8
%
 
61.0
%
Physical auction revenue per vehicle sold, excluding purchased vehicles
$
755

 
$
737

Online only revenue per vehicle sold, excluding ADESA Assurance Program vehicles
$
111

 
$
110


* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA increased $83.2 million, or 20%, to $498.0 million for the three months ended March 31, 2017, compared with $414.8 million for the three months ended March 31, 2016. The increase in revenue was primarily a result of a 16% increase in the number of vehicles sold (4% increase excluding acquisitions), as well as a 3% increase in revenue per vehicle sold. Businesses acquired in the last 12 months accounted for an increase in revenue of $48.4 million. Revenue increased $2.1 million due to fluctuations in the Canadian exchange rate.
The increase in volume sold was primarily attributable to a 20% increase in institutional volume (9% increase excluding acquisitions), including vehicles sold on our online only platform, as well as a 10% increase in dealer consignment units sold (7% decrease excluding acquisitions) for the three months ended March 31, 2017 compared with the three months ended March 31, 2016. Online sales volume for ADESA represented approximately 42% of the total vehicles sold in the first quarter of 2017, compared with approximately 43% in the first quarter of 2016. "Online sales" includes the following: (i) selling vehicles directly from a dealership or other interim storage location (upstream selling); (ii) online solutions that offer vehicles for sale while in transit to auction locations (midstream selling); (iii) simultaneously broadcasting video and audio of the physical auctions to online bidders (LiveBlock®); and (iv) bulletin-board or real-time online auctions (DealerBlock®). Upstream and midstream selling represent online only sales, which accounted for approximately 64% of ADESA's online sales volume. ADESA sold approximately 215,000 and 188,000 vehicles through its online only offerings in the first quarter of 2017 and 2016, respectively, of which approximately 107,000 and 92,000 represented vehicle sales to grounding dealers in the first quarter of 2017 and 2016, respectively. For the three months ended March 31, 2017, dealer consignment vehicles represented

25


approximately 44% of used vehicles sold at ADESA physical auction locations, compared with approximately 47% for the three months ended March 31, 2016. Vehicles sold at physical auction locations increased 17% (no increase excluding acquisitions) in the first quarter of 2017, compared with the first quarter of 2016. The used vehicle conversion percentage at North American physical auction locations, calculated as the number of vehicles sold as a percentage of the number of vehicles entered for sale at our ADESA auctions, increased to 61.8% for the three months ended March 31, 2017, compared with 61.0% for the three months ended March 31, 2016.
Physical auction revenue per vehicle sold increased $18, or 2%, to $755 for the three months ended March 31, 2017, compared with $737 for the three months ended March 31, 2016. Physical auction revenue per vehicle sold includes revenue from seller and buyer auction fees and ancillary and other related services, which includes non-auction services and excludes the sale of purchased vehicles. The increase in physical auction revenue per vehicle sold was primarily attributable to an increase in lower margin ancillary and other related services revenue, including revenue from certain businesses acquired and an increase in physical auction revenue per vehicle sold of $3 due to fluctuations in the Canadian exchange rate.
Excluding vehicles purchased as part of the ADESA Assurance Program, online only revenue per vehicle sold increased to $111 from $110 for the three months ended March 31, 2017 and 2016, respectively.
Gross Profit
For the three months ended March 31, 2017, gross profit for ADESA increased $30.7 million, or 17%, to $207.1 million, compared with $176.4 million for the three months ended March 31, 2016. Gross profit for ADESA was 41.6% of revenue for the three months ended March 31, 2017, compared with 42.5% of revenue for the three months ended March 31, 2016. The increase in gross profit was mainly attributable to the 16% increase in the number of vehicles sold.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment increased $10.7 million, or 14%, to $87.3 million for the three months ended March 31, 2017, compared with $76.6 million for the three months ended March 31, 2016, primarily due to increases in selling, general and administrative expenses associated with acquired businesses of $8.8 million, compensation expense of $3.3 million and other expenses aggregating $1.6 million, partially offset by a decrease in incentive-based compensation expense of $3.0 million.
IAA Results
 
Three Months Ended 
 March 31,
(Dollars in millions)
2017
 
2016
IAA revenue
$
297.4

 
$
269.6

Cost of services*
189.1

 
173.5

Gross profit*
108.3

 
96.1

Selling, general and administrative
25.9

 
25.7

Depreciation and amortization
23.2

 
21.3

Operating profit
$
59.2

 
$
49.1

Vehicles sold
592,000

 
534,000


* Exclusive of depreciation and amortization
Revenue
Revenue from IAA increased $27.8 million, or 10%, to $297.4 million for the three months ended March 31, 2017, compared with $269.6 million for the three months ended March 31, 2016, and included a decrease in revenue of $1.1 million from HBC. The increase in revenue was a result of an increase in vehicles sold of approximately 11% (11% excluding HBC) for the three months ended March 31, 2017 and an increase in revenue of $0.7 million due to fluctuations in the Canadian exchange rate, partially offset by a decrease in revenue of $2.0 million due to fluctuations in the U.K. exchange rate. Revenue per vehicle sold was consistent year over year. IAA's North American same-store total loss vehicle inventory increased approximately 17% at March 31, 2017, as compared to March 31, 2016. Vehicles sold under purchase agreements were approximately 5% (4% excluding HBC) and 7% (5% excluding HBC) of total salvage vehicles sold for the three months ended March 31, 2017 and 2016, respectively. Online sales volumes for IAA for the three months ended March 31, 2017 and 2016 represented approximately 60% of the total vehicles sold by IAA.

26


Gross Profit
For the three months ended March 31, 2017, gross profit at IAA increased to $108.3 million, or 36.4% of revenue, compared with $96.1 million, or 35.6% of revenue, for the three months ended March 31, 2016. The increase in gross profit was mainly attributable to a 10% increase in revenue, partially offset by a 9% increase in cost of services, which included costs associated with purchase contract vehicles and volume growth. Excluding HBC, IAA's gross profit margin was 37.4% and 37.1% for the three months ended March 31, 2017 and 2016, respectively. For the three months ended March 31, 2017 and 2016, HBC had revenue of approximately $12.8 million and $13.9 million, respectively, and cost of services of approximately $10.9 million and $12.6 million, respectively, as the majority of HBC's vehicles are sold under purchase contracts.
Selling, General and Administrative
Selling, general and administrative expenses at IAA increased $0.2 million, or 1%, to $25.9 million for the three months ended March 31, 2017, compared with $25.7 million for the three months ended March 31, 2016. The increase in selling, general and administrative expenses was primarily attributable to an increase in compensation expense of $0.8 million, partially offset by decreases in bad debt expense of $0.4 million and other expenses aggregating $0.2 million.
AFC Results
 
Three Months Ended 
 March 31,
(Dollars in millions except volumes and per loan amounts)
2017
 
2016
AFC revenue
 
 
 
Interest and fee income
$
71.3

 
$
69.4

Other revenue
2.9

 
2.4

Provision for credit losses
(11.1
)
 
(5.5
)
Other service revenue
8.1

 
7.6

Total AFC revenue
71.2

 
73.9

Cost of services*
21.2

 
20.1

Gross profit*
50.0

 
53.8

Selling, general and administrative
7.9

 
7.5

Depreciation and amortization
7.8

 
7.7

Operating profit
$
34.3

 
$
38.6

Loan transactions
456,000

 
454,000

Revenue per loan transaction, excluding "Other service revenue"
$
138

 
$
146


* Exclusive of depreciation and amortization
Revenue
For the three months ended March 31, 2017, AFC revenue decreased $2.7 million, or 4%, to $71.2 million, compared with $73.9 million for the three months ended March 31, 2016. The decrease in revenue was the result of an increase in the provision for credit losses to 2.5% of the average managed receivables for the three months ended March 31, 2017, partially offset by a 7% increase in "Other service revenue" generated by PWI. In addition, managed receivables increased to $1,760.7 million at March 31, 2017 from $1,705.5 million at March 31, 2016.
Revenue per loan transaction, which includes both loans paid off and loans curtailed, decreased $8, or 5%. The provision for credit losses, which is a reduction of revenue, resulted in a reduction of revenue per unit of $12 for the three months ended March 31, 2017. The remaining $4 increase in revenue per loan transaction was the result of increases in average portfolio duration and average loan values. Revenue per loan transaction excludes "Other service revenue."
The provision for credit losses has increased to 2.5% from 1.3% of the average managed receivables for the three months ended March 31, 2017 compared with the three months ended March 31, 2016. In the current credit environment, the provision for credit losses is expected to be approximately 1.75% to 2.25%, annually, of the average managed receivables balance. For 2017, the provision for credit losses is expected to be above the previously stated range in the first half of the year, with improvement in the second half of the year.

27


Gross Profit
For the three months ended March 31, 2017, gross profit for the AFC segment decreased $3.8 million, or 7%, to $50.0 million, or 70.2% of revenue, compared with $53.8 million, or 72.8% of revenue, for the three months ended March 31, 2016, primarily as a result of a 4% decrease in revenue and a 5% increase in cost of services. The increase in cost of services was the result of increases in lot checks of $0.5 million, compensation expenses of $0.3 million and collection costs of $0.3 million. The floorplan lending business gross profit margin percentage decreased from 79.5% to 76.6%. The floorplan lending business excludes PWI.
Selling, General and Administrative
Selling, general and administrative expenses at AFC increased $0.4 million, or 5%, to $7.9 million for the three months ended March 31, 2017, compared with $7.5 million for the three months ended March 31, 2016. The increase was primarily attributable to a $0.3 million increase in travel expenses and other expenses aggregating $0.1 million.
Holding Company Results
 
Three Months Ended 
 March 31,
(Dollars in millions)
2017
 
2016
Selling, general and administrative
$
36.3

 
$
31.3

Depreciation and amortization
6.4

 
4.9

Operating loss
$
(42.7
)
 
$
(36.2
)
Selling, General and Administrative
For the three months ended March 31, 2017, selling, general and administrative expenses at the holding company increased $5.0 million, or 16%, to $36.3 million, compared with $31.3 million for the three months ended March 31, 2016, primarily as a result of increases in compensation expense of $4.2 million, professional fees of $1.4 million, information technology costs of $1.0 million and other expenses aggregating $0.7 million, partially offset by a decrease in medical expenses of $2.3 million. The Company has increased Holding Company expenses to support the growing businesses of KAR. The increase in expenses relate to costs associated with talent management, technology and support of strategic initiatives.
LIQUIDITY AND CAPITAL RESOURCES
We believe that the significant indicators of liquidity for our business are cash on hand, cash flow from operations, working capital and amounts available under our Credit Facility. Our principal sources of liquidity consist of cash generated by operations and borrowings under our revolving credit facility.
(Dollars in millions)
March 31, 2017
 
December 31, 2016
 
March 31, 2016
Cash and cash equivalents
$
188.0

 
$
201.8

 
$
676.3

Restricted cash
18.4

 
17.9

 
14.9

Working capital
554.0

 
506.2

 
950.0

Amounts available under Credit Facility*
286.7

 
219.5

 
300.0

Cash flow from operations for the three months ended
142.0

 
 
 
70.1

*
There were related outstanding letters of credit totaling approximately $35.9 million, $29.7 million, and $28.0 million at March 31, 2017, December 31, 2016, and March 31, 2016, respectively, which reduced the amount available for borrowings under the revolving credit facility.
We regularly evaluate alternatives for our capital structure and liquidity given our expected cash flows, growth and operating capital requirements as well as capital market conditions.

28


Working Capital
A substantial amount of our working capital is generated from the payments received for services provided. The majority of our working capital needs are short-term in nature, usually less than a week in duration. Due to the decentralized nature of the business, payments for most vehicles purchased are received at each auction and branch. Most of the financial institutions place a temporary hold on the availability of the funds deposited that generally can range up to two business days, resulting in cash in our accounts and on our balance sheet that is unavailable for use until it is made available by the various financial institutions. There are outstanding checks (book overdrafts) to sellers and vendors included in current liabilities. Because a portion of these outstanding checks for operations in the U.S. are drawn upon bank accounts at financial institutions other than the financial institutions that hold the cash, we cannot offset all the cash and the outstanding checks on our balance sheet. Changes in working capital vary from quarter-to-quarter as a result of the timing of collections and disbursements of funds to consignors from auctions held near period end.
Approximately $77.9 million of available cash was held by our foreign subsidiaries. If the portion of funds held by our foreign subsidiaries that are considered to be permanently reinvested were to be repatriated, tax expense would need to be accrued at the U.S. statutory rate, net of any applicable foreign tax credits. Such foreign tax credits would substantially offset any U.S. taxes that would be due in the event cash held by our foreign subsidiaries was repatriated.
AFC offers short-term inventory-secured financing, also known as floorplan financing, to independent used vehicle dealers. Financing is primarily provided for terms of 30 to 90 days. AFC principally generates its funding through the sale of its receivables. The receivables sold pursuant to the securitization agreements are accounted for as secured borrowings. For further discussion of AFC's securitization arrangements, see "Securitization Facilities."
Credit Facilities
On March 9, 2016, we entered into an Incremental Commitment Agreement and First Amendment (the "First
Amendment") to the Credit Agreement. The First Amendment provided for, among other things, (i) a new seven-year senior
secured term loan facility ("Term Loan B-3") and (ii) a $300 million, five-year senior secured revolving credit facility (the
"revolving credit facility"), which replaced the previously existing revolving credit facility.

The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate
purposes. The Credit Agreement provides that with respect to the revolving credit facility, up to $75 million is available for
letters of credit and up to $75 million is available for swing line loans.

Term Loan B-2 was issued at a discount of $2.8 million and Term Loan B-3 was issued at a discount of $13.5 million.
The discounts are being amortized using the effective interest method to interest expense over the respective terms of the loans.
Both Term Loan B-2 and Term Loan B-3 are payable in quarterly installments equal to 0.25% of the original aggregate
principal amounts of the term loans, respectively. Such payments commenced on June 30, 2014 for Term Loan B-2 and on June
30, 2016 for Term Loan B-3, with the balances payable at each respective maturity date. The Credit Facility is subject to
mandatory prepayments and reduction in an amount equal to the net proceeds of certain debt offerings, certain asset sales and
certain insurance recovery events.

As set forth in the Credit Agreement, Term Loan B-2 bears interest at Adjusted LIBOR (as defined in the Credit
Agreement) plus 3.1875% (with an Adjusted LIBOR floor of 0.75% per annum), Term Loan B-3 at Adjusted LIBOR (as
defined in the Credit Agreement) plus 3.50% (with an Adjusted LIBOR floor of 0.75% per annum) and revolving loan
borrowings at Adjusted LIBOR plus 2.50%. However, for specified types of borrowings, the Company may elect to make Term
Loan B-2 borrowings at a Base Rate (as defined in the Credit Agreement) plus 2.1875%, Term Loan B-3 at a Base Rate plus
2.50% and revolving loan borrowings at a Base Rate plus 1.50%. The rates on Term Loan B-2 and Term Loan B-3 were 4.19% and 4.50% at March 31, 2017, respectively. In addition, if the Company reduces its Consolidated Senior Secured Leverage Ratio, which is based on a net debt calculation, to levels specified in the Credit Agreement, the applicable interest rate on the revolving credit facility will step down by 25 basis points. The Company also pays a commitment fee of 40 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility. The fee may step down to 35 basis points based on the Company's Consolidated Senior Secured Leverage Ratio as described above.
On March 31, 2017, $1,080.0 million was outstanding on Term Loan B-2, $1,336.5 million was outstanding on Term Loan B-3 and $13.3 million was drawn on the revolving credit facility. In addition, there were related outstanding letters of credit in the aggregate amount of $35.9 million at March 31, 2017, which reduce the amount available for borrowings under the Credit Facility. The Company intends to repay the $13.3 million of outstanding borrowings under the revolving credit facility within the next twelve months. Our Canadian operations also have a C$8 million line of credit which was undrawn as of March 31, 2017. However, there were related letters of credit outstanding totaling approximately C$0.9 million at March 31, 2017, which reduce the amount available for borrowings under the Canadian line of credit.

29


The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in 100% of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and 65% of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions.
The Credit Agreement contains certain restrictive loan covenants, including, among others, a financial covenant requiring that a maximum consolidated senior secured leverage ratio be satisfied as of the last day of each fiscal quarter if revolving loans are outstanding, and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, consummate change of control transactions, dispose of assets, pay dividends, make investments and engage in certain transactions with affiliates. The senior secured leverage ratio is calculated as total senior secured debt divided by the last four quarters consolidated Adjusted EBITDA. Senior secured debt includes term loan borrowings, revolving loans and capital lease liabilities less available cash as defined in the Credit Agreement. Consolidated Adjusted EBITDA is EBITDA (earnings before interest expense, income taxes, depreciation and amortization) adjusted to exclude among other things (a) gains and losses from asset sales; (b) unrealized foreign currency translation gains and losses in respect of indebtedness; (c) certain non-recurring gains and losses; (d) stock-based compensation expense; (e) certain other non-cash amounts included in the determination of net income; (f) charges and revenue reductions resulting from purchase accounting; (g) minority interest; (h) expenses associated with the consolidation of salvage operations; (i) consulting expenses incurred for cost reduction, operating restructuring and business improvement efforts; (j) expenses realized upon the termination of employees and the termination or cancellation of leases, software licenses or other contracts in connection with the operational restructuring and business improvement efforts; (k) expenses incurred in connection with permitted acquisitions; (l) any impairment charges or write-offs of intangibles; and (m) any extraordinary, unusual or non-recurring charges, expenses or losses.
Certain covenants contained within the Credit Agreement are critical to an investor's understanding of our financial liquidity, as the failure to maintain compliance with these covenants could result in a default and allow our lenders to declare all amounts borrowed immediately due and payable. The maximum consolidated senior secured leverage ratio is required to be met when there are revolving loans outstanding under our Credit Agreement. For the quarter ended March 31, 2017 the ratio could not exceed 3.75 to 1.0 and it steps down to 3.5 to 1.0 at September 30, 2017. Our actual consolidated senior secured leverage ratio, including capital lease obligations of $44.3 million, was 3.08 to 1.0 at March 31, 2017, excluding pro forma Adjusted EBITDA for businesses acquired in the last twelve months.
In addition, the Credit Agreement contains certain financial and operational restrictions that limit our ability to pay dividends and other distributions, make certain acquisitions or investments, incur indebtedness, grant liens and sell assets. The covenants in the Credit Agreement affect our operating flexibility by, among other things, restricting our ability to incur expenses and indebtedness that could be used to grow the business, as well as to fund general corporate purposes. We were in compliance with the covenants in the Credit Agreement at March 31, 2017.
We believe our sources of liquidity from our cash and cash equivalents on hand, working capital, cash provided by operating activities, and availability under our credit facility are sufficient to meet our short and long-term operating needs for the foreseeable future. In addition, we believe the previously mentioned sources of liquidity will be sufficient to fund our capital requirements, debt service payments, announced acquisitions and dividends for the next twelve months.
Securitization Facilities
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to AFC Funding Corporation. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires on January 31, 2020. AFC Funding Corporation had committed liquidity of $1.50 billion for U.S. finance receivables at March 31, 2017.

We also have an agreement for the securitization of AFCI's receivables. AFCI's committed facility is provided through a third party conduit (separate from the U.S. facility) and was C$125 million at March 31, 2017. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.
AFC managed total finance receivables of $1,760.7 million and $1,792.2 million at March 31, 2017 and December 31, 2016, respectively. AFC's allowance for losses was $12.3 million and $12.0 million at March 31, 2017 and December 31, 2016, respectively.

30


As of March 31, 2017 and December 31, 2016, $1,738.2 million and $1,774.8 million, respectively, of finance receivables and a cash reserve of 1 percent of the obligations collateralized by finance receivables served as security for the $1,241.8 million and $1,280.3 million of obligations collateralized by finance receivables at March 31, 2017 and December 31, 2016, respectively. There were unamortized securitization issuance costs of approximately $18.1 million and $19.7 million at March 31, 2017 and December 31, 2016, respectively. After the occurrence of a termination event, as defined in the U.S. securitization agreement, the banks may, and could, cause the stock of AFC Funding Corporation to be transferred to the bank facility, though as a practical matter the bank facility would look to the liquidation of the receivables under the transaction documents as their primary remedy.
Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At March 31, 2017, we were in compliance with the covenants in the securitization agreements.
EBITDA and Adjusted EBITDA
EBITDA and Adjusted EBITDA, as presented herein, are supplemental measures of our performance that are not required by, or presented in accordance with, generally accepted accounting principles in the United States, or GAAP. They are not measurements of our financial performance under GAAP and should not be considered substitutes for net income (loss) or any other performance measures derived in accordance with GAAP.
EBITDA is defined as net income (loss), plus interest expense net of interest income, income tax provision (benefit), depreciation and amortization. Adjusted EBITDA is EBITDA adjusted for the items of income and expense and expected incremental revenue and cost savings, as described above in the discussion of certain restrictive loan covenants under "Credit Facilities."
Management believes that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about one of the principal measures of performance used by our creditors. In addition, management uses EBITDA and Adjusted EBITDA to evaluate our performance. EBITDA and Adjusted EBITDA have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of the results as reported under GAAP. These measures may not be comparable to similarly titled measures reported by other companies.
The following tables reconcile EBITDA and Adjusted EBITDA to net income (loss) for the periods presented:
 
Three Months Ended March 31, 2017
(Dollars in millions)
ADESA
 
IAA
 
AFC
 
Corporate
 
Consolidated
Net income (loss)
$
51.3

 
$
32.2

 
$
20.9

 
$
(35.2
)
 
$
69.2

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
29.0

 
18.0

 
11.8

 
(24.7
)
 
34.1

Interest expense, net of interest income
0.1

 

 
10.3

 
29.8

 
40.2

Depreciation and amortization
27.1

 
23.2

 
7.8

 
6.4

 
64.5

Intercompany interest
9.2

 
9.4

 
(8.7
)
 
(9.9
)
 

EBITDA
116.7

 
82.8

 
42.1

 
(33.6
)
 
208.0

Intercompany charges
2.6

 

 

 
(2.6
)
 

Non-cash stock-based compensation
1.5

 
0.9

 
0.5

 
3.1

 
6.0

Acquisition related costs
1.7

 

 

 
0.4

 
2.1

Securitization interest

 

 
(8.1
)
 

 
(8.1
)
Minority interest
1.7

 

 

 

 
1.7

Other
0.8

 
0.1

 

 

 
0.9

  Total addbacks
8.3

 
1.0

 
(7.6
)
 
0.9

 
2.6

Adjusted EBITDA
$
125.0

 
$
83.8

 
$
34.5

 
$
(32.7
)
 
$
210.6

 

31


 
Three Months Ended March 31, 2016
(Dollars in millions)
ADESA
 
IAA
 
AFC
 
Corporate
 
Consolidated
Net income (loss)
$
39.3

 
$
24.9

 
$
24.0

 
$
(27.5
)
 
$
60.7

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
23.3

 
14.9

 
14.6

 
(16.1
)
 
36.7

Interest expense, net of interest income
0.1

 

 
7.8

 
20.8

 
28.7

Depreciation and amortization
22.5

 
21.3

 
7.7

 
4.9

 
56.4

Intercompany interest
11.9

 
9.4

 
(7.8
)
 
(13.5
)
 

EBITDA
97.1

 
70.5

 
46.3

 
(31.4
)
 
182.5

Intercompany charges
3.3

 
0.2

 

 
(3.5
)
 

Non-cash stock-based compensation
1.2

 
0.6

 
0.4

 
3.3

 
5.5

Loss on extinguishment of debt

 

 

 
4.0

 
4.0

Acquisition related costs
1.1

 

 

 
1.5

 
2.6

Securitization interest

 

 
(6.4
)
 

 
(6.4
)
Minority interest
0.6

 

 

 

 
0.6

Other
0.9

 
(0.2
)
 

 

 
0.7

  Total addbacks
7.1

 
0.6

 
(6.0
)
 
5.3

 
7.0

Adjusted EBITDA
$
104.2

 
$
71.1

 
$
40.3

 
$
(26.1
)
 
$
189.5


Certain of our loan covenant calculations utilize financial results for the most recent four consecutive fiscal quarters. The following table reconciles EBITDA and Adjusted EBITDA to net income (loss) for the periods presented:
 
Three Months Ended
 
Twelve
Months
Ended
(Dollars in millions)
June 30,
2016
 
September 30,
2016
 
December 31,
2016
 
March 31,
2017
 
March 31, 2017
Net income (loss)
$
61.8

 
$
54.4

 
$
45.5

 
$
69.2

 
$
230.9

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
37.7

 
31.8

 
26.7

 
34.1

 
130.3

Interest expense, net of interest income
35.7

 
36.1

 
37.9

 
40.2

 
149.9

Depreciation and amortization
59.0

 
60.5

 
64.7

 
64.5

 
248.7

EBITDA
194.2

 
182.8

 
174.8

 
208.0

 
759.8

Non-cash stock-based compensation
4.9

 
4.7

 
4.0

 
6.0

 
19.6

Loss on extinguishment of debt

 

 
1.4

 

 
1.4

Acquisition related costs
3.3

 
1.3

 
1.4

 
2.1

 
8.1

Securitization interest
(6.7
)
 
(7.2
)
 
(7.7
)
 
(8.1
)
 
(29.7
)
Minority interest
1.0

 
1.1

 
1.1

 
1.7

 
4.9

(Gain)/Loss on asset sales
0.4

 
1.3

 
0.3

 
0.5

 
2.5

Other

 
0.8

 
1.2

 
0.4

 
2.4

  Total addbacks
2.9

 
2.0

 
1.7

 
2.6

 
9.2

Adjusted EBITDA
$
197.1

 
$
184.8

 
$
176.5

 
$
210.6

 
$
769.0



32


Summary of Cash Flows
 
Three Months Ended 
 March 31,
(Dollars in millions)
2017
 
2016
Net cash provided by (used by):
 
 
 
Operating activities
$
142.0

 
$
70.1

Investing activities
(21.2
)
 
(100.3
)
Financing activities
(136.4
)
 
546.0

Effect of exchange rate on cash
1.8

 
5.5

Net (decrease) increase in cash and cash equivalents
$
(13.8
)
 
$
521.3

Cash flow from operating activities was $142.0 million for the three months ended March 31, 2017, compared with $70.1 million for the three months ended March 31, 2016. The increase in operating cash flow was primarily attributable to changes in operating assets and liabilities as a result of the timing of collections and the disbursement of funds to consignors for auctions held near period-ends.
Net cash used by investing activities was $21.2 million for the three months ended March 31, 2017, compared with $100.3 million for the three months ended March 31, 2016. The decrease in net cash used by investing activities was primarily attributable to a decrease in the additional finance receivables held for investment of approximately $87.0 million.
Net cash used by financing activities was $136.4 million for the three months ended March 31, 2017, compared with net cash provided by financing activities of $546.0 million for the three months ended March 31, 2016. The decrease in net cash from financing activities was primarily attributable to:
first quarter 2017 repayments of $67.2 million and $6.1 million on our line of credit and term loans, respectively, compared to the debt refinancing and payment activities in the first quarter of 2016, for which the Company received approximately $558.9 million of cash after the repayment and rollover of debt;
a decrease in the additional obligations collateralized by finance receivables of approximately $49.1 million; and
an increase in dividend payments of $6.5 million.
Capital Expenditures
Capital expenditures for the three months ended March 31, 2017 and 2016 approximated $37.2 million and $36.0 million, respectively. Capital expenditures were funded primarily from internally generated funds. We continue to invest in our core information technology capabilities and capacity expansion. Capital expenditures are expected to be approximately $145 million for fiscal year 2017. Anticipated capital expenditures are primarily attributable to ongoing information system projects, improvements and expansion at vehicle auction facilities and improvements in information technology systems and infrastructure. Future capital expenditures could vary substantially based on capital project timing, the opening of new auction facilities, capital expenditures related to acquired businesses and the initiation of new information systems projects to support our business strategies.
Dividends
Subject to board of director approval, we expect to pay a quarterly dividend of $0.32 per share in 2017 using cash flow from operations, representing an annualized dividend of $1.28 per share. The following dividend information has been released for 2017:
On May 9, 2017, the Company announced a cash dividend of $0.32 per share that is payable on July 6, 2017, to stockholders of record at the close of business on June 21, 2017.
On February 21, 2017, the Company announced a cash dividend of $0.32 per share that was paid on April 4, 2017, to stockholders of record at the close of business on March 22, 2017.
On November 3, 2016, the Company announced a cash dividend of $0.32 per share that was paid on January 6, 2017, to stockholders of record at the close of business on December 21, 2016.

33


Future dividend decisions will be based on and affected by a variety of factors, including our financial condition and results of operations, contractual restrictions, including restrictive covenants contained in our Credit Agreement and AFC's securitization facilities, capital requirements and other factors that our board of directors deems relevant. No assurance can be given as to whether any future dividends may be declared by our board of directors or the amount thereof.
Acquisition
In April 2017, KAR purchased all of the stock of CarCo Technologies, Inc. (“DRIVIN”) for $43 million in cash. DRIVIN aggregates automotive retail, pricing, registration and other market and economic data from a variety of public and proprietary sources. The insights generated from that data are deployed through predictive pricing, inventory management and vehicle matching tools that help customers buy, sell and source vehicles. The purchase accounting related to this acquisition is incomplete. Financial results for DRIVIN will be included in our consolidated financial statements beginning in the second quarter of 2017.
Contractual Obligations
The Company's contractual cash obligations for long-term debt, interest payments related to long-term debt, capital lease obligations and operating leases are summarized in the table of contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2016. Since December 31, 2016, there have been no material changes to the contractual obligations of the Company, with the exception of the following:
Operating lease obligations change in the ordinary course of business. We lease most of our auction facilities, as well as other property and equipment under operating leases. Future operating lease obligations will continue to change if renewal options are exercised and/or if we enter into additional operating lease agreements.
See Note 6 to the Consolidated Financial Statements, included elsewhere in this Quarterly Report on Form 10-Q, for additional information about the items described above. Our contractual cash obligations as of December 31, 2016, are discussed in the "Contractual Obligations" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission (the "SEC").
Critical Accounting Estimates
Our critical accounting estimates are discussed in the "Critical Accounting Estimates" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC. A summary of significant accounting policies is discussed in Note 2 and elsewhere in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016, which includes audited financial statements.
Off-Balance Sheet Arrangements
As of March 31, 2017, we had no off-balance sheet arrangements pursuant to Item 303(a)(4) of Regulation S-K under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
New Accounting Standards
In January 2017, the Financial Accounting Standards Board ("FASB") issued "Accounting Standards Update" ("ASU") 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the test for goodwill impairment by eliminating Step 2 (implied fair value measurement). Instead goodwill impairment would be measured as the amount by which a reporting unit's carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2017-04 will have a material impact on the consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which addresses diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2016-18 will have a material impact on the consolidated financial statements.


34


In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance on the statement of cash flows presentation of certain transactions where diversity in practice exists. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-15 will have on the consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted beginning in annual periods beginning after December 15, 2018, including interim periods within those fiscal years. We do not expect the adoption of ASU 2016-13 will have a material impact on the consolidated financial statements based on the short-term nature of AFC's loans.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which replaces existing lease guidance. The ASU is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet, with an exception for leases that meet the definition of a short-term lease. The new guidance will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted and the ASU is required to be applied with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on the consolidated financial statements and anticipates that the new guidance will significantly impact its consolidated financial statements, as the Company has a significant number of leases. Our current minimum commitments under non-cancelable operating leases are disclosed in the "Contractual Obligations" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our annual report on Form 10-K for the year ended December 31, 2016 and in Note 13 to the Consolidated Financial Statements of the same report. In addition, the recognition of these leases on our consolidated balance sheet would increase our net debt calculation which is included in the determination of our Consolidated Senior Secured Leverage Ratio. In this event, our Credit Agreement specifies that the covenant shall continue to be calculated as if the accounting standard had not occurred and that we could enter into negotiations to amend such provisions in the Credit Agreement so as to equitably reflect such changes with the desired result that the criteria for evaluating our financial condition would be the same after the change as if such change had not been made. We plan to amend the applicable provision in our Credit Agreement upon the adoption of ASU 2016-02.
    
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which superseded the revenue recognition requirements in Accounting Standards Codification 605, Revenue Recognition. The new guidance provides clarification on the recognition of revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosures to help financial statement users better understand the nature, amount, timing and uncertainty of revenue that is recognized. In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 by one year. In accordance with the agreed upon delay, the new guidance is effective for the first annual reporting period and interim periods beginning after December 15, 2017, and will require either retrospective application to each prior reporting period presented or retrospective application with the cumulative effect of initially applying the standard recognized at the date of adoption. The Company expects to use retrospective application with the cumulative effect as its transition method. The Company is currently evaluating the impact the adoption of ASU 2014-09 will have on the consolidated financial statements and related disclosures. However, we have identified services such as towing, vehicle inspection reports and other pre-sale services which could result in the acceleration of revenue recognition.


35


Item 3.    Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency
Our foreign currency exposure is limited and arises from transactions denominated in foreign currencies, particularly intercompany loans, as well as from translation of the results of operations from our Canadian and, to a much lesser extent, United Kingdom and Mexican subsidiaries. However, fluctuations between U.S. and non-U.S. currency values may adversely affect our results of operations and financial position. We have not entered into any foreign exchange contracts to hedge changes in the Canadian dollar, British pound or Mexican peso. Canadian currency translation positively affected net income by approximately $0.6 million for the three months ended March 31, 2017. A 1% change in the average Canadian exchange rate for the three months ended March 31, 2017 would have impacted net income by approximately $0.2 million. Currency exposure of our U.K. and Mexican operations is not material to the results of operations.
Interest Rates
We are exposed to interest rate risk on our variable rate borrowings. Accordingly, interest rate fluctuations affect the amount of interest expense we are obligated to pay. We currently use interest rate cap agreements to manage our exposure to interest rate changes. We have not designated any of the interest rate caps as hedges for accounting purposes. Accordingly, changes in the fair value of the interest rate caps are recognized as "Interest expense" in the consolidated statement of income.
In March 2017, we entered into two interest rate caps with an aggregate notional amount of $400 million to manage our exposure to interest rate movements on our variable rate Credit Facility when three-month LIBOR exceeds 2.0%. The interest rate cap agreements each had an effective date of March 31, 2017 and each mature on March 31, 2019. We paid an aggregate amount of approximately $0.7 million for the caps in April 2017.
In August 2015, we purchased three interest rate caps for an aggregate amount of approximately $1.5 million with an aggregate notional amount of $800 million to manage our exposure to interest rate movements on our variable rate Credit Facility if/when three-month LIBOR (i) exceeded 2.0% between August 19, 2015 (the effective date) and September 29, 2016 and (ii) exceeds 1.75% between September 30, 2016 and August 19, 2017 (the maturity date).
In April 2015, we purchased two interest rate caps for approximately $0.7 million with an aggregate notional amount of $400 million to manage our exposure to interest rate movements on our variable rate Credit Facility when three-month LIBOR exceeded 1.5%. The interest rate cap agreements cap three-month LIBOR at 1.5%, had an effective date of April 16, 2015 and matured on March 31, 2017.
Taking our interest rate caps into account, a sensitivity analysis of the impact on our variable rate corporate debt instruments to a hypothetical 100 basis point increase in short-term rates (LIBOR) for the three months ended March 31, 2017 would have resulted in an increase in interest expense of approximately $5.3 million.
Item 4.    Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended March 31, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


36


PART II
OTHER INFORMATION
Item 1.    Legal Proceedings
We are involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries; property damage; handling, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Such litigation is generally not, in the opinion of management, likely to have a material adverse effect on our financial condition, results of operations or cash flows. Legal and regulatory proceedings which could be material are discussed below.
Certain legal proceedings in which the Company is involved are discussed in Note 16 to the consolidated financial statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2016 and Part I, Item 3 of the same Annual Report. Unless otherwise indicated, all proceedings discussed in the Annual Report remain outstanding.
IAA—Lower Duwamish Waterway
Since June 2004, IAA has operated a branch on property it leases in Tukwila, Washington just south of Seattle. The property is located adjacent to a Superfund site known as the Lower Duwamish Waterway Superfund Site ("LDW Site"). The LDW Site had been designated a Superfund site in 2001, three years prior to IAA’s tenancy. On March 25, 2008, the United States Environmental Protection Agency, or the "EPA," issued IAA a General Notice of Potential Liability, or "General Notice," pursuant to Section 107(a), and a Request for Information pursuant to Section 104(e) of the Comprehensive Environmental Response, Compensation, and Liability Act, or "CERCLA," related to the LDW Site. On November 7, 2012, the EPA issued IAA a Second General Notice of Potential Liability, or "Second General Notice," for the LDW Site. The EPA's website indicates that the EPA has issued general notice letters to approximately 116 entities, and has issued Section 104(e) Requests to more than 300 entities related to the LDW Site. In the General Notice and Second General Notice, the EPA informed IAA that the EPA believes IAA may be a Potentially Responsible Party, or "PRP," but the EPA did not specify the factual basis for this assertion. At this time, the EPA still has not specified the factual basis for this assertion and has not demanded that IAA pay any funds or take any action apart from responding to the Section 104(e) Information Request. Four PRPs, The Boeing Company, the City of Seattle, the Port of Seattle and King County - the Lower Duwamish Waterway Group ("LDWG"), have funded a remedial investigation and feasibility study related to the cleanup of the LDW Site. In December 2014, the EPA issued a Record of Decision (ROD), detailing the final cleanup plan for the LDW Site. The ROD estimates the cost of cleanup to be $342 million, with the plan involving dredging of 105 acres, capping 24 acres, and enhanced natural recovery of 48 acres. The estimated length of the cleanup is 17 years, including 7 years of active remediation, and 10 years of monitored natural recovery. IAA is aware that certain authorities may bring natural resource damage claims against PRPs. On February 11, 2016, IAA received a Notice of Intent letter from the United States National Oceanic and Atmospheric Administration informing IAA that the Elliott Bay Trustee Council are beginning to conduct an injury assessment for natural resource damages in the LDW. The Notice of Intent indicates that the decision of the trustees to proceed with this natural resources injury assessment followed a pre-assessment screen performed by the trustees. More recently, in a letter dated August 16, 2016, EPA issued a status update to the PRPs at the LDW Site. The letter stated that EPA expects the bulk of the pre-remedial design work currently being performed by the LDWG to be completed by the beginning of 2018, with the Remedial Design/Remedial Action ("RD/RA")phase to follow. EPA expects to initiate RD/RA negotiations with all PRPs beginning in early 2018. At this time, however, the Company does not have adequate information to determine IAA's responsibility, if any, for contamination at this site, or to estimate IAA's loss as a result of this potential liability.
In addition, the Washington State Department of Ecology ("Ecology") is working with the EPA in relation to the LDW Site, primarily to investigate and address sources of potential contamination contributing to the LDW Site. In 2007, IAA installed a stormwater capture and filtration system designed to treat sources of potential contamination before discharge to the LDW site. The immediate-past property owner, the former property owner and IAA have had discussions with Ecology concerning possible source control measures, including an investigation of the water and soils entering the stormwater system, an analysis of the source of contamination identified within the system, if any, and possible repairs and upgrades to the stormwater system if required. Additional source control measures, if any, are not expected to have a material adverse effect on future recurring operating costs.
Item 1A.    Risk Factors
In addition to the other information set forth in this report, readers should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

37


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table provides information about purchases by KAR Auction Services of its shares of common stock during the quarter ended March 31, 2017:
Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
(Dollars in millions)
January 1 - January 31
 

 
 
 

 
$
419.6

February 1 - February 28
 

 
 
 

 
419.6

March 1 - March 31
 

 
 
 

 
419.6

Total
 

 
 
 

 
 
 
(1)
In October 2016, the board of directors authorized a repurchase of up to $500 million of the Company’s outstanding common stock, par value $0.01 per share, through October 26, 2019. Repurchases may be made in the open market or through privately negotiated transactions, in accordance with applicable securities laws and regulations, including pursuant to repurchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing and amount of any repurchases is subject to market and other conditions.

Item 6.    Exhibits
a)
Exhibits—the exhibit list in the Exhibit Index is incorporated herein by reference as the list of exhibits required as part of this report.
In reviewing the agreements included as exhibits to this Form 10-Q, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about KAR Auction Services, ADESA, IAA, AFC or other parties to the agreements.
The agreements included or incorporated by reference as exhibits to this Quarterly Report on Form 10-Q contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the benefit of the other parties to the applicable agreement and (i) were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; (ii) may have been qualified in such agreement by disclosures that were made to the other party in connection with the negotiation of the applicable agreement; (iii) may apply contract standards of "materiality" that are different from "materiality" under the applicable securities laws; and (iv) were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement.
The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this Quarterly Report on Form 10-Q not misleading. Additional information about the Company may be found elsewhere in this Quarterly Report on Form 10-Q and KAR Auction Services, Inc.'s other public filings, which are available without charge through the SEC's website at http://www.sec.gov.

38


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
KAR Auction Services, Inc.
 
 
(Registrant)
 
 
 
Date:
May 10, 2017
/s/ ERIC M. LOUGHMILLER