Notes to Consolidated Financial Statements
December 31, 2016
,
2015
and
2014
Note 1—Organization and Other Matters
KAR Auction Services, Inc. was organized in the State of Delaware on November 9, 2006. The KAR group of companies is comprised of ADESA, Inc., Insurance Auto Auctions, Inc., Automotive Finance Corporation and additional business units.
Defined Terms
Unless otherwise indicated or unless the context otherwise requires, the following terms used herein shall have the following meanings:
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"we," "us," "our" and "the Company" refer, collectively, to KAR Auction Services, Inc. and all of its subsidiaries;
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"ADESA" or "ADESA Auctions" refer, collectively, to ADESA, Inc., a wholly-owned subsidiary of KAR Auction Services, and ADESA, Inc.'s subsidiaries, including Openlane, Inc. (together with Openlane, Inc.'s subsidiaries, "Openlane") and ADESA Remarketing Limited (formerly known as GRS Remarketing Limited ("GRS" or "ADESA Remarketing Limited"));
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"AFC" refers, collectively, to Automotive Finance Corporation, a wholly-owned subsidiary of ADESA, and Automotive Finance Corporation's subsidiaries and other related entities, including PWI Holdings, Inc.;
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"Credit Agreement" refers to the Amended and Restated Credit Agreement, dated March 11, 2014, as amended on March 9, 2016, among KAR Auction Services, as the borrower, the several banks and other financial institutions or entities from time to time parties thereto and the administrative agent;
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"Original Credit Agreement" refers to the Credit Agreement, dated May 19, 2011, as amended on November 29, 2012 and March 12, 2013, among KAR Auction Services, as the borrower, the several banks and other financial institutions or entities from time to time parties thereto and the administrative agent;
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"Credit Facility" refers to the
three
-year senior secured term loan B-1 facility ("Term Loan B-1"), the
seven
-year senior secured term loan B-2 facility ("Term Loan B-2"), the
seven
-year senior secured term loan B-3 facility ("Term Loan B-3"), the
$300 million
,
five
-year senior secured revolving credit facility (the "revolving credit facility") and the
$250 million
,
five
-year senior secured revolving credit facility (the "old revolving credit facility"), the terms of which are set forth in the Credit Agreement. Term Loan B-1 and the old revolving credit facility were extinguished in March 2016 with proceeds received from Term Loan B-3;
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"Original Credit Facility" refers to the
six
-year senior secured term loan facility ("Term Loan B") and the
$250 million
,
five
-year senior secured revolving credit facility, the terms of which are set forth in the Original Credit Agreement;
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"IAA" refers, collectively, to Insurance Auto Auctions, Inc., a wholly-owned subsidiary of KAR Auction Services, and Insurance Auto Auctions, Inc.'s subsidiaries and other related entities, including HBC Vehicle Services Limited ("HBC"); and
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"KAR Auction Services" refers to KAR Auction Services, Inc. and not to its subsidiaries.
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Business and Nature of Operations
As of
December 31, 2016
, we have a North American network of
77
ADESA whole car auction sites and
172
IAA salvage vehicle auction sites; in addition, we offer online auctions for both whole car and salvage vehicles. ADESA also includes ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom. IAA also includes HBC Vehicle Services Limited, which operates from
11
locations in the United Kingdom. Our auctions facilitate the sale of used and salvage vehicles through physical, online or hybrid auctions, which permit Internet buyers to participate in physical auctions. ADESA and IAA are leading, national providers of wholesale and salvage vehicle auctions and related vehicle remarketing services for the automotive industry in North America. ADESA's online service offerings include customized private label solutions powered with software developed by its wholly-owned subsidiary, Openlane, that allow our institutional consignors (automobile manufacturers, captive finance companies and other institutions) to offer vehicles via the Internet prior to arrival at the physical auction. Remarketing services include a variety of activities designed to transfer used and salvage vehicles between sellers and buyers throughout the vehicle life cycle. ADESA and IAA facilitate the exchange of these vehicles through an auction marketplace, which aligns sellers and buyers. As an agent for customers, the Company
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
generally does not take title to or ownership of vehicles sold at the auctions. Generally, fees are earned from the seller and buyer on each successful auction transaction in addition to fees earned for ancillary services.
ADESA has the second largest used vehicle auction network in North America, based upon the number of used vehicles sold through auctions annually, and also provides services such as inbound and outbound transportation logistics, reconditioning, vehicle inspection and certification, titling, administrative and collateral recovery services. ADESA is able to serve the diverse and multi-faceted needs of its customers through the wide range of services offered.
IAA is one of the leading providers of salvage vehicle auctions and related services. The salvage auctions facilitate the remarketing of damaged vehicles that are designated as total losses by insurance companies, recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made, purchased vehicles and older model vehicles donated to charity or sold by dealers in salvage auctions. The salvage auction business specializes in providing services such as inbound transportation logistics, inspections, evaluations, salvage recovery services, titling and settlement administrative services.
AFC is a leading provider of floorplan financing to independent used vehicle dealers and this financing is provided through
126
locations throughout the United States and Canada as of
December 31, 2016
. Floorplan financing supports independent used vehicle dealers in North America who purchase vehicles at ADESA, IAA, other used vehicle and salvage auctions and non-auction purchases. In addition to floorplan financing, AFC also provides independent used vehicle dealers with other related services and products, such as vehicle service contracts.
Note 2—Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of KAR Auction Services and all of its majority owned subsidiaries. Significant intercompany transactions and balances have been eliminated.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates based in part on assumptions about current, and for some estimates, future economic and market conditions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the period. Although the current estimates contemplate current conditions and expected future changes, as appropriate, it is reasonably possible that future conditions could differ from these estimates, which could materially affect our results of operations and financial position. Among other effects, such changes could result in future impairments of goodwill, intangible assets and long-lived assets, incremental losses on finance receivables, additional allowances on accounts receivable and deferred tax assets, changes in litigation and other loss contingencies and changes in self insurance reserves.
Business Segments
Our operations are grouped into
three
operating segments: ADESA Auctions, IAA and AFC. The
three
operating segments also serve as our reportable business segments. Operations are measured through detailed budgeting and monitoring of contributions to consolidated income by each business segment.
Derivative Instruments and Hedging Activity
We recognize all derivative financial instruments in the consolidated financial statements at fair value in accordance with Accounting Standards Codification ("ASC") 815,
Derivatives and Hedging
. We currently use
five
interest rate caps to manage the variability of cash flows to be paid due to interest rate movements on our variable rate debt. The fair values of the interest rate derivatives are based on quoted market prices for similar instruments from commercial banks. The fair value of the derivatives is recorded in "Other assets" on the consolidated balance sheet. We have not designated any of the current interest rate caps as hedges for accounting purposes. Accordingly, changes in the fair value of the interest rate derivatives are recognized as "Interest expense" in the consolidated statement of income.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Foreign Currency Translation
The local currency is the functional currency for each of our foreign entities. Revenues and expenses denominated in foreign currencies are translated into U.S. dollars at average exchange rates in effect during the year. Assets and liabilities of foreign operations are translated using the exchange rates in effect at year end. Foreign currency transaction gains and losses are included in the consolidated statements of income within "Other income, net" and resulted in a loss of
$0.7 million
for the year ended
December 31, 2016
, a loss of
$1.0 million
for the year ended
December 31, 2015
and a loss of
$0.3 million
for the year ended
December 31, 2014
. Adjustments arising from the translation of net assets located outside the U.S. (gains and losses) are shown as a component of "Accumulated other comprehensive income."
Cash Equivalents
All highly liquid investments with an original maturity of three months or less are considered to be cash equivalents. These investments are valued at cost, which approximates fair value.
Restricted Cash
AFC Funding Corporation, a wholly-owned, bankruptcy remote, consolidated, special purpose subsidiary of AFC, is required to maintain a minimum cash reserve of
1
percent of total receivables sold to the group of bank purchasers as security for the receivables sold. Automotive Finance Canada Inc. ("AFCI") is also required to maintain a minimum cash reserve of
1
percent of total receivables sold to its securitization facility. The amount of the cash reserve depends on circumstances which are set forth in the securitization agreements. AFC also maintains other cash reserves from time to time associated with its banking and vehicle service contract program insurance relationships.
Receivables
Trade receivables include the unremitted purchase price of vehicles purchased by third parties at the auctions, fees to be collected from those buyers and amounts due for services provided by us related to certain consigned vehicles in our possession. The amounts due with respect to the consigned vehicles are generally deducted from the sales proceeds upon the eventual auction or other disposition of the related vehicles.
Finance receivables include floorplan receivables created by financing dealer purchases of vehicles in exchange for a security interest in those vehicles and special purpose loans. Floorplan receivables become due at the earlier of the dealer subsequently selling the vehicle or a predetermined time period (generally
30
to
90
days). Special purpose loans relate to loans that are either line of credit loans or working capital loans that can be either secured or unsecured based on the facts and circumstances of the specific loans.
Due to the nature of our business, substantially all trade and finance receivables are due from vehicle dealers, salvage buyers, institutional sellers and insurance companies. We have possession of vehicles or vehicle titles collateralizing a significant portion of the trade and finance receivables.
Trade receivables and finance receivables are reported net of an allowance for doubtful accounts and credit losses. The allowances for doubtful accounts and credit losses are based on management's evaluation of the receivables portfolio under current conditions, the volume of the portfolio, overall portfolio credit quality, review of specific collection issues and such other factors which in management's judgment deserve recognition in estimating losses.
Other Current Assets
Other current assets consist of inventories, prepaid expenses, taxes receivable and other miscellaneous assets. The inventories, which consist of vehicles, supplies and parts, are accounted for on the specific identification method and are stated at the lower of cost or net realizable value.
Goodwill
Goodwill represents the excess of cost over fair value of identifiable net assets of businesses acquired. Goodwill is tested for impairment annually in the second quarter, or more frequently as impairment indicators arise. ASC 350,
Intangibles—Goodwill and Other
, permits an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the two-step goodwill impairment model. If it is determined through the qualitative assessment that a reporting unit's fair value is more likely than not greater than its carrying
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. The quantitative assessment for goodwill impairment is a two-step test. Under the first step, the fair value of each reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and we must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with ASC 805,
Business Combinations
. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed.
Customer Relationships and Other Intangible Assets
Customer relationships are amortized on a straight-line basis over the life determined in the valuation of the particular acquisition. Other intangible assets generally consist of tradenames, computer software and non-compete agreements, which if amortized, are amortized using the straight-line method. Tradenames with indefinite lives are not amortized and tradenames that have been assigned a useful life are amortized over their estimated useful lives. Costs incurred related to software developed or obtained for internal use are capitalized during the application development stage of software development and amortized over their estimated useful lives. The non-compete agreements are amortized over the life of the agreements. The lives of other intangible assets are re-evaluated periodically when facts and circumstances indicate that revised estimates of useful lives may be warranted. Indefinite-lived tradenames are assessed for impairment, in accordance with ASC 350, annually in the second quarter or more frequently as impairment indicators arise. At the end of each assessment, we make a determination as to whether the tradenames still have an indefinite life.
Property and Equipment
Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates intended to depreciate the costs of assets over their estimated useful lives. Upon retirement or sale of property and equipment, the cost of the disposed assets and related accumulated depreciation is removed from the accounts and any resulting gain or loss is credited or charged to selling, general and administrative expenses. Expenditures for normal repairs and maintenance are charged to expense as incurred. Additions and expenditures for improving or rebuilding existing assets that extend the useful life are capitalized. Leasehold improvements made either at the inception of the lease or during the lease term are amortized over the shorter of their economic lives or the lease term including any renewals that are reasonably assured.
Unamortized Debt Issuance Costs
Debt issuance costs reflect the expenditures incurred in conjunction with term loan debt, the revolving credit facility and the U.S. and Canadian receivables purchase agreements. The debt issuance costs are being amortized to interest expense using the effective interest method or the straight-line method, as applicable, over the lives of the related debt issues.
We adopted Accounting Standards Update (“ASU”) 2015-03,
Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
, in the first quarter of 2016. The update required debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. The new guidance represents a change in accounting principle and required retrospective application. As shown in the table below, we have reclassified unamortized debt issuance costs previously reported as of December 31, 2015
(in millions):
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Originally Reported
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Reclassified
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As Adjusted
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Unamortized debt issuance costs
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$
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20.3
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$
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(20.3
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)
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$
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—
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Obligations collateralized by finance receivables
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1,201.2
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(12.2
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)
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1,189.0
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Long-term debt
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1,719.3
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(8.1
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)
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1,711.2
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KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Other Assets
Other assets consist of equity method investments, below market leases, deposits, notes receivable and other long-term assets.
Equity Method Investments
We use the equity method to account for investments in companies when we have the ability to exercise significant influence over operating and financial policies of the investee but do not have a controlling financial interest. Our judgment regarding the level of influence over an equity method investment includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy making decisions and material intercompany transactions. Under this method of accounting, the Company records its proportionate share of the net earnings or losses of the equity method investee and a corresponding increase or decrease to the investment balance, which is included in "Other assets" on the consolidated balance sheet. Based on the timing of when financial information is received from the investee, the Company records its share of net earnings or losses of such investments on a lag basis. The Company evaluates its equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable.
Long-Lived Assets
Management reviews our property and equipment, customer relationships and other intangible assets for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The determination includes evaluation of factors such as current market value, future asset utilization, business climate, and future cash flows expected to result from the use of the related assets. If the carrying amount of a long-lived asset exceeds the total amount of the estimated undiscounted future cash flows from that asset, a loss is recognized in the period to the extent that the carrying amount exceeds the fair value of the asset. The impairment analysis is based on our current business strategy, expected growth rates and estimated future economic and regulatory conditions.
Accounts Payable
Accounts payable include amounts due sellers from the proceeds of the sale of their consigned vehicles less any fees, as well as outstanding checks to sellers and vendors. Book overdrafts, representing outstanding checks in excess of funds on deposit, are recorded in "Accounts payable" and amounted to
$154.4 million
and
$136.7 million
at
December 31, 2016
and
2015
, respectively.
Self Insurance Reserves
We self-insure our employee medical benefits, as well as a portion of our automobile, general liability and workers' compensation claims. We have insurance coverage that limits the exposure on individual claims. We also have insurance coverage that limits the total exposure to overall automobile, general liability and workers' compensation claims. The cost of the insurance is expensed over the contract periods. We record an accrual for the claims expense related to our employee medical benefits, automobile, general liability and workers' compensation claims based upon the expected amount of all such claims. Accrued medical benefits and workers' compensation expenses are included in "Accrued employee benefits and compensation expenses" while accrued automobile and general liability expenses are included in "Other accrued expenses."
Environmental Liabilities
Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. These accruals are adjusted periodically as assessment and remediation efforts progress, or as additional technical or legal information becomes available. Accruals for environmental liabilities are included in "Other accrued expenses" at undiscounted amounts and exclude claims for recoveries from insurance or other third parties.
Revenue Recognition
ADESA Auction Services
Revenues and the related costs are recognized when the services are performed. Auction fees from sellers and buyers are recognized upon the sale of the vehicle through the auction process. Most of the vehicles that are sold through auctions are
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
consigned to ADESA by the seller and held at ADESA's facilities or third party locations. ADESA does not take title to these consigned vehicles and recognizes revenue when a service is performed as requested by the owner of the vehicle. ADESA does not record the gross selling price of the consigned vehicles sold at auction as revenue. Instead, ADESA records only its auction fees as revenue because it does not take title to the consigned vehicles, has no influence on the vehicle auction selling price agreed to by the seller and buyer at the auction and the fees that ADESA receives for its services are generally a fixed amount. Revenues from reconditioning, logistics, vehicle inspection and certification, titling, evaluation and salvage recovery services are generally recognized when the services are performed.
Subsequent to the issuance of our consolidated financial statements for the year ended December 31, 2015, we identified that the gross selling price for certain vehicles owned and subsequently sold by ADESA had been incorrectly netted against cost of services. As a result of the correction of this immaterial item, ADESA Auction Services revenue and cost of services have increased by
$51.0 million
and
$52.5 million
for the years ended December 31, 2015 and 2014, respectively. In addition, we have adjusted ADESA Auction Services revenue and cost of services in the applicable notes to the consolidated financial statements, including the unaudited quarterly financial data in Note 19.
IAA Salvage Services
Revenues (including vehicle sales and fee income) are generally recognized at the date the vehicles are sold at auction. Most of the vehicles that are sold through auctions are consigned to IAA by the seller and held at IAA's facilities. IAA does not take title to these consigned vehicles and recognizes revenue when a service is performed as requested by the owner of the vehicle. IAA does not record the gross selling price of the consigned vehicles sold at auction as revenue. Revenue not recognized at the date the vehicles are sold at auction includes annual buyer registration fees, which are recognized on a straight-line basis, and certain buyer-related fees, which are recognized when payment is received.
AFC
AFC's revenue is comprised of interest and fee income, provision for credit losses and other revenues associated with our finance receivables, as well as other service revenue. The following table summarizes the primary components of AFC's revenue:
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Year Ended December 31,
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AFC Revenue (In millions)
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2016
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2015
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2014
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Interest and fee income
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$
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275.1
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$
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246.8
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$
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225.0
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Other revenue
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10.3
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9.7
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11.9
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Provision for credit losses
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(30.7
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)
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(16.0
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)
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(12.3
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)
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Other service revenue
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32.1
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27.9
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25.5
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$
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286.8
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$
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268.4
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$
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250.1
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Interest and fee income
Interest on finance receivables is recognized based on the number of days the vehicle remains financed. AFC ceases recognition of interest on finance receivables when the loans become delinquent, which is generally
31
days past due. Dealers are also charged a fee to floorplan a vehicle ("floorplan fee"), to extend the terms of the receivable ("curtailment fee") and a document processing fee. AFC fee income including floorplan and curtailment fees is recognized over the life of the finance receivable.
Other revenue
Other revenue includes lot check fees, filing fees and lien holder payoff services, each of which are charged to and collected from AFC's customers.
Other service revenue
Other service revenue represents the revenue generated by Preferred Warranties, Inc. ("PWI"). PWI, a service contract business, was acquired in June 2013. PWI receives advance payments for vehicle service contracts and unearned revenue is deferred and recognized over the terms of the contracts.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Income Taxes
We file federal, state and foreign income tax returns in accordance with the applicable rules of each jurisdiction. We account for income taxes under the asset and liability method in accordance with ASC 740,
Income Taxes
. The provision for income taxes includes federal, foreign, state and local income taxes currently payable, as well as deferred taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable amounts in years in which those temporary differences are expected to be recovered or settled. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized.
In accordance with ASC 740, we recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than
50%
likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
Net Income per Share
Basic net income per share is computed by dividing net income by the weighted average common shares outstanding during the year. Diluted net income per share represents net income divided by the sum of the weighted average common shares outstanding plus potential dilutive instruments related to our stock-based employee compensation program. The effect of stock options and restricted stock on net income per share-diluted is determined through the application of the treasury stock method, whereby net proceeds received by the Company based on assumed exercises are hypothetically used to repurchase our common stock at the average market price during the period. Stock options that would have an anti-dilutive effect on net income per diluted share and performance-based restricted stock units ("PRSUs") subject to performance conditions which have not yet been satisfied are excluded from the calculations.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation under ASC 718,
Compensation—Stock Compensation
. We recognize all stock-based compensation as expense in the financial statements and that cost is measured as the fair value of the award at the grant date for equity-classified awards, while liability-classified awards are remeasured each reporting period at fair value. We also consider forfeitures in determining compensation expense. Additionally, in accordance with ASC 718, cash flows resulting from tax deductions from the exercise of stock options in excess of recognized compensation cost (excess tax benefits) are classified as financing cash flows.
New Accounting Standards
In November 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash,
which addresses diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-18 will have on the consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,
which provides guidance on the statement of cash flows presentation of certain transactions where diversity in practice exists. The new guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-15 will have on the consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
The update changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. The new guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted beginning in annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the consolidated financial statements.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
In March 2016, the FASB issued ASU 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. The update changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. The Company will adopt ASU 2016-09 in the first quarter of 2017 and, unless offset by other factors, expects that its income tax expense will initially be lower as a result of excess tax benefits from stock-based compensation, including the expected exercise of approximately
0.4 million
options that expire in 2017.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
, which replaces existing lease guidance. The ASU is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet, with an exception for leases that meet the definition of a short-term lease. The new guidance will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted and the ASU is required to be applied with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on the consolidated financial statements and anticipates that the new guidance will significantly impact its consolidated financial statements, as the Company has a significant number of leases. Our current minimum commitments under non-cancelable operating leases are disclosed in Note 13. In addition, the recognition of these leases on our consolidated balance sheet would increase our net debt calculation which is included in the determination of our Consolidated Senior Secured Leverage Ratio. In this event, our Credit Agreement specifies that the covenant shall continue to be calculated as if the accounting standard had not occurred and that we could enter into negotiations to amend such provisions in the Credit Agreement so as to equitably reflect such changes with the desired result that the criteria for evaluating our financial condition would be the same after the change as if such change had not been made. We plan to amend the applicable provision in our Credit Agreement upon the adoption of ASU 2016-02.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606)
, which superseded the revenue recognition requirements in ASC 605,
Revenue Recognition
. The new guidance provides clarification on the recognition of revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosures to help financial statement users better understand the nature, amount, timing and uncertainty of revenue that is recognized. In August 2015, the FASB issued ASU 2015-14
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
,
which defers the effective date of ASU 2014-09 by one year. In accordance with the agreed upon delay, the new guidance is effective for the first annual reporting period and interim periods beginning after December 15, 2017, and will require either retrospective application to each prior reporting period presented or retrospective application with the cumulative effect of initially applying the standard recognized at the date of adoption. The Company expects to use retrospective application with the cumulative effect as its transition method. The Company is currently evaluating the impact the adoption of ASU 2014-09 will have on the consolidated financial statements and related disclosures. However, we have identified services such as towing, vehicle inspection reports and other pre-sale services which could result in the acceleration of revenue recognition.
Note 3—Acquisitions and Equity Method Investment
2016 Acquisitions
In February 2016, ADESA signed a definitive agreement to acquire auctions owned by the Brasher family. In April 2016, ADESA completed the acquisition of Brasher's
eight
auctions, which strengthens ADESA's western U.S. footprint. In 2015, Brasher's had revenues of approximately
$140 million
. We entered into operating lease obligations related to various facilities through 2036. Initial annual lease payments for the various facilities are approximately
$5 million
per year.
In March 2016, ADESA signed a definitive agreement to acquire Sanford Auto Dealers Exchange ("SADE"). In May 2016, ADESA completed the acquisition of SADE, which expands ADESA's geographic footprint in central Florida.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
In June 2016, the Company acquired GRS, a subsidiary of Greenhous Group Limited. GRS is an established online vehicle remarketing business in the U.K. The acquisition complements the Company's wide range of vehicle remarketing services and provides the opportunity to offer our full range of services in the U.K.
In November 2016, ADESA completed the acquisition of Flint Auto Auction, a whole car auction facility in Flint, Michigan. This acquisition expands ADESA's geographic footprint in the Midwest.
Certain of the purchase agreements included contingent payments related to vehicle volumes subsequent to the purchase date. The purchased assets included land, buildings, accounts receivable, operating equipment, customer relationships, tradenames, software, inventory and other intangible assets. Financial results for each acquisition have been included in our consolidated financial statements from the date of acquisition.
The aggregate purchase price for the businesses acquired in 2016, net of cash acquired, was approximately
$433.4 million
, which included estimated contingent payments with a fair value of
$1.3 million
. The maximum amount of undiscounted contingent payments related to these acquisitions could approximate
$1.5 million
. The purchase price for the acquired businesses was allocated to acquired assets and liabilities based upon fair values, including
$136.8 million
to intangible assets, representing the fair value of acquired customer relationships of
$129.8 million
, software of
$4.9 million
, tradenames of
$1.8 million
and non-competes of
$0.3 million
, which are being amortized over their expected useful lives. The purchase accounting associated with these acquisitions is preliminary, subject to determination of working capital adjustments and a final valuation of intangibles related to the acquisition of Flint Auto Auction. The Company does not expect adjustments to the purchase accounting will be material. The acquisitions resulted in aggregate goodwill of
$269.6 million
. The goodwill is recorded in the ADESA Auctions and AFC reportable segments. The financial impact of these acquisitions, including pro forma financial results, was immaterial to the Company’s consolidated results for the year ended December 31, 2016.
2015 Acquisitions
In March 2015, ADESA completed the acquisition of Pittsburgh Auto Auction. This acquisition bolsters ADESA’s presence in the eastern region and complements its current buyer base.
In April 2015, ADESA purchased all of the equity interests in MobileTrac LLC ("MobileTrac"). MobileTrac provides retail and wholesale car buyers with instaVIN’s vehicle history reports as well as the instaLEAD and instaDEAL technology through which automotive dealers can attract and structure retail transactions with consumers online. MobileTrac enhances the Company’s portfolio of service offerings to its customers.
In May 2015, AutoVIN, a subsidiary of ADESA, completed the acquisition of the vehicle inspection business from DataScan Field Services. AutoVIN utilizes Internet-based technology to perform vehicle inspection services for major auto manufacturers, financial institutions, leasing companies and warranty companies. The network’s broad geographical reach in the U.S. and Canada will provide expanded coverage for inspection customers, and the acquisition also brings new offerings to the AutoVIN portfolio, including warranty claim inspections, certified pre-owned audits and physical damage appraisals.
In May 2015, ADESA purchased all of the issued and outstanding membership interests in Autoniq, LLC ("Autoniq"). Autoniq provides real-time information such as vehicle pricing, history reports and market guides to dealers. Its mobile app allows used car dealers to scan VINs on mobile devices, view auction run lists and access vehicle history reports and market value reports instantly. Autoniq offers access to valued resources such as CARFAX and AutoCheck, as well as Black Book Daily, NADA guides, Kelley Blue Book and Galves pricing guide information. It also includes a comprehensive wholesale and retail market report for all markets in the United States. Autoniq enhances the Company’s portfolio of service offerings to its customers.
In June 2015, ADESA (UK) Limited completed the acquisition of HBC, which specializes in salvage vehicle auctions and related services and is headquartered in Canvey Island, England. HBC provides salvage collection and disposal services for the U.K.’s top insurance, fleet and accident management companies. HBC conducts business using a variety of sales channels, including online auctions.
In December 2015, Impact Auto Auctions, a subsidiary of IAA, purchased the assets of Sudbury Auto Auction Ltd. ("SAA"). The purchase of SAA provides the opportunity to expand into northern Ontario.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Certain of the purchase agreements included contingent payments related to financial results subsequent to the purchase
date. The purchased assets included land, buildings, accounts receivable, operating equipment, customer relationships,
tradenames, software, inventory and other intangible assets. Financial results for each acquisition have been included in our
consolidated financial statements from the date of acquisition.
The aggregate purchase price for the businesses acquired in 2015, net of cash acquired, was approximately
$128.0 million
, which included estimated contingent payments with a fair value of
$9.9 million
. The maximum amount of
undiscounted contingent payments related to these acquisitions could approximate
$18.6 million
. The purchase price for the
acquired businesses was allocated to acquired assets and liabilities based upon fair values, including
$33.3 million
to intangible
assets, representing the fair value of acquired customer relationships, tradenames and software, which are being amortized over
their expected useful lives. The acquisitions resulted in aggregate goodwill of
$92.3 million
. The goodwill is recorded in the
ADESA Auctions and IAA reportable segments. The financial impact of these acquisitions, including pro forma financial
results, was immaterial to the Company’s consolidated results for the year ended December 31, 2015.
Equity Method Investment
In August 2014, ADESA acquired a
50%
interest in Nth Gen Software Inc. ("TradeRev") and its online vehicle remarketing system for approximately
$30 million
in cash. TradeRev is an online automotive remarketing system where dealers can launch and participate in real-time vehicle auctions at any time from their mobile devices or desktop. In addition, ADESA also entered into a joint marketing agreement with TradeRev to assist in expanding its footprint in the dealer-to-dealer online space in the U.S. and Canadian markets.
ASC 323,
Investments - Equity Method and Joint Ventures
, specifies that to the extent there is a basis difference between the cost and the underlying equity in the net assets of an equity investment, such difference is required to be allocated between tangible and intangible assets. At the date of acquisition, the carrying amount of the investment in TradeRev was greater than the Company’s equity in the underlying assets of TradeRev by approximately
$21.8 million
as a result of the difference in the carrying amounts of intangible assets. The difference attributable to amortizable intangible assets was approximately
$4.8 million
at the time of the equity investment, which is being amortized on a straight-line basis over the expected useful lives of the intangible assets, which range from
6
to
14
years. The intangible assets are not reflected on the balance sheet of KAR Auction Services.
TradeRev’s results of operations are recorded on a one-month lag basis. The Company’s share in the net losses of TradeRev for fiscal year 2016, 2015 and 2014 was
$3.8 million
,
$0.8 million
and
$0.2 million
, respectively. This amount was recorded to “Other income, net” in the consolidated statements of income.
Note 4—Stock and Stock-Based Compensation Plans
Our stock-based compensation expense has included expense associated with KAR Auction Services, Inc. PRSUs, service-based restricted stock units ("RSUs"), service options and exit options. We have classified the KAR Auction Services, Inc. PRSUs, RSUs, service options and exit options as equity awards.
The compensation cost that was charged against income for all stock-based compensation plans was
$18.1 million
,
$11.7 million
and
$28.0 million
for the years ended
December 31, 2016
,
2015
and
2014
, respectively, and the total income tax benefit recognized in the consolidated statement of income for options, PRSUs and RSUs was approximately
$6.9 million
,
$4.4 million
and
$10.1 million
for the years ended
December 31, 2016
,
2015
and
2014
, respectively. We did not capitalize any stock-based compensation cost in the years ended
December 31, 2016
,
2015
or
2014
.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The following table summarizes our stock-based compensation expense by type of award
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
PRSUs
|
$
|
10.3
|
|
|
$
|
6.1
|
|
|
$
|
3.5
|
|
RSUs
|
5.9
|
|
|
2.5
|
|
|
—
|
|
Service options
|
1.9
|
|
|
3.1
|
|
|
3.6
|
|
Exit options
|
—
|
|
|
—
|
|
|
20.9
|
|
Total stock-based compensation expense
|
$
|
18.1
|
|
|
$
|
11.7
|
|
|
$
|
28.0
|
|
KAR Auction Services, Inc. 2009 Omnibus Stock and Incentive Plan - PRSUs, RSUs, Service Options and Exit Options
We adopted the KAR Auction Services, Inc. 2009 Omnibus Stock and Incentive Plan ("Omnibus Plan") in December 2009. The Omnibus Plan is intended to provide equity or cash-based awards to our employees. At KAR Auction Services' Annual Meeting of Stockholders in June 2014, the stockholders approved the amendment and restatement of the Omnibus Plan. As a result, the maximum number of shares that may be issued pursuant to awards under the Omnibus Plan was increased from
6.5 million
to
12.5 million
. The Omnibus Plan provides for the grant of options, restricted stock, stock appreciation rights, other stock-based awards and cash-based awards. The PRSU and RSU grants described below were made pursuant to the Company's Policy on Granting Equity Awards.
PRSUs
In 2016, we granted a target amount of approximately
0.3 million
PRSUs to certain executive officers and management of the Company. The PRSUs vest if and to the extent that the Company's
three
-year operating adjusted earnings per share attains certain specified goals. The weighted average grant date fair value of the PRSUs was
$34.94
per share, which was determined using the closing price of the Company's common stock on the dates of grant.
In 2015, we granted a target amount of approximately
0.2 million
PRSUs to certain executive officers and management of the Company. The PRSUs vest if and to the extent that the Company's
three
-year adjusted earnings per share attains certain specified goals. The weighted average grant date fair value of the PRSUs was
$37.03
per share, which was determined using the closing price of the Company's common stock on the dates of grant.
In the first quarter of 2014, we granted a target amount of approximately
0.1 million
PRSUs to certain executive officers of the Company. Half of the PRSUs vest
three
years from the grant date if and to the extent that the Company's total shareholder return relative to that of companies within the S&P 500 Index exceeds certain levels over the same period. The other half of the PRSUs vest if and to the extent that the Company's
three
-year adjusted earnings per share attains certain specified goals. The grant date fair value of the PRSUs tied to total shareholder return was
$36.54
per share and was developed in consultation with independent valuation specialists who used a Monte-Carlo simulation using a geometric Brownian motion based upon a risk-neutral framework. Key assumptions in the valuation included the fair market value of our common stock on the date of grant, the expected volatility of our common stock over the expected term of the award and the risk-free interest rate for the expected term of the award. The grant date fair value of the PRSUs tied to adjusted earnings per share was
$30.89
per share, which was the closing price of the Company's common stock on the date of grant.
In December 2013, we granted a target amount of approximately
0.2 million
PRSUs to certain executive officers of the Company. The PRSUs vest
three
years from the grant date if and to the extent that the Company's total shareholder return relative to that of companies within the S&P 500 Index exceeds certain levels over the same period. The grant date fair value of the PRSUs granted in 2013 was
$32.79
per share and was developed in consultation with independent valuation specialists who used a Monte-Carlo simulation using a geometric Brownian motion based upon a risk neutral framework. Key assumptions in the valuation included the fair market value of our common stock on the date of grant, the expected volatility of our common stock over the expected term of the award and the risk-free interest rate for the expected term of the award.
As of December 31, 2016, an estimated
$8.8 million
of unrecognized compensation expense related to nonvested PRSUs is expected to be recognized over a weighted average term of approximately
1.6
years. Dividend equivalents accrue on the PRSUs and are subject to the same vesting and forfeiture terms as the PRSUs.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
RSUs
In 2016 and 2015, approximately
0.3 million
and
0.3 million
, respectively, RSUs were granted to certain executive officers and management of the Company. The RSUs are contingent upon continued employment and vest in
three
equal annual installments. The fair value of RSUs is the value of the Company's common stock at the date of grant and the weighted average grant date fair value of the RSUs was
$34.91
per share and
$37.04
per share in 2016 and 2015, respectively. Dividend equivalents accrue on the RSUs and are subject to the same vesting and forfeiture terms as the RSUs.
The following table summarizes RSU activity, excluding dividend equivalents, under the Omnibus Plan for the year ended December 31, 2016:
|
|
|
|
|
|
|
|
|
Restricted Stock Units
|
|
Number
|
|
Weighted Average Grant Date Fair Value
|
RSUs at January 1, 2016
|
|
240,387
|
|
|
$
|
37.04
|
|
Granted
|
|
285,386
|
|
|
34.91
|
|
Vested
|
|
(82,860
|
)
|
|
36.96
|
|
Forfeited
|
|
(25,201
|
)
|
|
35.78
|
|
RSUs at December 31, 2016
|
|
417,712
|
|
|
$
|
35.67
|
|
As of December 31, 2016, there was approximately
$9.5 million
of unrecognized compensation expense related to nonvested RSUs which is expected to be recognized over a weighted average term of
1.8
years.
Service Options
In
2014
, we granted approximately
0.9 million
service options, with a weighted average exercise price of
$30.06
per share under the Omnibus Plan. The service options have a
ten
year life and generally vest in
four
equal annual installments, commencing on the first anniversary of the respective grant dates.
Exit Options
The outstanding exit options granted in 2010 under the Omnibus Plan contain the same vesting criteria as the exit options noted below under the KAR Auction Services, Inc. Stock Incentive Plan.
KAR Auction Services, Inc. Stock Incentive Plan - Service Options and Exit Options
The Company adopted the KAR Auction Services, Inc. Stock Incentive Plan (the "Plan") in May 2007. The Plan was intended to provide equity incentive benefits to the Company's employees. The maximum number of shares that were to be issued pursuant to awards under the Plan was approximately
7.9 million
. The Plan provided for the grant of incentive stock options and non-qualified stock options and restricted stock. Awards granted since the adoption of the Plan were non-qualified stock options, and no further grants will be awarded under the Plan.
The Plan provided
two
types of stock options: service-related options, which were to vest ratably in
four
annual installments from the date of grant based upon the passage of time, and performance-related exit options, which were generally to become exercisable upon a change in equity control of our former parent company. Under the exit options, in addition to the change in equity control requirement, the number of options that vest were to be determined based on the strike price and certain performance hurdles based on our former owners and other investors' achievement of certain multiples on their original indirect equity investment in KAR Auction Services subject to a minimum internal rate of return at the time of change in equity control. All vesting criteria was subject to continued employment with our former parent company or affiliates thereof. Options were to be granted under the Plan at an exercise price of not less than the fair market value of a share of KAR Auction Services common stock on the date of grant and have a contractual life of
ten
years.
On December 10, 2009, in conjunction with the initial public offering, all outstanding service options became fully vested and exercisable. In addition, the vesting criteria and exercisability of the exit options were modified to become based on the price per share of our common stock, rather than vest upon the achievement of certain specified performance goals at the time of an exit event. On March 1, 2013, the board of directors approved additional amendments to the outstanding exit options that previously vested based on a
90
-day average closing price of the Company's common stock being above a stated dollar amount.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Generally, such vesting terms were amended to require that the average closing price over a period of
90
trading days be greater than a specified dollar amount to instead requiring that the closing price be greater than the specified dollar amount over a period of
20
consecutive trading days. As a result of this change, effective on March 1, 2013, approximately
1.4
million of such exit options became vested. The incremental expense related to the modification was approximately
$0.8 million
.
On November 6, 2013, another modification occurred stating that upon an exit event, exercisable stock option awards would not be canceled in exchange for cash and unexercisable options would not be canceled and forfeited, as specified in the Plan. As a result of the modification, there was
no
incremental compensation expense for the vested service and exit options under the Plan. The fair value of the vested service and exit options immediately before and immediately after the modification both approximated the intrinsic value of the respective options. However, the modification resulted in incremental compensation expense for the unvested exit options of approximately
$32.6 million
, which was recognized through December 31, 2014.
The exit options granted under the Plan and the Omnibus Plan vested as follows:
|
|
|
|
|
|
Amount Vested
|
|
Vesting Conditions
|
|
Vested & Exercisable Date
|
25% of exit options vested and became exercisable when
|
|
(i) the fair market value of Company common stock exceeded $20.00
|
|
March 2013
|
An additional 25% of exit options vested and became exercisable when
|
|
(i) the fair market value of Company common stock exceeded $25.00
|
|
August 2013
|
An additional 25% of exit options vested and became exercisable when
|
|
(i) the fair market value of Company common stock exceeded $30.00
|
|
March 2014
|
An additional 25% of exit options vested and became exercisable when
|
|
(i) the fair market value of Company common stock exceeds $35.00
|
|
March 2015
|
Service Options Summary
The following table summarizes service option activity under the Omnibus Plan and the Plan for the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service Options
|
Number
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
(in millions)
|
Outstanding at January 1, 2016
|
2,163,329
|
|
|
$
|
21.66
|
|
|
|
|
|
|
Granted
|
—
|
|
|
N/A
|
|
|
|
|
|
|
Exercised
|
(429,274
|
)
|
|
17.57
|
|
|
|
|
|
|
Forfeited
|
(28,760
|
)
|
|
25.66
|
|
|
|
|
|
|
Canceled
|
(17,370
|
)
|
|
25.87
|
|
|
|
|
|
|
Outstanding at December 31, 2016
|
1,687,925
|
|
|
$
|
22.59
|
|
|
5.8 years
|
|
$
|
33.8
|
|
Exercisable at December 31, 2016
|
1,149,057
|
|
|
$
|
19.45
|
|
|
5.1 years
|
|
$
|
26.6
|
|
The intrinsic value presented in the table above represents the amount by which the market value of the underlying stock exceeds the exercise price of the option at
December 31, 2016
. The intrinsic value changes continuously based on the fair value of our stock. The market value is based on KAR Auction Services' closing stock price of
$42.62
on
December 31, 2016
. The total intrinsic value of service options exercised during the years ended
December 31, 2016
,
2015
and
2014
was
$9.6 million
,
$11.0 million
and
$12.4 million
, respectively. The fair value of all vested and exercisable service options at
December 31, 2016
and
2015
was
$49.0 million
and
$45.1 million
, respectively.
As of
December 31, 2016
, there was approximately
$1.8 million
of unrecognized compensation expense related to nonvested service options which is expected to be recognized over a weighted average term of
1.1
years.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Service options have been accounted for as equity awards and, as such, compensation expense was measured based on the fair value of the award at the date of grant and recognized over the
four
year service periods, using the straight-line attribution method. The weighted average fair value of the service options granted was
$6.37
per share for the year ended December 31, 2014. The fair value of service options granted was estimated on the date of grant using the Black-Scholes option pricing model and the following assumptions:
|
|
|
|
Assumptions
|
2014
|
Risk-free interest rate
|
1.80% - 1.915%
|
|
Expected life
|
6.25 years
|
|
Expected volatility
|
30.0
|
%
|
Dividend yield
|
3.24% - 3.45%
|
|
Risk-free interest rate
—This is the yield on U.S. Treasury Securities posted at the date of grant (or date of modification) having a term equal to the expected life of the option. An increase in the risk-free interest rate will increase compensation expense.
Expected life—years
—This is the period of time over which the options granted are expected to remain outstanding. Options granted by KAR Auction Services have a maximum term of
ten
years. An increase in the expected life will increase compensation expense.
Expected volatility
—Actual changes in the market value of stock are used to calculate the volatility assumption. Based on the Company's limited time as a publicly traded company, the expected volatility used was determined based on a combination of historical volatility, the volatility of selected comparable companies and other relevant factors. An increase in the expected volatility will increase compensation expense.
Dividend yield
—This is the annual rate of dividends per share over the exercise price of the option. An increase in the dividend yield will decrease compensation expense.
Exit Options Summary
The following table summarizes exit option activity under the Omnibus Plan and the Plan for the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exit Options
|
Number
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
(in millions)
|
Outstanding at January 1, 2016
|
1,808,428
|
|
|
$
|
11.27
|
|
|
|
|
|
|
Granted
|
—
|
|
|
N/A
|
|
|
|
|
|
|
Exercised
|
(817,152
|
)
|
|
10.54
|
|
|
|
|
|
|
Forfeited
|
—
|
|
|
N/A
|
|
|
|
|
|
|
Canceled
|
—
|
|
|
N/A
|
|
|
|
|
|
|
Outstanding at December 31, 2016
|
991,276
|
|
|
$
|
11.90
|
|
|
2.0 years
|
|
$
|
30.4
|
|
Exercisable at December 31, 2016
|
991,276
|
|
|
$
|
11.90
|
|
|
2.0 years
|
|
$
|
30.4
|
|
The intrinsic value presented in the table above represents the amount by which the market value of the underlying stock exceeds the exercise price of the option at
December 31, 2016
. The intrinsic value changes continuously based on the fair value of our stock. The market value is based on KAR Auction Services' closing stock price of
$42.62
on
December 31, 2016
. The total intrinsic value of exit options exercised during the years ended
December 31, 2016
,
2015
and
2014
was
$23.8 million
,
$35.9 million
and
$30.8 million
, respectively. The fair value of all vested and exercisable exit options at
December 31, 2016
and
2015
was
$42.2 million
and
$67.0 million
, respectively.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The requisite service period and the fair value of the exit options were developed in consultation with independent valuation specialists. The original time horizons over which our stock price was projected to achieve the market conditions noted in the above tables ranged from
1.2
years to
3.9
years. As a result, compensation expense was originally recognized over the derived service periods ranging from
1.2
years to
3.9
years. In connection with the modifications in 2013, incremental compensation expense was recognized over a new derived service period which ended December 31, 2014. As of December 31, 2014, all of the compensation expense related to the exit options was recognized.
KAR Auction Services, Inc. Employee Stock Purchase Plan
A maximum of
1,000,000
shares of our common stock have been reserved for issuance under the KAR Auction Services, Inc. Employee Stock Purchase Plan ("ESPP"). At
December 31, 2016
,
554,576
shares remain available for purchase under the ESPP. The ESPP provides for one month offering periods with a
15%
discount from the fair market value of a share on the date of purchase. In accordance with ASC 718,
Compensation—Stock Compensation
, the entire
15%
purchase discount is recorded as compensation expense. A participant's combined payroll deductions and cash payments in the ESPP may not exceed
$25,000
per year.
Share Repurchase Programs
In October 2016, the board of directors authorized a repurchase of up to
$500 million
of the Company’s outstanding common stock, par value
$0.01
per share, through
October 26, 2019
. Repurchases may be made in the open market or through privately negotiated transactions, in accordance with applicable securities laws and regulations, including pursuant to repurchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing and amount of any repurchases is subject to market and other conditions. As of
December 31, 2016
, we had repurchased and retired a total of
1,931,200
shares of common stock in the open market at a weighted average price of
$41.61
per share under the October 2016 authorization.
In October 2014, the board of directors authorized a repurchase of up to
$300 million
of the Company’s outstanding common stock, par value
$0.01
per share, through
October 28, 2016
. Repurchases were made in the open market or through privately negotiated transactions, in accordance with applicable securities laws and regulations, including pursuant to repurchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing and amount of any repurchases was subject to market and other conditions. In 2015 we repurchased and retired a total of
744,900
shares of common stock in the open market at a weighted average price of
$37.04
per share. In 2016 we made
no
repurchases of common stock in the open market under the October 2014 authorization.
In August 2015, as part of the authorized program to repurchase common stock noted above, the Company entered into an accelerated share repurchase agreement under which it paid
$200 million
for an initial delivery of approximately
4.6 million
shares of its common stock. The initial delivery of shares represented
90%
of the shares anticipated to be repurchased based on current market prices at that time. The initial delivery of shares also resulted in an immediate reduction in the number of shares used to calculate the weighted average common shares outstanding for basic and diluted net income per share. The Company settled the accelerated share repurchase agreement in January 2016 and received approximately
0.8 million
additional shares of its common stock based on an adjusted volume weighted average price of its stock over the period. In total,
5,413,274
shares were repurchased under the accelerated share repurchase agreement at an average repurchase price of
$36.95
per share.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Note 5—Net Income Per Share
The following table sets forth the computation of net income per share
(in millions except per share amounts)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Net income
|
$
|
222.4
|
|
|
$
|
214.6
|
|
|
$
|
169.3
|
|
Weighted average common shares outstanding
|
137.6
|
|
|
140.1
|
|
|
140.2
|
|
Effect of dilutive stock options and restricted stock awards
|
1.5
|
|
|
2.2
|
|
|
1.6
|
|
Weighted average common shares outstanding and potential common shares
|
139.1
|
|
|
142.3
|
|
|
141.8
|
|
Net income per share
|
|
|
|
|
|
Basic
|
$
|
1.62
|
|
|
$
|
1.53
|
|
|
$
|
1.21
|
|
Diluted
|
$
|
1.60
|
|
|
$
|
1.51
|
|
|
$
|
1.19
|
|
Basic net income per share was calculated by dividing net income by the weighted average number of outstanding common shares for the period. Diluted net income per share was calculated consistent with basic net income per share including the effect of dilutive unissued common shares related to our stock-based employee compensation program. The effect of stock options and restricted stock on net income per share-diluted is determined through the application of the treasury stock method, whereby net proceeds received by the Company based on assumed exercises are hypothetically used to repurchase our common stock at the average market price during the period. Stock options that would have an anti-dilutive effect on net income per diluted share and PRSUs subject to performance conditions which have not yet been satisfied are excluded from the calculations.
No
options were excluded from the calculation of diluted net income per share for the years ended
December 31, 2016
and
2015
, respectively, and approximately
0.4 million
were excluded from the calculation of diluted net income per share for the year ended
December 31, 2014
. In addition, approximately
0.5 million
,
0.3 million
, and
0.1 million
PRSUs were excluded from the calculation of diluted net income per share for the years ended
December 31, 2016
,
2015
, and
2014
, respectively. Total options outstanding at
December 31, 2016
,
2015
and
2014
were
2.7 million
,
4.0 million
and
5.9 million
, respectively.
Note 6—Allowance for Credit Losses and Doubtful Accounts
The following is a summary of the changes in the allowance for credit losses related to finance receivables (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Allowance for Credit Losses
|
|
|
|
|
|
Balance at beginning of period
|
$
|
9.0
|
|
|
$
|
8.0
|
|
|
$
|
8.0
|
|
Provision for credit losses
|
30.7
|
|
|
16.0
|
|
|
12.3
|
|
Recoveries
|
4.2
|
|
|
4.1
|
|
|
3.5
|
|
Less charge-offs
|
(31.9
|
)
|
|
(19.1
|
)
|
|
(15.8
|
)
|
Balance at end of period
|
$
|
12.0
|
|
|
$
|
9.0
|
|
|
$
|
8.0
|
|
AFC's allowance for credit losses includes estimated losses for finance receivables currently held on the balance sheet of AFC and its subsidiaries.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The following is a summary of changes in the allowance for doubtful accounts related to trade receivables (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Allowance for Doubtful Accounts
|
|
|
|
|
|
Balance at beginning of period
|
$
|
6.6
|
|
|
$
|
6.3
|
|
|
$
|
4.8
|
|
Provision for credit losses
|
9.8
|
|
|
2.8
|
|
|
4.3
|
|
Less net charge-offs
|
(3.4
|
)
|
|
(2.5
|
)
|
|
(2.8
|
)
|
Balance at end of period
|
$
|
13.0
|
|
|
$
|
6.6
|
|
|
$
|
6.3
|
|
Recoveries of trade receivables were netted with charge-offs, as they were not material. Changes in the Canadian exchange rate did not have a material effect on the allowance for doubtful accounts.
Note 7—Finance Receivables and Obligations Collateralized by Finance Receivables
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to a wholly-owned, bankruptcy remote, consolidated, special purpose subsidiary ("AFC Funding Corporation"), established for the purpose of purchasing AFC's finance receivables. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. AFC Funding Corporation had committed liquidity of
$1.50 billion
for U.S. finance receivables at
December 31, 2016
.
In December 2016, AFC and AFC Funding Corporation entered into the Seventh Amended and Restated Receivables Purchase Agreement (the "Receivables Purchase Agreement"). The Receivables Purchase Agreement increased AFC Funding's U.S. committed liquidity from
$1.25 billion
to
$1.50 billion
and extended the facility's maturity date from June 29, 2018 to
January 31, 2020
. In addition, the definition of eligible receivables was expanded and the tangible net worth requirement increased. We capitalized approximately
$12.7 million
of costs in connection with the Receivables Purchase Agreement. In addition, we recorded a
$1.4 million
pretax charge resulting from the write-off of a portion of the unamortized securitization issuance costs.
In March 2016, AFC and AFC Funding Corporation entered into Amendment No. 1 (the "Amendment") to the Sixth Amended and Restated Receivables Purchase Agreement. The Amendment increased AFC Funding's U.S. committed liquidity from
$1.15 billion
to
$1.25 billion
. We capitalized approximately
$0.8 million
of costs in connection with the Amendment.
In June 2015, AFC and AFC Funding Corporation entered into the Sixth Amended and Restated Receivables Purchase Agreement. The Sixth Amended and Restated Receivables Purchase Agreement increased AFC Funding's U.S. committed liquidity from
$950 million
to
$1.15 billion
and extended the facility's maturity date. In addition, the definition of eligible receivables was expanded and the overcollateralization requirement was reduced. We capitalized approximately
$10.0 million
of costs in connection with the Sixth Amended and Restated Receivables Purchase Agreement.
We also have an agreement for the securitization of AFCI's receivables. AFCI's committed facility is provided through a third party conduit (separate from the U.S. facility) and was
C$125 million
at
December 31, 2016
. In December 2016, AFCI entered into the Fourth Amended and Restated Receivables Purchase Agreement (the "Canadian Receivables Purchase Agreement"). The Canadian Receivables Purchase Agreement extended the facility's maturity date from June 29, 2018 to
January 31, 2020
. We capitalized approximately
$0.7 million
of costs in connection with the Canadian Receivables Purchase Agreement. In June 2015, AFCI entered into the Third Amended and Restated Receivables Purchase Agreement. The Third Amended and Restated Receivables Purchase Agreement increased AFCI's committed liquidity from
C$100 million
to
C$125 million
and extended the facility's maturity date. In addition, the definition of eligible receivables was expanded. We capitalized approximately
$0.9 million
of costs in connection with the Third Amended and Restated Receivables Purchase Agreement. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The following tables present quantitative information about delinquencies, credit losses less recoveries ("net credit losses") and components of securitized financial assets and other related assets managed. For purposes of this illustration, delinquent receivables are defined as receivables
31
days or more past due.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Net Credit Losses
During 2016
|
|
Principal Amount of:
|
|
(in millions)
|
Receivables
|
|
Receivables
Delinquent
|
|
Floorplan receivables
|
$
|
1,781.1
|
|
|
$
|
12.0
|
|
|
$
|
27.7
|
|
Other loans
|
11.1
|
|
|
—
|
|
|
—
|
|
Total receivables managed
|
$
|
1,792.2
|
|
|
$
|
12.0
|
|
|
$
|
27.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Net Credit Losses
During 2015
|
|
Principal Amount of:
|
|
(in millions)
|
Receivables
|
|
Receivables
Delinquent
|
|
Floorplan receivables
|
$
|
1,635.5
|
|
|
$
|
7.0
|
|
|
$
|
15.0
|
|
Other loans
|
5.5
|
|
|
—
|
|
|
—
|
|
Total receivables managed
|
$
|
1,641.0
|
|
|
$
|
7.0
|
|
|
$
|
15.0
|
|
AFC's allowance for losses was
$12.0 million
and
$9.0 million
at
December 31, 2016
and
2015
, respectively.
As of
December 31, 2016
and
2015
,
$1,774.8 million
and
$1,626.6 million
, respectively, of finance receivables and a cash reserve of
1
percent of the obligations collateralized by finance receivables served as security for the obligations collateralized by finance receivables. Obligations collateralized by finance receivables consisted of the following:
|
|
|
|
|
|
|
|
|
|
December 31,
2016
|
|
December 31,
2015
|
Obligations collateralized by finance receivables, gross
|
$
|
1,300.0
|
|
|
$
|
1,201.2
|
|
Unamortized securitization issuance costs
|
(19.7
|
)
|
|
(12.2
|
)
|
Obligations collateralized by finance receivables
|
$
|
1,280.3
|
|
|
$
|
1,189.0
|
|
Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At
December 31, 2016
, we were in compliance with the covenants in the securitization agreements.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Note 8—Goodwill and Other Intangible Assets
Goodwill consisted of the following (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADESA
Auctions
|
|
IAA
|
|
AFC
|
|
Total
|
Balance at December 31, 2014
|
$
|
962.7
|
|
|
$
|
523.5
|
|
|
$
|
219.0
|
|
|
$
|
1,705.2
|
|
Increase for acquisition activity
|
77.6
|
|
|
14.7
|
|
|
—
|
|
|
92.3
|
|
Other
|
(0.9
|
)
|
|
(0.7
|
)
|
|
—
|
|
|
(1.6
|
)
|
Balance at December 31, 2015
|
$
|
1,039.4
|
|
|
$
|
537.5
|
|
|
$
|
219.0
|
|
|
$
|
1,795.9
|
|
Increase for acquisition activity
|
224.1
|
|
|
0.8
|
|
|
44.7
|
|
|
269.6
|
|
Other
|
(6.6
|
)
|
|
(1.9
|
)
|
|
—
|
|
|
(8.5
|
)
|
Balance at December 31, 2016
|
$
|
1,256.9
|
|
|
$
|
536.4
|
|
|
$
|
263.7
|
|
|
$
|
2,057.0
|
|
Goodwill represents the excess cost over fair value of identifiable net assets of businesses acquired. Goodwill increased in 2016 and 2015 primarily as a result of acquisitions. A majority of the goodwill resulting from the businesses acquired in 2016 and 2015 is expected to be deductible for tax purposes. The "other" category primarily represents the impact of fluctuations in exchange rates.
A summary of customer relationships is as follows (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Useful
Lives
(in years)
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Carrying
Value
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Carrying
Value
|
Customer relationships
|
5 - 19
|
|
$
|
1,168.8
|
|
|
$
|
(707.8
|
)
|
|
$
|
461.0
|
|
|
$
|
1,037.0
|
|
|
$
|
(619.3
|
)
|
|
$
|
417.7
|
|
The increase in customer relationships in 2016 was primarily related to customer relationships acquired, partially offset by the amortization of existing customer relationships, as well as changes in the Canadian exchange rate.
A summary of other intangibles is as follows (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Useful Lives
(in years)
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Carrying
Value
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Carrying
Value
|
Tradenames
|
2 - Indefinite
|
|
$
|
201.1
|
|
|
$
|
(6.9
|
)
|
|
$
|
194.2
|
|
|
$
|
199.2
|
|
|
$
|
(5.3
|
)
|
|
$
|
193.9
|
|
Computer software & technology
|
3 - 13
|
|
404.8
|
|
|
(279.7
|
)
|
|
125.1
|
|
|
354.2
|
|
|
(238.3
|
)
|
|
115.9
|
|
Covenants not to compete
|
1 - 5
|
|
15.8
|
|
|
(15.0
|
)
|
|
0.8
|
|
|
15.5
|
|
|
(14.5
|
)
|
|
1.0
|
|
Total
|
|
|
$
|
621.7
|
|
|
$
|
(301.6
|
)
|
|
$
|
320.1
|
|
|
$
|
568.9
|
|
|
$
|
(258.1
|
)
|
|
$
|
310.8
|
|
Other intangibles increased in 2016 primarily as a result of computer software additions and acquisitions, partially offset by the amortization of existing intangibles.
Amortization expense for customer relationships and other intangibles was
$151.0 million
,
$138.0 million
and
$128.8 million
for the years ended
December 31, 2016
,
2015
and
2014
, respectively. Estimated amortization expense on existing intangible assets for the next five years is
$146.1 million
for
2017
,
$109.3 million
for
2018
,
$81.7 million
for
2019
,
$57.6 million
for
2020
and
$40.7 million
for
2021
.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Note 9—Property and Equipment
Property and equipment consisted of the following (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
Useful Lives
(in years)
|
|
December 31,
|
|
2016
|
|
2015
|
Land
|
|
|
$
|
266.4
|
|
|
$
|
236.8
|
|
Buildings
|
5 - 40
|
|
244.7
|
|
|
217.0
|
|
Land improvements
|
5 - 20
|
|
167.7
|
|
|
149.1
|
|
Building and leasehold improvements
|
3 - 33
|
|
384.5
|
|
|
348.4
|
|
Furniture, fixtures and equipment
|
1 - 10
|
|
388.6
|
|
|
325.5
|
|
Vehicles
|
3 - 10
|
|
19.1
|
|
|
15.0
|
|
Construction in progress
|
|
|
27.1
|
|
|
44.7
|
|
|
|
|
1,498.1
|
|
|
1,336.5
|
|
Accumulated depreciation
|
|
|
(655.6
|
)
|
|
(569.6
|
)
|
Property and equipment, net
|
|
|
$
|
842.5
|
|
|
$
|
766.9
|
|
Depreciation expense for the years ended
December 31, 2016
,
2015
and
2014
was
$89.6 million
,
$74.8 million
and
$67.8 million
, respectively.
We have acquired furniture, fixtures and equipment by undertaking capital lease obligations. Assets held under the capital leases are depreciated in a manner consistent with our depreciation policy for owned assets. The assets included above that are held under capital leases are summarized below (
in millions
):
|
|
|
|
|
|
|
|
|
|
December 31,
|
Classes of Property
|
2016
|
|
2015
|
Furniture, fixtures and equipment
|
$
|
149.2
|
|
|
$
|
120.4
|
|
Accumulated depreciation
|
(94.2
|
)
|
|
(71.3
|
)
|
Capital lease assets
|
$
|
55.0
|
|
|
$
|
49.1
|
|
Note 10—Self Insurance and Retained Loss Reserves
We self-insure our employee medical benefits, as well as a portion of our automobile, general liability and workers' compensation claims. We have insurance coverage that limits the exposure on individual claims. We also have insurance coverage that limits the total exposure to overall automobile, general liability and workers' compensation claims. The cost of the insurance is expensed over the contract periods. Utilizing historical claims experience, we record an accrual for the claims based upon the expected amount of all such claims, which includes the cost of claims that have been incurred but not reported. Accrued medical benefits and workers' compensation expenses are included in "Accrued employee benefits and compensation expenses" while accrued automobile and general liability expenses are included in "Other accrued expenses."
The following is a summary of the changes in the reserves for self-insurance and the retained losses (
in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Balance at beginning of period
|
$
|
36.1
|
|
|
$
|
33.3
|
|
|
$
|
27.8
|
|
Net payments
|
(76.5
|
)
|
|
(66.3
|
)
|
|
(55.8
|
)
|
Expense
|
83.5
|
|
|
69.1
|
|
|
61.3
|
|
Balance at end of period
|
$
|
43.1
|
|
|
$
|
36.1
|
|
|
$
|
33.3
|
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Individual stop-loss coverage for medical benefits was
$0.5 million
in
2016
and
2015
. There was no aggregate policy limit for medical benefits for the Company in either year. The retention for automobile and general liability claims was
$1.0 million
per occurrence and the retention for workers' compensation claims was
$0.5 million
per occurrence with a
$1.0 million
corridor deductible in the
2016
policy year. The retention for automobile, general liability and workers' compensation claims was
$0.5 million
per occurrence with a
$1.0 million
corridor deductible in the
2015
policy year. Once the
$1.0 million
corridor deductible is met for workers' compensation claims, the deductible reverts back to
$0.5 million
per occurrence. The aggregate policy limits for the combined automobile, general liability and workers' compensation program was
$30.4 million
and
$25.0 million
for the
2016
and
2015
policy years, respectively.
Note 11—Long-Term Debt
Long-term debt consisted of the following
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
Interest Rate*
|
|
Maturity
|
|
2016
|
|
2015
|
Term Loan B-1
|
LIBOR
|
|
+ 2.50%
|
|
March 11, 2017
|
|
$
|
—
|
|
|
$
|
637.2
|
|
Term Loan B-2
|
Adjusted LIBOR
|
|
+ 3.1875%
|
|
March 11, 2021
|
|
1,082.7
|
|
|
1,098.0
|
|
Term Loan B-3
|
Adjusted LIBOR
|
|
+ 3.50%
|
|
March 9, 2023
|
|
1,339.9
|
|
|
—
|
|
Revolving credit facility
|
Adjusted LIBOR
|
|
+ 2.50%
|
|
March 9, 2021
|
|
80.5
|
|
|
—
|
|
Old revolving credit facility
|
LIBOR
|
|
+ 2.25%
|
|
March 11, 2019
|
|
—
|
|
|
140.0
|
|
Canadian line of credit
|
CAD Prime
|
|
+ 0.50%
|
|
Repayable upon demand
|
|
—
|
|
|
—
|
|
Total debt
|
|
|
|
|
|
|
2,503.1
|
|
|
1,875.2
|
|
Unamortized debt issuance costs/discounts
|
|
|
|
|
|
(32.8
|
)
|
|
(10.1
|
)
|
Current portion of long-term debt
|
|
|
|
|
|
|
(105.2
|
)
|
|
(153.9
|
)
|
Long-term debt
|
|
|
|
|
|
|
$
|
2,365.1
|
|
|
$
|
1,711.2
|
|
*The interest rates presented in the table above represent the rates in place at December 31, 2016. The weighted average interest rate on our variable rate debt was
4.39%
and
3.31%
at
December 31, 2016
and
2015
, respectively.
Credit Facility
On March 9, 2016, we entered into an Incremental Commitment Agreement and First Amendment (the "First Amendment") to the Credit Agreement. The First Amendment provided for, among other things, (i) a new
seven
-year senior secured term loan facility ("Term Loan B-3") and (ii) a
$300 million
,
five
-year senior secured revolving credit facility (the "revolving credit facility"), which replaced the previously existing revolving credit facility (the "old revolving credit facility"). The proceeds received from Term Loan B-3 were used to repay in full Term Loan B-1 and the amount outstanding on the old revolving credit facility.
No
early termination penalties were incurred by the Company; however, we incurred a non-cash loss on the extinguishment of debt of
$4.0 million
in the first quarter of 2016. The loss was a result of the write-off of unamortized debt issuance costs associated with Term Loan B-1 and the old revolving credit facility. The First Amendment did not change the amount outstanding on Term Loan B-2, but did increase its interest rate margin. In addition, we capitalized approximately
$18.0 million
of debt issuance costs in connection with the First Amendment.
The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate purposes. The Credit Agreement provides that with respect to the revolving credit facility, up to
$75 million
is available for letters of credit and up to
$75 million
is available for swing line loans.
Term Loan B-2 was issued at a discount of
$2.8 million
and the Term Loan B-3 was issued at a discount of
$13.5 million
. The discounts are being amortized using the effective interest method to interest expense over the respective terms of the loans. Both Term Loan B-2 and Term Loan B-3 are payable in quarterly installments equal to
0.25%
of the original aggregate principal amounts of the term loans, respectively. Such payments commenced on June 30, 2014 for Term Loan B-2 and on June 30, 2016 for Term Loan B-3, with the balances payable at each respective maturity date. The Credit Facility is subject to mandatory prepayments and reduction in an amount equal to the net proceeds of certain debt offerings, certain asset sales and
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
certain insurance recovery events. In addition, in accordance with the terms of the Credit Agreement,
50%
of the net cash proceeds from the sale-leaseback of certain technology and capital equipment were used to prepay
$6.5 million
and
$7.8 million
of Term Loan B-2 and Term Loan B-3, respectively, for the year ended
December 31, 2016
. Each such prepayment is credited to prepay, on a pro rata basis, in order of maturity the unpaid amounts due on the first
eight
scheduled quarterly installments of Term Loan B-2 and Term Loan B-3 and thereafter to the remaining scheduled quarterly installments of each term loan on a pro rata basis.
The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in
100%
of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and
65%
of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions. The Credit Agreement contains affirmative and negative covenants that we believe are usual and customary for a senior secured credit agreement. The negative covenants include, among other things, limitations on asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with our affiliates. The Credit Agreement also requires us to maintain a maximum leverage ratio, provided there are revolving loans outstanding. We were in compliance with the covenants in the Credit Agreement at
December 31, 2016
.
As set forth in the Credit Agreement, Term Loan B-2 bears interest at
Adjusted LIBOR
(as defined in the Credit Agreement) plus
3.1875%
(with an Adjusted LIBOR floor of
0.75%
per annum), Term Loan B-3 at
Adjusted LIBOR
(as defined in the Credit Agreement) plus
3.50%
(with an
Adjusted LIBOR
floor of
0.75%
per annum) and revolving loan borrowings at
Adjusted LIBOR
plus
2.50%
. However, for specified types of borrowings, the Company may elect to make Term Loan B-2 borrowings at a
Base Rate
(as defined in the Credit Agreement) plus
2.1875%
, Term Loan B-3 at a
Base Rate
plus
2.50%
and revolving loan borrowings at a
Base Rate
plus
1.50%
. The rates on Term Loan B-2 and Term Loan B-3 were
4.19%
and
4.50%
at
December 31, 2016
, respectively. In addition, if the Company reduces its Consolidated Senior Secured Leverage Ratio, which is based on a net debt calculation, to levels specified in the Credit Agreement, the applicable interest rate on the revolving credit facility will step down by 25 basis points. The Company also pays a commitment fee of 40 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility. The fee may step down to 35 basis points based on the Company's Consolidated Senior Secured Leverage Ratio as described above.
On
December 31, 2016
,
$80.5 million
was drawn on the revolving credit facility and
$140.0 million
was drawn on the old revolving credit facility at
December 31, 2015
. In addition, we had related outstanding letters of credit in the aggregate amount of
$29.7 million
and
$28.0 million
at
December 31, 2016
and
2015
, respectively, which reduce the amount available for borrowings under the respective revolving credit facility. The
$80.5 million
of outstanding borrowings under the revolving credit facility have been classified as current debt as the Company intends to repay the outstanding borrowings within the next twelve months.
Original Credit Facility
On March 11, 2014, we repaid all principal outstanding and interest due under the Original Credit Agreement.
No
early termination penalties were incurred by the Company in connection with the refinancing; however, we incurred a non-cash loss on the extinguishment of debt under the Original Credit Agreement of
$30.3 million
. The loss was a result of the write-off of certain unamortized debt issuance costs and the unamortized debt discount on Term Loan B.
Canadian Line of Credit
ADESA Canada has a
C$8 million
line of credit. The line of credit bears interest at a rate equal to the Canadian prime rate plus 50 basis points. There were
no
borrowings under the Canadian line of credit at
December 31, 2016
or
2015
. There were related letters of credit outstanding totaling approximately
C$0.9 million
at
December 31, 2016
and
2015
, which reduce credit available under the Canadian line of credit, but do not affect amounts available for borrowings under our revolving credit facility. The line of credit is guaranteed by certain ADESA Canada companies.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Future Principal Payments
At
December 31, 2016
, aggregate future principal payments on long-term debt are as follows (
in millions
):
|
|
|
|
|
2017
|
$
|
105.2
|
|
2018
|
24.7
|
|
2019
|
24.7
|
|
2020
|
24.7
|
|
2021
|
1,051.4
|
|
Thereafter
|
1,272.4
|
|
|
$
|
2,503.1
|
|
Note 12—Financial Instruments
Our derivative activities are initiated within the guidelines of documented corporate risk management policies. We do not enter into any derivative transactions for speculative or trading purposes.
Interest Rate Risk Management
We are exposed to interest rate risk on our variable rate borrowings. Accordingly, interest rate fluctuations affect the amount of interest expense we are obligated to pay. We use interest rate derivatives with the objective of managing exposure to interest rate movements, thereby reducing the effect of interest rate changes and the effect they could have on future cash flows. Currently, interest rate cap agreements are used to accomplish this objective.
|
|
•
|
In August 2015, we purchased
three
interest rate caps for an aggregate amount of approximately
$1.5 million
with an aggregate notional amount of
$800 million
to manage our exposure to interest rate movements on our variable rate Credit Facility if/when
three-month LIBOR
(i) exceeded
2.0%
between August 19, 2015 (the effective date) and September 29, 2016 and (ii) exceeds
1.75%
between September 30, 2016 and August 19, 2017 (the maturity date).
|
|
|
•
|
In April 2015, we purchased
two
interest rate caps for an aggregate amount of approximately
$0.7 million
with an aggregate notional amount of
$400 million
to manage our exposure to interest rate movements on our variable rate Credit Facility when
three-month LIBOR
exceeds
1.5%
. The interest rate cap agreements each had an effective date of April 16, 2015 and each matures on March 31, 2017.
|
|
|
•
|
In August 2013, we purchased
four
interest rate caps for an aggregate amount of approximately
$2.2 million
with an aggregate notional amount of
$1.2 billion
to manage our exposure to interest rate movements on our variable rate Credit Facility if/when
three-month LIBOR
exceeded
1.0%
. The interest rate cap agreements each matured on August 16, 2015.
|
We are exposed to credit loss in the event of non-performance by the counterparties; however, non-performance is not anticipated. ASC 815,
Derivatives and Hedging
, requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. The fair values of the interest rate derivatives are based on quoted market prices for similar instruments from commercial banks. The following table presents the fair value of our interest rate derivatives included in the consolidated balance sheets for the periods presented (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Derivatives
|
|
|
December 31, 2016
|
|
December 31, 2015
|
Derivatives Not Designated as Hedging Instruments
|
|
Balance Sheet Location
|
|
Fair Value
|
|
Balance Sheet Location
|
|
Fair Value
|
2015 Interest rate caps
|
|
Other assets
|
|
$
|
—
|
|
|
Other assets
|
|
$
|
0.7
|
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
We have not designated any of the interest rate caps as hedges for accounting purposes. Accordingly, changes in the fair value of the interest rate caps are recognized as "Interest expense" in the consolidated statement of income. The following table presents the effect of the interest rate derivatives on our consolidated statements of income for the periods presented (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Location of Gain / (Loss) Recognized in Income on Derivatives
|
|
Amount of Gain / (Loss)
Recognized in Income on Derivatives
|
|
|
|
Year Ended December 31,
|
Derivatives Not Designated as Hedging Instruments
|
|
|
2016
|
|
2015
|
|
2014
|
2015 Interest rate caps
|
|
Interest expense
|
|
$
|
(0.7
|
)
|
|
$
|
(1.5
|
)
|
|
N/A
|
|
2013 Interest rate caps
|
|
Interest expense
|
|
N/A
|
|
|
—
|
|
|
(0.8
|
)
|
Concentrations of Credit Risk
Financial instruments that potentially subject us to credit risk consist principally of interest-bearing investments, finance receivables, trade receivables and interest rate derivatives. We maintain cash and cash equivalents, short-term investments, and certain other financial instruments with various major financial institutions. We perform periodic evaluations of the relative credit standing of these financial institutions and companies and limit the amount of credit exposure with any one institution. Cash and cash equivalents include interest-bearing investments with maturities of three months or less. Due to the nature of our business, substantially all trade and finance receivables are due from vehicle dealers, salvage buyers, institutional sellers and insurance companies. We have possession of vehicles or vehicle titles collateralizing a significant portion of the trade and finance receivables. The risk associated with this concentration is limited due to the large number of accounts and their geographic dispersion. We monitor the creditworthiness of customers to which we grant credit terms in the normal course of business. In the event of nonperformance by counterparties to financial instruments we are exposed to credit-related losses, but management believes this credit risk is limited by periodically reviewing the creditworthiness of the counterparties to the transactions.
Financial Instruments
The carrying amounts of trade receivables, finance receivables, other current assets, accounts payable, accrued expenses and borrowings under our short-term revolving line of credit facilities approximate fair value because of the short-term nature of those instruments.
As of
December 31, 2016
and
2015
, the estimated fair value of our long-term debt amounted to
$2,528.0 million
and
$1,867.4 million
, respectively. The estimates of fair value were based on broker-dealer quotes for our debt as of
December 31, 2016
and
2015
. 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 13—Leasing Agreements
We lease property, computer equipment and software, automobiles, trucks and trailers, pursuant to operating lease agreements with terms expiring through 2036. Some of the leases contain renewal provisions upon the expiration of the initial lease term, as well as fair market value purchase provisions. In accordance with ASC 840,
Leases
, rental expense is being recognized ratably over the lease period, including those leases containing escalation clauses. The deferred portion of the rent, for the leases containing escalation clauses, is included in "Other liabilities" on the consolidated balance sheet.
We also lease furniture, fixtures and equipment under capital leases. The economic substance of the leases is that we are financing the purchase of furniture, fixtures and equipment through leases and, accordingly, they are recorded as assets and liabilities. The capital lease liabilities are included in "Other accrued expenses" and "Other liabilities" on the consolidated balance sheet. Depreciation expense includes the amortization of assets held under capital leases.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Total future minimum lease payments for non-cancelable operating and capital leases with terms in excess of one year (excluding renewal periods) as of
December 31, 2016
are as follows (
in millions
):
|
|
|
|
|
|
|
|
|
|
Operating
Leases
|
|
Capital
Leases
|
2017
|
$
|
121.7
|
|
|
$
|
27.2
|
|
2018
|
115.0
|
|
|
17.9
|
|
2019
|
105.2
|
|
|
7.2
|
|
2020
|
94.5
|
|
|
0.1
|
|
2021
|
88.1
|
|
|
0.1
|
|
Thereafter
|
594.4
|
|
|
—
|
|
|
$
|
1,118.9
|
|
|
$
|
52.5
|
|
Less: interest portion of capital leases
|
|
|
|
0.8
|
|
Total
|
|
|
|
$
|
51.7
|
|
Total lease expense for the years ended
December 31, 2016
,
2015
and
2014
was
$134.8 million
,
$115.0 million
and
$108.9 million
, respectively.
Note 14—Income Taxes
The components of our income before income taxes and the provision for income taxes are as follows (
in millions
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Income before income taxes:
|
|
|
|
|
|
Domestic
|
$
|
265.8
|
|
|
$
|
259.5
|
|
|
$
|
199.3
|
|
Foreign
|
89.5
|
|
|
81.0
|
|
|
65.7
|
|
Total
|
$
|
355.3
|
|
|
$
|
340.5
|
|
|
$
|
265.0
|
|
Income tax expense (benefit):
|
|
|
|
|
|
Current:
|
|
|
|
|
|
Federal
|
$
|
100.1
|
|
|
$
|
88.6
|
|
|
$
|
87.0
|
|
Foreign
|
22.9
|
|
|
22.6
|
|
|
21.1
|
|
State
|
14.1
|
|
|
9.7
|
|
|
12.1
|
|
Total current provision
|
137.1
|
|
|
120.9
|
|
|
120.2
|
|
Deferred:
|
|
|
|
|
|
Federal
|
(1.6
|
)
|
|
6.5
|
|
|
(18.6
|
)
|
Foreign
|
(2.4
|
)
|
|
(1.8
|
)
|
|
(2.2
|
)
|
State
|
(0.2
|
)
|
|
0.3
|
|
|
(3.7
|
)
|
Total deferred provision
|
(4.2
|
)
|
|
5.0
|
|
|
(24.5
|
)
|
Income tax expense
|
$
|
132.9
|
|
|
$
|
125.9
|
|
|
$
|
95.7
|
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The provision for income taxes was different from the U.S. federal statutory rate applied to income before taxes, and is reconciled as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Statutory rate
|
35.0
|
%
|
|
35.0
|
%
|
|
35.0
|
%
|
State and local income taxes, net
|
2.4
|
%
|
|
2.1
|
%
|
|
3.0
|
%
|
Reserves for tax exposures
|
(0.2
|
)%
|
|
0.3
|
%
|
|
(0.1
|
)%
|
Change in valuation allowance
|
0.6
|
%
|
|
0.3
|
%
|
|
(0.2
|
)%
|
International operations
|
(0.8
|
)%
|
|
(1.2
|
)%
|
|
(0.6
|
)%
|
Other, net
|
0.4
|
%
|
|
0.5
|
%
|
|
(1.0
|
)%
|
Effective rate
|
37.4
|
%
|
|
37.0
|
%
|
|
36.1
|
%
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. The valuation allowance as of December 31, 2016 primarily relates to net operating losses, tax credits and capital loss carryforwards that are not more likely than not to be utilized prior to their expiration.
We offset all deferred tax assets and liabilities by jurisdiction, as well as any related valuation allowance, and present them as a single non-current deferred income tax liability. Deferred tax assets (liabilities) are comprised of the following at December 31 (
in millions
):
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
Gross deferred tax assets:
|
|
|
|
Allowances for trade and finance receivables
|
$
|
9.1
|
|
|
$
|
5.5
|
|
Accruals and liabilities
|
62.6
|
|
|
54.1
|
|
Employee benefits and compensation
|
30.6
|
|
|
27.2
|
|
Net operating loss carryforwards
|
25.1
|
|
|
26.7
|
|
Investment basis difference
|
4.1
|
|
|
2.6
|
|
Other
|
11.6
|
|
|
9.9
|
|
Total deferred tax assets
|
143.1
|
|
|
126.0
|
|
Deferred tax asset valuation allowance
|
(26.4
|
)
|
|
(21.2
|
)
|
Total
|
116.7
|
|
|
104.8
|
|
Gross deferred tax liabilities:
|
|
|
|
Property and equipment
|
(120.0
|
)
|
|
(104.4
|
)
|
Goodwill and intangible assets
|
(274.6
|
)
|
|
(293.4
|
)
|
Other
|
(13.8
|
)
|
|
(7.8
|
)
|
Total
|
(408.4
|
)
|
|
(405.6
|
)
|
Net deferred tax liabilities
|
$
|
(291.7
|
)
|
|
$
|
(300.8
|
)
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
The tax benefit from state and federal net operating loss carryforwards expires as follows (
in millions
):
|
|
|
|
|
2017
|
$
|
0.3
|
|
2018
|
0.2
|
|
2019
|
0.2
|
|
2020
|
0.8
|
|
2021
|
0.8
|
|
2022 to 2036
|
22.8
|
|
|
$
|
25.1
|
|
Permanently reinvested undistributed earnings of our foreign subsidiaries were approximately
$120.3 million
at
December 31, 2016
. Because these amounts have been or will be permanently reinvested in properties and working capital, we have not recorded the deferred taxes associated with these earnings. If the undistributed earnings of foreign subsidiaries were to be remitted, tax expense would need to be recognized at the U.S. statutory rate, net of any applicable foreign tax credits. It is not practical for us to determine the additional tax that would be incurred upon remittance of these earnings.
We made federal income tax payments, net of federal income tax refunds, of
$79.2 million
,
$95.2 million
and
$69.2 million
in
2016
,
2015
and
2014
, respectively. State and foreign income taxes paid by us, net of refunds, totaled
$42.4 million
,
$34.7 million
and
$33.0 million
in
2016
,
2015
and
2014
, respectively.
We apply the provisions of ASC 740,
Income Taxes
. ASC 740 clarifies the accounting and reporting for uncertainty in income taxes recognized in an enterprise's financial statements. These provisions prescribe a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken on income tax returns.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (
in millions
):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Balance at beginning of period
|
$
|
14.9
|
|
|
$
|
18.6
|
|
Increase in prior year tax positions
|
1.2
|
|
|
—
|
|
Decrease in prior year tax positions
|
—
|
|
|
(1.9
|
)
|
Increase in current year tax positions
|
1.4
|
|
|
1.2
|
|
Settlements
|
—
|
|
|
—
|
|
Lapse in statute of limitations
|
(3.5
|
)
|
|
(3.0
|
)
|
Balance at end of period
|
$
|
14.0
|
|
|
$
|
14.9
|
|
The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was
$7.8 million
and
$8.2 million
at
December 31, 2016
and
2015
, respectively.
We record interest and penalties associated with the uncertain tax positions within our provision for income taxes on the income statement. We had reserves totaling
$3.2 million
and
$4.6 million
in
2016
and
2015
, respectively, associated with interest and penalties, net of tax.
The provision for income taxes involves management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which the Company operates. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by us. In addition, U.S. and non-U.S. tax authorities periodically review income tax returns filed by us and can raise issues regarding our filing positions, timing and amount of income or deductions and the allocation of income among the jurisdictions in which we operate. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. In the normal course of business we are subject to examination by taxing authorities in the U.S., Canada, United Kingdom and Mexico. In general, the examination of our material tax returns is completed for the years prior to 2011.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Based on the potential outcome of the Company's tax examinations and the expiration of the statute of limitations for specific jurisdictions, it is reasonably possible that the currently remaining unrecognized tax benefits will change within the next 12 months. The associated net tax impact on the reserve balance is estimated to be in the range of a
$2.0 million
to
$4.0 million
decrease.
Note 15—Employee Benefit Plans
401(k) Plan
We maintain a defined contribution 401(k) plan that covers substantially all U.S. employees. Participants are generally allowed to make non-forfeitable contributions up to the annual IRS limits. The Company matches
100 percent
of the amounts contributed by each individual participant up to
4 percent
of the participant's compensation. Participants are
100 percent
vested in the Company's contributions. For the years ended
December 31, 2016
,
2015
and
2014
we contributed
$13.0 million
,
$10.8 million
and
$9.0 million
, respectively.
Note 16—Commitments and Contingencies
We are involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries; property damage; handling, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Management considers the likelihood of loss or the incurrence of a liability, as well as the ability to reasonably estimate the amount of loss, in determining loss contingencies. We accrue an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss (or range of possible losses) can be reasonably estimated. Management regularly evaluates current information available to determine whether accrual amounts should be adjusted. Accruals for contingencies including litigation and environmental matters are included in "Other accrued expenses" at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. These accruals are adjusted periodically as assessment and remediation efforts progress, or as additional technical or legal information becomes available. If the amount of an actual loss is greater than the amount accrued, this could have an adverse impact on our operating results in that period. Legal fees are expensed as incurred.
We have accrued, as appropriate, for environmental remediation costs anticipated to be incurred at certain of our auction facilities. Liabilities for environmental matters included in "Other accrued expenses" were
$0.1 million
at
December 31, 2016
and
2015
. No amounts have been accrued as receivables for potential reimbursement or recoveries to offset this liability.
We store a significant number of vehicles owned by various customers that are consigned to us to be auctioned. We are 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, we also enter into various other guarantees and indemnities in our relationships with suppliers, service providers, customers and others. These guarantees and indemnifications do not materially impact our financial condition or results of operations, but indemnifications associated with our actions generally have no dollar limitations and historically have been inconsequential.
As noted above, we are involved in litigation and disputes arising in the ordinary course of business, such as actions related to injuries; property damage; handling, storage or disposal of vehicles; environmental laws and regulations; and other litigation incidental to the business such as employment matters and dealer disputes. Such litigation is generally not, in the opinion of management, likely to have a material adverse effect on our financial condition, results of operations or cash flows. Legal and regulatory proceedings which could be material are discussed below.
IAA—Lower Duwamish Waterway
Since June 2004, IAA has operated a branch on property it leases in Tukwila, Washington just south of Seattle. The property is located adjacent to a Superfund site known as the Lower Duwamish Waterway Superfund Site ("LDW Site"). The LDW Site had been designated a Superfund site in 2001,
three
years prior to IAA’s tenancy. On March 25, 2008, the United States Environmental Protection Agency, or the "EPA," issued IAA a General Notice of Potential Liability, or "General Notice," pursuant to Section 107(a), and a Request for Information pursuant to Section 104(e) of the Comprehensive Environmental
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Response, Compensation, and Liability Act, or "CERCLA," related to the LDW Site. On November 7, 2012, the EPA issued IAA a Second General Notice of Potential Liability, or "Second General Notice," for the LDW Site. The EPA's website indicates that the EPA has issued general notice letters to approximately
116
entities, and has issued Section 104(e) Requests to more than
300
entities related to the LDW Site. In the General Notice and Second General Notice, the EPA informed IAA that the EPA believes IAA may be a Potentially Responsible Party, or "PRP," but the EPA did not specify the factual basis for this assertion. At this time, the EPA still has not specified the factual basis for this assertion and has not demanded that IAA pay any funds or take any action apart from responding to the Section 104(e) Information Request.
Four
PRPs, The Boeing Company, the City of Seattle, the Port of Seattle and King County - the Lower Duwamish Waterway Group ("LDWG"), have funded a remedial investigation and feasibility study related to the cleanup of the LDW Site. In December 2014, the EPA issued a Record of Decision (ROD), detailing the final cleanup plan for the LDW Site. The ROD estimates the cost of cleanup to be
$342 million
, with the plan involving dredging of
105
acres, capping
24
acres, and enhanced natural recovery of
48
acres. The estimated length of the cleanup is
17
years, including
7
years of active remediation, and
10
years of monitored natural recovery. IAA is aware that certain authorities may bring natural resource damage claims against PRPs. On February 11, 2016, IAA received a Notice of Intent letter from the United States National Oceanic and Atmospheric Administration informing IAA that the Elliott Bay Trustee Council are beginning to conduct an injury assessment for natural resource damages in the LDW. The Notice of Intent indicates that the decision of the trustees to proceed with this natural resources injury assessment followed a pre-assessment screen performed by the trustees. More recently, in a letter dated August 16, 2016, EPA issued a status update to the PRPs at the LDW Site. The letter stated that EPA expects the bulk of the pre-remedial design work currently being performed by the LDWG to be completed by the beginning of 2018, with the Remedial Design/Remedial Action ("RD/RA")phase to follow. EPA expects to initiate RD/RA negotiations with all PRPs beginning in early 2018. At this time, however, the Company does not have adequate information to determine IAA's responsibility, if any, for contamination at this site, or to estimate IAA's loss as a result of this potential liability.
In addition, the Washington State Department of Ecology ("Ecology") is working with the EPA in relation to the LDW Site, primarily to investigate and address sources of potential contamination contributing to the LDW Site. In 2007, IAA installed a stormwater capture and filtration system designed to treat sources of potential contamination before discharge to the LDW site. The immediate-past property owner, the former property owner and IAA have had discussions with Ecology concerning possible source control measures, including an investigation of the water and soils entering the stormwater system, an analysis of the source of contamination identified within the system, if any, and possible repairs and upgrades to the stormwater system if required. Additional source control measures, if any, are not expected to have a material adverse effect on future recurring operating costs.
Note 17—Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following (
in millions
):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Foreign currency translation loss
|
$
|
(49.4
|
)
|
|
$
|
(40.3
|
)
|
Unrealized gain on postretirement benefit obligation, net of tax
|
0.1
|
|
|
0.1
|
|
Accumulated other comprehensive loss
|
$
|
(49.3
|
)
|
|
$
|
(40.2
|
)
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Note 18—Segment Information
ASC 280,
Segment Reporting
, requires reporting of segment information that is consistent with the manner in which the chief operating decision maker operates and views the Company. Our operations are grouped into
three
operating segments: ADESA Auctions, IAA and AFC, which also serve as our reportable business segments. These reportable business segments offer different services and have fundamental differences in their operations.
ADESA Auctions encompasses all physical and online wholesale auctions throughout North America (U.S., Canada and Mexico). Beginning in June 2016, the ADESA Auctions segment also includes ADESA Remarketing Limited (formerly known as GRS), an online whole car vehicle remarketing business in the United Kingdom. ADESA Auctions relates to used vehicle remarketing, including auction services, remarketing, or make ready services and all are interrelated, synergistic elements along the auto remarketing chain.
IAA encompasses all salvage auctions throughout North America (U.S. and Canada). Beginning in June 2015, the IAA segment also includes HBC, which operates salvage vehicle auctions and related services in the United Kingdom. IAA provides insurance companies and other vehicle suppliers cost-effective salvage processing solutions, including selling total loss and recovered theft vehicles. As such, IAA relates to total loss vehicle remarketing, including auction services, remarketing, or make ready services. All are interrelated, synergistic elements along the total loss vehicle remarketing chain.
AFC is primarily engaged in the business of providing short-term, inventory-secured financing to independent, used vehicle dealers. AFC also includes other businesses and ventures that AFC may enter into, focusing on providing independent used vehicle dealer customers with other related services and products, including vehicle service contracts. AFC conducts business primarily at or near wholesale used vehicle auctions in the U.S. and Canada.
The holding company is maintained separately from the
three
reportable segments and includes expenses associated with the corporate offices, such as salaries, benefits and travel costs for the corporate management team, certain human resources, information technology and accounting costs, and certain insurance, treasury, legal and risk management costs. Holding company interest expense includes the interest expense incurred on capital leases and the corporate debt structure. Intercompany charges relate primarily to interest on intercompany debt or receivables and certain administrative costs allocated by the holding company.
Financial information regarding our reportable segments is set forth below for the year ended
December 31, 2016
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADESA
Auctions
|
|
IAA
|
|
AFC
|
|
Holding
Company
|
|
Consolidated
|
Operating revenues
|
$
|
1,765.3
|
|
|
$
|
1,098.0
|
|
|
$
|
286.8
|
|
|
$
|
—
|
|
|
$
|
3,150.1
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
Cost of services (exclusive of depreciation and amortization)
|
1,036.5
|
|
|
708.0
|
|
|
82.9
|
|
|
—
|
|
|
1,827.4
|
|
Selling, general and administrative
|
327.0
|
|
|
104.2
|
|
|
28.7
|
|
|
123.2
|
|
|
583.1
|
|
Depreciation and amortization
|
100.0
|
|
|
87.9
|
|
|
31.1
|
|
|
21.6
|
|
|
240.6
|
|
Total operating expenses
|
1,463.5
|
|
|
900.1
|
|
|
142.7
|
|
|
144.8
|
|
|
2,651.1
|
|
Operating profit (loss)
|
301.8
|
|
|
197.9
|
|
|
144.1
|
|
|
(144.8
|
)
|
|
499.0
|
|
Interest expense
|
0.1
|
|
|
—
|
|
|
34.1
|
|
|
104.6
|
|
|
138.8
|
|
Other (income) expense, net
|
(0.5
|
)
|
|
(0.6
|
)
|
|
—
|
|
|
0.6
|
|
|
(0.5
|
)
|
Loss on extinguishment of debt
|
—
|
|
|
—
|
|
|
1.4
|
|
|
4.0
|
|
|
5.4
|
|
Intercompany expense (income)
|
52.6
|
|
|
38.1
|
|
|
(33.8
|
)
|
|
(56.9
|
)
|
|
—
|
|
Income (loss) before income taxes
|
249.6
|
|
|
160.4
|
|
|
142.4
|
|
|
(197.1
|
)
|
|
355.3
|
|
Income taxes
|
92.7
|
|
|
59.3
|
|
|
54.0
|
|
|
(73.1
|
)
|
|
132.9
|
|
Net income (loss)
|
$
|
156.9
|
|
|
$
|
101.1
|
|
|
$
|
88.4
|
|
|
$
|
(124.0
|
)
|
|
$
|
222.4
|
|
Total assets
|
$
|
2,898.0
|
|
|
$
|
1,358.9
|
|
|
$
|
2,213.8
|
|
|
$
|
86.9
|
|
|
$
|
6,557.6
|
|
Capital expenditures
|
$
|
74.8
|
|
|
$
|
41.1
|
|
|
$
|
7.3
|
|
|
$
|
31.9
|
|
|
$
|
155.1
|
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Financial information regarding our reportable segments is set forth below for the year ended
December 31, 2015
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADESA
Auctions
|
|
IAA
|
|
AFC
|
|
Holding
Company
|
|
Consolidated
|
Operating revenues
|
$
|
1,427.8
|
|
|
$
|
994.4
|
|
|
$
|
268.4
|
|
|
$
|
—
|
|
|
$
|
2,690.6
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
Cost of services (exclusive of depreciation and amortization)
|
836.9
|
|
|
633.6
|
|
|
78.0
|
|
|
—
|
|
|
1,548.5
|
|
Selling, general and administrative
|
276.6
|
|
|
98.1
|
|
|
27.8
|
|
|
99.5
|
|
|
502.0
|
|
Depreciation and amortization
|
86.2
|
|
|
80.8
|
|
|
30.8
|
|
|
15.0
|
|
|
212.8
|
|
Total operating expenses
|
1,199.7
|
|
|
812.5
|
|
|
136.6
|
|
|
114.5
|
|
|
2,263.3
|
|
Operating profit (loss)
|
228.1
|
|
|
181.9
|
|
|
131.8
|
|
|
(114.5
|
)
|
|
427.3
|
|
Interest expense
|
0.7
|
|
|
—
|
|
|
24.1
|
|
|
66.6
|
|
|
91.4
|
|
Other (income) expense, net
|
(1.7
|
)
|
|
(1.7
|
)
|
|
(1.5
|
)
|
|
0.3
|
|
|
(4.6
|
)
|
Intercompany expense (income)
|
57.6
|
|
|
38.4
|
|
|
(25.3
|
)
|
|
(70.7
|
)
|
|
—
|
|
Income (loss) before income taxes
|
171.5
|
|
|
145.2
|
|
|
134.5
|
|
|
(110.7
|
)
|
|
340.5
|
|
Income taxes
|
62.3
|
|
|
52.4
|
|
|
51.3
|
|
|
(40.1
|
)
|
|
125.9
|
|
Net income (loss)
|
$
|
109.2
|
|
|
$
|
92.8
|
|
|
$
|
83.2
|
|
|
$
|
(70.6
|
)
|
|
$
|
214.6
|
|
Total assets
|
$
|
2,390.9
|
|
|
$
|
1,292.1
|
|
|
$
|
2,025.0
|
|
|
$
|
63.5
|
|
|
$
|
5,771.5
|
|
Capital expenditures
|
$
|
70.0
|
|
|
$
|
40.4
|
|
|
$
|
7.0
|
|
|
$
|
17.3
|
|
|
$
|
134.7
|
|
Financial information regarding our reportable segments is set forth below for the year ended
December 31, 2014
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADESA
Auctions
|
|
IAA
|
|
AFC
|
|
Holding
Company
|
|
Consolidated
|
Operating revenues
|
$
|
1,271.0
|
|
|
$
|
895.9
|
|
|
$
|
250.1
|
|
|
$
|
—
|
|
|
$
|
2,417.0
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
Cost of services (exclusive of depreciation and amortization)
|
745.9
|
|
|
555.7
|
|
|
69.7
|
|
|
—
|
|
|
1,371.3
|
|
Selling, general and administrative
|
259.9
|
|
|
98.8
|
|
|
28.8
|
|
|
83.9
|
|
|
471.4
|
|
Depreciation and amortization
|
80.2
|
|
|
76.2
|
|
|
30.4
|
|
|
9.8
|
|
|
196.6
|
|
Total operating expenses
|
1,086.0
|
|
|
730.7
|
|
|
128.9
|
|
|
93.7
|
|
|
2,039.3
|
|
Operating profit (loss)
|
185.0
|
|
|
165.2
|
|
|
121.2
|
|
|
(93.7
|
)
|
|
377.7
|
|
Interest expense
|
0.9
|
|
|
0.2
|
|
|
18.7
|
|
|
66.4
|
|
|
86.2
|
|
Other (income) expense, net
|
(2.4
|
)
|
|
(1.6
|
)
|
|
—
|
|
|
0.2
|
|
|
(3.8
|
)
|
Loss on extinguishment of debt
|
—
|
|
|
—
|
|
|
—
|
|
|
30.3
|
|
|
30.3
|
|
Intercompany expense (income)
|
56.9
|
|
|
38.5
|
|
|
(22.7
|
)
|
|
(72.7
|
)
|
|
—
|
|
Income (loss) before income taxes
|
129.6
|
|
|
128.1
|
|
|
125.2
|
|
|
(117.9
|
)
|
|
265.0
|
|
Income taxes
|
43.2
|
|
|
48.4
|
|
|
48.6
|
|
|
(44.5
|
)
|
|
95.7
|
|
Net income (loss)
|
$
|
86.4
|
|
|
$
|
79.7
|
|
|
$
|
76.6
|
|
|
$
|
(73.4
|
)
|
|
$
|
169.3
|
|
Total assets
|
$
|
2,272.0
|
|
|
$
|
1,233.8
|
|
|
$
|
1,771.3
|
|
|
$
|
57.7
|
|
|
$
|
5,334.8
|
|
Capital expenditures
|
$
|
42.3
|
|
|
$
|
39.3
|
|
|
$
|
6.4
|
|
|
$
|
13.0
|
|
|
$
|
101.0
|
|
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Geographic Information
Our foreign operations include Canada, Mexico and the U.K. Most of our operations outside the U.S. are in Canada. Information regarding the geographic areas of our operations is set forth below
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Operating revenues
|
|
|
|
|
|
U.S.
|
$
|
2,737.6
|
|
|
$
|
2,337.9
|
|
|
$
|
2,094.3
|
|
Foreign
|
412.5
|
|
|
352.7
|
|
|
322.7
|
|
|
$
|
3,150.1
|
|
|
$
|
2,690.6
|
|
|
$
|
2,417.0
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Long-lived assets
|
|
|
|
U.S.
|
$
|
3,447.5
|
|
|
$
|
3,138.8
|
|
Foreign
|
268.9
|
|
|
186.6
|
|
|
$
|
3,716.4
|
|
|
$
|
3,325.4
|
|
No single customer accounted for more than ten percent of our total revenues in any fiscal year presented.
KAR Auction Services, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2016, 2015 and 2014
Note 19—Quarterly Financial Data (Unaudited)
Information for any one quarterly period is not necessarily indicative of the results that may be expected for the year. Revenues and cost of services shown in the tables below have been increased by the amounts for owned vehicles noted at the bottom of each of the tables. For a description of the changes, reference the
“Revenue Recognition - ADESA Auction Services”
section in Note 2.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016 Quarter Ended
|
March 31
|
|
June 30
|
|
Sept. 30
|
|
Dec. 31
|
Operating revenues
|
$
|
758.3
|
|
|
$
|
788.5
|
|
|
$
|
789.6
|
|
|
$
|
813.7
|
|
Operating expenses
|
|
|
|
|
|
|
|
Cost of services (exclusive of depreciation and amortization)
|
432.0
|
|
|
447.6
|
|
|
459.5
|
|
|
488.3
|
|
Selling, general, and administrative
|
141.1
|
|
|
146.9
|
|
|
146.3
|
|
|
148.8
|
|
Depreciation and amortization
|
56.4
|
|
|
59.0
|
|
|
60.5
|
|
|
64.7
|
|
Total operating expenses
|
629.5
|
|
|
653.5
|
|
|
666.3
|
|
|
701.8
|
|
Operating profit
|
128.8
|
|
|
135.0
|
|
|
123.3
|
|
|
111.9
|
|
Interest expense
|
28.7
|
|
|
35.8
|
|
|
36.3
|
|
|
38.0
|
|
Other (income) expense, net
|
(1.3
|
)
|
|
(0.3
|
)
|
|
0.8
|
|
|
0.3
|
|
Loss on extinguishment of debt
|
4.0
|
|
|
—
|
|
|
—
|
|
|
1.4
|
|
Income before income taxes
|
97.4
|
|
|
99.5
|
|
|
86.2
|
|
|
72.2
|
|
Income taxes
|
36.7
|
|
|
37.7
|
|
|
31.8
|
|
|
26.7
|
|
Net income
|
$
|
60.7
|
|
|
$
|
61.8
|
|
|
$
|
54.4
|
|
|
$
|
45.5
|
|
Basic net income per share of common stock
|
$
|
0.44
|
|
|
$
|
0.45
|
|
|
$
|
0.39
|
|
|
$
|
0.33
|
|
Diluted net income per share of common stock
|
$
|
0.44
|
|
|
$
|
0.44
|
|
|
$
|
0.39
|
|
|
$
|
0.33
|
|
|
|
|
|
|
|
|
|
Recorded increase in ADESA operating revenues and cost of services for owned vehicles
|
$
|
13.3
|
|
|
$
|
16.7
|
|
|
$
|
15.8
|
|
|
$
|
14.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2015 Quarter Ended
|
March 31
|
|
June 30
|
|
Sept. 30
|
|
Dec. 31
|
Operating revenues
|
$
|
645.0
|
|
|
$
|
671.5
|
|
|
$
|
678.4
|
|
|
$
|
695.7
|
|
Operating expenses
|
|
|
|
|
|
|
|
Cost of services (exclusive of depreciation and amortization)
|
364.7
|
|
|
379.7
|
|
|
389.8
|
|
|
414.3
|
|
Selling, general, and administrative
|
121.5
|
|
|
123.5
|
|
|
128.5
|
|
|
128.5
|
|
Depreciation and amortization
|
50.9
|
|
|
51.8
|
|
|
54.1
|
|
|
56.0
|
|
Total operating expenses
|
537.1
|
|
|
555.0
|
|
|
572.4
|
|
|
598.8
|
|
Operating profit
|
107.9
|
|
|
116.5
|
|
|
106.0
|
|
|
96.9
|
|
Interest expense
|
21.0
|
|
|
21.8
|
|
|
24.4
|
|
|
24.2
|
|
Other (income) expense, net
|
(2.2
|
)
|
|
0.4
|
|
|
(0.3
|
)
|
|
(2.5
|
)
|
Income before income taxes
|
89.1
|
|
|
94.3
|
|
|
81.9
|
|
|
75.2
|
|
Income taxes
|
34.6
|
|
|
34.8
|
|
|
29.6
|
|
|
26.9
|
|
Net income
|
$
|
54.5
|
|
|
$
|
59.5
|
|
|
$
|
52.3
|
|
|
$
|
48.3
|
|
Basic net income per share of common stock
|
$
|
0.39
|
|
|
$
|
0.42
|
|
|
$
|
0.37
|
|
|
$
|
0.35
|
|
Diluted net income per share of common stock
|
$
|
0.38
|
|
|
$
|
0.41
|
|
|
$
|
0.37
|
|
|
$
|
0.35
|
|
|
|
|
|
|
|
|
|
Recorded increase in ADESA operating revenues and cost of services for owned vehicles
|
$
|
12.6
|
|
|
$
|
13.2
|
|
|
$
|
11.7
|
|
|
$
|
13.5
|
|