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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and which are subject to certain risks, trends and uncertainties. In particular, statements made in this report on Form 10-Q that are not historical facts (including, but not limited to, expectations, estimates, assumptions and projections regarding the industry, business, future operating results, potential acquisitions and anticipated cash requirements) may be forward-looking statements. Words such as "should," "may," "will," "can," "of the opinion," "confident," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "continues," "outlook," initiatives," "goals," "opportunities" and similar expressions identify forward-looking statements. Such statements, including statements regarding the potential impacts of the COVID-19 pandemic; our future growth; anticipated cost savings, revenue increases, credit losses and capital expenditures; contractual obligations; dividend declarations and payments; common stock repurchases; tax rates and assumptions; strategic initiatives, greenfields and acquisitions; our competitive position and retention of customers; and our continued investment in information technology, are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results projected, expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Risk Factors" in this Quarterly Report on Form 10-Q and Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2021, filed on February 23, 2022, and those described from time to time in our future reports filed with the Securities and Exchange Commission. Many of these risk factors are outside of our control, and as such, they involve risks which are not currently known that could cause actual results to differ materially from those discussed or implied herein. The forward-looking statements in this document are made as of the date on which they are made and we do not undertake to update our forward-looking statements.
Pending Sale of ADESA U.S. Physical Auction Business and Discontinued Operations
In February 2022, the Company announced that it had entered into a definitive agreement with Carvana Group, LLC (“Carvana”) and Carvana Co., pursuant to which Carvana will acquire the ADESA U.S. physical auction business from KAR (the “Transaction”). The Transaction is valued at $2.2 billion and includes all auction sales, operations and staff at ADESA’s U.S. vehicle logistic centers and use of the ADESA.com marketplace in the U.S. The Transaction is subject to customary closing conditions and is expected to close in May 2022. In connection with the Transaction, the Company and Carvana expect to enter into various agreements to provide a framework for their relationship after the Transaction, including a transition services agreement and a commercial agreement. In addition, KAR will continue to own the ADESA tradename and the ADESA U.S. physical auctions will continue to utilize the tradename, which has an indefinite life.
The Company has classified the ADESA U.S. physical auctions as held-for-sale in its consolidated balance sheets, based on management’s intention to sell the business. Goodwill was allocated to the ADESA U.S. physical auctions based on relative fair value. The financial results of the ADESA U.S. physical auction business have been accounted for as discontinued operations for all periods presented. The business was formerly included in the Company’s ADESA Auctions reportable segment. The results presented in the "Results of Operations" discussion below only include continuing operations and do not include the results of the ADESA U.S. physical auction business.
Impact of COVID-19
In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. Although governmental restrictions that were imposed at the outset of the pandemic to reduce the spread of COVID-19 have since been lifted or scaled back in many jurisdictions, increases in new COVID-19 cases, including new variants, have resulted in the reimposition of restrictions in certain jurisdictions, and may lead to other restrictions being imposed. The COVID-19 pandemic and the related preventative measures taken to help slow the spread have caused, and may continue to cause, significant volatility, uncertainty and economic disruption.
The automotive industry has experienced unprecedented market conditions during the pandemic, including a decline in new vehicle production resulting from the shortage of semiconductors. This reduction in supply of new vehicles has caused increased new and used vehicle prices, as well as increased demand for used vehicles. More lessees and dealers are therefore purchasing vehicles at residual value, thus decreasing the number of off-lease vehicles coming to auction. Further, government support and loan accommodations have resulted in fewer repossessed vehicles coming to auction. These factors have contributed to our commercial vehicle volumes declining in 2021 and 2022 and are expected to continue for the foreseeable future.
While we continue to develop and implement health and safety and return-to-workplace protocols, business continuity plans and crisis management protocols in an effort to try to mitigate the negative impact of COVID-19 on our employees, customers and our business, the extent of the impact of the pandemic on our business and financial results will continue to depend on future developments that are uncertain and unpredictable.
The broader implications for our business and results of operations remain uncertain and will depend on many factors outside our control, including, without limitation, the duration and severity of the COVID-19 pandemic, the degree to which governmental restrictions are relaxed or reimposed, the length of time it takes for normal economic and operating conditions to resume, the impact of vaccines and numerous other uncertainties. Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts to our business.
Overview
We provide whole car auction services in North America and Europe. Our business is divided into two reportable business segments, each of which is an integral part of the vehicle remarketing industry: ADESA Auctions and AFC.
•The ADESA Auctions segment serves a domestic and international customer base through digital marketplaces for wholesale vehicles and 14 vehicle logistics center locations across Canada that are developed and strategically located to draw professional sellers and buyers together and allow the buyers to inspect and compare vehicles remotely or in person. Powered with software developed by Openlane, comprehensive private label remarketing solutions are offered to automobile manufacturers, captive finance companies and other institutions to offer vehicles via the Internet prior to arrival at on-premise marketplaces. Vehicles sold on ADESA's digital platforms are typically sold by commercial fleet operators, financial institutions, rental car companies, new and used vehicle dealers and vehicle manufacturers and their captive finance companies to franchise and independent used vehicle dealers. ADESA also provides value-added ancillary services including inbound and outbound transportation logistics, reconditioning, vehicle inspection and certification, titling, administrative and collateral recovery services. ADESA also includes BacklotCars, an app and web-based dealer-to-dealer wholesale vehicle platform utilized in the United States, CARWAVE, an online dealer-to-dealer marketplace in the United States, TradeRev, an online automotive remarketing platform in Canada where dealers can launch and participate in real-time vehicle auctions at any time, ADESA Remarketing Limited, an online whole car vehicle remarketing business in the United Kingdom and ADESA Europe, an online wholesale vehicle auction marketplace in Continental Europe.
•As noted above, the ADESA segment results no longer include the 56 ADESA U.S. physical auction locations. These locations sold approximately 212,000 and 295,000 vehicles in the three months ended March 31, 2022 and 2021, respectively.
•The AFC segment provides short-term, inventory-secured financing, known as floorplan financing, primarily to independent used vehicle dealers throughout the United States and Canada.
Beginning in the first quarter of 2022, results of the ADESA U.S physical auctions are now reported as discontinued operations (see Note 2). Segment results for prior periods have been reclassified to conform with the new presentation.
Industry Trends
Whole Car
We believe the North American wholesale used vehicle marketplace has a total addressable market of approximately 22 million vehicles. This wholesale used vehicle marketplace consists of the dealer-to-dealer market (franchise and independent dealers that both buy and sell vehicles) and the commercial market (commercial sellers). We believe digital applications, such as BacklotCars, CARWAVE and TradeRev, may provide an opportunity to expand our total addressable market for dealer-to-dealer transactions to 15 million units from approximately 5 million units in 2019. Commercial seller vehicles are estimated at approximately 8 million vehicles per year.
BacklotCars, CARWAVE and TradeRev sold approximately 550,000 vehicles in the North American digital dealer-to-dealer marketplace for the year ended December 31, 2021, compared with approximately 398,000 vehicles for the year ended December 31, 2020. For the three months ended March 31, 2022 and 2021, vehicles sold by these companies in the North American digital dealer-to-dealer marketplace were approximately 133,000 and 125,000, respectively. This volume data includes vehicles sold by CARWAVE prior to its acquisition in October 2021 and vehicles sold by BacklotCars prior to its acquisition in November 2020. The supply chain issues and current market conditions facing the automotive industry, including the disruption of new vehicle production, have had a material impact on the whole car auction industry and we are unable to estimate future volumes.
Automotive Finance
AFC works with independent used vehicle dealers to improve their results by providing a comprehensive set of business and financial solutions that leverage its local presence of branches and in-market representatives, industry experience and scale, as well as KAR affiliations. AFC's North American dealer base was comprised of approximately 14,500 dealers in 2021, and loan transactions, which includes both loans paid off and loans curtailed, were approximately 1.4 million in 2021.
Key challenges for the independent used vehicle dealer include demand for used vehicles, disruptions in pricing of used vehicle inventory, access to consumer financing and increased used car retail activity of franchise and public dealerships (most of which do not utilize AFC or its competitors for floorplan financing). These same challenges, to the extent they occur, could result in a material negative impact on AFC's results of operations. A significant decline in used vehicle sales would result in a decrease in consumer auto loan originations and an increased number of dealers defaulting on their loans. In addition, volatility in wholesale vehicle pricing impacts the value of recovered collateral on defaulted loans and the resulting severity of credit losses at AFC. A decrease in wholesale used car pricing could lead to increased losses if dealers are unable to satisfy their obligations.
Seasonality
The volume of vehicles sold through our auctions generally fluctuates from quarter-to-quarter. This seasonality is caused by several factors including weather, the timing of used vehicles available for sale from selling customers, holidays, and the seasonality of the retail market for used vehicles, which affects the demand side of the auction industry. Used vehicle auction volumes tend to decline during prolonged periods of winter weather conditions. As a result, revenues and operating expenses related to volume will fluctuate accordingly on a quarterly basis. The fourth calendar quarter typically experiences lower used vehicle auction volume as well as additional costs associated with the holidays and winter weather.
Sources of Revenues and Expenses
Our revenue is derived from auction fees and various on-premise and off-premise services, and from dealer financing fees, interest income and other revenue at AFC. Although auction revenues primarily include the auction services and related fees, our related receivables and payables include the gross value of the vehicles sold.
Our operating expenses consist of cost of services, selling, general and administrative and depreciation and amortization. Cost of services is composed of payroll and related costs, subcontract services, the cost of vehicles purchased, supplies, insurance, property taxes, utilities, service contract claims, maintenance and lease expense related to the auction sites and loan offices. Cost of services excludes depreciation and amortization. Selling, general and administrative expenses are composed of payroll and related costs, sales and marketing, information technology services and professional fees.
Results of Operations
Overview of Results of KAR Auction Services, Inc. for the Three Months Ended March 31, 2022 and 2021:
| | | | | | | | | | | |
| Three Months Ended March 31, |
(Dollars in millions except per share amounts) | 2022 | | 2021 |
Revenues from continuing operations | | | |
Auction fees | $ | 101.4 | | | $ | 102.5 | |
Service revenue | 137.5 | | | 146.3 | |
Purchased vehicle sales | 46.3 | | | 55.2 | |
Finance-related revenue | 84.2 | | | 65.8 | |
Total revenues from continuing operations | 369.4 | | | 369.8 | |
Cost of services* | 210.8 | | | 203.8 | |
Gross profit* | 158.6 | | | 166.0 | |
Selling, general and administrative | 118.9 | | | 107.3 | |
Depreciation and amortization | 26.0 | | | 26.9 | |
Operating profit | 13.7 | | | 31.8 | |
Interest expense | 25.6 | | | 30.8 | |
Other (income) expense, net | 1.2 | | | (49.7) | |
Income (loss) from continuing operations before income taxes | (13.1) | | | 50.7 | |
Income taxes | (4.7) | | | 24.5 | |
Net income (loss) from continuing operations | (8.4) | | | 26.2 | |
Net income from discontinued operations | 8.1 | | | 24.7 | |
Net income (loss) | $ | (0.3) | | | $ | 50.9 | |
Net income (loss) from continuing operations per share | | | |
Basic | $ | (0.16) | | | $ | 0.10 | |
Diluted | $ | (0.16) | | | $ | 0.10 | |
* Exclusive of depreciation and amortization
Discontinued Operations
The financial performance of the ADESA U.S. physical auction business is presented as discontinued operations. As a result, revenue, cost of services and all costs of discontinued operations are presented as one line item in the above table as "Net income from discontinued operations."
Overview
For the three months ended March 31, 2022, we had revenue of $369.4 million compared with revenue of $369.8 million for the three months ended March 31, 2021, a decrease of less than 1%. Businesses acquired in the last 12 months accounted for an increase in revenue of $18.0 million or 5% of revenue. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below.
Depreciation and Amortization
Depreciation and amortization decreased $0.9 million, or 3%, to $26.0 million for the three months ended March 31, 2022, compared with $26.9 million for the three months ended March 31, 2021. The decrease in depreciation and amortization was primarily the result of fixed assets that have become fully depreciated and a reduction in assets placed in service.
Interest Expense
Interest expense decreased $5.2 million, or 17%, to $25.6 million for the three months ended March 31, 2022, compared with $30.8 million for the three months ended March 31, 2021. The decrease was primarily attributable to an unrealized gain of $8.7 million related to the discontinuance of hedge accounting for the interest rate swaps, partially offset by an increase in interest expense at AFC of $3.0 million, which resulted from an increase in the average finance receivables balance for the three months ended March 31, 2022, as compared with the three months ended March 31, 2021.
Other (Income) Expense, Net
For the three months ended March 31, 2022, we had other expense of $1.2 million compared with other income of $49.7 million for the three months ended March 31, 2021. The increase in other expense was primarily attributable to unrealized losses on investment securities of approximately $3.0 million for the three months ended March 31, 2022, compared with unrealized gains on investment securities of approximately $43.5 million for the three months ended March 31, 2021, as well as a reduction in realized gains of approximately $17.0 million, partially offset by a decrease in contingent consideration valuation adjustments of $11.2 million, a decrease in foreign currency losses of $1.0 million and other miscellaneous items aggregating $0.4 million.
The Company invests in certain early-stage automotive companies and funds that relate to the automotive industry. We believe these investments have resulted in the expansion of relationships in the vehicle remarketing industry. There were no realized gains on these investments for the three months ended March 31, 2022. The Company had unrealized losses of $3.0 million for the three months ended March 31, 2022. Any future changes in the fair value of these investment securities will be reflected as unrealized gains or losses until these securities are sold.
Income Taxes
We had an effective tax rate of 35.9% on a pre-tax loss for the three months ended March 31, 2022, compared with an effective tax rate of 48.3% for the three months ended March 31, 2021. The effective tax rate for the three months ended March 31, 2022 was favorably impacted by deductions for stock-based compensation. The effective tax rate for the three months ended March 31, 2021 was unfavorably impacted by the expense for the increase in the estimated value of contingent consideration for which no tax benefit has been recorded.
Net Income from Discontinued Operations
In February 2022, the Company announced that it had entered into a definitive agreement with Carvana, pursuant to which Carvana will acquire the ADESA U.S. physical auction business from KAR. As such, the financial results of the ADESA U.S. physical auction business have been accounted for as discontinued operations for all periods presented. For the three months ended March 31, 2022 and 2021, the Company's financial statements included income from discontinued operations of $8.1 million and $24.7 million, respectively. For further discussion, reference the condensed notes to the consolidated financial statements.
Impact of Foreign Currency
For the three months ended March 31, 2022, fluctuations in the euro exchange rate decreased revenue by $3.1 million and had no impact on operating profit or net income. For the three months ended March 31, 2022, fluctuations in the Canadian exchange rate did not have a material impact on revenue, operating profit or net income.
ADESA Results
| | | | | | | | | | | |
| Three Months Ended March 31, |
(Dollars in millions, except per vehicle amounts) | 2022 | | 2021 |
Auction fees | $ | 101.4 | | | $ | 102.5 | |
Service revenue | 137.5 | | | 146.3 | |
Purchased vehicle sales | 46.3 | | | 55.2 | |
Total ADESA revenue from continuing operations | 285.2 | | | 304.0 | |
Cost of services* | 195.8 | | | 190.3 | |
Gross profit* | 89.4 | | | 113.7 | |
Selling, general and administrative | 108.4 | | | 98.5 | |
Depreciation and amortization | 23.9 | | | 24.5 | |
Operating profit (loss) | $ | (42.9) | | | $ | (9.3) | |
Commercial vehicles sold | 174,000 | | | 320,000 | |
Dealer consignment vehicles sold | 177,000 | | | 138,000 | |
Total vehicles sold | 351,000 | | | 458,000 | |
Auction fees per vehicle sold | $ | 289 | | | $ | 224 | |
Gross profit per vehicle sold* | $ | 255 | | | $ | 248 | |
Gross profit percentage, excluding purchased vehicles* | 37.4% | | 45.7% |
On-premise mix | 14% | | 12% |
Off-premise mix | 86% | | 88% |
* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA decreased $18.8 million, or 6%, to $285.2 million for the three months ended March 31, 2022, compared with $304.0 million for the three months ended March 31, 2021. The decrease in revenue was the result of a decrease in the number of vehicles sold, partially offset by an increase in average revenue per vehicle sold. Businesses acquired in the last 12 months accounted for an increase in revenue of $18.0 million. The change in revenue included the impact of a decrease in revenue of $3.1 million due to fluctuations in the euro exchange rate.
On-premise marketplace sales are initiated online for vehicles at any of our locations across Canada and include ADESA Simulcast, Simulcast+ and DealerBlock sales. Off-premise marketplace sales are initiated online and include Openlane, BacklotCars, CARWAVE, TradeRev and ADESA Europe sales. The 23% decrease in the number of vehicles sold was comprised of a decline in both on-premise and off-premise commercial volumes aggregating 46%, partially offset by an increase in both on-premise and off-premise dealer consignment volumes aggregating 28%. The decrease in the number of vehicles sold was driven by a lack of supply caused by high vehicle values.
Auction fees per vehicle sold for the three months ended March 31, 2022 increased $65, or 29%, reflecting higher vehicle values and a smaller mix of lower-fee commercial off-premise vehicles.
Service revenue for the three months ended March 31, 2022 decreased $8.8 million, or 6%, primarily as a result of a decrease in inspection service revenue and transportation revenue resulting from the decrease in vehicles sold, partially offset by an increase in repossession fees and reconditioning revenue. Typically consigned vehicles located at our facilities utilize our service offerings at a higher rate than off-premise vehicles.
Gross Profit
For the three months ended March 31, 2022, gross profit for ADESA decreased $24.3 million, or 21%, to $89.4 million, compared with $113.7 million for the three months ended March 31, 2021. Cost of services increased 3% for the three months ended March 31, 2022, while revenue decreased 6% during the same period. Gross profit for ADESA was 31.3% of revenue for the three months ended March 31, 2022, compared with 37.4% of revenue for the three months ended March 31, 2021. Excluding purchased vehicle sales, gross profit as a percentage of revenue was 37.4% and 45.7% for the three months ended
March 31, 2022 and 2021, respectively. The entire selling and purchase price of the vehicle is recorded as revenue and cost of services for purchased vehicles sold. Businesses acquired in the last 12 months accounted for an increase in cost of services of $9.6 million for the three months ended March 31, 2022.
Gross profit as a percentage of revenue decreased for the three months ended March 31, 2022 as compared with the three months ended March 31, 2021, primarily due to the 23% decrease in vehicles sold. A decline in the mix of off-premise commercial vehicles sold also resulted in a reduction of gross profit as a percentage of revenue. In addition, the net gross profit on purchased vehicles was lower and there were no benefits taken under the Canada Emergency Wage Subsidy in the first quarter of 2022, resulting in a reduction to gross profit as a percentage of revenue.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment increased $9.9 million, or 10%, to $108.4 million for the three months ended March 31, 2022, compared with $98.5 million for the three months ended March 31, 2021, primarily as a result of an increase in professional fees of $6.3 million, increases in selling, general and administrative expenses associated with acquisitions of $4.2 million, severance of $2.2 million and bad debt expense of $1.3 million, partially offset by decreases in incentive-based compensation of $3.8 million, information technology costs of $1.0 million and miscellaneous expenses aggregating $0.5 million. In addition, there was no Employee Retention Credit provided under the Canada Emergency Wage Subsidy for the three months ended March 31, 2022, compared with a credit of $1.2 million for the three months ended March 31, 2021.
AFC Results
| | | | | | | | | | | |
| Three Months Ended March 31, |
(Dollars in millions except volumes and per loan amounts) | 2022 | | 2021 |
Finance-related revenue | | | |
Interest and fee income | $ | 83.4 | | | $ | 68.6 | |
Other revenue | 2.2 | | | 2.0 | |
Provision for credit losses | (1.4) | | | (4.8) | |
Total AFC revenue | 84.2 | | | 65.8 | |
Cost of services* | 15.0 | | | 13.5 | |
Gross profit* | 69.2 | | | 52.3 | |
Selling, general and administrative | 10.5 | | | 8.8 | |
Depreciation and amortization | 2.1 | | | 2.4 | |
Operating profit | $ | 56.6 | | | $ | 41.1 | |
Loan transactions | 372,000 | | | 372,000 | |
Revenue per loan transaction | $ | 226 | | | $ | 177 | |
* Exclusive of depreciation and amortization
Revenue
For the three months ended March 31, 2022, AFC revenue increased $18.4 million, or 28%, to $84.2 million, compared with $65.8 million for the three months ended March 31, 2021. The increase in revenue was primarily the result of a 28% increase in revenue per loan transaction.
Revenue per loan transaction, which includes both loans paid off and loans curtailed, increased $49, or 28%, primarily as a result of an increase in loan values, a decrease in provision for credit losses for the three months ended March 31, 2022, an increase in interest yields and an increase in floorplan fees and other fee income per unit.
The provision for credit losses decreased to 0.2% of the average managed receivables for the three months ended March 31, 2022 from 1.0% for the three months ended March 31, 2021.
Gross Profit
For the three months ended March 31, 2022, gross profit for the AFC segment increased $16.9 million, or 32%, to $69.2 million, or 82.2% of revenue, compared with $52.3 million, or 79.5% of revenue, for the three months ended March 31, 2021. The increase in gross profit as a percent of revenue was primarily the result of a 28% increase in revenue, partially offset by an 11% increase in cost of services. The increase in cost of services was primarily the result of increases in compensation expense of $0.5 million, incentive-based compensation of $0.4 million, lot check expenses of $0.3 million and credit check expenses of $0.3 million.
Selling, General and Administrative
Selling, general and administrative expenses at AFC increased $1.7 million, or 19%, to $10.5 million for the three months ended March 31, 2022, compared with $8.8 million for the three months ended March 31, 2021 primarily as a result of increases in professional fees of $1.1 million, compensation expense of $0.4 million and other miscellaneous expenses aggregating $0.2 million.
LIQUIDITY AND CAPITAL RESOURCES
We believe that the significant indicators of liquidity for our business are cash on hand, cash flow from operations, working capital and amounts available under our Credit Facility. Our principal sources of liquidity consist of cash generated by operations and borrowings under our Revolving Credit Facility.
| | | | | | | | | | | | | | | | | |
| March 31, | | December 31, | | March 31, |
(Dollars in millions) | 2022 | | 2021 | | 2021 |
Cash and cash equivalents | $ | 134.2 | | | $ | 177.6 | | | $ | 715.1 | |
Restricted cash | 26.3 | | | 25.8 | | | 52.5 | |
Working capital | 939.4 | | | 382.5 | | | 869.5 | |
Amounts available under the Revolving Credit Facility* | 224.0 | | | 325.0 | | | 325.0 | |
Cash (used by) provided by operating activities for the three months ended | (9.5) | | | | | 150.2 | |
* There were related outstanding letters of credit totaling approximately $27.3 million, $27.6 million and $29.8 million at March 31, 2022, December 31, 2021 and March 31, 2021, respectively, which reduced the amount available for borrowings under the Revolving Credit Facility.
We regularly evaluate alternatives for our capital structure and liquidity given our expected cash flows, growth and operating capital requirements as well as capital market conditions.
Working Capital
A substantial amount of our working capital is generated from the payments received for services provided. The majority of our working capital needs are short-term in nature, usually less than a week in duration. Most of the financial institutions place a temporary hold on the availability of the funds deposited that generally can range up to two business days, resulting in cash in our accounts and on our balance sheet that is unavailable for use until it is made available by the various financial institutions. There are outstanding checks (book overdrafts) to sellers and vendors included in current liabilities. Because a portion of these outstanding checks for operations in the U.S. are drawn upon bank accounts at financial institutions other than the financial institutions that hold the cash, we cannot offset all the cash and the outstanding checks on our balance sheet. Changes in working capital vary from quarter-to-quarter as a result of the timing of collections and disbursements of funds to consignors from auctions held near period end.
Approximately $86.9 million of available cash was held by our foreign subsidiaries at March 31, 2022. If funds held by our foreign subsidiaries were to be repatriated, we expect any applicable taxes to be minimal.
AFC offers short-term inventory-secured financing, also known as floorplan financing, to independent used vehicle dealers. Financing is primarily provided for terms of 30 to 90 days. AFC principally generates its funding through the sale of its receivables. The receivables sold pursuant to the securitization agreements are accounted for as secured borrowings. For further discussion of AFC's securitization arrangements, see "Securitization Facilities."
Credit Facilities
On September 19, 2019, we entered into the seven-year, $950 million Term Loan B-6 and the $325 million, five-year Revolving Credit Facility.
The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate purposes. The Revolving Credit Facility also includes a $50 million sub-limit for issuance of letters of credit and a $60 million sub-limit for swingline loans.
Term Loan B-6 was issued at a discount of $2.4 million and the discount is being amortized using the effective interest method to interest expense over the term of the loan. Term Loan B-6 is payable in quarterly installments equal to 0.25% of the original aggregate principal amount, with the balance payable at the maturity date.
As set forth in the Credit Agreement, Term Loan B-6 bears interest at an adjusted LIBOR rate plus 2.25% or at the Company’s election, Base Rate (as defined in the Credit Agreement) plus 1.25%. Loans under the Revolving Credit Facility will bear interest at a rate calculated based on the type of borrowing (either adjusted LIBOR or Base Rate) and the Company’s Consolidated Senior Secured Net Leverage Ratio (as defined in the Credit Agreement), with such rate ranging from 2.25% to 1.75% for adjusted LIBOR loans and from 1.25% to 0.75% for Base Rate loans. The Company also pays a commitment fee between 25 to 35 basis points, payable quarterly, on the average daily unused amount of the Revolving Credit Facility based on the Company’s Consolidated Senior Secured Net Leverage Ratio, from time to time. The interest rate applicable to Term Loan B-6 was 2.75% at March 31, 2022.
On March 31, 2022, $926.2 million was outstanding on Term Loan B-6 and $101.0 million was drawn on the Revolving Credit Facility. We had related outstanding letters of credit in the aggregate amount of $27.3 million and $27.6 million at March 31, 2022 and December 31, 2021, respectively, which reduce the amount available for borrowings under the Revolving Credit Facility. Our European operations have lines of credit aggregating $33.2 million (€30 million) of which $14.6 million was drawn at March 31, 2022.
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 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) first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions.
Certain covenants contained within the Credit Agreement are critical to an investor’s understanding of our financial liquidity, as the failure to maintain compliance with these covenants could result in a default and allow the lenders under the Credit Agreement to declare all amounts borrowed immediately due and payable. The Credit Agreement contains a financial covenant requiring compliance with a Consolidated Senior Secured Net Leverage Ratio not to exceed 3.5 as of the last day of each fiscal quarter if revolving loans are outstanding. The Consolidated Senior Secured Net Leverage Ratio is calculated as consolidated total debt (as defined in the Credit Agreement) divided by the last four quarters consolidated Adjusted EBITDA. Consolidated total debt includes term loan borrowings, revolving loans, finance lease liabilities and other obligations for borrowed money less unrestricted cash as defined in the Credit Agreement. Consolidated Adjusted EBITDA is EBITDA (earnings before interest expense, income taxes, depreciation and amortization) adjusted to exclude among other things (a) gains and losses from asset sales; (b) unrealized foreign currency translation gains and losses in respect of indebtedness; (c) certain non-recurring gains and losses; (d) stock-based compensation expense; (e) certain other non-cash amounts included in the determination of net income; (f) charges and revenue reductions resulting from purchase accounting; (g) minority interest; (h) consulting expenses incurred for cost reduction, operating restructuring and business improvement efforts; (i) expenses realized upon the termination of employees and the termination or cancellation of leases, software licenses or other contracts in connection with the operational restructuring and business improvement efforts; (j) expenses incurred in connection with permitted acquisitions; (k) any impairment charges or write-offs of intangibles; and (l) any extraordinary, unusual or non-recurring charges, expenses or losses. Our Consolidated Senior Secured Net Leverage Ratio was 2.1 at March 31, 2022.
In addition, the Credit Agreement and the indenture governing our senior notes (see Note 6, "Long-Term Debt" for additional information) contain certain limitations on our ability to pay dividends and other distributions, make certain acquisitions or investments, grant liens and sell assets, and the Credit Agreement contains certain limitations on our ability to incur indebtedness. The applicable covenants in the Credit Agreement affect our operating flexibility by, among other things, restricting our ability to incur expenses and indebtedness that could be used to grow the business, as well as to fund general corporate purposes. We were in compliance with the covenants in the Credit Agreement and the indenture governing our senior notes at March 31, 2022.
We believe our sources of liquidity from our cash and cash equivalents on hand, working capital, cash provided by operating activities, and availability under our Credit Facility are sufficient to meet our operating needs for the foreseeable future. In addition, we believe the previously mentioned sources of liquidity will be sufficient to fund our capital requirements and debt service payments for the foreseeable future. A lack of recovery in market conditions, or further deterioration in market conditions, could materially affect the Company's liquidity.
Senior Notes
On May 31, 2017, we issued $950 million of 5.125% senior notes due June 1, 2025. The Company pays interest on the senior notes semi-annually in arrears on June 1 and December 1 of each year, which commenced on December 1, 2017. The senior notes may be redeemed at 102.563% currently, at 101.281% as of June 1, 2022 and at par as of June 1, 2023. The senior notes are guaranteed by the Subsidiary Guarantors.
Expected Use of Proceeds from the Transaction
The Company expects to generate gross proceeds from the sale of the U.S. physical auction business of $2.2 billion, $1.65 billion net of income taxes and transaction costs. The Transaction is expected to close in May 2022. Under terms of the Credit Agreement, unless reinvested, net cash proceeds from the Transaction must be used to repay Term Loan B-6 within three days of the Transaction. Accordingly, the net proceeds will be used to repay the outstanding amount on Term Loan B-6 and any outstanding amount on the Revolving Credit Facility within three days of the close of the Transaction. The terms of the senior notes specify that excess proceeds must be reinvested or used to pay down a portion of the senior notes. The Company expects to use any remaining proceeds to redeem, repay or otherwise retire the senior notes within 365 days of the close of the Transaction. The Company may issue additional debt and utilize such proceeds to redeem all senior notes at the time of the required redemption.
Securitization Facilities
AFC sells the majority of its U.S. dollar denominated finance receivables on a revolving basis and without recourse to AFC Funding Corporation. A securitization agreement allows for the revolving sale by AFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires on January 31, 2024. AFC Funding Corporation had committed liquidity of $1.70 billion for U.S. finance receivables at March 31, 2022.
We also have an agreement for the securitization of AFCI's receivables, which expires on January 31, 2024. AFCI's committed facility is provided through a third-party conduit (separate from the U.S. facility) and was C$225 million at March 31, 2022. The receivables sold pursuant to both the U.S. and Canadian securitization agreements are accounted for as secured borrowings.
AFC managed total finance receivables of $2,757.8 million and $2,529.0 million at March 31, 2022 and December 31, 2021, respectively. AFC's allowance for losses was $23.0 million and $23.0 million at March 31, 2022 and December 31, 2021, respectively.
As of March 31, 2022 and December 31, 2021, $2,710.9 million and $2,482.2 million, respectively, of finance receivables and a cash reserve of 1 or 3 percent of the obligations collateralized by finance receivables served as security for the $1,866.6 million and $1,692.3 million of obligations collateralized by finance receivables at March 31, 2022 and December 31, 2021, respectively. The amount of the cash reserve depends on circumstances which are set forth in the securitization agreements. There were unamortized securitization issuance costs of approximately $13.3 million and $15.1 million at March 31, 2022 and December 31, 2021, respectively. After the occurrence of a termination event, as defined in the U.S. securitization agreement, the banks may, and could, cause the stock of AFC Funding Corporation to be transferred to the bank facility, though as a practical matter the bank facility would look to the liquidation of the receivables under the transaction documents as their primary remedy.
Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC, AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. At March 31, 2022, we were in compliance with the covenants in the securitization agreements.
EBITDA and Adjusted EBITDA
EBITDA and Adjusted EBITDA, as presented herein, are supplemental measures of our performance that are not required by, or presented in accordance with, generally accepted accounting principles in the United States, or GAAP. They are not measurements of our financial performance under GAAP and should not be considered substitutes for net income (loss) or any other performance measures derived in accordance with GAAP.
EBITDA is defined as net income (loss), plus interest expense net of interest income, income tax provision (benefit), depreciation and amortization. Adjusted EBITDA is EBITDA adjusted for the items of income and expense and expected incremental revenue and cost savings, as described above in the discussion of certain restrictive loan covenants under "Credit Facilities."
Management believes that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about one of the principal measures of performance used by our creditors. In addition, management uses EBITDA and Adjusted EBITDA to evaluate our performance. EBITDA and Adjusted EBITDA have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of the results as reported under GAAP. These measures may not be comparable to similarly titled measures reported by other companies.
The following tables reconcile EBITDA and Adjusted EBITDA to net income (loss) from continuing operations for the periods presented:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 |
(Dollars in millions) | ADESA | | AFC | | Consolidated |
Net income (loss) from continuing operations | $ | (39.4) | | | $ | 31.0 | | | $ | (8.4) | |
Add back: | | | | | |
Income taxes | (15.1) | | | 10.4 | | | (4.7) | |
Interest expense, net of interest income | 13.2 | | | 12.3 | | | 25.5 | |
Depreciation and amortization | 23.9 | | | 2.1 | | | 26.0 | |
Intercompany interest | 0.1 | | | (0.1) | | | — | |
EBITDA | (17.3) | | | 55.7 | | | 38.4 | |
Non-cash stock-based compensation | 4.4 | | | 0.8 | | | 5.2 | |
Acquisition related costs | 0.3 | | | — | | | 0.3 | |
Securitization interest | — | | | (10.4) | | | (10.4) | |
(Gain)/Loss on asset sales | (0.1) | | | — | | | (0.1) | |
Severance | 3.2 | | | 0.2 | | | 3.4 | |
Foreign currency (gains)/losses | 1.2 | | | — | | | 1.2 | |
Net change in unrealized (gains) losses on investment securities | — | | | 3.0 | | | 3.0 | |
Professional fees related to business improvement efforts | 7.3 | | | 0.8 | | | 8.1 | |
Total addbacks/(deductions) | 16.3 | | | (5.6) | | | 10.7 | |
Adjusted EBITDA | $ | (1.0) | | | $ | 50.1 | | | $ | 49.1 | |
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2021 |
(Dollars in millions) | ADESA | | AFC | | Consolidated |
Net income (loss) from continuing operations | $ | (30.5) | | | $ | 56.7 | | | $ | 26.2 | |
Add back: | | | | | |
Income taxes | 5.0 | | | 19.5 | | | 24.5 | |
Interest expense, net of interest income | 21.3 | | | 9.3 | | | 30.6 | |
Depreciation and amortization | 24.5 | | | 2.4 | | | 26.9 | |
Intercompany interest | 0.1 | | | (0.1) | | | — | |
EBITDA | 20.4 | | | 87.8 | | | 108.2 | |
Non-cash stock-based compensation | 4.4 | | | 0.7 | | | 5.1 | |
Acquisition related costs | 1.3 | | | — | | | 1.3 | |
Securitization interest | — | | | (6.8) | | | (6.8) | |
(Gain)/Loss on asset sales | — | | | (0.8) | | | (0.8) | |
Severance | 0.2 | | | 0.2 | | | 0.4 | |
Foreign currency (gains)/losses | 2.2 | | | — | | | 2.2 | |
Contingent consideration adjustment | 11.2 | | | — | | | 11.2 | |
Net change in unrealized (gains) losses on investment securities | — | | | (43.5) | | | (43.5) | |
Other | 0.2 | | | (0.3) | | | (0.1) | |
Total addbacks/(deductions) | 19.5 | | | (50.5) | | | (31.0) | |
Adjusted EBITDA | $ | 39.9 | | | $ | 37.3 | | | $ | 77.2 | |
Certain of our loan covenant calculations utilize financial results for the most recent four consecutive fiscal quarters (total KAR results, including the ADESA U.S. physical auctions shown as discontinued operations). The following table reconciles EBITDA and Adjusted EBITDA to net income (loss) for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Twelve Months Ended |
(Dollars in millions) | June 30, 2021 | | September 30, 2021 | | December 31, 2021 | | March 31, 2022 | | March 31, 2022 |
Net income (loss) | $ | 11.5 | | | $ | (1.0) | | | $ | 5.1 | | | $ | (0.3) | | | $ | 15.3 | |
Less: Income from discontinued operations | 26.8 | | | 25.9 | | | (10.1) | | | 8.1 | | | 50.7 | |
Income (loss) from continuing operations | (15.3) | | | (26.9) | | | 15.2 | | | (8.4) | | | (35.4) | |
Add back: | | | | | | | | | |
Income taxes | 2.4 | | | 10.3 | | | (22.1) | | | (4.7) | | | (14.1) | |
Interest expense, net of interest income | 30.8 | | | 31.7 | | | 31.7 | | | 25.5 | | | 119.7 | |
Depreciation and amortization | 27.4 | | | 27.4 | | | 28.2 | | | 26.0 | | | 109.0 | |
EBITDA | 45.3 | | | 42.5 | | | 53.0 | | | 38.4 | | | 179.2 | |
Non-cash stock-based compensation | 4.3 | | | 3.6 | | | 1.3 | | | 5.2 | | | 14.4 | |
Acquisition related costs | 1.6 | | | 2.1 | | | 2.1 | | | 0.3 | | | 6.1 | |
Securitization interest | (6.8) | | | (7.9) | | | (8.3) | | | (10.4) | | | (33.4) | |
(Gain)/Loss on asset sales | — | | | — | | | 0.1 | | | (0.1) | | | — | |
Severance | 0.6 | | | 0.8 | | | 1.5 | | | 3.4 | | | 6.3 | |
Foreign currency (gains)/losses | 0.4 | | | 0.1 | | | 1.1 | | | 1.2 | | | 2.8 | |
Contingent consideration adjustment | 4.5 | | | 4.4 | | | 4.2 | | | — | | | 13.1 | |
Net change in unrealized (gains) losses on investment securities | 11.9 | | | 20.9 | | | 9.3 | | | 3.0 | | | 45.1 | |
Professional fees related to business improvement efforts | — | | | — | | | — | | | 8.1 | | | 8.1 | |
Other | 0.3 | | | 0.1 | | | — | | | — | | | 0.4 | |
Total addbacks/(deductions) | 16.8 | | | 24.1 | | | 11.3 | | | 10.7 | | | 62.9 | |
Adjusted EBITDA from continuing ops | $ | 62.1 | | | $ | 66.6 | | | $ | 64.3 | | | $ | 49.1 | | | $ | 242.1 | |
Adjusted EBITDA from discontinued ops | 54.4 | | | 30.0 | | | 33.6 | | | 22.6 | | | 140.6 | |
Adjusted EBITDA | $ | 116.5 | | | $ | 96.6 | | | $ | 97.9 | | | $ | 71.7 | | | $ | 382.7 | |
Summary of Cash Flows
| | | | | | | | | | | |
| Three Months Ended March 31, |
(Dollars in millions) | 2022 | | 2021 |
Net cash provided by (used by): | | | |
Operating activities - continuing operations | $ | (9.5) | | | $ | 150.2 | |
Operating activities - discontinued operations | (50.5) | | | (1.6) | |
Investing activities - continuing operations | (246.7) | | | (78.5) | |
Investing activities - discontinued operations | (11.8) | | | (0.7) | |
Financing activities - continuing operations | 250.6 | | | (121.8) | |
Financing activities - discontinued operations | 22.0 | | | 33.1 | |
Effect of exchange rate on cash | 3.0 | | | 2.6 | |
Net decrease in cash, cash equivalents and restricted cash | $ | (42.9) | | | $ | (16.7) | |
Cash flow used by operating activities (continuing operations) was $9.5 million for the three months ended March 31, 2022, compared with cash flow provided by operating activities of $150.2 million for the three months ended March 31, 2021. The decrease in operating cash flow was primarily attributable to changes in operating assets and liabilities as a result of the timing
of collections and the disbursement of funds to consignors for auctions held near period-ends and decreased profitability, partially offset by a net increase in non-cash item adjustments.
Net cash used by investing activities (continuing operations) was $246.7 million for the three months ended March 31, 2022, compared with $78.5 million for the three months ended March 31, 2021. The increase in net cash used by investing activities was primarily attributable to:
•an increase in the additional finance receivables held for investment of approximately $156.1 million; and
•a decrease in the proceeds from sale of investments of approximately $20.8 million;
partially offset by:
•a decrease in investments in securities of approximately $11.2 million.
Net cash provided by financing activities (continuing operations) was $250.6 million for the three months ended March 31, 2022, compared with net cash used by financing activities of $121.8 million for the three months ended March 31, 2021. The increase in net cash provided by financing activities was primarily attributable to:
•an increase in the additional obligations collateralized by finance receivables of approximately $195.6 million;
•an increase in the additional borrowings on lines of credit of approximately $102.7 million; and
•a decrease in the repurchase of common stock of approximately $80.8 million.
Capital Expenditures
Capital expenditures for the three months ended March 31, 2022 and 2021 approximated $13.5 million and $11.9 million, respectively. Capital expenditures were funded from internally generated funds. We continue to invest in our core information technology capabilities and our service locations. Capital expenditures related to continuing operations are expected to be approximately $75 - $80 million for fiscal year 2022. Future capital expenditures could vary substantially based on capital project timing, capital expenditures related to acquired businesses and the initiation of new information systems projects to support our business strategies.
Dividends
The Series A Preferred Stock ranks senior to the shares of the Company’s common stock, par value $0.01 per share, with respect to dividend rights and rights on the distribution of assets on any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company. The holders of the Series A Preferred Stock are entitled to a cumulative dividend at the rate of 7% per annum, payable quarterly in arrears. Dividends are payable in kind through the issuance of additional shares of Series A Preferred Stock for the first eight dividend payments, and thereafter, in cash or in kind, or in any combination of both, at the option of the Company. For the three months ended March 31, 2022, the holders of the Series A Preferred Stock received dividends in kind with a value in the aggregate of approximately $10.7 million. The holders of the Series A Preferred Stock are also entitled to participate in dividends declared or paid on our common stock on an as-converted basis.
The Company has temporarily suspended its quarterly common stock dividend in light of the impact of the COVID-19 pandemic on its operations. Future dividend decisions will be based on and affected by a variety of factors, including our financial condition and results of operations, contractual restrictions, including restrictive covenants contained in our Credit Agreement and AFC's securitization facilities and the indenture governing our senior notes, capital requirements and other factors that our board of directors deems relevant. No assurance can be given as to whether any future dividends may be declared by our board of directors or the amount thereof.
Contractual Obligations
The Company's contractual cash obligations for long-term debt, interest payments related to long-term debt, finance lease obligations, operating leases and contingent consideration related to acquisitions are summarized in the table of contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2021. Since December 31, 2021, there have been no material changes to the contractual obligations of the Company, with the exception of the following:
•Operating lease obligations change in the ordinary course of business. We lease most of our facilities, as well as other property and equipment under operating leases. Future operating lease obligations will continue to change if renewal options are exercised and/or if we enter into additional operating lease agreements.
Upon and following the close of the Transaction, the contractual cash obligations of the Company are expected to be reduced. See Note 2, Note 6 and Note 7 to the Consolidated Financial Statements, included elsewhere in this Quarterly Report on Form 10-Q, for additional information about the items described above. Our contractual cash obligations as of December 31, 2021, are discussed in the "Contractual Obligations" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission (the "SEC").
Critical Accounting Estimates
Our critical accounting estimates are discussed in the "Critical Accounting Estimates" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC. A summary of significant accounting policies is discussed in Note 2 and elsewhere in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2021, which includes audited financial statements.
Off-Balance Sheet Arrangements
As of March 31, 2022, we had no off-balance sheet arrangements pursuant to Item 303 of Regulation S-K under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that we believe are reasonably likely to have a current or future effect on our financial condition, results of operations, or cash flows.
New Accounting Standards
For a description of new accounting standards that could affect the Company, reference the "New Accounting Standards" section of Note 1 to the Unaudited Consolidated Financial Statements, included elsewhere in this Quarterly Report on Form 10-Q.