UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2005

 

Commission File Number 001-32198

 

 

ADESA, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware		35-1842546
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

13085 Hamilton Crossing Boulevard

Carmel, Indiana 46032

(Address of principal executive offices)

 

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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o No ý

 

The number of shares of common stock outstanding as of May 11, 2005:

 

 

 

Index

 

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Income
	Consolidated Balance Sheets
	Consolidated Statements of Stockholders’ Equity
	Consolidated Statements of Cash Flows
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.	Exhibits
Signatures
Exhibit Index

 

2

 

PART I

FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

ADESA, Inc.

Consolidated Statements of Income

(In millions, except per share data)

(unaudited)

 

		Three Months Ended March 31,
		2005			2004
Operating revenues
Auction and related services		$	215.0		$	218.4
Dealer financing		29.0			28.9
Total operating revenues		244.0			247.3
Operating expenses
Cost of services		115.2			120.8
Selling, general and administrative		55.5			59.2
Depreciation and amortization		9.2			9.2
Total operating expenses		179.9			189.2
Operating profit		64.1			58.1
Interest expense		8.1			4.0
Other income, net		(1.5		)	(0.8		)
Income before income taxes		57.5			54.9
Income taxes		22.5			21.6
Net income		$	35.0		$	33.3
Earnings per share—basic		$	0.39		$	0.38
Earnings per share—diluted		$	0.38		$	0.38
Dividends declared per common share (Note 10)		$	0.075		$	—

 

See notes to consolidated financial statements

 

3

 

ADESA, Inc.

Consolidated Balance Sheets

(In millions, except share data)

 

		March 31, 2005			December 31, 2004
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	341.6		$	309.4
Trade receivables, net of allowances of $7.3 (2005) and  $7.5 (2004)		286.0			161.1
Finance receivables, net of allowances of $5.4 (2005) and  $4.3 (2004)		266.6			218.6
Deferred income taxes		29.4			28.0
Other current assets		14.0			13.7
Total current assets		937.6			730.8
Other assets
Goodwill		514.2			514.6
Other intangible assets, net of accumulated amortization of $23.3 (2005) and $25.2 (2004)		35.4			31.6
Other assets		58.1			58.3
Total other assets		607.7			604.5
Property and equipment, net of accumulated depreciation of  $136.9 (2005) and $130.2 (2004)		583.9			578.2
Total assets		$	2,129.2		$	1,913.5

 

See notes to consolidated financial statements

 

4

 

ADESA, Inc.

Consolidated Balance Sheets

(In millions, except share data)

 

			March 31, 2005			December 31, 2004
			(unaudited)
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable			$	428.5		$	227.3
Employee benefits and compensation			30.9			40.4
Other accrued expenses			45.0			36.0
Income taxes payable			24.0			25.3
Current maturities of long-term debt			37.1			37.1
Current liabilities of discontinued operations			6.5			6.5
Total current liabilities			572.0			372.6
Non-current liabilities
Long-term debt			469.7			479.0
Deferred tax liabilities			44.1			42.1
Other liabilities			7.0			8.4
Total non-current liabilities			520.8			529.5
Commitments and contingencies (Note 11)			—			—
Stockholders’ equity
Preferred stock, $0.01 par value:
Authorized shares: 50,000,000			—			—
Issued shares: none
Common stock, $0.01 par value:
Authorized shares: 500,000,000
Issued shares: 94,868,104 (2005 and 2004)			1.0			1.0
Additional paid-in capital			669.9			675.1
Retained earnings			410.3			382.2
Unearned compensation			(3.6		)	(3.1		)
Treasury stock, at cost:
Shares:	4,112,778 (2005)
	4,343,478 (2004)		(82.4		)	(85.9		)
Accumulated other comprehensive income			41.2			42.1
Total stockholders’ equity			1,036.4			1,011.4
Total liabilities and stockholders’ equity			$	2,129.2		$	1,913.5

 

See notes to consolidated financial statements

 

5

 

ADESA, Inc.

Consolidated Statements of Stockholders’ Equity

(In millions)

 

		Common Stock Shares		Common Stock Amount			Additional Paid-In Capital			Retained Earnings			Unearned Compensation			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total
Balance at December 31, 2004		94.9		$	1.0		$	675.1		$	382.2		$	(3.1	)	$	(85.9	)	$	42.1		$	1,011.4
Comprehensive income:																						35.0
Net income										35.0
Other comprehensive income (loss), net of tax:
Foreign currency translation																			(1.9		)
Unrealized gain on interest rate swaps																			1.0
Other comprehensive loss																						(0.9		)
Comprehensive income																						34.1
Cash dividends paid to stockholders										(6.9		)										(6.9		)
Unearned compensation related to restricted stock units													(0.5		)							(0.5		)
Issuance of common stock under stock plans							(5.2		)							12.0						6.8
Repurchase of common stock																(8.5		)				(8.5		)
Balance at March 31, 2005 (unaudited)		94.9		$	1.0		$	669.9		$	410.3		$	(3.6	)	$	(82.4	)	$	41.2		$	1,036.4

 

See notes to consolidated financial statements

 

6

 

ADESA, Inc.

Consolidated Statements of Cash Flows

(In millions)

(unaudited)

 

		Three Months Ended March 31,
		2005			2004
Operating activities
Net income		$	35.0		$	33.3
Adjustments to reconcile net income to net cash (used by) provided by operating activities:
Depreciation and amortization		9.2			9.2
Bad debt expense		1.8			1.2
Deferred income taxes		0.5			2.6
Compensation associated with equity programs		0.4			—
Other non-cash, net		1.1			0.5
		48.0			46.8
Changes in operating assets and liabilities:
Finance receivables		(49.1		)	(52.6		)
Trade receivables and other assets		(125.7		)	(139.7		)
Accounts payable and accrued expenses		118.7			159.1
Net cash (used by) provided by operating activities		(8.1		)	13.6
Investing activities
Purchases of property and equipment		(13.7		)	(1.2		)
Purchase of intangibles		(6.3		)	(0.1		)
Proceeds from the sale of property and equipment		0.1			—
Net cash used by investing activities		(19.9		)	(1.3		)
Financing activities
Net increase in book overdrafts		75.4			84.4
Net increase in lines of credit		—			95.4
Payments on long-term debt		(9.3		)	(86.8		)
Issuance of common stock under stock plans		5.9			—
Dividends paid to ALLETE		—			(17.5		)
Dividends paid to stockholders		(6.9		)	—
Repurchase of common stock		(4.7		)	—
Net cash provided by financing activities		60.4			75.5
Effect of exchange rate changes on cash		(0.2		)	(0.5		)
Net increase in cash and cash equivalents		32.2			87.3
Cash and cash equivalents at beginning of period		309.4			116.1
Cash and cash equivalents at end of period		$	341.6		$	203.4
Non-cash activities
Capital contributions from ALLETE		$	—		$	1.2

 

See notes to consolidated financial statements

 

7

 

ADESA, Inc.

Notes to Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 footnotes required by generally accepted accounting principles for complete financial statements.  Operating results from 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 (consisting only of normal recurring accruals) considered necessary for a fair statement of the Company’s financial results for the periods presented.  The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period.  Actual results could differ from these estimates.  A listing of the Company’s critical accounting estimates is described in the “Critical Accounting Estimates” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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 for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K (Commission file number 001-32198) filed with the Securities and Exchange Commission (“SEC”).  As used herein, the terms “the Company” and “ADESA” shall mean ADESA, Inc. and its consolidated subsidiaries.  The term “ALLETE” shall mean ADESA’s former parent, ALLETE, Inc. and its consolidated subsidiaries.

 

ADESA is the second largest used vehicle auction network in North America, based upon the number of used vehicles passing through auctions annually, and also provides services such as inbound and outbound logistics, reconditioning, vehicle inspection and certification, titling, administrative and salvage recovery services. Through its wholly owned subsidiary Automotive Finance Corporation (“AFC”), the Company also provides short-term inventory-secured financing, known as floorplan financing, to primarily used vehicle dealers. ADESA is able to serve the diverse and multi-faceted needs of its customers through the wide range of services offered at its facilities.

 

Certain reclassifications have been made to prior year amounts to conform to current year presentation.

 

Note 2 – New Accounting Standards

 

ADESA discloses pro forma net income and earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) 123 Accounting for Stock-Based Compensation and 148 Accounting for Stock-Based Compensation—Transition and Disclosure.  In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123(R), Share-Based Payment.  This statement revises SFAS 123 and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees.  SFAS 123(R) requires that the cost of employees services received in exchange for an award of equity instruments be recognized in the income statement.  Compensation cost will be measured based on the grant-date fair value of the equity instruments issued.  The cost will be recognized over the period during which an employee is required to provide service in exchange for the award.  No compensation cost is recognized for equity instruments for which employees do not render service.

 

In March 2005, the SEC issued Staff Accounting Bulletin 107 (“SAB 107”), which offers guidance on SFAS 123(R).  SAB 107 was issued to assist preparers by simplifying some of the implementation challenges of SFAS 123(R) while enhancing the information that investors receive.  Key topics of SAB 107 include discussion on the valuation models available to preparers and guidance on key assumptions used in these valuation models, such as expected volatility and expected term, as well as guidance on accounting for the income tax effects of SFAS 123(R) and disclosure considerations, among other topics.

 

On April 14, 2005, the SEC approved a new rule for public companies that delayed the effective date of SFAS 123(R) to annual, rather than interim, periods that begin after June 15, 2005.  As such, the Company will adopt SFAS 123(R) on January 1, 2006.  Once adopted, the Company will be required to record compensation cost as expense for the portion of outstanding unvested awards, based on the grant-date fair value of those awards calculated using the Black-Scholes option pricing model used under SFAS 123 for pro forma disclosures.  The Company expects to apply the prospective transition method of SFAS 123(R), which would allow the Company to prospectively record expense for the compensation costs related to the portion of outstanding unvested awards at January 1, 2006, without restating any prior periods.  The Company is currently considering the financial accounting and income tax implications of SFAS 123(R) and SAB 107.

 

8

 

On March 9, 2005, the Board of Directors of the Company accelerated the vesting of certain unvested and “out-of-the-money” stock options previously awarded to employees and officers that have an exercise price of $24.  The awards accelerated were made under the ADESA, Inc. 2004 Equity and Incentive Plan in conjunction with ADESA’s initial public offering (“IPO”) in June 2004.  As a result, options to purchase approximately 2.9 million shares of the Company’s common stock became exercisable immediately.  The options awarded in conjunction with the IPO to the Company’s named executive officers and the majority of the other officers would have vested in equal increments at June 15, 2005, 2006 and 2007.  The options awarded to certain other executive officers and employees had different vesting terms.  One-third of the options awarded to the other executive officers and employees vested on December 31, 2004.  The remaining two-thirds of the options awarded to these executive officers and other employees in conjunction with the IPO would have vested in equal increments at December 31, 2005 and 2006.  All of these options expire in June 2010.  All other terms and conditions applicable to the outstanding stock option grants remain in effect.

 

The Company and its Board of Directors considered several factors in determining to accelerate the vesting of these options.  Primarily, the acceleration will enhance the comparability of the Company’s financial statements in prior and subsequent periods.  The options awarded to the executive officers were special, one-time grants in conjunction with the Company’s IPO.  As such, these grants are not indicative of past grants when ADESA was a subsidiary of ALLETE prior to June 2004 and are not representative of the Company’s expected future grants.  The Company and Board also believe that the acceleration is in the best interest of the stockholders as it will reduce the Company’s reported stock option expense in future periods mitigating the impact SFAS 123(R) that will take effect in the first quarter of 2006.

 

As a result of the acceleration, the Company has disclosed incremental, pro forma stock-based employee compensation expense of approximately $7.7 million, net of tax, in its first quarter 2005 pro forma disclosure.  The acceleration will result in reductions in the after tax pro forma stock-based employee compensation expense disclosed in the second, third and fourth quarters of $2.0 million, $1.1 million and $1.1 million.  The Company will not record any stock-based employee compensation expense in the consolidated statements of income associated with the acceleration of these options because the intrinsic value (excess of market price of common stock over the exercise price of option) of the options at the date of acceleration was not in excess of the original intrinsic value of the options.  The Company expects that the acceleration will reduce the stock option expense it otherwise would have been required to recognize in its consolidated statements of income in conjunction with adopting SFAS 123(R) by approximately $4.8 million in 2006 and $1.2 million in 2007 on a pre-tax basis.

 

Note 3 – Stock-Based Compensation

 

The Company has adopted the disclosure-only provisions of SFAS 123, as amended by SFAS 148.  The Company accounts for stock-based compensation under APB Opinion No. 25, and related interpretations, using the intrinsic value method.  Accordingly, the Company has not recognized compensation expense for employee stock options that have been granted.

 

On February 15, 2005, the Company granted options to purchase approximately 0.7 million shares of ADESA common stock, with an exercise price of $22.44 per share under the ADESA, Inc. 2004 Equity and Incentive Plan.  The options vest in equal increments at February 14, 2006, 2007, and 2008.  The options have a six year life.

 

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to all stock options.  The fair value of stock options was estimated as of the grant date using the Black-Scholes option-pricing model and the attribution method.  The Black-Scholes option-pricing model does not consider the non-traded nature of employee stock options, the lack of transferability or a vesting period.  If the model took these items into consideration, the resulting estimate for fair value of the stock options could be different.  These pro forma amounts may not be representative of the effects on reported net income for future years due to the uncertainty of stock option grant volume and potential changes in assumptions driven by market factors.

 

9

 

		Three Months Ended March 31,
(in millions except per share amounts)		2005			2004
Reported net income (1)		$	35.0		$	33.3
Deduct: total stock option employee compensation expense, net of tax		(9.9		)	(0.1		)
Pro forma net income		$	25.1		$	33.2
Earnings per share:
Basic—as reported		$	0.39		$	0.38
Basic—pro forma		$	0.28		$	0.38
Diluted—as reported		$	0.38		$	0.38
Diluted—pro forma		$	0.28		$	0.38

 

(1)     Reported amounts include expense associated with restricted stock units and performance share awards.

 

The expense noted above for employee stock options granted, determined under SFAS 123, was calculated using the Black-Scholes option pricing model and the following assumptions:

 

Assumptions		2005			2004
Risk—free interest rate		3.6	%		3.6	%
Expected life-years		4			4
Expected volatility		41.0	%		39.0	%
Dividend growth rate		1.34	%		1.25	%

 

During the period ended March 31, 2005, the Company awarded approximately 40,500 restricted stock units (“RSUs”) under the Company’s 2004 Equity and Incentive Plan to employees representing approximately $0.9 million of unearned compensation at the grant date.  Under the Plan, certain executive officers receive an annual RSU grant equal to 25% of the bonus earned in the prior year.  The awards granted during the period ended March 31, 2005, included approximately 18,800 RSUs (which vest after three years) granted to these certain executive officers of the Company.  The vesting schedule for the remaining RSUs granted during the period ended March 31, 2005 range from one to three years from the date of grant.  Compensation expense related to RSU awards is recognized ratably over the vesting period.  Compensation expense for RSU awards totaled $0.4 million for the three months ended March 31, 2005.

 

Note 4 –Long-Term Debt

 

Long-term debt consists of the following (in millions):

 

		Interest Rate		Maturity		March 31, 2005			December 31, 2004
Term Loan A		LIBOR + 2.25%		06/21/2009		$	148.7		$	157.5
Term Loan B		LIBOR + 2.50%		06/21/2010		198.5			199.0
Atlanta capital lease obligation		5.0%		12/01/2013		34.5			34.5
Other, secured by property		6.0%		12/31/2005		0.1			0.1
Senior subordinated notes		7 5/8%		06/15/2012		125.0			125.0
Total debt						506.8			516.1
Less current portion of long-term debt						37.1			37.1
Long-term debt						$	469.7		$	479.0

 

Concurrent with the Company’s June 2004 initial public offering and notes offering, the Company entered into a $525 million senior secured credit facility with a syndicate of lenders, consisting of a $150 million revolving credit facility and two term loan facilities aggregating $375 million.  Except for AFC’s special purpose subsidiary, the credit facility is guaranteed by substantially all of the Company’s direct and indirect domestic subsidiaries and is secured by a pledge of all of the equity interests in the guarantors and a pledge of 65% of the equity interests in certain of the Company’s Canadian and Mexican subsidiaries.  The credit facility contains customary affirmative and negative covenants, including restrictions on the ability to incur indebtedness, grant liens, pay dividends or make distributions to stockholders and make any prepayment or redemption

 

10

 

with respect to the senior subordinated notes. The credit facility also contains financial covenants including a maximum total leverage ratio, a minimum interest coverage ratio and a minimum fixed charge coverage ratio.  The senior notes contain certain financial and operational restrictions on paying dividends and other distributions, making certain acquisitions or investments and incurring indebtedness, and selling assets.  At March 31, 2005, the Company is in compliance with the covenants contained in both the credit facility and senior notes.

 

Note 5 – Derivatives

 

The Company uses interest rate swap agreements to manage its exposure to interest rate movements and to reduce borrowing costs.  In June 2004, the Company entered into two interest rate swap agreements with notional amounts of $105 million and $60 million to manage its exposure to interest rate movements on its variable rate debt.  Both interest rate swap agreements contain amortizing provisions and mature in December 2006.  The Company has designated its interest rate swap agreements as cash flow hedges.  At March 31, 2005, the fair value of the interest rate swap agreements is a $1.4 million gain which is recorded in “Other assets” on the consolidated balance sheet.  At December 31, 2004, the fair value of the interest rate swap agreements was a $0.2 million loss which was recorded in “Other liabilities” on the consolidated balance sheet.  Changes in the fair value of the interest rate swap agreements designated as cash flow hedges are recorded in “Other comprehensive income”.  Unrealized gains on interest rate swap agreements at March 31, 2005, totaling $0.9 million, net of taxes of $0.5 million, are included as a component of “Accumulated other comprehensive income”.  At December 31, 2004, there were unrealized losses on interest rate swap agreements totaling $0.1 million, net of taxes of $0.1 million, which were included as a component of “Accumulated other comprehensive income”.

 

Note 6 – Finance Receivables

 

AFC sells the majority of its US dollar denominated finance receivables on a revolving basis and without recourse to a wholly owned, bankruptcy remote, special purpose subsidiary that is consolidated for accounting purposes in accordance with SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.  The special purpose subsidiary, AFC Funding Corporation, was established for the purpose of purchasing AFC’s finance receivables.  AFC and AFC Funding Corporation amended their securitization agreement on October 14, 2004, to extend the expiration date to January 2006.  This agreement is subject to annual renewal and allows for the revolving sale by the subsidiary to a bank conduit facility of up to a maximum of $500 million in undivided interests in certain eligible finance receivables subject to committed liquidity.  AFC Funding Corporation had $425 million of committed liquidity at March 31, 2005.  Receivables sold to the bank conduit facility are not reported on the Company’s consolidated balance sheet.

 

At March 31, 2005, AFC managed total finance receivables of $657.8 million, of which $574.7 million had been sold to AFC Funding Corporation.  AFC Funding sold $385.8 million of these finance receivables to the bank conduit facility with recourse to AFC Funding Corporation at March 31, 2005, leaving $272.0 million of gross finance receivables recorded on the Company’s consolidated balance sheet at March 31, 2005.

 

Receivables under management, sold, and retained were as follows (in millions):

 

Finance Receivables		March 31, 2005			December 31, 2004
Total receivables managed		$	657.8		$	582.7
Less: amounts sold		(385.8		)	(359.8		)
Receivables retained		272.0			222.9
Less: allowance for losses		(5.4		)	(4.3		)
Net finance receivables		$	266.6		$	218.6

 

Proceeds from the revolving sale of receivables to the bank conduit facility were used to fund new loans to customers.  AFC and AFC Funding Corporation must maintain certain financial covenants including, among others, limits on the amount of debt AFC can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio.  The securitization agreement also incorporates the financial covenants of ADESA’s credit facility.  At March 31, 2005 the Company was in compliance with the covenants contained in the securitization agreement.

 

Note 7 – Earnings Per Share

 

The following table sets forth the computation of earnings per share (in millions except per share amounts):

 

11

 

		Three Months Ended March 31,
		2005			2004
Net income		$	35.0		$	33.3
Weighted average common shares outstanding		90.69			88.60
Effect of dilutive stock options and restricted stock awards		0.50			—
Weighted average common shares outstanding and assumed conversions		91.19			88.60
Earnings per share—basic		$	0.39		$	0.38
Earnings per share—diluted		$	0.38		$	0.38

 

Basic earnings per share were calculated based upon the weighted-average number of outstanding common shares for the period.  Diluted earnings per share were calculated consistent with basic earnings per share including the effect of dilutive unissued common shares related to the Company’s stock-based employee compensation programs.  Total options outstanding at March 31, 2005, were approximately 4.8 million.  There were no options outstanding at March 31, 2004.  Stock options with an exercise price per share greater than the average market price per share were excluded in the calculation of diluted earnings per share for all periods presented as including these options would have an anti-dilutive impact.  Approximately 3.7 million options were excluded from diluted earnings per share for the three months ended March 31, 2005.

 

During the three months ended March 31, 2005, the Company repurchased approximately 0.4 million shares of ADESA common stock at an aggregate cost of $8.5 million.  The shares repurchased during the first quarter of 2005 included approximately 0.3 million shares at an aggregate cost of $7.5 million repurchased pursuant to the previously approved $130 million share repurchase program.  In addition to purchases pursuant to the program approved in August 2004, the share activity for the three months ended March 31, 2005, reflects shares withheld during the first quarter of 2004 to satisfy tax withholding obligations in connection with the vesting of restricted stock units and performance share awards during the quarter.  On May 12, 2005, the Company completed its $130 million share repurchase program. The Company repurchased a cumulative total of 6.2 million shares at a weighted average price of $20.83 and an aggregate cost of $128.9 million pursuant to the program.

 

ADESA’s initial public offering of 6,250,000 shares of common stock was declared effective by the SEC in June 2004.  Assuming the issuance of the 6,250,000 shares had occurred at the beginning of 2004, weighted average common shares outstanding for the three months ended March 31, 2004 would have totaled approximately 93.81 million shares resulting in diluted earnings per share of $0.35 for the three months ended March 31, 2004.

 

Note 8 – Comprehensive Income

 

Comprehensive income is comprised of net income adjusted for changes in foreign currency translation and unrealized gains or losses on interest rate swap contracts designated and qualifying as cash flow hedges.  For the first quarter 2005 and 2004, comprehensive income was $34.1 million and $30.9 million.  The changes in comprehensive income are primarily due to changes in net income and volatility in the Canadian currency.

 

Note 9 – Segment Information

 

The Company operates in two business segments: auction and related services and dealer financing. These reportable segments offer different services and have fundamental differences in their operations.  The holding company is maintained separately from the two reportable segments and includes expenses associated with being a public company, such as salaries, benefits, travel costs for the corporate management team, Board of Directors’ fees, investor relations costs, incremental insurance, treasury, legal, accounting, and risk management costs.  Holding company interest includes the interest incurred on the corporate debt structure.  The majority of costs incurred at the holding company are not allocated to the two business segments.

 

12

 

Financial information regarding the Company’s two reportable segments is set forth below (in millions):

 

Three Months Ended March 31, 2005		Auction and Related Services			Dealer Financing			Holding Company			Consolidated
Operating revenues		$	215.0		$	29.0		$	—		$	244.0
Operating expenses
Cost of services		109.2			6.0			—			115.2
Selling, general and administrative		45.5			4.9			5.1			55.5
Depreciation and amortization		8.0			1.1			0.1			9.2
Total operating expenses		162.7			12.0			5.2			179.9
Operating profit (loss)		52.3			17.0			(5.2		)	64.1
Interest expense		1.3			—			6.8			8.1
Other income, net		(0.6		)	—			(0.9		)	(1.5		)
Income (loss) before income taxes		51.6			17.0			(11.1		)	57.5
Income taxes		20.3			6.5			(4.3		)	22.5
Net income (loss)		$	31.3		$	10.5		$	(6.8	)	$	35.0
Assets		$	1,402.4		$	345.9		$	380.9		$	2,129.2
Three Months Ended March 31, 2004
Operating revenues		$	218.4		$	28.9		$	—		$	247.3
Operating expenses
Cost of services		115.5			5.3			—			120.8
Selling, general and administrative		50.0			5.8			3.4			59.2
Depreciation and amortization		8.1			1.1			—			9.2
Total operating expenses		173.6			12.2			3.4			189.2
Operating profit (loss)		44.8			16.7			(3.4		)	58.1
Interest expense		4.0			—			—			4.0
Other income, net		(0.8		)	—			—			(0.8		)
Income (loss) before income taxes		41.6			16.7			(3.4		)	54.9
Income taxes		16.2			6.7			(1.3		)	21.6
Net income (loss)		$	25.4		$	10.0		$	(2.1	)	$	33.3
Assets		$	1,578.2		$	345.6		$	—		$	1,923.8

 

13

 

Note 10 – Dividends

 

On April 27, 2005, the Company’s Board of Directors declared a second quarter dividend of $0.075 per common share payable June 15, 2005, to stockholders of record on May 20, 2005.  In the first quarter of 2004, the Company paid dividends totaling $17.5 million to its former parent, ALLETE.  Cash dividends declared per share excludes dividends declared and paid to ALLETE prior to ADESA becoming an independent public company.

 

Note 11 – Commitments and Contingencies

 

The Company is involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries, property damage, handling 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.  The Company accrues an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss 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” and “Other liabilities” at undiscounted amounts and generally 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 become available.  If the amount of an actual loss is greater than the amount accrued, this could have an adverse impact on the Company’s operating results in that period.  Legal fees are expensed as incurred.

 

The Company has accrued, as appropriate, for environmental remediation costs anticipated to be incurred at certain of its auction facilities.  Liabilities for environmental matters included in “Other accrued expenses” and “Other liabilities” were $3.5 million and $4.8 million at March 31, 2005 and December 31, 2004.  No amounts have been accrued as receivables for potential reimbursement or recoveries to offset this liability.

 

The Company stores a significant number of vehicles owned by various customers and consigned to the Company to be auctioned.  The Company is contingently liable for each consigned vehicle until the eventual sale or other disposition; however, the Company is generally not liable for damage related to severe weather conditions, natural disasters or other factors outside of the Company’s control.  Loss is possible; however, at this time management cannot estimate a range of loss that could occur.  Individual stop loss and aggregate insurance coverage is maintained on the consigned vehicles.  These vehicles are consigned to the Company and are not included in the consolidated balance sheets.

 

In the normal course of business, the Company also enters into various other guarantees and indemnities in its relationships with suppliers, service providers, customers and others. These guarantees and indemnifications do not materially impact the Company’s financial condition or results of operations, but indemnifications associated with the Company’s actions generally have no dollar limitations and currently cannot be quantified.

 

As noted above, the Company is involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries, property damage, handling or disposal of vehicles, environmental laws and regulations, and other litigation incidental to the business such as employment matters and dealer disputes.  Such litigation is generally not, in the opinion of management, likely to have a material adverse effect on the financial condition, results of operations or cash flows.  Legal and regulatory proceedings which could be material are discussed in the description of legal proceedings in Part II, Item 1 (“Legal Proceedings”) of this report.

 

Note 12 – Subsequent Event

 

On May 3, 2005, the Company completed the purchase of certain of the assets of ABC Washington Dulles, LLC to gain access to the Washington, D.C. auction market.  The assets include a state-of-the-art 83-acre leased auction facility located in Sterling, Virginia which commenced operations in 2001 offering six auction lanes and reconditioning facilities, the related operating equipment and all customer contracts related to the auction.  In addition, the Company assumed operating lease obligations related to the facility approximating $1.9 million per year through 2025.  The Company did not assume any other liabilities or indebtedness in connection with the acquisition.  This acquisition, effective May 3, 2005, is an asset purchase and will be accounted for in the Company’s second quarter ending June 30, 2005.

 

14

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks, trends, and uncertainties.  In particular, statements made in this report that are not historical facts (including but not limited to expectations, estimates, assumptions and projections regarding the industry, business, future operating results, and anticipated cash requirements) may be forward-looking statements.  Actual results could 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 “Factors that May Affect Future Results” described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and filed on March 29, 2005.  Some of these factors include: general business conditions; market trends; competition; weather; vehicle production; trends in new and used vehicle sales; business development activities, including acquisitions; economic conditions including exchange rate and interest rate fluctuations; litigation developments and other risks described from time to time in ADESA’s filings with the Securities and Exchange Commission (“SEC”) including the Quarterly Reports on Form 10-Q to be filed by ADESA in 2005.  Many of these risk factors are outside of ADESA’s control, and as such, they involve risks which are not currently known to ADESA 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 hereof and ADESA does not undertake to update its forward-looking statements.

 

The Company’s future growth depends on a variety of factors, including its ability to increase volume, acquire additional auctions, manage expansion, control costs in its operations, introduce modest fee increases and new services, consolidate future auction acquisitions into existing operations and retain its executive officers and key employees.  In addition, the Company’s indebtedness will require it to use a portion of its operating cash flow to pay interest and principal on debt instead of for other corporate purposes, including funding future expansion and ongoing capital expenditures.  Accordingly, the Company cannot predict whether its growth strategy will be successful.  The Company cannot predict what portion of overall sales will be conducted through online auctions or other redistribution methods in the future and what impact this may have on its auction business.

 

The interim financial statements included in this Quarterly Report on Form 10-Q and the following discussion and analysis should be read in conjunction with the historical financial statements, related notes thereto, and other financial information included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, which includes audited financial statements for the three years ended December 31, 2004.

 

Executive Overview

 

In the first quarter of 2005, ADESA generated growth in earnings despite the constraints in institutional vehicle supply.  The continued decline in off-lease and repossessed volumes contributed to a 5% decrease in vehicles sold at ADESA auctions.  The operating results achieved in the first quarter of 2005 demonstrated the Company’s flexible cost structure which management was able to utilize to control costs.  ADESA achieved operating profit growth in both business segments, increased first quarter 2005 loan transactions over 6%, repurchased over 0.3 million shares of its common stock and paid a quarterly dividend.  Acceptance of the Company’s real-time interactive Internet bidding system, LiveBlock^TM, continues as both the number of LiveBlock dealers and auctions expanded.  In addition, the Company announced several management realignment changes to better position itself for the future and to take advantage of synergies across its business lines.  The Company strengthened its management team with the promotions of Bradley S. Todd to Chief Operating Officer of ADESA Corporation, LLC and Paul J. Lips to Senior Vice President of Operations for ADESA Corporation, LLC.  Jonathon Peisner was also appointed Vice President of Investor Relations and Planning.  The Company also announced the departure of James Hallett, Executive Vice President of ADESA, Inc., and President of ADESA, Corp., LLC. The departure was effective May 6, 2005.  On May 3, 2005, the Company announced that it has entered the Washington, D.C. auction market via the acquisition of ABC Washington Dulles, LLC, an 83 acre state-of-the-art leased facility located in Sterling, Virginia.

 

For the three months ended March 31, 2005, the Company reported revenue of $244.0 million and net income of $35.0 million or $0.38 per diluted share, compared with revenue of $247.3 million and net income of $33.3 million or $0.38 per diluted share for the three months ended March 31, 2004.  Cash used by operations was $8.1 million for the three months ended March 31, 2005, compared with cash flows generated from operations of $13.6 million for the three months ended March 31, 2004.  The Company incurred various charges and incremental expenses in 2004 and 2005 related to its initial public offering and subsequent separation from ALLETE that affect the comparability of its reported results of operations.  The impact of these transactions on net income is as follows (in millions):

 

15

 

		Three Months Ended March 31,
		2005			2004
Non-recurring item:
Transaction-related expense *		$	—		$	1.2
Incremental expenses
Corporate expenses *		2.9			—
Interest expense *		4.1			—
		7.0			—
Tax benefit of above items		(2.7		)	(0.4		)
Decrease to net income		$	4.3		$	0.8

 

* The non-recurring transaction-related expense in 2004 consisted primarily of legal and professional fees associated with the Company’s initial public offering and separation from ALLETE.  Incremental corporate expenses for 2005 consisted of salaries, benefits and other expenses due to the addition of corporate level personnel, professional fees, incremental insurance and other costs necessary to support an independent public company, while incremental interest expense is the result of the Company’s recapitalization and transition to an independent public company.

 

Critical Accounting Estimates

 

In preparing the financial statements in accordance with generally accepted accounting principles, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period.  Some of those judgments can be subjective and complex.  Consequently, actual results could differ from those estimates.  Accounting measurements that management believes are most critical to the reported results of operations and financial condition of the Company include: uncollectible receivables and allowance for credit losses and doubtful accounts, impairment of goodwill and long-lived assets, self-insurance programs, legal proceedings and other loss contingencies, and income taxes.

 

Management has discussed the development and selection of its critical accounting estimates with the Audit Committee of ADESA’s Board of Directors.  In addition to the critical accounting estimates, there are other items used in the preparation of ADESA’s consolidated financial statements that require estimation, but are not deemed critical based on the above criteria.  Changes in estimates used in these and other items could have a material impact on ADESA’s financial statements.

 

ADESA continually evaluates the accounting policies and estimates it uses to prepare the consolidated financial statements.  In cases where management estimates are used, they are based on historical experience, information from third-party professionals, and various other assumptions believed to be reasonable.  The Company’s critical accounting estimates are discussed in the “Critical Accounting Estimates” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission.  In addition, ADESA’s most significant accounting polices are discussed in Note 3 and elsewhere in the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K, which includes audited financial statements for the three years ended December 31, 2004.

 

Seasonality

 

Generally, the volume of vehicles sold at the Company’s auctions is highest in the first and second calendar quarters of each year and slightly lower in the third quarter.  Fourth quarter volume of vehicles sold is generally lower than all other quarters. This seasonality is affected by several factors including weather, the timing of used vehicles available for sale from selling customers, holidays, and the seasonality of the retail market for used vehicles, which affect the demand side of the auction industry.  Auction volumes tend to decline during prolonged periods of winter weather conditions, hurricanes and other major weather related events.  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 Company’s earnings are generally highest in the second calendar quarter followed by the third calendar quarter.  Although volume is typically higher in the first calendar quarter than the third calendar quarter, earnings are generally lower due to additional costs

 

16

 

associated with winter weather.  The fourth calendar quarter typically has the lowest earnings as a result of the lower volume and additional costs associated with the holidays and winter weather.

 

Results of Operations

 

The following table sets forth operations data for the periods indicated:

 

		Three Months Ended March 31,						Change
Operations Data:		2005			2004			$				%
Auction and related services revenue
US revenue		$	171.0		$	175.0
Canadian revenue		44.0			43.4
Dealer financing revenue
US revenue		27.2			27.3
Canadian revenue		1.8			1.6
Total revenue		244.0			247.3				(3.3	)		(1	)%
Cost of services		115.2			120.8				(5.6	)		(5	)%
Selling, general and administrative		55.5			59.2				(3.7	)		(6	)%
Depreciation and amortization		9.2			9.2				—			—
Operating profit		64.1			58.1				6.0			10	%
Net income		$	35.0		$	33.3		$	1.7			5	%

 

The following table sets forth operations data as a percentage of total revenue for the periods indicated:

 

		Three Months Ended March 31,
Operations Data:		2005			2004
Auction and related services revenue		88.1	%		88.3	%
Dealer financing revenue		11.9	%		11.7	%
Total revenue		100.0	%		100.0	%
Cost of services		47.2	%		48.8	%
Selling, general and administrative		22.7	%		24.0	%
Depreciation and amortization		3.8	%		3.7	%
Operating profit		26.3	%		23.5	%

 

The Company’s revenue is derived from auction fees and related services at its auction facilities and dealer financing services at AFC.  AFC’s net revenue consists of interest and fee income and gain on sale of finance receivables less provisions for credit losses.  This net presentation of AFC’s revenues is customary for finance companies.  Operating expenses for the Company consist of cost of services, selling, general and administrative expenses and depreciation and amortization.  Cost of services is composed of payroll and related costs, subcontract services, supplies, insurance, property taxes, utilities and maintenance.  Selling, general and administrative expenses are composed of indirect payroll and related costs, sales and marketing, information technology services and professional fees.

 

17