10-Q 1 karq2201710-q.htm FORM 10-Q - JUNE 30, 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 June 30, 2017
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34568
________________________________________________________
karlogoa04.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 July 31, 2017, 137,359,352 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Operating revenues
 
 
 
 
 
 
 
ADESA Auction Services
$
489.2

 
$
450.8

 
$
987.2

 
$
865.6

IAA Salvage Services
298.7

 
264.8

 
596.1

 
534.4

AFC
70.1

 
72.9

 
141.3

 
146.8

Total operating revenues
858.0

 
788.5

 
1,724.6

 
1,546.8

Operating expenses
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
481.7

 
447.6

 
982.9

 
879.6

Selling, general and administrative
154.6

 
146.9

 
312.0

 
288.0

Depreciation and amortization
64.5

 
59.0

 
129.0

 
115.4

Total operating expenses
700.8

 
653.5

 
1,423.9

 
1,283.0

Operating profit
157.2

 
135.0

 
300.7

 
263.8

Interest expense
40.1

 
35.8

 
80.4

 
64.5

Other income, net
(1.5
)
 
(0.3
)
 
(1.6
)
 
(1.6
)
Loss on extinguishment of debt
27.5

 

 
27.5

 
4.0

Income before income taxes
91.1

 
99.5

 
194.4

 
196.9

Income taxes
33.9

 
37.7

 
68.0

 
74.4

Net income
$
57.2

 
$
61.8

 
$
126.4

 
$
122.5

Net income per share
 
 
 
 
 
 
 
Basic
$
0.42

 
$
0.45

 
$
0.92

 
$
0.89

Diluted
$
0.41

 
$
0.44

 
$
0.91

 
$
0.88

Dividends declared per common share
$
0.32

 
$
0.29

 
$
0.64

 
$
0.58

   










See accompanying notes to consolidated financial statements

3


KAR Auction Services, Inc.
Consolidated Statements of Comprehensive Income
(In millions)
(Unaudited)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
57.2

 
$
61.8

 
$
126.4

 
$
122.5

Other comprehensive income (loss)
 
 
 
 
 
 
 
Foreign currency translation gain (loss)
10.3

 
(4.4
)
 
13.7

 
4.3

Comprehensive income
$
67.5

 
$
57.4

 
$
140.1

 
$
126.8

   

























See accompanying notes to consolidated financial statements

4


KAR Auction Services, Inc.
Consolidated Balance Sheets
(In millions)
(Unaudited)
 
June 30,
 2017
 
December 31, 2016
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
530.4

 
$
201.8

Restricted cash
18.3

 
17.9

Trade receivables, net of allowances of $9.5 and $13.0
711.0

 
682.9

Finance receivables, net of allowances of $12.5 and $12.0
1,724.0

 
1,780.2

Other current assets
152.4

 
158.4

Total current assets
3,136.1

 
2,841.2

Other assets
 
 
 
Goodwill
2,095.5

 
2,057.0

Customer relationships, net of accumulated amortization of $756.9 and $707.8
417.1

 
461.0

Other intangible assets, net of accumulated amortization of $303.7 and $301.6
325.2

 
320.1

Other assets
41.5

 
35.8

Total other assets
2,879.3

 
2,873.9

Property and equipment, net of accumulated depreciation of $704.0 and $655.6
841.3

 
842.5

Total assets
$
6,856.7

 
$
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)
 
June 30,
2017
 
December 31, 2016
Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
735.5

 
$
648.5

Accrued employee benefits and compensation expenses
82.8

 
100.7

Accrued interest
5.6

 
2.2

Other accrued expenses
147.9

 
149.4

Income taxes payable
4.6

 
5.0

Dividends payable
43.9

 
43.7

Obligations collateralized by finance receivables
1,224.9

 
1,280.3

Current maturities of long-term debt
17.7

 
105.2

Total current liabilities
2,262.9

 
2,335.0

Non-current liabilities
 
 
 
Long-term debt
2,675.2

 
2,365.1

Deferred income tax liabilities
294.7

 
291.7

Other liabilities
162.1

 
168.5

Total non-current liabilities
3,132.0

 
2,825.3

Commitments and contingencies (Note 9)

 

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:
 

 
 

June 30, 2017: 137,322,216
 

 
 

December 31, 2016: 136,639,217
1.4

 
1.4

Additional paid-in capital
1,384.2

 
1,371.1

Retained earnings
111.8

 
74.1

Accumulated other comprehensive loss
(35.6
)
 
(49.3
)
Total stockholders' equity
1,461.8

 
1,397.3

Total liabilities and stockholders' equity
$
6,856.7

 
$
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 December 31, 2016
136.6

 
$
1.4

 
$
1,371.1

 
$
74.1

 
$
(49.3
)
 
$
1,397.3

Net income
 

 
 
 
 
 
126.4

 
 
 
126.4

Other comprehensive income
 

 
 
 
 
 
 
 
13.7

 
13.7

Issuance of common stock under stock plans
0.8

 
 
 
6.9

 
 
 
 
 
6.9

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

 
 
 
11.0

 
 
 
 
 
11.0

Dividends earned under stock plans
 
 
 
 
0.9

 
(0.9
)
 
 
 

Cash dividends declared to stockholders ($0.64 per share)
 

 
 
 
 
 
(87.8
)
 
 
 
(87.8
)
Balance at June 30, 2017
137.3

 
$
1.4

 
$
1,384.2

 
$
111.8

 
$
(35.6
)
 
$
1,461.8

   





















See accompanying notes to consolidated financial statements

7


KAR Auction Services, Inc.
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
 
Six Months Ended 
 June 30,
 
2017
 
2016
Operating activities
 
 
 
Net income
$
126.4

 
$
122.5

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
129.0

 
115.4

Provision for credit losses
24.0

 
13.8

Deferred income taxes
6.8

 
(7.2
)
Amortization of debt issuance costs
5.1

 
4.2

Stock-based compensation
11.0

 
9.8

Gain on disposal of fixed assets
(0.5
)
 

Loss on extinguishment of debt
27.5

 
4.0

Other non-cash, net
4.9

 
3.5

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Trade receivables and other assets
(24.3
)
 
(207.3
)
Accounts payable and accrued expenses
64.0

 
106.0

Net cash provided by operating activities
373.9

 
164.7

Investing activities
 
 
 
Net decrease (increase) in finance receivables held for investment
36.4

 
(103.5
)
Acquisition of businesses (net of cash acquired)
(47.0
)
 
(353.3
)
Purchases of property, equipment and computer software
(75.4
)
 
(75.5
)
Advance to equity method investee
(5.0
)
 

Proceeds from the sale of property and equipment
0.3

 

(Increase) decrease in restricted cash
(0.4
)
 
1.2

Net cash used by investing activities
(91.1
)
 
(531.1
)
Financing activities
 
 
 
Net increase in book overdrafts
16.7

 
36.9

Net decrease in borrowings from lines of credit
(80.5
)
 
(140.0
)
Net (decrease) increase in obligations collateralized by finance receivables
(62.0
)
 
34.8

Proceeds from long-term debt
2,717.0

 
1,336.5

Payments for debt issuance costs/amendments
(21.8
)
 
(19.5
)
Payments on long-term debt
(2,422.6
)
 
(646.4
)
Payments on capital leases
(14.9
)
 
(11.7
)
Payments of contingent consideration and deferred acquisition costs
(7.0
)
 
(3.6
)
Initial net investment for interest rate caps
(0.7
)
 

Issuance of common stock under stock plans
6.9

 
11.6

Tax withholding payments for vested RSUs
(5.7
)
 
(1.0
)
Dividends paid to stockholders
(87.6
)
 
(77.0
)
Net cash provided by financing activities
37.8

 
520.6

Effect of exchange rate changes on cash
8.0

 
5.5

Net increase in cash and cash equivalents
328.6

 
159.7

Cash and cash equivalents at beginning of period
201.8

 
155.0

Cash and cash equivalents at end of period
$
530.4

 
$
314.7

Cash paid for interest
$
69.3

 
$
58.0

Cash paid for taxes, net of refunds
$
54.4

 
$
68.4


See accompanying notes to consolidated financial statements

8


KAR Auction Services, Inc.
Notes to Consolidated Financial Statements
June 30, 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 and May 31, 2017, 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 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 senior secured term loan B-4 facility due March 11, 2021 ("Term Loan B-4"), the senior secured term loan B-5 facility due March 9, 2023 ("Term Loan B-5") and the $350 million, senior secured revolving credit facility due March 9, 2021 (the "revolving credit facility"), the terms of which are set forth in the Credit Agreement. Term Loan B-2 and Term Loan B-3 were extinguished in May 2017 with the proceeds received from Term Loan B-4, Term Loan B-5 and the senior notes;
"Senior notes" refers to the 5.125% senior notes due 2025 ($950 million aggregate principal outstanding at June 30, 2017);
"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 June 30, 2017, we have a North American network of 77 ADESA whole car auction sites and 174 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.

9

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


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 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 June 30, 2017. Floorplan financing supports independent used vehicle dealers in North America who purchase vehicles at ADESA, IAA, TradeRev (partially owned by ADESA), 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 $0.9 million and $5.0 million of excess tax benefits from stock-based compensation as a discrete item in our income tax expense for the three and six months ended June 30, 2017, respectively. 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 six months ended June 30, 2016, which resulted in a reclassification of excess tax benefits from stock-based compensation of $5.8 million from cash flows provided by financing activities to cash flows provided by operating activities.
New Accounting Standards
In May 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The new guidance is expected to reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications. Changes that do not impact the fair value, vesting conditions or classification of an award will not require modification accounting. The new guidance is

10

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


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 2017-09 will have a material impact on the consolidated financial statements.

In January 2017, the 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.

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.
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

11

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


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 still in the process of evaluating the impact the adoption of ASU 2014-09 will have on the consolidated financial statements and is assessing its contracts with customers. Currently, we do not expect the adoption of ASU 2014-09 will have a material impact on the consolidated financial statements. We anticipate we will expand our consolidated financial statement disclosures in order to comply with the ASU.
Note 2—Acquisitions
In April 2017, KAR purchased all of the stock of CarCo Technologies, Inc. (“DRIVIN”). 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.

In May 2017, the Company acquired Dependable Auto Shippers ("DAS"). DAS provides vehicle transportation services for corporate and personal vehicle transportation needs.

The purchased assets included accounts receivable, software, and inventory. Financial results for each acquisition have been included in our consolidated financial statements from the date of acquisition.

The aggregate purchase price for the businesses acquired in the first six months of 2017, net of cash acquired, was approximately $47.0 million. The purchase price for the acquired businesses was allocated to acquired assets and liabilities based upon fair values, including $6.0 million to intangible assets, representing the fair value of acquired software which is being amortized over its expected useful life. The purchase accounting associated with these acquisitions is preliminary, subject to determination of working capital adjustments, tax attributes and a final valuation of intangibles related to the acquisition of DRIVIN and certain opening balance sheet fair value adjustments for DAS. The Company does not expect adjustments to the purchase accounting will be material. The acquisitions resulted in aggregate goodwill of $35.6 million. The goodwill is recorded in the ADESA Auctions reportable segment. The financial impact of these acquisitions, including pro forma financial results, was immaterial to the Company’s consolidated results of operations for the six months ended June 30, 2017.
Note 3—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 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
PRSUs
$
2.5

 
$
2.6

 
$
5.6

 
$
5.7

RSUs
2.3

 
1.5

 
4.5

 
3.0

Service options
0.4

 
0.5

 
0.9

 
1.1

Total stock-based compensation expense
$
5.2

 
$
4.6

 
$
11.0

 
$
9.8


12

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


PRSUs and RSUs
In the first six months 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 0.3 million RSUs were granted to certain executive officers and management of the Company. The RSUs are contingent upon continued employment and generally vest in three equal annual installments. The weighted average grant date fair value of the PRSUs and the RSUs was $44.43 per share and $44.03 per share, respectively, 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 six months 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.
Note 4—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 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
57.2

 
$
61.8

 
$
126.4

 
$
122.5

Weighted average common shares outstanding
137.2

 
137.6

 
137.0

 
137.4

Effect of dilutive stock options and restricted stock awards
1.2

 
1.7

 
1.4

 
1.7

Weighted average common shares outstanding and potential common shares
138.4

 
139.3

 
138.4

 
139.1

Net income per share
 
 
 
 
 
 
 
Basic
$
0.42

 
$
0.45

 
$
0.92

 
$
0.89

Diluted
$
0.41

 
$
0.44

 
$
0.91

 
$
0.88

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 or six months ended June 30, 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 June 30, 2017 and 2016, respectively, and approximately 0.7 million and approximately 0.5 million PRSUs were excluded from the calculation of diluted net income per share for the six months ended June 30, 2017 and 2016, respectively. Total options outstanding at June 30, 2017 and 2016 were 2.2 million and 3.1 million, respectively.

13

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


Note 5—Equity Method Investment
ADESA owns a 50% interest in Nth Gen Software Inc. ("TradeRev") and its online vehicle remarketing system which were acquired 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 June 30, 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 June 30, 2017, the carrying amount of the investment was $20.0 million. The Company’s share in the net losses of TradeRev for each of the three months ended June 30, 2017 and 2016 was $1.0 million, and the Company’s share in the net losses of TradeRev for the six months ended June 30, 2017 and 2016 was $2.7 million and $1.6 million, respectively. This amount was recorded to “Other income, net” in the consolidated statements of income.
Note 6—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 June 30, 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 June 30, 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.
 
June 30, 2017
 
Net Credit Losses
Three Months Ended June 30, 2017
 
Net Credit Losses
Six Months Ended June 30, 2017
 
Principal Amount of:
 
 
(in millions)
Receivables
 
Receivables
Delinquent
 
 
Floorplan receivables
$
1,722.6

 
$
9.3

 
$
11.2

 
$
22.1

Other loans
13.9

 

 

 

Total receivables managed
$
1,736.5

 
$
9.3

 
$
11.2

 
$
22.1



14

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


 
December 31, 2016
 
Net Credit Losses
Three Months Ended June 30, 2016
 
Net Credit Losses
Six Months Ended June 30, 2016
 
Principal Amount of:
 
 
(in millions)
Receivables
 
Receivables
Delinquent
 
 
Floorplan receivables
$
1,781.1

 
$
12.0

 
$
5.3

 
$
10.6

Other loans
11.1

 

 

 

Total receivables managed
$
1,792.2

 
$
12.0

 
$
5.3

 
$
10.6

AFC's allowance for losses was $12.5 million and $12.0 million at June 30, 2017 and December 31, 2016, respectively.
As of June 30, 2017 and December 31, 2016, $1,715.3 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:
 
June 30,
2017
 
December 31,
2016
Obligations collateralized by finance receivables, gross
$
1,241.4

 
$
1,300.0

Unamortized securitization issuance costs
(16.5
)
 
(19.7
)
Obligations collateralized by finance receivables
$
1,224.9

 
$
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 June 30, 2017, we were in compliance with the covenants in the securitization agreements.
Note 7—Long-Term Debt
Long-term debt consisted of the following (in millions):
 
Interest Rate *
 
Maturity
 
June 30, 2017
 
December 31, 2016
Term Loan B-2
Adjusted LIBOR
 
+ 3.1875%
 
March 11, 2021
 
$

 
$
1,082.7

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

 
1,339.9

Term Loan B-4
Adjusted LIBOR
 
+ 2.25%
 
March 11, 2021
 
717.0

 

Term Loan B-5
Adjusted LIBOR
 
+ 2.50%
 
March 9, 2023
 
1,050.0

 

Revolving credit facility
Adjusted LIBOR
 
+ 2.0%
 
March 9, 2021
 

 
80.5

Senior notes
 
 
5.125%
 
June 1, 2025
 
950.0

 

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

 

Total debt
 
 
 
 
 
 
2,717.0

 
2,503.1

Unamortized debt issuance costs/discounts
 
 
 
 
 
(24.1
)
 
(32.8
)
Current portion of long-term debt
 
 
 
 
 
 
(17.7
)
 
(105.2
)
Long-term debt
 
 
 
 
 
 
$
2,675.2

 
$
2,365.1

* The interest rates presented in the table above represent the rates in place at June 30, 2017.
On May 31, 2017, the Company used proceeds from the issuance of $950 million senior notes and proceeds from the issuance of $1,767 million in the aggregate of Term Loan B-4 and Term Loan B-5 to repay Term Loan B-2 and Term Loan B-3 in full and to repay the outstanding balance on the revolving credit facility.

15

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


Credit Facility
On May 31, 2017, we entered into an Incremental Commitment Agreement and Second Amendment (the "Second Amendment") to the Credit Agreement. The Second Amendment provided for, among other things, (i) the refinancing and repricing of the existing tranche B-2 term loans ("Term Loan B-2") remaining after the repayment with new tranche B-4 term loans in an aggregate principal amount of $717 million ("Term Loan B-4"), (ii) the refinancing and repricing of existing tranche B-3 term loans ("Term Loan B-3") remaining after the repayment with new tranche B-5 term loans in an aggregate principal amount of $1.05 billion ("Term Loan B-5") and (iii) a $350 million senior secured revolving credit facility (the "revolving credit facility"). A portion of the proceeds received from the issuance of the senior notes was used to repay a portion of Term Loan B-2 and Term Loan B-3, as well as the outstanding balance on the revolving credit facility. No early termination penalties were incurred by the Company; however, we incurred a non-cash loss on the extinguishment of debt of $27.5 million in the second quarter of 2017. The loss was a result of the write-off of unamortized debt issue costs and debt discounts associated with Term Loan B-2 and Term Loan B-3. We capitalized approximately $7.0 million of debt issuance costs in connection with the Second Amendment.
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 $90 million is available for swing line loans.
Both Term Loan B-4 and Term Loan B-5 are payable in quarterly installments equal to 0.25% of their respective original aggregate principal amounts. Such payments will commence on September 30, 2017, 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. In addition, in July 2017, in accordance with the terms of the Credit Agreement, 50% of the net cash proceeds from the sale-leaseback of certain technology and capital equipment were used to prepay $1.0 million and $1.5 million of Term Loan B-4 and Term Loan B-5, respectively. Each such prepayment is credited to prepay, on a pro rata basis, in order of maturity the unpaid amounts due on the first eight scheduled quarterly installments of Term Loan B-4 and Term Loan B-5 and thereafter to the remaining scheduled quarterly installments of each term loan on a pro rata basis.
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 June 30, 2017.
As set forth in the Credit Agreement, Term Loan B-4 bears interest at Adjusted LIBOR (as defined in the Credit Agreement) plus 2.25%, Term Loan B-5 at Adjusted LIBOR plus 2.50% and revolving loan borrowings at Adjusted LIBOR plus 2.0%. However, for specified types of borrowings, the Company may elect to make Term Loan B-4 borrowings at a Base Rate (as defined in the Credit Agreement) plus 1.25%, Term Loan B-5 at a Base Rate plus 1.50% and revolving loan borrowings at a Base Rate plus 1.0%. The rates on Term Loan B-4 and Term Loan B-5 were 3.56% and 3.81% at June 30, 2017, respectively. In addition, if the Company's Consolidated Senior Secured Leverage Ratio (as defined in the Credit Agreement), which is based on a net debt calculation, increases to levels specified in the Credit Agreement, the applicable interest rate on the revolving credit facility will step up by 25 basis points. The Company also pays a commitment fee of 30 to 35 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility based on the Company's Consolidated Senior Secured Leverage Ratio as described above.
On June 30, 2017, there were no borrowings on the revolving credit facility and $80.5 million was drawn 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 June 30, 2017 and December 31, 2016, respectively, which reduce the amount available for borrowings under the revolving credit facility.

16

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


Senior Notes
On May 31, 2017, we issued $950 million of 5.125% senior notes due June 1, 2025. The Company will pay interest on the senior notes semi-annually in arrears on June 1 and December 1 of each year, commencing December 1, 2017. We may redeem the senior notes, in whole or in part, at any time prior to June 1, 2020 at a redemption price equal to 100% of the principal amount plus a make-whole premium and thereafter at a premium that declines ratably to par in 2023. We capitalized approximately $14.7 million of debt issuance costs in connection with the senior notes. The senior notes are guaranteed by the Subsidiary Guarantors.
Fair Value of Debt

As of June 30, 2017, the estimated fair value of our long-term debt amounted to $2,745.6 million. The estimates of fair value were based on broker-dealer quotes for our debt as of June 30, 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.
Note 8—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
 
 
June 30, 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
 
$
0.3

 
Other assets
 
N/A

2015 Interest rate caps
 
Other assets
 
$

 
Other assets
 
$


17

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


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
Derivatives Not Designated as Hedging Instruments
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
2017 Interest rate caps
 
Interest expense
 
$
(0.4
)
 
N/A

 
$
(0.5
)
 
N/A

2015 Interest rate caps
 
Interest expense
 
$

 
$
(0.1
)
 
$

 
$
(0.7
)
Note 9—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 10—Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following (in millions):
 
June 30,
2017
 
December 31, 2016
Foreign currency translation loss
$
(35.7
)
 
$
(49.4
)
Unrealized gain on postretirement benefit obligation, net of tax
0.1

 
0.1

Accumulated other comprehensive loss
$
(35.6
)
 
$
(49.3
)
Note 11—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.

18

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


Financial information regarding our reportable segments is set forth below for the three months ended June 30, 2017 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
489.2

 
$
298.7

 
$
70.1

 
$

 
$
858.0

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
278.7

 
181.5

 
21.5

 

 
481.7

Selling, general and administrative
85.2

 
27.5

 
7.3

 
34.6

 
154.6

Depreciation and amortization          
26.9

 
22.9

 
7.8

 
6.9

 
64.5

Total operating expenses
390.8

 
231.9

 
36.6

 
41.5

 
700.8

Operating profit (loss)
98.4

 
66.8

 
33.5

 
(41.5
)
 
157.2

Interest expense
0.1

 

 
10.5

 
29.5

 
40.1

Other (income) expense, net
(0.7
)
 
(0.5
)
 

 
(0.3
)
 
(1.5
)
Loss on extinguishment of debt

 

 

 
27.5

 
27.5

Intercompany expense (income)
11.5

 
9.4

 
(9.8
)
 
(11.1
)
 

Income (loss) before income taxes
87.5

 
57.9

 
32.8

 
(87.1
)
 
91.1

Income taxes
33.8

 
20.6

 
12.5

 
(33.0
)
 
33.9

Net income (loss)
$
53.7

 
$
37.3

 
$
20.3

 
$
(54.1
)
 
$
57.2

Total assets
$
3,313.8

 
$
1,311.7

 
$
2,140.6

 
$
90.6

 
$
6,856.7

Financial information regarding our reportable segments is set forth below for the three months ended June 30, 2016 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
450.8

 
$
264.8

 
$
72.9

 
$

 
$
788.5

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
259.2

 
167.3

 
21.1

 

 
447.6

Selling, general and administrative
80.6

 
26.5

 
7.3

 
32.5

 
146.9

Depreciation and amortization          
24.8

 
21.2

 
7.9

 
5.1

 
59.0

Total operating expenses
364.6

 
215.0

 
36.3

 
37.6

 
653.5

Operating profit (loss)
86.2

 
49.8

 
36.6

 
(37.6
)
 
135.0

Interest expense
0.1

 

 
8.2

 
27.5

 
35.8

Other (income) expense, net
(0.5
)
 
(0.1
)
 

 
0.3

 
(0.3
)
Intercompany expense (income)
13.3

 
9.6

 
(8.6
)
 
(14.3
)
 

Income (loss) before income taxes
73.3

 
40.3

 
37.0

 
(51.1
)
 
99.5

Income taxes
27.1

 
15.1

 
14.0

 
(18.5
)
 
37.7

Net income (loss)
$
46.2

 
$
25.2

 
$
23.0

 
$
(32.6
)
 
$
61.8

Total assets
$
3,049.7

 
$
1,276.3

 
$
2,155.8

 
$
86.6

 
$
6,568.4


19

KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
June 30, 2017 (Unaudited)


Financial information regarding our reportable segments is set forth below for the six months ended June 30, 2017 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
987.2

 
$
596.1

 
$
141.3

 
$

 
$
1,724.6

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
569.6

 
370.6

 
42.7

 

 
982.9

Selling, general and administrative
172.5

 
53.4

 
15.2

 
70.9

 
312.0

Depreciation and amortization          
54.0

 
46.1

 
15.6

 
13.3

 
129.0

Total operating expenses
796.1

 
470.1

 
73.5

 
84.2

 
1,423.9

Operating profit (loss)
191.1

 
126.0

 
67.8

 
(84.2
)
 
300.7

Interest expense
0.3

 

 
20.8

 
59.3

 
80.4

Other (income) expense, net
(0.3
)
 
(0.9
)
 

 
(0.4
)
 
(1.6
)
Loss on extinguishment of debt

 

 

 
27.5

 
27.5

Intercompany expense (income)
23.3

 
18.8

 
(18.5
)
 
(23.6
)
 

Income (loss) before income taxes
167.8

 
108.1

 
65.5

 
(147.0
)
 
194.4

Income taxes
62.8

 
38.6

 
24.3

 
(57.7
)
 
68.0

Net income (loss)
$
105.0

 
$
69.5

 
$
41.2

 
$
(89.3
)
 
$
126.4

Financial information regarding our reportable segments is set forth below for the six months ended June 30, 2016 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
865.6

 
$
534.4

 
$
146.8

 
$

 
$
1,546.8

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
497.6

 
340.8

 
41.2

 

 
879.6

Selling, general and administrative
157.2

 
52.2

 
14.8

 
63.8

 
288.0

Depreciation and amortization          
47.3

 
42.5

 
15.6

 
10.0

 
115.4

Total operating expenses
702.1

 
435.5

 
71.6

 
73.8

 
1,283.0

Operating profit (loss)
163.5

 
98.9

 
75.2

 
(73.8
)
 
263.8

Interest expense
0.2

 

 
16.0

 
48.3

 
64.5

Other (income) expense, net
(1.1
)
 
(0.4
)
 

 
(0.1
)
 
(1.6
)
Loss on extinguishment of debt

 

 

 
4.0

 
4.0

Intercompany expense (income)
28.5

 
19.2

 
(16.4
)
 
(31.3
)
 

Income (loss) before income taxes
135.9

 
80.1

 
75.6

 
(94.7
)
 
196.9

Income taxes
50.4

 
30.0

 
28.6

 
(34.6
)
 
74.4

Net income (loss)
$
85.5

 
$
50.1

 
$
47.0

 
$
(60.1
)
 
$
122.5


20


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;

21


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 174 salvage vehicle auction sites in the United States and Canada at June 30, 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.

22


The AFC segment provides short-term, inventory-secured financing, known as floorplan financing, primarily to independent used vehicle dealers. At June 30, 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 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 2016 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. We believe that salvage auction industry volumes will grow 5% to 7% annually over the next three years.
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 six months of 2017, the price per ton of crushed auto bodies in North America has ranged from $156 to $188 and finished June 2017 at $184, as compared to $175 at June 30, 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.

23


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.

24


Results of Operations
Overview of Results of KAR Auction Services, Inc. for the Three Months Ended June 30, 2017 and 2016:
 
Three Months Ended 
 June 30,
(Dollars in millions except per share amounts)
2017
 
2016
Revenues
 
 
 
ADESA
$
489.2

 
$
450.8

IAA
298.7

 
264.8

AFC
70.1

 
72.9

Total revenues
858.0

 
788.5

Cost of services*
481.7

 
447.6

Gross profit*
376.3

 
340.9

Selling, general and administrative
154.6

 
146.9

Depreciation and amortization
64.5

 
59.0

Operating profit
157.2

 
135.0

Interest expense
40.1

 
35.8

Other income, net
(1.5
)
 
(0.3
)
Loss on extinguishment of debt
27.5

 

Income before income taxes
91.1

 
99.5

Income taxes
33.9

 
37.7

Net income
$
57.2

 
$
61.8

Net income per share
 
 
 
Basic
$
0.42

 
$
0.45

Diluted
$
0.41

 
$
0.44


* Exclusive of depreciation and amortization
Overview
For the three months ended June 30, 2017, we had revenue of $858.0 million compared with revenue of $788.5 million for the three months ended June 30, 2016, an increase of 9%. Businesses acquired in the last 12 months accounted for an increase in revenue of $18.2 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 $5.5 million, or 9%, to $64.5 million for the three months ended June 30, 2017, compared with $59.0 million for the three months ended June 30, 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 and 2017.
Interest Expense
Interest expense increased $4.3 million, or 12%, to $40.1 million for the three months ended June 30, 2017, compared with $35.8 million for the three months ended June 30, 2016. The increase was primarily attributable to an increase in interest expense at AFC of $2.3 million, which resulted from an increase in interest rates for the three months ended June 30, 2017 as compared with the three months ended June 30, 2016. In addition, interest expense increased as a result of an increase of approximately $95 million in the average outstanding balance of corporate debt for the three months ended June 30, 2017 compared with the three months ended June 30, 2016, as well as an increase in the weighted average interest rate for the same period of approximately 0.15%.

25


Loss on Extinguishment of Debt

In May 2017, we amended our Credit Agreement and recorded a $27.5 million pretax charge resulting from the write-off of unamortized debt issue costs and debt discounts associated with Term Loan B-2 and Term Loan B-3.
Income Taxes
We had an effective tax rate of 37.2% for the three months ended June 30, 2017, compared with an effective tax rate of 37.9% for the three months ended June 30, 2016. Our effective tax rate was lower in the second quarter of 2017 primarily as a result of the adoption of ASU 2016-09 in the first quarter of 2017. We recognized $0.9 million of excess tax benefits from employee stock-based compensation as a discrete item in our income tax expense for the three months ended June 30, 2017. These amounts were previously recorded to additional paid-in capital.
Impact of Foreign Currency
The strengthening of the U.S. dollar has impacted the reporting of our Canadian operations in U.S. dollars. For the three months ended June 30, 2017, fluctuations in the Canadian exchange rate decreased revenue by $4.1 million, operating profit by $1.6 million, net income by $0.9 million and net income per diluted share by less than $0.01.
ADESA Results
 
Three Months Ended 
 June 30,
(Dollars in millions except per vehicle amounts)
2017
 
2016
ADESA revenue
$
489.2

 
$
450.8

Cost of services*
278.7

 
259.2

Gross profit*
210.5

 
191.6

Selling, general and administrative
85.2

 
80.6

Depreciation and amortization
26.9

 
24.8

Operating profit
$
98.4

 
$
86.2

Vehicles sold
830,000

 
750,000

   Physical auction vehicles sold
585,000

 
552,000

   Online only vehicles sold
245,000

 
198,000

   Dealer consignment mix at physical auctions
46
%
 
49
%
   Conversion rate at North American physical auctions
61.1
%
 
59.1
%
Physical auction revenue per vehicle sold, excluding purchased vehicles
$
748

 
$
742

Online only revenue per vehicle sold, excluding ADESA Assurance Program vehicles
$
105

 
$
109


* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA increased $38.4 million, or 9%, to $489.2 million for the three months ended June 30, 2017, compared with $450.8 million for the three months ended June 30, 2016. The increase in revenue was primarily a result of an 11% increase in the number of vehicles sold (7% increase excluding acquisitions), partially offset by a 2% decrease in revenue per vehicle sold. Businesses acquired in the last 12 months accounted for an increase in revenue of $18.2 million. Revenue decreased $3.0 million due to fluctuations in the Canadian exchange rate.
The increase in volume sold was primarily attributable to a 17% increase in institutional volume (14% increase excluding acquisitions), including vehicles sold on our online only platform, partially offset by a 1% decrease in dealer consignment units sold (5% decrease excluding acquisitions) for the three months ended June 30, 2017 compared with the three months ended June 30, 2016. Online sales volume for ADESA represented approximately 45% of the total vehicles sold in the second quarter of 2017, compared with approximately 41% in the second 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 67% of ADESA's online sales volume.

26


ADESA sold approximately 245,000 and 198,000 vehicles through its online only offerings in the second quarter of 2017 and 2016, respectively, of which approximately 128,000 and 105,000 represented vehicle sales to grounding dealers in the second quarter of 2017 and 2016, respectively. For the three months ended June 30, 2017, dealer consignment vehicles represented approximately 46% of used vehicles sold at ADESA physical auction locations, compared with approximately 49% for the three months ended June 30, 2016. Vehicles sold at physical auction locations increased 6% (1% increase excluding acquisitions) in the second quarter of 2017, compared with the second 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 61.1% for the three months ended June 30, 2017, compared with 59.1% for the three months ended June 30, 2016.
Physical auction revenue per vehicle sold increased $6, or 1%, to $748 for the three months ended June 30, 2017, compared with $742 for the three months ended June 30, 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 auction fees related to higher average transaction prices and an increase in lower margin ancillary and other related services revenue, including revenue from certain businesses acquired, partially offset by a decrease in physical auction revenue per vehicle sold of $5 due to fluctuations in the Canadian exchange rate.
Online only auction revenue per vehicle sold decreased $2 to $121 for the three months ended June 30, 2017, compared with $123 for the three months ended June 30, 2016. The decrease in online only auction revenue per vehicle sold was attributable to a change in the mix of cars supplied in closed sales to non-grounding dealers as well as a change in the mix of cars supplied in open sales, partially offset by an increase in purchased vehicles associated with the ADESA Assurance Program and a decrease in online only auction revenue per vehicle sold of $1 due to fluctuations in the Canadian exchange rate. Excluding vehicles purchased as part of the ADESA Assurance Program, online only revenue per vehicle sold decreased to $105 from $109 for the three months ended June 30, 2017 and 2016, respectively.
Gross Profit
For the three months ended June 30, 2017, gross profit for ADESA increased $18.9 million, or 10%, to $210.5 million, compared with $191.6 million for the three months ended June 30, 2016. Gross profit for ADESA was 43.0% of revenue for the three months ended June 30, 2017, compared with 42.5% of revenue for the three months ended June 30, 2016. The increase in gross profit was mainly attributable to the 11% increase in the number of vehicles sold.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment increased $4.6 million, or 6%, to $85.2 million for the three months ended June 30, 2017, compared with $80.6 million for the three months ended June 30, 2016, primarily due to increases in selling, general and administrative expenses associated with acquired businesses of $4.4 million, compensation expense of $2.8 million, stock-based compensation expense of $0.6 million and other expenses aggregating $0.4 million, partially offset by decreases in incentive-based compensation expense of $2.1 million and professional fees of $1.5 million.

27


IAA Results
 
Three Months Ended 
 June 30,
(Dollars in millions)
2017
 
2016
IAA revenue
$
298.7

 
$
264.8

Cost of services*
181.5

 
167.3

Gross profit*
117.2

 
97.5

Selling, general and administrative
27.5

 
26.5

Depreciation and amortization
22.9

 
21.2

Operating profit
$
66.8

 
$
49.8

Vehicles sold
580,000

 
523,000


* Exclusive of depreciation and amortization
Revenue
Revenue from IAA increased $33.9 million, or 13%, to $298.7 million for the three months ended June 30, 2017, compared with $264.8 million for the three months ended June 30, 2016, and included a decrease in revenue of $3.2 million from HBC. The increase in revenue was a result of an increase in vehicles sold of approximately 11% (12% excluding HBC) for the three months ended June 30, 2017, partially offset by a decrease in revenue of $0.9 million due to fluctuations in the Canadian exchange rate and a decrease in revenue of $1.2 million due to fluctuations in the U.K. exchange rate. Revenue per vehicle sold increased 2% for the three months ended June 30, 2017 compared with the three months ended June 30, 2016. IAA's North American same-store total loss vehicle inventory increased approximately 9% at June 30, 2017, as compared to June 30, 2016. Vehicles sold under purchase agreements were approximately 5% (4% excluding HBC) and 6% (5% excluding HBC) of total salvage vehicles sold for the three months ended June 30, 2017 and 2016, respectively. Online sales volumes for IAA for the three months ended June 30, 2017 and 2016 represented approximately 60% of the total vehicles sold by IAA.
Gross Profit
For the three months ended June 30, 2017, gross profit at IAA increased to $117.2 million, or 39.2% of revenue, compared with $97.5 million, or 36.8% of revenue, for the three months ended June 30, 2016. The increase in gross profit was mainly attributable to a 13% increase in revenue, partially offset by an 8% increase in cost of services, which included costs associated with purchase contract vehicles and volume growth. Excluding HBC, IAA's gross profit margin was 40.2% and 38.4% for the three months ended June 30, 2017 and 2016, respectively. For the three months ended June 30, 2017 and 2016, HBC had revenue of approximately $10.2 million and $13.4 million, respectively, and cost of services of approximately $8.9 million and $12.4 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 $1.0 million, or 4%, to $27.5 million for the three months ended June 30, 2017, compared with $26.5 million for the three months ended June 30, 2016. The increase in selling, general and administrative expenses was primarily attributable to increases in compensation expense of $1.1 million, incentive-based compensation expense of $0.7 million and non-income based taxes of $0.5 million, partially offset by decreases in professional fees of $0.9 million and other expenses aggregating $0.4 million.

28


AFC Results
 
Three Months Ended 
 June 30,
(Dollars in millions except volumes and per loan amounts)
2017
 
2016
AFC revenue
 
 
 
Interest and fee income
$
70.0

 
$
67.7

Other revenue
3.0

 
2.6

Provision for credit losses
(11.4
)
 
(5.5
)
Other service revenue
8.5

 
8.1

Total AFC revenue
70.1

 
72.9

Cost of services*
21.5

 
21.1

Gross profit*
48.6

 
51.8

Selling, general and administrative
7.3

 
7.3

Depreciation and amortization
7.8

 
7.9

Operating profit
$
33.5

 
$
36.6

Loan transactions
416,000

 
422,000

Revenue per loan transaction, excluding "Other service revenue"
$
148

 
$
154


* Exclusive of depreciation and amortization
Revenue
For the three months ended June 30, 2017, AFC revenue decreased $2.8 million, or 4%, to $70.1 million, compared with $72.9 million for the three months ended June 30, 2016. The decrease in revenue was the result of an increase in the provision for credit losses to 2.6% of the average managed receivables for the three months ended June 30, 2017, partially offset by a 5% increase in "Other service revenue" generated by PWI. In addition, managed receivables decreased to $1,736.5 million at June 30, 2017 from $1,738.6 million at June 30, 2016.
Revenue per loan transaction, which includes both loans paid off and loans curtailed, decreased $6, or 4%. The provision for credit losses, which is a reduction of revenue, resulted in a reduction of revenue per unit of $14 for the three months ended June 30, 2017. The remaining $8 increase in revenue per loan transaction was the result of increases in fee revenue and interest yield as a result of prime rate increases. Revenue per loan transaction excludes "Other service revenue."
The provision for credit losses has increased to 2.6% from 1.3% of the average managed receivables for the three months ended June 30, 2017 compared with the three months ended June 30, 2016. 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 above the stated range for the first half of the year, with improvement expected in the second half of the year.
Gross Profit
For the three months ended June 30, 2017, gross profit for the AFC segment decreased $3.2 million, or 6%, to $48.6 million, or 69.3% of revenue, compared with $51.8 million, or 71.1% of revenue, for the three months ended June 30, 2016, primarily as a result of a 4% decrease in revenue, related to the increased provision for credit losses, and a 2% increase in cost of services. The increase in cost of services was the result of an increase in compensation expense of $0.4 million and an increase in lot checks of $0.3 million, partially offset by a decrease in incentive-based compensation of $0.2 million and other expenses aggregating $0.1 million. The floorplan lending business gross profit margin percentage decreased from 77.7% to 75.7%. The floorplan lending business excludes PWI.
Selling, General and Administrative
Selling, general and administrative expenses at AFC were $7.3 million for each of the three months ended June 30, 2017 and June 30, 2016. Increases in compensation expense and stock-based compensation expense aggregating $0.6 million and other expenses aggregating $0.1 million, were offset by a decrease in incentive-based compensation and travel expenses aggregating $0.7 million.

29


Holding Company Results
 
Three Months Ended 
 June 30,
(Dollars in millions)
2017
 
2016
Selling, general and administrative
$
34.6

 
$
32.5

Depreciation and amortization
6.9

 
5.1

Operating loss
$
(41.5
)
 
$
(37.6
)
Selling, General and Administrative
For the three months ended June 30, 2017, selling, general and administrative expenses at the holding company increased $2.1 million, or 6%, to $34.6 million, compared with $32.5 million for the three months ended June 30, 2016, primarily as a result of increases in compensation expense of $3.3 million and information technology costs of $1.2 million, partially offset by a decrease in incentive-based compensation of $0.7 million and other expenses aggregating $1.7 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.
Overview of Results of KAR Auction Services, Inc. for the Six Months Ended June 30, 2017 and 2016:
 
Six Months Ended 
 June 30,
(Dollars in millions except per share amounts)
2017
 
2016
Revenues
 
 
 
ADESA
$
987.2

 
$
865.6

IAA
596.1

 
534.4

AFC
141.3

 
146.8

Total revenues
1,724.6

 
1,546.8

Cost of services*
982.9

 
879.6

Gross profit*
741.7

 
667.2

Selling, general and administrative
312.0

 
288.0

Depreciation and amortization
129.0

 
115.4

Operating profit
300.7

 
263.8

Interest expense
80.4

 
64.5

Other income, net
(1.6
)
 
(1.6
)
Loss on extinguishment of debt
27.5

 
4.0

Income before income taxes
194.4

 
196.9

Income taxes
68.0

 
74.4

Net income
$
126.4

 
$
122.5

Net income per share
 
 
 
Basic
$
0.92

 
$
0.89

Diluted
$
0.91

 
$
0.88

* Exclusive of depreciation and amortization
Overview
For the six months ended June 30, 2017, we had revenue of $1,724.6 million compared with revenue of $1,546.8 million for the six months ended June 30, 2016, an increase of 11%. Businesses acquired in the last 12 months accounted for an increase in revenue of $66.6 million. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below.

30


Depreciation and Amortization
Depreciation and amortization increased $13.6 million, or 12%, to $129.0 million for the six months ended June 30, 2017, compared with $115.4 million for the six months ended June 30, 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 and 2017.
Interest Expense
Interest expense increased $15.9 million, or 25%, to $80.4 million for the six months ended June 30, 2017, compared with $64.5 million for the six months ended June 30, 2016. The increase was primarily attributable to an increase of approximately $275 million in the average outstanding balance of corporate debt for the six months ended June 30, 2017 compared with the six months ended June 30, 2016, as well as an increase in the weighted average interest rate for the same period of approximately 0.44%. In addition, there was an increase in interest expense at AFC of $4.8 million, which resulted from an increase in interest rates for the six months ended June 30, 2017 as compared with the six months ended June 30, 2016.
Loss on Extinguishment of Debt

In May 2017, we amended our Credit Agreement and recorded a $27.5 million pretax charge resulting from the write-off of unamortized debt issue costs and debt discounts associated with Term Loan B-2 and Term Loan B-3.

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 a previous revolving credit facility.
Income Taxes
We had an effective tax rate of 35.0% for the six months ended June 30, 2017, compared with an effective tax rate of 37.8% for the six months ended June 30, 2016. Our effective tax rate was lower for the first six months of 2017 as compared with the first six months of 2016, primarily as a result of the adoption of ASU 2016-09 in the first quarter of 2017. We recognized $5.0 million of excess tax benefits from employee stock-based compensation as a discrete item in our income tax expense for the six months ended June 30, 2017. These amounts were previously recorded to additional paid-in capital.
Impact of Foreign Currency
The strengthening of the U.S. dollar has impacted the reporting of our Canadian operations in U.S. dollars. For the six months ended June 30, 2017, fluctuations in the Canadian exchange rate decreased revenue by $1.1 million, operating profit by $0.4 million, net income by $0.2 million and net income per diluted share by less than $0.01.

31


ADESA Results
 
Six Months Ended 
 June 30,
(Dollars in millions except per vehicle amounts)
2017
 
2016
ADESA revenue
$
987.2

 
$
865.6

Cost of services*
569.6

 
497.6

Gross profit*
417.6

 
368.0

Selling, general and administrative
172.5

 
157.2

Depreciation and amortization
54.0

 
47.3

Operating profit
$
191.1

 
$
163.5

Vehicles sold
1,648,000

 
1,453,000

   Physical auction vehicles sold
1,188,000

 
1,067,000

   Online only vehicles sold
460,000

 
386,000

   Dealer consignment mix at physical auctions
45
%
 
48
%
   Conversion rate at North American physical auctions
61.4
%
 
60.0
%
Physical auction revenue per vehicle sold, excluding purchased vehicles
$
751

 
$
740

Online only revenue per vehicle sold, excluding ADESA Assurance Program vehicles
$
108

 
$
109


* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA increased $121.6 million, or 14%, to $987.2 million for the six months ended June 30, 2017, compared with $865.6 million for the six months ended June 30, 2016. The increase in revenue was primarily a result of a 13% increase in the number of vehicles sold (5% increase excluding acquisitions), as well as a 1% increase in revenue per vehicle sold. Businesses acquired in the last 12 months accounted for an increase in revenue of $66.6 million. Revenue decreased $0.8 million due to fluctuations in the Canadian exchange rate.
The increase in volume sold was primarily attributable to a 18% increase in institutional volume (12% increase excluding acquisitions), including vehicles sold on our online only platform, as well as a 5% increase in dealer consignment units sold (6% decrease excluding acquisitions) for the six months ended June 30, 2017 compared with the six months ended June 30, 2016. Online sales volume for ADESA represented approximately 44% of the total vehicles sold in the first six months of 2017, compared with approximately 41% in the first six months of 2016. Upstream and midstream selling represent online only sales, which accounted for approximately 64% of ADESA's online sales volume. ADESA sold approximately 460,000 and 386,000 vehicles through its online only offerings in the first six months of 2017 and 2016, respectively, of which approximately 235,000 and 197,000 represented vehicle sales to grounding dealers in the first six months of 2017 and 2016, respectively. For the six months ended June 30, 2017, dealer consignment vehicles represented approximately 45% of used vehicles sold at ADESA physical auction locations, compared with approximately 48% for the six months ended June 30, 2016. Vehicles sold at physical auction locations increased 11% (no increase excluding acquisitions) in the first six months of 2017, compared with the first six months 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 61.4% for the six months ended June 30, 2017, compared with 60.0% for the six months ended June 30, 2016.
Physical auction revenue per vehicle sold increased $11, or 1%, to $751 for the six months ended June 30, 2017, compared with $740 for the six months ended June 30, 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 auction fees related to higher average transaction prices and an increase in lower margin ancillary and other related services revenue, including revenue from certain businesses acquired, partially offset by a decrease in physical auction revenue per vehicle sold of $1 due to fluctuations in the Canadian exchange rate.
Online only auction revenue per vehicle sold increased $2 to $122 for the six months ended June 30, 2017, compared with $120 for the six months ended June 30, 2016. The increase in online only auction revenue per vehicle sold was attributable to an increase in purchased vehicles associated with the ADESA Assurance Program, partially offset by a change in the mix of cars supplied in closed sales to non-grounding dealers as well as a change in the mix of cars supplied in open sales. Excluding

32


vehicles purchased as part of the ADESA Assurance Program, online only revenue per vehicle sold decreased to $108 from $109 for the six months ended June 30, 2017 and 2016, respectively.
Gross Profit
For the six months ended June 30, 2017, gross profit for ADESA increased $49.6 million, or 13%, to $417.6 million, compared with $368.0 million for the six months ended June 30, 2016. Gross profit for ADESA was 42.3% of revenue for the six months ended June 30, 2017, compared with 42.5% of revenue for the six months ended June 30, 2016. The increase in gross profit was mainly attributable to the 13% increase in the number of vehicles sold.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment increased $15.3 million, or 10%, to $172.5 million for the six months ended June 30, 2017, compared with $157.2 million for the six months ended June 30, 2016, primarily due to increases in selling, general and administrative expenses associated with acquired businesses of $13.3 million, compensation expense of $6.1 million, stock-based compensation expense of $0.9 million, benefit-related expenses of $0.8 million and other expenses aggregating $2.5 million, partially offset by decreases in incentive-based compensation expense of $5.1 million, professional fees of $1.5 million, bad debt expense of $0.9 million and marketing expenses of $0.8 million.
IAA Results
 
Six Months Ended 
 June 30,
(Dollars in millions)
2017
 
2016
IAA revenue
$
596.1

 
$
534.4

Cost of services*
370.6

 
340.8

Gross profit*
225.5

 
193.6

Selling, general and administrative
53.4

 
52.2

Depreciation and amortization
46.1

 
42.5

Operating profit
$
126.0

 
$
98.9

Vehicles sold
1,171,000

 
1,057,000


* Exclusive of depreciation and amortization
Revenue
Revenue from IAA increased $61.7 million, or 12%, to $596.1 million for the six months ended June 30, 2017, compared with $534.4 million for the six months ended June 30, 2016, and included a decrease in revenue of $4.3 million from HBC. The increase in revenue was a result of an increase in vehicles sold of approximately 11% (11% excluding HBC) for the six months ended June 30, 2017, partially offset by a decrease in revenue of $0.3 million due to fluctuations in the Canadian exchange rate and a decrease in revenue of $3.2 million due to fluctuations in the U.K. exchange rate. Revenue per vehicle sold increased 1% for the six months ended June 30, 2017 compared with the six months ended June 30, 2016. Vehicles sold under purchase agreements were approximately 5% (4% excluding HBC) and 6% (5% excluding HBC) of total salvage vehicles sold for the six months ended June 30, 2017 and 2016, respectively. Online sales volumes for IAA for the six months ended June 30, 2017 and 2016 represented approximately 60% of the total vehicles sold by IAA.
Gross Profit
For the six months ended June 30, 2017, gross profit at IAA increased to $225.5 million, or 37.8% of revenue, compared with $193.6 million, or 36.2% of revenue, for the six months ended June 30, 2016. The increase in gross profit was mainly attributable to a 12% 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 38.8% and 37.7% for the six months ended June