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EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - KAR Auction Services, Inc.dex321.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - KAR Auction Services, Inc.dex312.htm
EX-32.2 - CERTIFICATION OF CHIEF FIANANCIAL OFFICER PURSUANT TO SECTION 906 - KAR Auction Services, Inc.dex322.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - KAR Auction Services, Inc.dex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 333-148847

 

 

KAR Auction Services, Inc.

(formerly known as KAR Holdings, Inc.)

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   20-8744739

(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, including zip code)

Registrant’s telephone number, including area code: (800) 923-3725

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  ¨     Non-accelerated filer  x    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 31, 2009, 10,685,366 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

 

 

 


Table of Contents

KAR Auction Services, Inc.

Table of Contents

 

          Page
PART I—FINANCIAL INFORMATION   

Item 1.

  

Financial Statements

  
  

Consolidated Statements of Operations

   3
  

Consolidated Balance Sheets

   4
  

Consolidated Statement of Stockholders’ Equity

   6
  

Consolidated Statements of Cash Flows

   7
  

Notes to Consolidated Financial Statements

   8
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   35
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

   56
Item 4T.   

Controls and Procedures

   57
PART II—OTHER INFORMATION   
Item 1.   

Legal Proceedings

   58
Item 1A.   

Risk Factors

   58
Item 6.   

Exhibits

   68

Signatures

   69

Exhibit Index

   70

 

2


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements

KAR Auction Services, Inc.

Consolidated Statements of Operations

(In millions)

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2009             2008             2009             2008      

Operating revenues

        

ADESA Auction Services

   $ 270.8      $ 286.4      $ 838.6      $ 862.7   

IAAI Salvage Services

     135.5        135.4        412.5        426.0   

AFC

     23.8        22.8        60.6        86.5   
                                

Total operating revenues

     430.1        444.6        1,311.7        1,375.2   
                                

Operating expenses

        

Cost of services (exclusive of

depreciation and amortization)

     239.6        261.4        755.1        792.9   

Selling, general and administrative

     101.4        92.7        274.3        285.2   

Depreciation and amortization

     41.6        45.0        129.9        137.3   

Goodwill and other intangibles impairment

     —          164.4        —          164.4   
                                

Total operating expenses

     382.6        563.5        1,159.3        1,379.8   
                                

Operating profit (loss)

     47.5        (118.9     152.4        (4.6

Interest expense

     39.3        52.1        132.8        161.5   

Other (income) expense, net

     (4.8     4.1        (9.3     4.9   
                                

Income (loss) before income taxes

     13.0        (175.1     28.9        (171.0

Income taxes

     4.4        (5.2     11.0        (4.1
                                

Net income (loss)

   $ 8.6      ($ 169.9   $ 17.9      ($ 166.9
                                

 

See accompanying Notes to Consolidated Financial Statements

 

3


Table of Contents

KAR Auction Services, Inc.

Consolidated Balance Sheets

(In millions)

 

     September 30,
2009
   December 31,
2008
     (unaudited)     

Assets

     

Current assets

     

Cash and cash equivalents

   $ 380.8    $ 158.4

Restricted cash

     8.8      15.9

Trade receivables, net of allowances of $9.2 and $10.8

     318.4      285.7

Finance receivables, net of allowances of $5.4 and $6.3

     146.2      158.9

Retained interests in finance receivables sold

     77.9      43.4

Deferred income tax assets

     38.6      43.2

Other current assets

     44.2      47.2
             

Total current assets

     1,014.9      752.7

Other assets

     

Goodwill

     1,526.3      1,524.7

Customer relationships, net of accumulated amortization of $165.0 and $111.4

     768.6      805.8

Other intangible assets, net of accumulated amortization of $56.1 and $37.9

     265.8      264.7

Unamortized debt issuance costs

     59.8      69.4

Other assets

     16.4      18.6
             

Total other assets

     2,636.9      2,683.2

Property and equipment, net of accumulated depreciation of $215.7 and $153.6

     682.7      721.7
             

Total assets

   $ 4,334.5    $ 4,157.6
             

 

 

See accompanying Notes to Consolidated Financial Statements

 

4


Table of Contents

KAR Auction Services, Inc.

Consolidated Balance Sheets

(In millions, except share and par value data)

 

     September 30,
2009
    December 31,
2008
 
     (unaudited)        

Liabilities and Stockholders’ Equity

    

Current liabilities

    

Accounts payable

   $ 404.4      $ 283.4   

Accrued employee benefits and compensation expenses

     54.3        42.4   

Accrued interest

     35.1        15.4   

Other accrued expenses

     70.0        102.7   

Income taxes payable

     3.8        —     

Current maturities of long-term debt

     —          4.5   
                

Total current liabilities

     567.6        448.4   

Non-current liabilities

    

Long-term debt

     2,522.9        2,522.9   

Deferred income tax liabilities

     329.0        335.8   

Other liabilities

     114.0        99.8   
                

Total non-current liabilities

     2,965.9        2,958.5   

Commitments and contingencies (Note 11)

     —          —     

Stockholders’ equity

    

Preferred stock, $0.01 par value:

    

Authorized shares: 5,000,000

    

Issued shares: none

     —          —     

Common stock, $0.01 par value:

    

Authorized shares: 20,000,000

    

Issued shares: 10,685,366 (2009 and 2008)

     0.1        0.1   

Additional paid-in capital

     1,026.7        1,029.8   

Retained deficit

     (239.8     (257.7

Accumulated other comprehensive income (loss)

     14.0        (21.5
                

Total stockholders’ equity

     801.0        750.7   
                

Total liabilities and stockholders’ equity

   $ 4,334.5      $ 4,157.6   
                

See accompanying Notes to Consolidated Financial Statements

 

5


Table of Contents

KAR Auction Services, Inc.

Consolidated Statement of Stockholders’ Equity

(In millions)

(Unaudited)

 

     Common
Stock

Shares
   Common
Stock

Amount
   Additional
Paid-In
Capital
    Retained
Deficit
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  

Balance at December 31, 2008

   10.7    $ 0.1    $ 1,029.8      ($ 257.7   ($ 21.5   $ 750.7   

Comprehensive income:

              

Net income

        —        —          17.9        —          17.9   

Other comprehensive income, net of tax:

              

Unrealized gain on interest rate derivatives

        —        —          —          4.1        4.1   

Foreign currency translation

        —        —          —          31.4        31.4   
                                            

Comprehensive income

        —        —          17.9        35.5        53.4   

Stock-based compensation expense

        —        8.7        —          —          8.7   

Reclassification of options from equity to liability

        —        (11.8     —          —          (11.8
                                            

Balance at September 30, 2009

   10.7    $ 0.1    $ 1,026.7      ($ 239.8   $ 14.0      $ 801.0   
                                            

 

See accompanying Notes to Consolidated Financial Statements

 

6


Table of Contents

KAR Auction Services, Inc.

Consolidated Statements of Cash Flows

(In millions)

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2009     2008  

Operating activities

    

Net income (loss)

   $ 17.9      ($ 166.9

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation and amortization

     129.9        137.3   

Provision for credit losses

     2.3        7.1   

Deferred income taxes

     (8.5     (27.8

Amortization of debt issuance costs

     10.0        10.2   

Stock-based compensation

     15.7        (4.2

Loss on disposal of fixed assets

     1.1        5.6   

Goodwill and other intangibles impairment

     —          164.4   

Other noncash, net

     8.3        6.2   

Changes in operating assets and liabilities, net of acquisitions:

    

Finance receivables held for sale

     23.0        33.9   

Retained interests in finance receivables sold

     (34.5     10.7   

Trade receivables and other assets

     (33.0     (43.9

Accounts payable and accrued expenses

     106.9        74.9   
                

Net cash provided by operating activities

     239.1        207.5   

Investing activities

    

Net (increase) decrease in finance receivables held for investment

     (2.8     8.8   

Acquisition of businesses, net of cash acquired

     (4.1     (155.8

Purchases of property, equipment and computer software

     (40.8     (85.7

Proceeds from the sale of property and equipment

     0.3        73.4   

Decrease in restricted cash

     7.1        6.3   
                

Net cash used by investing activities

     (40.3     (153.0

Financing activities

    

Net increase in book overdrafts

     30.8        2.5   

Net decrease in borrowings from lines of credit

     (4.5     —     

Payments for debt issuance costs

     (0.3     (1.2

Payments on long-term debt

     —          (55.7

Payments on capital leases

     (2.2     (0.3

Initial net investment for interest rate cap

     (1.3     —     

Repurchase of common stock

     —          (0.1
                

Net cash provided (used) by financing activities

     22.5        (54.8

Effect of exchange rate changes on cash

     1.1        (2.6
                

Net increase (decrease) in cash and cash equivalents

     222.4        (2.9

Cash and cash equivalents at beginning of period

     158.4        204.1   
                

Cash and cash equivalents at end of period

   $ 380.8      $ 201.2   
                

See accompanying Notes to Consolidated Financial Statements

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements

September 30, 2009 (Unaudited)

Note 1—Basis of Presentation and Nature of Operations

On November 3, 2009, KAR Holdings, Inc. changed its name to KAR Auction Services, Inc.

Defined Terms

Unless otherwise indicated, the following terms used herein shall have the following meanings:

 

   

“ADESA” refers to ADESA, Inc. and its subsidiaries;

 

   

“AFC” refers to Automotive Finance Corporation, a subsidiary of ADESA;

 

   

“Axle LLC” refers to Axle Holdings II, LLC, which is owned by affiliates of certain of the Equity Sponsors (Kelso & Company and Parthenon), certain members or former members of IAAI management, and certain co-investors in connection with the acquisition of IAAI in 2005;

 

   

“Equity Sponsors” refers, collectively, to Kelso Investment Associates VII, L.P., GS Capital Partners VI, L.P., ValueAct Capital Master Fund, L.P. and Parthenon Investors II, L.P., which own through their respective affiliates substantially all of KAR Auction Services equity;

 

   

“IAAI” refers to Insurance Auto Auctions, Inc. and its subsidiaries;

 

   

“KAR Auction Services” or “the Company” refers to KAR Auction Services, Inc., a Delaware corporation, that is a wholly owned subsidiary of KAR LLC. KAR Auction Services is the parent company of ADESA and IAAI; and

 

   

“KAR LLC” refers to KAR Holdings II, LLC, which is owned by affiliates of the Equity Sponsors, management of the Company and Axle LLC.

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 notes required by generally accepted accounting principles for annual financial statements. Operating results for interim periods are not necessarily indicative of results that may be expected for the year as a whole. In the opinion of management, the consolidated financial statements reflect all adjustments necessary, consisting of normal recurring accruals, except as otherwise noted, for a fair statement of the Company’s financial results for the periods presented. In preparing the accompanying financial statements, management has evaluated subsequent events through November 9, 2009, the date the financial statements were issued. 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” in this Form 10-Q and elsewhere in the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission (“SEC”) on March 11, 2009 (File No: 333-148847), which includes audited financial statements.

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

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

for the year ended December 31, 2008 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The 2008 year-end consolidated balance sheet data included in this Form 10-Q was derived from the audited financial statements referenced above, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Nature of operations

As of September 30, 2009, the network of 62 ADESA whole car auctions and 152 IAAI salvage vehicle auctions facilitates the sale of used and salvage vehicles through physical, online or hybrid auctions, which permit Internet buyers to participate in physical auctions. ADESA and IAAI are leading national providers of wholesale and salvage vehicle auctions and related vehicle redistribution services for the automotive industry in North America. Redistribution services include a variety of activities designed to transfer used and salvage vehicles between sellers and buyers throughout the vehicle life cycle. ADESA and IAAI facilitate the exchange of these vehicles through an auction marketplace, which aligns sellers and buyers. As an agent for customers, the companies do not take title or ownership to substantially all vehicles sold at the auctions. Generally fees are earned from the seller and buyer on each successful auction transaction in addition to fees earned for ancillary services.

ADESA has the second largest used vehicle auction network in North America, based upon the number of used vehicles sold through auctions annually, and also provides services such as inbound and outbound logistics, reconditioning, vehicle inspection and certification, titling, administrative and salvage recovery services. ADESA is able to serve the diverse and multi-faceted needs of its customers through the wide range of services offered at its facilities.

IAAI is one of the two largest providers of salvage vehicle auctions and related services in North America. The salvage auctions facilitate the redistribution of damaged vehicles that are designated as total losses by insurance companies, recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made and older model vehicles donated to charity or sold by dealers in salvage auctions. The salvage auction business specializes in providing services such as inbound and outbound logistics, inspections, evaluations, titling and settlement administrative services.

AFC is a leading provider of floorplan financing to independent used vehicle dealers and this financing is provided through 87 loan production offices located throughout North America. Floorplan financing supports independent used vehicle dealers in North America who purchase vehicles at ADESA, IAAI, independent auctions and auctions affiliated with other auction networks.

Note 2—New Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162. This release established the FASB Accounting Standards Codification (“Codification”) as the source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The codification reorganized existing U.S. accounting and reporting standards issued by the FASB and other related private sector standard setters into a single source of authoritative accounting principles arranged by topic. The Codification was effective on a prospective basis

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

for interim and annual reporting periods ending after September 15, 2009. The adoption of the Codification changed the Company’s references to GAAP accounting standards but did not have a material impact on the consolidated financial statements.

In February 2008, the FASB issued new guidance for the accounting for nonfinancial assets and nonfinancial liabilities. The new guidance, which is now a part of Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, delayed the effective date by one year of the application of fair value accounting for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, at least annually. The adoption of the new guidance on January 1, 2009 did not have a material impact on the consolidated financial statements.

In December 2007, the FASB issued revised guidance for the accounting for business combinations. The revised guidance, which is now a part of ASC 805, Business Combinations, establishes principles and requirements for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in an acquisition, at their fair value as of the acquisition date and requires the expensing of acquisition-related costs as incurred. In addition, in relation to previous acquisitions, the provisions of ASC 805 require any release of existing income tax valuation allowances or recognition of previously unrecognized tax benefits initially established through purchase accounting to be included in earnings rather than as an adjustment to goodwill. This revised guidance was effective for annual reporting periods beginning after December 15, 2008. The adoption of the guidance on January 1, 2009 did not have a material impact on the consolidated financial statements. However, depending on the extent and size of future acquisitions, if any, the revised guidance may have material effects.

In December 2007, the FASB issued new guidance for the accounting for noncontrolling interests. The new guidance, which is now a part of ASC 810, Consolidation, establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The provisions of the new guidance were effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of the new guidance on January 1, 2009 did not have a material impact on the consolidated financial statements.

In March 2008, the FASB issued new guidance on the disclosure of derivative instruments and hedging activities. The new guidance, which is now a part of ASC 815, Derivatives and Hedging, requires enhanced disclosures for derivative instruments, including those used in hedging activities. These enhanced disclosures include information about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. The provisions of the new guidance were effective for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of the new guidance on January 1, 2009 did not have a material impact on the consolidated financial statements. See Note 7 for additional information.

In May 2009, the FASB issued new guidance on subsequent events. The new guidance, which is now a part of ASC 855, Subsequent Events, requires the disclosure of the date through which an entity has evaluated subsequent events and whether that represents the date the financial statements were issued or were available to be issued. The provisions of the new guidance were effective for interim and annual periods ending after June 15, 2009. The adoption of the new guidance on June 30, 2009 did not have a material impact on the consolidated financial statements.

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

In June 2009, the FASB issued new guidance on the accounting for the transfers of financial assets. The new guidance, which was issued as Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets – an Amendment of FASB Statement No. 140, has not yet been adopted into the Codification. The release eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial assets. The new guidance is effective on a prospective basis for annual periods ending after November 15, 2009. The Company is currently evaluating the impact that the adoption of the new guidance will have on the consolidated financial statements. At September 30, 2009, $318 million of loans sold to a bank conduit facility are not included in the Company’s balance sheet. This new guidance may require inclusion of loans sold to a bank conduit facility and originated after December 31, 2009, in the Company’s financial statements.

Note 3—Stock-Based Compensation Plans

The Company’s stock-based compensation expense includes expense associated with the Company’s service option awards, KAR LLC operating unit awards and Axle LLC operating unit awards. The Company initially classified the service options as equity awards and the KAR LLC and Axle LLC operating units as liability awards. In February 2009, the Company took certain actions related to its stock-based compensation plans which resulted in all outstanding awards being classified as liability awards prospectively. The main difference between a liability-classified award and an equity-classified award is that liability-classified awards are remeasured each reporting period at fair value. The liability for these awards is recorded in “Other liabilities” on the consolidated balance sheet. Per ASC 718, an award that changes its classification from equity to liability should result in compensation cost equal to the greater of (1) the grant-date fair value of the original equity award or (2) the fair value of the liability award when it is settled. The related liability and compensation expense of KAR LLC and Axle LLC, which is for the benefit of Company employees, results in a capital contribution from KAR LLC and Axle LLC to the Company and compensation expense for the Company.

The compensation cost that was charged against income for all stock-based compensation plans was $14.8 million and $15.7 million for the three and nine months ended September 30, 2009, respectively, and the total income tax benefit recognized in the consolidated statement of operations for stock-based compensation agreements was approximately $2.4 million and $2.7 million for the three and nine months ended September 30, 2009.

The compensation cost that was charged against income for service options was $0.5 million and $1.6 million for the three and nine months ended September 30, 2008, respectively, and the total income tax benefit recognized in the consolidated statement of operations for service options was approximately $0.2 million and $0.6 million for the three and nine months ended September 30, 2008, respectively. The Company recognized a reduction in compensation expense for operating units of approximately $7.3 million for the three months ended September 30, 2008 to reduce expense previously recorded in 2007 and 2008. The $7.3 million discussed above was offset by $1.5 million of compensation expense for operating units recorded in the first six months of 2008, resulting in a net reduction in compensation expense for operating units of approximately $5.8 million for the nine months ended September 30, 2008. The reduction in operating unit compensation expense for the three and nine months ended September 30, 2008 resulted from marking the operating units to fair value. The Company did not capitalize any stock-based compensation cost in the nine months ended September 30, 2009 or 2008.

Note 4—Finance Receivables

AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to a wholly owned, bankruptcy remote, consolidated, special purpose subsidiary (“AFC Funding

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Corporation”), established for the purpose of purchasing AFC’s finance receivables. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a bank conduit facility of up to a maximum of $750 million in undivided interests in certain eligible finance receivables subject to committed liquidity. The agreement expires on April 20, 2012. AFC Funding Corporation had committed liquidity of $450 million at September 30, 2009. Receivables that AFC Funding Corporation sells to the bank conduit facility qualify for sales accounting for financial reporting purposes pursuant to ASC 860, Transfers and Servicing, and as a result are not reported on the Company’s consolidated balance sheet.

On January 30, 2009, AFC and AFC Funding Corporation entered into an amendment to the Receivables Purchase Agreement with the other parties named therein. The aggregate maximum commitment of the purchasers is $450 million. In addition, the calculation of the purchasers’ participation was amended, reducing the amount received by AFC Funding Corporation upon the sale of an interest in the receivables to the purchasers.

At September 30, 2009, AFC managed total finance receivables of $547.5 million, of which $460.1 million had been sold without recourse to AFC Funding Corporation. At December 31, 2008, AFC managed total finance receivables of $506.6 million, of which $436.5 million had been sold without recourse to AFC Funding Corporation. Undivided interests in finance receivables were sold by AFC Funding Corporation to the bank conduit facility with recourse totaling $318.0 million and $298.0 million at September 30, 2009 and December 31, 2008. Finance receivables include $34.3 million and $6.6 million classified as held for sale which are recorded at lower of cost or fair value, and $117.3 million and $158.6 million classified as held for investment at September 30, 2009 and December 31, 2008. Finance receivables classified as held for investment include $19.1 million and $69.8 million related to receivables that were sold to the bank conduit facility that were repurchased by AFC at fair value when they became ineligible under the terms of the collateral agreement with the bank conduit facility at September 30, 2009 and December 31, 2008. The face amount of these receivables was $20.6 million and $78.7 million at September 30, 2009 and December 31, 2008.

AFC’s allowance for losses of $5.4 million and $6.3 million at September 30, 2009 and December 31, 2008 included an estimate of losses for finance receivables held for investment as well as an allowance for any further deterioration in the finance receivables after they are repurchased from the bank conduit facility. Additionally, accrued liabilities of $1.9 million and $3.0 million for the estimated losses for loans sold by the special purpose subsidiary were recorded at September 30, 2009 and December 31, 2008. These loans were sold to a bank conduit facility with recourse to the special purpose subsidiary and will come back on the balance sheet of the special purpose subsidiary at fair market value if they become ineligible under the terms of the collateral arrangement with the bank conduit facility.

The outstanding receivables sold, the retained interests in finance receivables sold and a cash reserve of 1 or 3 percent of total sold receivables serve as security for the receivables that have been sold to the bank conduit facility. The amount of the cash reserve depends on circumstances which are set forth in the securitization agreement. After the occurrence of a termination event, as defined in the securitization agreement, the bank conduit facility may, and could, cause the stock of AFC Funding Corporation to be transferred to the bank conduit facility, though as a practical matter the bank conduit facility would look to the liquidation of the receivables under the transaction documents as their primary remedy.

Proceeds from the revolving sale of receivables to the bank conduit facility are 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

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

tied to the performance of the finance receivables portfolio. The securitization agreement also incorporates the financial covenants of the Company’s credit facility. At September 30, 2009, the Company was in compliance with the covenants in the securitization agreement.

The following illustration presents quantitative information about delinquencies, credit losses less recoveries (“net credit losses”) and components of securitized financial assets and other related assets managed. For purposes of this illustration, delinquent receivables are defined as receivables 31 days or more past due.

 

     September 30, 2009    Net Credit Losses
Three Months Ended
September 30, 2009
   Net Credit Losses
Nine Months Ended
September 30, 2009
     Principal Amount of:      

(in millions)

   Receivables    Receivables
Delinquent
     

Floorplan receivables

   $ 140.9    $ 2.3    $ 1.1    $ 2.1

Special purpose loans

     10.7      3.7      —        —  
                           

Finance receivables held

     151.6    $ 6.0    $ 1.1    $ 2.1
                       

Receivables sold

     318.0         
           

Retained interests in finance receivables sold

     77.9         
               

Total receivables managed

   $ 547.5         
               

The net credit losses for receivables sold approximated $3.4 million and $21.5 million for the three and nine months ended September 30, 2009.

 

     December 31, 2008    Net Credit Losses
Three Months Ended
September 30, 2008
   Net Credit Losses
Nine Months Ended
September 30, 2008
     Principal Amount of:      

(in millions)

   Receivables    Receivables
Delinquent
     

Floorplan receivables

   $ 151.2    $ 7.4    $ 0.3    $ 1.3

Special purpose loans

     14.0      7.1      —        —  
                           

Finance receivables held

     165.2    $ 14.5    $ 0.3    $ 1.3
                       

Receivables sold

     298.0         
           

Retained interests in finance receivables sold

     43.4         
               

Total receivables managed

   $ 506.6         
               

The net credit losses for receivables sold approximated $9.7 million and $23.9 million for the three and nine months ended September 30, 2008.

The following table summarizes certain cash flows received from and paid to the special purpose subsidiaries (in millions):

 

     Nine Months Ended
September 30,
     2009    2008

Proceeds from sales of finance receivables

   $ 2,313.6    $ 3,481.6

Servicing fees received

   $ 7.5    $ 12.1

Proceeds received on retained interests in finance receivables sold

   $ 59.1    $ 81.1

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

The Company’s retained interests in finance receivables sold, including a nominal interest only strip, amounted to $77.9 million and $43.4 million at September 30, 2009 and December 31, 2008. Sensitivities associated with the Company’s retained interests were insignificant at all periods presented due to the short-term nature of the asset.

Note 5—Goodwill and Other Intangible Assets

Goodwill consisted of the following (in millions):

 

     ADESA
Auctions
   IAAI     AFC     Total  

Balance at December 31, 2007

   $ 806.7    $ 452.4      $ 358.5      $ 1,617.6   

Increase for acquisition activity

     17.4      52.1        —          69.5   

Impairment

     —        —          (161.5     (161.5

Other

     0.7      (0.9     (0.7     (0.9
                               

Balance at December 31, 2008

   $ 824.8    $ 503.6      $ 196.3      $ 1,524.7   

Acquisition activity

     1.3      (0.2     —          1.1   

Other

     0.5      —          —          0.5   
                               

Balance at September 30, 2009

   $ 826.6    $ 503.4      $ 196.3      $ 1,526.3   
                               

Goodwill represents the excess cost over fair value of identifiable net assets of businesses acquired. The Company tests goodwill and tradenames for impairment at the reporting unit level annually in the second quarter, or more frequently as impairment indicators arise. In the third quarter of 2008, a noncash goodwill impairment charge of $161.5 million was recorded in the AFC reporting unit. In light of the overall economy and in particular the automotive and finance industries which continued to face severe pressures, AFC and its customer dealer base were negatively impacted. In addition, AFC was negatively impacted by reduced interest rate spreads. As a result of reduced interest rate spreads and increased risk associated with lending in the automotive industry, AFC tightened credit policies and experienced a decline in its portfolio of finance receivables. These factors contributed to lower operating profits and cash flows at AFC throughout 2008 as compared to 2007. Based on this trend, the forecasted performance was revised and the fair value of the reporting unit declined. The fair value of that reporting unit was estimated using the expected present value of future cash flows.

In addition, in the third quarter of 2008, a noncash tradename charge of approximately $2.9 million was recorded in the AFC reporting unit, reducing its carrying value of $11.6 million to its fair value of $8.7 million. The fair value of the tradename was estimated using the royalty savings method, a form of the income approach.

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Note 6—Long-Term Debt

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

 

     Interest Rate    Maturity    September 30,
2009
   December 31,
2008

Term Loan B

   LIBOR + 2.25%    October 19, 2013    $ 1,497.9    $ 1,497.9

$300 million revolving credit facility

   LIBOR + 2.25%    April 19, 2013      —        —  

Floating rate senior notes

   LIBOR + 4.00%    May 01, 2014      150.0      150.0

Senior notes

   8.75%    May 01, 2014      450.0      450.0

Senior subordinated notes

   10%    May 01, 2015      425.0      425.0

Canadian line of credit

   Prime + 1.75%    August 31, 2010      —        4.5
                   

Total debt

           2,522.9      2,527.4

Less current portion of long-term debt

           —        4.5
                   

Long-term debt

         $ 2,522.9    $ 2,522.9
                   

Credit Facilities

In 2007, the Company entered into senior secured credit facilities, comprised of a $300.0 million revolving credit facility and a $1,565.0 million term loan (Term Loan B in the table above). The revolver was entered into for working capital and general corporate purposes. There were no borrowings under the revolver at September 30, 2009 or December 31, 2008, although the Company did have related outstanding letters of credit in the aggregate amount of $31.3 million and $29.3 million at September 30, 2009 and December 31, 2008.

On October 23, 2009, the Company entered into an amendment to its Credit Agreement. As part of the amendment, the Company agreed to pay an amendment fee of 25 basis points to approving lenders, based on commitments outstanding as of October 23, 2009, on the effective date of the amendment. The amendment will not become effective until the satisfaction of certain conditions precedent, including the consummation of the Company’s proposed initial public offering and the optional prepayment of $250 million or more of the term loan. If the amendment becomes effective the amendment will (i) allow KAR LLC to own less than 100% of the Company’s outstanding capital stock, (ii) permit the Company to use proceeds from the Company’s proposed initial public offering and any future offering of common stock plus unrestricted cash on hand at the time of the Company’s proposed initial public offering to repay, redeem, repurchase or defease, or segregate funds with respect to, one or more of the Company’s senior subordinated notes, fixed rate senior notes and floating rate senior notes and (iii) permit the Company to pay accelerated management fees to the Company’s Equity Sponsors in connection with the termination of its financial advisory agreements with them. In addition, if the amendment becomes effective, the following revisions, among others, will occur:

 

   

availability of borrowings under the revolving credit facility will be reduced by $50 million to $250 million;

 

   

the revolving credit facility and Term Loan B interest rate will be increased to LIBOR plus a margin of 2.75% from LIBOR plus a margin of 2.25%; and

 

   

the pricing grid of both facilities will be eliminated.

In accordance with the terms of the Credit Agreement, the Company prepaid approximately $51.5 million of the term loan during 2008 as a result of certain asset sales. The prepayments were credited to prepay in direct order of maturity the unpaid amounts due on the next eight scheduled quarterly installments of the term loan, and thereafter to the remaining scheduled quarterly installments of the term loan on a pro rata basis. As such, there are no scheduled quarterly installments due on the term loan until March 31, 2011. In addition, commencing with the fiscal year ended December 31, 2008, the Company was subject to a potential prepayment on the term loan. If there is any excess cash flow, as defined in the Company’s senior secured credit facility, the Company shall prepay the term loan in an amount equal to 50% of the excess cash flow on or before the 105th day following the end of the fiscal year. There was no excess cash flow, as defined, for the year ended December 31, 2008.

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

The senior secured credit facilities are guaranteed by KAR LLC and each of the Company’s direct and indirect present and future material domestic subsidiaries, subject to certain exceptions (excluding among others, AFC Funding Corporation). The senior secured credit facilities are secured by a perfected first priority security interest in, and mortgages on, all present and future tangible and intangible assets of the Company and the guarantors, and the capital stock of the Company and each of its direct and indirect material domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries.

The credit agreement includes covenants that, among other things, limit or restrict the Company’s and its subsidiaries’ abilities to dispose of assets, incur additional indebtedness, incur guarantee obligations, prepay other indebtedness, including the senior notes, pay dividends, create liens, make equity or debt investments, make acquisitions, modify the terms of the indenture, engage in mergers, make capital expenditures and engage in certain transactions with affiliates. In addition, the senior secured credit facilities are subject to a senior secured leverage ratio test, provided there are revolving loans outstanding. There were no revolving loans outstanding at September 30, 2009. The Company was in compliance with the covenants in the credit facility at September 30, 2009.

Canadian Line of Credit

On August 31, 2009, the Company entered into a Second Amendment to the line of credit available to ADESA Canada. Pursuant to the Second Amendment, the line of credit was reduced from C$8 million to C$4 million. In addition, the line of credit bears interest at a rate equal to the prime rate plus 175 basis points. There were no borrowings under the Canadian line of credit at September 30, 2009 and there were $4.5 million in borrowings at December 31, 2008. There were related letters of credit outstanding totaling approximately C$1.8 million and C$2.5 million at September 30, 2009 and December 31, 2008, which reduce credit available under the Canadian line of credit, but do not affect amounts available for borrowings under the Company’s revolving credit facility. The line of credit is guaranteed by certain ADESA Canada companies and is secured by a first priority security interest in the obligor’s accounts receivable.

Fair Value of Debt

As of September 30, 2009, the estimated fair value of the Company’s long-term debt amounted to $2,445.6 million. The estimate of fair value is based on current market prices for the Company’s publicly-traded debt as of September 30, 2009. The estimates presented on long-term financial instruments are not necessarily indicative of the amounts that would be realized in a current market exchange.

Note 7—Derivatives

The Company is exposed to interest rate risk on borrowings. Accordingly, interest rate fluctuations affect the amount of interest expense the Company is obligated to pay. The Credit Agreement of KAR Auction Services required that interest on at least 50% of the aggregate principal amount of the notes and the term loans be fixed by means of interest rate protection for an initial period of not less than 2 years. As such, in July 2007, the Company entered into an interest rate swap agreement with a notional amount of $800 million to manage its exposure to interest rate movements on its variable rate Term Loan B credit facility. The interest rate swap agreement effectively resulted in a fixed LIBOR interest rate of 5.345% on $800 million of the Term Loan B credit facility and matured on June 30, 2009.

In May 2009, the Company entered into an interest rate swap agreement with a notional amount of $650 million to manage its exposure to interest rate movements on its variable rate Term Loan B credit facility. The

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

interest rate swap agreement had an effective date of June 30, 2009, matures on June 30, 2012 and effectively results in a fixed LIBOR interest rate of 2.19% on $650 million of the Term Loan B credit facility. The Company is exposed to credit loss in the event of non-performance by the counterparty; however, non-performance is not anticipated.

In May 2009, the Company also purchased an interest rate cap for $1.3 million with a notional amount of $250 million to manage its exposure to interest rate movements on its variable rate Term Loan B credit facility when one-month LIBOR exceeds 2.5%. The interest rate cap relates to a portion of the variable rate debt that is not covered by an interest rate swap agreement. The interest rate cap agreement had an effective date of June 30, 2009 and matures on June 30, 2011. The initial $1.3 million investment is recorded in “Other assets” on the consolidated balance sheet and will be amortized over the life of the interest rate cap to interest expense. The Company is exposed to credit loss in the event of non-performance by the counterparty; however, non-performance is not anticipated.

ASC 815 requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. In accordance with ASC 815, the Company has designated its interest rate derivatives as cash flow hedges. The fair values of the interest rate derivatives are estimated using pricing models widely used in financial markets and represent the estimated amounts the Company would receive or pay to terminate the agreements at the reporting date. The following table presents the fair value of the Company’s interest rate derivatives included in the consolidated balance sheet for the periods presented (in millions):

 

    Asset Derivatives   Liability Derivatives
    September 30, 2009   December 31, 2008   September 30, 2009   December 31, 2008

Derivatives Designated as Hedging

Instruments Under ASC 815

  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value

$800 million notional interest rate swap

  Other
assets
    N/A   Other
assets
  $ —     Other
accrued
expenses
    N/A   Other
accrued
expenses
  $ 16.3

$650 million notional interest rate swap

  Other
assets
  $ —     Other
assets
    N/A   Other
accrued
expenses
  $ 9.7   Other
accrued
expenses
    N/A

$250 million notional interest rate cap

  Other
assets
  $ 0.9   Other
assets
    N/A   Other
accrued
expenses
  $ —     Other
accrued
expenses
    N/A

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

The earnings impact of the interest rate derivatives designated as cash flow hedges are recorded upon the recognition of the interest related to the hedged debt. Any ineffectiveness in the hedging relationships is recognized in current earnings. There was no significant ineffectiveness in the first nine months of 2009 or 2008. Changes in the fair value of the interest rate derivatives designated as cash flow hedges are recorded in “Other comprehensive income”. Unrealized gains or losses on the interest rate derivatives are included as a component of “Accumulated other comprehensive income”. At September 30, 2009, there was a net unrealized loss totaling $6.2 million, net of tax benefits of $3.8 million. At December 31, 2008, there was a net unrealized loss totaling $10.3 million, net of tax benefits of $6.0 million. The following table presents the effect of the interest rate derivatives on the Company’s statement of equity and consolidated statements of income for the periods presented (in millions):

 

    Amount of Gain /
(Loss) Recognized in
OCI on Derivative
(Effective Portion)
  Location of Gain / (Loss)
Reclassified from

Accumulated OCI into Income
(Effective Portion)
  Amount of Gain /
(Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)
 

Derivatives in ASC 815

Cash Flow Hedging Relationships

  Three Months Ended
September 30,
    Three Months Ended
September 30,
 
  2009      2008     2009        2008  

$800 million notional interest rate swap

  N/A       $ 4.0   Interest expense     N/A         ($ 5.2

$650 million notional interest rate swap

  ($3.7      N/A   Interest expense   ($ 3.2        N/A   

$250 million notional interest rate cap

  ($0.2      N/A   N/A   $ —             N/A   
    Amount of Gain /
(Loss) Recognized in
OCI on Derivative
(Effective Portion)
  Location of Gain / (Loss)
Reclassified from

Accumulated OCI into Income
(Effective Portion)
  Amount of Gain /
(Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)
 

Derivatives in ASC 815 Cash

Flow Hedging Relationships

  Nine Months Ended
September 30,
    Nine Months Ended
September 30,
 
  2009      2008     2009        2008  

$800 million notional interest rate swap

  $10.3       $ 3.9   Interest expense   ($ 16.1      ($ 11.6

$650 million notional interest rate swap

  ($6.0      N/A   Interest expense   ($ 3.2        N/A   

$250 million notional interest rate cap

  ($0.2      N/A   N/A   $ —             N/A   

Note 8—Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2009     2008      2009    2008  

Net income (loss)

   $ 8.6      ($ 169.9    $ 17.9    ($166.9

Other comprehensive income (loss), net of tax

          

Foreign currency translation gain (loss)

     21.2        (11.0      31.4    (18.7

Unrealized (loss) gain on interest rate derivatives

     (3.9     4.0         4.1    3.9   
                              

Comprehensive income (loss)

   $ 25.9      ($ 176.9    $ 53.4    ($181.7
                              

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

The composition of “Accumulated other comprehensive income” at September 30, 2009 consisted of the net unrealized loss on the interest rate derivatives of $6.2 million, a $0.4 million unrealized gain on post-retirement benefit obligation and foreign currency translation gain of $19.8 million. The composition of “Accumulated other comprehensive loss” at December 31, 2008 consisted of the net unrealized loss on the interest rate derivative of $10.3 million, a $0.4 million unrealized gain on post-retirement benefit obligation and a foreign currency translation loss of $11.6 million.

Note 9—Fair Value Measurements

The Company applies ASC 820, Fair Value Measurements and Disclosures, to its financial assets and liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The standard establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels:

 

   

Level 1—Quoted prices in active markets for identical assets or liabilities.

 

   

Level 2—Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities, such as models or other valuation methodologies.

 

   

Level 3—Unobservable inputs that are based on the Company’s assumptions, are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include instruments for which the determination of fair value requires significant management judgment or estimation.

The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis in accordance with ASC 820 (in millions):

 

Description

   September 30,
2009
   Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
   Significant Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Assets:

           

Retained interest

   $ 77.9    $ —      $ —      $ 77.9

Interest rate cap

     0.9      —        0.9      —  

Liabilities:

           

Interest rate swap

   $ 9.7    $ —      $ 9.7    $ —  

 

Description

   December 31,
2008
   Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
   Significant Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Assets:

           

Retained interest

   $ 43.4    $ —      $ —      $ 43.4

Liabilities:

           

Interest rate swap

   $ 16.3    $ —      $ 16.3    $ —  

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Retained Interest—Representative of the retained interests in finance receivables sold. The fair value of the retained interests is based upon the Company’s estimates of future cash flows, using assumptions that market participants would use to value such investments, including estimates of anticipated credit losses over the life of the finance receivables sold. The cash flows were discounted using a market discount rate. The recorded fair value, however, requires significant management judgment or estimation and may not necessarily represent what the Company would receive in an actual sale of the receivables.

Interest Rate Swaps—Under the interest rate swap agreements, the Company pays a fixed LIBOR rate on a notional amount and receives a variable LIBOR rate which effectively hedges a portion of the Term Loan B credit facility. The fair value of the interest rate swaps is based on quoted market prices for similar instruments from a commercial bank.

Interest Rate Cap—Under the interest rate cap agreement, the Company will receive interest on a notional amount when one-month LIBOR exceeds 2.5%. This agreement effectively hedges a portion of the Term Loan B credit facility. The fair value of the interest rate cap is based on quoted market prices for similar instruments from a commercial bank.

Note 10—Segment Information

ASC 280, Segment Reporting, requires reporting of segment information that is consistent with the manner in which the chief operating decision maker operates and views the Company. KAR Auction Services has three reportable business segments: ADESA Auctions, IAAI and AFC. These reportable segments offer different services and are managed separately based on the fundamental differences in their operations.

The holding company is maintained separately from the three reportable segments and includes expenses associated with the corporate office, such as salaries, benefits, and travel costs for the corporate management team, certain human resources, information technology and accounting costs, and incremental insurance, treasury, legal and risk management costs. Holding company interest includes the interest incurred on the corporate debt structure. Other than some information technology costs, costs incurred at the holding company are not allocated to the three business segments.

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Financial information regarding KAR Auction Services’ reportable segments is set forth below for the three months ended September 30, 2009 (in millions):

 

     ADESA
Auctions
    IAAI     AFC     Holding
Company
    Consolidated  

Operating revenues

   $ 270.8      $ 135.5      $ 23.8      $ —        $ 430.1   
                                        

Operating expenses

          

Cost of services (exclusive of depreciation and amortization)

     146.1        86.4        7.1        —          239.6   

Selling, general and administrative

     52.2        21.4        2.6        25.2        101.4   

Depreciation and amortization

     21.0        14.3        6.1        0.2        41.6   
                                        

Total operating expenses

     219.3        122.1        15.8        25.4        382.6   
                                        

Operating profit (loss)

     51.5        13.4        8.0        (25.4     47.5   

Interest expense

     0.2        0.4        —          38.7        39.3   

Other (income) expense, net

     (0.2     (0.3     —          (4.3     (4.8

Intercompany expense (income)

     9.1        10.9        (1.6     (18.4     —     
                                        

Income (loss) before income taxes

     42.4        2.4        9.6        (41.4     13.0   

Income taxes

     12.7        1.0        3.7        (13.0     4.4   
                                        

Net income (loss)

   $ 29.7      $ 1.4      $ 5.9      ($ 28.4   $ 8.6   
                                        

Assets

   $ 2,130.2      $ 1,170.6      $ 651.3      $ 382.4      $ 4,334.5   
                                        

Financial information regarding KAR Auction Services’ reportable segments is set forth below for the three months ended September 30, 2008 (in millions):

 

     ADESA
Auctions
    IAAI     AFC     Holding
Company
    Consolidated  

Operating revenues

   $ 286.4      $ 135.4      $ 22.8      $ —        $ 444.6   
                                        

Operating expenses

          

Cost of services (exclusive of depreciation and amortization)

     162.1        90.0        9.3        —          261.4   

Selling, general and administrative

     63.9        18.3        3.7        6.8        92.7   

Depreciation and amortization

     23.0        15.4        6.2        0.4        45.0   

Goodwill and other intangibles
impairment

     —          —          164.4        —          164.4   
                                        

Total operating expenses

     249.0        123.7        183.6        7.2        563.5   
                                        

Operating profit (loss)

     37.4        11.7        (160.8     (7.2     (118.9

Interest expense

     0.1        0.2        —          51.8        52.1   

Other (income) expense, net

     (0.8     (0.1     —          5.0        4.1   

Intercompany expense (income)

     11.1        10.0        (0.5     (20.6     —     
                                        

Income (loss) before income taxes

     27.0        1.6        (160.3     (43.4     (175.1

Income taxes

     12.3        0.2        0.9        (18.6     (5.2
                                        

Net income (loss)

   $ 14.7      $ 1.4      ($ 161.2   ($ 24.8   ($ 169.9
                                        

Assets

   $ 2,254.0      $ 1,162.6      $ 711.4      $ 217.0      $ 4,345.0   
                                        

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Financial information regarding KAR Auction Services’ reportable segments is set forth below for the nine months ended September 30, 2009 (in millions):

 

     ADESA
Auctions
    IAAI     AFC     Holding
Company
    Consolidated  

Operating revenues

   $ 838.6      $ 412.5      $ 60.6      $ —        $ 1,311.7   
                                        

Operating expenses

          

Cost of services (exclusive of depreciation and amortization)

     468.1        264.5        22.5        —          755.1   

Selling, general and administrative

     157.2        52.1        8.1        56.9        274.3   

Depreciation and amortization

     66.8        43.9        18.4        0.8        129.9   
                                        

Total operating expenses

     692.1        360.5        49.0        57.7        1,159.3   
                                        

Operating profit (loss)

     146.5        52.0        11.6        (57.7     152.4   

Interest expense (income)

     0.5        1.0        —          131.3        132.8   

Other (income) expense, net

     (2.0     (1.2     1.2        (7.3     (9.3

Intercompany expense (income)

     27.1        31.8        (5.4     (53.5     —     
                                        

Income (loss) before income taxes

     120.9        20.4        15.8        (128.2     28.9   

Income taxes

     43.7        8.4        5.7        (46.8     11.0   
                                        

Net income (loss)

   $ 77.2      $ 12.0      $ 10.1      ($ 81.4   $ 17.9   
                                        

Financial information regarding KAR Auction Services’ reportable segments is set forth below for the nine months ended September 30, 2008 (in millions):

 

     ADESA
Auctions
    IAAI     AFC     Holding
Company
    Consolidated  

Operating revenues

   $ 862.7      $ 426.0      $ 86.5      $ —        $ 1,375.2   
                                        

Operating expenses

          

Cost of services (exclusive of depreciation and amortization)

     492.2        273.5        27.2        —          792.9   

Selling, general and administrative

     181.1        52.7        12.6        38.8        285.2   

Depreciation and amortization

     69.1        46.6        19.2        2.4        137.3   

Goodwill and other intangibles impairment

     —          —          164.4        —          164.4   
                                        

Total operating expenses

     742.4        372.8        223.4        41.2        1,379.8   
                                        

Operating profit (loss)

     120.3        53.2        (136.9     (41.2     (4.6

Interest expense

     1.1        0.1        —          160.3        161.5   

Other (income) expense, net

     (2.5     (0.5     —          7.9        4.9   

Intercompany expense (income)

     30.5        28.3        0.2        (59.0     —     
                                        

Income (loss) before income taxes

     91.2        25.3        (137.1     (150.4     (171.0

Income taxes

     37.1        9.9        9.8        (60.9     (4.1
                                        

Net income (loss)

   $ 54.1      $ 15.4      ($ 146.9   ($ 89.5   ($ 166.9
                                        

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

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, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Management considers the likelihood of loss or the incurrence of a liability, as well as the ability to reasonably estimate the amount of loss, in determining loss contingencies. The Company accrues an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss (or range of possible losses) can be reasonably estimated. Management regularly evaluates current information available to determine whether accrual amounts should be adjusted. Accruals for contingencies including litigation and environmental matters are included in “Other accrued expenses” at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. These accruals are adjusted periodically as assessment and remediation efforts progress, or as additional technical or legal information 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” were $1.1 million and $0.9 million at September 30, 2009 and December 31, 2008, respectively. 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 that are consigned to the Company to be auctioned. The Company is contingently liable for each consigned vehicle until the eventual sale or other disposition, subject to certain natural disaster exceptions. Individual stop loss and aggregate insurance coverage is maintained on the consigned vehicles. These consigned vehicles 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, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Such litigation is generally not, in the opinion of management, likely to have a material adverse effect on the Company’s financial condition, results of operations or cash flows. Legal and regulatory proceedings which could be material are discussed below.

IAAI—Lower Duwamish Waterway

On March 25, 2008, the United States Environmental Protection Agency, or EPA, issued a General Notice of Potential Liability pursuant to Section 107(a), and a Request for Information pursuant to Section 104(e) of the Comprehensive Environmental Response, Compensation, and Liability Act, or “CERCLA” to IAAI for a Superfund site known as the Lower Duwamish Waterway Superfund Site in Seattle, Washington, or “LDW.” At this time, the EPA has not demanded that IAAI pay any funds or take any action apart from responding to the Section 104(e) Information Request. The EPA has advised IAAI that, to date, it has sent out approximately 60 general notice letters to other parties, and has sent Section 104(e) Requests to more than 250 other parties. A

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

remedial investigation has been conducted for this site by some of the potentially responsible parties, who have also commenced a feasibility study pursuant to CERCLA. IAAI is aware that certain authorities may wish to bring Natural Resource Damage claims against potentially responsible parties. In addition, the Washington State Department of Ecology is working with the EPA in relation to LDW, primarily to investigate and address sources of potential contamination contributing to LDW. IAAI and the owner and predecessor at their Tukwila location, which is adjacent to the LDW, are currently in discussion with the Department of Ecology concerning possible source control obligations, including an investigation of the water and soils entering the stormwater system, an analysis of the source of any contamination identified within the system and possible repairs and upgrades to the stormwater capture and filtration system.

Note 12—Supplemental Guarantor Information

The Company’s obligations related to its term loan, revolver, 10% senior subordinated notes, 8 3/4% senior notes and floating rate senior notes are guaranteed on a full, unconditional, joint and several basis by certain direct and indirect present and future domestic subsidiaries (the “Guarantor Subsidiaries”). AFC Funding Corporation and all foreign subsidiaries of the Company are not guarantors (the “Non-Guarantor Subsidiaries”). The following financial information sets forth, on a condensed consolidating basis, the balance sheets, statements of operations and statements of cash flows for the periods indicated for KAR Auction Services, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and the eliminations to arrive at KAR Auction Services on a consolidated basis.

The condensed consolidating financial statements are provided as an alternative to filing separate financial statements of the Guarantor Subsidiaries. The condensed consolidating financial statements should be read in conjunction with the consolidated financial statements of KAR Auction Services, Inc. and notes thereto.

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Income

For the Three Months Ended September 30, 2009

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Operating revenues

   $ —        $ 337.5      $ 92.6      $ —      $ 430.1   
                                       

Operating expenses

           

Cost of services (exclusive of depreciation and amortization)

     —          203.1        36.5        —        239.6   

Selling, general and administrative

     10.9        77.8        12.7        —        101.4   

Depreciation and amortization

     —          36.0        5.6        —        41.6   
                                       

Total operating expenses

     10.9        316.9        54.8        —        382.6   
                                       

Operating profit (loss)

     (10.9     20.6        37.8        —        47.5   

Interest expense

     20.7        17.4        1.2        —        39.3   

Other income, net

     —          (4.7     (0.1     —        (4.8

Intercompany (income) expense

     —          (5.4     5.4        —        —     
                                       

Income (loss) before income taxes

     (31.6     13.3        31.3        —        13.0   

Income taxes

     (9.4     2.4        11.4        —        4.4   
                                       

Net income (loss)

   ($ 22.2   $ 10.9      $ 19.9      $ —      $ 8.6   
                                       

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Operations

For the Three Months Ended September 30, 2008

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Operating revenues

   $ —        $ 344.4      $ 100.2      $ —      $ 444.6   
                                       

Operating expenses

           

Cost of services (exclusive of depreciation and amortization)

     —          220.3        41.1        —        261.4   

Selling, general and administrative

     (6.0     86.1        12.6        —        92.7   

Depreciation and amortization

     —          39.2        5.8        —        45.0   

Goodwill and other intangibles impairment

     —          164.4        —          —        164.4   
                                       

Total operating expenses

     (6.0     510.0        59.5        —        563.5   
                                       

Operating profit (loss)

     6.0        (165.6     40.7        —        (118.9

Interest expense

     34.1        14.6        3.4        —        52.1   

Other (income) expense, net

     —          4.5        (0.4     —        4.1   

Intercompany charges

     —          (8.5     8.5        —        —     
                                       

Income (loss) before income taxes

     (28.1     (176.2     29.2        —        (175.1

Income taxes

     (12.1     (5.6     12.5        —        (5.2
                                       

Net income (loss)

   ($ 16.0   ($ 170.6   $ 16.7      $ —      ($ 169.9
                                       

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Income

For the Nine Months Ended September 30, 2009

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Operating revenues

   $ —        $ 1,058.2      $ 253.5      $ —      $ 1,311.7   
                                       

Operating expenses

           

Cost of services (exclusive of depreciation and amortization)

     —          645.8        109.3        —        755.1   

Selling, general and administrative

     15.0        225.7        33.6        —        274.3   

Depreciation and amortization

     —          113.3        16.6        —        129.9   
                                       

Total operating expenses

     15.0        984.8        159.5        —        1,159.3   
                                       

Operating profit (loss)

     (15.0     73.4        94.0        —        152.4   

Interest expense

     79.6        49.9        3.3        —        132.8   

Other income, net

     —          (8.2     (1.1     —        (9.3

Intercompany expense (income)

     —          (11.5     11.5        —        —     
                                       

Income (loss) before income taxes

     (94.6     43.2        80.3        —        28.9   

Income taxes

     (34.0     16.7        28.3        —        11.0   
                                       

Net income (loss)

   ($ 60.6   $ 26.5      $ 52.0      $ —      $ 17.9   
                                       

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Operations

For the Nine Months Ended September 30, 2008

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Operating revenues

   $ —        $ 1,062.3      $ 312.9      $ —      $ 1,375.2   
                                       

Operating expenses

           

Cost of services (exclusive of depreciation and amortization)

     —          665.3        127.6        —        792.9   

Selling, general and administrative

     (2.0     249.9        37.3        —        285.2   

Depreciation and amortization

     —          119.5        17.8        —        137.3   

Goodwill and other intangibles impairment

     —          164.4        —          —        164.4   
                                       

Total operating expenses

     (2.0     1,199.1        182.7        —        1,379.8   
                                       

Operating profit (loss)

     2.0        (136.8     130.2        —        (4.6

Interest expense

     109.0        40.8        11.7        —        161.5   

Other (income) expense, net

     —          6.1        (1.2     —        4.9   

Intercompany charges

     —          (19.6     19.6        —        —     
                                       

Income (loss) before income taxes

     (107.0     (164.1     100.1        —        (171.0

Income taxes

     (43.2     (0.2     39.3        —        (4.1
                                       

Net income (loss)

   ($ 63.8   ($ 163.9   $ 60.8      $ —      ($ 166.9
                                       

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Balance Sheet

As of September 30, 2009

(In millions)

(Unaudited)

 

     Parent    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations
and
Adjustments
    Total

Assets

             

Current assets

             

Cash and cash equivalents

   $ —      $ 356.7    $ 24.1    $ —        $ 380.8

Restricted cash

     —        3.6      5.2      —          8.8

Trade receivables, net of allowances

     0.8      278.4      53.3      (14.1     318.4

Finance receivables, net of allowances

     —        4.1      142.1      —          146.2

Retained interests in finance receivables sold

     —        —        77.9      —          77.9

Deferred income tax assets

     1.4      37.2      —        —          38.6

Other current assets

     0.6      39.8      3.8      —          44.2
                                   

Total current assets

     2.8      719.8      306.4      (14.1     1,014.9

Other assets

             

Investments in and advances to affiliates, net

     2,886.5      4.0      77.8      (2,968.3     —  

Goodwill

     —        1,522.5      3.8      —          1,526.3

Customer relationships, net of accumulated amortization

     —        657.1      111.5      —          768.6

Other intangible assets, net of accumulated amortization

     —        254.2      11.6      —          265.8

Unamortized debt issuance costs

     59.8      —        —        —          59.8

Other assets

     0.8      15.0      0.6      —          16.4
                                   

Total other assets

     2,947.1      2,452.8      205.3      (2,968.3     2,636.9

Property and equipment, net of accumulated depreciation

     —        543.5      139.2      —          682.7
                                   

Total assets

   $ 2,949.9    $ 3,716.1    $ 650.9    ($ 2,982.4   $ 4,334.5
                                   

 

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Table of Contents

KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Balance Sheet

As of September 30, 2009

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations
and
Adjustments
    Total

Liabilities and Stockholders’ Equity

            

Current liabilities

            

Accounts payable

   $ —        $ 373.5    $ 45.0    ($ 14.1   $ 404.4

Accrued employee benefits and compensation expenses

     —          48.8      5.5      —          54.3

Accrued interest

     35.1        —        —        —          35.1

Other accrued expenses

     0.8        62.8      6.4      —          70.0

Income taxes payable

     —          1.4      2.4      —          3.8
                                    

Total current liabilities

     35.9        486.5      59.3      (14.1     567.6

Non-current liabilities

            

Investments by and advances from affiliates, net

     79.3        117.1      —        (196.4     —  

Long-term debt

     1,701.4        718.0      103.5      —          2,522.9

Deferred income tax liabilities

     (2.4     299.1      32.3      —          329.0

Other liabilities

     9.6        99.0      5.4      —          114.0
                                    

Total non-current liabilities

     1,787.9        1,233.2      141.2      (196.4     2,965.9

Commitments and contingencies

     —          —        —        —          —  

Stockholders’ equity

            

Total stockholders’ equity

     1,126.1        1,996.4      450.4      (2,771.9     801.0
                                    

Total liabilities and stockholders’ equity

   $ 2,949.9      $ 3,716.1    $ 650.9    ($ 2,982.4   $ 4,334.5
                                    

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Balance Sheet

As of December 31, 2008

(In millions)

 

     Parent    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations
and
Adjustments
    Total

Assets

             

Current assets

             

Cash and cash equivalents

   $ —      $ 129.5    $ 28.9    $ —        $ 158.4

Restricted cash

     —        3.6      12.3      —          15.9

Trade receivables, net of allowances

     —        260.8      31.1      (6.2     285.7

Finance receivables, net of allowances

     —        3.8      155.1      —          158.9

Retained interests in finance receivables sold

     —        —        43.4      —          43.4

Deferred income tax assets

     6.0      37.2      —        —          43.2

Other current assets

     0.4      43.7      3.1      —          47.2
                                   

Total current assets

     6.4      478.6      273.9      (6.2     752.7

Other assets

             

Investments in and advances to affiliates, net

     2,858.8      —        76.1      (2,934.9     —  

Goodwill

     —        1,521.4      3.3      —          1,524.7

Customer relationships, net of accumulated amortization

     —        700.9      104.9      —          805.8

Other intangible assets, net of accumulated amortization

     —        253.0      11.7      —          264.7

Unamortized debt issuance costs

     69.4      —        —        —          69.4

Other assets

     —        15.9      2.7      —          18.6
                                   

Total other assets

     2,928.2      2,491.2      198.7      (2,934.9     2,683.2

Property and equipment, net of accumulated depreciation

     —        595.2      126.5      —          721.7
                                   

Total assets

   $ 2,934.6    $ 3,565.0    $ 599.1    ($ 2,941.1   $ 4,157.6
                                   

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Balance Sheet

As of December 31, 2008

(In millions)

 

     Parent    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations
and
Adjustments
    Total

Liabilities and Stockholders’ Equity

             

Current liabilities

             

Accounts payable

   $ —      $ 273.9    $ 15.7    $ (6.2   $ 283.4

Accrued employee benefits and compensation expenses

     —        38.0      4.4      —          42.4

Accrued interest

     15.4      —        —        —          15.4

Other accrued expenses

     18.7      78.1      5.9      —          102.7

Current maturities of long- term debt

     —        —        4.5      —          4.5
                                   

Total current liabilities

     34.1      390.0      30.5      (6.2     448.4

Non-current liabilities

             

Investments by and advances from affiliates, net

     56.6      109.2      —        (165.8     —  

Long-term debt

     1,701.4      705.0      116.5      —          2,522.9

Deferred income tax liabilities

     —        304.1      31.7      —          335.8

Other liabilities

     —        96.2      3.6      —          99.8
                                   

Total non-current liabilities

     1,758.0      1,214.5      151.8      (165.8     2,958.5

Commitments and contingencies

     —        —        —        —          —  

Stockholders’ equity

             

Total stockholders’ equity

     1,142.5      1,960.5      416.8      (2,769.1     750.7
                                   

Total liabilities and stockholders’ equity

   $ 2,934.6    $ 3,565.0    $ 599.1    $ (2,941.1   $ 4,157.6
                                   

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2009

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Net cash provided by operating activities

   $ 1.6      $ 228.2      $ 9.3      $ —      $ 239.1   
                                       

Investing activities

           

Net decrease (increase) in finance receivables held for investment

     —          9.2        (12.0     —        (2.8

Acquisition of businesses, net of cash acquired

     —          (4.1     —          —        (4.1

Purchases of property, equipment and computer software

     —          (38.7     (2.1     —        (40.8

Proceeds from sale of property, equipment and computer software

     —          0.3        —          —        0.3   

(Increase) decrease in restricted cash

     —          —          7.1        —        7.1   
                                       

Net cash used by investing activities

     —          (33.3     (7.0     —        (40.3

Financing activities

           

Net increase (decrease) in book overdrafts

     —          34.1        (3.3     —        30.8   

Net increase (decrease) in borrowings from lines of credit

     —          —          (4.5     —        (4.5

Payments for debt issuance costs

     (0.3     —          —          —        (0.3

Payments on capital leases

     —          (1.8     (0.4     —        (2.2

Initial net investment for interest rate cap

     (1.3     —          —          —        (1.3
                                       

Net cash provided by (used by) financing activities

     (1.6     32.3        (8.2     —        22.5   

Effect of exchange rate changes on cash

     —          —          1.1        —        1.1   
                                       

Net increase (decrease) in cash and cash equivalents

     —          227.2        (4.8     —        222.4   

Cash and cash equivalents at beginning of period

     —          129.5        28.9        —        158.4   
                                       

Cash and cash equivalents at end of period

   $ —        $ 356.7      $ 24.1      $ —      $ 380.8   
                                       

 

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KAR Auction Services, Inc.

Notes to Consolidated Financial Statements—(Continued)

September 30, 2009 (Unaudited)

 

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2008

(In millions)

(Unaudited)

 

     Parent     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations
and
Adjustments
   Total  

Net cash (used by) provided by operating activities

   $ 57.0      $ 139.6      $ 10.9      $ —      $ 207.5   
                                       

Investing activities

           

Net decrease (increase) in finance receivables held for investment

     —          (1.2     10.0        —        8.8   

Acquisition of businesses, net of cash acquired

     —          (149.3     (6.5     —        (155.8

Purchases of property, equipment and computer software

     —          (80.6     (5.1     —        (85.7

Proceeds from the sale of property, equipment and computer software

     —          73.4        —          —        73.4   

(Increase) decrease in restricted cash

     —          4.3        2.0        —        6.3   
                                       

Net cash (used by) provided by investing activities

     —          (153.4     0.4        —        (153.0

Financing activities

           

Net increase (decrease) in book overdrafts

     —          12.6        (10.1     —        2.5   

Payments for debt issuance costs

     (1.2     —          —          —        (1.2

Payments on long-term debt

     (55.7     —          —          —        (55.7

Payments on capital leases

     —          (0.3     —          —        (0.3

Repurchase of common stock

     (0.1     —          —          —        (0.1
                                       

Net cash provided by (used by) financing activities

     (57.0     12.3        (10.1     —        (54.8

Effect of exchange rate changes on cash

     —          —          (2.6     —        (2.6
                                       

Net increase (decrease) in cash and cash equivalents

     —          (1.5     (1.4     —        (2.9

Cash and cash equivalents at beginning of period

     —          172.3        31.8        —        204.1   
                                       

Cash and cash equivalents at end of period

   $ —        $ 170.8      $ 30.4      $ —      $ 201.2   
                                       

 

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of federal securities laws. Such statements are subject to certain risks, trends and uncertainties. In particular, statements made in this report on Form 10-Q that are not historical facts (including, but not limited to, expectations, estimates, assumptions and projections regarding the industry, business, future operating results, potential acquisitions and anticipated cash requirements) may be forward-looking statements. Words such as “should”, “may”, “will”, “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions identify forward-looking statements. Such statements, including statements regarding the Company’s future growth; anticipated cost savings, revenue increases and capital expenditures; strategic initiatives, greenfields and acquisitions; the Company’s competitive position; and its continued investment in information technology are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results projected, expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2009. Some of these factors include:

 

   

fluctuations in consumer demand for and in the supply of used, leased and salvage vehicles and the resulting impact on auction sales volumes, conversion rates and loan transaction volumes;

 

   

trends in new and used vehicle sales and incentives, including wholesale used vehicle pricing;

 

   

the ability of consumers to lease or finance the purchase of new and/or used vehicles;

 

   

the ability to recover or collect from delinquent or bankrupt customers;

 

   

economic conditions including fuel prices, foreign exchange rates and interest rate fluctuations;

 

   

trends in the vehicle remarketing industry;

 

   

changes in the volume of vehicle production, including capacity reductions at the major original equipment manufacturers;

 

   

the introduction of new competitors;

 

   

laws, regulations and industry standards, including changes in regulations governing the sale of used vehicles, the processing of salvage vehicles and commercial lending activities;

 

   

changes in the market value of vehicles auctioned, including changes in the actual cash value of salvage vehicles;

 

   

competitive pricing pressures;

 

   

costs associated with the acquisition of businesses or technologies;

 

   

litigation developments;

 

   

the Company’s ability to successfully implement the Company’s business strategies or realize expected cost savings and revenue enhancements;

 

   

the Company’s ability to develop and implement information systems responsive to customer needs;

 

   

business development activities, including acquisitions and integration of acquired businesses;

 

   

the costs of environmental compliance and/or the imposition of liabilities under environmental laws and regulations;

 

   

weather;

 

   

general business conditions;

 

   

the Company’s substantial amount of debt;

 

   

restrictive covenants in the Company’s debt agreements;

 

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the Company’s assumption of the settlement risk for vehicles sold;

 

   

any impairment to the Company’s goodwill;

 

   

the Company’s self-insurance for certain risks;

 

   

any losses of key personnel;

 

   

interruptions to service from the Company’s workforce;

 

   

changes to accounting standards;

 

   

proposed tax legislation;

 

   

the Company’s tax indemnification of ALLETE; and

 

   

other risks described from time to time.

Many of these risk factors are outside of the Company’s control, and as such, they involve risks which are not currently known that could cause actual results to differ materially from those discussed or implied herein. The forward-looking statements in this document are made as of the date on which they are made and the Company 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 vehicle sold volumes and loan transaction volumes, acquire additional auctions, manage expansion, relocate and integrate acquisitions, control costs in its operations, introduce fee increases, expand its product and service offerings, including information systems development, and retain its executive officers and key employees. Certain initiatives that management considers important to the Company’s long-term success include substantial capital investment in e-business, information technology, facility relocations and expansions, as well as operating initiatives designed to enhance overall efficiencies, have significant risks associated with their execution, and could take several years to yield any direct monetary benefits. Accordingly, the Company cannot predict whether its growth strategy will be successful. In addition, 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.

Overview

The Company provides whole car and salvage auction services in North America. The business is divided into three reportable business segments, each of which is an integral part of the vehicle redistribution industry: ADESA, IAAI and AFC.

 

   

The ADESA segment consists primarily of a 62 whole car auction network in North America. Vehicles at ADESA’s auctions are typically sold by commercial fleet operators, financial institutions, rental car companies, used vehicle dealers and vehicle manufacturers and their captive finance companies to franchised and independent used vehicle dealers. ADESA also provides value-added ancillary services including inspections, storage, transportation, reconditioning and titling and other administrative services.

 

   

The IAAI segment consists of salvage vehicle auctions and related services provided at 152 sites in North America. The salvage auctions facilitate the redistribution of damaged or low value vehicles designated as total losses by insurance companies and charity donation vehicles, as well as recovered stolen (or theft) vehicles. The salvage auction business specializes in providing services such as transportation, titling, salvage recovery and claims settlement administrative services.

 

   

The AFC segment provides short-term, inventory-secured financing, known as floorplan financing, primarily to independent used vehicle dealers. AFC conducts business through 87 branches in North America.

The holding company is maintained separately from the three reportable segments and includes expenses associated with the corporate office, such as salaries, benefits, and travel costs for our management team, certain

 

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human resources, information technology and accounting costs, and incremental insurance, treasury, legal and risk management costs. Holding company interest includes the interest incurred on the corporate debt structure. Other than some information technology costs, costs incurred at the holding company are not allocated to the three business segments.

Industry Outlook and Trends

During the period from 1999 to 2008, approximately 9.2 to 10.0 million used vehicles per year were sold in North America through whole car auctions. The stable number of vehicles sold at auction in North America is primarily dependent upon the total population of cars on the road as opposed to the more volatile annual new vehicle sales. The Company believes, for the foreseeable future, that the annual number of used vehicle sales at whole car auctions in North America will be consistent with the range of vehicles sold from 1999 to 2008.

During the period from 2006 through 2008, the North American salvage vehicle auction industry volumes have increased. Vehicles deemed a total loss by automobile insurance companies represent the largest category of vehicles sold in the salvage vehicle auction industry. As vehicles become more complex with additional enhancements, such as airbags and electrical components, they are more costly to repair following an accident and insurance companies are more likely to declare a damaged vehicle a total loss. The percentage of claims resulting in total losses continues at a high level of 14%. This trend, along with increases in miles driven and vehicles per household, has contributed to growth in salvage vehicle volumes.

In 2008 and earlier in 2009, the overall economy and in particular the automotive finance industries faced pressures which negatively affected the used vehicle dealer base. In excess of 4,000 independent dealers went out of business during 2008, almost a 10% reduction in the independent dealer base. Used vehicle dealers experienced a significant decline in sales which resulted in a decrease in loan originations and an increased number of dealers defaulting on their loans, increasing credit losses. In addition, the value of recovered collateral on defaulted loans was impacted to some degree by the volatility in the vehicle pricing market. To the extent these negative trends continue, they could have a material adverse impact on AFC’s results of operations.

In 2008 and earlier in 2009, significant changes occurred in the economy which impacted our business. A lack of availability of consumer credit for retail used vehicle buyers, a decline in consumer spending, a reduction in the number of franchised and independent used vehicle dealers in the Untied States, reduced miles driven and decreases in commodity prices such as steel and platinum all negatively impacted us. These factors contributed to a 3% decrease in revenues for each of ADESA and IAAI for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008.

In addition, changes in the business environment for automotive manufacturers have resulted in a number of initiatives to reduce costs in the auto industry. Chrysler LLC, or Chrysler, and General Motors Corporation, or GM, each have a longstanding relationship with ADESA and regularly use its auctions to remarket their vehicles. Chrysler and GM have publicly announced that they are in the process of significantly reducing the number of franchised dealerships. The reduced number of franchised dealerships may have an impact on the Company’s future financial performance.

The availability of financing to franchised dealerships and consumers from the vehicle manufacturers’ captive finance companies and their respective remarketing programs may also impact the supply of vehicles to the wholesale auction industry in the future. A change in the supply of used vehicles could impact the value of used vehicles sold, conversion rates (calculated as the number of vehicles sold as a percentage of the number of vehicles entered for sale) and ADESA’s profitability on the sale of vehicles.

 

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Seasonality

The volume of vehicles sold at the Company’s auctions generally fluctuates from quarter to quarter. This seasonality is caused by several factors including weather, the timing of used vehicles available for sale from selling customers, the availability and quality of salvage vehicles, holidays, and the seasonality of the retail market for used vehicles, which affects the demand side of the auction industry. Used vehicle auction volumes tend to decline during prolonged periods of winter weather conditions. In addition, mild weather conditions and decreases in traffic volume can each lead to a decline in the available supply of salvage vehicles because fewer traffic accidents occur, resulting in fewer damaged vehicles overall. As a result, revenues and operating expenses related to volume will fluctuate accordingly on a quarterly basis. The fourth calendar quarter typically experiences lower used vehicle auction volume as well as additional costs associated with the holidays and winter weather.

Sources of Revenues and Expenses

The Company’s revenue is derived from auction fees and related services at its whole car and salvage auction facilities and dealer financing fees and net interest income at AFC. Although auction revenues primarily include the auction services and related fees, the Company’s related receivables and payables include the value of the vehicles sold. AFC’s net revenue consists primarily of securitization income and interest and fee income less provisions for credit losses. Securitization income is primarily comprised of the gain on sale of finance receivables sold, but also includes servicing income, discount accretion, and any change in the fair value of the retained interest in finance receivables sold. Operating expenses for the Company consist of cost of services, selling, general and administrative and depreciation and amortization. Cost of services is composed of payroll and related costs, subcontract services, supplies, insurance, property taxes, utilities, maintenance and lease expense related to the auction sites and loan offices. Cost of services excludes depreciation and amortization. Selling, general and administrative expenses are composed of indirect payroll and related costs, sales and marketing, information technology services and professional fees.

Results of Operations

Overview of Results of KAR Auction Services for the Three Months Ended September 30, 2009 and 2008:

 

     Three Months Ended
September 30,
 

(In millions)

   2009     2008  

Revenues

    

ADESA

   $ 270.8      $ 286.4   

IAAI

     135.5        135.4   

AFC

     23.8        22.8   
                

Total revenues

     430.1        444.6   

Cost of services*

     239.6        261.4   
                

Gross profit*

     190.5        183.2   

Selling, general and administrative

     101.4        92.7   

Depreciation and amortization

     41.6        45.0   

Goodwill and intangibles impairment

     —          164.4   
                

Operating profit (loss)

     47.5        (118.9

Interest expense

     39.3        52.1   

Other (income) expense, net

     (4.8     4.1   
                

Income before income taxes

     13.0        (175.1

Income taxes

     4.4        (5.2
                

Net income (loss)

   $ 8.6      ($ 169.9
                

 

* Exclusive of depreciation and amortization

 

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For the three months ended September 30, 2009, the Company had revenue of $430.1 million compared with revenue of $444.6 million for the three months ended September 30, 2008, a decrease of 3%. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below.

Depreciation and Amortization

Depreciation and amortization decreased $3.4 million, or 8%, to $41.6 million for the three months ended September 30, 2009, compared with the three months ended September 30, 2008. The decrease is representative of certain assets becoming fully depreciated as well as a decrease in 2009 capital spending compared to recent years.

Interest Expense

Interest expense decreased $12.8 million, or 25%, to $39.3 million for the three months ended September 30, 2009, compared with interest expense of $52.1 million for the three months ended September 30, 2008. The decrease in interest expense was the result of a decrease in interest rates for the Company’s variable rate debt instruments as well as payments on Term Loan B of $59.3 million during 2008 which decreased the outstanding principal balance of the Company’s debt. In addition, the swap agreement which became effective on June 30, 2009 effectively resulted in a fixed LIBOR interest rate of 2.19% on $650 million of the term loan compared with the previous swap, which expired on June 30, 2009, and effectively resulted in a fixed LIBOR interest rate of 5.345% on $800 million of the term loan.

Other (Income) Expense

Other income was $4.8 million for the three months ended September 30, 2009 compared with other expense of $4.1 million for the three months ended September 30, 2008, representing an increase of $8.9 million. The change in other (income) expense was primarily representative of foreign currency transaction gains in the third quarter of 2009 versus foreign currency transaction losses in the third quarter of 2008.

Income Taxes

The Company’s effective tax rate increased from 3.0% for the three months ended September 30, 2008 to 33.8% for the three months ended September 30, 2009. The increase in the tax rate was primarily attributable to the 2008 noncash goodwill impairment charge at AFC that was not deductible for tax purposes.

ADESA Results

 

     Three Months Ended
September 30,

(In millions)

   2009    2008

ADESA revenue

   $ 270.8    $ 286.4

Cost of services*

     146.1      162.1
             

Gross profit*

     124.7      124.3

Selling, general and administrative

     52.2      63.9

Depreciation and amortization

     21.0      23.0
             

Operating profit

   $ 51.5    $ 37.4
             

 

* Exclusive of depreciation and amortization

 

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Revenue

Revenue from ADESA decreased $15.6 million, or 5%, to $270.8 million for the three months ended September 30, 2009, compared with $286.4 million for the three months ended September 30, 2008. The decrease in revenue was primarily a result of a 2% decrease in the number of vehicles sold as well as a 4% decrease in revenue per vehicle sold for the three months ended September 30, 2009, compared with the three months ended September 30, 2008.

The 4% decrease in revenue per vehicle sold resulted in decreased auction revenue of approximately $10.0 million. The decrease in revenue per vehicle sold was primarily attributable to a net decrease in ancillary services such as shop services and other services, which resulted in decreased ADESA revenue of approximately $12.6 million for the three months ended September 30, 2009 compared with the three months ended September 30, 2008. In addition, fluctuations in the Canadian exchange rate decreased revenue by approximately $3.1 million. Partially offsetting the impact of the Canadian exchange rate and ancillary services was incremental fee income related to higher used vehicle values and selective fee increases.

The total number of used vehicles sold at ADESA decreased 2% for the three months ended September 30, 2009 compared with the three months ended September 30, 2008, resulting in a decrease in ADESA revenue of approximately $5.6 million. The volume sold decrease was attributable to same store volume decreases.

The used vehicle conversion percentage, calculated as the number of vehicles sold as a percentage of the number of vehicles entered for sale at the Company’s used vehicle auctions, increased to 66.3% for the three months ended September 30, 2009 compared with 62.6% for the three months ended September 30, 2008. The increase in conversion rates was representative of a reduced supply of vehicles at auction combined with relatively constant demand.

Gross Profit

For the three months ended September 30, 2009, gross profit in the ADESA segment increased $0.4 million, or less than 1%, to $124.7 million. Gross margin for ADESA was 46.0% of revenue for the three months ended September 30, 2009 compared with 43.4% of revenue for the three months ended September 30, 2008. The increase in gross margin for the three months ended September 30, 2009 compared with the three months ended September 30, 2008 is representative of a decrease in lower margin ancillary services as well as reduced labor associated with the higher conversion rates.

Selling, General and Administrative

Selling, general and administrative expenses for the ADESA segment decreased $11.7 million, or 18%, to $52.2 million for the three months ended September 30, 2009 compared with the three months ended September 30, 2008, primarily due to a $5.3 million decrease for the prior year loss on the sale of land related to the sale-leaseback, a $2.6 million decrease in marketing costs, a $2.1 million decrease in professional fees, a $1.7 million decrease in bad debt expense and a $0.5 million decrease related to fluctuations in the Canadian exchange rate. The decreases to selling, general and administrative expenses were partially offset by an increase in incentive compensation expense, stock-based compensation expense and an increase in costs at acquired sites.

 

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IAAI Results

 

     Three Months Ended
September 30,

(In millions)

   2009    2008

IAAI revenue

   $ 135.5    $ 135.4

Cost of services*

     86.4      90.0
             

Gross profit*

     49.1      45.4

Selling, general and administrative

     21.4      18.3

Depreciation and amortization

     14.3      15.4
             

Operating profit

   $ 13.4    $ 11.7
             

 

* Exclusive of depreciation and amortization

Revenue

Revenue from IAAI increased $0.1 million, or less than 1%, to $135.5 million for the three months ended September 30, 2009, compared with $135.4 million for the three months ended September 30, 2008. The increase in revenue was a result of an increase in the number of salvage vehicles sold during the three months ended September 30, 2009, partially offset by a decrease in auction services revenue related to a decline in average selling price for vehicles sold at salvage auctions.

Gross Profit

For the three months ended September 30, 2009, gross profit at IAAI was $49.1 million, or 36% of revenue, compared with $45.4 million, or 34% of revenue, for the three months ended September 30, 2008. Gross profit increased as a percentage of revenue, primarily due to the reductions in cost of services. Cost of services decreased due to decreased outside labor, travel, computer supplies, telecommunication costs and auction costs. In addition, IAAI experienced a $1.6 million decrease in tow costs due to decreased fuel costs and related tow charges, offset slightly by an increase in the number of vehicles sold.

Selling, General and Administrative

Selling, general and administrative expenses at IAAI increased $3.1 million, or 17%, to $21.4 million for the three months ended September 30, 2009, compared with $18.3 million for the three months ended September 30, 2008. The increase in selling, general and administrative expenses was attributable to an increase in incentive compensation expense as well as stock-based compensation expense, partially offset by decreases in integration expenses, travel expenses and computer supplies.

 

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AFC Results

 

     Three Months Ended
September 30,
 

(In millions except loan volumes and per loan amounts)

   2009     2008  

AFC revenue

    

Securitization income

   $ 12.5      $ 7.6   

Interest and fee income

     11.9        15.5   

Other revenue

     0.1        0.2   

Provision for credit losses

     (0.7     (0.5
                

Total AFC revenue

     23.8        22.8   

Cost of services*

     7.1        9.3   
                

Gross profit*

     16.7        13.5   

Selling, general and administrative

     2.6        3.7   

Depreciation and amortization

     6.1        6.2   

Goodwill and intangibles impairment

     —          164.4   
                

Operating profit (loss)

   $ 8.0      ($ 160.8
                

Loan transactions

     199,843        285,643   

Revenue per loan transaction

   $ 119      $ 80   

 

* Exclusive of depreciation and amortization

Revenue

For the three months ended September 30, 2009, AFC revenue increased $1.0 million, or 4%, to $23.8 million, compared with $22.8 million for the three months ended September 30, 2008. The increase in revenue was the result of a 49% increase in revenue per loan transaction for the three months ended September 30, 2009, partially offset by a 30% decrease in loan transactions to 199,843 for the three months ended September 30, 2009 compared with the same period in 2008.

The decrease in loan transactions, which includes both loans paid off and loans curtailed, compared to the three months ended September 30, 2008, was primarily the result of a decrease in loans outstanding. AFC implemented a number of strategic initiatives in 2008 and early 2009 designed to tighten credit standards and reduce risk and exposure in its portfolio of finance receivables. These initiatives, along with the soft retail used vehicle market, have resulted in a 32% decrease in the size of AFC’s average managed portfolio of finance receivables compared to the three months ended September 30, 2008. In addition, these initiatives have resulted in a substantial improvement in the delinquency of the managed portfolio resulting in decreased credit losses.

Revenue per loan transaction, which includes both loans paid off and loans curtailed, increased $39, or 49%, primarily as a result of a decrease in credit losses for both loans held and sold, increased fee income per unit and a decrease in cost of funds, partially offset by a decrease in the average portfolio duration.

Gross Profit

For the three months ended September 30, 2009, gross profit for the AFC segment increased $3.2 million, or 24%, to $16.7 million primarily as a result of a 24% decrease in cost of services and the 4% increase in revenue. The decrease in cost of services was primarily the result of decreased compensation and related employee benefit costs. Compensation and related employee benefit costs decreased as the number of AFC employees was reduced to correspond with the decrease in the size of the finance receivables portfolio.

 

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Selling, General and Administrative

Selling, general and administrative expenses at AFC decreased $1.1 million, or 30%, for the three months ended September 30, 2009, compared with the three months ended September 30, 2008. The decrease was primarily the result of decreased compensation and related employee benefit costs as well as decreased travel and other miscellaneous expenses.

Goodwill and Other Intangibles Impairment

In the third quarter of 2008, a noncash goodwill impairment charge of approximately $161.5 million was recorded in the AFC reporting unit. In addition, in the third quarter of 2008, a noncash tradename impairment charge of approximately $2.9 million was recorded in the AFC reporting unit. In light of the overall economy and in particular the automotive and finance industries which continued to face severe pressures, AFC and its customer dealer base were negatively impacted. In addition, AFC was negatively impacted by reduced interest rate spreads. As a result of reduced interest rate spreads and increased risk associated with lending in the automotive industry, AFC tightened credit policies and experienced a decline in its portfolio of finance receivables. These factors contributed to lower operating profits and cash flows at AFC throughout 2008 as compared to 2007. Based on this trend, the forecasted performance was revised and the fair value of the reporting unit declined.

Holding Company Results

 

     Three Months Ended
September 30,
 

(In millions)

   2009     2008  

Selling, general and administrative

   $ 25.2      $ 6.8   

Depreciation and amortization

     0.2        0.4   
                

Operating loss

   ($ 25.4   ($ 7.2
                

Selling, General and Administrative

For the three months ended September 30, 2009, selling, general and administrative expenses at the holding company increased $18.4 million, or 271%, to $25.2 million, primarily as a result of an increase in stock-based compensation expense, incentive compensation expense and professional fees. For the three months ended September 30, 2009, stock-based compensation expense related to the KAR LLC and Axle LLC operating units was $8.7 million. For the three months ended September 30, 2008, stock-based compensation expense was reduced $7.3 million related to the KAR LLC and Axle LLC operating units which are remeasured each reporting period to fair value.

 

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Overview of Results of KAR Auction Services for the Nine Months Ended September 30, 2009 and 2008:

 

     Nine Months Ended
September 30,
 

(In millions)

   2009     2008  

Revenues

    

ADESA

   $ 838.6      $ 862.7   

IAAI

     412.5        426.0   

AFC

     60.6        86.5   
                

Total revenues

     1,311.7        1,375.2   

Cost of services*

     755.1        792.9   
                

Gross profit*

     556.6        582.3   

Selling, general and administrative

     274.3        285.2   

Depreciation and amortization

     129.9        137.3   

Goodwill and other intangibles impairment

     —          164.4   
                

Operating profit (loss)

     152.4        (4.6

Interest expense

     132.8        161.5   

Other (income) expense, net

     (9.3     4.9   
                

Income (loss) before income taxes

     28.9        (171.0

Income taxes

     11.0        (4.1
                

Net income (loss)

   $ 17.9      ($ 166.9
                

 

* Exclusive of depreciation and amortization

For the nine months ended September 30, 2009, the Company had revenue of $1,311.7 million compared with revenue of $1,375.2 million for the nine months ended September 30, 2008, a decrease of 5%. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below.

Depreciation and Amortization

Depreciation and amortization decreased $7.4 million, or 5%, to $129.9 million for the nine months ended September 30, 2009, compared with the nine months ended September 30, 2008. The decrease is representative of certain assets becoming fully depreciated as well as a decrease in 2009 capital spending compared to recent years.

Interest Expense

Interest expense decreased $28.7 million, or 18%, to $132.8 million for the nine months ended September 30, 2009, compared with $161.5 million for the nine months ended September 30, 2008. The decrease in interest expense was the result of a decrease in interest rates for the Company’s variable rate debt instruments as well as payments on Term Loan B of $59.3 million during 2008 which decreased the outstanding principal balance of the Company’s debt. In addition, the swap agreement which became effective on June 30, 2009 effectively resulted in a fixed LIBOR interest rate of 2.19% on $650 million of the term loan compared with the previous swap, which expired on June 30, 2009, and effectively resulted in a fixed LIBOR interest rate of 5.345% on $800 million of the term loan.

Other (Income) Expense

Other income was $9.3 million for the nine months ended September 30, 2009 compared with other expense of $4.9 million for the nine months ended September 30, 2008, representing an increase of $14.2 million. The

 

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change in other (income) expense was primarily representative of foreign currency transaction gains in 2009 versus foreign currency transaction losses in 2008, partially offset by a decrease in interest income resulting from lower interest rates in 2009.

Income Taxes

The Company’s effective tax rate increased from 2.4% for the nine months ended September 30, 2008 to 38.1% for the nine months ended September 30, 2009. The increase in the tax rate was primarily attributable to the 2008 noncash goodwill impairment charge at AFC that was not deductible for tax purposes.

ADESA Results

 

     Nine Months Ended
September 30,

(In millions)

   2009    2008

ADESA revenue

   $ 838.6    $ 862.7

Cost of services*

     468.1      492.2
             

Gross profit*

     370.5      370.5

Selling, general and administrative

     157.2      181.1

Depreciation and amortization

     66.8      69.1
             

Operating profit

   $ 146.5    $ 120.3
             

 

* Exclusive of depreciation and amortization

Revenue

Revenue from ADESA decreased $24.1 million, or 3%, to $838.6 million for the nine months ended September 30, 2009, compared with $862.7 million for the nine months ended September 30, 2008. The decrease in revenue was primarily a result of a 2% decrease in revenue per vehicle sold and a less than 1% decrease in the total number of used vehicles sold at ADESA for the nine months ended September 30, 2009, compared with the nine months ended September 30, 2008.

The 2% decrease in revenue per vehicle sold resulted in decreased auction revenue of approximately $16.6 million. The decrease in revenue per vehicle sold reflects fluctuations in the Canadian exchange rate which decreased revenue by approximately $23.7 million for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008. In addition, a net decrease in ancillary services such as shop services and other services resulted in decreased ADESA revenue of approximately $8.5 million. Partially offsetting the impact of the Canadian exchange rate and ancillary services was incremental fee income related to higher used vehicle values and selective fee increases.

The total number of used vehicles sold at ADESA decreased less than 1% for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008 and resulted in a decrease in ADESA revenue of approximately $7.7 million. The volume sold decrease was attributable to same store volume decreases.

The used vehicle conversion percentage, calculated as the number of vehicles sold as a percentage of the number of vehicles entered for sale at the Company’s used vehicle auctions, increased to 68.4% for the nine months ended September 30, 2009 compared with 61.8% for the nine months ended September 30, 2008. The increase in conversion rates was representative of a reduced supply of vehicles at auction combined with relatively constant demand.

 

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Gross Profit

For the nine months ended September 30, 2009, gross profit in the ADESA segment remained constant at $370.5 million. Gross margin for ADESA was 44.2% of revenue for the nine months ended September 30, 2009 compared with 42.9% of revenue for the nine months ended September 30, 2008. The increase in gross margin for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008 is representative of a decrease in lower margin ancillary services as well as reduced labor associated with the higher conversion rates.

Selling, General and Administrative

Selling, general and administrative expenses for the ADESA segment decreased $23.9 million, or 13%, to $157.2 million for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008, primarily due to a $8.5 million decrease in marketing costs, a $5.3 million decrease for the prior year loss on the sale of land related to the sale-leaseback, a $4.7 million decrease in professional fees, a $4.2 million decrease in bad debt expense, a $3.1 million decrease related to fluctuations in the Canadian exchange rate and a $1.5 million decrease in supplies expense. The decreases to selling, general and administrative expenses were partially offset by an increase in incentive compensation expense and an increase in costs at sites acquired in 2008.

IAAI Results

 

     Nine Months Ended
September 30,

(In millions)

   2009    2008

IAAI revenue

   $ 412.5    $ 426.0

Cost of services*

     264.5      273.5
             

Gross profit*

     148.0      152.5

Selling, general and administrative

     52.1      52.7

Depreciation and amortization

     43.9      46.6
             

Operating profit

   $ 52.0    $ 53.2
             

 

* Exclusive of depreciation and amortization

Revenue

Revenue from IAAI decreased $13.5 million, or 3%, to $412.5 million for the nine months ended September 30, 2009, compared with $426.0 million for the nine months ended September 30, 2008. The decrease in revenue was primarily a result of a decline in average selling price for vehicles sold at salvage auctions, partially offset by an increase in the number of salvage vehicles sold during the nine months ended September 30, 2009. IAAI’s decrease in average selling price was due primarily to the sharp decline in steel scrap prices.

Gross Profit

For the nine months ended September 30, 2009, gross profit at IAAI decreased to $148.0 million, or 36% of revenue, compared with $152.5 million, or 36% of revenue, for the nine months ended September 30, 2008. Cost of services decreased due to a decline in value and the number of vehicles sold under the purchase agreement method of sales. In addition, there were cost reductions in outside labor, supplies, travel and auction costs. These reductions were partially offset by increases in occupancy costs relating to the addition of facilities as a result of acquisitions and greenfields.

 

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Selling, General and Administrative

Selling, general and administrative expenses at IAAI decreased $0.6 million, or 1%, to $52.1 million for the nine months ended September 30, 2009, compared with $52.7 million for the nine months ended September 30, 2008. The decrease in selling, general and administrative expenses was attributable to decreases in integration expenses and incentive compensation based on the financial performance of IAAI, offset by an increase in sales and marketing expenses and stock-based compensation expense.

AFC Results

 

     Nine Months Ended
September 30,
 

(In millions except loan volumes and per loan amounts)

   2009     2008  

AFC revenue

    

Securitization income

   $ 26.8      $ 34.4   

Interest and fee income

     34.9        52.2   

Other revenue

     0.2        1.7   

Provision for credit losses

     (1.3     (1.8
                

Total AFC revenue

     60.6        86.5   

Cost of services*

     22.5        27.2   
                

Gross profit*

     38.1        59.3   

Selling, general and administrative

     8.1        12.6   

Depreciation and amortization

     18.4        19.2   

Goodwill and intangibles impairment

     —          164.4   
                

Operating profit (loss)

   $ 11.6      ($ 136.9
                

Loan transactions

     589,093        900,584   

Revenue per loan transaction

   $ 103      $ 96   

 

* Exclusive of depreciation and amortization

Revenue

For the nine months ended September 30, 2009, AFC revenue decreased $25.9 million, or 30%, to $60.6 million, compared with $86.5 million for the nine months ended September 30, 2008. The decrease in revenue was the result of a 35% decrease in loan transactions to 589,093 for the nine months ended September 30, 2009 partially offset by a 7% increase in revenue per loan transaction for the nine months ended September 30, 2009.

The decrease in loan transactions, which includes both loans paid off and loans curtailed, compared to the nine months ended September 30, 2008, was primarily the result of a decrease in loans outstanding. AFC implemented a number of strategic initiatives in 2008 and early 2009 designed to tighten credit standards and reduce risk and exposure in its portfolio of finance receivables. These initiatives, along with the soft retail used vehicle market, have resulted in a 32% decrease in the size of AFC’s average managed portfolio of finance receivables compared to the nine months ended September 30, 2008. In addition, these initiatives have resulted in a substantial improvement in the delinquency of the managed portfolio resulting in decreased credit losses.

Revenue per loan transaction, which includes both loans paid off and loans curtailed, increased $7, or 7%, primarily as a result of a decrease in credit losses for both loans held and sold, increased fee income per unit and a decrease in cost of funds, partially offset by the average portfolio duration and the average loan value.

 

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Gross Profit

For the nine months ended September 30, 2009, gross profit for the AFC segment decreased $21.2 million, or 36%, to $38.1 million primarily as a result of a 35% decrease in loan transactions. The decrease in cost of services was primarily the result of decreased compensation and related employee benefit costs. Compensation and related employee benefit costs decreased as the number of AFC employees was reduced to correspond with the decrease in the size of the finance receivables portfolio.

Selling, General and Administrative

Selling, general and administrative expenses at AFC decreased $4.5 million, or 36%, for the nine months ended September 30, 2009, compared with the nine months ended September 30, 2008. The decrease was primarily the result of decreased compensation and related employee benefit costs as well as decreased travel and other miscellaneous expenses.

Goodwill and Other Intangibles Impairment

In the third quarter of 2008, a noncash goodwill impairment charge of approximately $161.5 million was recorded in the AFC reporting unit. In addition, in the third quarter of 2008, a noncash tradename impairment charge of approximately $2.9 million was recorded in the AFC reporting unit. In light of the overall economy and in particular the automotive and finance industries which continued to face severe pressures, AFC and its customer dealer base were negatively impacted. In addition, AFC was negatively impacted by reduced interest rate spreads. As a result of reduced interest rate spreads and increased risk associated with lending in the automotive industry, AFC tightened credit policies and experienced a decline in its portfolio of finance receivables. These factors contributed to lower operating profits and cash flows at AFC throughout 2008 as compared to 2007. Based on this trend, the forecasted performance was revised and the fair value of the reporting unit declined.

Holding Company Results

 

     Nine Months Ended
September 30,
 

(In millions)

   2009