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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 28, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________________ to ______________________
Commission File Number: 0-19594
INSURANCE AUTO AUCTIONS, INC.
________________________________________________________________________________
(Exact name of registrant as specified in its charter)
Illinois 95-3790111
________________________________________________________________________________
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
850 East Algonquin Road, Suite 100, Schaumburg, Illinois 60173-3855
________________________________________________________________________________
(Address of principal executive offices) (Zip Code)
(847) 839-3939
________________________________________________________________________________
(Registrant's telephone number, including area code)
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 [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act.) Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
Number of shares outstanding of each of the issuer's classes of common stock, as
of April 30, 2004:
Class Outstanding
_____ ___________
Common Stock, $0.001 Par Value 11,608,799 shares
INDEX
INSURANCE AUTO AUCTIONS, INC.
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION ............................................................ 3
Item 1. Financial Statements (Unaudited) ................................................. 3
Condensed Consolidated Statements of Operations .................................. 3
Condensed Consolidated Balance Sheets ............................................ 4
Condensed Consolidated Statements of Cash Flows .................................. 5
Notes to Condensed Consolidated Financial Statements ............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................................... 9
Overview ......................................................................... 9
Results of Operations ............................................................ 10
Financial Condition and Liquidity ................................................ 10
Factors That May Affect Future Results ........................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk ....................... 13
Item 4. Controls and Procedures .......................................................... 14
PART II. OTHER INFORMATION ................................................................ 14
Item 1. Legal Proceedings ................................................................ 14
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.. 14
Item 3. Defaults upon Senior Securities .................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders .............................. 15
Item 5. Other Information ................................................................ 15
Item 6. Exhibits and Reports on Form 8-K ................................................. 15
SIGNATURE.................................................................................. 16
2
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands except per share amounts)
THREE MONTHS ENDED
-----------------------
MARCH 28, MARCH 30,
2004 2003
----------- ---------
(Unaudited)
Revenues:
Vehicle sales $ 7,127 $ 13,304
Fee income 50,064 42,736
-------- --------
57,191 56,040
Cost of sales:
Vehicle cost 5,984 11,771
Branch cost 38,395 32,964
-------- --------
44,379 44,735
-------- --------
Gross profit 12,812 11,305
Operating expense:
Selling, general and administrative 8,480 7,168
Business transformation costs - 797
-------- --------
Earnings from operations 4,332 3,340
Other (income) expense:
Interest expense 477 55
Other income (12) (79)
-------- --------
Earnings before income taxes 3,867 3,364
Provision for income taxes 1,566 1,388
-------- --------
Net earnings $ 2,301 $ 1,976
======== ========
Net earnings per share:
Basic $ .20 $ .16
======== ========
Diluted $ .20 $ .16
======== ========
Weighted average shares outstanding:
Basic 11,537 12,045
Effect of dilutive securities - stock options 132 96
-------- --------
Diluted 11,669 12,141
======== ========
See accompanying notes to condensed consolidated financial statements.
3
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share amounts)
MARCH 28, DECEMBER 28,
2004 2003
--------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 23,655 $ 15,486
Accounts receivable, net 50,420 48,375
Inventories 14,887 13,602
Other current assets 2,746 3,099
--------- ---------
Total current assets 91,708 80,562
--------- ---------
Property and equipment, net 62,402 60,187
Deferred income taxes 10,170 9,788
Intangible assets, net 1,969 2,101
Goodwill, net 135,062 135,062
Other assets 228 93
--------- ---------
$ 301,539 $ 287,793
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 40,074 $ 35,005
Accrued liabilities 11,985 13,195
Short-term borrowings 7,000 -
Obligations under capital leases 2,605 2,822
Income taxes payable 2,117 -
Current installments of long-term debt 7,547 7,547
--------- ---------
Total current liabilities 71,328 58,569
--------- ---------
Deferred income taxes 18,522 17,748
Other liabilities 3,562 3,612
Obligation under capital leases 1,396 1,891
Long-term debt, excluding current installments 15,001 16,887
--------- ---------
Total liabilities 109,809 98,707
--------- ---------
Shareholders' equity:
Preferred stock, par value of $.001 per share
Authorized 5,000,000 shares; none issued - -
Common stock, par value of $.001 per share
Authorized 20,000,000 shares; 12,345,508 shares issued and
11,538,299 outstanding as of March 28, 2004; and 12,325,482
shares issued and 11,518,273 outstanding as of
December 28, 2003 12 12
Additional paid-in capital 146,115 145,856
Treasury stock, 807,209 shares (8,012) (8,012)
Deferred compensation related to restricted stock (835) (892)
Accumulated other comprehensive income (loss) (598) (625)
Retained earnings 55,048 52,747
--------- ---------
Total shareholders' equity 191,730 189,086
--------- ---------
$ 301,539 $ 287,793
========= =========
See accompanying notes to condensed consolidated financial statements.
4
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
THREE MONTHS ENDED
---------------------
MARCH 28, MARCH 30,
2004 2003
--------- ---------
(UNAUDITED)
Cash flows from operating activities:
Net earnings $ 2,301 $ 1,976
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 3,243 2,352
Gain on disposal of fixed assets (2) (42)
Loss on change in fair market value of derivative unhedged portion - (307)
Deferred compensation related to restricted stock 57 -
Changes in assets and liabilities (excluding effects of acquired
companies):
(Increase) decrease in:
Accounts receivable, net (2,045) (1,259)
Inventories (1,285) 546
Other current assets 353 1,263
Other assets (117) (379)
Increase (decrease) in:
Accounts payable 5,069 (268)
Accrued liabilities (1,338) (1,843)
Income taxes, net 2,509 1,272
-------- --------
Total adjustments 6,444 1,335
-------- --------
Net cash provided by operating activities 8,745 3,311
-------- --------
Cash flows from investing activities:
Capital expenditures (5,417) (2,769)
Proceeds from disposal of property and equipment 180 44
Payments made in connection with acquisitions, net of cash acquired - (2,360)
-------- --------
Net cash used in investing activities (5,237) (5,085)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 259 215
Proceeds from term loan - 30,000
Proceeds from short-term borrowings 7,000 -
Principal payments on long-term debt (1,886) (10)
Purchase of treasury stock - (7,401)
Principal payments - capital leases (712) (573)
-------- --------
Net cash provided by financing activities 4,661 22,231
-------- --------
Net increase in cash and cash equivalents 8,169 20,457
Cash and cash equivalents at beginning of period 15,486 10,027
-------- --------
Cash and cash equivalents at end of period $ 23,655 $ 30,484
======== ========
Supplemental disclosures of cash flow information:
Cash paid or refunded during the period for:
Interest $ 656 $ 317
======== ========
Income taxes paid $ 2 $ 20
======== ========
Income taxes refunded $ 1,011 $ 1,250
======== ========
Non-cash financing activities:
Property and equipment additions resulting from capital leases $ - $ 2,250
======== ========
See accompanying notes to condensed consolidated financial statements.
5
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
The unaudited condensed consolidated financial statements of Insurance
Auto Auctions, Inc. and its subsidiaries (collectively, the "Company")
have been prepared on the same basis as the annual audited consolidated
financial statements and, in the opinion of the Company, reflect all
adjustments necessary for a fair presentation for each of the periods
presented. The results of operations for interim periods are not
necessarily indicative of results for full fiscal years.
As contemplated by the Securities and Exchange Commission ("SEC") under
Rule 10-01 of Regulation S-X, the accompanying consolidated financial
statements and related notes have been condensed and do not contain
certain information that is included in the Company's annual consolidated
financial statements and notes thereto. For further information, refer to
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 28, 2003.
Fiscal year 2003 consisted of 52 weeks and ended December 28, 2003. Fiscal
year 2004 will consist of 52 weeks and will end on December 26, 2004.
Certain reclassifications have been made to the prior year financial
information to conform to the current year presentation.
2. INCOME TAXES
Income taxes were computed using the effective tax rates estimated to be
applicable for the full fiscal years, which are subject to ongoing review
and evaluation by the Company.
3. COMPUTATION OF EARNINGS PER SHARE
The computation of basic earnings per share is made using the weighted
average number of common shares outstanding during the period. Diluted
earnings per share includes the number of additional shares that would
have been outstanding if the dilutive common shares had been issued. The
following table sets forth the computation of basic and diluted earnings
per share:
MARCH 28, MARCH 30,
2004 2003
--------- ---------
BASIC EARNINGS PER SHARE:
Net income $ 2,301 $ 1,976
Average basic shares outstanding 11,537 12,045
Basic net income per share $ .20 $ .16
DILUTED EARNINGS PER SHARE:
Net income $ 2,301 $ 1,976
Average basic shares outstanding 11,537 12,045
Effect of dilutive securities:
Stock options 131 96
Restricted stock 67 -
Average diluted shares outstanding 11,735 12,141
Diluted net income per share $ .20 $ .16
6
4. GOODWILL AND INTANGIBLES
The Company's goodwill is assessed at least annually for impairment. The
Company performs its annual impairment test during the first quarter of
each year. This year's annual impairment test did not indicate any
impairment. Goodwill and other intangibles are recorded at cost less
accumulated amortization and consist of the following at March 28, 2004
and December 28, 2003:
MARCH 28, DECEMBER 28,
ASSIGNED LIFE 2004 2003
------------- --------- ------------
(dollars in millions)
Goodwill Indefinite $135.1 $135.1
Covenants not to compete 5 to 15 years 2.0 2.1
------ ------
$137.1 $137.2
====== ======
Amortization expense for the three months ended March 28, 2004 and March
30, 2003 was $0.1 million in both periods. This amount is included within
selling, general and administration expense on the Company's Condensed
Consolidated Statements of Operations. Based upon existing intangibles,
the projected annual amortization expense for each of the years 2004, 2005
and 2006 is $0.5 million, $0.4 million for 2007 and $0.2 million for 2008.
5. FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The Company, as a matter of policy, does not enter into derivative
contracts for trading or speculative purposes. During the first quarter of
2002, the Company entered into an interest rate swap to mitigate its
exposure to interest rate fluctuations and to effectively fix its
borrowing rate at 5.6%. Under the interest rate swap agreement, the
Company pays a fixed rate of interest of 5.6% and receives a LIBOR-based
floating rate. At March 28, 2004, the entire swap agreement qualified for
hedge accounting.
6. COMPREHENSIVE INCOME
Comprehensive income consists of net earnings and the change in fair value
of the Company's interest rate swap agreement as follows (dollars in
thousands):
THREE MONTHS ENDED
------------------------
MARCH 28, MARCH 30,
2004 2003
--------- ---------
Net earnings $ 2,301 $ 1,976
Other comprehensive income (loss)
Change in fair value of interest
rate swap agreement 44 (266)
Income tax benefit (expense) (17) 100
------- -------
Comprehensive income $ 2,328 $ 1,810
======= =======
The changes in fair value of the Company's interest rate swap agreement
were due to changes in interest rates.
7
7. STOCK OPTIONS
The Company accounts for its fixed plan stock options under the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense would be recorded on the
date of grant and amortized over the period of service only if the current
market value of the underlying stock exceeded the exercise price. No
stock-based employee compensation cost related to stock option grants is
recognized in net earnings, as all options granted had an exercise price
equal to the market value of the underlying common stock on the date of
grant.
The following table illustrates the effect on net earnings if the Company
had applied the fair value recognition provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation," to the measurement of stock-based employee compensation
relating to stock options and restricted stock, including straight-line
recognition of compensation costs over the related vesting periods for
fixed awards:
MARCH 28, MARCH 30,
2004 2003
-----------------------
(dollars in thousands)
Net earnings as reported $ 2,301 $ 1,976
Add: Stock-based employee compensation
expense included in reported net
earnings, net of related tax effects 34 -
---------- ----------
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method
for all awards, net of related tax effects (619) (436)
---------- ----------
Pro forma net earnings $ 1,716 $ 1,540
========== ==========
Earnings per share:
Basic - as reported $ .20 $ .16
========== ==========
Basic - pro forma $ .15 $ .13
========== ==========
Diluted - as reported $ .20 $ .16
========== ==========
Diluted - pro forma $ .15 $ .13
========== ==========
8. POSTRETIREMENT BENEFIT OBLIGATION
In connection with the acquisition of the capital stock of Underwriters
Salvage Company (USC), the Company assumed the obligation for certain
health care and dental benefits for retired employees of USC. In
accordance with Statement of Financial Accounting Standards No. 132
(revised), "Employers' Disclosures about Pensions and Other Postretirement
Benefits," the components of net periodic benefits cost related to this
plan are presented below (dollars in thousands).
THREE MONTHS ENDED
----------------------
MARCH 28, MARCH 30,
2004 2003
--------- ---------
Interest cost $ 23 $ 24
Amortization of net (gain)loss (27) (33)
------ ------
Total net periodic benefit costs (income) $ (4) $ (9)
====== ======
8
Effective January 20, 1994, the date of acquisition, the Company
discontinued future participation for active employees.
9. RELATED PARTY TRANSACTION
The Company leases certain properties from a member of its Board of
Directors. The Company believes the terms of the leases are no less
favorable than those available from unaffiliated third party lessors. In
2003 and in the first quarter of 2004, the Company incurred $2.7 million
and $1.3 million, respectively, of costs to upgrade properties owned by
the related party. A portion of the investment to upgrade these facilities
has been funded by the related party. The Company agreed to modify its
future lease payments to take into consideration the costs to be funded by
the related party. The total amount of all future rent payments related to
the related party's funding is $2.4 million. The Company also initiated a
temporary lease agreement in March to expand the amount of property
available at one of the facilities leased. The temporary lease agreement
does not have a specified term, can be terminated by either party upon 30
days written notice and has an annual fee of less than $0.1 million.
10. SUBSEQUENT EVENT
The Company's principal executive office is located in Schaumburg,
Illinois and occupies a total of 39,000 square feet of space under an
extended lease that expires in September 2004. In April 2004, the Company
entered into a new lease agreement for 38,000 square feet of space for
future use as its executive offices in Westchester, Illinois. This lease
commences in September 2004 and expires in August 2016. The total future
rent obligation associated with this new lease is $10.3 million. The
Company has an allowance totaling $1.9 million from the lessor for the
build-out of the office space. The Company does not expect rent expense
related to its corporate office to increase as a result of this move.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Report contains forward-looking statements that are subject to certain
risks, trends and uncertainties that could cause actual results to differ
materially from those projected, expressed, or implied by such forward-looking
statements. In some cases, you can identify forward-looking statements by use of
words such as "may, will, should, believes, expects, plans, future, intends,
could, estimate, predict, projects, targeting, potential or contingent," the
negative of these terms or other similar expressions. The Company's actual
results could differ materially from those discussed or implied herein. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed in "Factors That May Affect Future Results" and in the
Company's annual report on Form 10-K for the fiscal year ended December 28,
2003. You should not place undue reliance on any forward-looking statements.
Except as expressly required by the federal securities laws, the Company
undertakes no obligation to publish, update or revise any forward-looking
statements, whether as a result of new information, future events, changed
circumstances, or any other reason.
OVERVIEW
Insurance Auto Auctions, Inc. offers insurance companies and other vehicle
suppliers cost-effective salvage processing solutions on either a consignment or
purchase agreement method of sale. Consignment method sales are consummated
under either a fixed fee or percentage of sale basis. The percentage of sale
consignment method offers potentially increased profits over fixed fee
consignment by providing incentives to both the Company and the salvage provider
to invest in vehicle enhancements, thereby maximizing vehicle selling prices.
Under the fixed fee and percentage of sale consignment methods, the vehicle is
not owned by the Company and only the fees associated with processing the
vehicle are recorded as revenue. The proceeds from the sale of the vehicle
itself are not included in revenue. Under the purchase agreement sales method,
the vehicle is owned by the Company, and the proceeds from the sale of the
vehicle are recorded as revenue.
9
The Company has grown primarily through a series of acquisitions and
opening of new sites to now include 75 sites. During the first quarter of 2004,
the Company established a new facility in Tucson, Arizona.
The Company's operating results are subject to fluctuations, including
quarterly fluctuations, that can result from a number of factors, some of which
are more significant for sales under the purchase agreement method. See "Factors
That May Affect Future Results" below for a further discussion of some of the
factors that affect or could affect the Company's business, operating results
and financial condition.
RESULTS OF OPERATIONS
Three Months Ended March 28, 2004 Compared to the Three Months Ended March 30,
2003
Revenues were $57.2 million for the three months ended March 28, 2004, up
from $56.0 million for the same three month period in 2003. Fee income in the
first quarter increased 17% to $50.1 million, versus $42.7 million in the first
quarter of last year due to the Company's continued shift away from the purchase
agreement method of sale, more favorable pricing and an increase in volumes
sold. Vehicles sold under the purchase agreement method accounted for 3% of the
total vehicles sold in the first quarter of 2004, versus 8% for the same quarter
last year.
Cost of sales decreased $0.3 million to $44.4 million for the three months
ended March 28, 2004, versus $44.7 million for the same period last year.
Vehicle cost of $6.0 million is $5.8 million less than the $11.8 million
incurred in the first quarter of 2003. This decrease is primarily related to the
Company's shift away from vehicles sold under the purchase agreement method.
Branch cost of $38.4 million increased $5.4 million from $33.0 million for the
same period last year. This increase is primarily the result of higher volumes
of vehicles processed for the quarter, higher per unit tow costs, along with the
impact of new branches opened in 2003.
Gross profit increased 13% to $12.8 million for the three months ended
March 28, 2004, from $11.3 million for the comparable period in 2003.
Selling, general and administrative expense of $8.5 million increased $1.3
million, or 18%, from the $7.2 million of expense incurred during the first
quarter of last year. This increase is due to bonus accruals, depreciation and
expenses related to amending the Company's credit agreement. Amortization of
intangible assets is now included within this category of expense and amounted
to $0.1 million in each year.
There were no business transformation costs for the three months ended
March 28, 2004 compared to $0.8 million in the same period last year. Business
transformation costs included expenses related to data base conversions,
training and other activity related to the roll out of the Company's new
information technology system.
Interest expense increased to $0.5 million for the three months ended
March 28, 2004, from $0.1 million for the comparable period in 2003. Included in
interest expense for the three months ended March 30, 2003 was a non-cash
benefit of $0.3 million related to the change in fair value of the Company's
interest rate swap agreement.
The Company's effective income tax rate was 40.5% and 41.3% in 2004 and
2003, respectively.
FINANCIAL CONDITION AND LIQUIDITY
At March 28, 2004, the Company had current assets of $91.7 million, which
includes $23.7 million of cash and cash equivalents. Current liabilities were
$71.3 million. The Company had working capital of $20.4 million at March 28,
2004, a $1.6 million decrease from December 28, 2003.
At March 28, 2004, the Company's long-term debt, including current
installments, consisted of $0.1 million in notes payable, $7.0 million of
short-term borrowings against the $20.0 million revolving credit facility and
$22.5 million borrowed under its term credit facility. The notes payable bear
interest at an annual
10
rate of 8.0%. Borrowings against the revolving credit facility provide for
interest to be paid by the Company at the prime rate or at a variable rate based
upon LIBOR. The term credit facility was a one-year revolver that converted on
February 15, 2003, into a four-year term loan carrying a variable rate based
upon LIBOR. The aggregate principal balance of the loan is required be paid in
sixteen consecutive equal quarterly installments commencing on March 31, 2003.
At March 28, 2004, the Company was in compliance with its credit agreement
covenants.
On March 19, 2004, the Company entered into a Second Amended and Restated
Credit Agreement relating to its senior credit facility. The agreement amends
certain financial covenants, provides that advances made under the facility will
be subject to a monthly asset coverage test equal to 85% of eligible receivables
and requires the Company to provide collateral for amounts due under the
facility in the event it fails to meet certain financial projections for two
consecutive quarters.
Other long-term liabilities include the fair market on the Company's
interest rate swap along with the Company's post-retirement benefits liability
that relates to the acquisition in 1994 of Underwriters Salvage Company. The
amount recorded at March 28, 2004 for the post-retirement benefits liability is
approximately $2.6 million.
Capital expenditures were $5.4 million for the three months ended March
28, 2004. These capital expenditures consisted of various branch improvements
including upgrades to existing branches, the new facility in Tucson, Arizona,
and continued enhancements to the new technology system.
The Company's Board of Directors authorized the purchase of 1,500,000
shares of the Company's common stock in September 2000 and an additional 750,000
shares in April 2003, for a combined authorization of 2,250,000 shares.
Purchases may be made from time to time in the open market or in privately
negotiated transactions, subject to the requirements of applicable laws, and
will be financed with existing cash and cash equivalents, marketable securities,
and cash from operations. In the first quarter of 2003, the Company purchased
757,409 shares pursuant to this authorization at an average price of $9.77 per
share, or a total amount of $7.4 million. No shares were purchased during the
first quarter of 2004.
The Company believes that existing cash and cash equivalents, as well as
cash generated from operations will be sufficient to fund capital expenditures
and provide adequate working capital for operations for the next twelve months.
Part of the Company's plan is to pursue continued growth, possibly through new
facility start-ups, acquisitions, and the development of new claims processing
services. At some time in the future, the Company may require additional
financing. There can be no assurance that additional financing, if required,
will be available on favorable terms.
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as the related disclosures.
The Company believes the critical accounting policies that require significant
judgments and estimates are Goodwill, deferred income taxes, and long-lived
assets. For further information, refer to the Company's Form 10-K for the year
ended December 28, 2003.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a changing environment that involves a number of
risks, some of which are beyond the Company's control. The following discussion
highlights some of these risks.
Period Fluctuations. The Company's operating results have in the past and
may in the future fluctuate significantly depending on a number of factors.
These factors include, but are not limited to, the Actual Cash Value ("ACV") of
salvage vehicles, changes in the market value of salvage vehicles, delays or
changes in state title processing, general weather conditions, changes in
regulations governing the processing of salvage vehicles, the availability and
quality of salvage vehicles and buyer attendance at salvage auctions. The
Company is also dependent upon receiving a sufficient number of total-loss
vehicles as well as recovered theft vehicles to sustain its profit margins.
Factors that can affect the number of vehicles received include, but are not
limited to, driving patterns, reduction of policy writing by insurance
providers, which would affect the
11
number of claims over a period of time, and changes in direct repair procedures
that would reduce the number of newer, less damaged total-loss vehicles, which
tend to have the higher salvage values. Future decreases in the quality and
quantity of vehicle inventory, and in particular the availability of newer and
less-damaged vehicles, especially for inventory disposed of under the purchase
agreement method of sale, would have a material adverse effect on the operating
results and financial condition of the Company. Additionally, in the last few
years there has been a declining trend in theft occurrences. As a result, the
Company believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied upon as an indication of
future performance. Revenues for any future quarter are not predictable with any
significant degree of accuracy, and the Company's operating results may vary
significantly due to its relatively fixed expense levels. Due to all of the
foregoing factors, it is likely that in some future quarters the Company's
operating results will fall below the expectations of public market analysts and
investors. Any failure to meet expectations of securities analysts or the market
in general could adversely affect the market price of the Company's common
stock.
Competition. The Company faces intense competition for the supply of
salvage vehicles as well as competition from processors of vehicles from other
regional salvage pools. The Company may encounter further competition from
existing competitors and new market entrants that are significantly larger and
have greater financial and marketing resources. Other potential competitors
include used car auction companies, providers of claims software to insurance
companies, certain salvage buyer groups and insurance companies, some of which
presently supply auto salvage to the Company. While most insurance companies
have abandoned or reduced efforts to sell salvage vehicles without the use of
service providers such as the Company, they may in the future decide to dispose
of their salvage directly to end users. The Company may not be able to compete
successfully against current or future competitors, which could impair its
ability to grow and achieve or sustain profitability.
Dependence on Key Insurance Company Suppliers. Historically, a limited
number of insurance companies has accounted for a substantial portion of the
Company's revenues. For example, in 2003, vehicles supplied by the Company's
three largest suppliers accounted for approximately 36% of the Company's total
unit sales. The largest suppliers, State Farm Insurance, Farmers Insurance, and
Allstate, accounted for approximately 16%, 12%, and 8%, respectively, of the
Company's unit sales. A loss or reduction in the number of vehicles from any of
these suppliers, or adverse changes in the agreements that these suppliers have
with the Company, could have a material adverse effect on the Company's
operating results, financial condition and quantity or quality of inventory.
Enterprise-Wide System Redesign Project. The Company developed a new
enterprise-wide application to manage its salvage and auction process. The new
Web-based system is intended to support and streamline vehicle registration and
tracking, financial reporting, transaction settlement, vehicle title transfer,
and branch/headquarters communications. Development and testing of the
enterprise-wide application began in the third quarter of 2001. The Company
began rolling out the new system to its branches during the third quarter of
2002. Though the Company encountered some unanticipated issues during the
implementation phase, which delayed completion of the project and caused the
Company to incur additional costs beyond the project's original estimates, the
Company completed the roll-out of the new system by the end of 2003. However,
there remain inherent risks associated with the application and continued
enhancement of the new system that could continue to adversely impact the
Company's ability to achieve cost savings and increased profitability.
Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
agencies statutes and ordinances. The acquisition and sale of totaled and
recovered theft vehicles is regulated by state motor vehicle departments in each
of the locations in which the Company operates. Changes in law or governmental
regulations or interpretations of existing law or regulations could result in
increased costs, reduced salvage vehicle prices and decreased profitability for
the Company. In addition to the regulation of sales and acquisitions of
vehicles, the Company is also subject to various local zoning requirements with
regard to the location of its auction and storage facilities. These zoning
requirements vary from location to location. Failure to comply with present or
future regulations or changes in existing regulations could have a material
adverse effect on the Company's operating results and financial condition.
12
Provision of Services as a National or Regional Supplier. The provision of
services to insurance company suppliers on a national or regional basis requires
that the Company expend resources and dedicate management to a small number of
individual accounts, resulting in a significant amount of fixed costs. The
development of a referral-based national network service, in particular, has
required the devotion of financial resources without immediate reimbursement of
these expenses by the insurance company suppliers. The Company may not realize
sufficient revenue from these services to cover these expenses, in which case,
its results of operations may be materially adversely affected.
Expansion and Integration of Facilities. The Company seeks to increase
sales and profitability through acquisitions of other salvage auction
facilities, new site expansion and the increase of salvage vehicle volume at
existing facilities. The Company may not be able to continue to acquire new
facilities or add additional facilities on terms economically favorable to the
Company, or at all, or increase revenues at newly-acquired facilities above
levels realized prior to acquisition. The Company's ability to achieve these
objectives is dependent on, among other things, the integration of new
facilities, and their information systems, into its existing operations, the
identification and lease of suitable premises, and the availability of capital.
There can be no assurance that this integration will occur, that suitable
premises will be identified or that additional capital will be available to fund
the expansion and integration of the Company's business. Any delays or obstacles
in this integration process could have a material adverse effect on the
Company's operating results and financial condition. The Company has limited
sources of additional capital available for acquisitions, expansions and
start-ups. The Company's ability to integrate and expand its facilities will
depend on its ability to identify and obtain additional sources of capital.
Volatility of Stock Price. The market price of the Company's common stock
has been and will continue to be subject to significant fluctuations in response
to various factors and events, including variations in the Company's operating
results, the timing and size of acquisitions and facility openings, the loss of
vehicle suppliers or buyers, the announcement of new vehicle supply agreements
by the Company or its competitors, changes in regulations governing the
Company's operations or its vehicle suppliers, environmental problems or
litigation. Any failure to meet expectations of securities analysts or the
market in general could adversely affect the market price of the Company's
common stock.
Environmental Regulation. The Company's operations are subject to federal,
state and local environmental laws and regulations. In the salvage vehicle
auction industry, large numbers of wrecked vehicles are stored at auction
facilities for short periods of time. Minor spills of gasoline, motor oils and
other fluids may occur from time to time at the Company's facilities and may
result in soil, surface water or groundwater contamination. Petroleum products
and other hazardous materials are contained in aboveground or underground
storage tanks located at certain of the Company's facilities. Waste materials,
such as waste solvents or used oils, are generated at some of the Company's
facilities and are disposed of as non-hazardous or hazardous wastes. The Company
believes that it is in compliance in all material respects with applicable
environmental regulations and does not anticipate any material capital
expenditure for environmental compliance or remediation. To date, the Company
has not incurred significant expenditures for preventive or remedial action with
respect to contamination or the use of hazardous materials. Environmental laws
and regulations could become more stringent over time and the Company may be
subject to significant compliance costs in the future. Future contamination at
any one or more of the Company's facilities, or the potential contamination by
previous users of certain acquired facilities, create the risk, however, that
the Company could incur significant expenditures for preventive or remedial
action, as well as potential liability arising as a consequence of hazardous
material contamination, which could have a material adverse effect on the
Company's operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate fluctuations on its floating rate
credit facility, under which the Company has outstanding a $22.5 million term
loan. In 2002, the Company entered into an interest rate swap to mitigate its
exposure to interest rate fluctuations, and does not, as a matter of policy,
enter into hedging contracts for trading or speculative purposes. At March 28,
2004, the interest rate swap agreement had a notional amount of $22.5 million
under which the Company paid a fixed rate of interest of 5.6% and received a
LIBOR-based floating rate. At March 28, 2004, the entire swap agreement
qualified for hedge accounting.
13
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
The Company completed an evaluation as of the end of the period covered by
this Report under the supervision and with the participation of
management, including its Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of its
disclosure controls and procedures pursuant to rule 13a-14 of the
Securities Exchange Act of 1934. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective in alerting them on a
timely basis of material information relating to the Company required to
be included in its periodic Securities and Exchange Commission filings.
b. Changes in Internal Controls
Subsequent to the Company's evaluation, there were no significant changes
in the internal controls or in other factors that could significantly
affect internal controls, including any corrective actions with regard to
significant deficiencies and material weaknesses. While there were no
significant changes to the internal controls, the Company completed the
implementation of a new enterprise-wide application to manage the salvage
and auction process in the fourth quarter of 2003. The Company continues
to modify and improve the overall systems environment.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS.
In addition to the legal proceedings described in its Annual Report for
the year ended December 28, 2003, the Company is from time to time subject to
claims and suits arising in the ordinary course of business. Although the
ultimate disposition of such proceedings is not presently determinable,
management does not believe that the ultimate resolution of these matters will
have a material adverse effect on the Company's financial condition, results of
operations or cash flows. The Company maintains comprehensive general liability
insurance that it believes to be adequate for the continued operation of its
business.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
The Company has never declared or paid any cash dividends on its common
stock and does not anticipate paying any cash dividends in the foreseeable
future. The Company intends to retain any future earnings to finance the growth
and development of its business. In addition, the Company's financing agreement
limits the Company's ability to pay cash dividends to no more than 25% of the
Company's consolidated net income earned over a specified period.
The Company records treasury stock purchases using the cost method of
accounting. In March 2003, the Company repurchased 757,409 shares of its common
stock at an average price of $9.77 per share and a total cost of $7.4 million.
The Company did not repurchase any shares during the first quarter 2004.
14
ISSUER PURCHASES OF EQUITY SECURITIES
(c) TOTAL NUMBER OF (d) MAXIMUM
(a) TOTAL SHARES PURCHASED AS NUMBER OF SHARES
NUMBER OF (b) AVERAGE PART OF PUBLICLY THAT MAY YET BE
SHARES PRICE PAID ANNOUNCED PLANS OR PURCHASED UNDER THE
PERIOD PURCHASED PER SHARE PROGRAMS (1) PLANS OR PROGRAMS
- ------ --------- --------- ------------ -----------------
FIRST QUARTER 2003
January 0 0 0 1,500,000
February 0 0 0 1,500,000
March 757,409 $9.77 757,409 742,591
------- ----- --------- ---------
Total 2003 757,409 $9.77 757,409 742,591
(1) The Company's Board of Directors authorized the purchase of 1,500,000 shares
of the Company's common stock in September 2000 and an additional 750,000 shares
in April 2003, for a combined authorization of 2,250,000 shares. Purchases may
be made from time to time in the open market or in privately negotiated
transactions, subject to the requirements of applicable laws, and will be
financed with existing cash and cash equivalents, and cash from operations. As
of March 28, 2004, the Company had purchased 807,209 shares pursuant to this
authorization at an average price of $9.93 per share. The repurchase plan
expires upon the repurchase of all authorized shares.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Inapplicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Inapplicable
ITEM 5. OTHER INFORMATION. Inapplicable
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K.
(A) EXHIBITS.
10.1* Lease Agreement, dated April 13, 2004, by and between
Westbrook Corporate Center, L.L.C. and Insurance Auto
Auctions, Inc.
31.1* Certification by the CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2* Certification by the CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32** Certification by the CEO and CFO pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
* Filed herewith
** Furnished herewith.
(B) REPORTS ON FORM 8-K.
The Company filed a current report on Form 8-K, dated February 27,
2004, which contained a press release announcing the Company's
financial results for the year ended December 28, 2003.
The Company filed a current report on Form 8-K, dated April 23,
2004, which contained a press release announcing the Company's
financial results for the quarter ended March 28, 2004.
15
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INSURANCE AUTO AUCTIONS, INC.
Date: May 11, 2004 By: /s/ Scott P. Pettit
----------------------------------
Name: Scott P. Pettit
Title: Senior Vice President and Chief
Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
16
EXHIBIT INDEX
EXHIBIT NO.
10.1 Lease Agreement, dated April 13, 2004, by and between Westbrook Corporate
Center, L.L.C. and Insurance Auto Auctions, Inc.
31.1 Certification by the CEO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification by the CFO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32 Certification by the CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.