10-Q 1 karq1201910-q.htm 10-Q - MARCH 31, 2019 Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34568
kargreenlogonewoct2018.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
 
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 Act). Yes o    No ý

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading symbol
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
KAR
 
New York Stock Exchange
As of April 30, 2019, 133,279,015 shares of the registrant's common stock, par value $0.01 per share, were outstanding.
 



KAR Auction Services, Inc.
Table of Contents

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I
FINANCIAL INFORMATION
Item 1.    Financial Statements
KAR Auction Services, Inc.
Consolidated Statements of Income
(In millions, except per share data)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2019
 
2018
Operating revenues
 
 
 
ADESA Auction Services
$
599.7

 
$
528.1

IAA Salvage Services
357.2

 
337.3

AFC
89.9

 
85.1

Total operating revenues
1,046.8

 
950.5

Operating expenses
 
 
 
Cost of services (exclusive of depreciation and amortization)
612.3

 
535.0

Selling, general and administrative
207.6

 
187.4

Depreciation and amortization
66.1

 
70.3

Total operating expenses
886.0

 
792.7

Operating profit
160.8

 
157.8

Interest expense
56.9

 
41.5

Other income, net
(2.0
)
 
(0.1
)
Income before income taxes
105.9

 
116.4

Income taxes
28.1

 
26.4

Net income
$
77.8

 
$
90.0

Net income per share
 
 
 
Basic
$
0.58

 
$
0.67

Diluted
$
0.58

 
$
0.66

Dividends declared per common share
$
0.35

 
$
0.35

   











See accompanying condensed notes to consolidated financial statements

3


KAR Auction Services, Inc.
Consolidated Statements of Comprehensive Income
(In millions)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2019
 
2018
Net income
$
77.8

 
$
90.0

Other comprehensive income (loss)
 
 
 
Foreign currency translation gain (loss)
8.1

 
(6.9
)
Comprehensive income
$
85.9

 
$
83.1

   




























See accompanying condensed notes to consolidated financial statements

4


KAR Auction Services, Inc.
Consolidated Balance Sheets
(In millions)
(Unaudited)
 
March 31,
2019
 
December 31,
2018
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
265.6

 
$
337.1

Restricted cash
24.3

 
27.6

Trade receivables, net of allowances of $13.7 and $12.0
962.5

 
765.6

Finance receivables, net of allowances of $14.3 and $14.0
1,974.8

 
2,000.8

Other current assets
233.0

 
183.1

Total current assets
3,460.2

 
3,314.2

Other assets
 
 
 
Goodwill
2,374.0

 
2,213.7

Customer relationships, net of accumulated amortization of $893.8 and $873.7
311.7

 
302.3

Other intangible assets, net of accumulated amortization of $424.8 and $403.5
366.4

 
358.5

Operating lease right-of-use assets
942.5

 

Other assets
41.0

 
41.3

Total other assets
4,035.6

 
2,915.8

Property and equipment, net of accumulated depreciation of $825.8 and $856.6
828.3

 
976.2

Total assets
$
8,324.1

 
$
7,206.2

   

















See accompanying condensed notes to consolidated financial statements

5


KAR Auction Services, Inc.
Consolidated Balance Sheets
(In millions, except share and per share data)
(Unaudited)
 
March 31,
2019
 
December 31,
2018
Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
997.8

 
$
820.3

Accrued employee benefits and compensation expenses
86.4

 
102.5

Accrued interest
23.0

 
7.9

Other accrued expenses
302.8

 
186.3

Income taxes payable
2.1

 
2.9

Dividends payable
46.6

 
46.5

Obligations collateralized by finance receivables
1,360.6

 
1,445.3

Current maturities of long-term debt
126.3

 
13.1

Total current liabilities
2,945.6

 
2,624.8

Non-current liabilities
 
 
 
Long-term debt
2,650.9

 
2,654.3

Deferred income tax liabilities
193.2

 
188.4

Operating lease liabilities
919.7

 

Other liabilities
112.2

 
274.5

Total non-current liabilities
3,876.0

 
3,117.2

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:
 

 
 

March 31, 2019: 133,261,444
 

 
 

December 31, 2018: 132,887,029
1.3

 
1.3

Additional paid-in capital
1,131.5

 
1,131.9

Retained earnings
422.9

 
392.3

Accumulated other comprehensive loss
(53.2
)
 
(61.3
)
Total stockholders' equity
1,502.5

 
1,464.2

Total liabilities and stockholders' equity
$
8,324.1

 
$
7,206.2









See accompanying condensed 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, 2018
132.9

 
$
1.3

 
$
1,131.9

 
$
392.3

 
$
(61.3
)
 
$
1,464.2

Cumulative effect adjustment for adoption of
ASC Topic 842, net of tax
 
 
 
 
 
 
1.1

 
 
 
1.1

Net income
 
 
 
 
 
 
77.8

 
 
 
77.8

Other comprehensive income
 
 
 
 
 
 
 
 
8.1

 
8.1

Issuance of common stock under stock plans
0.6

 
 
 
0.7

 
 
 
 
 
0.7

Surrender of RSUs for taxes
(0.2
)
 
 
 
(10.2
)
 
 
 
 
 
(10.2
)
Stock-based compensation expense
 
 
 
 
7.4

 
 
 
 
 
7.4

Dividends earned under stock plans
 
 
 
 
1.7

 
(1.7
)
 
 
 

Cash dividends declared to stockholders ($0.35 per share)
 
 
 
 
 
 
(46.6
)
 
 
 
(46.6
)
Balance at March 31, 2019
133.3

 
$
1.3

 
$
1,131.5

 
$
422.9

 
$
(53.2
)
 
$
1,502.5

 
 
Common
Stock
Shares
 
Common
Stock
Amount
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Balance at December 31, 2017
134.3

 
$
1.3

 
$
1,251.8

 
$
257.0

 
$
(25.2
)
 
$
1,484.9

Cumulative effect adjustment for adoption of
ASC Topic 606, net of tax
 
 
 
 
 
 
(3.0
)
 
 
 
(3.0
)
Net income
 
 
 
 
 
 
90.0

 
 
 
90.0

Other comprehensive loss
 
 
 
 
 
 
 
 
(6.9
)
 
(6.9
)
Issuance of common stock under stock plans
0.8

 
 
 
5.6

 
 
 
 
 
5.6

Surrender of RSUs for taxes
(0.1
)
 
 
 
(9.7
)
 
 
 
 
 
(9.7
)
Stock-based compensation expense
 
 
 
 
6.4

 
 
 
 
 
6.4

Dividends earned under stock plans
 
 
 
 
1.8

 
(1.8
)
 
 
 

Cash dividends declared to stockholders ($0.35 per share)
 
 
 
 
 
 
(47.2
)
 
 
 
(47.2
)
Balance at March 31, 2018
135.0

 
$
1.3

 
$
1,255.9

 
$
295.0

 
$
(32.1
)
 
$
1,520.1




















See accompanying condensed notes to consolidated financial statements

7


KAR Auction Services, Inc.
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2019
 
2018
Operating activities
 
 
 
Net income
$
77.8

 
$
90.0

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
66.1

 
70.3

Provision for credit losses
10.3

 
9.6

Deferred income taxes
3.4

 
2.4

Amortization of debt issuance costs
2.6

 
2.7

Stock-based compensation
7.4

 
6.4

Loss (gain) on disposal of fixed assets
0.1

 
(0.1
)
Other non-cash, net
4.2

 
(4.4
)
Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Trade receivables and other assets
(214.4
)
 
(249.9
)
Accounts payable and accrued expenses
136.2

 
225.3

Net cash provided by operating activities
93.7

 
152.3

Investing activities
 
 
 
Net decrease (increase) in finance receivables held for investment
18.6

 
(29.6
)
Acquisition of businesses (net of cash acquired)
(120.7
)
 
(23.3
)
Purchases of property, equipment and computer software
(54.0
)
 
(38.7
)
Proceeds from the sale of property and equipment
0.1

 
0.1

Net cash used by investing activities
(156.0
)
 
(91.5
)
Financing activities
 
 
 
Net increase in book overdrafts
38.4

 
23.1

Net increase in borrowings from lines of credit
108.8

 

Net decrease in obligations collateralized by finance receivables
(88.5
)
 
(3.0
)
Payments on long-term debt
(10.7
)
 

Payments on capital leases
(10.3
)
 
(7.8
)
Payments of contingent consideration and deferred acquisition costs

 
(3.0
)
Issuance of common stock under stock plans
0.7

 
5.6

Tax withholding payments for vested RSUs
(10.2
)
 
(9.7
)
Dividends paid to stockholders
(46.5
)
 
(47.0
)
Net cash used by financing activities
(18.3
)
 
(41.8
)
Effect of exchange rate changes on cash
5.8

 
(4.2
)
Net (decrease) increase in cash, cash equivalents and restricted cash
(74.8
)
 
14.8

Cash, cash equivalents and restricted cash at beginning of period
364.7

 
336.6

Cash, cash equivalents and restricted cash at end of period
$
289.9

 
$
351.4

Cash paid for interest, net of proceeds from interest rate caps
$
35.7

 
$
29.8

Cash paid for taxes, net of refunds
$
29.3

 
$
28.6










See accompanying condensed notes to consolidated financial statements

8


KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements
March 31, 2019 (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"), Nth Gen Software Inc. ("TradeRev"), ADESA Remarketing Limited (formerly known as GRS Remarketing Limited ("GRS" or "ADESA Remarketing Limited")) and CarsOnTheWeb ("COTW");
"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"), the $350 million, senior secured revolving credit facility due March 9, 2021 (the "revolving credit facility") and the $300 million, five-year senior secured revolving credit facility (the "2016 revolving credit facility"), the terms of which are set forth in the Credit Agreement. Term Loan B-2, Term Loan B-3 and the 2016 revolving credit facility were repaid in May 2017 with proceeds from Term Loan B-4, Term Loan B-5 and the senior notes (defined below);
"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");
"KAR Auction Services" refers to KAR Auction Services, Inc. and not to its subsidiaries; and
"Senior notes" refers to the 5.125% senior notes due 2025 ($950 million aggregate principal outstanding at March 31, 2019).
Business and Nature of Operations
As of March 31, 2019, we have a North American network of 75 ADESA whole car auction sites and 179 IAA salvage vehicle auction sites; in addition, we offer online auctions for both whole car and salvage vehicles. ADESA also includes TradeRev, an online automotive remarketing system where dealers can launch and participate in real-time vehicle auctions at any time, ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom and CarsOnTheWeb, an online wholesale vehicle auction marketplace in Continental Europe. IAA also includes HBC Vehicle Services Limited, which operates from 14 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.

9

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

ADESA has the second largest used vehicle auction network in North America, based upon the number of used vehicles sold through auctions annually, and also provides services such as inbound and outbound transportation logistics, reconditioning, vehicle inspection and certification, titling, administrative and collateral recovery services. ADESA is able to serve the diverse and multi-faceted needs of its customers through the wide range of services offered.
IAA is one of the leading providers of salvage vehicle auctions and related services. The salvage auctions facilitate the remarketing of damaged vehicles that are designated as total losses by insurance companies, recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made, purchased vehicles and older model vehicles donated to charity or sold by dealers in salvage auctions. The salvage auction business specializes in providing services such as 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 127 locations throughout the United States and Canada as of March 31, 2019. Floorplan financing supports independent used vehicle dealers in North America who purchase vehicles at ADESA, IAA, TradeRev, 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.
Potential Spin-off of IAA
In February 2018, the Company announced that its board of directors had approved a plan to pursue the separation of its salvage auction business, currently operated by IAA, through a spin-off. The Company also announced that the separation was subject to customary regulatory approvals, the execution of intercompany agreements between the Company and the new salvage auction company ("IAA Spinco"), final approval of the board of directors and other customary matters.
The Company expects to complete the spin-off in June 2019. The Company may, at any time and for any reason until the proposed transaction is complete, abandon, modify or change the terms of the spin-off. There can be no assurance as to whether or when the spin-off will occur. IAA Spinco filed its initial Registration Statement on Form 10 on June 28, 2018, Amendment No. 1 to its Registration Statement on Form 10 on August 30, 2018, Amendment No. 2 to its Registration Statement on Form 10 on November 20, 2018 and Amendment No. 3 to its Registration Statement on Form 10 on March 5, 2019.
Basis of Presentation
The accompanying unaudited condensed 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, 2018, as filed with the Securities and Exchange Commission on February 21, 2019. The 2018 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 the consolidated financial statements in conformity with U.S. GAAP requires management to make
estimates based in part on assumptions about current, and for some estimates, future economic and market conditions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the period. Although the current estimates contemplate
current conditions and expected future changes, as appropriate, it is reasonably possible that future conditions could differ from
these estimates, which could materially affect our results of operations and financial position. Among other effects, such
changes could result in future impairments of goodwill, intangible assets and long-lived assets, incremental losses on finance
receivables, additional allowances on accounts receivable and deferred tax assets and changes in litigation and other loss
contingencies.

10

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Leases
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, Leases (Topic 842), which replaces the existing lease guidance in Topic 840. The ASU is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use ("ROU") 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 continues to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income.
We adopted Topic 842 in the first quarter of 2019 and as permitted by ASU 2018-11, Leases (Topic 842): Targeted Improvements, we applied the new standard at the adoption date and recognized the cumulative-effect of initially applying the new standard as an increase of $1.1 million to the opening balance of retained earnings. The cumulative-effect adjustment related to the derecognition of existing fixed assets for which we were determined to be the accounting owner under Topic 840 and related liabilities associated with certain sale leaseback transactions in build-to-suit arrangements that did not qualify for sale accounting under Topic 840. Depreciation related to these fixed assets was recorded consistently with owned property and equipment in depreciation expense. In accordance with Topic 842, the lease agreements associated with the derecognized fixed assets and related liabilities generated ROU assets and lease liabilities that will be amortized to lease expense over the lease term. In addition, we recognized additional operating liabilities of approximately $1,026 million with related ROU assets of approximately $956 million based on the present value of the remaining minimum rental payments for existing operating leases.
Our Credit Agreement specifies that the net debt covenant shall continue to be calculated as if the accounting standard had not been adopted and that we could enter into negotiations to amend such provisions in the Credit Agreement so as to equitably reflect such changes with the desired result that the criteria for evaluating our financial condition would be the same after the change as if such change had not been made.
We determine if an arrangement is a lease at inception. Operating leases are included in “Operating lease right-of-use assets,” “Other accrued expenses” and “Operating lease liabilities” in our consolidated balance sheets. Finance leases are included in “Property and equipment, net,” “Other accrued expenses” and “Other liabilities” in our consolidated balance sheets.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and operating lease liabilities are recognized at the commencement date based on the present value of the lease payments over the lease term. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. The operating lease ROU assets also include any lease payments made and exclude lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, we account for the lease and non-lease components as a single lease component.
New Accounting Standards
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of ASU 2018-15 will have on the consolidated financial statements.


11

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

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 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. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the consolidated financial statements, however we do not expect that it will have a material impact based on the short-term nature of AFC's loans.
Note 2—Acquisitions
In January 2019, the Company completed the acquisition of Dent-ology. Dent-ology enhances our mobile reconditioning capabilities and bolsters our offerings to include wheel repair and expanded hail catastrophe response services.
In January 2019, the Company also completed the acquisition of CarsOnTheWeb. COTW is an online auction company serving the wholesale vehicle sector in Continental Europe that seamlessly connects OEMs, fleet owners, wholesalers and dealers. The acquisition advances KAR’s international strategy and extends its strong North American and U.K.-based portfolio of physical, online and digital auction marketplaces.
Certain of the purchase agreements included additional payments over a specified period contingent on certain terms, conditions and performance. The purchased assets included accounts receivable, inventory, property and equipment, customer relationships, tradenames and software. 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 quarter of 2019, net of cash acquired, was approximately $193.5 million, which included net cash payments of $120.7 million, deferred payments with a fair value of $19.7 million and estimated contingent payments with a fair value of $53.1 million. The maximum amount of undiscounted deferred payments and undiscounted contingent payments related to these acquisitions could approximate $77.0 million. The purchase price for the acquired businesses was allocated to acquired assets and liabilities based upon fair values, including $33.4 million to intangible assets, representing the fair value of acquired customer relationships of $27.0 million, software of $4.3 million and tradenames of $2.1 million, which are being amortized over their expected useful lives. The purchase accounting associated with these acquisitions is preliminary, subject to final valuation results. The acquisitions resulted in aggregate goodwill of $160.5 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 for the three months ended March 31, 2019.


12

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

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 and/or cash-based awards to our executive officers and key 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 determined that the KAR Auction Services, Inc. PRSUs, RSUs and service options should be classified as equity awards.
The following table summarizes our stock-based compensation expense by type of award (in millions):
 
Three Months Ended March 31,
 
2019
 
2018
PRSUs
$
3.8

 
$
3.4

RSUs
3.6

 
2.9

Service options

 
0.1

Total stock-based compensation expense
$
7.4

 
$
6.4


PRSUs and RSUs
In the three months ended March 31, 2019, we granted a target amount of approximately 0.3 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 cumulative operating adjusted net income 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 $47.06 per share, which was determined using the closing price of the Company's common stock on the dates of grant.
Share Repurchase Program
In October 2016, the board of directors authorized a repurchase of up to $500 million of the Company’s outstanding common stock, par value $0.01 per share, through October 26, 2019. Repurchases may be made in the open market or through privately negotiated transactions, in accordance with applicable securities laws and regulations, including pursuant to repurchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing and amount of any repurchases is subject to market and other conditions. No shares of common stock were repurchased during the three months ended March 31, 2019. In 2018, we repurchased and retired 2,695,978 shares of common stock in the open market at a weighted average price of $55.64 per share under the October 2016 authorization.

13

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

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 
 March 31,
 
2019
 
2018
Net income
$
77.8

 
$
90.0

Weighted average common shares outstanding
133.1

 
134.6

Effect of dilutive stock options and restricted stock awards
0.7

 
1.2

Weighted average common shares outstanding and potential common shares
133.8

 
135.8

Net income per share
 
 
 
Basic
$
0.58

 
$
0.67

Diluted
$
0.58

 
$
0.66

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 each of the three months ended March 31, 2019 and 2018. In addition, approximately 0.8 million and 0.7 million PRSUs were excluded from the calculation of diluted net income per share for the three months ended March 31, 2019 and 2018, respectively. Total options outstanding at March 31, 2019 and 2018 were 1.0 million and 1.6 million, respectively.
Note 5—Finance Receivables and Obligations Collateralized by Finance Receivables
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to a wholly-owned, bankruptcy remote, consolidated, special purpose subsidiary ("AFC Funding Corporation"), established for the purpose of purchasing AFC's finance receivables. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires on January 28, 2022. AFC Funding Corporation had committed liquidity of $1.70 billion for U.S. finance receivables at March 31, 2019.
We also have an agreement for the securitization of Automotive Finance Canada Inc.'s ("AFCI") receivables which expires on January 28, 2022. AFCI's committed facility is provided through a third-party conduit (separate from the U.S. facility) and was C$175 million at March 31, 2019. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.

14

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

The following tables present quantitative information about delinquencies, credit losses less recoveries ("net credit losses") and components of securitized financial assets and other related assets managed. For purposes of this illustration, delinquent receivables are defined as receivables 31 days or more past due.
 
March 31, 2019
 
Net Credit Losses
Three Months Ended
March 31, 2019
 
Total Amount of:
 
(in millions)
Receivables
 
Receivables
Delinquent
 
Floorplan receivables
$
1,976.4

 
$
15.5

 
$
8.0

Other loans
12.7

 

 

Total receivables managed
$
1,989.1

 
$
15.5

 
$
8.0


 
December 31, 2018
 
Net Credit Losses
Three Months Ended
March 31, 2018
 
Total Amount of:
 
(in millions)
Receivables
 
Receivables
Delinquent
 
Floorplan receivables
$
2,001.9

 
$
15.9

 
$
7.4

Other loans
12.9

 

 

Total receivables managed
$
2,014.8

 
$
15.9

 
$
7.4


AFC's allowance for losses was $14.3 million and $14.0 million at March 31, 2019 and December 31, 2018, respectively.
As of March 31, 2019 and December 31, 2018, $1,916.4 million and $1,973.2 million, respectively, of finance receivables and a cash reserve of 1 percent of the obligations collateralized by finance receivables served as security for the obligations collateralized by finance receivables. Obligations collateralized by finance receivables consisted of the following:
 
March 31,
2019
 
December 31,
2018
Obligations collateralized by finance receivables, gross
$
1,378.5

 
$
1,464.7

Unamortized securitization issuance costs
(17.9
)
 
(19.4
)
Obligations collateralized by finance receivables
$
1,360.6

 
$
1,445.3

Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At March 31, 2019, we were in compliance with the covenants in the securitization agreements.

15

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Note 6—Long-Term Debt
Long-term debt consisted of the following (in millions):
 
Interest Rate*
 
Maturity
 
March 31,
2019
 
December 31,
2018
Term Loan B-4
Adjusted LIBOR
 
+ 2.25%
 
March 11, 2021
 
$
704.4

 
$
704.4

Term Loan B-5
Adjusted LIBOR
 
+ 2.50%
 
March 9, 2023
 
1,031.5

 
1,031.5

Revolving credit facility
Adjusted LIBOR
 
+ 2.0%
 
March 9, 2021
 
93.5

 

Senior notes
 
 
5.125%
 
June 1, 2025
 
950.0

 
950.0

European lines of credit
Euribor
 
+ 1.25%
 
Repayable upon demand
 
15.3

 

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

 

Total debt
 
 
 
 
 
 
2,794.7

 
2,685.9

Unamortized debt issuance costs
 
 
 
 
 
 
(17.5
)
 
(18.5
)
Current portion of long-term debt
 
 
 
 
 
 
(126.3
)
 
(13.1
)
Long-term debt
 
 
 
 
 
 
$
2,650.9

 
$
2,654.3

*The interest rates presented in the table above represent the rates in place at March 31, 2019.
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").
The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate purposes. The Company also pays a commitment fee of 30 to 35 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility. The rates on Term Loan B-4 and Term Loan B-5 were 4.88% and 5.13% at March 31, 2019, respectively.
The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in 100% of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and 65% of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions. The Credit Agreement contains affirmative and negative covenants that we believe are usual and customary for a senior secured credit agreement. The negative covenants include, among other things, limitations on asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with our affiliates. The Credit Agreement also requires us to maintain a maximum leverage ratio, provided there are revolving loans outstanding. We were in compliance with the covenants in the Credit Agreement at March 31, 2019.
On March 31, 2019, $93.5 million was drawn on the revolving credit facility and there were no borrowings on the revolving credit facility at December 31, 2018. In addition, we had related outstanding letters of credit in the aggregate amount of $32.9 million at March 31, 2019 and December 31, 2018, which reduce the amount available for borrowings under the revolving credit facility. The $93.5 million of outstanding borrowings under the revolving credit facility have been classified as current debt as the Company intends to repay the outstanding borrowings within the next twelve months.

16

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

European Lines of Credit

COTW has lines of credit aggregating €30 million. The lines of credit have an interest rate of Euribor plus 1.25% and had an aggregate $15.3 million of borrowings outstanding at March 31, 2019. The lines of credit are guaranteed by certain COTW subsidiaries. In addition, as part of the acquisition of COTW, we assumed debt of approximately $10.7 million which was paid off in the first quarter of 2019.

Fair Value of Debt
As of March 31, 2019, the estimated fair value of our long-term debt amounted to $2,785.3 million. The estimates of fair value were based on broker-dealer quotes for our debt as of March 31, 2019. 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 7—Derivatives
We are exposed to interest rate risk on our variable rate borrowings. Accordingly, interest rate fluctuations affect the amount of interest expense we are obligated to pay. We use interest rate derivatives with the objective of managing exposure to interest rate movements, thereby reducing the effect of interest rate changes and the effect they could have on future cash flows. Currently, interest rate cap agreements are used to accomplish this objective.
In August 2017, we entered into two interest rate caps with an aggregate notional amount of $800 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 September 30, 2017 and each mature on September 30, 2019. We paid an aggregate amount of approximately $1.0 million for the caps in August 2017.
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 exceeded 2.0%. The interest rate cap agreements each had an effective date of March 31, 2017 and each matured on March 31, 2019. We paid an aggregate amount of approximately $0.7 million for the caps in April 2017.
We are exposed to credit loss in the event of non-performance by the counterparties; however, non-performance is not anticipated. ASC 815, Derivatives and Hedging, requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. The fair values of the interest rate derivatives are based on quoted market prices for similar instruments from commercial banks. The following table presents the fair value of our interest rate derivatives included in the consolidated balance sheets for the periods presented (in millions):
 
 
Asset Derivatives
 
 
March 31, 2019
 
December 31, 2018
Derivatives Not Designated as Hedging Instruments
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
2017 Interest rate caps
 
Other assets
 
$
2.3

 
Other assets
 
$
5.2

We have not designated any of the interest rate caps as hedges for accounting purposes. Accordingly, changes in the fair value of the interest rate caps are recognized as "Interest expense" in the consolidated statement of income. The following table presents the effect of the interest rate derivatives on our consolidated statements of income for the periods presented (in millions):
 
 
Location of Gain / (Loss) Recognized in Income on Derivatives
 
Amount of Gain / (Loss)
Recognized in Income on Derivatives
 
 
 
Three Months Ended 
 March 31,
Derivatives Not Designated as Hedging Instruments
 
 
2019
 
2018
2017 Interest rate caps
 
Interest expense
 
$
(0.5
)
 
$
4.7


17

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Note 8—Leases

We lease property, software, automobiles, trucks and trailers pursuant to operating lease agreements. We also lease furniture, fixtures and equipment under finance leases. Our leases have varying remaining lease terms with leases expiring through 2038, some of which include options to extend the leases.

The components of lease expense were as follows (in millions):
 
Three Months Ended
March 31,
2019
Operating lease cost
$
42.0

Finance lease cost:
 
   Amortization of right-of-use assets
$
7.6

   Interest on lease liabilities
0.7

Total finance lease cost
$
8.3


Supplemental cash flow information related to leases was as follows (in millions):
 
Three Months Ended
March 31,
2019
Cash paid for amounts included in the measurement of lease liabilities:
 
   Operating cash flows related to operating leases
$
41.0

   Operating cash flows related to finance leases
0.7

   Financing cash flows related to finance leases
10.3

Right-of-use assets obtained in exchange for lease obligations:
 
   Operating leases
14.4

   Finance leases
1.7



18

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Supplemental balance sheet information related to leases was as follows (in millions, except lease term and discount rate):
 
March 31,
2019
Operating Leases
 
Operating lease right-of-use assets
$
942.5

Other accrued expenses
$
94.3

Operating lease liabilities
919.7

Total operating lease liabilities
$
1,014.0

Finance Leases
 
Property and equipment, gross
$
205.2

Accumulated depreciation
(146.3
)
Property and equipment, net
$
58.9

Other accrued expenses
$
21.9

Other liabilities
25.1

Total finance lease liabilities
$
47.0

Weighted Average Remaining Lease Term
 
Operating leases
11.8 years

Finance leases
2.2 years

Weighted Average Discount Rate
 
Operating leases
6.1
%
Finance leases
4.6
%

Maturities of lease liabilities as of March 31, 2019 were as follows (in millions):
 
Operating
Leases
 
Finance Leases
2019 (excluding the three months ended March 31, 2019)
$
117.3

 
$
23.6

2020
141.7

 
16.3

2021
132.0

 
9.6

2022
121.0

 
0.3

2023
109.8

 
0.1

Thereafter
834.9

 

Total lease payments
1,456.7

 
49.9

Less imputed interest
(442.7
)
 
(2.9
)
Total
$
1,014.0

 
$
47.0


As of March 31, 2019, we have additional operating leases of approximately $67.5 million that have not yet commenced. These leases, primarily for facilities, are expected to commence in the next 12 months with lease terms up to 15 years.

19

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

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, 2018.
Note 10—Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following (in millions):
 
March 31,
2019
 
December 31,
2018
Foreign currency translation loss
$
(53.3
)
 
$
(61.4
)
Unrealized gain on postretirement benefit obligation, net of tax
0.1

 
0.1

Accumulated other comprehensive loss
$
(53.2
)
 
$
(61.3
)

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.

20

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Financial information regarding our reportable segments is set forth below as of and for the three months ended March 31, 2019 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
599.7

 
$
357.2

 
$
89.9

 
$

 
$
1,046.8

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
370.7

 
218.4

 
23.2

 

 
612.3

Selling, general and administrative
126.6

 
31.3

 
7.2

 
42.5

 
207.6

Depreciation and amortization          
35.0

 
21.8

 
2.4

 
6.9

 
66.1

Total operating expenses
532.3

 
271.5

 
32.8

 
49.4

 
886.0

Operating profit (loss)
67.4

 
85.7

 
57.1

 
(49.4
)
 
160.8

Interest expense
0.7

 

 
17.1

 
39.1

 
56.9

Other (income) expense, net
(1.9
)
 
0.1

 
(0.1
)
 
(0.1
)
 
(2.0
)
Intercompany expense (income)
10.3

 
10.0

 
(1.2
)
 
(19.1
)
 

Income (loss) before income taxes
58.3

 
75.6

 
41.3

 
(69.3
)
 
105.9

Income taxes
15.9

 
19.2

 
10.8

 
(17.8
)
 
28.1

Net income (loss)
$
42.4

 
$
56.4

 
$
30.5

 
$
(51.5
)
 
$
77.8

Total assets
$
3,797.0

 
$
2,022.5

 
$
2,406.1

 
$
98.5

 
$
8,324.1

Financial information regarding our reportable segments is set forth below as of and for the three months ended March 31, 2018 (in millions):
 
ADESA
Auctions
 
IAA
 
AFC
 
Holding
Company
 
Consolidated
Operating revenues
$
528.1

 
$
337.3

 
$
85.1

 
$

 
$
950.5

Operating expenses
 
 
 
 
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
306.0

 
206.7

 
22.3

 

 
535.0

Selling, general and administrative
108.8

 
30.5

 
8.0

 
40.1

 
187.4

Depreciation and amortization          
31.2

 
24.1

 
7.8

 
7.2

 
70.3

Total operating expenses
446.0

 
261.3

 
38.1

 
47.3

 
792.7

Operating profit (loss)
82.1

 
76.0

 
47.0

 
(47.3
)
 
157.8

Interest expense
0.6

 

 
13.4

 
27.5

 
41.5

Other (income) expense, net
(0.3
)
 

 

 
0.2

 
(0.1
)
Intercompany expense (income)
12.1

 
9.4

 
(0.5
)
 
(21.0
)
 

Income (loss) before income taxes
69.7

 
66.6

 
34.1

 
(54.0
)
 
116.4

Income taxes
15.5

 
16.3

 
8.4

 
(13.8
)
 
26.4

Net income (loss)
$
54.2

 
$
50.3

 
$
25.7

 
$
(40.2
)
 
$
90.0

Total assets
$
3,278.5

 
$
1,465.1

 
$
2,329.9

 
$
192.7

 
$
7,266.2


21

KAR Auction Services, Inc.
Condensed Notes to Consolidated Financial Statements (Continued)
March 31, 2019 (Unaudited)

Geographic Information
Our foreign operations include Canada, Mexico, Continental Europe and the U.K. Most of our operations outside the U.S. are in Canada. Approximately 73% and 89% of our foreign operating revenues were from Canada for the three months ended March 31, 2019 and 2018, respectively. Information regarding the geographic areas of our operations is set forth below (in millions):
 
Three Months Ended 
 March 31,
 
2019
 
2018
Operating revenues
 
 
 
U.S. 
$
894.2

 
$
828.6

Foreign
152.6

 
121.9

 
$
1,046.8

 
$
950.5


22


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; the potential spin-off of our salvage auction business; anticipated cost savings, revenue increases, credit losses and capital expenditures; dividend declarations and payments; common stock repurchases; tax rates and assumptions; 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 the section entitled "Risk Factors" in this Quarterly Report on Form 10-Q and Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2018, filed on February 21, 2019. Some of these factors include:
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;
our ability to successfully implement our business strategies or realize expected cost savings and revenue enhancements;
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;
any losses of key personnel;
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;

23


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;
the taxable nature of the potential spin-off of our salvage auction business (as described further below) and our ability to successfully complete the spin-off within the expected time frame or at all;
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 75 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 TradeRev, an online automotive remarketing system where dealers can launch and participate in real-time vehicle auctions at any time, ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom and CarsOnTheWeb, an online wholesale vehicle auction marketplace in Continental Europe.

24


The IAA segment serves a domestic and international customer base through live and online auctions and through 179 salvage vehicle auction sites in the United States and Canada at March 31, 2019. IAA also includes HBC, which operates from 14 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. Another important component of the IAA service offering is the ability to process large volumes of total loss vehicles in a short period of time following catastrophic events such as hurricanes, tornadoes, floods, hail storms, fires or other natural disasters.
The AFC segment provides short-term, inventory-secured financing, known as floorplan financing, primarily to independent used vehicle dealers. At March 31, 2019, AFC conducted business at 127 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.
Potential Spin-off of IAA
In February 2018, the Company announced that its board of directors had approved a plan to pursue the separation of its salvage auction business, currently operated by IAA, through a spin-off. The Company also announced that the separation was subject to customary regulatory approvals, the execution of intercompany agreements between the Company and IAA Spinco, final approval of the board of directors and other customary matters. The Company continues to work on and evaluate the spin-off and the options available to the Company for maximizing shareholder value. While at this time the Company expects to complete the spin-off in June 2019, the Company may, at any time and for any reason until the proposed transaction is complete, abandon, modify or change the terms of the spin-off.
It is currently expected that IAA Spinco will have total net debt of approximately 3.5 times Adjusted EBITDA. The actual amount of debt that will be issued by IAA Spinco will be determined at a future date when capital is raised for IAA Spinco. This is subject to approval by the board of directors at the time of the issuance of debt and completion of the spin-off. The total net leverage levels for IAA Spinco and KAR are expected to maintain the current corporate debt rating of BB-/B1 currently held by KAR for both entities. The Company expects to provide additional information on the expected dividend policies and the target leverage levels of each enterprise as we get closer to completion of the spin-off. There can be no assurance as to whether or when the spin-off will occur. IAA Spinco filed its initial Registration Statement on Form 10 on June 28, 2018, Amendment No. 1 to its Registration Statement on Form 10 on August 30, 2018, Amendment No. 2 to its Registration Statement on Form 10 on November 20, 2018 and Amendment No. 3 to its Registration Statement on Form 10 on March 5, 2019.
Industry Trends
Whole Car
Used vehicles sold in North America through whole car auctions, including online only sales, were approximately 10.6 million and 11.1 million in 2016 and 2017, respectively. Data for the whole car auction industry is collected by the NAAA through an annual survey. The NAAA industry volumes collected by the annual survey do not include online only volumes or mobile application volumes (e.g. Openlane and TradeRev). We have included online only volumes in the totals above for 2016 and 2017. Used vehicle auction volumes in North America in 2018 were approximately 11.5 million vehicles, including online only volumes and mobile application volumes. We expect that used vehicle auction volumes in North America, including online only volumes and mobile application volumes, will be over 11 million units in 2019, 2020 and 2021. Our estimates are based on information from the Bureau of Economic Analysis, IHS Automotive, Kontos Total Market Estimates, NAAA's annual survey and management estimates.
In addition to the traditional whole car auction market described above, which we estimate has sold near 11 million units in each of the last few years, mobile applications, such as TradeRev, may provide an opportunity to expand our total addressable market for whole car by approximately 5 million units. We are incurring costs to grow TradeRev in the U.S. and Canada. TradeRev incurred operating losses of $16.8 million and $11.1 million for the three months ended March 31, 2019 and 2018, respectively.

25


Salvage
Vehicles deemed a total loss by automobile insurance companies represent the largest category of vehicles sold in the salvage vehicle auction industry. Based on data from CCC Information Services, the percentage of claims resulting in total losses was approximately 18% in 2018, 18% in 2017 and 17% in 2016. 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, for the foreseeable future.
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, proceeds, revenue and gross profit at salvage auctions may be negatively impacted, which could adversely affect the level of profitability. During the first three months of 2019, the price per ton of crushed auto bodies in North America ranged from $177 to $179 and finished March 2019 at $178. In comparison, for the year ended December 31, 2018, the price per ton of crushed auto bodies in North America ranged from $187 to $215.
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. AFC's North American dealer base was comprised of approximately 15,800 dealers in 2018, and loan transactions, which includes both loans paid off and loans curtailed, were approximately 1.8 million in 2018.
Key challenges for the independent used vehicle dealer include demand for used vehicles, disruptions in pricing of used vehicle inventory, lack of access to consumer financing and increased competition resulting from consolidation in the used vehicle dealer industry. 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.
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.

26


Results of Operations
Overview of Results of KAR Auction Services, Inc. for the Three Months Ended March 31, 2019 and 2018:
 
Three Months Ended 
 March 31,
(Dollars in millions except per share amounts)
2019
 
2018
Revenues
 
 
 
ADESA
$
599.7

 
$
528.1

IAA
357.2

 
337.3

AFC
89.9

 
85.1

Total revenues
1,046.8

 
950.5

Cost of services*
612.3

 
535.0

Gross profit*
434.5

 
415.5

Selling, general and administrative
207.6

 
187.4

Depreciation and amortization
66.1

 
70.3

Operating profit
160.8

 
157.8

Interest expense
56.9

 
41.5

Other income, net
(2.0
)
 
(0.1
)
Income before income taxes
105.9

 
116.4

Income taxes
28.1

 
26.4

Net income
$
77.8

 
$
90.0

Net income per share
 
 
 
Basic
$
0.58

 
$
0.67

Diluted
$
0.58

 
$
0.66


* Exclusive of depreciation and amortization
Overview
For the three months ended March 31, 2019, we had revenue of $1,046.8 million compared with revenue of $950.5 million for the three months ended March 31, 2018, an increase of 10%. Businesses acquired accounted for an increase in revenue of $31.8 million or 3% of revenue. 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 decreased $4.2 million, or 6%, to $66.1 million for the three months ended March 31, 2019, compared with $70.3 million for the three months ended March 31, 2018. The decrease in depreciation and amortization was primarily the result of certain intangible assets that became fully amortized in the first quarter of 2019 and an approximately $2 million decrease resulting from the derecognition of fixed assets associated with certain sale leaseback transactions associated with the adoption of Topic 842, partially offset by certain assets placed in service over the last twelve months and depreciation and amortization for the assets of businesses acquired in 2018 and 2019.
Interest Expense
Interest expense increased $15.4 million, or 37%, to $56.9 million for the three months ended March 31, 2019, compared with $41.5 million for the three months ended March 31, 2018. The increase was primarily attributable to an increase of approximately $121 million in the average outstanding balance of corporate debt for the three months ended March 31, 2019 compared with the three months ended March 31, 2018, as well as an increase in the weighted average interest rate for the same period of approximately 0.71%. In addition, there was an increase in interest expense at AFC of $3.7 million, which resulted from an increase in interest rates under the U.S. securitization agreement for the three months ended March 31, 2019, as compared with the three months ended March 31, 2018. The increases in interest expense were partially offset by $2.4 million received from the counterparties to the interest rate cap agreements.


27



Income Taxes
We had an effective tax rate of 26.5% for the three months ended March 31, 2019, compared with an effective tax rate of 22.7% for the three months ended March 31, 2018. Excluding the effect of discrete items, our effective tax rate for the three months ended March 31, 2019 and 2018 would have been 28.2% and 27.5%, respectively.
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 March 31, 2019, fluctuations in the Canadian exchange rate decreased revenue by $5.5 million, operating profit by $1.1 million, net income by $0.6 million and net income per diluted share by less than $0.01.
ADESA Results
 
Three Months Ended 
 March 31,
(Dollars in millions, except per vehicle amounts)
2019
 
2018
ADESA revenue
$
599.7

 
$
528.1

Cost of services*
370.7

 
306.0

Gross profit*
229.0

 
222.1

Selling, general and administrative
126.6

 
108.8

Depreciation and amortization
35.0

 
31.2

Operating profit
$
67.4

 
$
82.1

Vehicles sold
945,000

 
878,000

   Physical auction vehicles sold in North America
555,000

 
557,000

   Online only vehicles sold in North America
367,000

 
309,000

   Vehicles sold in Europe
23,000

 
12,000

   Dealer consignment mix at physical auctions
38
%
 
41
%
   Conversion rate at North American physical auctions
63.8
%
 
62.6
%
Physical auction revenue per vehicle sold, excluding purchased vehicles
$
875

 
$
820

Online only revenue per vehicle sold, excluding purchased vehicles
$
144

 
$
117


* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA increased $71.6 million, or 14%, to $599.7 million for the three months ended March 31, 2019, compared with $528.1 million for the three months ended March 31, 2018. The increase in revenue was primarily a result of an 8% increase in the number of vehicles sold (6% increase excluding acquisitions) and average revenue per vehicle sold increased 5%. Businesses acquired in the last 12 months accounted for an increase in revenue of $31.8 million.
The increase in vehicles sold was primarily attributable to a 12% increase in institutional volume, including vehicles sold on our online only platform, partially offset by a 3% decrease in dealer consignment units sold (5% decrease excluding acquisitions) for the three months ended March 31, 2019 compared with the three months ended March 31, 2018. Online sales volume for ADESA represented approximately 57% of the total vehicles sold in the first quarter of 2019, compared with approximately 52% in the first quarter of 2018. "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) vehicles sold on the TradeRev platform; (iv) vehicle sales in Europe, including units sold by COTW; (v) simultaneously broadcasting video and audio of the physical auctions to online bidders (LiveBlock®); and (vi) bulletin-board or real-time online auctions (DealerBlock®). Upstream selling, midstream selling and TradeRev sales, which represent online only sales, accounted for approximately 71% of ADESA's North American online sales volume. ADESA sold approximately 367,000 (including approximately 31,000 from TradeRev) and 309,000 (including approximately 22,000 from TradeRev) vehicles through its North American online only offerings in the first quarter of 2019 and 2018, respectively. For the three months ended March 31, 2019, dealer consignment vehicles represented approximately 38% of used vehicles sold at ADESA physical auction locations, compared with approximately 41% for the three months ended March 31, 2018. Vehicles

28


sold at physical auction locations in the first quarter of 2019 were consistent with the first quarter of 2018. 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 63.8% for the three months ended March 31, 2019, compared with 62.6% for the three months ended March 31, 2018.
Physical auction revenue per vehicle sold increased $55, or 7%, to $875 for the three months ended March 31, 2019, compared with $820 for the three months ended March 31, 2018. Physical auction revenue per vehicle sold includes revenue from seller and buyer auction fees and ancillary and other related services, which includes non-auction services and excludes the sale of purchased vehicles. The increase in physical auction revenue per vehicle sold was primarily attributable to an increase in lower margin ancillary and other related services revenue and auction fees related to higher average transaction prices, 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 increased $75 to $206 for the three months ended March 31, 2019, compared with $131 for the three months ended March 31, 2018. The increase in online only auction revenue per vehicle sold was attributable to an increase in purchased vehicles associated with the ADESA Assurance Program and the inclusion of TradeRev and CarsOnTheWeb sales. Excluding vehicles purchased as part of the ADESA Assurance Program and vehicles purchased by CarsOnTheWeb, online only revenue per vehicle would have been $144 and $117 for the three months ended March 31, 2019 and 2018, respectively. The $27 increase in online only revenue per vehicle was attributable to increased revenue per vehicle for units sold on the TradeRev platform and the addition of CarsOnTheWeb.
Gross Profit
For the three months ended March 31, 2019, gross profit for ADESA increased $6.9 million, or 3%, to $229.0 million, compared with $222.1 million for the three months ended March 31, 2018. Gross profit for ADESA was 38.2% of revenue for the three months ended March 31, 2019, compared with 42.1% of revenue for the three months ended March 31, 2018. Gross profit as a percentage of revenue decreased for the three months ended March 31, 2019 as compared with the three months ended March 31, 2018 as a result of an increase in purchase vehicles primarily related to the acquisition of COTW and increased activity under ADESA Assurance, as well as an increase in lower margin related services. Excluding purchased vehicles, gross profit as a percentage of revenue was 42.2% and 44.2% for the three months ended March 31, 2019 and 2018, respectively. Businesses acquired in the last 12 months accounted for an increase in cost of services of $26.9 million for the three months ended March 31, 2019.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment increased $17.8 million, or 16%, to $126.6 million for the three months ended March 31, 2019, compared with $108.8 million for the three months ended March 31, 2018, primarily due to increases in costs associated with TradeRev aggregating $8.0 million, acquisitions of $4.6 million, compensation expense of $2.7 million, incentive-based compensation $1.8 million, information technology costs of $1.5 million, benefit related expense of $0.6 million, and other miscellaneous expenses aggregating $1.0 million, partially offset by fluctuations in the Canadian exchange rate of $1.2 million and a decrease in supplies expense of $1.2 million.
IAA Results
 
Three Months Ended 
 March 31,
(Dollars in millions)
2019
 
2018
IAA revenue
$
357.2

 
$
337.3

Cost of services*
218.4

 
206.7

Gross profit*
138.8

 
130.6

Selling, general and administrative
31.3

 
30.5

Depreciation and amortization
21.8

 
24.1

Operating profit
$
85.7

 
$
76.0

Vehicles sold
649,000

 
643,000


* Exclusive of depreciation and amortization

29


Revenue
Revenue from IAA increased $19.9 million, or 6%, to $357.2 million for the three months ended March 31, 2019, compared with $337.3 million for the three months ended March 31, 2018. The increase in revenue was a result of an increase in vehicles sold of approximately 1% for the three months ended March 31, 2019. Revenue per vehicle sold increased 5% for the three months ended March 31, 2019 compared with the three months ended March 31, 2018, and included a decrease in revenue of $1.8 million due to fluctuations in the Canadian exchange rate, as well as a decrease in revenue of $1.5 million from HBC, which included a decrease in revenue of $0.6 million due to fluctuations in the U.K. exchange rate. IAA's North American same-store total loss vehicle inventory increased approximately 10% at March 31, 2019, as compared to March 31, 2018. Vehicles sold under purchase agreements were approximately 4% of total salvage vehicles sold for the three months ended March 31, 2019 and 2018. North American online sales volumes for IAA for the three months ended March 31, 2019 and 2018 each represented over 60% of the total vehicles sold by IAA.
Gross Profit
For the three months ended March 31, 2019, gross profit at IAA increased to $138.8 million, or 38.9% of revenue, compared with $130.6 million, or 38.7% of revenue, for the three months ended March 31, 2018. The increase in gross profit was mainly attributable to a 6% increase in revenue, partially offset by a 6% increase in cost of services, which included costs associated with purchase contract vehicles, additional lease expense related to lease agreements previously impacting depreciation expense and organic volume growth. 
Excluding HBC, IAA's gross profit margin was 39.3% and 39.2% for the three months ended March 31, 2019 and 2018, respectively. For the three months ended March 31, 2019 and 2018, HBC had revenue of approximately $8.2 million and $9.7 million, respectively, and cost of services of approximately $6.5 million and $7.6 million, respectively, as fewer of HBC's vehicles were sold under purchase contracts. The entire selling and purchase price of the vehicle is recorded as revenue and cost of services for purchase contracts.
Selling, General and Administrative
Selling, general and administrative expenses at IAA increased $0.8 million, or 3%, to $31.3 million for the three months ended March 31, 2019, compared with $30.5 million for the three months ended March 31, 2018. The increase in selling, general and administrative expenses was primarily attributable to increases in compensation expense of $0.8 million and other miscellaneous expenses aggregating $0.6 million, partially offset by a decrease in incentive-based compensation expense of $0.6 million.
AFC Results
 
Three Months Ended 
 March 31,
(Dollars in millions except volumes and per loan amounts)
2019
 
2018
AFC revenue
 
 
 
Interest and fee income
$
86.9

 
$
81.9

Other revenue
2.8

 
2.9

Provision for credit losses
(8.2
)
 
(7.7
)
Other service revenue
8.4

 
8.0

Total AFC revenue
89.9

 
85.1

Cost of services*
23.2

 
22.3

Gross profit*
66.7

 
62.8

Selling, general and administrative
7.2

 
8.0

Depreciation and amortization
2.4

 
7.8

Operating profit
$
57.1

 
$
47.0

Loan transactions
461,000

 
464,000

Revenue per loan transaction, excluding "Other service revenue"
$
177

 
$
166


* Exclusive of depreciation and amortization

30


Revenue
For the three months ended March 31, 2019, AFC revenue increased $4.8 million, or 6%, to $89.9 million, compared with $85.1 million for the three months ended March 31, 2018. The increase in revenue was primarily the result of a 7% increase in revenue per loan transaction.
Revenue per loan transaction, which includes both loans paid off and loans curtailed, increased $11, or 7%. Approximately $12 of the increase in revenue per loan transaction was the result of increases in interest yield and fee revenue as a result of prime rate increases, as well as an increase in average loan values. The increase in provision for credit losses, which is a reduction of revenue, resulted in a decrease in revenue per loan transaction of $1 for the three months ended March 31, 2019. Revenue per loan transaction excludes "Other service revenue."
The provision for credit losses remained constant at 1.6% of the average managed receivables for the three months ended March 31, 2019 and 2018. The provision for credit losses is expected to be under 2%, annually, of the average managed receivables balance. However, the actual losses in any particular quarter could deviate from this range.
Gross Profit
For the three months ended March 31, 2019, gross profit for the AFC segment increased $3.9 million, or 6%, to $66.7 million, or 74.2% of revenue, compared with $62.8 million, or 73.8% of revenue, for the three months ended March 31, 2018, primarily as a result of a 6% increase in revenue, partially offset by a 4% increase in cost of services. The increase in cost of services was the result of increases in PWI expenses of $0.6 million, compensation expense of $0.3 million and other miscellaneous expenses aggregating $0.4 million, partially offset by a decrease in lot checks of $0.4 million.
Selling, General and Administrative
Selling, general and administrative expenses at AFC decreased $0.8 million, or 10%, to $7.2 million for the three months ended March 31, 2019, compared with $8.0 million for the three months ended March 31, 2018, primarily as a result of decreases in compensation expense of $0.3 million, incentive-based compensation of $0.3 million and travel expenses of $0.3 million, partially offset by an increase in other miscellaneous expenses aggregating $0.1 million.
Holding Company Results
 
Three Months Ended 
 March 31,
(Dollars in millions)
2019
 
2018
Selling, general and administrative
$
42.5

 
$
40.1

Depreciation and amortization
6.9

 
7.2

Operating loss
$
(49.4
)
 
$
(47.3
)
Selling, General and Administrative
For the three months ended March 31, 2019, selling, general and administrative expenses at the holding company increased $2.4 million, or 6%, to $42.5 million, compared with $40.1 million for the three months ended March 31, 2018, primarily as a result of increases in compensation expense of $1.1 million, information technology costs of $1.0 million, stock-based compensation expense of $0.7 million and incentive-based compensation of $0.6 million, partially offset by a decrease in other miscellaneous expenses aggregating $1.0 million.

31


LIQUIDITY AND CAPITAL RESOURCES
We believe that the significant indicators of liquidity for our business are cash on hand, cash flow from operations, working capital and amounts available under our Credit Facility. Our principal sources of liquidity consist of cash generated by operations and borrowings under our revolving credit facility.
(Dollars in millions)
March 31,
2019
 
December 31,
2018
 
March 31,
2018
Cash and cash equivalents
$
265.6

 
$
337.1

 
$
330.8

Restricted cash
24.3

 
27.6

 
20.6

Working capital
514.6

 
689.4

 
783.2

Amounts available under Credit Facility*
256.5

 
350.0

 
350.0

Cash flow from operations for the three months ended
93.7

 
 
 
152.3

*
There were related outstanding letters of credit totaling approximately $32.9 million at March 31, 2019 and December 31, 2018 and $32.4 million at March 31, 2018, which reduced the amount available for borrowings under the revolving credit facility.
We regularly evaluate alternatives for our capital structure and liquidity given our expected cash flows, growth and operating capital requirements as well as capital market conditions.
Working Capital
A substantial amount of our working capital is generated from the payments received for services provided. The majority of our working capital needs are short-term in nature, usually less than a week in duration. Due to the decentralized nature of the business, payments for most vehicles purchased are received at each auction and branch. Most of the financial institutions place a temporary hold on the availability of the funds deposited that generally can range up to two business days, resulting in cash in our accounts and on our balance sheet that is unavailable for use until it is made available by the various financial institutions. There are outstanding checks (book overdrafts) to sellers and vendors included in current liabilities. Because a portion of these outstanding checks for operations in the U.S. are drawn upon bank accounts at financial institutions other than the financial institutions that hold the cash, we cannot offset all the cash and the outstanding checks on our balance sheet. Changes in working capital vary from quarter-to-quarter as a result of the timing of collections and disbursements of funds to consignors from auctions held near period end.
Approximately $100.6 million of available cash was held by our foreign subsidiaries at March 31, 2019. If funds held by our foreign subsidiaries were to be repatriated, state and local income tax expense and foreign withholding tax expense would need to be recognized, net of any applicable foreign tax credits.
AFC offers short-term inventory-secured financing, also known as floorplan financing, to independent used vehicle dealers. Financing is primarily provided for terms of 30 to 90 days. AFC principally generates its funding through the sale of its receivables. The receivables sold pursuant to the securitization agreements are accounted for as secured borrowings. For further discussion of AFC's securitization arrangements, see "Securitization Facilities."
Credit Facilities
On 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").

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, with the balances payable at each respective maturity date. The Credit Facility is subject to

32


mandatory prepayments and reduction in an amount equal to the net proceeds of certain debt offerings, certain asset sales and certain insurance recovery events.

As set forth in the Credit Agreement, Term Loan B-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 4.88% and 5.13% at March 31, 2019, 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 March 31, 2019, $704.4 million was outstanding on Term Loan B-4, $1,031.5 million was outstanding on Term Loan B-5 and $93.5 million was drawn on the revolving credit facility. In addition, we had related outstanding letters of credit in the aggregate amount of $32.9 million at March 31, 2019 and December 31, 2018, which reduce the amount available for borrowings under the revolving credit facility. Our Canadian operations also have a C$8 million line of credit which was undrawn at March 31, 2019. However, there were related letters of credit outstanding totaling approximately C$1.0 million at March 31, 2019, which reduce amounts available under the Canadian line of credit. In addition, our European operations have lines of credit aggregating €30 million of which $15.3 million was drawn at March 31, 2019.
The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in 100% of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and 65% of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions.
The Credit Agreement contains certain restrictive loan covenants, including, among others, a financial covenant requiring that a maximum consolidated senior secured leverage ratio be satisfied as of the last day of each fiscal quarter if revolving loans are outstanding, and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, consummate change of control transactions, dispose of assets, pay dividends, make investments and engage in certain transactions with affiliates. The senior secured leverage ratio is calculated as total senior secured debt divided by the last four quarters consolidated Adjusted EBITDA. Senior secured debt includes term loan borrowings, revolving loans and capital lease liabilities less available cash as defined in the Credit Agreement. Consolidated Adjusted EBITDA is EBITDA (earnings before interest expense, income taxes, depreciation and amortization) adjusted to exclude among other things (a) gains and losses from asset sales; (b) unrealized foreign currency translation gains and losses in respect of indebtedness; (c) certain non-recurring gains and losses; (d) stock-based compensation expense; (e) certain other non-cash amounts included in the determination of net income; (f) charges and revenue reductions resulting from purchase accounting; (g) minority interest; (h) expenses associated with the consolidation of salvage operations; (i) consulting expenses incurred for cost reduction, operating restructuring and business improvement efforts; (j) expenses realized upon the termination of employees and the termination or cancellation of leases, software licenses or other contracts in connection with the operational restructuring and business improvement efforts; (k) expenses incurred in connection with permitted acquisitions; (l) any impairment charges or write-offs of intangibles; and (m) any extraordinary, unusual or non-recurring charges, expenses or losses.
Certain covenants contained within the Credit Agreement are critical to an investor's understanding of our financial liquidity, as the failure to maintain compliance with these covenants could result in a default and allow our lenders to declare all amounts borrowed immediately due and payable. The maximum consolidated senior secured leverage ratio is required to be met when there are revolving loans outstanding under our Credit Agreement. For the quarter ended March 31, 2019 the ratio could not exceed 3.5 to 1.0. Our consolidated senior secured leverage ratio, including capital lease obligations of $47.0 million, was 1.96 to 1.0 at March 31, 2019.
In addition, the Credit Agreement and the indenture governing our senior notes contain certain financial and operational restrictions that limit our ability to pay dividends and other distributions, make certain acquisitions or investments, incur indebtedness, grant liens and sell assets. The covenants in the Credit Agreement and the indenture governing our senior notes affect our operating flexibility by, among other things, restricting our ability to incur expenses and indebtedness that could be used to grow the business, as well as to fund general corporate purposes. We were in compliance with the covenants in the Credit Agreement and the indenture governing our senior notes at March 31, 2019.

33


We believe our sources of liquidity from our cash and cash equivalents on hand, working capital, cash provided by operating activities, and availability under our credit facility are sufficient to meet our short and long-term operating needs for the foreseeable future. In addition, we believe the previously mentioned sources of liquidity will be sufficient to fund our capital requirements, debt service payments, announced acquisitions and dividends for the next twelve months.
Senior Notes
On May 31, 2017, we issued $950 million of 5.125% senior notes due June 1, 2025. The Company pays interest on the senior notes semi-annually in arrears on June 1 and December 1 of each year, which commenced on 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. The senior notes are guaranteed by the Subsidiary Guarantors.
Securitization Facilities
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to AFC Funding Corporation. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires on January 28, 2022. AFC Funding Corporation had committed liquidity of $1.70 billion for U.S. finance receivables at March 31, 2019.
We also have an agreement for the securitization of AFCI's receivables. AFCI's committed facility is provided through a third-party conduit (separate from the U.S. facility) and was C$175 million at March 31, 2019. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.
AFC managed total finance receivables of $1,989.1 million and $2,014.8 million at March 31, 2019 and December 31, 2018, respectively. AFC's allowance for losses was $14.3 million and $14.0 million at March 31, 2019 and December 31, 2018, respectively.
As of March 31, 2019 and December 31, 2018, $1,916.4 million and $1,973.2 million, respectively, of finance receivables and a cash reserve of 1 percent of the obligations collateralized by finance receivables served as security for the $1,360.6 million and $1,445.3 million of obligations collateralized by finance receivables at March 31, 2019 and December 31, 2018, respectively. There were unamortized securitization issuance costs of approximately $17.9 million and $19.4 million at March 31, 2019 and December 31, 2018, respectively. After the occurrence of a termination event, as defined in the U.S. securitization agreement, the banks may, and could, cause the stock of AFC Funding Corporation to be transferred to the bank facility, though as a practical matter the bank facility would look to the liquidation of the receivables under the transaction documents as their primary remedy.
Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At March 31, 2019, we were in compliance with the covenants in the securitization agreements.
EBITDA and Adjusted EBITDA
EBITDA and Adjusted EBITDA, as presented herein, are supplemental measures of our performance that are not required by, or presented in accordance with, generally accepted accounting principles in the United States, or GAAP. They are not measurements of our financial performance under GAAP and should not be considered substitutes for net income (loss) or any other performance measures derived in accordance with GAAP.
EBITDA is defined as net income (loss), plus interest expense net of interest income, income tax provision (benefit), depreciation and amortization. Adjusted EBITDA is EBITDA adjusted for the items of income and expense and expected incremental revenue and cost savings, as described above in the discussion of certain restrictive loan covenants under "Credit Facilities."
Management believes that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about one of the principal measures of performance used by our creditors. In addition, management uses EBITDA and Adjusted EBITDA to evaluate our performance. EBITDA and Adjusted EBITDA have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of the results as reported under GAAP. These measures may not be comparable to similarly titled measures reported by other companies.

34


The following tables reconcile EBITDA and Adjusted EBITDA to net income (loss) for the periods presented:
 
Three Months Ended March 31, 2019
(Dollars in millions)
ADESA
 
IAA
 
AFC
 
Corporate
 
Consolidated
Net income (loss)
$
42.4

 
$
56.4

 
$
30.5

 
$
(51.5
)
 
$
77.8

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
15.9

 
19.2

 
10.8

 
(17.8
)
 
28.1

Interest expense, net of interest income
0.4

 

 
16.9

 
39.0

 
56.3

Depreciation and amortization
35.0

 
21.8

 
2.4

 
6.9

 
66.1

Intercompany interest
7.1

 
9.4

 
(1.2
)
 
(15.3
)
 

EBITDA
100.8

 
106.8

 
59.4

 
(38.7
)
 
228.3

Intercompany charges
3.2

 
0.6

 

 
(3.8
)
 

Non-cash stock-based compensation
2.4

 
1.1

 
0.5

 
3.7

 
7.7

Acquisition related costs
1.6

 

 

 
2.3

 
3.9

Securitization interest

 

 
(14.8
)
 

 
(14.8
)
Severance
2.7

 
0.2

 

 
1.0

 
3.9

IAA separation costs

 

 

 
0.8

 
0.8

Foreign currency gains/losses
(0.6
)
 
0.1

 

 

 
(0.5
)
Other
0.7

 
0.8

 

 

 
1.5

  Total addbacks
10.0

 
2.8

 
(14.3
)
 
4.0

 
2.5

Adjusted EBITDA
$
110.8

 
$
109.6

 
$
45.1

 
$
(34.7
)
 
$
230.8

 
 
Three Months Ended March 31, 2018
(Dollars in millions)
ADESA
 
IAA
 
AFC
 
Corporate
 
Consolidated
Net income (loss)
$
54.2

 
$
50.3

 
$
25.7

 
$
(40.2
)
 
$
90.0

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
15.5

 
16.3

 
8.4

 
(13.8
)
 
26.4

Interest expense, net of interest income
0.4

 

 
13.4

 
27.5

 
41.3

Depreciation and amortization
31.2

 
24.1

 
7.8

 
7.2

 
70.3

Intercompany interest
7.7

 
9.4

 
(0.5
)
 
(16.6
)
 

EBITDA
109.0

 
100.1

 
54.8

 
(35.9
)
 
228.0

Intercompany charges
4.4

 

 

 
(4.4
)
 

Non-cash stock-based compensation
2.1

 
1.0

 
0.5

 
3.1

 
6.7

Acquisition related costs
1.4

 

 

 
0.8

 
2.2

Securitization interest

 

 
(11.4
)
 

 
(11.4
)
Severance
1.5

 

 

 

 
1.5

IAA separation costs

 

 

 
1.1

 
1.1

Other
0.7

 
0.6

 

 

 
1.3

  Total addbacks
10.1

 
1.6

 
(10.9
)
 
0.6

 
1.4

Adjusted EBITDA
$
119.1

 
$
101.7

 
$
43.9

 
$
(35.3
)
 
$
229.4


35


Certain of our loan covenant calculations utilize financial results for the most recent four consecutive fiscal quarters. The following table reconciles EBITDA and Adjusted EBITDA to net income (loss) for the periods presented:
 
Three Months Ended
 
Twelve
Months
Ended
(Dollars in millions)
June 30,
2018
 
September 30,
2018
 
December 31,
2018
 
March 31,
2019
 
March 31, 2019
Net income (loss)
$
93.2

 
$
77.5

 
$
67.3

 
$
77.8

 
$
315.8

Add back:
 
 
 
 
 
 
 
 
 
Income taxes
35.2

 
25.1

 
21.0

 
28.1

 
109.4

Interest expense, net of interest income
47.5

 
47.8

 
51.5

 
56.3

 
203.1

Depreciation and amortization
66.9

 
65.6

 
67.1

 
66.1

 
265.7

EBITDA
242.8

 
216.0

 
206.9

 
228.3

 
894.0

Non-cash stock-based compensation
5.3

 
6.8

 
5.5

 
7.7